** **

**UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-QSB**

** **

| **(Mark One)** |
|----------------|
| **ý**     |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|           |   |   |
|           |   | **For the quarterly period  ended:  March 31, 2004** |
|           |   |   |
| **OR**         |
|           |   |   |
| **o**          |   | **TRANSITION  REPORT PURSUANT SECTION 13 OR 15(d) OF THE EXCHANGE ACT** |
|           |   |   |
|           |   | **For the transition period  from:               to               ** |
|           |   |   |
|           |   | **Commission file  number:  001-32161** |

 

| **VendingData Corporation**                                                         |
|-------------------------------------------------------------------------------------|
| (Exact name of small business issuer as  specified in its charter)                  |
|                                                                                |   |   |
| **Nevada**                                                                          |   | **91-1696010** |
| (State or other jurisdiction of  incorporation or organization)                     |   | (I.R.S. Employer Identification No.) |
|                                                                                |   |   |
| **6830 Spencer Street, Las Vegas, Nevada  89119**                              |
| (Address of principal executive offices)                                            |
|                                                                                |   |   |
| **(702) 733-7195**                                                                  |
| (Issuer’s telephone number)                                                    |
|                                                                                |   |   |
|                                                                                |
| (Former name, former address and former  fiscal year, if changed since last report) |

 

Check whether theissuer (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 thatthe registrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes  ý  No  o

 

**APPLICABLE ONLY TO CORPORATE ISSUERS**

 

State the numberof shares outstanding of each of the issuer’s classes of common equity, as ofthe latest practicable date:  17,187,799 shares of common stock,$.001 par value, as of March 31, 2004

 

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

 

 

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**VENDINGDATACORPORATION**

 

**FORM10-QSB**

 

**TABLEOF 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 OR  PLAN OF OPERATIONS. |   |
|                                    |    |   |   |
|                                    |    | OVERVIEW |   |
|                                    |    |   |   |
|                                    |    | CRITICAL ACCOUNTING POLICIES AND ESTIMATES |   |
|                                    |    |   |   |
|                                    |    | 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**

# ** **

## **ITEM1.  FINANCIAL STATEMENTS.**

## ** **

**VENDINGDATA CORPORATION**

### **Balance Sheets**

 
|                                                                                                                  |   | **March 31,  2004** |       | **December 31,****2003** |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|-------------------------------|--------|
|                                                                                                                  |   | **(unaudited)**          |       |                          |   |
| **ASSETS**                                                                                                            |   |                     |       |                          |   |
| Current assets:                                                                                                       |   |                     |       |                          |   |
| Cash and cash equivalents                                                                                             |   | $                        | 5,830,540  |                          | $      | 11,526,664 |   |
| Current portion of accounts receivable,  trade, net of allowance for uncollectables of $125,530                       |   | 2,426,102                |       | 2,354,054                     |   |
| Due from affiliate                                                                                                    |   | 31,802                   |       | 31,802                        |   |
| Other receivables                                                                                                     |   | 137,867                  |       | 29,836                        |   |
| Inventories                                                                                                           |   | 4,768,942                |       | 4,150,414                     |   |
| Prepaid expenses                                                                                                      |   | 80,202                   |       | 52,028                        |   |
|                                                                                                                  |   | 13,275,455               |       | 18,144,798                    |   |
|                                                                                                                  |   |                     |       |                          |   |
| Equipment rented to customers, net of  accumulated depreciation of $378,467 and $316,245                              |   | 551,263                  |       | 608,555                       |   |
| Property & equipment, net of  accumulated depreciation of $1,977,416 and $1,859,206                               |   | 1,017,029                |       | 1,063,951                     |   |
| Intangible assets, net of accumulated  amortization of $327,272 and $288,203                                          |   | 1,242,354                |       | 1,282,088                     |   |
| Due from affiliate - non current                                                                                      |   | 118,800                  |       | 118,800                       |   |
| Accounts receivable, trade, net of current  portion, less unamortized discount                                        |   | 1,329,296                |       | 1,140,984                     |   |
| Deferred expenses                                                                                                     |   | 225,232                  |       | 250,697                       |   |
| Deposits                                                                                                              |   | 1,599,731                |       | 1,284,827                     |   |
| Other assets                                                                                                          |   | 236,026                  |       | 265,478                       |   |
|                                                                                                                  |   | $                        | 19,595,186 |                          | $      | 24,160,178 |   |
|                                                                                                                  |   |                     |       |                          |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                         |   |                     |       |                          |   |
| Current liabilities:                                                                                                  |   |                     |       |                          |   |
| Current portion of leases payable                                                                                     |   | $                        | 2,069,470  |                          | $      | 2,237,073 |   |
| Accounts payable                                                                                                      |   | 1,086,905                |       | 1,727,460                     |   |
| Accrued expenses                                                                                                      |   | 471,561                  |       | 824,307                       |   |
| Deferred revenues, current portion                                                                                    |   | 216,480                  |       | 171,875                       |   |
| Short-term debt                                                                                                       |   | 236,350                  |       | 270,743                       |   |
| Current portion of convertible debt                                                                                   |   | —                   |       | 2,368,077                     |   |
| Customer deposits                                                                                                     |   | 181,400                  |       | 178,805                       |   |
|                                                                                                                  |   | 4,262,166                |       | 7,778,340                     |   |
|                                                                                                                  |   |                     |       |                          |   |
| Deferred revenues, net of current portion                                                                             |   | 227,368                  |       | 219,890                       |   |
| Leases payable, net of current portion                                                                                |   | 1,480,716                |       | 1,916,723                     |   |
|                                                                                                                  |   | 5,970,250                |       | 9,914,953                     |   |
| Stockholders’ equity:                                                                                            |   |                     |       |                          |   |
| 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, 17,187,799 and 16,765,580 shares issued and outstanding |   | 17,188                   |       | 16,766                        |   |
| Additional paid-in capital                                                                                            |   | 59,659,307               |       | 58,810,806                    |   |
| Deficit                                                                                                               |   | (46,051,559              | )          | (44,582,347                   | )      |
| Total stockholders’ equity                                                                                       |   | 13,624,936               |       | 14,245,225                    |   |
| Total liabilities and stockholders’ equity                                                                       |   | $                        | 19,595,186 |                          | $      | 24,160,178 |   |

 

See accompanying notes to financialstatements.

 

1

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**VENDINGDATA CORPORATION**

### **Statements of Operations**

### ** **

**(UNAUDITED)**

 
|                                |   | **Three  Months Ended March 31,** |
|-------------------------------------|--------|----------------------------------------|
|                                |   | **2004**                               |   | **2003** |   |
|                                |   |                                   |   |   |   |
| **Revenues:**                       |   |                                   |   |   |   |
| Sales                               |   | $                                      | 993,054 |   | $ | 1,575,086 |   |
| Rental                              |   | 211,063                                |   | 331,803 |   |
| Other                               |   | 88,773                                 |   | 28,469 |   |
|                                |   | 1,292,890                              |   | 1,935,358 |   |
| **Operating expenses:**             |   |                                   |   |   |   |
| Cost of sales                       |   | 780,737                                |   | 1,355,646 |   |
| Selling, general and administrative |   | 1,426,034                              |   | 1,082,444 |   |
| Research and development            |   | 278,753                                |   | 285,989 |   |
|                                |   | 2,485,524                              |   | 2,724,079 |   |
| Loss from operations                |   | (1,192,634                             | ) | (788,721 | ) |
|                                |   |                                   |   |   |   |
| Interest expense, unrelated parties |   | 262,622                                |   | 497,676 |   |
| Interest expense, related parties   |   | 14,523                                 |   | 159,821 |   |
| Gain on disposition of assets       |   | (567                                   | ) | — |   |
| Total interest expense, net         |   | 276,578                                |   | 657,497 |   |
|                                |   |                                   |   |   |   |
| Net loss                            |   | $                                      | (1,469,212 | ) | $ | (1,446,218 | ) |
|                                |   |                                   |   |   |   |
| Basic and diluted loss per share    |   | $                                      | (0.09 | ) | $ | (0.19 | ) |
|                                |   |                                   |   |   |   |
| Weighted average shares outstanding |   | 17,105,700                             |   | 7,625,814 |   |

 

See accompanying notes to financialstatements.

 

2

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**VENDINGDATA CORPORATION**

### **Statements of Cash Flows**

### ** **

**(UNAUDITED)**

 
|                                                                             |   | **Three  Months Ended March 31,** |
|----------------------------------------------------------------------------------|--------|----------------------------------------|
|                                                                             |   | **2004**                               |   | **2003** |   |
|                                                                             |   |                                   |   |   |   |
| Net loss                                                                         |   | $                                      | (1,469,212 | ) | $ | (1,446,218 | ) |
|                                                                             |   |                                   |   |   |   |
| Adjustments to reconcile net loss to net  cash provided by operating activities: |   |                                   |   |   |   |
| Accumulated depreciation                                                         |   | 224,816                                |   | 198,077 |   |
| Amortization of deferred interest                                                |   | 74,269                                 |   | (13,556 | ) |
| Non-cash compensation expense                                                    |   | 11,863                                 |   | — |   |
| Equipment produced and held for rental                                           |   | (4,930                                 | ) | (9,500 | ) |
| Increase in operating (assets) liabilities:                                      |   |                                   |   |   |   |
| Trade accounts receivable                                                        |   | (260,360                               | ) | (832,959 | ) |
| Other receivables                                                                |   | (108,031                               | ) | (132,286 | ) |
| Inventory                                                                        |   | (618,528                               | ) | (571,208 | ) |
| Prepaid expenses                                                                 |   | (28,174                                | ) | 162,900 |   |
| Deferred expenses                                                                |   | (63,473                                | ) | — |   |
| Deposits with vendors                                                            |   | (314,904                               | ) | — |   |
| Other assets                                                                     |   | 29,452                                 |   | (88,333 | ) |
| Accounts payable                                                                 |   | (640,555                               | ) | (208,943 | ) |
| Accrued expenses                                                                 |   | (302,746                               | ) | 70,562 |   |
| Deferred revenues                                                                |   | 52,085                                 |   | — |   |
| Customer deposits                                                                |   | 2,595                                  |   | (200,142 | ) |
|                                                                             |   |                                   |   |   |   |
| Total adjustments                                                                |   | (1,946,621                             | ) | (1,625,388 | ) |
|                                                                             |   |                                   |   |   |   |
| Net used in operating activities                                                 |   | (3,415,833                             | ) | (3,071,606 | ) |
|                                                                             |   |                                   |   |   |   |
| Cash flows from investing activities:                                            |   |                                   |   |   |   |
| Acquisition of plant and equipment                                               |   | (76,790                                | ) | (23,147 | ) |
| Disposition of equipment produced for  rental                                    |   | —                                 |   | 134,400 |   |
| Disposition of plant and equipment                                               |   | 183                                    |   | — |   |
| Other                                                                            |   | 665                                    |   | — |   |
| Deposits                                                                         |   | —                                 |   | 33,402 |   |
|                                                                             |   |                                   |   |   |   |
| Net cash provided by (used in) investing  activities                             |   | (75,942                                | ) | 144,655 |   |
|                                                                             |   |                                   |   |   |   |
| Cash flows from financing activities:                                            |   |                                   |   |   |   |
| Reimbursement of offering expense                                                |   | 36,731                                 |   | — |   |
| Proceeds from leases payable                                                     |   | —                                 |   | 862,500 |   |
| Repayment of leases payable                                                      |   | (603,610                               | ) | (833,205 | ) |
| Repayment of stockholder loans                                                   |   | —                                 |   | (218,000 | ) |
| Repayment of short-term debt                                                     |   | (34,393                                | ) | — |   |
| Proceeds from convertible debt                                                   |   | —                                 |   | 2,650,000 |   |
| Repayment of convertible debt                                                    |   | (1,603,077                             | ) | — |   |
| Net cash provided by financing activities                                        |   | (2,204,349                             | ) | 2,461,295 |   |
| Decrease in cash                                                                 |   | (5,696,124                             | ) | (465,656 | ) |
| Cash and cash equivalents at beginning of  period                                |   | 11,526,664                             |   | 1,778,297 |   |
| Cash and cash equivalents at end of period                                       |   | $                                      | 5,830,540 |   | $ | 1,312,641 |   |

 

See accompanying notes to financialstatements.

 

3

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**VENDINGDATACORPORATION AND SUBSIDIARIES**

**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, 2003, 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 periodpresentation.

 

**Note 2—Segments**

 

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

 
|          |   | **March 31,  2004** |      | **March 31,  2003** |   |
|---------------|--------|---------------------|-----------|--------------------------|--------|
| United States |   | $                   | 1,044,556 |                     | $      | 1,759,466 |   |
| Asia          |   | $                   | 38,334    |                     | $      | 134,392 |   |
| Europe        |   | $                   | 210,000   |                     | — |   |
| South America |   | $                   | —    |                     | 41,500 |   |

 

4

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TheCompany’s revenues, depreciation and operating income distributed by productare as follows:

 
|                                  |   | **Three  Months Ended**  |       |
|---------------------------------------|--------|--------------------------|------------|
|                                  |   | **March 31,  2004** |       | **March 31,  2003** |   |
| Revenues                              |   |                     |       |   |   |
| Secure Drop®                     |   | $                        | 195,533    |   | $ | 1,149,509 |   |
| Shuffler                              |   | 457,275                  |       | 744,817 |   |
| Deck CheckerTM                        |   | 551,309                  |       | 12,563 |   |
| Other revenue                         |   | 88,773                   |       | 28,469 |   |
|                                  |   | $                        | 1,292,890  |   | $ | 1,935,358 |   |
| Depreciation and amortization         |   |                     |       |   |   |
| Secure Drop®                     |   | $                        | —     |   | $ | — |   |
| Shuffler                              |   | 55,562                   |       | 155,788 |   |
| Deck CheckerTM                        |   | 6,660                    |       | — |   |
| Selling, general & administrative |   | 162,594                  |       | 42,289 |   |
|                                  |   | $                        | 224,816    |   | $ | 198,077 |   |
| Operating income (loss)               |   |                     |       |   |   |
| Secure Drop® gross margin        |   | $                        | 91,564     |   | $ | 680,951 |   |
| Shuffler gross margin                 |   | 362,515                  |       | 483,807 |   |
| Deck CheckerTM gross margin           |   | 414,006                  |       | 3,083 |   |
| Other cost of goods sold              |   | (355,932                 | )          | (588,129 | ) |
| Selling, general & administrative |   | (1,426,034               | )          | (1,082,444 | ) |
| Research and development              |   | (278,753                 | )          | (285,989 | ) |
|                                  |   | $                        | (1,192,634 | ) | $ | (788,721 | ) |

 

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

 

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**

 

The company retired $2,368,077 of convertible debtduring the period with cash payments and conversions to common stock.

 

**Note 5—Options**

 

TheCompany currently has two stock option plans. No stock-based employeecompensation expense for stock options was reflected in net income for yearsprior to 2003, as all stock options granted under those plans had an exerciseprice equal to or greater than the fair market value of the underlying commonstock on the date of grant. The exercise price range is between $1.75 and $15with a weighted average exercise price of $3.50. There were 2,089,520 optionsoutstanding as of March 31, 2004.

 

5

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**Note 6—****LiquidityIssues**

 

The Company’s ability tomaintain adequate liquidity may be dependent upon the success of management’s plansto address and overcome prior operating losses.  Management has developed and refined its 2004 operating plan toincrease its sales by expanding its product line and improving its salesefforts domestically and internationally. Increased sales in the year ended December 31, 2003 show increasedacceptance of the Company’s product line. Management has adopted a program to reduce operating costs through thetransfer of manufacturing operations to China and restructuring servicefunctions to reduce labor and rental expense. Management has focused on financial condition and liquidity improvementsthrough its capital raising efforts in 2003 along with substantial debtreduction and debt conversion, resulting in an improved cash position andsubstantially reduced indebtedness at March 31, 2004.  As a result of anticipated salesimprovements and operating cost initiatives, management believes that theCompany will begin to generate positive operating cash flow during the secondhalf of 2004.  In addition, theCompany’s financial advisors have expressed confidence that additional capitalcan be raised by the Company, if necessary, in 2004, and the Company hasreceived a one-year commitment for a $3.0 million lease line of credit.

 

**Note 7—Trade Receivables From Major Customers**

 

Asof and during the three months ended March 31, 2004, approximately 7.4% oftrade receivables and 11.2 % of total sales and, as of and during the yearended December 31, 2003, approximately 17.6% of trade receivables and13.3% of total sales were concentrated in the Nevada gaming industry among fivecustomers under common ownership. The Company’s future operations could beaffected by adverse changes in the financial condition of, or the Company’srelationships with, the commonly owned Nevada gaming customers, or economic,competitive and political conditions in our customers’ respective local areasor the gaming industry, in general.

 

TheCompany manages its concentrations of credit risk by evaluating thecreditworthiness of customers before credit is extended and monitoring itthereafter. The maximum losses that the Company would incur if a customerfailed to pay amounts owed would be limited to the recorded receivables afterany allowances provided.

 

**Note 8—Contingencies**

 

TheCompany is a party to certain claims, legal actions, and complaints, includinga patent infringement action between the Company and one of its maincompetitors. The Company cannot predict the likely outcome of any suchlitigation or whether any such substantial litigation would have a materialadverse effect on its business as presently conducted or as anticipated.

 

**Note 9—Subsequent Events**

 

Inearly February 2004, the State of Nevada initiated a sales/use tax auditof Central and Madison Leasing. As of this filing the State of Nevada has notmade a determination if there has been a shortfall in the payment of thesales/use tax. The Company has sold and leased back shufflers and Deck Checkersover the last five years.  The auditorfor the State of Nevada is trying to determine at what level a sales/use taxneeds to be collected.  The Company nowcollects from our customers in Nevada and remits payments to the State ofNevada.  If the State of Nevadadetermines that the sales of the products to the leasing companies is the levelat which sales/use tax should have been collected, liability of the leasingcompanies would be passed to the Company. The amount of this potential liability could range from a refund of$144,000 to the payment of sales/use tax with interest and penalties of up to$500,000.  The Company intends to defendits position in this matter.

 

6

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## **ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSISOR PLAN OF OPERATIONS.**

## ** **

**Statement onForward-Looking Information**

** **

Certain informationincluded herein contains statements that may be considered forward-lookingstatements within the meaning of Section 27A of the Securities Act andSection 21E of the Exchange Act, such as statements relating to plans forproduct development, product placement, capital spending and financingsources.  Such forward-lookinginformation involves important risks and uncertainties that could significantlyaffect anticipated results in the future and, accordingly, such results maydiffer from those expressed in any forward-looking statements made herein.  These risks and uncertainties include, butare not limited to, those relating to our liquidity requirements, our abilityto locate necessary sources of capital to sustain our operations, the continuedgrowth of the gaming industry, the success of our product developmentactivities, the acceptance of our products in the marketplace, vigorouscompetition in the gaming industry, our dependence on existing management,changes in gaming laws and regulations (including actions affecting licensing),our leverage and debt service (including sensitivity to fluctuations ininterest rates) and domestic or global economic conditions.

 

### **OVERVIEW**

### ** **

Our strategy is todevelop cost-effective niche products for the global gaming industry.  We focus on products that increase thesecurity, productivity and profitability of casino operations.  Our strategy involves marketing certain ofour products for sale or lease, depending on the product, the geographiclocation of the customer and other factors. We rely on our internal sales staff and distributor relationships forthe sale and rental of our products. Although we anticipate significant sales development and revenue growth,there is no assurance that we will generate sufficient revenue, cash flow orprofit to sustain our operations.

 

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

### ** **

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

 

The preparation offinancial statements in conformity with generally accepted accountingprinciples requires our management to make estimates and assumptions thataffect reported amounts and disclosures, some of which may require revision infuture periods.  Actual results coulddiffer from these estimates.  Thefollowing is a summary of what our management believes are the criticalaccounting policies related to our operations. The application of these policies, in some cases, requires ourmanagement to make subjective judgments and estimates regarding the effect ofmatters that are 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.  These estimates have the potential forcritically affecting the determination of results of operations for any givenperiod.  Factors considered bymanagement in making such estimates and adjustments include any concentrationsamong customers, changes in our relationships therewith, payment history andthe apparent financial condition thereof.

 

7

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

 

***Intangible Assets.***

 

We have acquiredpatent rights for various products since 2001 and acquired the patent rightsfor the Deck CheckerTM for $1,004,900 in the third quarter of 2003.  We have estimated an economic useful life of10 years for the Deck CheckerTM patents. We currently amortize our intangible assets on a straight-line basisover the estimated useful lives of 10 years.

 

**FINANCIALCONDITION**

 

During the three monthsended March 31, 2004, total assets decreased by $4,564,992 from$24,160,178 at December 31, 2003 to $19,595,186 at March 31,2004.  The decrease in total assets wasdue primarily to the $5,696,124 decrease in cash.  Accounts receivable (trade) increased from $2,354,054 to$2,426,102 between December 31, 2003 and March 31, 2004.  The primaryreasons for the increase in trade receivables were the conversion of shuffler rentals to purchases and the saleof Deck CheckersTM on terms.  Inventorieshave increased during the current period by $618,528 from $4,150,414 atDecember 31, 2003 to $4,768,942 at March 31, 2004.  The increase is primarily due to the rampingup of manufacturing in China for Deck CheckerTM units, shuffler production andthe PokerOneTM Shuffler.

 

Total liabilities havedecreased from $9,914,953 at December 31, 2003 to $5,970,252 atMarch 31, 2004.  Accounts payabledecreased from $1,727,460 at December 31, 2003 to $1,086,905 atMarch 31, 2004 primarily due to the payment of the final $500,000 for theintellectual property rights for the Deck CheckerTM and the payment ofoutstanding payables with funds received from the public offering inDecember of 2003.  Convertible debtdecreased from $2,368,077 at December 31, 2003 to $0 at March 31,2004 due to the retirement of long- and short-term convertible debt throughcash payments and conversion to common stock. Short-term debt decreased from $270,743 at December 31, 2003 to$236,350 at March 31, 2004 due to the repayment of short-term debt.

 

8

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### **RESULTSOF OPERATIONS**

### ** **

##### ***Comparisonof Three Months Ended March 31, 2004 and 2003***

##### *** ***

###### **Revenue**

###### ** **

For the three monthsended March 31, 2004, we generated total revenues of $1,292,890, comparedto $1,935,358 for the three months ended March 31, 2003, a decrease of$642,468, or 33.2%.  Our revenues forthe three months ended March 31, 2004 consisted of SecureDrop® sales of $195,533,shuffler rentals of $154,183, shuffler sales of $303,092, Deck CheckerTM  rentalsof $56,880, Deck Checker TMsales of $494,429 and miscellaneous other revenues of $88,773.  The decrease in revenue was primarily due toa decrease in SecureDrop® sales of $953,976, a decrease in shuffler rentals of $177,620,and a decrease in shuffler sales of $109,922.

 

**Revenues – SecureDrop® Sales. **For the three months ended March 31, 2004,we generated revenue related to the sale of our SecureDrop® products of$195,533, compared to $1,149,509 for the three months ended March 31,2003, a decrease of $953,976, or 83.0%. We did not secure substantial signed agreements for SecureDrop® systeminstallations in late 2003 which resulted in lower revenues in the firstquarter of 2004.  The Company iscurrently attempting to secure new SecureDrop® system contracts.

 

**Revenues – Shuffler Sales. **For the three months ended March 31, 2004, wegenerated revenue related to the sale of our shufflers of $303,092, compared to$413,014 for the three months ended March 31, 2003, a decrease of$109,922, or 26.6%.  The majority ofthese sales were from the conversion of shufflers on rent to purchases throughlong-term sales agreements that range from 24-48 months.  We made a strategic decision to offer ourcustomers the choice to either continue renting or instead to purchase ourshufflers for the same monthly payments. This decision was based on competitive forces in the marketplace and theanticipated introduction of our next generation shufflers in 2004.  By offering some of our customers theability to trade up to our new shuffler, the RandomPlusÔShuffler, when approved by the relevant regulatory bodies, we will be able toobtain binding purchase commitments for our shufflers and ensure that ourproducts are not readily replaced with those of our competitors.  We believe that conversions will notcontribute to shuffler sales in the future to the same extent conversions didin 2003.  Management believes thisintroduction of the new RandomPlusÔ Shuffler in thesecond half of 2004 will provide a needed addition to our product line andimprove shuffler revenue in the latter part of the year.

 

**Revenue – Shuffler Rentals.**  For the three months ended March 31,2004, we generated revenue related to the rental of our shufflers of $154,183,compared to $331,803 for the three months ended March 31, 2003, a decreaseof $177,620, or 53.5%.  The conversionof rental units to purchases reduced the number of shufflers that were rentedthroughout this quarter compared to the first quarter of 2003.  Management anticipates introducing the newRandomPlusÔ Shuffler by the second half of 2004.  Management believes that the construction ofthe new shuffler will reverse the trend and increase shuffler rentals.  Management believes that the price point andreliability of the new shuffler will make the new product very competitive inthe marketplace.

 

**Revenue – Deck Checker****TM.** For the three months endedMarch 31, 2004, we generated revenue related to the sale of our DeckCheckerTM of $494,429and revenue related to the rental of Deck CheckersTM of $56,880.  Asthe Deck CheckerTM  was introduced in the second quarter of 2003,we expect Deck CheckerTM  sales will continue to grow as the number ofjurisdictions where we can sell the product increases and with the anticipatedacceptance of the product in the casino industry.  Production has begun at our facility in China at a lower cost perunit; this will allow us to lower the product price point and continue tomaintain margins.

 

**Revenue – Other Income. **For the three months ended March 31, 2004, wegenerated other revenues of $88,773, compared to income of $28,469 for thethree months ended March 31, 2003, an increase of $60,304.  The primary driver for the increase was thesale of supplies for SecureDrop® and

 

9

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the Deck CheckerTM. Theupward trend will continue for these consumables as we increase the installedbase of these two product lines.

 

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

###### ** **

For the three monthsended March 31, 2004, our cost of sales was $780,737, compared to$1,355,646 for the three months ended March 31, 2003, a decrease of$574,909, or 42.4%.  Our cost of salesfor the three months ended March 31, 2004 included cost of SecureDrop®sales of $103,969, cost of shuffler sales of $39,560, shuffler rentaldepreciation of $55,200, shuffler service costs of $298,496, manufacturingcosts of $90,270, Deck CheckerTM costs of $130,643, Deck CheckerTM rental depreciation of$6,660, warranty costs of $7,901 and other expenses of $48,038.  The manufacturing of products in China willcontinue the trend of reducing cost of sales on a per unit basis.  The gross margin on revenue for the threemonths ended March 31, 2004 was $512,153, or 39.6%, compared to the grossmargin on revenue for the year ended March 31, 2003 of $579,712, or30.0%.  The decrease in gross profit of$67,559 from the three months ended March 31, 2003 to the three monthsended March 31, 2004 reflects the decreased revenue.

 

**Cost ofSales – SecureDrop**®**Sales.**  Our cost of SecureDrop®****salesrevenue was $103,969 for the three months ended March 31, 2004 compared to$468,558 for the three months ended March 31, 2003, representing adecrease of $364,589, or 77.8%.  Thegross margin percentage on revenue from SecureDrop®****sales revenue was 46.8% in the threemonths ended March 31, 2004 compared to 59.2% for the three months endedMarch 31, 2003.  The decrease ingross margin percentage on SecureDrop® is attributed to the fixed costsassociated with the installation team combined with the low revenue.  The introduction of components built at ourChina facility and increased revenue volume in the longer term will improve themargins in the future.

 

**Cost ofSales – Shuffler Sales.** Our cost of shuffler****sales revenue was $39,560 for thethree months ended March 31, 2004 compared to $105,222 for the threemonths ended March 31, 2003, representing a decrease of $65,662, or62.4%.  The decrease in the cost of shuffler****salesrevenue was due to the decreased placement of shuffler****units duringthe three months ended March 31, 2004. The gross margin percentage on revenue from shuffler****salesrevenue was 86.9% in the three months ended March 31, 2004 compared to74.5% for the three months ended March 31, 2003.  The conversion of existing rental shufflers to purchases that hadlow book values due to depreciation reduced the product cost.

 

**Cost of Sales – Deck Checker****TM Sales. **Our cost of Deck CheckerTMsales revenue was $130,643 for the quarter ended March 31, 2004.  The gross margin percentage on revenue fromDeck CheckerTM salesrevenue was 73.6%.  The year 2003 wasthe introductory year for the Deck CheckerTM product.  Weanticipate the move of the manufacture of the Deck CheckerTM to China will improve thecurrent margins.

 

###### **General andAdministrative Expense**

###### ** **

For the three monthsended March 31, 2004, our general and administrative expenses were$1,426,034, compared to $1,082,444 for the three months ended March 31,2003, an increase of $343,590, or 31.7%. The increase in general and administrative expenses related primarily toa $210,267 increase in salaries and related costs, a $54,625 increase inconsulting and accounting expense, a $7,229 increase in trade show expenses, a$14,326 increase in supplies, a $20,816 increase in insurance, a $91,352 increasein depreciation and a $94,058 increase in other expenses.  The addition of new staff in the finance andexecutive departments is responsible for the majority of the increase inpayroll expense.

 

10

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Our general andadministrative expenses for the three months ended March 31, 2004consisted of the following: salaries and related costs of $571,614; consultingand accounting services of $91,318; advertising and marketing costs of $5,909;travel and entertainment costs of $104,474; gaming industry show costs of$41,098; rent of $87,812; repairs and maintenance expense of $22,423; suppliesof $19,694; legal and regulatory expenses of $197,895; insurance expenses of$27,639; depreciation and amortization of $153,561; and other expenses of$102,597.

 

###### **Research andDevelopment Expense**

###### ** **

For the three monthsended March 31, 2004, research and development expenses were $278,753,compared to $285,989 for the three months ended March 31, 2003, a decreaseof $7,236, or 2.5%.  The decrease inresearch and development expenses was due to the closing of the Boise, IdahoR&D facility in June of 2003. The development of the RandomPlusTM shuffler and PokerOneTM will requirean increase in R&D expenses in the near term.  The transition of the R&D staff from Las Vegas has begun andwill accelerate to the point that most development will occur at our facilityin China.

 

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

###### ** **

For the three monthsended March 31, 2004, we incurred interest expenses of $277,145, comparedto $657,497 for the three months ended March 31, 2003, a decrease of$380,352, or 57.8%.  This decrease was primarily attributable tothe reduced debt service as a result of a decrease in our outstandingindebtedness during the three months ended March 31, 2004.  The retirement and conversion of $20,331,995in 2003 and early 2004 will continue to reduce this expense if we do not incuradditional debt.

 

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

###### ** **

For the three monthsended March 31, 2004, we had a net loss of $1,469,212 compared to a netloss of $1,446,218 for the three months ended March 31, 2003, an increaseof $22,994, or 1.6%.  The increase innet loss was primarily due to a $67,559 decrease in gross margin and a $343,590increase in general and administrative expenses.  Basic loss per share was $0.09 for the three months endedMarch 31, 2004, compared to $0.19 for the three months endedMarch 31, 2003.

 

### **LIQUIDITY AND CAPITAL RESOURCES**

### ** **

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 $3,415,833 and $3,071,606 in the three months endedMarch 31, 2004 and 2003, respectively. In addition, to fund our development and operating activities, wegenerated cash through financing activities in 2003 of $23,047,432.  We have used cash of $2,204,349 in financingactivities during the three months ending March 31, 2004 for the repaymentof leases payable, short-term debt, and convertible debt.

 

Consequently, we havebeen substantially dependent on cash from financing activities to fund ourdevelopment and operating activities. We will continue to require cash from financing activities for ourcurrent operating needs until our operations generate sufficient cash flow toprovide for such cash requirements.  Asa result of anticipated sales improvements and operating cost initiatives,management believes that the Company will begin to generate positive operatingcash flow during the second half of 2004. In addition, the Company’s financial advisors have expressed confidencethat additional capital can be raised by the Company, if necessary, in 2004,and the Company has received a one-year commitment for a $3.0 million leaseline of credit.

 

11

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###### **Sources of Capital**

###### ** **

In the event our cash onhand plus cash from operations should be insufficient during future periods, weanticipate relying upon private and institutional sources of debt and equity,and we may seek public, private and institutional sources of capital forworking capital purposes.  During theyears ended December 31, 2003 and 2002, our sources of capital included apublic stock offering, 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 repaid $603,610 for thethree months ending March 31, 2004, received proceeds of $2,988,385 andrepaid $2,823,331 for the year ended December 31, 2002 and have receivedproceeds of $989,820 and repaid $2,754,607 for the year ended December 31,2003.  As of March 31, 2004, we hadoutstanding equipment financing of $3,550,186. These equipment leases have terms of 36 to 39 months and were notrecorded as sales because each of the leases included a mandatory buy-backprovision.

 

With respect to ourshort-term debt, we have received proceeds of $2,264,871 and repaid $650,000for the year ended December 31, 2002 and have received proceeds of$7,400,000 and repaid $1,310,000 for the year ended December 31, 2003 andhave repaid $34,393 for the three months ended March 31, 2004.  As of March 31, 2004, we hadoutstanding short-term loans in the aggregate amount of $236,350.  Prior to 2003, we were substantiallydependent on short-term loans from our principal stockholder and otherdirectors.  Despite such reliance,neither our principal stockholder nor our directors are obligated to provideadditional financing to us, and our principal stockholder and directors arefree to decline to fund additional financings to us at any time.  In such event and in the absence of thirdparty financing sources, we may have substantial difficulties in raisingadditional financings.

 

With respect to ourconvertible debentures, we received proceeds of $4,903,076 and $11,050,000during the years ended December 31, 2002 and 2003, respectively, and havecompletely retired the convertible debentures as of March 31, 2004.

 

With respect to thepublic offering of common stock in December 2003, we sold 5,500,000 sharesat $5.00 per share to raise approximately $27,500,000.  The net proceeds after all offering andcommission expenses were $24,800,000.

 

###### **Outlook**

###### ** **

Our ability to maintainadequate liquidity is substantially dependent upon the success of management’splans to address and overcome prior operating losses.  Management has developed and refined its 2004 operating plan toincrease its sales by expanding its product line and improving its salesefforts domestically and internationally. Increased sales in the year ended December 31, 2003 show increasedacceptance of our product line. Management has adopted efforts to reduce operating costs through thetransfer of manufacturing operations to China and restructuring servicefunctions to reduce labor and rental expense. Management has focused on financial condition and liquidity improvementsthrough its capital raising efforts in 2003 along with substantial debtreduction and debt conversion, resulting in positive cash position andsubstantially reduced indebtedness at March 31, 2004.  As a result of anticipated salesimprovements and operating cost initiatives, management believes that we willbegin to generate positive operating cash flow by the end of 2004.  In addition, our financial advisors haveexpressed confidence that additional capital can be raised by us, if necessary,in 2004 and we have received a one-year commitment for a $3.0 million leaseline of credit.

 

12

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Based on presently knowncommitments and plans, we believe that we will be able to fund our operationsand required expenditures through the fourth quarter of 2004 through cash onhand, cash flow from operations, and cash from private placements of debt orequity or from lease financing sources.** **In the event that such sourcesare insufficient or unavailable, we will need to seek cash from public orprivate placements of debt or equity, institutional or other lending sources,sell certain assets or change operating plans to accommodate such liquidityissues.  No assurances can be given thatwe will successfully obtain liquidity sources necessary to fund our operationsin the upcoming year.  If we continue togenerate significant losses from our operations and we are not able to locatedadditional sources of liquidity, we may be unable to continue as a goingconcern.

 

### **RISK FACTORS**

### ** **

**RISKSRELATED TO VENDINGDATA**

** **

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

##### *** ***

Ourfinancial statements report recurring losses and accumulated deficits.  Based on presently known commitments andplans, we believe that we will be able to fund our operations and requiredexpenditures through the fourth quarter of 2004 from cash on hand, cash flowfrom operations and cash from debt or equity financings or from lease financingsources.  The completion of the offering of 5,500,000 shares of common stock inDecember 2003 allowed us to pay off all bridge financing, to convertapproximately $5,730,000 of our convertible debt and accrued interest, to repayour convertible debt, to retire $7,500,000 of our convertible 10% senior notesand still have adequate funds available with which to fund additional productinventory, and use for general corporate purposes.  If we are unable to generate a sufficientamount of sales of our products to fund our operations, we will need to seekcash 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 maynot be able to obtain other liquidity sources as may be necessary to fund ouroperations in the future.

 

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

##### *** ***

We have a history ofsignificant operating losses and anticipate continued operating losses for theforeseeable future.  For the threemonths ended March 31, 2004 and years ended December 31, 2003 and2002, we have incurred net losses of $1,469,212, $7,812,089 and $6,192,786,respectively, and our operations have used $3,410,903, $11,731,150 and$5,206,489 of cash, respectively.  As ofMarch 31, 2004, December 31, 2003 and 2002, we had accumulateddeficits of $46,051,561, $44,582,347 and $36,770,258, respectively.  If we are unable to generate a positive cashflow in 2004, we will be required to locate additional sources of capital.  If our revenues do not increase verysubstantially, or if our spending levels exceed our expectations, we will notbecome profitable.  Revenues may notgrow in the future, and we may not generate sufficient revenues forprofitability.  If we become profitable,we may not be able to sustain profitable operations.

 

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

##### *** ***

We currently compensateour executive officers and significant employees with substantial salaries andother benefits and, in the future, may pay increased salaries andbenefits.  In 2003, we paid an aggregateamount equal to approximately $1,300,000 to our executive officers andsignificant employees.  In June andJuly 2003, we extended our employment agreements for an additional fiveyears with Mr. Blad and an additional three years with seven other keyemployees.  In February 2004, we

 

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expanded our managementteam with the hiring of H. Michael Jahnke as our Chief Operating Officer.  We intend to continue to pay substantialsalaries and benefits to Mr. Blad and certain of our other executiveofficers and employees.  The payment ofsuch compensation and benefits may be a burden on us and may be a factor inlimiting or preventing our profitability. Upon the expiration of those employment agreements, we may elect tocontinue compensating management with similar or higher salaries and otherbenefits.

 

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

##### *** ***

If we fail to generatesufficient demand for our products, we may be unable to sustain operations orgenerate a return to investors.  UntilJanuary 2000, we were in the development stage and derived minimalrevenues from our products.  Currentlywe are an operating company that continues to develop new products.  Since January 2000, our activities havebeen limited to analyzing and consulting with persons in the gaming industry,developing and manufacturing new products, establishing distribution networksfor our products, marketing our products to the gaming industry, and commencingproduct sales.  During such time, wehave derived only limited revenues, which have been insufficient to sustain ouroperations.  We may not generatesufficient revenue to sustain our operations. No independent organization has conducted market research providingmanagement with independent assurance from which to estimate potential demandfor our products.  The overall marketmay not be receptive to our products, and we may not successfully compete inthe target market for our products.

 

##### ***Themarket has not yet demonstrated significant acceptance of our SecureDrop®System or the Deck Checker***Ô, and these products may never receivemarket acceptance.

##### *** ***

Wehave not yet demonstrated significant market acceptance of our SecureDrop®System or the Deck CheckerTM andmay be unable to do so.  We haveonly sold our SecureDrop® Hard Count Module to a small number of casinos.  The SecureDrop® System Soft Count Module hasbeen slow to sell outside Nevada.  Eventhough we have sold units of the SecureDrop® System to various customers inprior periods, newer versions of SecureDrop® products were in beta teststhrough most of 2002.  We believe thatcertain barriers and problems occurred that caused us to have problems breakinginto the market, including a longer than expected sales cycle, product flawsthat we subsequently corrected, and the resistance of gaming company customersto the implementation of unproven technologies.  We have only placed 77Deck CheckerTM units (including19 rentals) as of March 31, 2004. The commercial success of our SecureDrop® System and Deck CheckerTM will depend upon the degree of marketacceptance of these products in the gaming community and will depend on anumber of factors, including:

 
| • |   | demonstration of  effectiveness and reliability;                                                                                                               |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                           |
| • |   | the prevalence and  severity of any quality problems or defects in the early stage of  introduction that were not anticipated in the design of those products; |
|   |   |                                                                                                                                                           |
| • |   | effectiveness of our  marketing and distribution capabilities;                                                                                                 |
|   |   |                                                                                                                                                           |
| • |   | ability to promptly  service and repair the products; and                                                                                                      |
|   |   |                                                                                                                                                           |
| • |   | receipt of approval by  respective gaming jurisdictions.                                                                                                       |

 

If we fail to expand oursales and leases for our SecureDrop® System and our Deck CheckerTM, we may beunable to generate sufficient revenues to continue to operate our business.

 

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

##### *** ***

We are substantiallydependent upon sales to a few major customers. In the first quarter 2004 and in the fiscal year 2003, CaesarsEntertainment, Inc. (formerly Park Place Entertainment Corporation), ourlargest customer, accounted for more than 10% of our revenues.  During the three months endingMarch 31, 2004, approximately 7.4% of trade receivables and 11.2% of totalsales and during the year ended December 31, 2003, approximately 17.6% oftrade receivables and 13.3% of total sales were concentrated in the Nevadagaming industry among five customers under the common ownership of CaesarsEntertainment, Inc.  Any adverse changesin the financial condition of our major customers, any loss of our majorcustomers, or any meaningful reduction in the level of sales to any of thesecustomers could have a materially adverse impact on us.

 

##### ***Theacceptance and expansion of coinless gaming may adversely affect the demand forour 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 of totally coinless gaming devices mayreduce the demand for the SecureDrop® Hard Count Module, which is based on coinusage, and may adversely affect our operations in the future.  For example, International Game Technologyhas introduced the EZ-PayTM system, which attempts to reduce operating costs andmachine downtime by providing gaming operators with machines that drop coinsfor smaller payouts and print tickets for larger, predetermined payouts.  As a result of the issuance of tickets,players are not required to wait for attendants in order to be paid largerpayouts and may use their tickets at other machines equipped with the EZ-PayTMsystem or similar systems.  Due topositive customer response, the number of slot operations with online systemsthat use coinless gaming systems continues to grow.  However, while SecureDrop® Hard Count Module sales may beadversely impacted, we believe demand for our SecureDrop® Soft Count Module hasbeen enhanced.

 

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

##### *** ***

All of our leasedshufflers are placed with customers under short-term lease arrangements, which,unlike long-term leases or permanent sales of our products, can easily beterminated by a dissatisfied customer. The manner in which such short-term leases are structured puts our shufflersat greater risk of replacement due to pressure from competitors, changes ineconomic conditions, obsolescence and declining popularity.  Casino operators may terminate the use ofour products, and we may not be able to maintain and expand the number ofinstalled shufflers through enhancement of existing shufflers, introduction ofnew shufflers, customer service or otherwise. Our ability to compete may be damaged, and our revenues may be reducedif we are unable to protect our intellectual property rights adequately.

 

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

 
| • |   | contractual  arrangements providing for non-disclosure and prohibitions on use; |
|--------|--------|---------------------------------------------------------------------------------|
|   |   |                                                                            |
| • |   | patents  and pending patent applications;                                       |

 

15

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| • |   | trade  secret, copyright and trademark laws; and |
|--------|--------|--------------------------------------------------|
|   |   |                                             |
| • |   | certain  built-in technical product features.    |

 

Patent, trade secret,copyright and trademark laws provide limited protection.  The protections provided by laws governingintellectual property rights do not prevent our competitors from developing,independently, products similar or superior to our products andtechnologies.  In addition, effectiveprotection of copyrights, trade secrets, trademarks, and other proprietaryrights may be unavailable or limited 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 thefuture.  Legal or regulatory proceedingsto enforce our patents, trademarks or copyrights could be costly, timeconsuming, and could divert the attention of management and technicalpersonnel.

 

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

##### *** ***

Shuffle Master, Inc., ourprincipal 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 inus owing it substantial sums of money, and, if large enough, could have amaterial adverse effect on our liquidity and our ability to conductoperations.  Although we believe ourposition to be meritorious, litigation of this nature is a drain on our cashresources and our management’s time. Inasmuch as Shuffle Master has asserted patent infringement claims andwe have reasonable defenses to the same, we cannot determine whether we willprevail in this litigation, nor whether damages, if awarded, wouldsignificantly impact our ability to continue to manufacture and sell particularproducts within the United States and its territories.  If we do not prevail, we will be unable tosell our shuffler products unless we change certain components used in theshufflers or obtain a license from Shuffle Master to use the playing cardshuffler apparatus and the display. Similarly, we cannot determine whether Shuffle Master will assert otherlitigation claims based upon other patents it may currently or in the futureown, nor can we determine the likely outcome of any such litigation or whetherany such substantial litigation would have a material adverse effect on ourbusiness as presently conducted or as anticipated.

 

##### ***Webelieve that it is likely that our PokerOneTM Shuffler will be the subject offuture patent litigation if the product is sold and installed in the UnitedStates and, if commenced, could subject us to continuing litigation costs andrisks.***

##### *** ***

Other than theallegations made by Shuffle Master, Inc. discussed above, we are not aware ofany claims or basis for our current products infringing on the proprietaryrights of third parties.  To the extentthat we introduce new products that incorporate the same or similar technology,it is likely that Shuffle Master, Inc. will bring one or more claims against usseeking damages, injunctive or other equitable relief, or both.  Moreover, we believe that it is reasonablylikely that if we introduce the PokerOneTM Shuffler in the United States,Shuffle Master will bring one or more claims against us seeking variousremedies at equity or law.  We cannotpredict the outcome of any future litigation that may occur.

 

If our future productsincorporate technology that infringes the proprietary rights of third partiesand we do not secure licenses from them, we could be liable for substantialdamages that would cause a material reduction in revenues and impair ourprospects for achieving growth and profitability.

 

In furtherance of thedevelopment of our services or products, we may need to acquire licenses forintellectual property to avoid infringement of third party rights or claims ofinfringement.  These licenses may not beavailable on commercially reasonable terms, if at all.  Claims for infringement, if

 

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made, could damage our businessprospects, our results of operations and financial condition, whether or notthe claims have merit, by:

 
| • |   | consuming  substantial time and financial resources required to defend against them;       |
|--------|--------|--------------------------------------------------------------------------------------------|
|   |   |                                                                                       |
| • |   | diverting  the attention of management from growing our business and managing  operations; |
|   |   |                                                                                       |
| • |   | resulting  in costly litigation; and                                                       |
|   |   |                                                                                       |
| • |   | disrupting  product sales and shipments.                                                   |

 

If any third partyprevails in an action against us for infringement of its proprietary rights, wecould be required to pay damages and either enter into costly licensingarrangements or redesign our products so as to exclude the infringingtechnology.  As a result, we would incursubstantial costs and delays in product development, sales and shipments, ourrevenues may decline substantially and we may not be able to achieve the growthrequired for us to achieve profitability.

 

##### ***Ourfailure to compete successfully against innovative competitors or new entrantscould adversely impact our ability to sell our products and generate revenues.***

##### *** ***

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

 

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

##### *** ***

We may not be able tocomplete development of the PokerOneTM Shuffler.  We are continuing to fine tune this product, and we plan to startthe testing phase in Asia by the end of the second quarter of 2004.  We have expended significant time andresources into the development of this product, and our failure to bring abouta viable product may limit our long-term revenue growth in our shuffler productline.

 

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

##### *** ***

In the event that 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 tested our products forsecurity and our products have been tested by certain gaming regulators as partof the approval process, our products may be susceptible to schemes by thirdparties to defraud the properties where our products are used.  Vulnerabilities in the security of ourproducts will almost certainly reduce demand for these products.  Our shufflers may become vulnerable to cardcounters or expert players, and the use of our shufflers may result infinancial losses for our customers.  Theoccurrence of any of these events would likely have a material adverse effecton our sales revenues.

 

17

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

##### *** ***

The success of ourbusiness depends solely on the gaming industry where revenues are sensitive togeneral economic conditions and generally rise or fall rapidly in relation tothe condition of the overall economy. Although we cannot accurately estimate the economic impact of past orfuture terrorist attacks or current international conflicts at this time, thegaming industry has been negatively affected by the reduction in air travel andtourism, and we expect that any significant decline in the economic health orgrowth of the gaming industry will reduce demand for our products.

 

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

##### *** ***

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

 

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

##### *** ***

We have centralized mostphases of the manufacturing process for our products at our own facility inXiaolan Town in Zhongshan City, China. We will be adversely impacted if there is an interruption in our abilityto receive components or inventory from, or a material increase in labor costsin, China.  Factors that may cause asupply interruption include political unrest, closure of ports, worldwidehealth concerns, including SARS, and other events beyond our control.  In the event that our manufacturingoperations in Xiaolan Town are interrupted, our ability to fill orders, shipsuch orders and realize the revenues therefrom could be adversely affected.

 

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

##### *** ***

As a result of theopening of our manufacturing facility in China, we are currently operating ininternational markets, and we propose to further expand our international salesand operations.  Engaging in businessoutside the United States will subject us to the customary risks of doingbusiness in foreign countries.  Theserisks include 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 oneor more of these factors could materially adversely affect our ability toconduct business outside the United States and therefore our business as whole.

 

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

##### *** ***

In general, substantiallyall sales of our products outside the United States are achieved throughdistributor relationships.  We believethe distributors that we have engaged are experienced and reputable, however,if we are unable to manage these relationships, our ability to generate revenueand 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.

 

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

##### *** ***

Our executive officersand members of our board beneficially own approximately 9,139,944 shares ofcommon stock, or approximately 50.5% of the outstanding shares of our commonstock, assuming exercise or conversion of all options, warrants and convertibledebentures held by our executive officers and members of our board that areexercisable within 60 days of March 1, 2004.  Accordingly, these stockholders have the power to control****all matters requiring approval by ourstockholders, including the election of directors and approval of mergers andother significant corporate transactions. This concentration of ownership also has the effect of delaying,preventing or expediting, as the case may be, a change in control of ourcompany.

 

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

##### *** ***

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

 

**RISKSRELATED TO OUR INDUSTRY**

** **

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

##### *** ***

There is 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 withwhich we compete in the shuffler market are substantially larger, have moresubstantial histories, backgrounds, experience and records of successfuloperations, greater financial, technical, marketing and other resources, moreemployees and more extensive facilities than we now have, or will have in theforeseeable future.  It is also likelythat other competitors will emerge in the near future.  Other companies may develop productscompetitive to our SecureDrop® System. We may not be able to compete successfully with other established gamingproduct manufacturers.  Our inability tocompete successfully will likely result in loss of market share and lowerrevenues, or increases in operating costs, such as marketing costs.

 

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##### ***Weface extensive regulation from gaming and 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 introduce gaming products or conceptsinto such jurisdictions may be required to submit applications relating totheir activities or products (including detailed background informationconcerning controlling persons within their organization), which are thenreviewed for approval.  In this regard,we may incur significant expenses in seeking to obtain licenses for our gamingproducts and concepts, and our products may not be approved in alljurisdictions.  The failure to obtainsuch approval in any jurisdiction in which we may seek to introduce our productsor concepts could have a material adverse effect on our business.  In addition, any change to the applicablestatutes, rules and regulations that restricts or prevents our ability tooperate could have an adverse effect on us.

 

##### ***Anyperson who is the beneficial owner of our common stock or with whom we have amaterial relationship that fails or refuses to apply for a finding ofsuitability, or that is found unsuitable for licensing, would be required todispose of all of our stock.***

##### *** ***

Certain gaming regulatoryagencies to which we are subject may investigate any beneficial holder of ourvoting securities (regardless of the numbers of shares owned), and anyindividual who has a material relationship or involvement with us, in order todetermine whether such individual is suitable or should be licensed as abusiness associate of ours.  Inaddition, the gaming authorities of various jurisdictions may require ourofficers, directors and certain key employees to be licensed or found suitableby these gaming authorities, which would require these officers, directors andkey employees to submit detailed background information.  Any person who fails or refuses to apply fora finding of suitability or a license after being ordered to do so by gamingregulatory agencies may be found unsuitable, and we could be subject to adverseregulatory action.  In the event thatthe gaming authorities were to find an officer, director, key employee,stockholder, or any other individual that has a material relationship with us,unsuitable for licensing or unsuitable to continue having a relationship withus, we would have to sever all relationships with that individual, and thatindividual would be required to dispose of all of our stock.  This could result in the loss of key personscritical to our success or in significant selling pressure on our stock if suchpersons are required to dispose of shares of our common stock in an amount thatexceeds typical trading volumes in our shares.

 

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

##### *** ***

We design and 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 gaming industry, and, therefore, ourrevenues, are affected by a number of factors beyond our control, including:

 
| • |   | general  economic conditions, such as recession, inflation, business cycle  fluctuations and interest rates; |
|--------|--------|--------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                         |
| • |   | levels  of disposable income of gaming property patrons;                                                     |
|   |   |                                                                                                         |
| • |   | acts  of terrorism and anti-terrorism efforts;                                                               |
|   |   |                                                                                                         |
| • |   | increased  transportation costs resulting in decreased travel by gaming patrons;                             |
|   |   |                                                                                                         |
| • |   | changes  or proposed changes in tax laws;                                                                    |

 

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| • |   | legal  and regulatory issues affecting the development, operation and licensing of  our gaming customers; and |
|--------|--------|---------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                          |
| • |   | competitive  conditions in the gaming industry.                                                               |

 

These factors mayadversely impact the demand for our products and materially affect the revenuesthat we realize on the sale or placement of our products.

 

**RISKSRELATED TO OUR COMMON STOCK**

** **

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

##### *** ***

There had been no tradingmarket for our common stock until September 10, 2003, when our commonstock became eligible for quotation on the OTC Bulletin Board.  Due to the limited trading history of ourcommon stock, an active trading and/or a liquid market may not bemaintained.  Moreover, in the event thatwe are unable to continue as a going concern and we are dissolved or otherwiseterminated, you could lose your entire investment in our common stock.  Investment in our common stock is at risk ofcomplete loss if our operations are unsuccessful.

 

Historically, our commonstock has been deemed to be “penny stock” as that term is defined in Rule3a51-1 promulgated under the Securities Exchange Act of 1934, or the ExchangeAct.  Penny stock may be more difficultfor investors to resell.  Penny stocksare stocks:

 
| • |   | with a price of less  than $5.00 per share;                                                                                                                                                                                                                                                     |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                            |
| • |   | that are not traded on  a “recognized” national exchange (exchange-listed securities must still have  a price of not less than $5.00 per share);                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                            |
| • |   | whose prices are not  quoted on the Nasdaq automated quotation system (Nasdaq-listed stock must  still have a price of not less than $5.00 per share); or                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                            |
| • |   | from issuers with net  tangible assets less than $2.0 million (if the issuer has been in continuous  operation for at least three years) or $5.0 million (if in continuous  operation for less than three years), or with average revenues of less than  $6.0 million for the last three years. |

 

Although our AMEX listingapplication has been approved and our common stock began trading on the AMEX onMay 4, 2004, since the closing price for our common stock is less than $5.00per share, our common stock is deemed to be penny stock for purposes ofSection 15(b)(6) of the Exchange Act. Federal rules and regulations generally impose additional sale practiceand disclosure requirements and penalties on broker/dealers and personsassociated with or seeking to become associated with such broker/dealers whosell or recommend penny stocks to certain investors.  These requirements mayreduce the potential market for our common stock by reducing the number ofpotential investors, and any or all of these factors may make it more difficultfor investors in our common stock to sell shares to third parties or tootherwise dispose of them and could cause our stock price to decline.  Moreover, broker/dealers are requiredto determine whether an investment in a penny stock is a suitable investmentfor a prospective investor and receive the investor’s written consent to thetransaction.

 

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

##### *** ***

Our operations may notbecome profitable.  If we becomeprofitable, we intend to use any earnings that may be generated to finance thegrowth of our business.  Any payment offuture dividends will be at the discretion of our board of directors and willdepend on, among other things, our earnings, financial condition, capitalrequirements, level of indebtedness, statutory and contractual restrictionsapplying to the payment of dividends, and other considerations that our boardof directors deems relevant. Accordingly, stockholders may have to sell some or all of their commonstock in order to generate cash flow from their investment.  Stockholders may not realize a gain on theirinvestment, and they may lose all or a significant amount of their investmentwhen they sell their common stock.

 

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

##### *** ***

We have supplemented thecash deficit arising from our operations with the proceeds of ourDecember 2003 offering of 5,500,000 shares of common stock and havereceived a one-year commitment for a $3 million lease line of credit, and will,if necessary, continue to supplement with cash from private or publicplacements of debt or equity, institutional or other lending sources.  We have also utilized convertible debtsecurities and warrants to raise capital in the past.  The issuance of additional equity or convertible debt securitieswill have the effect of reducing the percentage ownership of our currentstockholders.  In addition, these equityor convertible debt securities may have additional rights, preferences orprivileges to those of our common stock, such as registration rights andpreferences in liquidation.  In the eventwe are required to raise additional funds to support our operations, additionalfunds may not be available on terms favorable to our company, or at all.  If adequate funds are not available or arenot available on acceptable terms, we may not be able to fund our operations orotherwise continue as a going concern.

 

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

##### *** ***

In addition to the numberof shares registered on behalf of the Selling Stockholders, we haveapproximately 7,595,200 sharesof common stock that are either freely tradable pursuant to Rule 144(k) of theSecurities Act of 1933, or the Securities Act, or have previously beenregistered by us through a registration statement filed with the SEC.  As such, the future sale of a substantialnumber of shares of our common stock in market transactions, or the perceptionthat these sales could occur, may depress the market price for our commonstock.  These sales could also impairour ability to raise additional capital through the sale of our equitysecurities in the future.

 

##### ***Ourboard of directors may issue blank check preferred stock, which may affect thevoting rights of our holders and could deter or delay an attempt to obtaincontrol 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 commonstock with respect to dividends rights, liquidation preferences, or both, andmay have full or limited voting rights. Accordingly, issuance of shares of preferred stock could adverselyaffect the voting power of holders of our common stock and could have theeffect of deterring or delaying an attempt to obtain control of us.

 

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## **ITEM3.**                             CONTROLS AND PROCEDURES

## ** **

(a)                                  *Evaluation of Disclosure Controls.*  We evaluated the effectiveness of ourdisclosure controls and procedures as of the end of the three months endedMarch 31, 2004.  This evaluationwas done with the participation of our chief executive officer and our chieffinancial officer.  Disclosure controlsand procedures are controls and other procedures that are designed to ensurethat information required to be disclosed by us in the reports that we file orsubmit under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms.  Disclosure controls and procedures include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed by us in the reports that we file under the ExchangeAct is accumulated and communicated to our management, as appropriate to allowtimely decisions regarding required disclosure.

 

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

 

Based on this evaluation,we concluded that, subject to the limitations noted above, our disclosurecontrols and procedures are effective to ensure that information we arerequired to disclose in reports that we file or submit under the Exchange Actis recorded, processed, summarized, and reported within the time periodsspecified in the SEC’s rules and forms.

 

(b)                                 *Changes in Disclosure Controls and Procedures.*  Although there have been no significantchanges in internal controls or in other factors that could significantlyaffect these controls subsequent to the date of their evaluation, we arecontinuously evaluating means of enhancing our internal controls.  During the twelve months endedDecember 31, 2003, we added qualified staff to our accounting department,we improved our approval process for accounting entries, and we commencedimplementation of MAS-500 integrated financial and manufacturing softwareapplication.  MAS-500 has beenimplemented in Las Vegas to provide an integrated control process forpurchasing, inventory control and manufacturing and should improve the accuracyand timeliness of our financial reporting. The training of staff at our China facility commenced in the secondquarter of 2004 and full implementation is expected to be complete by the endof the quarter.

 

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# **PART II – OTHER INFORMATION**

# ** **

## **ITEM1.  LEGAL PROCEEDINGS**

## ** **

On March 27, 2002,Shuffle Master, Inc., or Shuffle Master, filed a complaint (CaseNo. CV-S-02-0438-JCM-PAL) against VendingData in the United StatesDistrict Court, District of Nevada.  Theamended complaint alleges, among other things, claims for patent infringementand requests treble damages, an injunction enjoining us from infringing on twoof Shuffle Master’s patents, an accounting of our gains and profits thatresulted from our alleged infringement, and for interest, costs and attorneys’fees.  The Shuffle Master patents thatare at issue in the litigation concern registering use of a playing cardshuffler apparatus and the displaying of the use on a display.  We have filed our answer, counterclaims, andamended counterclaims against Shuffle Master. In our answer, we deny Shuffle Master’s allegation of patentinfringement and request that Shuffle Master’s complaint be dismissed.  We also seek, in our amended counterclaim, adeclaration that we do not infringe Shuffle Master’s patents and that ShuffleMaster’s patents and certain of its related claims are invalid.  We further assert counterclaims againstShuffle Master for breach of contract and violation of the Uniform TradeSecrets Act.  On May 20, 2002, theUnited States District Court, District of Nevada denied Shuffle Master’s motionfor preliminary injunction against us. Discovery in this litigation is now closed.  On May 28, 2003, we filed a motion for summary judgmentrequesting that the court dismiss the case against us.  The hearing for our motion for summaryjudgment was taken off calendar pending a ruling by a magistrate judge withrespect to a October 24, 2003 claim construction hearing to determine thescope and definition of the patent claims at issue.  On March 31, 2004, the magistrate judge issued an order withregard to claim interpretation, to which the Company has filed writtenobjections.  The court has not yetscheduled oral argument regarding the objections to claim interpretation.

 

On July 22, 2003,Shuffle Master, Inc. filed a petition (Case No. 20003-11016) againstVendingData Corporation and Casinovations, Inc., an inactive wholly-ownedsubsidiary of VendingData Corporation, in the Civil District Court for theParish of Orleans, State of Louisiana. The petition alleges that VendingData and/or Casinovations violated theLouisiana Unfair Sales Law by offering to sell or lease the Random EjectionShufflerTM at a price that is below the cost of producing and selling or leasingthe Random Ejection ShufflerTM.  Thepetition further alleges that VendingData and/or Casinovations violated theLouisiana Unfair Trade Practices Act by intending to “dump” Random EjectionShufflersTM into the market with the intent to “steal” customers from ShuffleMaster.  The third claim asserted byShuffle Master is that the actions of VendingData and/or Casinovationsconstitute fraud, theft by conversion, misappropriation, intentionalmisrepresentation and/or general negligence. The petition requests the court to enter a preliminary and permanentinjunction against VendingData and/or Casinovations from selling or leasing theRandom Ejection ShufflerTM and other automatic playing card shufflers toHarrah’s Jazz Casino located in New Orleans, reasonable attorneys’ fees andcosts, and all other relief in law or in equity that the circumstancesmerit.  This matter has been settled bythe parties, however, as of May 10, 2004, we have not received thefully-executed settlement documents.

 

On September 8, 2003,we received a Notice of Administrative Charges and Opportunity for anAdjudicative Proceeding from the State of Washington Gambling Commission.  The administrative charges arose out of ourfailure to timely deliver certain detailed financial and other informationabout certain of our larger debtholders, (who were all subsequently repaid inDecember 2003).  As a result of ourfailure to timely and completely reply, the Notice of Administrative Chargesasserted violations of Washington regulatory provisions that could carrypenalties including up to the suspension or revocation of our Washingtonlicense.  We attempted to obtain therequested information from our debtholders but were unable to satisfy theagents of the State of Washington Gambling Commission.  While we have continued to cooperate andmake efforts to comply with the information requests, we engaged Washingtonlegal counsel to respond to the alleged violations and advise us on proceduraland

 

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substantive steps we musttake.  The State of Washington GamblingCommission issued an amended Notice of Administrative Charges, which reflectedtechnical modifications to the lender-related charges and included a chargerelating to the provision of an automatic card shuffler device to an unlicenseddealer school in Washington.  InApril 2004, we entered into an Agreed Order of Settlement and Agreed Orderwith the State of Washington Gambling Commission that provided for theforfeiture of the shuffling device to the State of Washington GamingCommission.  In addition, the settlementprovided for a ten day license suspension, seven days of which were vacatedpursuant to the payment of a fine and three days of which were deferred for aperiod of one year, provided we do not violate the gambling statutes orregulations of Washington State, or the terms of the Agreed Order.

 

## **ITEM2.  CHANGES IN SECURITIES.**

## ** **

Not applicable.

 

## **ITEM3.  DEFAULTS UPON SENIOR SECURITIES.**

## ** **

Not applicable.

 

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

## ** **

Not applicable.

 

## **ITEM5.  OTHER INFORMATION.**

## ** **

On May 4, 2004, ourcommon stock began trading on the American Stock Exchange under the tradingsymbol, “VNX.”  Previously, our commonstock was quoted on the OTC Bulletin Board under the trading symbol, “VNDC.”

 

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

## ** **

| (a)    |   | Exhibits.            |
|--------|--------|----------------------|
|   |   |                 |
|   |   | 31.1                 | Certifications Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
|   |   |                 |   |
|   |   | 31.2                 | Certifications Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
|   |   |                 |   |
|   |   | 32.1                 | Certification of President and Chief Financial  Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18  U.S.C. Section 1350). |
|   |   |                 |
| (b)    |   | Reports on Form 8-K. |

 

During the three months ended March 31, 2004, we filed thefollowing:

 
| • |   | Current Report on Form  8-K filed on February 18, 2004 reporting the appointment of H. Michael  Jahnke as our Chief Operating Officer;    |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                           |
| • |   | Current Report on Form  8-K filed on February 19, 2004 reporting our preliminary revenues for  the year ended December 31, 2003; and |
|   |   |                                                                                                                                           |
| • |   | Current Report on Form  8-K filed on March 26, 2004 reporting our financial results for the 2003  fiscal year and fourth quarter of 2003. |

 

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**SIGNATURE**

** **

In accordance with therequirements of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.

 
|   |         | **VENDINGDATA  CORPORATION** |
|--------|--------------|------------------------------|
|   |         | (Registrant)                 |
|   |         |                         |   |
| Date:  | May 17, 2004 | By:                          |  /s/ Steven J.  Blad |   |
|   |         |                         |  Steven J. Blad |
|   |         | Its:                         |  Chief Executive  Officer and President   (Principal Executive Officer and Duly   Authorized Officer) |

 

 

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