**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

----

 

**FORM10-QSB/A**

 

**Amendment No. 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:  September 30, 2003**                                                                                                                                      |
|                                                                                                                                                                                                   |
| **OR**                                                                                                                                                                                                 |
|                                                                                                                                                                                                   |
| **o**                                                                                                                                                                                                  |   | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE EXCHANGE ACT** |
|                                                                                                                                                                                                   |
| **For the transition period from                 to               ** |
|                                                                                                                                                                                                   |
| **Commission file 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) |

 
|                                     | Check whether the issuer (1) filed all reports  required to be filed by Section 13 or 15(d) of the Exchange Act during  the past 12 months (or for such shorter period that the registrant was  required to file such reports), and (2) has been subject to such filing  requirements for the past 90 days.   Yes   o      No   ý |
|------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                     |                                                                                                                                                                                                                                                                                                                                                                                                                   |
| **APPLICABLE ONLY TO CORPORATE ISSUERS** |
|                                     |                                                                                                                                                                                                                                                                                                                                                                                                                   |
|                                     | State the number of shares outstanding of each of  the issuer’s classes of common equity, as of the latest practicable  date:  7,700,814 shares of common  stock, $.001 par value, as of October 31, 2003                                                                                                                                                                                               |
|                                     |                                                                                                                                                                                                                                                                                                                                                                                                                   |
|                                     | Transitional Small 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 as of January 1, 2003,of the requirements of Emerging Issues Task Force Issue No. 00-21, Revenue Arrangementswith Multiple Deliverables.  Therestatements were made after reconsideration of the Company’s prior revenue(and warranty cost) recognition practices regarding certain sales contractsentered into beginning in the second quarter of 2003.  The result of this change was to defer recognition of anallocated portion of revenues from the affected sales contracts, representingthe estimated fair value of extended warranty and maintenance services includedtherein.  Such deferred revenues are nowbeing amortized over the applicable service periods in the contracts.  The effects of the restatements aresummarized in Note 1 to the accompanying restated 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 |   |
|                                   |     |   |   |
|                                   | ITEM  2. | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |   |
|                                   |     |   |   |
|                                   |     | Overview |   |
|                                   |     |   |   |
|                                   |     | Critical  Accounting Policies and Estimates |   |
|                                   |     |   |   |
|                                   |     | Financial  Condition |   |
|                                   |     |   |   |
|                                   |     | Results  of Operations |   |
|                                   |     |   |   |
|                                   |     | Liquidity and Capital  Resources |   |
|                                   |     |   |   |
|                                   |     | Risk Factors |   |
|                                   |     |   |   |
|                                   | ITEM 3.  | CONTROLS AND PROCEDURES |   |
|                                   |     |   |   |
| **PART II—OTHER INFORMATION**     |     |
|                                   |     |
|                                   | ITEM  1. | LEGAL  PROCEEDINGS |   |
|                                   |     |   |   |
|                                   | ITEM 2.  | CHANGES IN SECURITIES |   |
|                                   |     |   |   |
|                                   | ITEM 3.  | DEFAULTS UPON  SENIOR 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**

**ITEM 1.FINANCIAL STATEMENTS.**

**VENDINGDATA CORPORATION**

**Balance Sheets**

 
|                                                                                                                     |   | **September 30,  2003** |       | **December 31,********2002** |   |
|--------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|------------|-----------------------------------|--------|
|                                                                                                                     |   | **(Restated)  (Unaudited)**  |       |                              |   |
| **ASSETS**                                                                                                               |   |                         |       |                              |   |
| Current assets:                                                                                                          |   |                         |       |                              |   |
| Cash and cash equivalents                                                                                                |   | $                            | 314,009    |                              | $      | 1,778,297 |   |
| Current portion of accounts receivable, trade, net  of allowance for uncollectibles of $25,530 and $25,530, respectively |   | 3,138,172                    |       | 106,791                           |   |
| Due from affiliate                                                                                                       |   | 45,029                       |       | 30,593                            |   |
| Other receivables                                                                                                        |   | 175,373                      |       | 39,305                            |   |
| Inventories                                                                                                              |   | 3,747,627                    |       | 1,850,051                         |   |
| Prepaid expenses                                                                                                         |   | 172,879                      |       | 236,579                           |   |
|                                                                                                                     |   |                         |       |                              |   |
|                                                                                                                     |   | 7,593,089                    |       | 4,041,616                         |   |
| Equipment rented to customers, net of accumulated  depreciation of $1,229,870 and $1,406,574                             |   | 754,530                      |       | 1,353,925                         |   |
| Property and equipment, net of accumulated  depreciation of $1,720,240 and $1,422,313, respectively                      |   | 930,608                      |       | 593,253                           |   |
| Intangible assets, net of accumulated amortization  of $249,130 and $191,520, respectively                               |   | 1,317,713                    |       | 352,603                           |   |
| Due from affiliate                                                                                                       |   | 118,800                      |       | 118,800                           |   |
| Accounts receivable, trade, net of current portion,  less unamortized discount                                           |   | 1,439,244                    |       | —                            |   |
| Deferred expenses                                                                                                        |   | 615,644                      |       | 100,000                           |   |
| Deposits                                                                                                                 |   | 1,073,313                    |       | 868,520                           |   |
| Other assets                                                                                                             |   | 496,481                      |       | 638,029                           |   |
|                                                                                                                     |   |                         |       |                              |   |
|                                                                                                                     |   | $                            | 14,339,422 |                              | $      | 8,066,746 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY DEFICIENCY**                                                                 |   |                         |       |                              |   |
| Current liabilities:                                                                                                     |   |                         |       |                              |   |
| Current portion of leases payable                                                                                        |   | $                            | 2,215,939  |                              | $      | 2,286,243 |   |
| Accounts payable                                                                                                         |   | 2,079,829                    |       | 1,084,637                         |   |
| Accrued expenses                                                                                                         |   | 191,505                      |       | 385,570                           |   |
| Accrued wages                                                                                                            |   | 195,176                      |       | 249,147                           |   |
| Accrued interest                                                                                                         |   | 1,059,420                    |       | 461,308                           |   |
| Deferred revenues, current portion                                                                                       |   | 191,400                      |       | —                            |   |
| Short-term debt                                                                                                          |   | 920,743                      |       | 904,743                           |   |
| Current portion of convertible debt                                                                                      |   | 4,953,076                    |       | —                            |   |
| Customer deposits                                                                                                        |   | 672,333                      |       | 386,819                           |   |
|                                                                                                                     |   |                         |       | —                            |   |
|                                                                                                                     |   | 12,479,421                   |       | 5,758,467                         |   |
| Deferred revenue, net of current portion                                                                                 |   | 312,400                      |       |                              |   |
| Convertible debt, net of current portion                                                                                 |   | 12,949,996                   |       | 8,853,072                         |   |
| Leases payable, net of current portion                                                                                   |   | 2,447,776                    |       | 3,497,859                         |   |
|                                                                                                                     |   |                         |       |                              |   |
|                                                                                                                     |   | 28,189,593                   |       | 18,109,398                        |   |
|                                                                                                                     |   |                         |       |                              |   |
| Stockholders’ equity deficiency:                                                                                    |   |                         |       |                              |   |
| Preferred stock, $.001 par value, 10,000,000 shares  authorized, no shares issued and outstanding                        |   | —                       |       | —                            |   |
| Common stock, $.001 par value, 25,000,000 shares  authorized, 7,700,814 and 7,625,814 shares issued and outstanding      |   | 7,701                        |       | 7,626                             |   |
| Additional paid-in capital                                                                                               |   | 27,294,325                   |       | 26,719,980                        |   |
| Deficit                                                                                                                  |   | (41,152,197                  | )          | (36,770,258                       | )      |
|                                                                                                                     |   |                         |       |                              |   |
| Total stockholders’ equity deficiency                                                                               |   | (13,850,171                  | )          | (10,042,652                       | )      |
|                                                                                                                     |   |                         |       |                              |   |
| Total liabilities and stockholders’ equity  deficiency                                                              |   | $                            | 14,339,422 |                              | $      | 8,066,746 |   |

 

See accompanying notes to financial statements.

 

1

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**VENDINGDATA CORPORATION**

 

**Statementsof Operations**

**(UNAUDITED)**

 
|                                |   | **Three Months Ended  September 30,** |       | **Nine Months Ended  September 30,** |   |
|-------------------------------------|--------|---------------------------------------|------------|--------------------------------------|--------|
|                                |   | **2003**                              |       | **2002**                             |   | **2003** |   | **2002** |   |
|                                |   | **(Restated)**                        |       |                                 |   | **(Restated)** |   |   |   |
|                                |   |                                  |       |                                 |   |   |   |   |   |
| Sales                               |   | $                                     | 2,239,935  |                                 | $      | 252,893 |   | $ | 5,463,915 |   | $ | 1,780,764 |   |
| Rental                              |   | 216,818                               |       | 358,044                              |   | 847,561 |   | 1,073,478 |   |
| Other                               |   | 9,399                                 |       | 14,431                               |   | 9,531 |   | 26,068 |   |
|                                |   |                                  |       |                                 |   |   |   |   |   |
|                                |   | 2,466,152                             |       | 625,368                              |   | 6,321,007 |   | 2,880,310 |   |
|                                |   |                                  |       |                                 |   |   |   |   |   |
| **Operating expenses:**             |   |                                  |       |                                 |   |   |   |   |   |
| Cost of sales                       |   | 1,403,546                             |       | 619,727                              |   | 3,566,691 |   | 2,384,200 |   |
| Selling, general and administrative |   | 1,267,831                             |       | 864,979                              |   | 4,303,496 |   | 2,314,672 |   |
| Research and development            |   | 336,910                               |       | 356,914                              |   | 709,770 |   | 1,077,838 |   |
|                                |   |                                  |       |                                 |   |   |   |   |   |
| Loss from operations                |   | (542,135                              | )          | (1,216,252                           | )      | (2,258,950 | ) | (2,896,400 | ) |
| Interest expense, unrelated parties |   | 620,569                               |       | 389,749                              |   | 1,709,430 |   | 1,006,314 |   |
| Interest expense, related parties   |   | 139,256                               |       | 115,439                              |   | 413,559 |   | 299,608 |   |
|                                |   |                                  |       |                                 |   |   |   |   |   |
| Total interest expense              |   | 759,825                               |       | 505,188                              |   | 2,122,989 |   | 1,305,922 |   |
|                                |   |                                  |       |                                 |   |   |   |   |   |
| Net loss                            |   | $                                     | (1,301,960 | )                                    | $      | (1,721,440 | ) | $ | (4,381,939 | ) | $ | (4,202,322 | ) |
|                                |   |                                  |       |                                 |   |   |   |   |   |
| Basic loss per share                |   | $                                     | (0.17      | )                                    | $      | (0.23 | ) | $ | (0.57 | ) | $ | (0.55 | ) |
|                                |   |                                  |       |                                 |   |   |   |   |   |
| Weighted average shares outstanding |   | 7,700,814                             |       | 7,625,814                            |   | 7,675,957 |   | 7,625,814 |   |

 

Seeaccompanying notes to financial statements.

 

2

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**VENDINGDATA CORPORATION**

** **

**Statementsof Cash Flows**

**(UNAUDITED)**

** **
|                                             |   | **Nine Months Ended  September 30,** |       |
|--------------------------------------------------|--------|--------------------------------------|------------|
|                                             |   | **2003**                             |       | **2002** |   |
| Net cash used in operating activities            |   | $                                    | (8,897,624 | ) | $ | (3,146,150 | ) |
|                                             |   |                                 |       |   |   |
| Cash flows from investing activities:            |   |                                 |       |   |   |
| Acquisition of intangible assets                 |   | (1,022,720                           | )          | — |   |
| Acquisition of plant and equipment               |   | (635,990                             | )          | (213,694 | ) |
| Acquisition of equipment produced for rental     |   | (9,500                               | )          | (509,301 | ) |
| Disposition of equipment produced for rental     |   | 785,600                              |       | — |   |
| Disposition of plant and equipment               |   | 705                                  |       | — |   |
| Deposits                                         |   | (204,794                             | )          | (134,263 | ) |
|                                             |   |                                 |       |   |   |
| Net cash used in investing activities            |   | (1,086,699                           | )          | (857,258 | ) |
|                                             |   |                                 |       |   |   |
| Cash flows from financing activities:            |   |                                 |       |   |   |
| Proceeds from sale of stock                      |   | 75                                   |       | — |   |
| Warrants                                         |   | 234,500                              |       | — |   |
| Options                                          |   | 171,170                              |       | — |   |
| Additional paid-in capital                       |   | 168,675                              |       | — |   |
| Proceeds from leases payable                     |   | 989,820                              |       | 2,241,926 |   |
| Repayment of leases payable                      |   | (2,110,205                           | )          | (1,986,421 | ) |
| Proceeds from short-term debt                    |   | 400,000                              |       | 3,285,000 |   |
| Proceeds from short-term convertible debt        |   | 4,000,000                            |       | — |   |
| Repayment of short-term debt                     |   | (384,000                             | )          | (595,950 | ) |
| Proceeds from issuance of convertible debentures |   | 5,050,000                            |       | 499,999 |   |
|                                             |   |                                 |       |   |   |
| Net cash provided by financing activities        |   | 8,520,035                            |       | 3,444,554 |   |
|                                             |   |                                 |       |   |   |
| Decrease in cash                                 |   | (1,464,288                           | )          | (558,853 | ) |
| Cash balance at beginning of period              |   | 1,778,297                            |       | 866,998 |   |
|                                             |   |                                 |       |   |   |
| Cash balance at end of period                    |   | $                                    | 314,009    |   | $ | 308,145 |   |

 

Seeaccompanying notes to financial statements.

 

3

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**VENDINGDATA CORPORATION**

 

**NOTES TO FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**Note 1—Basis of Presentation**

 

Theaccompanying unaudited financial statements of VendingData Corporation (the“Company”) have been prepared in accordance with generally accepted accountingprinciples for interim financial information and with the instructionsincorporated in Regulation S-B of the Securities and Exchange Commission.Accordingly, they do not include all of the information and footnotes requiredby generally accepted accounting principles for complete financial statements.In the opinion of management, all adjustments (consisting of normal recurringadjustments and accruals) considered necessary for a fair presentation havebeen included.

 

Theresults of operations for the periods presented are not necessarily indicativeof the results to be expected for the full year. The accompanying financialstatements should be read in conjunction with the Company’s audited financialstatements for the year ended December 31, 2002, as included in theCompany’s Annual Report on Form 10-KSB as filed with the Securities andExchange Commission from which the accompanying balance sheet information as ofthat date was derived. Certain reclassifications have been made to amountspresented in prior periods for comparability to the current period presentation.

 

Theaccompanying revised financial statements reflect the restatement for adoption,effective January 1, 2003, of the requirements of Emerging Issues Task Force("EITF") Issue No. 00-21, *RevenueArrangements with Multiple Deliverables*, thus deferring recognitionof an allocated portion of revenues from certain sales contracts initiated inthe second and third quarters of 2003, representing the estimated fair value ofextended warranty and maintenance services included therein.  Such deferred revenues are being amortizedover the applicable service periods in the contracts.  The effect of the restatement on the three-month and nine-monthperiods ended September 30, 2003, was to increase the net losses by $145,411and $440,971 respectively.  In addition,the Company has restated its financial statements for the three-month andsix-month periods ended June 30, 2003 and amended its Quarterly Report on Form10-QSB accordingly for the second quarter of 2003, increasing the previouslyreported deficit as of June 30, 2003, and previously reported net losses foreach of those periods, by $295,560.  Asummary of the effects of these changes follows:

 
|                                           |   | **Three  Months Ended  September 30, 2003** |       | **Nine  Months Ended  September 30, 2003** |   |
|------------------------------------------------|--------|---------------------------------------------|------------|--------------------------------------------|--------|
|                                           |   |                                        |       |                                       |   |
| Net loss as originally reported                |   | $                                           | (1,156,549 | )                                          | $      | (3,940,968 | ) |
| Effect of restatement for revenue  recognition |   | (145,411                                    | )          | (440,971                                   | )      |
| Net loss as restated                           |   | (1,301,960                                  | )          | (4,381,939                                 | )      |
|                                           |   |                                        |       |                                       |   |
| Per share amounts:                             |   |                                        |       |                                       |   |
| Net loss as originally reported                |   | (0.15                                       | )          | (0.51                                      | )      |
| Effect of restatement for revenue  recognition |   | (0.02                                       | )          | (0.06                                      | )      |
| Net loss as restated                           |   | (0.17                                       | )          | (0.57                                      | )      |
|                                                |        |                                             |            |                                            |        |  |  |

 

4

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Priorto 2003, the Company accounted for its stock option plans under the recognitionand measurement provisions of APB Opinion No. 25, “Accounting for StockIssued to Employees” (APB No. 25) and related interpretations. During thesecond quarter of 2003, the Company adopted the fair value recognitionprovisions of Statement of Financial Accounting Standards (“SFAS”) No. 123under the prospective transition method, effective as of January 1, 2003.For additional information, see Note 5—Options.

 

InNovember 2002, the Financial Accounting Standards Board (“FASB”) issuedInterpretation No. 45 (“FIN 45”), *Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others.*Among other things, FIN 45supplements the requirements of Statement of Financial Accounting Standards(“SFAS”) No. 5, Accounting for Contingencies, relating to disclosure withrespect to product warranties. As part of the normal sale of its products, theCompany has provided its customers with product warranties. The warranties varyon the terms of the sales agreement and by product line. The followingsummarizes the accrual of product warranties that is recorded as accruedexpenses in the accompanying balance sheet at September 30, 2003.

 

|                     |   | **Three Months  Ended  September 30,  2003** |   | **Nine Months  Ended  September 30,  2003** |   |
|--------------------------|--------|---------------------------------------------------|--------|--------------------------------------------------|--------|
| Opening Balance          |   | $                                                 | 16,721 |                                             | $      | 10,151 |   |
| Accruals for Warranties  |   | 22,604                                            |   | 29,174                                           |   |
| Payments in Period       |   | —                                            |   | —                                           |   |
|                     |   |                                              |   |                                             |   |
| Balance at end of Period |   | $                                                 | 39,325 |                                             | $      | 39,325 |   |

 

5

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**Note 2—Segments**

 

Thesegments identified for geographic region-based enterprise-wide data are asfollows:

 
|          |   | **Three Months Ended  September 30, 2003** |      | **Nine Months Ended  September 30, 2003** |   |
|---------------|--------|-------------------------------------------------|-----------|------------------------------------------------|--------|
|          |   | **Revenue**                                     |      | **Long-lived assets**                          |   | **Revenue** |   |
| United States |   | $                                               | 1,856,432 |                                           | $      | 2,890,728 |   | $ | 5,636,287 |   |
| Asia          |   | $                                               | 236,250   |                                           | $      | 112,123 |   | $ | 236,250 |   |
| Europe        |   | $                                               | 225,000   |                                           | – |   | $ | 300,000 |   |
| South America |   | $                                               | 148,470   |                                           | – |   | $ | 148,470 |   |

 

TheCompany’s revenues distributed by product are as follows:

 
| **Three Months Ended September 30, 2003** |    | **Nine Months Ended September 30, 2003** |   |
|------------------------------------------------|---------|-----------------------------------------------|--------|
| **Shufflers**                                  |    | **Deck  CheckersTM**                      |   | **SecureDrop®** |   | **Shufflers** |   | **Deck  CheckersTM** |   | **SecureDrop®** |   |
| $                                              | 670,409 |                                          | $      | 996,658 |   | $ | 789,786 |   | $ | 2,932,233 |   | $ | 1,224,770 |   | $ | 2,124,519 |   |
|                                                |         |                                               |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Note 3—Loss per Share (Basic and Diluted)**

 

Basicloss per share is computed by dividing net income (loss) available to commonstockholders by the weighted average number of shares of common stockoutstanding during the year. Diluted loss per share is computed by dividing netincome (loss) available to common stockholders by the weighted-average numberof shares of common stock outstanding during the year plus potential dilutiveinstruments such as stock options, warrants and convertible debt. The effect ofstock options on diluted loss per share is determined through the applicationof the treasury stock method, whereby proceeds received by the Company based onassumed exercises are hypothetically used to repurchase the Company’s commonstock at the average market price during the period.

 

Thebasic loss per share is computed by dividing the net loss for the period by theweighted average number of common shares outstanding for the period. Loss pershare is unchanged on a diluted basis since the assumed exercise of commonstock equivalents would have an anti-dilutive effect due to the existence ofoperating losses.

** **

**Note 4—Debt**

 

Inthe quarter ended September 30, 2003, the Company borrowed $3,000,000 at a10% interest rate, the principal and all accrued interest of which are due onNovember 22, 2003. At any time until the due date, the holder may convertup to 15% of its then outstanding principal amount into shares of the Company’scommon stock at $2.25 per share. In connection with this transaction, theCompany also issued warrants to purchase 225,000 shares of its common stock at$2.25 per share and agreed to issue additional five-year warrants to purchase50,000 shares of our common stock with an exercise price of $2.25 per share foreach $1,000,000 in principal that remains outstanding after November 22,2003.

 

Inaddition, the Company secured a 90-day convertible loan in the principal amountof $1,000,000 at a 10% interest rate, the principal and all accrued interest ofwhich were due on September 16, 2003. The Company also issued five-yearwarrants to the holder to purchase 50,000 shares of its common stock at a priceof $2.25 per share. The term of the note was extended until November 20,2003 in exchange for the issuance of additional five-year warrants to theholder to purchase 50,000 shares of the Company’s common stock at a price of$2.25 per share. Under the new terms, the holder may convert up to 15% of its

 

6

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then outstanding principal amount into sharesof the Company’s common stock at a rate of $2.25 per share. The Company alsoagreed to issue additional five-year warrants to purchase 50,000 shares of itscommon stock at $2.25 per share for each 30-day period that the note remainsoutstanding past November 20, 2003.

 

For additional informationon the Company’s current indebtedness, see Note 13—Subsequent Events.

 

**Note 5—Options**

 

The Company currently hastwo stock option plans. No stock-based employee compensation expense for stockoptions was reflected in net income for years prior to 2003, as all stockoptions granted under those plans had an exercise price equal to or greaterthan the fair market value of the underlying common stock on the date of grant.

 

The impact of the adoptionof the fair value method of accounting for stock-based compensation was anincrease to stock-based compensation expense of approximately $98,370 for thenine-month period ended September 30, 2003. This stock compensationexpense was recorded in selling, general and administrative expenses. As aresult of adopting SFAS No. 123 under the prospective transition method ofSFAS No. 148, prior periods have not been restated to reflect the impactof the fair value method.

 
|                                                                                                            |   | **Three Months Ended  September 30,** |       | **Nine Months Ended  September 30,** |       |
|-----------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|------------|--------------------------------------|------------|
|                                                                                                            |   | **2003**                              |       | **2002**                             |       | **2003** |   | **2002** |   |
| Net loss, as reported                                                                                           |   | $                                     | (1,301,960 | )                                    | $          | (1,721,440 | ) | $ | (4,381,939 | ) | $ | (4,202,322 | ) |
| Add—Stock-based employee compensation  expense included in reported net income, net of related tax effects |   | 67,338                                |       | —                               |       | 98,370 |   | — |   |
| Deduct—Stock-based employee compensation  expense determined under the fair value method                   |   | (108,070                              | )          | (41,231                              | )          | (171,170 | ) | (45,910 | ) |
|                                                                                                            |   |                                  |       |                                 |       |   |   |   |   |
| Net loss, pro forma                                                                                             |   | $                                     | (1,342,692 | )                                    | (1,762,671 | ) | $ | (4,454,739 | ) | (4,248,232 | ) |
|                                                                                                            |   |                                  |       |                                 |       |   |   |   |   |
| Basic and diluted net loss per share                                                                            |   |                                  |       |                                 |       |   |   |   |   |
| As reported                                                                                                     |   | $                                     | (0.17      | )                                    | $          | (0.23 | ) | $ | (0.57 | ) | $ | (0.55 | ) |
| Pro forma                                                                                                       |   | $                                     | (0.17      | )                                    | $          | (0.23 | ) | $ | (0.58 | ) | $ | (0.56 | ) |

 

**Note 6—GoingConcern**

 

The accompanying financialstatements have been prepared assuming that the Company will continue as agoing concern. The Company incurred a net loss of $4,381,939 for the ninemonths ended September 30, 2003. Additionally, the Company had a workingcapital deficiency of approximately $4,886,332 at September 30, 2003.Accordingly, the Company’s ability to continue as a going concern may bedependent upon the success of management’s plans to address and overcome theseconditions. Management’s plans with respect to these matters include reducingoperating costs through the manufacturing of component parts in China andrestructuring service functions to reduce labor and rental expense. Managementis evaluating sources of additional capital, including debt or equityfinancings. In September 2003, the Company filed a registration statementwith the United States Securities and Exchange Commission for a proposed publicoffering of up to 5,500,000 shares of its common stock. The registrationstatement has not yet been declared effective. Management believes that theincreased sales in the first nine months of 2003 indicate growing customeracceptance of the Company’s product line and

 

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will result in improvedrevenue. The Company may not be successful in raising additional capital or inachieving profitable operations. The accompanying financial statements do notinclude any adjustments that might be necessary should the Company be unable tocontinue as a going concern.

 

**Note 7—TradeReceivables From Major Customers**

 

As of and during the yearended December 31, 2002, approximately 10.2% of trade receivables and 39%of total sales were the result of a one-time transaction with a singlecustomer. As of and during the nine months ended September 30, 2003,approximately 24.7% of trade receivables and 21.29% of total sales wereconcentrated in the Nevada gaming industry among five customers under commonownership. The Company’s future operations could be affected by adverse changesin the financial condition of, or the Company’s relationships with, thecommonly owned Nevada gaming customers, or economic, competitive and politicalconditions in our customers’ respective local areas or the gaming industry, ingeneral.

 

Included in accountsreceivable, trade, at September 30, 2003, was $4,577,416 (with thenon-current portion, $1,439,294), net of unamortized discounts of $90,266.These receivables, which are payable over periods ranging from 20 monthsto 35 months, and related revenues arose from the sale of shufflers andDeck CheckersTM to major customers during the nine-month period endedSeptember 30, 2003, and were discounted in the Company’s financialstatements based on the fair value of the products sold resulting in imputedinterest rates ranging from 1.08% to 9.55%. As discussed in Note 1, above, these sales arrangements includedwarranty and maintenance services where reveneue has been deferred pursuant toEITF 00-21.

 

The Company manages itsconcentrations of credit risk by evaluating the creditworthiness of customers beforecredit is extended and monitoring it thereafter. The maximum losses that theCompany would incur if a customer failed to pay amounts owed would be limitedto the recorded receivables after any allowances provided.

 

**Note 8—Deposits**

 

The amounts of deposits(assets) were $1,073,313 and $868,520 as of September 30, 2003 andDecember 31, 2002 respectively. The table below sets forth the details ofthe deposits as of September 30, 2003:

 

| **Item**  |   | **Amount** |      |
|-----------|--------|------------|-----------|
| Rent      |   | $          | 52,039    |   |
| Leases    |   | $          | 631,399   |   |
| Vendors   |   | $          | 299,747   |   |
| Other     |   | $          | 90,128    |   |
|      |   |       |      |
| **Total** |   | $          | 1,073,313 |   |

 

**Note 9—IntangibleAssets**

 

FAS 142 requires thattangible assets with definite lives be amortized over their estimated usefullives and reviewed for impairment when events or changes in circumstances indicatethat the carrying amount of such assets may not be recoverable.  The Company has acquired patent rights forvarious products since 2001 and acquired the patent rights for the DeckCheckerTM for $1,004,900 in the third quarter of 2003.  The Company has estimated an economic useful life of ten yearsfor the Deck CheckerTM patents.  TheCompany currently amortizes its intangible assets on a straight-line basis overthe estimated useful lives of 10 years. Amortization taken to date as of September 30, 2003 was$249,130.  The following table setsforth the estimated aggregate amortization expenses for the next fiveyears:  

 

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| **Year** |   | **Amortization  Expense** |    |
|----------|--------|---------------------------|---------|
| 2004     |   | $                         | 156,045 |   |
| 2005     |   | $                         | 156,045 |   |
| 2006     |   | $                         | 156,045 |   |
| 2007     |   | $                         | 140,508 |   |
| 2008     |   | $                         | 138,050 |   |

** **

**Note 10—IncomeTaxes**

 

The deferred tax assetresulting from a net operating loss carryforward has been fully reservedresulting in an effective tax benefit rate of zero for the periods presented.

 

**Note 11—RelatedParty Transactions**

 

An officer and director ofthe Company has an outstanding balance due to the Company in an amount equal to$28,976 that is attributable to disbursements that were personal expenses overthe past five years. Subsequent to June 30, 2003, the officer and directorpaid $5,040, which represented the net balance due arising after July 30,2002, the effective date of the Sarbanes-Oxley Act of 2002.

 

**Note 12—Contingencies**

 

The Company is a party tocertain claims, legal actions, and complaints, including a patent infringementaction between the Company and one of its main competitors. The Company cannotpredict the likely outcome of any such litigation or whether any suchsubstantial litigation would have a material adverse effect on its business aspresently conducted or as anticipated.

 

**Note 13—SubsequentEvents**

 

On October 9, 2003 andOctober 21, 2003, the Company received bridge financing in the aggregateprincipal amount of $1,000,000. On October 21, 2003, the Company issued apromissory note in the principal amount of $1,000,000. The promissory notematures on January 2, 2004 and requires the payment of an interest fee inthe amount of $50,000 on the maturity date. The holder of the promissory notemay elect to waive payment of the interest fee in exchange for shares of theCompany’s common stock at a rate of $2.25 per share. For each 30-day periodthat the promissory note remains outstanding after January 2, 2004, theholder of the promissory note is entitled to a warrant to purchase 25,000 sharesof common stock with an exercise price of $2.25 per share. The proceeds fromthe bridge financing have been used for working capital purposes.

 

On November 5, 2003,the Company received bridge financing in the aggregate principal amount of$1,000,000. The promissory note matures on January 12, 2004 and requiresthe payment of an interest fee in the amount of $50,000 on the maturity date.The holder of the promissory note may elect to waive payment of the interestfee in exchange for shares of the Company’s common stock at a rate of $2.25 pershare. For each 30-day period that the promissory note remains outstandingafter January 12, 2004, the holder of the promissory note is entitled to awarrant to purchase 25,000 shares of common stock with an exercise price of$2.25 per share. The proceeds from the bridge financing have been used forworking capital purposes.

 

The Company has agreed toissue a promissory note convertible into 177,777 shares of common stock, wherethe convertible note will be issued upon the surrender of two notes in theaggregate principal amount of $400,000 held by a charitable foundation forwhich the Company’s Chairman of the Board is one of three trustees.

 

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**ITEM2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS.**

 

The following discussionshould be read in conjunction with our financial statements and notes to ourfinancial statements, 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,” “predicts,” “potential” or “continue” or the negative of suchterms or other comparable terminology. These statements are only predictionsand involve known and unknown risks, uncertainties and other factors that maycause our actual results, levels of activity, performance or achievements to bematerially different from any future results, levels of activity, performanceor achievements expressed or implied by any forward-looking statements. Theserisks and uncertainties include, but are not limited to, the following:

 

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

 

•                       Competition in the gaming industry;

 

•                       Regulatory and judicial proceedings;

 

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

 

•                       Continued growth in the gaming industry;

 

•                       Changes in our business strategy or plans;

 

•                       Product development, product placement, andthe acceptance of our products in the marketplace;

 

•                       Loss of any of our management or key personnel;

 

•                       Financing sources and availability of capital to fundand sustain our operations; and

 

•                       Leverage and debt service (includingsensitivity to fluctuations in interest rates).

 

Although we believe that theexpectations reflected in our forward-looking statements are reasonable, wecannot guarantee future results, levels of activity, performance orachievements. We are under no duty to update any of the forward-lookingstatements after the date of this report to conform these statements to actualresults.

 

**OVERVIEW**

 

For a complete descriptionof our products, please review our most recent Annual Report onForm 10-KSB/A filed with the Securities and Exchange Commission onApril 28, 2003.

 

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**Business Strategy**

 

While we transitioned from adevelopment stage to an operating company in 2000, we have continued to developand acquire new products. The focus on the development and acquisition of newproducts is reflected in our operating results. Our strategy to increaserevenue and margins is based on four key factors:

 

•                       ***Developmentof two product lines with limited competition.*** Our ability to offer the SecureDrop® Systemand the Deck CheckerTM have given us two product lines that our informalindustry and patent research led us to conclude have limited or virtually nocompetition. In contrast, our shuffler products face intense competition dueprimarily to the dominance in the installed shuffler market base in NorthAmerica by Shuffle Master, Inc. In this regard, during 2001 and 2000, whena substantial portion of our revenue was generated by our shuffler products,our margins declined. By offering two products with limited competition, ourmanagement believes that we will have a significant competitive advantage asour products are installed and become accepted by the gaming industry.

 

•                       ***Expansioninto additional domestic gaming markets and into international gaming marketsfor our products.*** Theglobal economic downturn has forced non-gaming jurisdictions to look at newways to raise revenue. Accordingly, from time to time different states andforeign countries may consider legalizing various forms of casino gaming as anadditional revenue source. These include slot machines at racetracks, NativeAmerican Class-III casinos and Las Vegas-style casinos. The worldwide expansionof gaming should provide new markets for our products, and we have targetedsales opportunities in these new markets in addition to our traditionalestablished gaming markets.

 

•                       ***Increasein the market penetration of our products.*** Since we have only recently introducedcertain elements of our SecureDrop® System in 2002 and only introduced the DeckCheckerTM in early 2003, the market penetration of these products is low. As aresult of the positive feedback received from senior executives from Park PlaceEntertainment Corporation, the parent company of over 27 casinosinternationally, on the installations of the SecureDrop® Soft Count Module inthe first half of 2003, our management believes that our products are gainingacceptance in the industry, and we are seeking to increase the marketpenetration of our products.

 

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

 

•                       *Reducing the cost of ourcomponent parts through the use of production facilities in China*. By opening an office, manufacturing,service and warehouse facility in Xiaolan Town in Zhongshan City, China, wepropose to shift our component sources to China and lower our costs. To date,we have shifted the production of over 80% of the components of the SecureDrop®System and our shufflers to China. As a result, our management estimates thatthe cost of such components will decrease from approximately 40% of revenue toapproximately 20% of revenue. Although we propose to outsource many componentsof our products, we intend to maintain a five- to six-month inventory ofcomponents at our principal offices in Las Vegas, Nevada.

 

•                       *Closing two of our fiveregional service locations and centralizing all technical service functions toour facilities in Las Vegas, Nevada.* The use of five service

 

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locations with techniciansand customer service representatives for the repair and service of ourshufflers has not been cost effective. By closing the Atlantic City, New Jerseyand Miami, Florida service locations and relying more on the use of sparemachines, we have centralized all technical service functions in Las Vegasduring the third quarter of 2003. The remaining service locations will continueto provide non-technical support through customer service representatives.

 

•                       *Eliminating our Boise,Idaho research facility and consolidating the management of the research anddevelopment related to our table game and slot support products in Las Vegas.* Our management believes that consolidatingall research and development to Las Vegas with support from our facility inChina will speed development and be more efficient in the set up of themanufacturing of our new products. The Boise facility was closed onJune 30, 2003.

 

•                       *Implementing a new computersystem designed to improve productivity through the use of eleven modules,including a financial and manufacturing application*. Our new computer software will provide anintegrated control process for purchasing, inventory control and manufacturingin our Las Vegas and China facilities. The implementation will be complete inthe fourth quarter of 2003.

 

**CRITICALACCOUNTING POLICIES AND ESTIMATES**

 

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

 

***Allowance for Doubtful Accounts.***

 

In connection with thepreparation of our financial statements, management reviews and evaluates thecollectibility of our trade receivables and adjusts our allowance for estimateduncollectible accounts as deemed necessary in the circumstances. Theseestimates have the potential for critically affecting the determination ofresults of operations for any given period. Factors considered by management inmaking such estimates and adjustments include any concentrations amongcustomers, changes in our relationships therewith, payment history and theapparent financial condition thereof.

 

***Revenue Recognition.***

 

We recognize revenue fromthe sale of our products upon installation and functional testing at customerlocations because that is when the customer’s obligation becomes fixed andcertain pursuant to our standard contracts for the sale of units of theSecureDrop® System, shufflers and Deck CheckersTM.  Sales are recognized immediately when shufflers that are rentedare converted to purchases or there is a long-term contract for new equipmentdepending on the creditworthiness and payment history of the casino companysince payment terms are from 20 to 48 months.  The extended warranty and maintenance components that are part oflong term sales contracts are unbundled and the related revenue is deferred andamortized over the remaining life of the sales agreement after the initial90-day warranty as required by the Emerging Issues Task Force Issue No. 00-21, *Revenue Arrangements with Multiple Deliverables*.  The estimated useful life of our shufflersand Deck CheckersTM is five years with proper maintenance; the life can beextended with the replacement of component parts.  If the customer does not possess the required creditworthiness oran established payment history with us, we would then book the revenue as aninstallment sale and recognize it over time as payments are received.  Revenue from shuffler rentals is recorded atthe first of each month in accordance with rental contract terms.  All rental contracts are cancelable upon30-day written notice by the customer. Maintenance expense for rental units is recorded in the period it isincurred.  Although

 

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sales are not generally madewith a right to return, upon occasion, usually associated with the performancewarranty, sales returns and allowances are recorded after returned goods arereceived and inspected.  We providecurrently for estimated warranty repair costs associated with sales contracts.  We do provide for stand-alone maintenancecontracts that are billed and recognized on a monthly basis.

 

***Intangible Assets.***

 

FAS 142 requires thattangible assets with definite lives be amortized over their estimated usefullives and reviewed for impairment when events or changes in circumstances indicatethat the carrying amount of such assets may not be recoverable. We haveacquired patent rights for various products since 2001 and acquired the patentrights for the Deck CheckerTM for $1,004,900 in the third quarter of 2003. TheCompany has estimated an economic useful life of ten years for the DeckCheckerTM patents. We currently amortize our intangible assets on astraight-line basis over the estimated useful lives of 10 years.

 

***Stock-Based Compensation.***

 

We currently have two stockoption plans. No stock-based employee compensation expense for stock optionswas reflected in net income for years prior to 2003, as all stock optionsgranted under those plans had an exercise price equal to or greater than thefair market value of the underlying common stock on the date of grant.

 

The impact of the adoptionof the fair value method of accounting for stock-based compensation was anincrease to stock-based compensation expense of approximately $98,370 for thenine-month period and $67,338 for the three month period ended September, 30,2003. This stock compensation expense was recorded in selling, general andadministrative expenses.

 

**FINANCIAL CONDITION**

 

During the three monthsended September 30, 2003, total assets increased by $6,272,676 from$8,066,746 at December 31, 2002 to $14,339,422 at September 30, 2003.Accounts receivable (trade) increased from $106,791 to $3,138,172 betweenDecember 31, 2002 and September 30, 2003. The primary reasons for theincrease in trade receivables were the installation of the SecureDrop® Systemat Paris Las Vegas and Bally’s Las Vegas, the conversion of shuffler rentals topurchases and the sale of Deck CheckersTM on terms. Inventories have increasedduring the current period by $1,897,576 from $1,850,051 at December 31,2002 to $3,747,627 at September 30, 2003. The increase is primarily due tothe purchase of 200 Deck CheckersTM and related components and SecureDrop®components. In addition, as we move more manufacturing to China, the level ofinventories at our Las Vegas facility will increase in order to maintain afive- to six-month inventory on hand to guard against unexpected transportinterruptions.

 

Total liabilities haveincreased from $18,109,398 at December 31, 2002 to $28,189,593 atSeptember 30, 2003. Accounts payable increased from $1,084,637 atDecember 31, 2002 to $2,079,829 at September 30, 2003 primarily dueto costs associated with our proposed common stock offering, the purchase ofthe intellectual property for the Deck CheckerTM and the components for onehundred Deck CheckerTM units. Convertible debt increased primarily due toprivate placements of an additional $4,000,000 in short term convertible notesduring the quarter ended September 30, 2003. Short-term debt increasedfrom $904,743 at December 31, 2002 to $920,743 at September 30, 2003due to a short-term loan.

 

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**RESULTS OF OPERATIONS**

 

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

 

**Revenue**

 

Forthe three months ended September 30, 2003, we generated total revenues of$2,466,152 compared to $625,368 for the three months ended September 30,2002, an increase of $1,840,784 or 294.4%. Our revenues for the three monthsended September 30, 2003 consisted of SecureDrop® sales of $789,786,shuffler sales of $453,591, shuffler rentals of $216,818, Deck CheckerTM salesof $996,558 and miscellaneous other income of $9,399. The increase in revenuewas primarily due to increases in SecureDrop® sales, shuffler sales, DeckCheckerTM sales and Deck CheckerTM leases, offset, in part, by a decrease inshuffler rentals. The increase in shuffler sales and the decrease in shufflerrentals reflected the trend with customers to shift from the rental to thepurchase of shufflers.

 

**Revenues—SecureDrop® Sales.**    For the three monthsended September 30, 2003, we generated revenue from the sale of ourSecureDrop® products of $789,786, compared to $146,893 for the three monthsended September 30, 2002, an increase of $642,893, or 437.7%. The increasein revenue was due primarily to the SecureDrop® installations at Paris LasVegas and Bally’s Las Vegas and the sales of the SecureDrop® Soft Count Moduleduring the three months ended September 30, 2003. The SecureDrop® SoftCount Module was not available for sale during the three months endedSeptember 30, 2002.

 

**Revenues—Shuffler Sales.**    For the three monthsended September 30, 2003, we generated revenue from the sale of ourshufflers of $453,591, compared to $106,000 for three months endedSeptember 30, 2002, an increase of $347,591. We made a strategic decisionto offer our customers the choice to either continue renting or instead topurchase our shufflers for the same monthly payments. This decision was basedon competitive forces in the marketplace and the anticipated introduction ofour next generation shufflers in 2004. By offering some of our customers theability to trade up to the new shufflers when approved by the relevantregulatory bodies, we will be able to obtain binding purchase commitments forour shufflers and ensure that our products are not readily replaced with thoseof our competitors. We believe that the trend for shuffler revenues will betowards shuffler sales due to the current availability of lower interest ratesfor sales with terms.

 

**Revenue—Shuffler Rentals.**    For the three monthsended September 30, 2003, we generated revenue from the rental of ourshufflers of $216,818, compared to $358,044 for the three months endedSeptember 30, 2002, a decrease of $141,226, or 39.4%. The decrease inshuffler rentals was primarily due to the shift of our customers to shufflersales.

 

**Revenue—Deck CheckerTM Sales and Rentals.**    For the three monthsended September 30, 2003, we generated revenue from the sale and therental of our Deck CheckerTM of $943,626 and $52,932, respectively. As the DeckCheckerTM is a new product this year, there was no revenue related to it for thethree months ended September 30, 2002.

 

**Revenue—Other Income.**    For the three monthsended September 30, 2003, we generated other income of $9,399 compared to$14,431 for the three months ended September 30, 2002, a decrease of$5,032 or 34.9%.

 

**Cost of Sales**

 

For the three months endedSeptember 30, 2003, our cost of sales was $1,403,546 compared to $619,727for the three months ended September 30, 2002, an increase of $783,819 or126.5%. Our cost of sales for the three months ended September 30, 2003included cost of SecureDrop® sales of $355,236,

 

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cost of shuffler sales of$46,304, cost of Deck CheckerTM sales of $254,177, shuffler rental depreciationof $141,252, shuffler service costs of $245,753, manufacturing costs of$335,273, warranty costs of $22,604 and other expenses of $2,946. We believethat the outsourcing of components from China will continue the trend ofreducing the per unit cost of sales through the fourth quarter of 2003. Thegross margin on revenue for the three months ended September 30, 2003 was$1,062,606, or 43.1%, compared to the gross margin on revenue for the threemonths ended September 30, 2002 of $5,641, or 0.9%. The improvement ingross margin from 0.9% to 43.1% from the three months ended September 30,2002 to the three months ended September 30, 2003 reflects the continuinggoal to lower the cost per unit sold through the transfer of manufacturingoperations to China and the benefits of economies of scale achieved throughincreased production.

 

The following discussion ofcost of sales by principal product does not include certain costs that are notallocated to individual products.

 

**Cost of Sales—SecureDrop® Sales.**    Our cost ofSecureDrop® sales was $355,236 for the three months ended September 30,2003 compared to $165,792 for the three months ended September 30, 2002,representing an increase of $189,444, or 114.3%. The increase in the cost ofSecureDrop® sales resulted from the increase in SecureDrop® sales during thethree months ended September 30, 2003.    The grossmargin on revenue from SecureDrop® sales was $434,550, or 55.0%, for the threemonths ended September 30, 2003 compared to gross margin deficit of$18,899, or (12.9%), for the three months ended September 30, 2002. Theimprovement in gross margin and gross margin percentage on our SecureDrop®sales resulted primarily from the lower manufacturing costs in China and thelower per unit labor costs related to increased unit production.

 

**Cost of Sales—Shuffler Sales.**    Our cost of shufflersales revenue was $46,304 for the three months ended September 30, 2003compared to $0 for the three months ended September 30, 2002. The increasein cost of shuffler sales revenue resulted from the increase in shuffler salesthrough conversions during the three months ended September 30, 2002. Thegross margin on revenue from shuffler sales was $407,287, or 89.8%, for thethree months ended September 30, 2003. The gross margin on revenue fromshuffler sales resulted from the sale of rental units that had beensubstantially depreciated.

 

**Cost of Sales—Deck CheckerTM.**    For the three monthsended September 30, 2003, our cost of sales from the sale and rental ofour Deck CheckerTM was $254,177, resulting in a gross margin on revenue fromDeck CheckerTM sales of $689,449, or 73.1%. There were no comparable numbers forthe three months ended September 30, 2002 as this product was notavailable for sale last year.

 

**Selling, General and Administrative Expense**

 

For the three months endedSeptember 30, 2003, our selling, general and administrative expenses were$1,267,831 compared to $864,979 for the three months ended September 30,2002, an increase of $402,852, or 47.0%. The increase in selling, general andadministrative expenses related primarily to travel and lodging to set up theoffice, assembly area and warehouse facility in China, legal fees associatedwith the Shuffle Master litigation, and regulatory expenses. For moreinformation, see “Part II, Item 1—Legal Proceedings.”

 

Our selling, general andadministrative expenses for the three months ended September 30, 2003consisted of the following: salaries and related costs of $629,385; consultingservices of $52,671; advertising and marketing costs of $24,735; travel andentertainment costs of $94,859; gaming industry shows costs of $39,738; rent of$52,575; repairs and maintenance expenses of $13,785; legal and regulatoryexpenses of $146,073; supplies of $31,792; insurance expenses of $7,370;depreciation and amortization of $81,750; and other expenses of $93,098.

 

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**Research and Development Expense**

 

For the three months endedSeptember 30, 2003, research and development expenses were $336,910,compared to $356,914 for the three months ended September 30, 2002, adecrease of $20,004, or 5.6%. Notwithstanding the nominal decrease in researchand development expenses, we continue to incur continuous research anddevelopment expenses related to the continued development of our product lines.

 

**Interest Expense**

 

For the three months endedSeptember 30, 2003, we incurred interest expense of $759,825, compared to$505,188 for the three months ended September 30, 2002, an increase of$254,637, or 50.4%. The increase in interest expense was primarily attributableto increased borrowings necessary to sustain our operations.

 

**Net Loss**

 

For the three months endedSeptember 30, 2003, we had a net loss of $1,301,960, compared to a netloss of $1,721,440 for the three months ended September 30, 2002, adecreased net loss of $419,480, or 24.4%. Basic loss per share was $0.17 forthe three months ended September 30, 2003, compared to $0.23 for the threemonths ended September 30, 2002. The decrease in net loss and the decreasein basic loss per share resulted from the $1,840,784 increase in revenue, offset,by the $1,166,667 increase in operating expenses and the $254,637 increase ininterest expense.

 

***Comparison of Nine Months Ended September 30, 2003 and 2002***

 

**Revenue**

 

For the nine months endedSeptember 30, 2003, we generated total revenues of $6,321,007, compared to$2,880,310 for the nine months ended September 30, 2002, an increase of$3,440,697, or 119.5%. Our revenues for the nine months endedSeptember 30, 2003 consisted of SecureDrop® sales of $2,124,519, shufflersales of $2,082,422, shuffler rentals of $849,811, Deck CheckerTM sales of$1,224,770 and miscellaneous other income of $39,485. The increase in revenuewas primarily due to increases in SecureDrop® sales, shuffler sales, DeckCheckerTM sales and Deck CheckerTM leases, offset, in part, by a decrease inshuffler rentals.

 

**Revenues—SecureDrop® Sales.**    For the nine monthsended September 30, 2003, we generated revenue from the sale of ourSecureDrop® products of $2,124,519, compared to $1,667,314 for the nine monthsended September 30, 2002, an increase of $457,205, or 27.4%. The increasein revenue was due primarily to the SecureDrop® installations at Paris LasVegas and Bally’s Las Vegas and the sales of the SecureDrop® Soft Count Moduleduring the nine months ended September 30, 2003. The SecureDrop® SoftCount Module was not available for sale until the fourth quarter of 2002.

 

**Revenue—Shuffler Sales.**    For the nine monthsended September 30, 2003, we generated revenue from the sale of ourshufflers of $2,082,422, compared to $113,450 for nine months endedSeptember 30, 2002, an increase of $1,968,972. We made a strategicdecision to offer our customers the choice to continue renting or insteadpurchase our shufflers for the same monthly payments. This decision was basedon competitive forces in the marketplace and the anticipated introduction ofour next generation shufflers in 2004. By offering some of our customers theability to trade up to the new shufflers when approved by the relevantregulatory bodies, we will be able to obtain binding purchase commitments forour shufflers and ensure that our products are not readily replaced with thoseof our

 

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competitors. We believe thatthe trend for shuffler revenues will be towards shuffler sales due to thecurrent availability of lower interest rates for sales with terms.

 

**Revenue—Shuffler Rentals.**    For the nine monthsended September 30, 2003, we generated revenue from the rental of ourshufflers of $849,811, compared to $1,073,478 for the nine months endedSeptember 30, 2002, a decrease of $223,667, or 20.8%. The decrease inshuffler rentals reflected the increasing preference to purchase shufflersrather than lease shufflers.

 

**Revenue—Deck CheckerTM Sales and Rentals.**    For the nine monthsended September 30, 2003, we generated revenue from the sale and therental of our Deck CheckerTM of $1,135,729 and $89,041, respectively. As theDeck CheckerTM is a new product this year, there was no revenue related to itfor the nine months ended September 30, 2002.

 

**Revenue—Other Income.**    For the nine monthsended September 30, 2003, we generated other income of $39,485 compared to$26,068 for the nine months ended September 30, 2002, an increase of$13,417 or 51.5%.

 

**Cost of Sales**

 

For the nine months endedSeptember 30, 2003, our cost of sales was $3,566,691, compared to$2,384,200 for the nine months ended September 30, 2002, an increase of$1,182,491, or 49.6%. Our cost of sales for the nine months endedSeptember 30, 2003 included cost of SecureDrop® sales of $1,019,290, costof shuffler sales of $359,505, cost of Deck CheckerTM sales of $344,700,shuffler rental depreciation of $426,269, shuffler service costs of $671,311,manufacturing costs of $568,074, warranty costs of $29,174 and other expensesof $148,368. The gross margin on revenue for the nine months endedSeptember 30, 2003, was $2,754,316, or 43.6%, compared to the gross marginon revenue for the nine months ended September 30, 2002, of $496,110, or17.2%. The improvement in gross margin from 17.2% to 43.6% from the nine monthsended September 30, 2002, to the nine months ended September 30,2003, reflects the continuing goal to lower the cost per unit sold through thetransfer of manufacturing operations to China and the benefits of economies ofscale achieved through increased production.

 

The following discussion ofcost of sales by principal product does not include certain costs that are notallocated to individual products.

 

**Cost of Sales—SecureDrop® Sales.**    Our cost ofSecureDrop® sales was $1,019,290 for the nine months ended September 30,2003 compared to $1,043,430 for the nine months ended September 30, 2002,representing a minimal decrease of $24,140, or 2.3%. Although our revenue fromSecureDrop® sales increased from the nine months ended September 30, 2003compared to the nine months ended September 30, 2002, our costs of salesremained relatively constant due to increased efficiencies in manufacturing andassembly of our products. The gross margin on revenue from SecureDrop® saleswas $1,105,229, or 52.0%, for the nine months ended September 30, 2003compared to a gross margin of $623,884, or 37.4%, for the nine months endedSeptember 30, 2002. The improvement in gross margin and gross marginpercentage on our SecureDrop® sales resulted primarily from the lowermanufacturing costs in China and the lower per unit labor costs related toincreased unit production.

 

**Cost of Sales—Shuffler Sales.**    Our cost of shufflersales revenue was $359,505 for the nine months ended September 30, 2003compared to $51,200 for the nine months ended September 30, 2002. Theincrease in cost of shuffler sales revenue resulted primarily from theincreased sales of our shufflers through conversions during the nine monthsended September 30, 2003. The gross margin on revenue from shuffler saleswas $1,722,917 or 82.7%, for the nine months ended September 30, 2003,compared to a gross margin of $62,250, or 54.9%, for the nine months ended September 30,2002. The improvement

 

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in gross margin on shufflersales resulted from the sale of rental units that had been substantiallydepreciated.

 

**Cost of Sales—Deck Checker**TM. For the nine months endedSeptember 30, 2003, our cost of sales from the sales and rental of ourDeck CheckerTM was $344,700, resulting in a gross margin on revenue from DeckCheckerTM sales of $791,029 or 69.6%. There were no comparable numbers for the threemonths ended September 30, 2002 as this product was not available for salelast year.

 

**Selling, General and Administrative Expense**

 

For the nine months endedSeptember 30, 2003, our selling, general and administrative expenses were$4,303,496, compared to $2,314,672 for the nine months ended September 30,2002, an increase of $1,988,824, or 85.9%. Our selling, general andadministrative expenses for the nine months ended September 30, 2003consisted of the following: selling, salaries and related costs of $1,567,439;consulting services of $218,230; advertising and marketing costs of $49,805;travel and entertainment costs of $510,990; gaming industry trade show costs of$94,385; rent of $265,522; repairs and maintenance expenses of $56,335; legaland regulatory expenses of $717,666; supplies of $119,972; insurance expensesof $26,268; depreciation and amortization of $301,684; and other expenses of$375,200.

 

The increase in selling,general and administrative expenses related primarily to a $676,186 increase inselling, salaries and related costs, a $249,331 increase in travel andentertainment costs, a $717,586 increase in legal and regulatory expenses and a$347,117 increase in other expenses. Many of the increases related to the costsassociated with establishing the office, assembly area and warehouse facilityin China, the legal fees incurred with respect to the Shuffle Master litigationand the continuing regulatory expenses.

 

**Research and Development Expense**

 

For the nine months endedSeptember 30, 2003, research and development expenses were $709,770,compared to $1,077,838 for the nine months ended September 30, 2002, adecrease of $368,068, or 34.1%. The decrease in research and developmentexpenses was primarily due to the consolidation of our Boise, Idaho researchfacility into the Las Vegas office.

 

**Interest Expense**

 

For the nine months endedSeptember 30, 2003, we incurred interest expense of $2,122,989, comparedto $1,305,922 for the nine months ended September 30, 2002, an increase of$817,067, or 62.6%. The increase in interest expense was primarily attributableto increased borrowings necessary to sustain our operations.

 

**Net Loss**

 

For the nine months endedSeptember 30, 2003, we had a net loss of $4,381,939, compared to a netloss of $4,202,322 for the nine months ended September 30, 2002, anincrease of $179,617, or 4.3%.  Basicloss per share was $0.57 for the nine months ended September 30, 2003,compared to $0.55 for the nine months ended September 30, 2002. Theincrease in net loss and the increase in basic loss per share resulted from the$2,803,247 increase in operating expenses and the $817,067 increase in interestexpense offset by the $3,440,777 increase in revenue.

 

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**LIQUIDITY ANDCAPITAL RESOURCES**

 

**Overview**

 

Because of our efforts totransition from a development stage company to an operating company, we havegenerated substantial cash flow deficits from operations, including cash usedin operating activities of $8,897,624, $5,206,489 and $5,712,867 in the ninemonths ended September 30, 2003 and the years ended December 31, 2002and 2001, respectively. In addition, to fund our development and operatingactivities, we have been provided cash by financing activities of $8,520,035,$6,683,001 and $6,430,282 during the nine months ended September 30, 2003and the years ended December 31, 2002 and 2001, respectively.

 

Consequently, we have beensubstantially dependent on cash from financing activities to fund ourdevelopment and operating activities. We will continue to require cash fromfinancing activities for our current operating needs until our operationsgenerate sufficient cash flow to provide for such cash requirements.

 

**Sources of Capital**

 

Until normalized saleslevels are achieved such that our revenue is sufficient to sustain ouroperations, we will be relying upon private and institutional sources of debtand equity, and we may seek public, private and institutional sources ofcapital for working capital purposes. During the nine months endedSeptember 30, 2003 and the year ended December 31, 2002, our sourcesof capital included equipment financing from a third party, short-term notesfrom stockholders, convertible debentures and other private sources of capital.

 

With respect to ourequipment financing where we have sold and leased back most of our furniture,equipment, tooling and shufflers held for rent, we have received proceeds of$2,241,926 and repaid $1,986,421 for the year ended December 31, 2002 andhave received proceeds of $989,820 and repaid $2,110,205 for the nine monthsended September 30, 2003. As of September 30, 2003, we hadoutstanding equipment financing of $4,663,715. These equipment leases haveterms of 36 to 39 months and were not recorded as sales because each ofthe leases 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$400,000 and repaid $384,000 for the nine months ended September 30, 2003.As of September 30, 2003, we had outstanding short-term loans in theaggregate amount of $920,743. Historically, we have been substantiallydependant on short-term loans from our principal stockholder and otherdirectors. Despite such reliance, neither our principal stockholder nor ourdirectors are obligated to provide additional financing to us, and ourprincipal stockholder and directors are free to decline to fund additionalfinancings to us at any time. In such event and in the absence of third partyfinancing sources, we may have substantial difficulties in raising additionalfinancings.

 

With respect to ourconvertible debentures, including our short-term convertible notes, we receivedproceeds of $3,249,999 and $9,050,000 during the year ended December 31,2002 and the nine months ended September 30, 2003, respectively, and haveoutstanding convertible debentures in the aggregate amount of $17,903,072 as ofSeptember 30, 2003. The recent issuance of convertible debentures includethe following:

 

•                  From December 2002 to May 2003, weconducted a private placement of 10% senior notes in the aggregate principalamount of $7,500,000 and warrants to purchase 900,000 shares of common stock.The warrants were issued at a rate of warrants to purchase 6,000 shares per

 

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$50,000 of 10% senior notessold. The 10% senior notes require the payment of accrued interestsemi-annually in arrears with the principal due on December 15, 2005, and,at any time after December 15, 2004, and until June 15, 2005, holdersof these notes may convert up to 15% of their then outstanding principal intoshares of our common stock at a rate of $2.25 per share.

 

•                  In June 2003, we secured a 90-dayconvertible loan from Triage Capital Management LP in the principal amount of$1,000,000 at a 10% interest rate, the principal and all accrued interest ofwhich were due on September 16, 2003. We also issued warrants to TriageCapital Management LP to purchase 50,000 shares of our common stock at a priceof $2.25 per share and agreed to issue additional five-year warrants topurchase 25,000 shares of our common stock at $2.25 per share for each 30-dayperiod that the note remains outstanding past September 16, 2003. The termof the note was extended until November 20, 2003 in exchange for ourissuance of additional five-year warrants to Triage Capital Management LP topurchase 50,000 shares of our common stock at a price of $2.25 per share. Underthe new terms, Triage Capital Management LP may convert up to 15% of its thenoutstanding principal amount into shares of our common stock at a rate of $2.25per share and will be issued additional five-year warrants to purchase 50,000shares of our common stock at a price of $2.25 per share for each 30-day periodthat the note remains outstanding past November 20, 2003.

 

•                  In July 2003, we borrowed $3,000,000from Mellon HBV SPV, LLC, an affiliate of Mellon Bank, at a 10% interest rate,the principal and all accrued interest of which are due on November 22,2003. At any time until the due date, the holder may convert up to 15% of itsthen outstanding principal amount into shares of our common stock at a rate of$2.25 per share. In connection with this transaction, we also issued warrantsto purchase 225,000 shares of our common stock at $2.25 per share and agreed toissue additional warrants to purchase 50,000 shares of our common stock with anexercise price of $2.25 per share for each $1,000,000 in principal that remainsoutstanding after November 22, 2003.

 

•                  On October 9, 2003 and October 21,2003, we received bridge financing from Triage Offshore Fund, Ltd. in theaggregate principal amount of $1,000,000. On October 21, 2003, we issued apromissory note in the principal amount of $1,000,000. The promissory notematures on January 2, 2004 and requires the payment of an interest fee inthe amount of $50,000 on the maturity date. Triage Offshore Fund, Ltd. mayelect to waive payment of the interest fee in exchange for shares of our commonstock at a rate of $2.25 per share. For each 30-day period that the promissorynote remains outstanding after January 2, 2004, Triage OffshoreFund, Ltd. is entitled to a warrant to purchase 25,000 shares of common stockwith an exercise price of $2.25 per share. The proceeds from the bridgefinancing have been used for working capital purposes.

 

•                  On November 5, 2003, we received bridgefinancing from LC Capital Master Fund, Ltd. in the aggregate principalamount of $1,000,000. The promissory note matures on January 12, 2004 andrequires the payment of an interest fee in the amount of $50,000 on thematurity date. LC Capital Master Fund, Ltd. may elect to waive payment ofthe interest fee in exchange for shares of our common stock at a rate of $2.25per share. For each 30-day period that the promissory note remains outstandingafter January 12, 2004, LC Capital Master Fund, Ltd. is entitled to awarrant to purchase 25,000 shares of common stock with an exercise price of$2.25 per share. The proceeds from the bridge financing have been used forworking capital purposes.

 

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Due to our significant cashand working capital requirements, our management is currently evaluating othersources of financing. Through the filing of a registration statement with theSecurities and Exchange Commission (File No. 333-109115), we are currentlyin the process of registering a minimum of 3,000,000 shares and a maximum of5,500,000 shares of common stock for sale to the public. This registrationstatement has not yet been declared effective. We may also seek additionalpublic 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.

 

**Outlook**

 

Based on presently knowncommitments and plans, we believe that we will be able to fund our operationsand required expenditures for the next twelve months from cash on hand,including funds remaining from recent short-term loans, cash flow fromoperations, cash from our private placement of convertible 10% senior notes,cash from the net proceeds of our proposed public offering and cash from debtor equity financings or from lease financing sources. The sale of the minimumnumber of shares at the proposed offering price in our proposed public offeringwill allow us to satisfy our obligations under our short-term bridge financingsand to repay a portion of our convertible debt. However, if we sell the maximumnumber of shares at the proposed offering price in our proposed publicoffering, we will be able to retire $7,500,000 of our 10% convertible notes andstill have adequate funds available with which to fund inventory and use forgeneral corporate purposes. In the event that we need additional capital andshould we not complete our proposed public offering, we will need to seek cashfrom private or public placements of debt or equity, institutional or otherlending sources, to sell certain assets or to change operating plans toaccommodate our liquidity issues. If we do not complete our proposed publicoffering, we may also need to seek cash to fund the repayment of the $1,000,000and $3,000,000 short-term loans due in November 2003 and the repayment ofthe $2,000,000 short-term loans due in January 2004. In this quarterlyreport for the period ended September 30, 2003, the notes to our financialstatements express uncertainty as to our ability to continue as a goingconcern. No assurances can be given that we will successfully obtain liquiditysources necessary to fund our operations in the upcoming year. If adequatefunds are not available or are not available on acceptable terms, we may, infact, be unable to fund operations or otherwise continue as a going concern.

 

**Contractual Cash Obligations**

 

Our contractual cashobligations under our debt agreements, capital leases and operating leases asof September 30, 2003 and for the next five years are as follows:

 
|                         |   |      |           | **Payments Due by Period** |   |
|------------------------------|--------|-----------|----------------|----------------------------|--------|
| **Contractual  Obligations** |   | **Total** |           | **1 Year**                 |   | **2-3 Years** |   | **4-5 Years** |   | **After 5 Years** |   |
| Debt Agreements              |   | $         | 23,499,730     |                       | $      | 8,357,060 |   | $ | 10,721,813 |   | $ | 4,420,857 |   | $ | — |   |
| Capital Leases               |   | 5,490,214 |           | 2,833,543                  |   | 2,656,671 |   | — |   | — |   |
| Operating Leases             |   | 1,505,745 |           | 517,481                    |   | 988,264 |   | — |   | — |   |
|                         |   |      |           |                       |   |   |   |   |   |   |   |
| **Total**                    |   | **$**     | **30,495,689** | ** **                 | **$**  | **11,708,084** | ** ** | **$** | **14,366,748** | ** ** | **$** | **4,420,857** | ** ** | **$** | **—** | ** ** |

 

The above table does not includetwo bridge loans of $1,000,000 each obtained in October and November 2003,respectively, maturing January 2, 2004 and January 12, 2004,respectively. We expect to repay both of these loans out of the proceeds ofthis offering.

 

We have entered into certainsale-leaseback transactions primarily for assets rented to, or intended to berented to, customers, under operating leases. Since the leases containedeffective mandatory buyback provisions resulting in our retaining rights to usethese assets in our business for their

 

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remaining useful lives, no gainor loss was recognized on the sale-leaseback transactions. The amortization ofthe assets recorded as capital leases is included with depreciation. Theeffective annual interest rates implicit in the capital leases range from 25%to 28%. The terms of the leases range from 36 months to 39 months. Our futureobligations under these capital lease transactions, including buybackrequirements, are $797,812 in the three months ending December 31, 2003,and $2,684,267, $1,820,758 and $187,377 in the years 2004, 2005 and 2006,respectively.

 

We entered into a letteragreement in November 2003 with Industrial Research Limited of New Zealand forassistance in the development, manufacture and assembly of the Deck CheckerTM.The letter agreement requires us to pay a $250 per unit royalty with aguaranteed minimum of $426,000 by June 30, 2004, and, thereafter, $250 perunit with no minimum. These royalty obligations are not included in the abovetable.

 

**RISKFACTORS**

 

**RISKS RELATED TO VENDINGDATA**

 

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

 

Our footnotes to financialstatements express substantial doubt as to our ability to continue as a goingconcern given our recurring losses and accumulated deficits. Based on presentlyknown commitments and plans, we believe that if we sell the minimum number ofshares offered in our currently proposed public offering at the proposedoffering price per share, we will be able to fund our operations and requiredexpenditures through the third quarter of 2004 from cash on hand, includingfunds remaining from recent short-term loans, cash flow from operations, cashfrom our recent private placement of 10% senior notes, and cash from debt orequity financings or from lease financing sources. The sale of the minimumnumber of shares in our proposed public offering at the proposed offering priceper share will allow us to pay off all bridge financing and repay a portion ofour convertible debt, whereas, if the sale of the maximum number of shares inour proposed public offering will allow us to retire $7,500,000 of ourconvertible 10% senior notes, and still have adequate funds available withwhich to fund additional product inventory, and use for general corporatepurposes. If we do not complete our proposed public offering, however, to fundthe repayment of the $4,000,000 in short-term loans due in November 2003and $2,000,000 in short-term loans due in January 2004, we will need toseek cash from private or public placements of debt or equity, institutional orother lending sources, to sell certain assets or to change operating plans toaccommodate our liquidity issues. We may not be able to obtain other liquiditysources as may be necessary to fund our operations in the future.

 

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

 

We have a history ofsignificant operating losses and anticipate continued operating losses for theforeseeable future. For the years ended December 31, 2002 and 2001 and thenine months ended September 30, 2003, we have incurred net losses of$6,192,786, $7,566,090 and $4,381,939, respectively, and our operations haveused $5,206,489, $5,712,867 and $8,897,624 of cash, respectively. As ofDecember 31, 2002 and 2001 and September 30, 2003, we had accumulateddeficits of $36,770,258, $30,557,860 and $41,152,197, respectively. If we areunable to generate a positive cash flow in 2004, assuming the minimum number ofshares in our proposed public offering is sold at the proposed offering priceper share, we will be required to locate additional sources of capital.

 

If our revenues do notincrease very substantially, or if our spending levels exceed our expectations,we will not become profitable. Revenues may not grow in the future, and we maynot

 

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generate sufficient revenues forprofitability. If we become profitable, we may not be able to sustainprofitable operations.

 

***The demand for our products may beinsufficient to generate enough revenues to sustain our operations.***

 

Until January 2000, wewere in the development stage and derived minimal revenues from our products.Currently we are an operating company that continues to develop new products.Since January 2000, our activities have been limited to analyzing andconsulting with persons in the gaming industry, developing and manufacturingnew products, establishing distribution networks for our products, marketingour products to the gaming industry, and commencing product sales. During suchtime we have derived only limited revenues, which have been insufficient tosustain our operations. We may not generate sufficient revenue to sustain ouroperations. No independent organization has conducted market research providingmanagement with independent assurance from which to estimate potential demandfor our products. The overall market may not be receptive to our products, andwe may not successfully compete in the target market for our products. If wefail to generate sufficient demand for our products, we may be unable tosustain operations or generate a return to investors.

 

***The market has not yet demonstratedsignificant acceptance of our SecureDrop® System or the Deck CheckerTM, andthese products may never receive market acceptance.***

 

We have not yet demonstratedsignificant market acceptance of our SecureDrop® System or the Deck CheckerTMand may be unable to do so. We have only sold our SecureDrop® Hard Count Moduleto a small number of casinos. The SecureDrop® System Soft Count Module has beenslow to sell outside of Nevada due to the lengthy regulatory approval processin various jurisdictions. Even though we have sold units of the SecureDrop®System to various customers in prior periods, newer versions of SecureDrop®products were in beta tests through most of 2002. We believe that certainbarriers and problems occurred that caused us to have problems breaking intothe market, including a longer than expected sales cycle, product flaws that wesubsequently corrected, and the resistance of gaming company customers to theimplementation of unproven technologies. We have only placed 60 Deck CheckerTMunits (including 16 rentals) as of October 31, 2003. The commercialsuccess of our SecureDrop® System and Deck CheckerTM will depend upon the degreeof market acceptance of these products in the gaming community and will dependon a number of factors, including:

 

•                  demonstration of effectiveness andreliability;

 

•                  the prevalence and severity of any qualityproblems or defects in the early stage of introduction that were notanticipated in the design of those products;

 

•                  effectiveness of our marketing anddistribution capabilities;

 

•                  ability to promptly service and repair theproducts; and

 

•                  receipt of approval by respective gamingjurisdictions.

 

If we fail to expand oursales and leases for our SecureDrop® System and our Deck CheckerTM, 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 SecureDrop® Hard Count Module.***

 

Certain gaming operatorshave tested and employed as part of their current operations certain gamingdevices that have totally eliminated the use of coins or tokens, or use acombination of coins and “cashless” vouchers. The acceptance and expansion oftotally coinless gaming devices may reduce the

 

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demand for the SecureDrop® HardCount Module, which is based on coin usage, and may adversely affect ouroperations in the future. 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 aresult of the issuance of tickets, players are not required to wait forattendants in order to be paid larger payouts and may use their tickets atother machines equipped with the EZ-PayTM system or similar systems. Due topositive customer response, the number of slot operations with online systemsthat use coinless gaming systems continues to grow.

 

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

 

All of our leased shufflersare placed with customers under short-term lease arrangements, which, unlikelong-term leases or permanent sales of our products, can easily be terminatedby a dissatisfied customer. The manner in which such short-term leases arestructured puts our shufflers at greater risk of replacement due to pressurefrom competitors, changes in economic conditions, obsolescence and decliningpopularity. Casino operators may terminate the use of our products, and we maynot be able to maintain and expand the number of installed shufflers throughenhancement of existing shufflers, introduction of new shufflers, customerservice 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 uponmaintaining the confidentiality and proprietary nature of our intellectualproperty rights. Our ability to compete may be damaged and our revenues may bereduced if we are unable to protect our intellectual property rightsadequately. To protect these rights, we rely principally on a combination of:

 

•                  contractual arrangements providing fornon-disclosure and prohibitions on use;

 

•                  patents and pending patent applications;

 

•                  trade secret, copyright and trademark laws;and

 

•                  certain built-in technical product features.

 

Patent, trade secret,copyright and trademark laws provide limited protection. The protectionsprovided by laws governing intellectual property rights do not prevent ourcompetitors from developing, independently, products similar or superior to ourproducts and technologies. In addition, effective protection of copyrights,trade secrets, trademarks, and other proprietary rights may be unavailable orlimited in certain foreign countries. We may be unaware of certain non-publiclyavailable patent applications, which, if issued as patents, could relate to ourservices and products as currently designed or as we may modify them in the future.Legal or regulatory proceedings to enforce our patents, trademarks orcopyrights could be costly, time consuming, and could divert the attention ofmanagement and technical personnel.

 

***Adverse results in current litigation couldresult in substantial monetary damages and impacts on the manufacture and saleof certain of our shuffler products.***

 

Shuffle Master, Inc.,our principal competitor in the shuffler market, has sued us for patentinfringement and alleges that our shufflers violate two of its patentsconcerning registering use of a playing card shuffler apparatus and thedisplaying of the use on a display. Shuffle Master seeks treble damages, which,if awarded, could result in us owing them substantial sums of money, which iflarge

 

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enough would have a materialadverse effect on our liquidity and our ability to conduct operations. Althoughwe believe our position to be meritorious, litigation of this nature is a drainon our cash resources and our management’s time. Inasmuch as Shuffle Master hasasserted patent infringement claims and we have reasonable defenses, we cannotdetermine 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. If we donot prevail, we will be unable to sell our shuffler products unless we changecertain components used in the shufflers or obtain a license from ShuffleMaster to use the playing card shuffler apparatus and the display. Similarly,we cannot determine whether Shuffle Master will assert other litigation claimsbased upon other patents it may currently or in the future own, nor can wedetermine 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“Business—Legal Proceedings.”

 

***We believe that it is likely that ourPokerOneTM Shuffler will be the subject of future patent litigation if theproduct is sold and installed in the United States and, if commenced, couldsubject us to continuing litigation costs and risks.***

 

Other than the allegationsmade by Shuffle Master, Inc. discussed above, we are not aware of anyclaims or basis for our current products infringing on the proprietary rightsof third parties. To the extent that we introduce new products that incorporatethe same or similar technology, it is likely that Shuffle Master, Inc.will bring one or more claims against us seeking damages, injunctive or otherequitable relief, or both. Moreover, we believe that it is reasonably likelythat if we introduce the PokerOneTM Shuffler in the United States, ShuffleMaster will bring one or more claims against us seeking various remedies atequity or law. We cannot predict the outcome of any future litigation that mayoccur.

 

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

 

In furtherance of thedevelopment of our services or products, we may need to acquire licenses forintellectual property to avoid infringement of third party rights or claims ofinfringement. These licenses may not be available on commercially reasonable terms,if at all. 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 financialresources required to defend against them;

 

•                  diverting the attention of management fromgrowing our business and managing operations;

 

•                  resulting in costly litigation; and

 

•                  disrupting product sales and shipments.

 

If any third party prevailsin an action against us for infringement of its proprietary rights, we could berequired to pay damages and either enter into costly licensing arrangements orredesign our products so as to exclude the infringing technology. As a result,we would incur 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.

 

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

 

Our market is characterizedby changing technology, periodic product obsolescence and continuous protectionof proprietary technology. Our success will depend upon our ability to sell our

 

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current products, and todevelop successor systems. We will need to introduce new products and featuresin a timely manner to meet evolving customer requirements. We may not succeedin these efforts. Even if we succeed, products or technologies developed byothers may render our products or technologies noncompetitive or obsolete,which would impair our ability to sell our products and reduce our revenue.

 

***Our inability to complete the developmentof our specialty game shuffler could adversely impact potential revenue growth.***

 

We may not be able tocomplete development of the PokerOneTM Shuffler. We are continuing to fine tunethis product, and we plan to start the testing phase in Asia by the firstquarter of 2004. We have expended significant time and resources into thedevelopment of this product, and our failure to bring about a viable productmay limit our long-term revenue growth in our shuffler product line.

 

***Scrutiny and attempts by third parties tocompromise our products’ security, if successful, could injure product demandand force us to take back impacted products.***

 

In the event that ourproducts become susceptible to attacks by third parties that result in adecrease or compromise of the security of our customers’ operations, we willmost likely be required to take back our products from existing customers andwill lose sales and rentals from prospective customers. Although we have testedour products for security and our products have been tested by certain gamingregulators as part of the approval process, our products may be susceptible toschemes by third parties to defraud the properties where our products are used.Vulnerabilities in the security of our products will almost certainly reducedemand for these products. Our shufflers may become vulnerable to card countersor expert players, and the use of our shufflers may result in financial lossesfor our customers. The occurrence of any of these events would likely have amaterial adverse effect on our sales revenues.

 

***Any conditions that adversely affect thegaming industry could also have a material adverse effect on demand for ourproducts.***

 

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

 

***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, suchas terrorist attacks, acts of war or worldwide health concerns, may causedamage or disruption to our operations, which, in turn, could significantlyimpact our revenues, costs and expenses, and financial condition. The 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 has beenaffected by the downturn in the tourist industry as a result of theSeptember 11, 2001 attacks. Because our business is directly tied to thegaming industry, the long-term effects from the September 11, 2001 attacksare unknown. The potential for future terrorist attacks, the national andinternational responses to terrorist attacks, other acts of war or hostilityand concerns about the spread of certain diseases, including severe acuterespiratory syndrome, or SARS, have created many economic and

 

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

 

***Supply interruption from our manufacturingfacility in China could cause us to fail to supply customer orders on a timelybasis.***

 

We have centralized mostphases of the manufacturing process for our products at our own facility inXiaolan Town in Zhongshan City, China. Although we intend to maintain a five-to six-month inventory of parts at our principal offices in Las Vegas, Nevada,we will be adversely impacted if there is an interruption in our ability toreceive components or inventory from, or a material increase in labor costs in,China. Factors that may cause a supply interruption include political unrest,closure of ports, worldwide health concerns, including SARS, and other eventsbeyond our control. In the event that our manufacturing operations in XiaolanTown are interrupted, our ability to fill orders, ship such orders and realizethe revenues therefrom could be adversely affected.

 

***Our efforts to expand into internationalmarkets pose special risks that could adversely affect all of our business.***

 

As a result of the openingof our manufacturing facility in China, we are currently operating ininternational markets and we propose to further expand our international salesand operations. Engaging in business outside of the United States will subjectus to the customary risks of doing business in foreign countries. These risksinclude fluctuations in foreign currency exchange rates and controls,competitive disadvantages to established foreign businesses with significantcurrent market share and business/customer relationships, nationalization andother economic, tax and regulatory policies of local governments and thepossibility of trade embargoes, political instability or war or otherhostility, as well as the laws and policies of the United Sates affectingforeign trade and investment. Any one or more of these factors could materiallyadversely affect our ability to conduct business outside the United States andtherefore our business as whole.

 

***Our reliance on distributors ininternational markets and our limited sales experience in foreign countriescould cause us to lose sales and collections on such sales.***

 

In general, substantially allsales of our products outside the United States are achieved throughdistributor relationships. We believe the distributors that we have engaged areexperienced and reputable, however, if we are unable to manage theserelationships, our ability to generate revenue and profits in the non-U.S.market may be adversely affected. To the extent that we engage in direct salesoutside the United States, we have limited sales experience and history inforeign markets.

 

***Due to our management’s controllinginterest in our common stock, our management has the power to control allmatters submitted to our stockholders, which renders a non-managementstockholders’ efforts to effect substantial changes in our company moredifficult.***

 

Our executive officers andmembers of our board beneficially own 6,237,169 shares of common stock, orapproximately 73.2% of the outstanding shares of our common stock, assumingexercise or conversion of all options, warrants and convertible debentures heldby our executive officers and members of our board that are exercisable within60 days of October 31, 2003. Accordingly, these stockholders have thepower to control all matters requiring approval by our stockholders, includingthe election of directors and approval of mergers and other significantcorporate transactions. This concentration of ownership also has the effect ofdelaying, preventing or expediting, as the case may be, a change in control ofour company.

 

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***The loss of our executive officers,significant employees or certain members of our management could adverselyimpact our operations.***

 

Our success is substantiallydependent upon the efforts and skills of Steven J. Blad, our chief executiveofficer and president, and John R. Spina, our chief financial officer andtreasurer. We have entered into employment agreements with Messrs. Bladand Spina and nine other executive officers and significant employees. However,if we were to lose the services rendered by any of our executive officers orsignificant employees, key management, product development and sales functionscould be adversely affected. In addition, we compete with other potentialemployers for employees, and we may not succeed in hiring and retaining theexecutives and other employees that we need. An inability to hire and retainquality employees could have a material adverse effect on our business,financial condition and results of operations.

 

***Even if our operations do not becomeprofitable, we will continue to be obligated to pay our management salaries andbenefits.***

 

We currently compensate ourexecutive officers and significant employees with substantial salaries andother benefits and, in the future, may pay increased salaries and benefits. In2002, we paid an aggregate amount equal to approximately $1,300,000 to ourexecutive officers and significant employees. In June and July 2003, weextended our employment agreements for an additional five years withMr. Blad and an additional three years with seven other key employees. Thepayment of such compensation and benefits may be a burden on us and may be afactor in limiting or preventing our profitability. Upon the expiration ofthose employment agreements, we may elect to continue compensating managementwith similar or higher salaries and other benefits.

 

***Our cash position may be depleted in theevent that holders of certain 9.5% convertible notes do not agree to extend thematurities of outstanding promissory notes or convert them to common stock.***

 

In February 2002, wecommenced a private placement of $4,799,995 principal amount of convertiblenotes, which was completed in January 2003. The convertible notes accrueinterest at 9.5% per annum and mature one year from the date of issuance(subject to the right of each holder to extend the maturity date for up to fourone-year periods). The notes are convertible into shares of our common stock ata rate of $1.75 per share. In addition, for each convertible note of$49,995.95, we issued a warrant to purchase 2,500 shares of our common stockwith an exercise price of $1.75. Through September 30, 2003, a total of$4,799,995 principal amount of convertible notes were issued for $675,000 incash with the remaining $4,124,995 representing a rollover of principal andinterest of $3,124,995 and $1,000,000 for short-term and convertible notes,respectively. In June 2003, the holders of these convertible notesexecuted agreements in which they agreed to extend the respective maturitydates by one year (to between April 2004 and January 2005) and todefer receipt of any accrued interest until December 31, 2003. The holdersof these notes may not agree to convert the notes to shares of our common stockand may not extend the maturities of the convertible notes in the future.

 

In the event that theholders do not agree to convert to common stock or further extend the maturitydates in the future, we will be required to pay principal and interest on thesenotes. If we do not at that time have sufficient cash available or sources ofcash to make such payments, we may not be able to continue as a going concern.

 

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**RISKSRELATED TO OUR INDUSTRY**

 

***We face intense competition from companieswith longer operating histories, greater resources and more established brandnames that could use such advantages to lower our market share and reduce ourrevenues.***

 

There is significantcompetition in the shuffler market, where we compete with established companiesand other entities, most of which possess substantially greater resources thanwe do. Almost all of the companies with which we compete in the shuffler marketare substantially larger, have more substantial histories, backgrounds,experience and records of successful operations, greater financial, technical,marketing and other resources, more employees and more extensive facilitiesthan we now have, or will have in the foreseeable future. It is also likelythat other competitors will emerge in the near future. Other companies maydevelop products competitive to our SecureDrop® System. We may not be able tocompete successfully with other established gaming product manufacturers. Ourinability to compete successfully will likely result in loss of market shareand lower revenues, or increases in operating costs, such as marketing costs.

 

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

 

The gaming industry is ahighly regulated industry and is subject to numerous statutes, rules andregulations administered by the gaming commissions or similar regulatoryauthorities of each jurisdiction. Generally, companies that seek to introducegaming products or concepts into such jurisdictions may be required to submitapplications relating to their activities or products (including detailedbackground information concerning controlling persons within theirorganization), which are then reviewed for approval. In this regard, we mayincur significant expenses in seeking to obtain licenses for our gamingproducts and concepts, and our products may not be approved in alljurisdictions. The failure to obtain such approval in any jurisdiction in whichwe may seek to introduce our products or concepts could have a material adverseeffect on our business. In addition, any change to the applicable statutes,rules and regulations that restricts or prevents our ability to operate couldhave an adverse effect on us. A summary of regulatory issues is set forth belowunder “Business—Regulation and Licensing.”

 

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

 

Certain gamingregulatory agencies to which we are subject may investigate any beneficialholder of our voting securities (regardless of the numbers of shares owned),and any individual who has a material relationship or involvement with us, inorder to determine whether such individual is suitable or should be licensed asa business associate of ours. In addition, the gaming authorities of variousjurisdictions may require our officers, directors and certain key employees tobe licensed or found suitable by these gaming authorities, which would requirethese officers, directors and key employees to submit detailed backgroundinformation. Any person who fails or refuses to apply for a finding ofsuitability or a license after being ordered to do so by gaming regulatoryagencies may be found unsuitable and we could be subject to adverse regulatoryaction. In the event that the gaming authorities were to find an officer,director, key employee, stockholder, or any other individual that has amaterial relationship with us, unsuitable for licensing or unsuitable tocontinue having a relationship with us, we would have to sever allrelationships with that individual, and that individual would be required todispose of all of our stock. This could result in the loss of key personscritical to our successor in significant selling pressure on our stock if such persons are required todispose of shares of our common stock in an amount that exceeds typical tradingvolumes in our shares.

 

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***Our focus on products for the gamingindustry subjects us to greater risk than we would have if we marketed ourproducts to multiple industries.***

 

We design and manufactureproducts and concepts solely for the gaming industry and depend almostexclusively on our ability to generate revenues from the rental or sale of ourproducts to customers 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 asrecession, inflation, business cycle fluctuations and interest rates;

 

•                  levels of disposable income of gamingproperty patrons;

 

•                  acts of terrorism and anti-terrorism efforts;

 

•                  increased transportation costs resulting indecreased travel by gaming patrons;

 

•                  changes or proposed changes in tax laws;

 

•                  legal and regulatory issues affecting thedevelopment, operation and licensing of our gaming customers; and

 

•                  competitive conditions in the gamingindustry.

 

These factors may adverselyimpact the demand for our products and materially affect the revenues that werealize on the sale or placement of our products.

 

**RISKSRELATED TO OUR COMMON STOCK**

 

***There has only recently been a publicmarket for our common stock, so our stockholders may be unable to dispose oftheir investment, or may lose the total value of their investment.***

 

There had been no tradingmarket for our common stock until September 10, 2003. An active tradingand/or a liquid market may not ever develop or, if developed, it may not bemaintained. In addition, in the event that we are unable to continue as a goingconcern and our company is dissolved or otherwise terminated, you could loseyour investment in our common stock. Investment in our common stock is at riskof complete loss if our operations are unsuccessful.

 

***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 deemedto be “penny stock” as that term is defined in Rule 3a51-1 promulgatedunder the Securities Exchange Act of 1934. Penny stock may be more difficultfor investors to resell. Penny stocks are stocks:

 

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

 

•                  that are not traded on a “recognized” nationalexchange;

 

•                  whose prices are not quoted on the Nasdaqautomated quotation system (Nasdaq-listed stock must still have a price of notless than $5.00 per share); or

 

•                  from issuers with net tangible assets lessthan $2.0 million (if the issuer has been in continuous operation for atleast three years) or $5.0 million (if in continuous operation for lessthan three years), or with average revenues of less than $6.0 million forthe last three years.

 

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Federal rules andregulations generally impose additional sale practice and disclosurerequirements on broker/dealers who sell or recommend our shares to certaininvestors. These requirements may reduce the potential market for our commonstock by reducing the number of potential investors, and any or all of thesefactors may make it more difficult for investors in our common stock to sellshares to third parties or to otherwise dispose of them and could cause ourstock price to decline. Moreover, broker/dealers are required to determinewhether an investment in a penny stock is a suitable investment for aprospective investor and receive the investor’s written consent to thetransaction. In addition, many institutional investors have restrictionsregarding investments in penny stocks, which further limits the liquidity ofthe market for our shares.

 

***Investors seeking guaranteed dividendpaying investments should not invest in our common stock.***

 

At the present time we arenot permitted to pay a dividend under applicable law if doing so could renderus insolvent. Since our total liabilities currently exceed total assets, wepresently could be considered insolvent. Our operations may not becomeprofitable. If we become profitable, we intend to use any earnings that may begenerated to finance the growth of our business. Any payment of futuredividends will be at the discretion of our board of directors and will dependon, 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 sell some orall of their common stock in order to generate cash flow from their investment.Stockholders may not realize a gain on their investment, and they may lose allor a significant amount of their investment when they sell their 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 theneed to supplement the cash deficit arising from our operations with theproceeds of our proposed public offering of our common stock and cash fromprivate or public placements of debt or equity, institutional or other lendingsources, if necessary. We have also utilized convertible debt securities andwarrants to raise capital in the past. The issuance of additional equity orconvertible debt securities will have the effect of reducing the percentage ownershipof our current stockholders. In addition, these equity or convertible debtsecurities may have additional rights, preferences or privileges to those ofour common stock, such as registration rights and preferences in liquidation.In the event we are required to raise additional funds to support ouroperations, additional funds may not be available on terms favorable to ourcompany, 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.***

 

We have 2,095,200 shares ofcommon stock that are either freely tradable pursuant to Rule 144(k) ofthe Securities Act of 1933 or have previously been registered by us through aregistration statement filed with the Commission. In addition, we have grantedregistration rights to holders of certain convertible indebtedness and warrantswith respect to an aggregate of an additional 5,860,060 shares of common stockas of October 31, 2003. Holders of approximately 4,104,220 shares of ourcommon stock underlying that debt and those warrants have agreed to waive suchregistration rights together with our stated intention to register up to5,860,060 shares, upon the future conversion of debt or exchange of warrants,on their behalf within 90 days following the completion of our proposedpublic offering. The

 

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future sale of a substantialnumber of shares of our common stock in market transactions following ourproposed public offering, or the perception that these sales could occur, maydepress the market price for our common stock. These sales could also impairour ability to raise additional capital through the sale of our equitysecurities 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 isauthorized, without stockholder approval, to issue preferred stock in seriesand to fix and state the voting rights and powers, designation, preferences andrelative, participating, optional or other special rights of the shares of eachsuch series 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 voting rights.Accordingly, issuance of shares of preferred stock could adversely affect thevoting power of holders of our common stock and could have the effect ofdeterring or delaying an attempt to obtain control of us.

 

**ITEM 3.****    CONTROLSAND PROCEDURES**

 

**Evaluation of Disclosure Controls and Procedures.**    Our chief executiveofficer and our chief financial officer, after evaluating the effectiveness ofour “disclosure controls and procedures” (as defined in the Securities ExchangeAct of 1934, Rules 13a-15(e) and 15d-15(e)) during the period in whichthis report is being prepared, have concluded that based upon the changesdiscussed below our disclosure controls and procedures were adequate anddesigned to ensure that material information relating to us and ourconsolidated subsidiaries would be made known to them by others within thoseentities.

 

Disclosure controls andprocedures are controls and other procedures that are designed to ensure thatinformation required to be disclosed in our reports filed or submitted underthe Securities Exchange Act of 1934, as amended, is recorded, processed,summarized and reported, within the time periods specified in the Commission’srules and forms. 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) andRule 15d-15(e) under the Securities Exchange Act of 1934, as amended) areeffective.

 

**Changes in Internal Controls.**    Our chief financialofficer undertook a review of our internal controls during the second quarterof this year. This review was discussed with our outside auditors and resultedin a letter of reportable conditions. The letter of reportable conditions wasdiscussed with our chief executive officer and audit committee. Areas subjectto recommended changes in procedures included our purchasing and disbursementfunctions, inventory control and payroll. As a result, we have increased ouraccounting staff, separated duties and modified our control procedures. Thesechanges were implemented in our second quarter and in the beginning of ourthird quarter. In addition, during the third quarter of 2003, we have formed adisclosure committee that is designed to ensure the reliability of ourfinancial reporting, the effectiveness and efficiency of our operations and ourcompliance with applicable laws and regulations. This committee will also beresponsible for providing our chief executive officer and our audit committeewith its assessments and recommendations with respect to our disclosurecontrols and procedures. The disclosure committee will consist of our chieffinancial officer, our corporate counsel, a representative from marketing and arepresentative from operations. In addition, we will be implementing afinancial and manufacturing software application, which will provide anintegrated control process for purchasing, inventory control and manufacturingand which will improve our financial reporting.

 

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**PARTII—OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

On March 27, 2002,Shuffle Master, Inc., or Shuffle Master, filed a complaint (CaseNo. CV-S-02-0438-JCM-PAL) against VendingData in the United StatesDistrict Court, District of Nevada. The amended complaint alleges, among otherthings, claims for patent infringement and requests treble damages, aninjunction enjoining us from infringing on two of Shuffle Master’s patents, anaccounting of our gains and profits that resulted from our allegedinfringement, and for interest, costs and attorneys’ fees. The Shuffle Masterpatents that are at issue in the litigation concern registering use of aplaying card shuffler apparatus and the displaying of the use on a display. Wehave filed our answer, counterclaims, and amended counterclaims against ShuffleMaster. In our answer, we deny Shuffle Master’s allegation of patentinfringement and request that Shuffle Master’s complaint be dismissed. We alsoseek, in our amended counterclaim, a declaration that we do not infringeShuffle Master’s patents and that Shuffle Master’s patents and certain of itsrelated claims are invalid. We further assert counterclaims against ShuffleMaster for breach of contract and violation of the Uniform Trade Secrets Act.On May 20, 2002, the United States District Court, District of Nevadadenied Shuffle Master’s motion for preliminary injunction against us. Discoveryin this litigation is now closed. On May 28, 2003, we filed a motion forsummary judgment requesting that the court dismiss the case against us. Thehearing for our motion for summary judgment was taken off calendar pending aruling by a magistrate judge with respect to a October 24, 2003 claimconstruction hearing to determine the scope and definition of the patent claimsat issue. As of October 31, 2003, the magistrate judge had the matterunder advisement.

 

On July 22, 2003,Shuffle Master, Inc. filed a petition (Case No. 20003-11016) againstVendingData Corporation and Casinovations, Inc., an inactive wholly-ownedsubsidiary of VendingData Corporation, in the Civil District Court for theParish of Orleans, State of Louisiana. The petition alleges that VendingDataand/or Casinovations violated the Louisiana Unfair Sales Law by offering tosell or lease the Random Ejection ShufflerTM at a price that is below the costof producing and selling or leasing the Random Ejection ShufflerTM. The petitionfurther alleges that VendingData and/or Casinovations violated the LouisianaUnfair Trade Practices Act by intending to “dump” Random Ejection ShufflersTMinto the market with the intent to “steal” customers from Shuffle Master. Thethird claim asserted by Shuffle Master is that the actions of VendingDataand/or Casinovations constitute fraud, theft by conversion, misappropriation,intentional misrepresentation and/or general negligence. The petition requeststhe court to enter a preliminary and permanent injunction against VendingData and/orCasinovations from selling or leasing the Random Ejection ShufflerTM and otherautomatic playing card shufflers to Harrah’s Jazz Casino located in NewOrleans, reasonable attorneys’ fees and costs, and all other relief in law orin equity that the circumstances merit. Based on advice of counsel, we believethat we have meritorious defenses against all these claims, and we intend tovigorously defend against these allegations. In connection with this matter, wehave received notice from the Louisiana Department of Justice that ShuffleMaster has notified the Louisiana Department of Justice of its claims againstus for the purposes of preserving its right to treble damages, if successful.The Louisiana Department of Justice has not investigated this matter and makesno determination as to the merits thereof.

 

On September 8, 2003,we received a Notice of Administrative Charges and Opportunity for anAdjudicative Proceeding from the State of Washington Gambling Commission. Theadministrative charges arise out of our failure to timely deliver certaindetailed financial and other information about certain of our largerdebtholders. As a result of our failure to timely and completely reply, theNotice of Administrative Charges asserts violations of Washington regulatoryprovisions that could carry penalties including up to the suspension orrevocation of our Washington license. We have attempted to obtain the requestedinformation from our debtholders but have thus far been unable to satisfy theagents of the State of Washington Gambling Commission. While we intend tocontinue to cooperate and make efforts to

 

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comply with the informationrequests, we have engaged Washington legal counsel to respond to the allegedviolations and advise us on procedural and substantive steps we must take.

 

On August 5, 2003, DanPurjes, one of our stockholders, filed a complaint (Case No. 114071/03)against us in the Supreme Court of the State of New York, County of New York.The complaint alleges that we owe $28,500 plus attorneys’ fees and costsrelated to a promissory note that we executed in favor of Mr. Purjes. Thiscase was settled by agreement executed November 11, 2003 under whichMr. Purjes will be permitted to credit $28,500 against an exercise ofcommon stock warrants held by Mr. Purjes for 60,000 shares, at an exerciseprice of $1.75 per share with the balance, $76,500, to be paid in cash.

 

On November 22, 1999,Moll Industries, Inc., or Moll, filed a complaint (Case No. 817296)against VendingData in the Superior Court of the State of California for theCounty of Orange, California. The second amended complaint alleged claims forbreach of contract, quantum meruit, an accounting, and declaratory relief, andarises from a dispute between the parties regarding the manufacture of partsfor the Random Ejection ShufflerTM. We answered Moll’s second amended complaintand filed a cross-complaint for breach of contract and breach of impliedcovenant of good faith and fair dealing. The parties entered into a stipulationas of December 2000, which required us to pay Moll $60,000. To date, wehave paid $35,000 and once we have completed all payments to Moll, thislitigation will be dismissed. In light of VendingData being informed that Mollhas filed bankruptcy, payments pursuant to the stipulation have been suspended.

 

**ITEM 2.CHANGES IN SECURITIES.**

 

**Recent Sales of Unregistered Securities.**

 

In June 2003, we issued75,000 shares of common stock to Philadelphia Brokerage Corporation forfinancial advisory services. We did not receive any cash proceeds in connectionwith the issuance of the shares. In June 2003, we issued five-yearwarrants to Philadelphia Brokerage Corporation to purchase 375,000 shares ofour common stock at a price of $2.25 per share in conjunction with placement ofour 10% senior notes. In addition, in June 2003, we issued additionalfive-year warrants to Philadelphia Brokerage Corporation to purchase 100,000shares of our common stock at a price of $2.25 per share in conjunction withthe placement of our bridge financing. We relied upon the exemption fromregistration provided by Section 4(2) of the Securities Act of 1933 anddid not use a broker-dealer.

 

On October 9, 2003 andOctober 21, 2003, we received bridge financing from Triage OffshoreFund, Ltd. in the aggregate principal amount of $1,000,000. OnOctober 21, 2003, we issued a promissory note in the principal amount of$1,000,000. The promissory note matures on January 2, 2004 and requires thepayment of an interest fee in the amount of $50,000 on the maturity date.Triage Offshore Fund, Ltd. may elect to waive payment of the interest feein exchange for shares of our common stock at a rate of $2.25 per share. Foreach 30-day period that the promissory note remains outstanding afterJanuary 2, 2004, Triage Offshore Fund, Ltd. is entitled to a warrantto purchase 25,000 shares of common stock with an exercise price of $2.25 pershare. The proceeds from the bridge financing have been used for working capitalpurposes. Because this loan was negotiated with a single lender, we relied onthe exemption from registration of securities provided by Section 4(2) ofthe Securities Act and Rule 506 of Regulation D.

 

On November 5, 2003, wereceived additional bridge financing from LC Capital Master Fund, Ltd. inthe aggregate principal amount of $1,000,000. The promissory note matures onJanuary 12, 2004 and requires the payment of an interest fee in the amountof $50,000 on the maturity date. LC Capital Master Fund, Ltd. may elect towaive payment of the interest fee in exchange for shares of our common stock ata rate of $2.25 per share. For each 30-day period that the promissory noteremains outstanding after January 12, 2004, LC Capital MasterFund, Ltd. is entitled to a warrant to purchase 25,000 shares of commonstock with an exercise price of $2.25 per share. The proceeds from the bridge

 

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financing have been used forworking capital purposes. Because this loan was negotiated with a singlelender, we relied on the exemption from registration of securities provided bySection 4(2) of the Securities Act and Rule 506 of Regulation D.

 

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES.**

 

Not applicable.

 

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

 

Not applicable.

 

**ITEM 5. OTHER INFORMATION.**

 

On September 9, 2003,under our Amended and Restated 1999 Directors’ Stock Option Plan, our board ofdirectors approved one-time grants of stock options to purchase 50,000 shares ofour common stock at an exercise price of $2.50 per share to each of our threenon-employee directors in consideration for past services and in lieu of otherdirector compensation. Pursuant to our Amended and Restated 1999 Directors’Stock Option Plan, the exercise price of $2.50 per share was determined by ourboard of directors to be the fair market value per share at the time of grant.

 

We have issued demandregistration rights with respect to the following: the shares underlying the9.5% convertible notes due 2004, the shares underlying the 9.5% convertiblenotes due 2002 and the warrants issued in connection with the notes due 2002,and the shares underlying the 9.5% convertible notes due 2003 and the warrantsissued in connection with the notes due 2003. We have issued piggy-backregistration rights with respect to the following: the warrants issued inconnection with a loan in 2001, the warrants issued in conjunction with theextension of a loan in 2002, the warrants issued in conjunction with the purchaseof certain technology in 2001, the warrants issued pursuant to a consultingagreement in 2002, the warrants issued in conjunction with our privateplacement of 10% senior notes due December 15, 2005, the warrants issuedin conjunction with the placement of our 10% senior notes in 2003, the warrantsissued in June and July 2003 in connection with bridge loan financings,and the warrants issued in conjunction with the placement of the bridge loanfinancings. We have received waivers from the holders of 1,055,733 sharesunderlying the future conversion of the notes or exercise of warrants, or 41.8%of the piggy-back registration rights, and the holders of 3,108,487 sharesunderlying the future conversion of the notes or exercise of warrants, or 99.8%of the demand registration rights. Even though we have not received waiversfrom all of the holders of demand and piggy-back registration rights, we intendto file a registration statement to register all shares underlying thefuture conversion of the notes or exercise of warrants within 90 days ofthe completion of our proposed public offering in order to remedy anyoutstanding obligations that we may owe to these holders of registrationrights.

 

**ITEM 6. EXHIBITS****AND REPORTS ONFORM 8-K.**

 

(a)*   Exhibits.*

 

*31.1       *Certifications Pursuant to Section 302of the Sarbanes-Oxley Act of 2002.

 

*31.2       *Certifications Pursuant to Section 302of the Sarbanes-Oxley Act of 2002.

 

*32.1       *Certification of President and ChiefFinancial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of2002 (18 U.S.C. Section 1350).

 

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(b)*    Reports on Form 8-K.*

 

During the three monthsended September 30, 2003 and from the end of such period to the date ofthis report, we filed the following:

 

•                  Current Report on Form 8-K filed onSeptember 10, 2003 reporting that shares of common stock of VendingDataCorporation commenced trading on the Over-the-Counter Bulletin Board effectiveSeptember 10, 2003;

 

•                  Current Report on Form 8-K filed on September 30,2003 reporting the filing of a registration statement on Form SB-2 with theSecurities and Exchange Commission to register shares of common stock ofVendingData Corporation;

 

•                  Current Report on Form 8-K filed onOctober 27, 2003 reporting the receipt of bridge loan financing in theprincipal amount of $1,000,000 and the issuance of a promissory note; and

 

•                  Current Report on Form 8-K filed onNovember 7, 2003 reporting the receipt of bridge loan financing in theprincipal amount of $1,000,000 and the issuance of a promissory note.

 

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**SIGNATURE**

 

In accordance with therequirements of the Exchange Act, the registrant caused this AmendmentNo. 2 to report to be signed on its behalf by the undersigned, thereuntoduly 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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