**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM10-QSB/A**

 

**AmendmentNo. 2**

 
| **(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 TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT** |
|           |   |
|           | **For the transition period from                    to                         ** |

 

**Commissionfile number:  000-25855**

 

**VendingDataCorporation**

(Exact name of small business issuer asspecified 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) |

 

**APPLICABLEONLY TO CORPORATE ISSUERS**

 

Statethe number of shares outstanding of each of the issuer’s classes of commonequity, as of the latest practicable date: 7,700,826 shares of common stock, $.001 par value, as of July 31,2003

 

TransitionalSmall Business Disclosure Format (check one): Yes  o                No   ý

 

 

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**NOTE: **VendingData Corporation (the “Company”) isamending its Quarterly Reports on Form 10-QSB for the second and thirdquarters of 2003 to restate its financial statements for the interim periodsended June 30 and September 30, and to make conforming changes in Management’sDiscussion and Analysis of Financial Position and Results of Operations andother related disclosures, reflecting the adoption of, as of January 1,2003, of the requirements of Emerging Issues Task Force Issue No. 00-21,Revenue Arrangements with Multiple Deliverables.  The restatements were made after reconsideration of the Company’sprior revenue (and warranty cost) recognition practices regarding certain salescontracts entered into beginning in the second quarter of 2003.  The result of this change was to deferrecognition of an allocated portion of revenues from the affected salescontracts, representing the estimated fair value of extended warranty andmaintenance services included therein. Such deferred revenues are now being amortized over the applicableservice periods in the contracts.  Theeffects of the restatements are summarized in Note 1 to the accompanyingrestated financial statements.

 

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**VENDINGDATA CORPORATION**

 

**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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**PART I –FINANCIAL INFORMATION**

 

**ITEM1.  FINANCIAL STATEMENTS.**

 

**VENDINGDATA CORPORATION**

**BalanceSheets**

 
|                                                                                                                |   | **June  30,********2003**   |       | **December  31,********2002** |       |
|---------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|------------|-------------------------------|------------|
|                                                                                                                |   | **(Restated)  (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                                                                                                    |   | 348,373                     |       | 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                     |       | —                        |       |
| Current portion of deferred maintenance  revenue                                                                    |   | 135,960                     |       | —                        |       |
| Customer deposits                                                                                                   |   | 441,545                     |       | 386,819                       |       |
|                                                                                                                |   | 7,736,362                   |       | 5,486,435                     |       |
|                                                                                                                |   |                        |       |                          |       |
| Deferred maintenance revenue, net of  current portion                                                               |   | 204,380                     |       |                          |       |
| Convertible debt, net of current portion                                                                            |   | 13,099,996                  |       | 8,853,072                     |       |
| Leases payable, net of current portion                                                                              |   | 2,783,906                   |       | 3,180,196                     |       |
|                                                                                                                |   | 23,824,644                  |       | 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                                                                                                             |   | (39,850,237                 | )          | (36,770,258                   | )          |
|                                                                                                                |   | (12,760,081                 | )          | (10,042,652                   | )          |
|                                                                                                                |   | $                           | 11,064,563 |                          | $          | 7,477,051 |   |

 

Seeaccompanying notes to financial statements.

 

1

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**VENDINGDATA CORPORATION**

**Statementsof Operations**

 

(UNAUDITED)

 
|                                |   | **Three  Months Ended June 30,** |       | **Six  Months Ended June 30,** |   |
|-------------------------------------|--------|----------------------------------|------------|--------------------------------|--------|
|                                |   | **(Restated)  2003**             |       | **2002**                       |   | **(Restated)  2003** |   | **2002** |   |
|                                |   |                             |       |                           |   |   |   |   |   |
| Sales                               |   | $                                | 1,619,055  |                           | $      | 504,708 |   | $ | 3,223,980 |   | $ | 1,527,871 |   |
| Rental                              |   | 300,430                          |       | 360,807                        |   | 630,743 |   | 715,434 |   |
| Other                               |   | 12                               |       | 5,915                          |   | 132 |   | 11,637 |   |
|                                |   | 1,919,497                        |       | 871,430                        |   | 3,854,855 |   | 2,254,942 |   |
|                                |   |                             |       |                           |   |   |   |   |   |
| **Operating expenses:**             |   |                             |       |                           |   |   |   |   |   |
| Cost of sales                       |   | 887,082                          |       | 659,391                        |   | 2,134,286 |   | 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                |   | (928,094                         | )          | (918,314                       | )      | (1,716,815 | ) | (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                            |   | $                                | (1,633,761 | )                              | $      | (1,342,241 | ) | $ | (3,079,979 | ) | $ | (2,483,568 | ) |
|                                |   |                             |       |                           |   |   |   |   |   |
| Basic loss per share                |   | $                                | (0.21      | )                              | $      | (0.18 | ) | $ | (0.40 | ) | $ | (0.33 | ) |
| Weighted average shares outstanding |   | 7,646,430                        |       | 7,625,814                      |   | 7,636,185 |   | 7,625,814 |   |

 

Seeaccompanying notes to financial statements.

 

2

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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 |   |

 

Seeaccompanying notes to financial statements.

 

3

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**VENDINGDATA CORPORATION AND SUBSIDIARIES**

** **

**NOTES TOFINANCIAL STATEMENTS**

** **

**(UNAUDITED)**

*** ***

***Note 1 – Basis of Presentation***

 

The accompanying unaudited financialstatements of VendingData Corporation (the “Company”) have been prepared inaccordance with generally accepted accounting principles for interim financialinformation and with the instructions incorporated in Regulation S-B ofthe Securities and Exchange Commission.  Accordingly, they do not includeall of the information and footnotes required by generally accepted accountingprinciples for complete financial statements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring adjustments andaccruals) 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 financial statements should be read inconjunction with the Company’s audited financial statements for the year endedDecember 31, 2002, as included in the Company’s Annual Report on Form10-KSB as filed with the Securities and Exchange Commission from which theaccompanying balance sheet information as of that date was derived. Certain reclassifications have been made to amounts presented in prior periodsfor comparability to the current period presentation.

 

The accompanying revised financial statementsreflect the restatement for adoption, effective January 1, 2003, of therequirements of Emerging Issues Task Force ("EITF") Issue No. 00-21, *Revenue Arrangements with Multiple Deliverables*,thus deferring recognition of an allocated portion of revenues from certainsales contracts initiated in the second quarter of 2003, representing theestimated fair value of extended warranty and maintenance services includedtherein.  Such deferred revenues arebeing amortized over the applicable service periods in the contracts.  The effect of the restatement on thethree-month and six-month periods ended June 30, 2003, was to increase the netlosses by $295,560 and $295,560 respectively. A summary of the effects of these changes follows:

 

 
|                                           |   | **Three  Months Ended  June 30, 2003** |       | **Six Months  Ended   June 30, 2003** |   |
|------------------------------------------------|--------|----------------------------------------|------------|---------------------------------------|--------|
|                                           |   |                                   |       |                                  |   |
| Net loss as originally reported                |   | $                                      | (1,338,201 | )                                     | $      | (2,784,419 | ) |
| Effect of restatement for revenue  recognition |   | (295,560                               | )          | (295,560                              | )      |
| Net loss as restated                           |   | (1,633,761                             | )          | (3,079,979                            | )      |
|                                           |   |                                   |       |                                  |   |
| Per share amounts:                             |   |                                   |       |                                  |   |
| Net loss as originally reported                |   | (0.18                                  | )          | (0.36                                 | )      |
| Effect of restatement for revenue  recognition |   | (0.03                                  | )          | (0.04                                 | )      |
| Net loss as restated                           |   | (0.21                                  | )          | (0.40                                 | )      |
|                                                |        |                                        |            |                                       |        |  |  |

 

***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.  Dilutedloss per share is computed by dividing net income (loss) available to commonstockholders by the weighted-average 

 

4

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number of shares of common stock outstandingduring the year plus potential dilutive instruments such as stock options,warrants and convertible debt.  The effect of stock options on diluted lossper share is determined through the application of the treasury stock method,whereby proceeds received by the Company based on assumed exercises arehypothetically used to repurchase the Company’s common stock at the averagemarket price during the period.

 

The basic loss per share is computed bydividing the net loss for the period by the weighted average number of commonshares outstanding for the period.  Loss per share is unchanged on adiluted basis since the assumed exercise of common stock equivalents would havean anti-dilutive effect due to the existence of operating losses.

 

***Note 3 – Debt***

 

In the quarter ended June 30, 2003, theCompany received a short-term bridge loan for $1,000,000 and $2,400,000 wasraised as part of the private placement of 10% convertible notes.

 

***Note 4 – Options***

 

The Company currently has two stock optionplans.  Prior to 2003, the Company accounted for those plans under therecognition and measurement provisions of APB Opinion No. 25, “*Accounting for Stock Issued to Employees*”(APB No. 25) and related interpretations.  No stock-based employeecompensation expense for stock options was reflected in net income for yearsprior to 2003, as all stock options granted under those plans had an exerciseprice equal to or greater than the fair market value of the underlying commonstock on the date of grant.  During the second quarter of 2003, theCompany adopted the fair value recognition provisions of Statement of FinancialAccounting Standards (“SFAS”) No. 123 under the prospective transitionmethod, 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.  This stock compensation expense wasrecorded in selling, general and administrative expenses.  As a result ofadopting SFAS No. 123 under the prospective transition method of SFASNo. 148, prior periods have not been restated to reflect the impact of thefair value method. 

 
|                                                                                                              |   | **Three  Months Ended June 30,** |       | **Six  Months Ended June 30,** |   |
|-------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|------------|-------------------------------------|--------|
|                                                                                                              |   | **2003**                         |       | **2002**                            |   | **2003** |   | **2002** |   |
|                                                                                                              |   |                             |       |                                |   |   |   |   |   |
| Net loss, as reported                                                                                             |   | $                                | (1,633,761 | )                                   | $      | (1,342,241 | ) | $ | (3,079,979 | ) | $ | (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                                                                                               |   | $                                | (1,633,761 | )                                   | $      | (1,342,241 | ) | $ | (3,079,979 | ) | $ | (2,483,568 | ) |
| Basic and diluted net loss per share                                                                              |   |                             |       |                                |   |   |   |   |   |
| As reported                                                                                                       |   | $                                | (0.21      | )                                   | $      | (0.18 | ) | $ | (0.40 | ) | $ | (0.33 | ) |
| Pro forma                                                                                                         |   | $                                | (0.21      | )                                   | $      | (0.18 | ) | $ | (0.40 | ) | $ | (0.33 | ) |

 

***Note 5 – Going Concern***

 

The accompanying financial statements havebeen prepared assuming that the Company will continue as a going concern. The Company incurred a net loss of $3,079,979 for the six months endedJune 30, 2003.  Additionally, the Company had a working capitaldeficiency of approximately $1,323,533 at June 30, 2003.  Accordingly, the Company’s ability tocontinue as a going concern may be dependent upon the 

 

5

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success of management’s plans to address andovercome 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 evaluating sources of additional capital,including debt or equity financings.  Moreover, management believes thatthe increased sales in the first six months of 2003 indicates customeracceptance of the Company’s product line and will result in improvedrevenue.  There is no assurance that the Company will be successful inraising additional capital or in achieving profitable operations.  Theaccompanying financial statements do not include any adjustments that might benecessary should the Company be unable to continue as a going concern.

 

***Note 6 – Trade Receivables From MajorCustomers***

 

Approximately 51.5% of trade receivables areconcentrated among 5 major customers at June 30, 2003, none of whichindividually are in excess of 20% of the 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 Party Transactions***

 

An officer and director of the Company has anoutstanding balance due to the Company in an amount equal to $36,116 that isattributable to disbursements that were personal expenses over the past fiveyears.  Subsequent to June 30, 2003, the officer and director paid $5,040,which represented the net balance due arising after July 30, 2002, theeffective date of the Sarbanes-Oxley Act of 2002.

 

***Note 9 –*****Contingencies**

 

The Company is a party to certain claims,legal actions, and complaints, including patent infringement actions betweenthe Company and one of its main competitors.  The Company cannot predictthe likely outcome of any such litigation or whether any such substantiallitigation would have a material adverse effect on its business as presentlyconducted or as anticipated.

 

***Note 10 – Subsequent Event***

 

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

 

**ITEM 2.**    **MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

 

The following discussion should be read inconjunction with our financial statements and notes to our financialstatements, included elsewhere in this report.  This discussion containsforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of1934.  These statements relate to future events or our future financialperformance and include statements about our plans, objectives and business aswell as our expectations and intentions. In some cases, you can identify theseforward-looking statements by terminology such as “may,” “will,” “should,”“could,” “expects,” “plans,” “potential,” “anticipates,” “believes,”“estimates,” 

 

6

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“predicts,” “potential” or “continue” or thenegative of such terms or other comparable terminology.  These statementsare only predictions and involve known and unknown risks, uncertainties andother factors that may cause our actual results, levels of activity,performance or achievements to be materially different from any future results,levels of activity, performance or achievements expressed or implied by anyforward-looking statements. These risks and uncertainties include, but are notlimited to, the following:

 

•      General economic and business conditions, both nationally andinternationally in those areas in which we operate;

 

•      Competition in the gaming industry;

 

•      Regulatory and judicial proceedings;

 

•      Changes in gaming laws and regulations (including actions affectinglicensing);

 

•      Continued growth in the gaming industry;

 

•      Changes in our business strategy or plans;

 

•      Product development, product placement, and the acceptance of ourproducts in the marketplace;

 

•      Loss of any of our management or key personnel;

 

•      Financing sources and availability of capital to fund and sustain ouroperations; and

 

•      Leverage and debt service (including sensitivity to fluctuations ininterest rates).

 

Although we believe that the expectationsreflected in our forward-looking statements are reasonable, we cannot guaranteefuture results, levels of activity, performance or achievements. We are underno duty to update any of the forward-looking statements after the date of thisreport to conform these statements to actual results.

 

**OVERVIEW**

 

For a complete description of our products,please review our most recent annual report on Form 10-KSB filed with theSecurities and Exchange Commission.

 

**BusinessStrategy. ** Whilewe transitioned from a development stage to an operating company in 2000, wehave continued to develop or acquire new products. The focus on the developmentand acquisition of new products is reflected in our operating results. Ourstrategy to increase revenue and margins is based on four key factors:

 

•      **We developed two product lines with limitedcompetition.**  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.  In contrast, our shuffler productsface intense competition due primarily to the dominance 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 products with virtually no competition,our management believes that we will have a significant competitive advantageas our products are installed and become accepted by the gaming industry.

 

•      **We expanded into additional domestic gaming marketsand into international gaming markets for our products.**  The global economic downturn hasforced non-gaming 

 

7

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jurisdictions to look at newways 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 machinesat racetracks, Native American Class-III casinos and Las Vegas-stylecasinos.  The worldwide expansion of gaming should provide new markets forour products, and we have targeted sales opportunities in these new markets inaddition to our traditional established gaming markets.

 

•      **We intend to increase the market penetration of ourproducts.**  Since wehave only recently introduced our SecureDropTM System and Deck Checker®, themarket penetration of these products is low.  As a result of the positivefeedback received from senior executives from Park Place EntertainmentCorporation, the parent 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 reduction initiatives to increasegross margins. **Throughthe implementation of cost reduction initiatives, our management believes thatthe gross margins on our products will improve over time.  The costreduction 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 shiftedthe production of over 80% of the components of the SecureDropTM System and ourshufflers to China.  As a result, our management estimates that the costof such components will decrease from approximately 40% of revenue toapproximately 20% of revenue.  Although we propose to outsource manycomponents of our products, we intend to maintain a five- to six-monthinventory of components at our principal offices in Las Vegas, Nevada.

 

•      *Closing two of our five regional service locationsand centralizing all technical service functions to our facilities in LasVegas, Nevada.*  The useof five 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 and Miami, Florida service locationsand relying more on the use of spare machines, we propose to centralize alltechnical service functions by the end of the third quarter of 2003.  Theremaining service locations will continue to provide non-technical supportthrough customer 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 thatconsolidation of our research and development facilities in Las Vegas willallow us to achieve reductions in our labor and overhead costs for research anddevelopment of $100,000 in 2003.  The Boise facility was closed on June30, 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.

 

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**CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

 

Following is a summary of what our managementbelieves are the critical accounting policies related to our operations. The application of these policies, in some cases, requires our management tomake subjective judgments regarding the effect of matters that are inherentlyuncertain.

 

**Allowancefor Doubtful Accounts**. In connection with the preparation of our quarterly financial statements,management reviews and evaluates the collectibility of our trade receivablesand adjusts our allowance for estimated uncollectible accounts as deemednecessary in the circumstances.  These estimates have the potential forcritically affecting the determination of results of operations for any givenperiod.  Factors considered by management in making such estimates andadjustments include any concentrations among customers, changes in ourrelationships therewith, payment history and the apparent financial conditionthereof.

 

**RevenueRecognition.**  We recognize revenue from the sale of our products upon installation andfunctional testing at customer locations because that is when the customer’sobligation becomes fixed and certain pursuant to our standard contracts for thesale of units of the SecureDrop® System, shufflers and Deck CheckersTM.  Sales are recognized immediately whenshufflers that are rented are converted to purchases or there is a long-termcontract for new equipment depending on the creditworthiness and paymenthistory of the casino company since payment terms are from 20 to48 months.  The extended warrantyand maintenance components that are part of long term sales contracts areunbundled and the related revenue is deferred and amortized over the remaininglife of the sales agreement after the initial 90-day warranty as required bythe Emerging Issues Task Force Issue No. 00-21, *Revenue Arrangements with Multiple Deliverables*. Theestimated useful life of our shufflers and Deck CheckersTM is five years withproper maintenance; the life can be extended with the replacement of componentparts.  If the customer does not possessthe required creditworthiness or an established payment history with us, wewould then book the revenue as an installment sale and recognize it over timeas payments are received.  Revenue fromshuffler rentals is recorded at the first of each month in accordance withrental contract terms.  All rentalcontracts are cancelable upon 30-day written notice by the customer.  Maintenance expense for rental units isrecorded in the period it is incurred. Although sales are not generally made with a right to return, upon occasion,usually associated with the performance warranty, sales returns and allowancesare recorded after returned goods are received and inspected.  We provide currently for estimated warrantyrepair costs associated with sales contracts. We do provide for stand-alone maintenance contracts that are billed andrecognized on a monthly basis.

 

**Stock-BasedCompensation**. We currently have two stock option plans.  Prior to 2003, we accounted forthose plans under the recognition and measurement provisions of APB OpinionNo. 25, “*Accounting for Stock Issued toEmployees*” (APB No. 25) and related interpretations.  Nostock-based employee compensation expense for stock options was reflected innet income for years prior to 2003, as all stock options granted under thoseplans had an exercise price equal to or greater than the fair market value ofthe underlying common stock on the date of grant.  During the secondquarter of 2003, we adopted the fair value recognition provisions of SFASNo. 123 under the prospective transition method effective as ofJanuary 1, 2003.  This change will probably result in increasedcompensation expense in future periods.

 

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.  This stock compensation expense wasrecorded in selling, general and administrative expenses.  As a result ofadopting the prospective transition method of SFAS No. 123 and SFASNo. 148, prior periods have not been restated to reflect the impact of theadoption of the fair value method under SFAS No. 123.

 

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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 $1,766,176between December 31, 2002 and June 30, 2003.  The installationof the SecureDropTM System at two major Las Vegas casino properties in the firstquarter of 2003 and the conversion of shuffler rentals to purchases were theprimary reasons for the increase in trade receivables.  Inventories haveincreased during the current period by $2,056,612 from $1,850,051 atDecember 31, 2002.  The purchase of 200 Deck Checkers® and related componentsconstituted approximately $1,000,000 of the increase in inventory.  Inaddition, as we moved more manufacturing to China, the level of inventories atour Las Vegas facility will increase in order to maintain a five- to six-monthinventory on hand to guard against unexpected transport interruptions.

 

Total liabilities have increased from$17,519,703 at December 31, 2002 to $23,824,644 at June 30,2003.  Convertible debt increased primarily due to private placements ofan additional $2,400,000 during the quarter ended June 30, 2003. Short-term debt increased from $904,743 at December 31, 2002 to $1,674,743at June 30, 2003 due to a short-term loan for 90 days for $1,000,000.

 

**RESULTS OF OPERATIONS**

 

***Comparison of Three Months Ended June 30,2003 and 2002***

 

**Revenue**

 

For the three months ended June 30,2003, we generated total revenues of $1,919,497, compared to $871,430 for thethree months ended June 30, 2002, an increase of $1,048,067, or120.3%.  Our revenues for the three months ended June 30, 2003consisted of SecureDropTM sales of $185,223, shuffler sales of $1,215,817,shuffler rentals of $301,191, Deck Checker® sales of $215,649 and miscellaneousother income of $1,617.  The increase in revenue was primarily due to anincrease in SecureDropTM sales and conversions from rental to customer purchasesof shufflers.

 

**Revenues –SecureDropTM Sales. **For the three months ended June 30, 2003, we generated revenue from thesale of our SecureDropTM products of $185,223, compared to $504,708 for thethree months ended June 30, 2002, a decrease of $319,485, or 63.3%. The reduction in revenue was due to the installation delays at two major casinoproperties in Las Vegas to the third quarter of 2003.

 

**Revenues –Shuffler Sales. **For the three months ended June 30, 2003, we generated revenue from thesale of our shufflers of $1,215,817, compared to $0 for three months endedJune 30, 2002, an increase of $1,215,817.  The increase in shufflersales was primarily due to casino operators purchasing shufflers instead ofrenting.  Many gaming companies prefer the purchase of equipment torental.  We believe that the trend for shuffler revenues will be towardsshuffler sales due to lower interest rates for sales with terms.

 

**Revenue –Shuffler Rentals.** For the three months ended June 30, 2003, we generated revenue from therental of our shufflers of $301,191, compared to $360,807 for the three monthsended June 30, 2002, a decrease of $59,616, or 16.5%.  The decreasein shuffler rentals was primarily due to the shift of our customers to shufflersales.  We believe that shuffler rentals will increase somewhat when ournext generation shuffler model is 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**®. For the three months ended June 30, 2003, we generated revenue from thesales and leases of our Deck Checker® of $215,649.  As Deck Checker® is anew product this year, there was no revenue related to it for the three monthsended June 30, 2002.

 

**Revenue –Other Income. **For the 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, adecrease of $4,298, or 72.7%.

 

**Cost of Sales**

 

For the three months ended June 30, 2003, ourcost of sales was $887,082, compared to $659,391 for the three months endedJune 30, 2002, an increase of $227,691, or 34.5%.  Our cost of salesfor the three months ended June 30, 2003 included cost of SecureDropTMsales of $212,147, cost of shuffler sales of $169,324, cost of Deck Checker®sales of $81,143, shuffler rental depreciation of $129,229, shuffler servicecosts of $215,233, manufacturing costs of $0, and other expenses of$80,006.  We believe that the outsourcing of components from China willcontinue the trend of reducing cost of sales through the third and fourthquarters of 2003.  The gross margin on revenue for the three months endedJune 30, 2003 was $1,032,415, or 53.8%, compared to the gross margin onrevenue for the three months ended June 30, 2002 of $212,039, or24.3%.  The increase in gross margin of $820,376 from the three monthsended June 30, 2002 to the three months ended June 30, 2003 reflectsthese efficiencies.

 

**Cost of Sales– SecureDropTM Sales.** Our cost of SecureDropTM sales was $212,147 for the three months endedJune 30, 2003 compared to $278,611 for the three months endedJune 30, 2002, representing a decrease of $66,464, or 23.9%.  Therevenue for the three months ended June 30, 2003 remained basically flat with2002 due to a delay in the installations in two major casino properties locatedin Las Vegas until the third quarter of 2003.  The cost of sales wasimpacted by a replacement of SecureDropTM canisters that could have becomedefective at an unknown time in the future at two properties, which cost usapproximately $50,000 in the second quarter of 2003.  The gross margin onrevenue from SecureDropTM sales revenue was $(26,923), or (12.7)%, for the threemonths ended June 30, 2003 compared to $226,097, or 44.8%, for the threemonths ended June 30, 2002.  The decrease in gross margin/grossmargin percentage on SecureDropTM sales revenue resulted primarily from adecrease in SecureDropTM installations and continued fixed expense ofinstallation staff.

 

**Cost ofSales – Shuffler Sales.** Our cost of shuffler sales revenue was $169,324 for the three months endedJune 30, 2003 compared to $0 for the three months ended June 30,2002.  The gross margin on revenue from shuffler sales was $1,046,493, or86.1%, for the three months ended June 30, 2003.

 

**Cost ofSales – Deck Checker**®. For the three months ended June 30, 2003, our cost of sales from the salesand leases of our Deck Checker® was $81,143, resulting in a gross margin on revenuefrom Deck Checker® sales of $134,506, or 62.4%.  There were no comparablenumbers for the three months ended June 30, 2002 as this product was notavailable for sale last year.

 

**Selling, General and Administrative Expense**

 

For the three months ended June 30,2003, our selling, general and administrative expenses were $1,732,033,compared to $782,003 for the three months ended June 30, 2002, an increaseof $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.”

 

Our selling, general and administrativeexpenses for the three months ended June 30, 2003 consisted of thefollowing: salaries and related costs of $546,782; consulting services of$114,296; advertising and 

 

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marketing costs of $19,419; travel andentertainment costs of $302,581; gaming industry shows costs of $34,467; rentof $62,665; repairs and maintenance expenses of $13,756; legal and regulatory expensesof $315,480; supplies of $45,132; insurance expenses of $12,075; depreciationand amortization of $116,253; and other expenses of $149,127.

 

**Research and Development Expense**

 

For the three months ended June 30,2003, research and development expenses were $228,475, compared to $347,703 forthe three months ended June 30, 2002, a decrease of $119,228, or34.3%.  The decrease in research and development expenses was primarilydue to our transition from research to production on our product lines.

 

**Interest Expense**

 

For the three months ended June 30,2003, we incurred interest expense of $705,667, compared to $423,927 for thethree months ended June 30, 2002, an increase of $281,740, or 66.5%. The increase in interest expense was primarily attributable to increasedborrowing.

 

**Net Loss**

 

For the three months ended June 30,2003, we had a net loss of $1,633,761, compared to a net loss of $1,342,241 forthe three months ended June 30, 2002, an increased net loss of $291,520,or 21.7%.  The net loss increased even with an 120.3% increase in revenuedue to increased infrastructure costs incurred to sustain higher futurerevenues.  These increases include a permanent SecureDropTM installationteam, and increased staffing in marketing, finance, sales and legal. Basic loss per share was $0.21 and $0.18 for the three months endedJune 30, 2003 and 2002.

 

***Comparison of Six Months Ended June 30,2003 and 2002***

 

**Revenue**

 

For the six months ended June 30, 2003,we generated total revenues of $3,854,855, compared to $2,254,942 for the sixmonths ended June 30, 2002, an increase of $1,599,913, or 71.0%.  Ourrevenues for the six months ended June 30, 2003 consisted of SecureDropTMsales of $1,334,733, shuffler sales of $1,628,831, shuffler rentals of$632,993, Deck Checker® sales of $228,212 and miscellaneous other income of$30,086.  The increase in revenue was primarily due to an increase inshuffler sales, which increase represented primarily conversions from rental tosales of shufflers.

 

**Cost of Sales**

 

For the six months ended June 30, 2003,our cost of sales was $2,134,286, compared to $1,764,473 for the six monthsended June 30, 2002, an increase of $369,813, or 21.0%.  Our cost ofsales for the six months ended June 30, 2003 included cost of SecureDropTMsales of $680,704, cost of shuffler sales of $274,161, cost of Deck Checker®sales of $90,523, shuffler rental depreciation of $285,017, shuffler servicecosts of $425,558, manufacturing costs of $232,801, and other expenses of$145,522.  The gross margin on revenue for the six months endedJune 30, 2003 was $1,720,569, or 44.6%, compared to the gross margin onrevenue for the six months ended June 30, 2002 of $490,469, or22.0%.  The increase in gross margin of $1,230,100 from the six monthsended June 30, 2002 to the six months ended June 30, 2003 reflects ourtransition from a development stage to an operating company and other factorspreviously described.

 

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**Selling, General and Administrative Expense**

 

For the six months ended June 30, 2003,our selling, general and administrative expenses were $3,064,524, compared to$1,451,036 for the six months 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 forthe six months ended June 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 Development Expense**

 

For the six months ended June 30, 2003,research and development expenses were $372,860, compared to $720,924 for thesix months ended June 30, 2002, a decrease of $348,064, or 48.3%. The decrease in research and development expenses was primarily due to ourtransition from research to production on our product lines.

 

**Interest Expense**

 

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

 

**Net Loss**

 

For the six months ended June 30, 2003,we had a net loss of $3,079,979, compared to a net loss of $2,483,568 for thesix months ended June 30, 2002, an increase of $596,411, or 24.0%. The increase in net loss was primarily due to increasing our infrastructure coststo sustain higher future revenues and a replacement of SecureDropTM canistersthat could have become defective at some unknown time in the future at twocasino properties.  These infrastructure increases include a permanentSecureDropTM installations team and increased staffing in marketing, finance,sales and legal.  Basic loss per share was $0.40 for the six months endedJune 30, 2003, compared to $0.33 for the six months ended June 30,2002.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

**Overview**

 

Because of our efforts to transition from adevelopment stage company to an operating company, we have generatedsubstantial cash flow deficits from operations, including cash used inoperating activities of $5,206,489, $5,712,867, $7,016,487 and $1,894,452 inthe years ended December 31, 2002 and 2001 and the six months endedJune 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 months ended June 30,2003 and 2002, respectively.  Consequently, we have been substantiallydependent on cash from financing activities to fund our development andoperating activities.  We will continue to require cash from financingactivities for our current operating needs until our operations begin togenerate sufficient cash flow to provide for such cash requirements.

 

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To fund the execution of our businessstrategy described above, we continue to seek sources of outsidefinancing.  From December 2002 to May 2003, we conducted a privateplacement of 10% senior notes in the aggregate principal amount of $7,500,000and warrants to purchase 900,000 shares of common stock.  Of the$7,500,000, $2,400,000 was raised during the quarter ended June 30, 2003. The warrants were issued at a rate of warrants to purchase 6,000 shares per$50,000 of 10% senior notes sold.  The 10% senior notes require thepayment of accrued interest semi-annually in arrears with the principal due onDecember 15, 2005 and, at any time after December 15, 2004 and untilJune 15, 2005, holders of these notes may convert up to 15% of their thenoutstanding principal into shares of our common stock at a rate of $2.25 pershare.  There were 10% senior notes in principal amount of $7,500,000outstanding at June 30, 2003.

 

During the six months ended June 30,2003 and the year ended December 31, 2002, our sources of capital includedequipment financing from a third party, short-term notes from stockholders,convertible debentures and other private sources of capital.  With respectto our equipment financing where we have sold and leased back most of ourfurniture, equipment, tooling and shufflers held for rent, we have receivedproceeds 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.  Asof June 30, 2003, there was outstanding equipment financing of $4,718,752,which includes $152,601 of deferred interest.  These equipment leases haveterms of 36 to 39 months and were not recorded as sales because each of theleases included a mandatory buy back provision.  With respect to ourshort-term debt, we have received proceeds of $3,917,948 and repaid $650,000for the year ended December 31, 2002 and have received proceeds of $1,000,000and repaid $180,000 for the six months ended June 30, 2003.  As ofJune 30, 2003, there were outstanding short-term loans in the aggregateamount of $1,674,743.  With respect to our convertible debentures, wereceived proceeds of $3,249,999 and $5,000,000 during the year endedDecember 31, 2002 and the six months ended June 30, 2003,respectively, and have outstanding convertible debentures in the aggregateamount of $13,903,072 as of June 30, 2003.

 

In June 2003, we secured a 90-day convertibleloan from Triage Capital Management LP in the principal amount of $1,000,000 ata 10% interest rate.  If the loan is not paid within 90 days, the holderhas the option to convert the note into shares of our common stock at $2.25 pershare.  We also issued warrants to the lender to purchase 50,000 shares ofour common stock at a price of $2.25 per share and agreed to issue additionalwarrants to purchase 25,000 shares of our common stock for each 30-day periodthat the note remains outstanding past 90 days.

 

In July 2003, we borrowed $3,000,000 fromMellon HBV SPV, LLC, an affiliate of Mellon Bank, at a 10% interest rate, theprincipal and all accrued interest of which 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 with this transaction, we also issuedwarrants to purchase 225,000 shares of our common stock at $2.25 per share.

 

Our cash and working capital requirementsremain significant.  As a result, our management is currently evaluatingother sources of financing.  We are currently evaluating the need to seekpublic or private sources of debt or equity financing, institutional or bankfinancing, lease financing, or other sources of financing.  Should suchfinancing sources not be available, we would be required to take other steps,including the sale of certain assets or the deferral or change of operatingplans.

 

During the six months ended June 30,2003 and the year ended December 31, 2002, we relied substantially uponloans from certain stockholders and directors, placements of senior notes andwarrants and other private sources of debt and equity capital to sustain ouroperations.  Until normalized sales levels are achieved such that ourrevenue is sufficient to sustain our operations, we will be relying uponprivate and institutional 

 

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sources of debt and equity, and we may seekpublic, private and institutional sources of capital for working capitalpurposes.  In the past, we have also been substantially dependant on loansfrom our principal stockholder and other directors.  Despite suchreliance, neither our principal stockholder nor our directors are obligated toprovide additional financing to us, and our principal stockholder and directorsare free to decline to fund additional financings to us at any time.  Insuch event and in the absence of third party financing sources, we may havesubstantial difficulties in raising additional financings.

 

Based on presently known commitments andplans, we believe that we will be able to fund our operations and requiredexpenditures through the fourth quarter of 2003 from cash on hand, cash flowfrom operations, and cash from our recent private placement of senior notes andfrom our June 2003 $1,000,000 short-term loan and our July 2003 $3,000,000short-term loan.  However, to fund the 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 thereport on our most recent financial statements, our independent auditorexpressed substantial doubt as to our ability to continue as a goingconcern.  No assurances can be given that we will successfully obtainother liquidity sources as may be necessary to fund our operations in thefuture.  If adequate funds are not available or are not available onacceptable terms, we may, in fact, be unable to fund operations or otherwisecontinue as a going concern.  See “Risk Factors” discussed below.

 

**ContractualCash Obligations. **Our contractual cash obligations including principal and interest under ourdebt agreements, capital leases and operating leases as of June 30, 2003and for 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 loandue November 22, 2003.

 

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**RISK FACTORS**

 

**RISKS RELATED TO VENDINGDATA**

 

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

 

Based on presently known commitments andplans, we believe that we will be able to fund our operations and requiredexpenditures through the fourth quarter of 2003 from cash on hand, cash flowfrom operations, and cash from our recent private placement of senior notes andcash from our June 2003 $1,000,000 short-term loan and our July 2003 $3,000,000short-term loan.  However, to fund the 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 thereport on our most recent financial statements, our independent auditorsexpressed substantial doubt as to our ability to continue as a goingconcern.  No assurances can be given that we will successfully obtainother liquidity sources as may be necessary to fund our operations in thefuture.  If adequate funds are not available or are not available onacceptable terms, we may not be able to fund operations or otherwise continueas a going concern.

 

***We have a history of significant operatinglosses and anticipate continued operating losses, and we may be unable toachieve profitability.***

 

We have a history of significant operatinglosses and anticipate continued operating losses for the foreseeablefuture.  For the years ended December 31, 2002 and 2001 and the sixmonths ended June 30, 2003, we have incurred net losses of $6,192,786,$7,566,090 and $3,079,979, respectively, and our operations have used $5,206,489,$5,712,867 and $7,016,487 of cash, respectively.  As of December 31,2002 and 2001 and June 30, 2003, we had accumulated deficits of$36,770,258, $30,557,860 and $39,850,237, respectively.

 

If our revenues do not increase verysubstantially, or if our spending levels exceed our expectations, we will notbecome profitable.  We cannot assure that revenues will grow in the futureor that we will generate sufficient revenues for profitability, or thatprofitability, if achieved, can be sustained on an ongoing basis.

 

***We have limited operating results and noindependent market research of potential demand for current operations.***

 

Until January 2000, we were in thedevelopment stage and derived minimal revenues from our products.  SinceJanuary 2000, our activities have been limited to analyzing and consulting withpersons in the gaming industry, developing and manufacturing products,establishing distribution networks for our products, marketing our products tothe gaming industry, and commencing product sales.  During such time wehave derived limited revenues insufficient to sustain our operations.  Inaddition, we have not yet commenced the sale or leasing of the PokerOneTMShuffler or the SecureHopperTM.  There is no assurance that we willgenerate sufficient revenue to sustain our operations.  No independentorganization has conducted market research providing management withindependent assurance from which to estimate potential demand for ourproducts.  There is no assurance that the overall market will be receptiveto our products or that we will successfully compete in the target market forour products.  If we fail to generate sufficient demand for our products,there is no assurance that we will be able to sustain operations or generate areturn to investors.

 

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***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 HardCount Module in 1999 and have only sold these products to a limited number ofcasinos.  The introduction of the SecureDropTM System Soft Count Module in2002 has been slow to sell outside Nevada due to the lengthy regulatoryapproval process in various jurisdictions.  Even though SecureDropTMSystems sales began, much of our newer SecureDrop products were in beta teststhrough most of 2002.  In addition, we believe that certain barriers andproblems occurred that caused us to have problems breaking into the market, includinglong sales lead time, glitches to the product that we corrected, and gamingcompanies being resistant to change.  We began to distribute the DeckChecker® in late 2002 and have only placed 21 units.  We have not yetdemonstrated significant market acceptance of those products and may be unableto do so.  The commercial success of our SecureDropTM System and DeckChecker®, or any other products that we may develop, will depend upon thedegree of market acceptance of these products in the gaming community and willdepend on a number of factors, including:

 

•      Demonstration of effectiveness and reliability;

 

•      The prevalence and severity of any quality problems or defects in theearly stage of introduction that were not anticipated in the design of thoseproducts;

 

•      Effectiveness of our marketing and distribution capabilities;

 

•      Ability to promptly service and repair the products; and

 

•      Receipt of approval by respective gaming jurisdictions.

 

If we fail to expand our sales and leases forour SecureDropTM System and our Deck Checker®, we will be dependent on ourshuffler products or other new products that we may develop.  If we failto generate significant revenue from our existing products and are unable tointroduce new products, our future operations will be limited and we may beunable to generate sufficient revenues to continue to operate our business.

 

***The acceptance and expansion of coinlessgaming may adversely affect the demand for our products.***

 

Certain gaming operators have tested andemployed as part of their current operations certain gaming devices that havetotally eliminated the use of coins or tokens, or use a combination of coinsand “cashless” vouchers.  For example, International Game Technology hasintroduced 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 forattendants in order to be paid larger payouts and may use their tickets atother machines equipped with the EZ-PayTM system.  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 oftotally coinless gaming devices may reduce the demand for the SecureDropTM HardCount Module and SecureHopperTM, which are based on coin usage, and mayadversely affect our operations in the future.

 

***We place our shufflers in casinos undershort-term lease arrangements, which makes these products susceptible toreplacement due to pressure from competitors, changes in economic conditions,obsolescence and declining popularity.***

 

Many of our shufflers are placed withcustomers under short-term lease arrangements, which, unlike long-term leasesor permanent sales of our products, can easily be terminated by a dissatisfiedcustomer.  This manner in which such short-term leases are structured putsour shufflers at greater risk of replacement due 

 

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to pressure from competitors, changes ineconomic conditions, obsolescence and declining popularity.  We cannotassure that casino operators will not decide to terminate the use of ourproducts or that we can maintain and expand the number of installed shufflersthrough enhancement of existing shufflers, introduction of new shufflers,customer service or otherwise.

 

***Our ability to compete may be damaged andour revenues may be reduced if we are unable to protect our intellectualproperty rights adequately.***

 

Our success depends upon maintaining theconfidentiality and proprietary nature of our intellectual propertyrights.  To protect these rights, we rely principally on a combination of:

 

•      contractual arrangements providing for non-disclosure and prohibitionson use;

 

•      patents and pending patent applications;

 

•      trade secret, copyright and trademark laws; and

 

•      certain technical measures.

 

Patent, trade secret, copyright and trademarklaws provide limited protection.  Because patent applications filed beforeNovember 29, 2000 in the United States are not publicly disclosed until therelevant patent is issued, applications may have been filed, which, if issuedas patents, could relate to our services and products as currently designed oras we may modify them in the future to meet the market’s requirements. Trade secret, copyright and trademark laws, in combination with the steps wetake to protect our proprietary rights, may not adequately preventmisappropriation of those rights.  We may be required to bring proceedingsin the United States Patent and Trademark office or other legal action toenforce our patents, trademarks or copyrights.  We may find it necessaryto litigate to protect our trade secrets and know-how.  Any legal actionswould be costly, time consuming, and would divert the attention of managementand technical personnel.

 

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

 

Our inability or failure to protect ourproprietary technology could damage our ability to compete, reduce our revenuesand damage our prospects for achieving growth and profitability.

 

***Our Random Ejection ShufflerTM and ourContinuous Random Ejection Shuffler are the subject of patent litigation.***

 

Shuffle Master, Inc., our principalcompetitor in the shuffler market, has sued us for patent infringement andalleges that our shufflers violate two of its patents concerning registeringuse of a playing card shuffler apparatus and the displaying of the use on adisplay.  Shuffle Master seeks treble damages, which, if awarded, couldresult in us owing them substantial sums of money.  Although we believeour position to be meritorious, litigation of this nature is a drain on ourcash resources and our management’s time.  Inasmuch as Shuffle Master hasasserted patent infringement claims and we have reasonable defenses, we cannotpredict whether we will prevail in this litigation, nor whether damages, ifawarded, would significantly impact our ability to continue to manufacture andsell particular products within the United States and its territories. Similarly, we cannot predict whether Shuffle Master will assert litigationclaims based upon other patents it may currently or in the future own, nor canwe predict the likely outcome of any such litigation or whether any suchsubstantial litigation would have a material adverse effect on our business aspresently conducted or as anticipated.  For more information, see “PartII—Other Information—Legal Proceedings.”

 

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

 

Other than the allegations made by ShuffleMaster, Inc. discussed above, we are not aware of any claims or basis for ourcurrent products infringing on the proprietary rights of third parties. To the extent that we introduce new products that incorporate same or similartechnology, it is likely that Shuffle Master, Inc. will sue us.  Moreover,we believe that it is reasonably likely that if we introduce the PokerOneTMShuffler in the United States, Shuffle Master will bring some type of claim andwill seek various remedies at equity or law.  We cannot predict theoutcome of any future litigation that may occur.

 

In furtherance of the development of ourservices or products, we may need to acquire licenses for intellectual propertyto avoid infringement of third party rights or claims of infringement. These licenses may not be available on commercially reasonable terms, if atall.  Claims for infringement, if made, could damage our businessprospects, our results of operations and financial condition, whether or notthe claims have merit, by:

 

•      consuming substantial time and financial resources required to defendagainst them;

 

•      diverting the attention of management from growing our business andmanaging operations;

 

•      resulting in costly litigation; and

 

•      disrupting product sales and shipments.

 

If any third party prevails in an actionagainst us for infringement of its proprietary rights, we could be required topay damages and either enter into costly licensing arrangements or redesign ourproducts so as to exclude the infringing technology.  As a result, wewould 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 againstinnovative competitors or new entrants.***

 

Our market is characterized by changingtechnology, periodic product obsolescence and continuous protection ofproprietary technology.  Our success will depend upon our ability to sellour current products and to develop successor systems.  We will need tointroduce new products and features in a timely manner to meet evolvingcustomer requirements.  We may not succeed in these efforts.  Even ifwe succeed, products or technologies developed by others may render ourproducts or technologies noncompetitive or obsolete, which would impair ourability to sell our products and reduce our revenue.

 

***We may not be able to complete thedevelopment of our specialty game shuffler.***

 

There is no assurance that our development ofthe PokerOneTM Shuffler will be successfully completed.  We are continuingdevelopment on this product, and we plan to start the testing phase in Asiaduring either the fourth quarter of 2003 of the first quarter of 2004.  Wehave expended significant time and resources into the development of thisproduct, and our failure to bring about a viable product will cause usfinancial loss and have an adverse effect on our business.

 

***The gaming industry has demonstrated apreference for relying on a single provider of shufflers.***

 

Our customers have demonstrated a strongpreference for conducting business with only one provider of automatic shufflerproducts.  Our competitors, including our primary competitor, ShuffleMaster, Inc., offer specialty game shufflers in addition to shuffler productsthat perform functions similar to our existing products, the Random EjectionShufflerTM and the Continuous Random Ejection Shuffler.  

 

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Because our specialty game shuffler, thePokerOneTM Shuffler, is still in development and may or may not be successfullyadded to our product line in North America, we will continue to be at acompetitive disadvantage against competitors that offer a broader product linethan ours.  Our inability to increase our market share of shufflers willcontinue to put pressure on our ability to generate revenue and profits.

 

***Our products will be subject to constantscrutiny and attempts by third parties to compromise their security.***

 

In the event that our products becomesusceptible to attacks by third parties that result in a decrease or compromiseof the security of our customer’s operations, we will most likely be requiredto take back our products from existing customers and will lose sales and rentalsfrom 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 in the security of our products willalmost certainly reduce demand for these products.  There is no assurancethat our shufflers will not become vulnerable to card counters or expertplayers or that the use of our shufflers will not result in financial lossesfor our customers.  The occurrence of any of these events would likelyhave a material adverse effect on our operations.

 

***Any conditions that adversely affect thegaming industry could also have a material adverse effect on our operation andour financial condition.***

 

The success of our business depends solely onthe gaming industry where revenues are sensitive to general economic conditionsand generally rise or fall rapidly in relation to the condition of the overalleconomy.  Although we cannot accurately estimate the economic impact ofthe recent terrorist attacks at this time, the gaming industry has beennegatively affected by the reduction in air travel and tourism, and we expectthat any significant decline in the economic health or growth of the gamingindustry will reduce demand for our products.

 

***We are unable to predict the future impactthat extraordinary events, such as terrorism, the uncertainty of war andworldwide health concerns, may have on our business and operations.***

 

Extraordinary events, such as terroristattacks, acts of war or worldwide health concerns, may cause damage ordisruption to our operations, which, in turn, could significantly impact ourrevenues, costs and expenses, and financial condition.  The terroristattacks that took place in the United States on September 11, 2001 wereunprecedented events that have created many economic and politicaluncertainties, especially to the gaming industry, some of which have materiallyadversely affected our business, results of operations, and financial conditionand may do so again in the future.  In particular, the gaming industry hasbeen affected by the downturn in the tourist industry as a result of theSeptember 11, 2001 attacks.  Because our business is directly tied tothe gaming industry, the long-term effects from the September 11, 2001attacks are unknown.  The potential for future terrorist attacks, thenational and international responses to terrorist attacks, other acts of war orhostility and concerns about the spread of certain diseases, including severeacute respiratory syndrome, or SARS, have created many economic and politicaluncertainties, which could materially adversely affect our business, results ofoperations and financial condition in ways that we currently cannot predict.

 

***Reliance on our manufacturing facility inChina could subject us to supply interruption.***

 

We have located most phases of themanufacturing process of all of our products to our own facility in XiaolanTown in Zhongshan City, China.  Although we intend to maintain a five- tosix-month inventory of parts at our principal offices in Las Vegas, Nevada, wewill be adversely impacted if there is an interruption in our ability toreceive components from, or an increase in labor costs in, China.  Factors

 

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that may cause a supply interruption includepolitical unrest, closure of ports, worldwide health concerns, including SARS,and other events beyond our control.  In the event that our manufacturingoperations in Xiaolan Town are interrupted, our business could be materiallyadversely affected.

 

***Our efforts to expand into internationalmarkets pose special risks.***

 

As a result of the opening of ourmanufacturing facility in China, we are currently operating in internationalmarkets and we propose to further expand our international sales andoperations.  Engaging in business outside of the United States will subjectus to the customary risks of doing business in foreign countries.  Theserisks include fluctuations in foreign currency exchange rates and controls,competitive issues relative to established businesses with significant currentmarket share and business/customer relationships, nationalization and othereconomic, tax and regulatory policies of local governments and the possibilityof trade embargoes, political instability or war or other hostility, as well asthe laws and policies of the United States affecting foreign trade andinvestment.

 

***We have limited sales experience sellingour products in foreign countries.***

 

We have limited sales experience and historyin foreign markets.  We typically sell our products through distributors,who we believe to be experienced and reputable, however, if we are unable tomanage these relationships, our ability to generate revenue and profits may beadversely affected.

 

***Due to our management’s controllinginterest in our common stock, our management has the power to influence allmatters submitted to our stockholders.***

 

As of April 18, 2003, our executiveofficers and members of our board beneficially own 6,723,968 shares of commonstock, or approximately 81.2% of the outstanding shares of our common stock,assuming exercise or conversion of all options, warrants and convertibledebentures that are exerciseable within 60 days.  Accordingly, thesestockholders have the power to control all matters requiring approval by ourstockholders, including the election of directors and approval of mergers andother significant corporate transactions.  This concentration of ownershipalso has the effect of delaying, preventing or expediting, as the case may be,a change in control of our company.

 

***We depend upon our key employees and certainmembers of our management.***

 

Our success is substantially dependent uponthe efforts and skills of Steven J. Blad, our chief executive officer andpresident, and John R. Spina, our chief financial officer.  We haveentered into employment agreements with Messrs. Blad and Spina and nineother key employees.  However, if we were to lose the services rendered byany of our key employees, our operations could be adversely affected.  Inaddition, we compete with other potential employers for employees, and we maynot succeed in hiring and retaining the executives and other employees that weneed.  An inability to hire and retain quality employees could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

***Even if our operations do not becomeprofitable, our management will continue to be compensated through the paymentof salaries and benefits.***

 

We currently compensate our management withsubstantial salaries and other benefits and, in the future, may pay increased salariesand benefits.  In June and July 2003, we extended our employmentagreements for an additional five years with Mr. Blad and three years withseven other key employees.  The payment of such compensation and benefitsmay be a burden on us and may be a factor in limiting or preventing ourprofitability.  Upon the expiration of those employment agreements, we mayelect to continue compensating management with similar or higher salaries andother benefits.

 

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***Our business may be adversely affected inthe event that holders of certain 9.5% convertible notes do not agree to extendthe maturities of outstanding promissory notes or convert them to common stock.***

 

In February 2002, we commenced a privateplacement of $4,799,990 principal amount of convertible notes, which placementwas 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 convertible into shares of our common stock at arate 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 been issued for $675,000in cash with the remaining $4,124,990 representing a rollover of principal andinterest of $3,124,990 and $1,000,000 for short-term and convertible notes,respectively.  The maturity dates, as extended, for the 9.5% convertiblenotes are between April 2004 and January 2005.  In June 2003, the holdersof these convertible notes executed agreements in which they agreed to extendthe respective maturity dates by one year and to defer receipt of any accruedinterest until December 31, 2003.  There can be no assurance that theholders of these notes will agree to convert the notes to shares of our commonstock or to extend the maturities of the convertible notes in the future, andin the event that the holders do not agree to convert these notes to commonstock or further extend the maturity dates in the future, we will be requiredto pay principal and interest on these notes.  If we do not at that timehave sufficient cash available or sources of cash to make such payments, we maynot be able to continue as a going concern.

 

**RISKS RELATED TO OUR INDUSTRY**

 

***We face intense competition for customersfor our products from companies with longer operating histories, greaterresources and more established brand names.***

 

There is significant competition in theshuffler market, where we compete with established companies and otherentities, most of which possess substantially greater resources than wedo.  Almost all of the companies with which we compete in the shufflermarket are substantially larger, have more substantial histories, backgrounds,experience and records of successful operations, greater financial, technical,marketing and other resources, more employees and more extensive facilitiesthan we now have, or will have in the foreseeable future.  It is alsolikely that other competitors will emerge in the near future.  Othercompanies may develop products competitive to our SecureDropTM System. There is no assurance that we will be able to compete successfully with otherestablished gaming product manufacturers.  Our inability to competesuccessfully will likely result in loss of market share and lower revenues, orincreases in operating costs, such as marketing costs, which would have anadverse effect on our business and financial condition.

 

***We face extensive regulation from gamingand other government authorities.***

 

The gaming industry is a highly regulatedindustry and is subject to numerous statutes, rules and regulationsadministered by the gaming commissions or similar regulatory authorities ofeach jurisdiction.  Generally, companies that seek to introduce gamingproducts 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, wemay incur significant expenses in seeking to obtain licenses for our gamingproducts and concepts, and no assurance can be given that our products will beapproved in any particular jurisdiction.  The failure to obtain suchapproval in any jurisdiction in which we may seek to introduce our products orconcepts could have a material adverse effect on our business.

 

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***Any person who is the beneficial owner of ourcommon stock or with whom we have a material relationship that fails or refusesto apply for a finding of suitability, or that is found unsuitable forlicensing, would be required to dispose of all of our stock.***

 

Certain gaming regulatory agencies to whichwe are subject may investigate any beneficial holder of our voting securities(regardless of the numbers of shares owned), and any individual who has amaterial relationship or involvement with us, in order to determine whethersuch individual is suitable or should be licensed as a business associate ofours.  In addition, the gaming authorities of various jurisdictions mayrequire our officers, directors and certain key employees to be licensed orfound suitable by these gaming authorities, which would require these officers,directors and key employees to submit detailed background information. Any person who fails or refuses to apply for a finding of suitability or alicense after being ordered to do so by gaming regulatory agencies may be foundunsuitable.  In the event that the gaming authorities were to find anofficer, director, key employee, stockholder, or any other individual that hasa material relationship with us, unsuitable for licensing or unsuitable tocontinue having a relationship with us, we would have to sever allrelationships with that individual, and that individual would be required todispose of all of our stock.  This could result in a material adverseeffect on our business.

 

***Due to our focus on products designed for thegaming industry, our operations are not diversified and are dependent solely uponthe gaming industry.***

 

We design and manufacture products andconcepts solely for the gaming industry and depend almost exclusively on ourability to generate revenues from the rental or sale of our products tocustomers in the gaming industry.  The economic health of the gamingindustry, and, therefore, our revenues, are affected by a number of factorsbeyond our control, including:

 

•      General economic conditions, such as recession, inflation, businesscycle fluctuations and

 

•      Levels of disposable income of gaming property patrons;

 

•      Acts of terrorism and anti-terrorism efforts;

 

•      Increased transportation costs resulting in decreased travel by gamingpatrons;

 

•      Changes or proposed changes in tax laws;

 

•      Legal and regulatory issues affecting the development, operation andlicensing of our gaming customers; and

 

•      Competitive conditions in the gaming industry.

 

These factors may adversely impact the demandfor our products and materially affect the revenues that we realize on the saleor placement of our products.

 

**RISKS RELATED TO OUR COMMON STOCK**

 

***There is no current public market for ourcommon stock, so our stockholders may be unable to dispose of their investment,or may lose the total value of their investment.***

 

There has been no trading market for ourcommon stock.  There can be no assurance that an active trading and/or aliquid market for our common stock will ever develop or, if developed, that itwill be maintained.  Accordingly, we cannot assure you of the liquidity ofthe market for our common stock or the prices at which you may be able to sellour common stock, if at all.  In addition, if our operations areunsuccessful or we are unable to continue as a going concern and our company isdissolved or otherwise terminated, you could lose your entire investment in ourcommon stock.

 

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***Our common stock is deemed to be “pennystock” which may make it more difficult for investors to resell their sharesdue to suitability requirements.***

 

Our common stock is deemed to be “pennystock” as that term is defined in Rule 3a51-1 promulgated under the SecuritiesExchange Act 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 quoted on the Nasdaq automated quotation system(Nasdaq-listed stock must still have a price of not less than $5.00 per share);or

 

•      From issuers with net tangible assets less than $2.0 million (if theissuer has been in continuous operation for at least three years) or $5.0million (if in continuous operation for less than three years), or with averagerevenues of less than $6.0 million for the last three years.

 

Federal rules and regulations under theSecurities Exchange Act of 1934 generally impose additional sale practice anddisclosure requirements on broker/dealers who sell or recommend our shares tocertain investors.  Broker/dealers dealing in penny stocks are required toprovide potential investors with a document disclosing the risks of pennystocks.  Moreover, broker/dealers are required to determine whether aninvestment in a penny stock is a suitable investment for a prospective investorand receive the investor’s written consent to the transaction.  In addition,many institutional investors have restrictions regarding investments in pennystocks, which further limits the liquidity of the market for our shares. These requirements may reduce the potential market for our common stock byreducing the number of potential investors, and any or all of these factors maymake it more difficult for investors in our common stock to sell shares tothird parties or to otherwise dispose of them and could cause our stock priceto decline.

 

***We have no intention of paying any dividendssince we intend to use our earnings, if any, to expand our operations.***

 

At the present time we are not permitted topay a dividend under applicable law because to do so could render usinsolvent.  There can be no assurance that our operations will becomeprofitable.  If we become profitable, we intend to use any earnings thatmay be generated to finance the growth of our business.  Any payment offuture dividends will be at the discretion of our board of directors and willdepend on, among other things, our earnings, financial condition, capitalrequirements, level of indebtedness, statutory and contractual restrictionsapplying to the payment of dividends, and other considerations that our boardof 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 not realize a gain on their investment, andthey may lose all or a significant amount of their investment when they selltheir common stock.

 

***If we are unable to generate sufficientrevenue to provide the cash required to fund our operations in the future, wemay be required to issue additional equity or convertible debt securities toprovide our operations with additional working capital which, in turn, willhave the effect of diluting the relative ownership of our existingstockholders.***

 

We currently anticipate the need tosupplement the cash deficit arising from our operations with cash from privateor public placements of debt or equity, institutional or other lending sources,to sell certain assets or to change operating plans to accommodate ourliquidity issues.  We have also utilized convertible debt securities andwarrants to raise capital in the past.  The issuance of additional equityor convertible debt securities will have the effect of reducing the percentageownership of our current

 

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stockholders.  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 the event we are required to raiseadditional funds to support our operations, we cannot assure our stockholdersthat the additional funds will be available on terms favorable to our company,or at all.  If adequate funds are not available or are not available onacceptable terms, we may not be able to fund our operations or otherwisecontinue as a going concern.

 

***Shares eligible for sale in the near futuremay cause the market price for our common stock to decline.***

 

In the event that a public market for ourcommon stock develops, we have 1,622,594 shares of common stock that are freelytradable pursuant to Rule 144(k) of the Securities Act of 1933.  Inaddition, we have granted registration rights to holders of certainindebtedness and warrants with respect to an aggregate of an additional6,046,180 shares of common stock.  The future sale of a substantial numberof shares of our common stock in market transactions, or the perception thatthese sales could occur, may depress the market price for our commonstock.  These sales could also impair our ability to raise additionalcapital through the sale of our equity securities in the future.

 

***Our board of directors may issue blankcheck preferred stock which may affect the voting rights of our holders andcould deter or delay an attempt to obtain control of us.***

 

Our board of directors is authorized, withoutstockholder approval, to issue preferred stock in series and to fix and statethe voting rights and powers, designation, preferences and relative,participating, optional or other special rights of the shares of each suchseries and the qualifications, limitations and restrictions thereof. Preferred stock may rank prior to our common stock with respect to dividendsrights, liquidation preferences, or both, and may have full or limited votingrights.  Accordingly, issuance of shares of preferred stock couldadversely affect the voting power of holders of our common stock and could havethe effect of deterring or delaying an attempt to obtain control of us.

 

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

 

**Evaluationof Disclosure Controls and Procedures. ** Our chief executive officer and our chieffinancial officer, after evaluating the effectiveness of our “disclosurecontrols and procedures” (as defined in the Securities Exchange Act of 1934,Rules 13a-15(e) and 15d-15(e)) during the period in which this report isbeing prepared, have concluded that based upon the changes discussed below ourdisclosure controls and procedures were adequate and designed to ensure thatmaterial information relating to us and our consolidated subsidiaries would bemade known to them by others within those entities.

 

Disclosure controls and procedures arecontrols and other procedures that are designed to ensure that informationrequired to be disclosed in our reports filed or submitted under the SecuritiesExchange Act of 1934, as amended, is recorded, processed, summarized andreported, within the time periods specified in the Commission’s rules andforms.  Based on our evaluation as of the end of the period covered bythis report and based upon the changes discussed below, our chief executiveofficer and our chief financial officer have concluded that our disclosurecontrols and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) underthe Securities Exchange Act of 1934, as amended) are effective.

 

**Changes inInternal Controls. **Our chief financial officer undertook a review of our internal controls duringthe second quarter of this year.  This review was discussed with ouroutside auditors and resulted in a letter of reportable conditions.  Theletter of reportable conditions was discussed with our chief executive officerand audit committee.  Areas subject to recommended changes in proceduresincluded our purchasing and disbursement functions, inventory control andpayroll.  As a result, we have increased our accounting staff, separatedduties and modified our control procedures.  These changes wereimplemented in our second quarter and in the beginning of our thirdquarter.  We propose to form a

 

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disclosure committee in the third quarter of2003 that will be designed to ensure the reliability of our financialreporting, the effectiveness and efficiency of our operations and ourcompliance with applicable laws and regulations.  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.  The disclosure committee will consistof our chief financial officer, our corporate counsel, a representative frommarketing and a representative from operations.  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.

 

**PART II – OTHER INFORMATION**

 

**ITEM1.  LEGAL PROCEEDINGS.**

 

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

 

On May 18, 2000, Heath ElectronicsManufacturing Corporation filed a complaint (Case No. CV OC 00-02422D) againstVendingData in the District Court of the Fourth Judicial District of the Stateof 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 finalpayment in August 2003, we will have fulfilled our obligations under thesettlement agreement.

 

On July 29, 2002, Contract ManufacturingService, Inc., filed a complaint (Case No. A454098) in the District Court ofClark County, Nevada.  The complaint alleges non-payment for productallegedly delivered, and requests compensatory damages in the amount of$29,896.14, interest, attorneys’ fees and costs.  The parties have enteredinto a stipulation as of February 2003, which requires us to make monthlypayment installments, the fulfillment of which will lead to the dismissal ofthis litigation.

 

On March 27, 2002, Shuffle Master, Inc., orShuffle Master, filed a complaint (Case No. CV-S-02-0438-JCM-PAL) againstVendingData in the United States District Court, District of Nevada.  Theamended complaint alleges, among other things, claims for patent infringementand requests treble damages, an injunction enjoining us from infringing on twoof Shuffle Master’s patents, an accounting of our gains and profits thatresulted from our alleged infringement, and interest, costs and attorneys’fees.  The Shuffle Master patents that are at issue in the litigationconcern registering use of a playing card shuffler apparatus and the displayingof the use on a display.  We have filed our answer, counterclaims, andamended counterclaims against Shuffle Master.  In our answer, we denyShuffle Master’s allegation of patent infringement and request that ShuffleMaster’s complaint be dismissed.  We also seek, in our amendedcounterclaim, a declaration that we do not infringe Shuffle Master’s patentsand that Shuffle Master’s patents and certain of their related claims areinvalid.  We further assert counterclaims against Shuffle Master forbreach of contract and violation of the Uniform Trade Secrets Act.  On May20, 2002, the United States District Court, District of Nevada denied ShuffleMaster’s motion for preliminary injunction against us.  Discovery in thislitigation is now closed.  On May 28, 2003, we filed a motion for summaryjudgment requesting that the court dismiss the case against us.

 

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 Shuffle Master will assert other patentsit

 

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may currently or in the future own, nor canwe predict the likely outcome of any such litigation or whether any suchsubstantial litigation would have a material adverse effect on our business aspresently conducted or as anticipated.  See “Part 1, Item 2,—RiskFactors.”

 

On July 22, 2003, Shuffle Master, Inc. fileda petition (Case No. 20003-11016) against VendingData Corporation andCasinovations, Inc. in the Civil 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.  Thepetition further alleges that VendingData and/or Casinovations violated theLouisiana Unfair Trade Practices Act by intending to “dump” Random EjectionShufflersTM into the market with the intent to “steal” customers from ShuffleMaster.  The third claim asserted by Shuffle Master is that the actions ofVendingData and/or Casinovations constitute fraud, theft by conversion, misappropriation,intentional misrepresentation and/or general negligence.  The petitionrequests the court to enter a preliminary and permanent injunction againstVendingData and/or Casinovations from selling or leasing the Random EjectionShufflerTM and other automatic playing card shufflers to Harrah’s Jazz Casinolocated in New Orleans, reasonable attorneys’ fees and costs, and all otherrelief in law or in equity that the circumstances merit.  Based on adviceof counsel, we believe that we have meritorious defenses against all theseclaims and we intend to vigorously defend against these allegations.

 

On August 5, 2003, Dan Purjes, one of ourstockholders, filed a complaint (Case No. 114071/03) against us in the SupremeCourt of the State of New York, County of New York.  The complaint allegesthat we owe $28,500 plus attorneys’ fees and costs related to a promissory notethat we executed in favor of Mr. Purjes.  We intend to vigorously defendagainst Mr. Purjes’ allegations.

 

**ITEM2.  CHANGES IN SECURITIES.**

 

(a)           Recent Sales of Unregistered Securities.

 

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

 

The warrants were issued at a rate of 6,000shares per $50,000 of 10% senior notes sold.  The 10% senior notes requirethe payment of accrued interest semi-annually in arrears with the principal dueon December 15, 2005 and, at any time after December 15, 2004 and until June15, 2005, may have 15% of its then outstanding principal converted into sharesof our common stock at a rate of $2.25 per share.  All notes were placedwith accredited investors.  We received net proceeds from the privateplacement of approximately $7,200,000 after deducting the underwritingdiscounts and commissions and the offering expenses.  The proceeds fromthis placement are being used for the acquisition of the Deck Checker®,inventory and working capital.  We relied upon the exemption from registrationprovided by Section 4(2) of the Securities Act, Rule 506 of Regulation Dthereunder and Regulation S.

 

In June 2003, we secured a 90-day convertibleloan from Triage Capital Management LP in the principal amount of $1,000,000 ata 10% interest rate.  If the loan is not paid within 90 days, the holderhas the option to convert the note into shares of our common stock at $2.25 pershare.  We also issued warrants to the lender to purchase 50,000 shares ofour common stock at a price of $2.25 per share and agreed to issue additionalwarrants to purchase 25,000 shares of our common stock for each 30-day periodthat the note remains outstanding past 90 days.  Because this loan wasnegotiated with a single lender, we relied on the exemption from registrationof securities provided by Section 4(2) of the Securities Act and Rule 506 ofRegulation D.

 

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In July 2003, after the end of the secondquarter, we borrowed $3,000,000 from Mellon HBV SPV, LLC, an affiliate of MellonBank, at a 10% interest rate, the principal and all accrued interest of whichare due on November 22, 2003.  At any time until the due date, theholder may convert up to 15% of its then outstanding principal amount intoshares of our common stock at a rate of $2.25 per share.  In connectionwith this transaction, we also issued warrants to purchase 225,000 shares ofour common stock at $2.25 per share.  Because this loan was negotiatedwith a single lender, we relied on the exemption from registration ofsecurities provided by Section 4(2) of the Securities Act and Rule 506 ofRegulation D.

 

(b)           Dividends.

 

We have never paid cash dividends on ourcommon stock and do not currently intend to pay cash dividends on our commonstock in the foreseeable future.  We may be restricted from payingdividends on our common stock under state law and we are currently required tocomply with certain conditions pursuant to the terms of notes and warrantsissued by us related to our issuance of dividends.  We currentlyanticipate that we will retain any earnings for use in the continueddevelopment of our business.

 

**ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS.**

 

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

 

1.             Election of 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.             Amendment to Amended and Restated Articles ofIncorporation to increase the authorized shares of capital stock from16,000,000 to 25,000,000 shares.

 

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

 

3.             Amendment to the 1999 Stock Option Plan.

 

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

 

**ITEM5.  OTHER INFORMATION.**

 

In June and July 2003, we entered intoindemnification agreements with members of our board of directors and certainof our executive officers and significant employees in which we agreed to holdharmless and indemnify such directors, officers and significant employees tothe fullest extent authorized under Nevada law, and to pay any and all relatedexpenses reasonably incurred by the indemnitee.  The four members of ourboard 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,

 

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Slot Systems; Tyson K. Adams, SoftwareEngineering Manager; Lynn C. Hessing, Director of Engineering;Robert G. Pietrosanto, Table Games Sales – Division President;William B. Roquemore, Vice President, Manufacturing and Service; Joseph D.Corradino, Director of Sales/Table Games; and Jessica N. Neville, VicePresident of Marketing and Public Relations.

 

In June and July 2003, we entered intoamended employment agreements with seven employees under which the terms oftheir employment agreements were extended 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 theseven employees, Stacie L. Brown, Corporate Counsel and

 

Secretary was included.  In addition,other significant employees included: D. Dean Barnett, Vice President,Sales; Kenneth R. Dickinson, Vice President, Slot Systems; Tyson K.Adams, Software Engineering Manager; Lynn C. Hessing, Director ofEngineering; Robert G. Pietrosanto, Table Games Sales – DivisionPresident; and William B. Roquemore, Vice President, Manufacturing andService.  .  In June 2003, we entered into a second amendment to theemployment agreement of Steven J. Blad, Chief Executive Officer and President,in which we extended the term of Mr. Blad’s employment through December 31,2009, granted to Mr. Blad stock options to purchase 500,000 shares of ourcommon stock at $2.50 per share, and agreed that Mr. Blad’s base salary shallbe $282,000 per year.  In July 2003, we entered into an amendment to theemployment agreement of John R. Spina, Chief Financial Officer.  Pursuantto this amendment, we awarded Mr. Spina an option to purchase 25,000 shares ofour common stock at an exercise price of $2.50 per share and accelerated thevesting date of certain existing options

 

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**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 Warrant 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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(*) Previously filed through a prioramendment.

 

(b)           Reports on Form 8-K.

 

During the three months ended June 30, 2003and from the end of such period to the date of this report, we filed thefollowing:

 

•      Current Report on Form 8-K filed on April 22, 2003 (as amended byForm 8-K/A filed May 6, 2003) reporting the retention of the firm ofPiercy, Bowler, Taylor & Kern as our independent accountants;

 

•      Current Report on Form 8-K filed on April 28, 2003 reporting theresignation of Steven J. Blad as treasurer and the election of John R. Spina asour treasurer;

 

•      Current Report on Form 8-K/A-2 filed on May 29, 2003 supplementingthe information regarding the change in our auditors;

 

•      Current Report on Form 8-K filed on June 3, 2003 reporting theresults of matters voted on at the Annual Meeting of Stockholders; and

 

•      Current Report on Form 8-K filed on June 18, 2003 reporting thefiling of the Second Amended and Restated Articles of Incorporation of thecompany.

 

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**SIGNATURE**

 

In accordance with the requirements of theExchange Act, the registrant caused this Amendment No. 2 to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 

 
|                                                            | **VENDINGDATA  CORPORATION** |
|-----------------------------------------------------------------|------------------------------|
|                                                            | (Registrant)                 |
|                                                            |                         |   |
|                                                            |                         |   |
|                                                            |                         |   |
| Date:      December 9,  2003 | By:                          |   /s/ JOHN R. SPINA |   |
|                                                            |                         |   John R. Spina |
|                                                            |                         |   |
|                                                            | Its:                         | *  Chief Financial Officer and Treasurer    (Principal Financial Officer and Duly    Authorized Officer)* |

 

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