UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-K





x
            ANNUAL REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For
the fiscal year ended December 31, 2008





OR





o
            TRANSITION REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For
the transition period from
_____________________to______________________





Commission
File Number: 000-51572











PokerTek,
      Inc.


(Exact
name of registrant as specified in its charter)


North
      Carolina
            
            61-1455265(State
      or other jurisdiction of incorporation or organization)
            
            (I.R.S.
      Employer Identification No.)1150
      Crews Road, Suite F, Matthews, North Carolina 28105(Address
      of principal executive offices) (Zip
Code)


(704)
849-0860


(Registrant’s
      telephone number, including area
code)





Securities
registered pursuant to Section 12(b) of the Act:


Title of each class
            Name of each exchange on which
      registeredCommon
      Stock, no par value
            The
      NASDAQ Stock Market LLC
              (NASDAQ
      Capital Market)





Securities registered pursuant to
Section 12(g) of the Act:None




Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  Yes o  No x


Yes o  No x




Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.  Yes x   No
o





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. o





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act (check one):


o
              Large
      accelerated filer
              o
              Accelerated
      filero
              Non-accelerated
      filer (do not check if a smaller reporting company)
              x
              Smaller
      reporting company


Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).  Yes o  No x




The
aggregate market value of the common equity held by non-affiliates of the
registrant as of June 30, 2008 was $18,658,255 based upon the last reported sale
price on the NASDAQ Global Market (on which our shares were traded prior to our
transition to the NASDAQ Capital Market in December 2008) on June 30,
2008.





On March
13, 2009, there were 11,021,429 outstanding shares of the registrant’s common
stock.





DOCUMENTS
INCORPORATED BY REFERENCE


Certain
portions of our Proxy Statement for the 2009 Annual Meeting of Shareholders are
incorporated by reference into Part III of this Annual Report on Form
10-K.









TABLE OF CONTENTS




PageCautionary
      Note Regarding Forward-Looking Statements
                    
                    iiPART
      IItem 1.
                    
                    Business
                    
                    1Item
      1A.
                    
                    Risk
      Factors
                    
                    8Item
      1B.
                    
                    Unresolved
      Staff Comments
                    
                    16Item
      2.
                    
                    Properties
                    
                    16Item
      3.
                    
                    Legal
      Proceedings
                    
                    16Item
      4.
                    
                    Submission
      of Matters to a Vote of Security Holders
                    
                    16PART
      IIItem
      5.
                    
                    Market
      for Registrant’s Common Equity, Related Stockholder Matters and
      Issuer Purchases of Equity Securities
                    
                    16Item
      6.
                    
                    Selected
      Financial Data
                    
                    17Item
      7.
                    
                    Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                    
                    18Item 7A.
                    
                    Quantitative
      and Qualitative Disclosures about Market Risk
                    
                    27Item
      8.
                    
                    Financial
      Statements and Supplementary Data
                    
                    28Item
      9.
                    
                    Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                    
                    28Item
      9A (T).
                    
                    Controls
      and Procedures
                    
                    29Item
      9B.
                    
                    Other
      Information
                    
                    30PART
      IIIItem
      10.
                    
                    Directors,
      Executive Officers and Corporate Governance
                    
                    31Item
      11.
                    
                    Executive
      Compensation
                    
                    31Item
      12.
                    
                    Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                    
                    31Item
      13.
                    
                    Certain
      Relationships and Related Transactions, and Director
      Independence
                    
                    31Item 14.
                    
                    Principal
      Accounting Fees and Services
                    
                    31PART
      IVItem
      15.
                    
                    Exhibits,
      Financial Statement Schedules
                    
                    32Signatures
                    
                    33Exhibit
      Index




(i)




Cautionary
Note Regarding Forward-Looking Statements





This
annual report on Form 10-K contains forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the
“Exchange Act”), including but not limited to Item 7, “Management’s Discussion
and Analysis of Financial Condition and Results of Operations”.  These
forward-looking statements are made under the provisions of The Private
Securities Litigation Reform Act of 1995.  In some cases, words such
as “may,” “will,” “could,” “would,” “should,” “expect,” “intend,” “plan,”
“anticipate,” “believe,” “estimate,” “predict,” “project,” “potential,”
“continue,” “ongoing” or other comparable words identify forward-looking
statements.  Our actual results, performance or experience may differ
materially from those expressed or implied by forward-looking statements as a
result of many factors, including our critical accounting policies and risks and
uncertainties related, but not limited to: the impact of global macroeconomic
and credit conditions on our business and the business of our suppliers and
customers, overall industry environment, customer acceptance of our products,
delay in the introduction of new products, further approvals of regulatory
authorities, adverse court rulings, production and/or quality control problems,
the denial, suspension or revocation of permits or licenses by regulatory or
governmental authorities, termination or non-renewal of customer contracts,
competitive pressures and general economic conditions and our financial
condition, including our ability to maintain sufficient liquidity to operate our
business. These and other risks and uncertainties are described in more detail
under the caption “Risk Factors” in Item 1A of Part I of this annual report on
Form 10-K and other reports that we file with the Securities and Exchange
Commission.  As a result of these risks and uncertainties, the results
or events indicated by these forward-looking statements may not
occur.  We caution you not to place undue reliance on any
forward-looking statement.





Forward-looking
statements speak only as of the date they are made and should not be relied upon
as representing our views as of any subsequent date.  We undertake no
obligation to update or revise such statements to reflect new circumstances or
unanticipated events as they occur, except as required by applicable laws, and
you are urged to review and consider disclosures that we make in the reports
that we file with the Securities and Exchange Commission that discuss other
factors germane to our business.




(ii)




PART
I





Item
1.                 Business.





We are
engaged in the development, manufacture and marketing of electronic products for
use in the gaming and amusement markets.   The Company was
founded on August 22, 2003 and we completed our initial public offering on
October 13, 2005.  Our common stock began trading on October 14, 2005
and is currently listed on the NASDAQ Capital Markets under the ticker symbol
PTEK.  Our corporate office is located in Matthews, North
Carolina.  We also operate a Canadian subsidiary, PokerTek Canada,
Inc. and derive a substantial portions of our revenues from Canada, Australia,
and Europe.  For the year ended December 31, 2008, revenues from
customers outside the United States accounted for 63% of consolidated revenue.
See Note 15, “Segment
Information”
in Item 8, “Financial Statements and Supplementary Data.”





We
currently have two product lines – PokerPro® and Heads-Up
ChallengeTM:





PokerPro®-The PokerPro system
consists of electronic poker table(s) and related peripheral equipment providing
commercial casinos, tribal casinos, cruise ships and card clubs with a
fully-automated poker-room environment designed to improve the profitability of
poker by enhancing operator revenue opportunities while decreasing startup and
operating costs.   We first introduced PokerPro in late 2005 and
have continued to invest in features and innovations to enhance the player and
operator experience. We distribute PokerPro domestically using our internal
sales force to customers in the United States, Canada and cruise ships,
generally on a recurring revenue lease model.





Internationally,
we sell PokerPro to Aristocrat International Pty. Limited (“Aristocrat”) for
distribution in most markets outside North America.  Aristocrat is a
leading global provider of gaming solutions including video slot machines,
progressive systems and casino management systems and is a significant
shareholder of the Company, owning approximately 16.4% of our outstanding common
stock as of December 31, 2008.  Aristocrat purchases the PokerPro
tables from us and assumes responsibility for all marketing, regulatory,
distribution and support in their markets.





As of
December 31, 2008, there were 275 PokerPro tables, consisting of 177 PokerPro
tables on lease with 16 gaming customers at 75 sites in the United States,
Canada, and on major cruise lines and 98 PokerPro tables sold to Aristocrat for
lease to its customers internationally.





Heads-Up
ChallengeTM.  Heads-Up Challenge is an innovative amusement
platform that enables two players to compete head to head against each other for
entertainment purposes in non-gambling venues such as bars and
restaurants.  We introduced Heads-Up Challenge in late 2007 as a Texas
Hold’em Poker amusement game. We intend to develop other games to take advantage
of the unique heads-up platform and to enhance our operators’ revenue
opportunities.  Bocce was added to the product offering during the
fourth quarter of 2008.





We sell
our Heads-Up Challenge product through a network of independent distributors
throughout the world.  We have signed arrangements with 15
distributors for the United States, Canada, the United Kingdom and the United
States Military.  In Australia and New Zealand, Aristocrat serves as
our distributor for Heads-Up Challenge.   As of December 31,
2008, we had sold an aggregate of 1,148 units since product launch.





PokerPro
Gaming Products





Overview.Poker is one of several card games in which two or more players
strategically bet against each other. Many casinos and card clubs operate poker
rooms that typically consist of tables at which up to 10 players play any of
several types of poker against the other players at the table. A dealer employed
by the casino or card club is responsible for dealing cards, calculating bets,
distributing payouts and collecting the amount the casino or card club charges
as a service fee. Unlike most other games played at a casino, where the casino
may win the full amount of a player’s bet, the casino or card club’s revenue
from the poker room is limited to a service fee, typically a small amount taken
from each pot (the “rake”) or a fixed amount charged at a regular
interval.  The poker rooms’ revenue directly correlates to the amount of
hands / time played per day, not on the win-loss rate of player bets. 
Accordingly, poker typically generates lower relative profits for the casino
operator than slot machines and other table games.  Our gaming products
seek to improve the profitability of poker by enhancing operator revenue
opportunities while decreasing startup and operating costs.





The
PokerPro system is an automated 10-seated poker table with electronic components
that allows players to play poker against one another using electronic cards and
chips.  Each player position has a touch screen monitor to view their
cards, betting options and other game information. The players use their touch
screen monitor to input game decisions, make bets, and manage their account. In
the center of the table is an LCD video screen which displays information such
as chips bet by each player, total pot or pots and community cards dealt.
Electronic cards are dealt to the players by a central server, which is
physically separate from the table.





1




In
addition to the table, the PokerPro system comes with a Cashless Wagering System
(“CWS”), which creates and maintains player accounts and transacts cash-in and
cash-out functions. A player who wants to play on the PokerPro system must first
establish an account in the CWS and receive an account card. If a table seat is
available, the player can insert his or her account card into the PokerPro
player monitor, bring money to the table and begin playing. If the tables are
full, the player can use an automated kiosk to get on a waiting list for the
game he or she wants to play. There is a waiting list display which indicates
where a player is in the queue and when a position becomes available, directs
the player to the appropriate table.





The
PokerPro system also has administrative tools which are designed to allow casino
management to stop, start and monitor the poker games in progress.  They
allow management to choose the variety of poker being played, the betting limits
and the number of players required to start a poker game. The administrative
tools are also designed to track statistics about game play and specific
players, such as the number of hands being played per hour and the average pot
size of each game.





The
PokerPro system currently allows players to play Texas Hold’em, Omaha, and Seven
Card Stud poker and all games can be played as cash games, single-table
tournaments or multi-table tournaments.  The casinos or card clubs can
offer these games in a variety of limits, including, no-limit, limit, spread
limit and pot limit.  Omaha can be played as high hand only, or high / low
split pot.  Seven Card Stud can be played as high hand only, high / low
split pot, or Razz (low hand only).  Poker games offered by the PokerPro
system are completely configurable, so each game can be played in accordance
with the same rules that apply to live poker games.





Market
Opportunities.The game of poker has been increasing in popularity over
the past several years. We believe PokerPro is an innovative product from both
the casino and the player perspective and our goal is to capture a significant
share of this growing market.   . The table below presents the
number of poker tables in our target markets worldwide (source is the Casino
City Press, Winter 2009).  Each market presents varying degrees of
opportunity and operates under different regulatory guidelines.




2008
                  
                  
                  2007
                  
                  
                  2006
                  
                  
                  2005
                  
                  
                  2004Commercial
      Casinos
                  
                  
                  2,631
                  
                  
                  
                  2,381
                  
                  
                  
                  2,354
                  
                  
                  
                  1,722
                  
                  
                  
                  868Tribal
      Casinos
                  
                  
                  2,153
                  
                  
                  
                  2,086
                  
                  
                  
                  1,989
                  
                  
                  
                  1,755
                  
                  
                  
                  1,046Card
      Clubs
                  
                  
                  1,396
                  
                  
                  
                  1,351
                  
                  
                  
                  1,352
                  
                  
                  
                  1,198
                  
                  
                  
                  1,028Other
                  
                  
                  955
                  
                  
                  
                  934
                  
                  
                  
                  703
                  
                  
                  
                  341
                  
                  
                  
                  269Total
      North American Market
                  
                  
                  7,135
                  
                  
                  
                  6,752
                  
                  
                  
                  6,398
                  
                  
                  
                  5,016
                  
                  
                  
                  3,211Total
      International Market
                  
                  
                  3,048
                  
                  
                  
                  2,645
                  
                  
                  
                  2,619
                  
                  
                  
                  2,006
                  
                  
                  
                  1,670Total
      Global Market
                  
                  
                  10,183
                  
                  
                  
                  9,397
                  
                  
                  
                  9,017
                  
                  
                  
                  7,022
                  
                  
                  
                  4,881North
      American Annual Growth
                  
                  
                  5.7
                  %
                  
                  
                  5.5
                  %
                  
                  
                  27.6
                  %
                  
                  
                  56.2
                  %
                  
                  
                  11.9
                  %International
      Annual Growth
                  
                  
                  15.2
                  %
                  
                  
                  1.0
                  %
                  
                  
                  30.6
                  %
                  
                  
                  20.1
                  %
                  
                  
                  28.3
                  %




During
late 2008 and early 2009, overall economic conditions weakened in the United
States and abroad, negatively impacting attendance and consumer spending in most
gaming markets. Accordingly, as casino operators experience increased financial
pressure, we expect that growth in poker tables could slow or reverse in
2009.





Commercial Casinos. North
American commercial casinos have experienced significant growth in poker tables
over the past five years. This segment of the market represents a significant
market opportunity for us.  The commercial casino market is highly
regulated and approval from the date of initial application for commercial
casinos can be up to 24 months or longer.





In 2008,
the American Gaming Association (“AGA”) reported that, in the United States,
there were 467 commercial casinos operating in 12 states that offered legalized
gaming.  Of the 12 states, Nevada and New Jersey were the largest
commercial casino markets in North America in terms of gross gaming revenue with
270 casinos and 11 casinos, respectively.





2




In
Canada, there were 63 commercial casinos operating in 8 provinces.  We
have regulatory approval to operate in commercial casinos in Quebec and are
pursuing regulatory approval to operate in Ontario, as well as in the Canadian
provinces operated by the Atlantic Lottery Corporation.




As of
December 31, 2008, we had 87 PokerPro tables in commercial casinos in the United
States and Canada.





Tribal Casinos.As of
December 31, 2008, there were approximately 441 tribal gaming facilities in
the United States and Canada.





As of
December 31, 2008, we had 25 PokerPro tables in tribal casinos in Michigan and
California.





Card Clubs. Several states,
such as California, Washington, North Dakota, Minnesota and Montana, have card
clubs that specialize in poker. California and Washington are the two largest
card club markets in terms of revenue. As of December 2008, according to Casino
City Press, California is the largest card club market in the United States,
with 90 card clubs operating approximately 1,110 tables.  In
Washington, there are 90 card clubs operating approximately 272
tables.





As
of December 31, 2008, we had 5 PokerPro tables located in card clubs in
California.





Cruise Ships. As of December
2008, per the Casino City Press, there were 111 poker tables on approximately
146 ocean-going cruise ships in the world.  Unlike other markets in
which we operate, the cruise ship market is generally unregulated. We have
PokerPro tables on several major cruise lines, including Carnival Corporation,
Royal Caribbean and Norwegian, and we successfully completed installations on
100% of the Carnival Cruise Lines fleet during 2008.





As of
December 31, 2008, we had 60 PokerPro tables located on 57 cruise
ships.





International Casinos.
According to the Casino City Press, as of December 2008, markets outside of
North America and cruise ships contained 3,048 poker tables.  We
believe that international markets may grow faster than the North American
markets in the future and represent a significant growth opportunity for
PokerPro.





Aristocrat
serves as our international distributor.  Our distribution agreement
provides Aristocrat with exclusive rights (excluding the United States, Canada
and cruise ships) to distribute, market, enter into license agreements and,
under certain circumstances, manufacture the PokerPro system.





As of
December 31, 2008, we had sold an aggregate of 98 PokerPro tables to Aristocrat
for lease to its international customers.





Competition.The overall market for gaming devices is mature and characterized by
numerous competitors that develop and license proprietary table games. We are
aware of several other companies in the United States and abroad offering
automated poker products and additional competitive forces could join the
market. Potential competitors include established manufacturers of gaming
devices that may have widespread brand recognition and substantially greater
resources and marketing capabilities than we have.  In addition, they
may have some of the regulatory approvals required to market and sell automated
poker tables in our target markets. Potential competitors also could offer lower
cost products manufactured in less regulated or lower cost foreign
markets.





We also
compete with gaming supply companies and with other gaming and entertainment
products for space on the customers’ floor, as well as for the customers’
capital spending. Some of the larger gaming supply companies with whom we
compete are International Game Technology, Progressive Gaming International,
Shuffle Master, Inc. and WMS Industries, Inc.





In
addition, we compete with internet poker websites and other forms of internet
gaming.





Product Supply.We purchase all parts, including hardware components, table game felts,
signs and accessories for the PokerPro system from third-party suppliers. We
assemble the PokerPro system from such component parts at our facility in
Matthews, North Carolina.





We
believe that our facility has sufficient capacity to meet demand and that our
sources of supply are adequate. Several key components we use in the manufacture
of our products are proprietary and are currently assembled by a single contract
manufacturer.  Also, certain complex integrated circuits are
manufactured by a single source and are critical to our product
designs.  Changing manufacturers for any of these components would
require significant time and effort on the part of our management team, may
require additional engineering development work, and could have a disruptive
impact on our operations.




3




In
addition, as part of an initiative underway to reduce our manufacturing costs,
we are transitioning more of our components to the contract manufacturer that
also produces our Heads-Up Challenge product, increasing our overall dependency
on this supplier.




The
components we use are produced primarily in Taiwan and China and are subject to
long lead times and other issues associated with managing an international
supply chain.  Furthermore, we compete with other companies for the
production capacity of third-party manufacturers and suppliers for displays and
for other components.





Distribution
Method.We distribute our gaming products to North American
casinos and to cruise ships on a direct basis using our own internal sales
force.  We employ account managers who are assigned geographic sales
territories and continue to be closely involved with our customers following the
deployment of tables to provide advice and manage the overall customer
relationship.  We generally lease PokerPro to customers on a recurring
revenue basis (either a fixed-fee lease or participation arrangement where we
share the customers revenue on a percentage basis)





Outside
of North America, we sell our PokerPro products to Aristocrat for distribution
to its customers in those markets.  Aristocrat purchases the PokerPro
tables from us and assumes responsibility for marketing, regulatory compliance,
distribution and support in their markets.





Heads-Up
Challenge Amusement Products





Overview.Heads-Up Challenge is an innovative amusement platform that enables two
players to compete head to head against each other for entertainment purposes in
non-gambling venues such as bars and restaurants.  We introduced
Heads-Up Challenge in late 2007 as a Texas Hold’em Poker amusement game. We
intend to develop other games to take advantage of the unique heads-up platform
and to enhance our operators’ revenue opportunities.





Players
can play no-limit Texas Hold’em with traditional poker action and realistic
movements and sounds against one another for entertainment
purposes.  It can be played in single player mode, two player mode or
tournament mode with up to 8 players.   We are also developing
other games for the Heads-Up Challenge platform and introduced Bocce in the
fourth quarter of 2008.  However, we can provide no assurance that
additional games will be developed or will be successful.





We sell
our Heads-Up Challenge product through a network of independent distributors
throughout the world.  We have signed arrangements with 15
distributors for the United States, Canada, the United Kingdom and the United
States Military.  In Australia and New Zealand, Aristocrat serves as
our distributor for Heads-Up Challenge.   As of December 31,
2008, we had sold an aggregate of 1,148 units since product launch.





Market
Opportunities.The market for Heads-Up Challenge includes restaurants,
bars and other amusement venues.  There are an estimated 176,000
restaurants and bars worldwide as well as opportunities for other outlets, such
as in homes.





Competition.The overall market for coin-in amusement game devices is mature and
characterized by numerous competitors.   We compete with other
popular and more established games, such as Golden Tee and Big Buck Hunter, for
a share of the operators’ capital spending.  Some of these competitors
are established manufacturers, including Incredible Technologies and Play
Mechanics, Inc., that may have more widespread brand recognition and
substantially greater resources and marketing capabilities than we
have.   We also compete with other games and activities for floor
space in the bar or restaurant.





Product
Supply. We purchase our Heads-Up Challenge tables from a contract
manufacturer located in Taipei, Taiwan. The units are essentially complete and
ready for sale when delivered.  Our master distributors in the United
States, Australia and the United Kingdom load software, install bill and coin
validators and other minor steps to complete the table once
received.





We
believe that our contract manufacturer has ample capacity to meet demand and
that sources of supply are adequate.  However, because our supply
chain crosses the ocean and we rely on a third party, our ability to meet demand
is dependent on their performance as well as our ability to provide accurate
production forecasts and manage long logistical lead times.





Distribution
Method.We distribute our amusement products through a network
of independent distributors. These distributors are generally given exclusive or
non-exclusive rights to sell the product within a specified geographic territory
(and typically we retain the right to make direct sales where applicable). The
distributors typically sell the product to operators who place the products in
restaurants, bars or other venues.  The operator assumes
responsibility for the operation and maintenance of the units following
purchase.





4




As of
December 31, 2008 we have signed arrangements with 15 distributors for the
United States, Canada, the United Kingdom and the United States
Military.  Aristocrat distributes our amusement product in Australia
and New Zealand.





We also
sell units directly to consumers for home use and may establish direct
relationships with larger corporate customers in the future.





Gaming
Regulations and Licensing





Regulatory
Overview.Generally, the manufacture, sale and use of gambling devices is
subject to extensive federal, state, local and tribal regulation. In order to
sell and distribute the PokerPro system to our target markets, we must comply
with the applicable regulations of each jurisdiction in which we
operate.





We
normally expect regulatory approval in most jurisdictions to take up to 24
months or longer. The PokerPro system is a relatively new and innovative
technology, increasing the difficulty to accurately predict the time and expense
required to obtain approvals or licenses in any particular
jurisdiction.  Further, the laws and regulations of the jurisdictions
in which we operate or intend to operate are subject to amendment and
reinterpretation from time to time, and therefore it is possible that even if
the PokerPro system is approved at one time, its use may be restricted,
conditioned or prohibited in the future.





Some
states prohibit playing poker or gambling in any form. We do not intend to sell
or distribute the PokerPro system in these states or to Native American tribes
located in these states unless such sales or distribution is specifically
authorized by the tribal-state compact, a legally binding agreement between
states and tribes.





The
following is a brief description of the significant regulations that apply to us
in the jurisdictions in which we are located or intend to market and sell the
PokerPro system.





Federal
Regulation.Gaming devices are governed by the Federal Gambling Devices
Act of 1962 (the “Johnson Act”). The Johnson Act generally prohibits the
transportation of a gambling device from one state to another unless the
receiving state has legalized the use of the gambling device. The Johnson Act
also requires registration for manufacturers of gaming devices.





Commercial
Casinos.States that allow some form of casino-style
gambling usually have extensive regulatory requirements that must be met before
the PokerPro system can be marketed to commercial casinos located in these
states. Generally, each state’s respective gaming commission requires that a
license or finding of suitability be issued with respect to PokerTek as an
entity, the PokerPro system, or both. Among those states that require regulatory
approval for both PokerTek and the PokerPro system, some states consider such
approval simultaneously, while others, such as Nevada, require that we obtain
company approval before considering approval for the PokerPro system itself.
Some states also require that gaming products be placed in the market on a trial
basis before receiving final approvals.  Some states require the
licenses and findings of suitability to be renewed on a regular basis. State
commissions can deny our applications for licenses and findings of suitability
or revoke our licenses or prior findings of suitability for any
cause.





If a
state requires that we obtain company approval in addition to the product
approval required for the PokerPro system, we are required to submit detailed
financial and operating reports and furnish other information. Our officers,
directors, certain key employees and any person having a material relationship
with us may have to qualify with the state commission and obtain a finding of
suitability. Our beneficial owners, especially beneficial owners of more than 5%
of our outstanding common stock, may also be required to obtain a finding of
suitability.





Tribal Casinos.Gaming on tribal lands is governed by the Indian Regulatory Gaming Act of
1988 (the “IGRA”), the National Indian Gaming Commission (the “NIGC”), specific
tribal ordinances and regulations and, in some instances, agreements between
Native American tribes and their respective states, referred to under the IGRA
as a tribal-state compact.





The IGRA
provides a statutory basis for Native American tribes to operate certain gaming
activities, depending on how a particular game is classified and whether the
laws of the state where the Native American tribe is located allow or prohibit
the particular game. The gaming classifications are: Class I, Class II and Class
III.


·
            Class
      I gaming include traditional Native American social and ceremonial games
      and are regulated only by the
tribes.


·
            Class
      II gaming includes bingo and certain card games such as poker, so long as
      the card game is not prohibited by the laws of the state where the tribe
      is located, the card game is played somewhere in the state and the playing
      of the card game conforms to any applicable state
  law.


·
            Class
      III gaming consists of all forms of gaming that are not Class I or Class
      II, such as video lottery games, slot machines, most table games and
      keno.





5




The
classification of a gaming device is determined by the operator in each
jurisdiction.





We must
also obtain certification from an Independent Testing Laboratory (“ITL”) prior
to the installation of the PokerPro system in certain tribal
jurisdictions.  As discussed below, these were obtained in October 2006
with respect to the tribal jurisdictions in which we operate.





We must
also become approved as a gaming supplier with each federally recognized
tribe.





Card Clubs.States that allow poker to be played in card clubs have various
regulatory requirements that apply to manufacturers of gambling devices similar
to commercial casinos.





Cruise
Ships.The cruise ship market is authorized under the Johnson
Act, and not subject to regulatory oversight; therefore, the PokerPro system is
currently under no regulatory restrictions aboard cruise ships.





International
Casinos.Internationally, the regulatory environment is complex and
varies by jurisdiction.  Certain foreign countries permit the
importation, sale and operation of gaming equipment in casino and non-casino
environments.





In
accordance with our distribution agreement, Aristocrat is responsible for
managing the regulatory process and obtaining necessary approvals to sell or
operate PokerPro tables in this market.





Regulatory
Status.As of December 31, 2008, we have regulatory approval of the
PokerPro system from British Columbia Gaming Policy & Enforcement, Société
des Casinos du Québec Inc., Arkansas Racing Commission, State of California
Gambling Control Commission, Connecticut Department of Revenue, the Iowa Racing
and Gaming Commission and Indiana Gaming Commission, Louisiana Department of
Public Safety and Corrections, Louisiana Department of Public Safety and
Corrections - Indian Gaming Division, Michigan Gaming Control Board, Mississippi
Gaming Commission, Nevada Gaming Control Board, Washington State Gambling
Commission, West Virginia Lottery Commission, CA - Berry Creek Rancheria Gaming
Commission, Cabazon Band of Mission Indians, Tuolumne Me-Wuk Tribal Gaming
Agency, Viejas Tribal Gaming Commission; CT - Mashantucket Pequot - Connecticut
Department of Revenue, Mohegan Tribe of Indians - Connecticut Department of
Revenue; MI - Pokagon Band of Potawatomi Indians; NM - Pueblo of Laguna Tribal
Gaming Regulatory Authority; OK - Choctaw Gaming Commission, Cherokee Nation
Gaming Commission, Iowa Tribe of Oklahoma Gaming Commission; OR - Confederated
Tribes Gaming Commission.





We have
submitted applications seeking product approval of the PokerPro system and
operating in a field trial status with the Louisiana State Police Gaming
Division, New Jersey Casino Control Commission and the Nevada Gaming Control
Board.  Subsequent to December 31, 2008, we removed our tables from
our field trial site in New Jersey, placing our regulatory progress on hold
until a suitable partner is identified to continue the field trial.





We were
notified by the Nevada Gaming Commission on March 19, 2009, that the PokerPro
system had been approved by the commission.





We have
petitioned the Washington State Gaming Commission for rule changes to allow the
use of electronic poker tables in its commercial casinos.





For our
international markets, as of December, 31, 2008, Aristocrat has regulatory
approval in Australia, Bulgaria, Germany, Italy, Japan, Macau, Panama,
Philippines, South Africa and United Kingdom and is in the process of seeking
approval in several other jurisdictions, notably France and
Switzerland.





We have
received product certifications from Gaming Laboratories International (“GLI”)
and BMM International (“BMM”), independent testing laboratories for our PokerPro
products.  Other certifications that we have received for our
products, including electrical, communications and safety certifications,
include:





·
            Conformité
      Européenne (“CE”), a mandatory European marking for certain product groups
      to indicate      conformity with the
      essential health and safety requirements set out in European
      Directives;


·
            Federal
      Communications Commission (“FCC”), which regulates radio emissions of
      electronic devices;


·
            The
      RoHS Directive (“ROHS”), which bans the placing on the European Union
      market of new electrical and electronic equipment containing more than
      agreed levels of certain hazardous materials;
  and


·
            Underwriters
      Laboratories, Inc. (“UL”), a product safety compliance testing
      laboratory.





6





Corporate
History





The
Company was founded on August 22, 2003, by Gehrig H. “Lou” White, James T.
Crawford and Arthur Lee Lomax.  It was initially organized as a North
Carolina corporation named National Card Club Corporation.  During the
period from March 19, 2004 through July 27, 2004, National Card Club Corporation
owned a majority interest in an affiliated limited liability company called
PokerTek, LLC.  On July 27, 2004, PokerTek, LLC merged with and into
National Card Club Corporation and each member of PokerTek, LLC received six
shares of common stock for each unit of limited liability membership interest in
PokerTek, LLC held by such member. The units of limited liability membership
interest held immediately before the merger were cancelled. Simultaneous with
this merger, the name was changed to PokerTek, Inc.





We
completed our initial public offering on October 13, 2005 and our common stock
now trades on the NASDAQ Capital Market under the ticker symbol
“PTEK”.




Available
Information





The Company is subject to the
informational requirements of the Exchange Act.  The Company therefore
is required to file periodic reports, proxy and information statements and other
information with the Securities and Exchange Commission (“SEC”).  Such
reports may be obtained by visiting the Public Reference Room of the SEC at 100
F Street, N.E., Washington, DC 20549, or by calling the SEC at
1-800-SEC-0330.  In addition, the SEC maintains an internet site
(www.sec.gov)
that contains reports, proxy and information statements and other information
regarding issuers that file electronically.





The
Company also maintains an internet site (www.pokertek.com)
where interested parties can obtain copies of all reports, proxy and information
statements and other information that the Company submits to the
SEC.  The information contained on, or that can be accessed through,
our website is not incorporated by reference into this annual
report.  We have included our website address as a factual reference
and do not intend it as an active link to our website.





Our
corporate office is located at 1150 Crews Road, Suite F, Matthews, North
Carolina 28105.




Research
and Development





We have
invested considerable time and resources on the research and development efforts
necessary to invent and commercialize both PokerPro and Heads-Up Challenge. Our
research and development expenses were $2.8 million, $4.0 million and $3.5
million during the fiscal years ended December 31, 2008, December 31, 2007 and
December 31, 2006, respectively.





We
continue to develop new releases and improvements to the PokerPro system,
including designing additional varieties of poker and developing additional
functionality for the PokerPro system.  These development efforts are
focused on improving operator revenue, enhancing the player experience,
improving back-end operations and reporting for the operator, and complying with
regulatory requirements.





We also
began a hardware and software project in 2008 that is ongoing in 2009 to
reengineer the PokerPro table to simplify its components and reduce the
manufactured cost of table.





Heads-Up
Challenge was commercialized in late 2007.  We continue to work on the
development of new games and improvements to the existing hardware and software
platform and to reduce its cost to manufacture.




Intellectual
Property





Trademarks.Gehrig H. "Lou" White, our Vice Chairman of the Board of Directors, and
James Crawford, our President, jointly filed an application with the U.S. Patent
and Trademark Office to register the PokerPro trademark. The trademark has been
registered by the U.S. Patent and Trademark Office and an assignment of the
trademark to PokerTek has been recorded.





Patents.We currently have applications for more than 40 patents before the U.S.
Patent and Trademark Office which relate to various aspects of our products,
though we are regularly refining the list of patents that we pursue because of
factors such as passage of time, cost, and likelihood of issuance. Patent
applications are costly, can take many years to issue and we can provide no
assurance that any of these patents will actually be issued. As we continue to
develop new technology, we may file additional patent applications with respect
to such technology. Additionally, we have numerous foreign patent application
equivalents pending in various non-U.S. jurisdictions.





7




Licenses.


World Poker Tour:WPT
Enterprises, Inc. (“WPT”), which operates the World Poker Tour, granted
PokerTek, LLC (our former affiliate) an exclusive, 10-year, royalty-free,
non-sublicensable license to use the “World Poker Tour” name and related logo
and trademark in connection with the lease, sale or distribution in the United
States of tables featuring automated live poker games and tournaments. We can
also market and offer certain WPT branded packaged deals to its prospective
customers.  The license was transferred to PokerTek, Inc. in July
2004.  WPT may terminate the license in the event that we breach any
material term of the license, we fail to adhere to WPT’s style guide for its
logos and trademarks or if we become subject to bankruptcy proceedings
(voluntary or involuntary) that are not dismissed within 30 days.





World Series of Poker:On
April 17, 2007, Harrah’s License Company, LLC (“Harrah’s”) granted PokerTek,
Inc. a limited, non-exclusive, non-transferable license with limited right of
sublicense to utilize the “World Series of Poker®” name, related logos and
trademarks in connection with the design, development, manufacture, marketing,
advertisement, promotion and lease of our gaming tables
worldwide.  The license term is five years with three two-year options
to renew.  Harrah’s may terminate the license in the event that we
become subject to bankruptcy proceedings (voluntary or involuntary) that are not
dismissed within 30 days.





Other.We
have registered the www.pokertek.com internet domain name.





Seasonality
and Business Fluctuations





Our
business is not generally subject to seasonality. However, quarterly revenue and
net income may vary significantly based on the timing of regulatory approvals,
product sales, the introduction of new products and changes in our installed
base of PokerPro systems.  In addition, approximately 13.1% of our
revenues are derived from cruise ships, where casino play may vary from quarter
to quarter depending on a number of factors, including the itinerary, length of
cruises, and demographics of the passengers.





Backlog





The
nature of our business does not lend itself to maintaining a significant backlog
of unshipped orders.





Customer
Dependence





As of
December 31, 2008 we have 17 customers.  Five of our customers made up
approximately 75% of our total revenues.  The loss of any of these
customers or changes in our relationship with any of them could have a material
adverse effect on our business.




Employees





As of
December 31, 2008, we had 57 full-time employees, a reduction of 20 from 77
full-time employees as of December 31, 2007.  Subsequent to the end of
2008, we further reduced our employee count to 39 during January 2009 as we
continued to streamline our operations and reduce operating
overhead.





We
consider our relationships with our employees to be satisfactory. None of our
employees are covered by a collective bargaining agreement.





Item
1A.                      Risk
Factors.





Our
business is closely tied to the casino industry and factors that negatively
impact the casino industry may also negatively affect our ability to generate
revenues.





Casinos and other gaming operators
represent a significant portion of our customers. Therefore, factors that may
negatively impact the casino industry may also negatively impact our future
revenues. If casinos experience reduced patronage, revenues may be reduced as
our games may not perform well and may be taken off of the casino floor
altogether. The level of casino patronage, and therefore our revenues, are
affected by a number of factors beyond our control, including:


·
            general
      economic conditions;




8




·
            levels
      of disposable income of casino
patrons;


·
            downturn
      or loss in popularity of the gaming industry in general, and table and
      slot games in particular;


·
            the
      relative popularity of entertainment alternatives to casino
      gaming;


·
            the
      growth and number of legalized gaming
  jurisdictions;


·
            local
      conditions in key gaming markets, including seasonal and weather-related
      factors;


·
            increased
      transportation costs;


·
            acts
      of terrorism and anti-terrorism
efforts;


·
            changes
      or proposed changes to tax
laws;


·
            increases
      in gaming taxes or fees;


·
            legal
      and regulatory issues affecting the development, operation and licensing
      of casinos;


·
            the
      availability and cost of capital to construct, expand or renovate new and
      existing casinos;


·
            the
      level of new casino construction and renovation schedules of existing
      casinos; and


·
            competitive
      conditions in the gaming industry and in particular gaming markets,
      including the effect of such conditions on the pricing of our games and
      products.





These factors significantly impact
the demand for our products and technologies.





Our
business would suffer if demand for gaming in general, or poker in particular,
decreases.





We derive
a significant portion of our revenues from the leasing, licensing and sale of
the PokerPro system and from providing related maintenance and support services.
Although the popularity of poker in particular and gaming in general has
recently been growing in the United States and abroad, gaming has historically
experienced backlash from various constituencies and communities. Public tastes
are unpredictable and subject to change and may be affected by changes in the
country’s political and social climate. A change in public tastes or a backlash
among certain constituencies or in certain communities could result in reduced
popularity of poker or increased regulation of the gaming industry, either of
which could significantly reduce demand for the PokerPro system.





Moreover,
the market for the PokerPro system is limited; according to Casino City Press,
as of December 2008, there were approximately 7,135 poker tables operating in
the United States and Canada and 3,048 outside the United States and
Canada.  Although we believe that this represents a significant
opportunity for the PokerPro system, the number of venues in which the PokerPro
system can be placed is finite, as the number of jurisdictions in which gaming
is legal is limited.




During
late 2008 and continuing into 2009, the global economy experienced a significant
downturn that has impacted attendance and consumer spending on gaming and other
leisure activities. Casino operators are experiencing unprecedented financial
pressure which may lead them to curtail operations, close facilities, delay
poker room conversions, or be unable to meet their financial
obligations.  In addition, reductions in consumer spending may impact
the ability of amusement operators to generate acceptable returns or continue to
operate their businesses.  Our vendors are also under increased
financial pressure, which could impact their ability to operate their businesses
or deliver products to us.




We derive
a significant portion of our revenues from the leasing, licensing and sale of
the PokerPro system and from providing related maintenance and
support.  Gaming revenues and occupancy in major gaming markets have
declined significantly, causing many casino operators to reevaluate their
operations, reduce expenses, and in some cases to cease operations or seek
bankruptcy protection.  We also believe that operators in the
amusement markets are experiencing increasing financial pressures and believe
that many operators have limited financial resources and would be adversely
impacted by a sustained economic downturn.  During early 2009, we
believe that some smaller operators have been forced to curtail or cease
operations. We also understand that electronics and other vendors in the Far
East are experiencing significant declines in demand from their international
customers, which could possibly impact their ability to manufacture and deliver
products efficiently and at acceptable costs.




A prolonged decline in consumer
spending on gaming and amusement activities could have a significant impact on
our customers and our vendors.  Accordingly, such a prolonged downturn
could have a significant impact our business operations and financial
condition.




We recently
entered into new debt financing arrangements, which could have a material
adverse effect on our financial health and our ability to obtain financing in
the future, and may impair our ability to react quickly to changes in our
business.




9




We
entered into a loan and two credit facilities during 2008, introducing certain
risks associated with debt financing.  As of December 31, 2008, we had
$4.9 million in debt outstanding. and we had the ability to borrow additional
funds. Our increased exposure to debt financing could limit our ability to
satisfy our obligations, limit our ability to operate our business and impair
our competitive position. For example, it could:




•
              increase
      our vulnerability to adverse economic and industry conditions, including
      interest rate fluctuations,   because a portion of our
      borrowings are at variable rates of interest;•
              require
      us to dedicate future cash flows to the repayment of debt.  This
      could reduce the availability of cash to fund working capital, capital
      expenditures or other general corporate purposes;•
              limit
      our flexibility in planning for, or reacting to, changes in our business
      and industry; and•
              limit
      our ability to obtain additional debt or equity financing due to
      applicable financial and restrictive covenants contained in our debt
      agreements.




Despite
current indebtedness levels, we may also incur additional indebtedness in the
future, which could materially increase the impact of these risks on our
financial condition and results of operations.




Our
ability to repay our debt depends on many factors beyond our
control.  If we elect to raise equity capital in the future, our
current shareholders could be subjected to significant dilution. If we are
unable to raise capital in the future, we may seek other avenues to fund the
business, including sale/leaseback arrangements, transitioning PokerPro from a
capital intensive leasing strategy to a product sale strategy, or seeking to
sell assets of all, or a portion of, our operations.




Payments
on our debt will depend on our ability to generate cash or secure additional
financing in the future. This ability, to an extent, is subject to general
economic, financial, competitive, legislative, regulatory and other factors
beyond our control. If our business does not generate sufficient cash flow from
operations, and sufficient future financing is not available to us, we may not
be able to repay our debt, operate our business or fund our other liquidity
needs. If we cannot meet or refinance our obligations when they become due, this
may require us to attempt to raise capital, sell assets, reduce expenditures or
take other actions which we may be unable to successfully complete or, even if
successful, could have a material adverse effect on us. If such sources of
capital are not available or not available on sufficiently favorable terms, we
may seek other avenues to fund the business, including sale/leaseback
arrangements, transitioning PokerPro from a capital intensive leasing strategy
to a product sale strategy, or seeking to sell assets of all, or a portion of,
our operations. If we decide to raise capital in the equity markets or take
other actions, our shareholders could incur significant dilution or diminished
valuations, or, if we are unable to raise capital, our ability to effectively
operate our business could be impaired.




In
addition, based on the recent trading price of our common stock, if we are
successful in raising capital in the equity markets to repay our indebtedness,
or for any other purpose in the future, our shareholders would incur significant
dilution.




The
agreements and instruments governing our debt contain restrictions and
limitations which could significantly impact our ability to operate our
business.




Our
credit facility with Silicon Valley Bank contains a number of significant
covenants that could adversely impact our business by limiting our ability to
obtain future financing, withstand a future downturn in our business or the
economy in general, conduct operations or otherwise take advantage of business
opportunities that may arise.  The credit facility includes covenants
requiring the achievement of specified financial ratios and thresholds and
contains other terms and conditions qualifying the terms upon which Silicon
Valley Bank is required to extend funds.  Our ability to comply with
these provisions may be affected by events beyond our control.




We
are dependent on a small number of key suppliers and customers.  Changes in
our relationships with these parties, or changes in the economic environments in
which they operate, could have a material adverse effect on our business,
financial condition, results of operations and cash flows.




Our
revenues are concentrated with a small number of customers.  As of December
31, 2008, five of our customers made up approximately 75% of our total
revenues.  The loss of any of these customers or changes in our
relationship with them could have a material adverse effect on our
business.




To
manufacture our casino and amusement products, we purchase components from
independent manufacturers, many of whom are located in the Far
East.  An extended interruption in the supply of these products or
suitable substitute inventory would disrupt our operations, which could have a
material adverse effect on our business, financial condition and results of
operations.




For a
number of our inventory components, and for all of our Heads-Up Challenge
finished goods, we rely on a single supplier. We are currently transitioning the
manufacturing of more of our components to this supplier, increasing our
dependence on that third party.  We cannot estimate with any certainty
the length of time that would be required to establish alternative supply
relationships, or whether the quantity or quality of materials that could be so
obtained would be sufficient.  Furthermore, we may incur additional
costs in sourcing materials from alternative producers.  The
disruption of our inventory supply, even in the short term, could have a
material adverse effect on our business, financial condition and results of
operations.




10




A significant portion of our
business is conducted with customers and suppliers located outside of the United
States.  Currency, economic, political and other risks associated with our
international operations could adversely affect our operating
results.




Our revenues from international
customers and our inventory costs from international suppliers are exposed to
the potentially adverse effects of currency exchange rates, local economic
conditions, political instability and other risks associated with doing business
in foreign countries. To the extent that our revenues and purchases from
international business partners increase in the future, our exposure to changes
in foreign economic conditions and currency fluctuations will
increase.




Our dependence on foreign customers and suppliers means, in part, that we
may be affected by changes in the relative value of the U.S. dollar to foreign
currencies.  Although our receipts from foreign customers and our
purchases of foreign products are principally negotiated and paid for in U.S.
dollars, changes in the applicable currency exchange rates might negatively
affect the profitability and business prospects of our customers and
vendors.  This, in turn, might cause such vendors to demand higher
prices, delay shipments, or discontinue selling to us.  This also might
cause such customers to demand lower prices, delay or discontinue purchases of
our products or demand other changes to the terms of our relationships. 
These situations could in turn ultimately reduce our revenues or increase our
costs, which could have a material adverse effect on our business, financial
condition and results of operations.




We
have reported significant deficiencies in internal control over financial
reporting, which could materially impact our financial reporting
ability.





We have
reported four significant deficiencies in internal control over financial
reporting in Item 9A (T), “Controls and Procedures” in this annual
report on Form 10-K.





While we
are implementing new systems and taking other steps to strengthen our internal
controls, we can provide no assurance that any or all new systems will
be fully deployed or that the implementation of new systems and other procedures
will fully resolve all significant deficiencies or that we will not create or
discover additional significant deficiencies during that
transition.  If we are unable to remediate those significant
deficiencies or if we discover other deficiencies, our ability to accurately
report financial information could be impaired.





We
have a limited operating history and a history of losses. We may be unable to
generate sufficient net revenue in the future to achieve or sustain
profitability.





We have
experienced net losses for each quarterly and annual period since our inception
in August 2003. To continue our business plan and generate increased revenues,
we must obtain necessary regulatory approvals and customer commitments in many
additional jurisdictions. The timing of our revenue generation will be driven in
part by our receipt of such approvals in additional jurisdictions and entry into
definitive agreements with customers in those jurisdictions. We anticipate that
we will continue to incur losses and cash flow deficits during 2009. For the
reasons discussed above and elsewhere in this report, it is possible that we may
not generate significant revenues or profits in the foreseeable future or at
all. Even if we achieve profitability, we may not be able to sustain or increase
profitability on a quarterly or annual basis, and our failure to do so would
adversely affect our business and the market price of our common stock and may
require us to raise additional capital, which may not be available on terms
acceptable to us or at all.





Our
success depends on the PokerPro system achieving and maintaining widespread
acceptance by casinos and poker players.





Our
success depends to a large extent on broad market acceptance of the PokerPro
system among casinos and poker players. Even if we demonstrate the effectiveness
of the PokerPro system and our business model, casinos and poker players may
still not use the PokerPro system for a number of other reasons, including
preference for live dealers, mistrust of technology and perceived lack of
reliability. We believe that increased acceptance of the PokerPro system by
casinos and poker players will depend on the following factors:


·
            our ability to demonstrate the PokerPro system’s economic
      and other benefits to casinos;


·
            players
      becoming comfortable with using the PokerPro system;
  and




11




·
            the
      reliability of the hardware and software comprising the PokerPro
      system.





If
we fail to obtain or maintain gaming licenses and regulatory approvals, we will
be unable to operate the PokerPro segment of our business and license or sell
our gaming products.





The
manufacture and distribution of gaming machines is subject to extensive federal,
state, local and tribal regulation. Most jurisdictions require licenses, permits
and other forms of approval for gaming devices. Most, if not all, jurisdictions
also require licenses, permits and documentation of suitability, including
evidence of financial stability, for the manufacturers and distributors of such
gaming devices and for their officers, directors, major shareholders and key
personnel. Our failure to obtain regulatory approval in any jurisdiction will
prevent us from distributing our products and generating gaming revenue in that
jurisdiction.





Any
registrations, licenses, approvals or findings of suitability that we currently
have or may obtain in the future may be revoked, suspended or conditioned at any
time. The revocation or denial of a license in a particular jurisdiction will
prevent us from distributing the PokerPro system in that jurisdiction, and could
adversely affect our ability to obtain and/or maintain licenses in other
jurisdictions.





Gaming
authorities in multiple jurisdictions have determined that certain of our
executive officers, key employees, directors and significant shareholders are
suitable. The inability of an executive officer, key employee, director or
significant shareholder to obtain a determination of suitability in a
jurisdiction may adversely affect the sale or licensing of our gaming products
in that jurisdiction.





Gaming
authorities in some jurisdictions may investigate any individual who has a
material relationship with us and any of our shareholders to determine whether
the individual or shareholder is suitable to those gaming authorities. Certain
of our executive officers, key employees, directors and significant shareholders
have been found suitable in multiple jurisdictions by various gaming
authorities. If a gaming authority in any jurisdiction fails to find any of our
executive officers, key employees, directors or significant shareholders
suitable, we may be prohibited from leasing, licensing or selling our gaming
products in that jurisdiction.





A finding
of suitability is generally determined based upon numerous facts and
circumstances surrounding the entity or individual in question and many gaming
authorities have broad discretion in determining whether a particular entity or
individual is suitable. We are unaware of circumstances that would categorically
prevent a gaming authority from finding any of our officers, key employees,
directors or significant shareholders suitable.





Gehrig H.
“Lou” White, our Vice Chairman of the Board of Directors and beneficial owner of
approximately 19.3% of our common stock, has disclosed in applications for the
determination of suitability filed with gaming authorities that the IRS has
recently completed an examination of his 2000 and 2001 federal individual income
tax returns. The IRS previously issued an examination report showing a proposed
income tax deficiency for Mr. White’s 2000 federal income tax return of $410,215
(plus additional interest and penalties attributable to that underpayment of
tax) based on a disallowance of certain deductions for charitable contributions
that Mr. White made to a foundation he established and mortgage interest that
Mr. White paid to Legacy Capital, LLC, an affiliate of Merrill Scott. Merrill
Scott is an investment advisor that was placed under receivership in 2002 by the
SEC for violations of a variety of federal securities laws in connection with
fraud and misappropriations of client funds by the firm through a scheme in
which it obtained funds from its clients seeking above-market returns and other
benefits. Mr. White is currently appealing the IRS’s proposed income tax
deficiency. The IRS examination of Mr. White’s 2001 federal tax return resulted
in the issuance of a notice of deficiency for additional income tax in the
amount of $75,445 (plus additional interest and penalties attributable to that
underpayment of tax). In his original 2001 federal tax return, Mr. White claimed
deductions relating to a partnership investment he made after receiving advice
from a law firm. The law firm subsequently informed Mr. White that the IRS had
challenged the tax treatment of the investment structure and that he should file
an amended return. Mr. White then filed an amended federal income tax return for
2001 eliminating the deductions relating to the partnership investment. He also
paid the federal income taxes resulting from the elimination of such deductions.
The IRS notice of deficiency assessed additional income taxes as the result of
disallowing deductions for tax advice in connection with the partnership
investment transaction and an accuracy penalty in connection with the losses
claimed with respect to that investment. These amounts have been paid, which
completes the audit process for Mr. White’s 2001 return. Due to the broad
discretionary powers of gaming authorities, it is unknown what effect the IRS
examinations of Mr. White’s federal income tax returns may have on Mr. White’s
applications for a determination of suitability.





If any of
our executive officers, certain key employees, directors or significant
shareholders is not found suitable in a jurisdiction requiring a finding of
suitability, we would be prevented from leasing, licensing or selling our gaming
products in that jurisdiction as long as the individual or entity in question
remained an officer, key employee, director or a significant shareholder. Such
an occurrence would likely delay introduction of our gaming products into such
jurisdictionor prevent us from introducing our gaming
products in such jurisdiction altogether. Depending on how material such
jurisdiction is to our plan of operations, failure to obtain such findings of
suitability could have a material adverse effect on our results of operations.
In addition, a finding that one of our executive officers, certain key
employees, directors or significant shareholders is not suitable in any
jurisdiction may hinder our ability to obtain necessary regulatory approvals in
other jurisdictions. Conversely, however, a finding of suitability by one or
more gaming authorities does not ensure that similar suitability determinations
will be obtained from any other gaming authorities.





12




Although
we have the ability to terminate the employment of an executive officer or key
employee in the event that such executive officer or key employee fails to be
found suitable, such termination would disrupt the management of our company,
may trigger severance provisions under certain employment agreements and would
likely have an adverse effect on our business and results of operations. In
addition, the removal of a director under the provisions of our Amended and
Restated Bylaws requires action on the part of our shareholders at a
shareholders’ meeting. Our Amended and Restated Articles of Incorporation
provide that we may redeem at fair market value any or all shares of our capital
stock held by any person or entity whose status as a shareholder, in the opinion
of our Board of Directors, jeopardizes the approval, continued existence, or
renewal of any federal, state, local or tribal license we hold. However, we may
not have the funds available for such a redemption, especially if the
shareholder in question holds a significant amount of our common stock. We have
not determined what action we would take in such event. We will also be
prevented from effecting such a redemption if it would violate North Carolina
law.





If
the Johnson Act is found to apply to the PokerPro system, the Department of
Justice may institute criminal and/or civil proceedings against us.





Gaming
devices are regulated at the federal level by the Johnson Act. The Johnson Act
broadly defines an illegal gambling device as any machine or mechanical device
designed and manufactured primarily for use in connection with gambling and
that, when operated, delivers money or other property to a player as the result
of the application of an element of chance. We believe the Johnson Act does not
apply to the use of the PokerPro system by tribal casinos because several courts
have held that electronic aids to permitted Class II gaming devices under the
IGRA are not prohibited by the Johnson Act. However, there is no guarantee that
our belief is correct. These decisions have focused on the use by tribal casinos
of electronic aids to bingo. We are not aware of any court or regulatory body
that has considered how the Johnson Act applies to the PokerPro system or any
other form of electronic poker table. The Department of Justice, the primary law
enforcement entity responsible for enforcing the Johnson Act, has traditionally
taken a broad view as to what constitutes a gambling device prohibited by the
Johnson Act. It is possible that the Department of Justice may institute
criminal and/or civil proceedings against us and that a court may rule that the
Johnson Act prohibits the use of the PokerPro system by tribal casinos unless
the tribe and state have entered into an appropriate tribal-state compact. Any
such proceedings could interfere with our ability to obtain necessary regulatory
approvals.





We
could face substantial competition, which could reduce our market share and
negatively impact our net revenue.





There are
a number of companies that offer poker-related entertainment or manufacture and
distribute automated gaming machines. Most of these companies have greater
financial resources than we have. The primary barriers to entry are the
establishment of relationships with the owners and operators of casinos and card
clubs, the receipt of necessary regulatory approvals and the development of the
technology necessary to create an automated poker table. It is likely that our
potential competitors could include manufacturers of gaming devices that have
already established such relationships and that have received some, if not all,
of the regulatory approvals that would be required to market and sell automated
poker tables in our target markets. In addition, most of these companies have
greater financial resources than we have. Therefore, the barriers to entry
discussed above may not pose a significant obstacle for such manufacturers if
they sought to compete with us.




If
we fail to protect our intellectual property rights, competitors may be able to
use our technology, which could weaken our competitive position, reduce our net
revenue and increase our costs.





Our
long-term success will depend to a large degree on our ability to protect the
proprietary technology that we have developed or may develop or acquire in the
future. We currently have applications for more than 40 patents pending before
the U.S. Patent and Trademark Office that relate to various aspects of the
PokerPro system. Patent applications can take many years to issue and we can
provide no assurance that any of these patents will be issued. If we are denied
any or all of these patents, we may not be able to successfully prevent our
competitors from imitating the PokerPro system or using some or all of the
processes that are the subject of such patent applications. Such imitation may
lead to increased competition within the finite market for the PokerPro system.
Even if our pending patents are issued, our intellectual property rights may not
be sufficiently comprehensive to prevent our competitors from developing similar
competitive products and technologies. Although we may aggressively pursue
anyone whom we reasonably believe is infringing upon our intellectual property
rights, initiating and maintaining suits against third parties that may infringe
upon our intellectual property rights will require substantial financial
resources. We may not have the financial resources to bring such suits and if we
do bring such suits, we may not prevail. Regardless of our success in any such
actions, we could incur significant expenses in connection with such
suits.





13




Third
party claims of infringement against us could adversely affect our ability to
market our products and require us to redesign our products or seek licenses
from third parties.





We are
susceptible to intellectual property lawsuits that could cause us to incur
substantial costs, pay substantial damages or prohibit us from distributing our
products. Whether a product infringes a patent involves complex legal and
factual issues, the determination of which is often uncertain. In addition,
because patent applications can take many years to issue, there may be
applications now pending of which we are unaware, which later may result in
issued patents that our products may infringe. If any of our products infringe a
valid patent, we could be prevented from distributing that product unless and
until we can obtain a license or redesign it to avoid infringement. A license
may not be available or may require us to pay substantial royalties. We also may
not be successful in any attempt to redesign the product to avoid any
infringement. Infringement and other intellectual property claims, with or
without merit, can be expensive and time-consuming to litigate, and we may not
have the financial and human resources to defend ourselves against any
infringement suits that may be brought against us.





Defects
in, and fraudulent manipulation of, the PokerPro system could reduce our
revenue, increase our costs, burden our engineering and marketing resources,
involve us in litigation and adversely affect our gaming licenses.





Our
success will depend on our ability to avoid, detect and correct software and
hardware defects and prevent fraudulent manipulation of our products. The
PokerPro system is subject to rigorous internaltesting, and
additional testing by regulators in certain gaming jurisdictions. We may not be
able to maintain products that are free from defects or manipulation and that
continue to satisfy these tests. Although we have taken steps to prevent
defects, our products could suffer such defects and our PokerPro products could
be subject to manipulation after they have been widely
distributed.





Although
we do not believe it is likely, it is possible that an individual could breach
the security systems of a casino or card club, gain access to the server on
which the PokerPro system operates and fraudulently manipulate its operations.
The occurrence of such fraudulent manipulation or of defects or malfunctions
could result in financial losses for our customers and the subsequent
termination of agreements, cancellation of orders, product returns and diversion
of our resources. Even if our customers do not suffer financial losses,
customers may replace our products if they do not perform according to
expectations. Any of these occurrences could also result in the loss of or delay
in market acceptance of our products, loss of sales and, in the case of gaming
products, loss of regulatory approvals.





In
addition, the occurrence of defects in, or fraudulent manipulation of, the
PokerPro system and its associated software may give rise to claims for lost
revenues and related litigation by our customers and may subject us to
investigation or other disciplinary action by regulatory authorities that could
include suspension or revocation of our regulatory approvals.





If
the network infrastructure of certain of the casinos in which the PokerPro
system is or will be installed proves unreliable, market acceptance of the
PokerPro system would be materially and adversely affected.





We have
entered into agreements with customers that operate casinos and card clubs in
more than one location. In such cases, our agreement with such customer provides
that such customer will be responsible for providing, at its expense, a
dedicated high-speed connection between the tables comprising the PokerPro
system in the various locations operated by the customer to a remote central
server supporting such tables. Failures or disruptions of a customer’s dedicated
high-speed connection that result in the stoppage of play or in reduced
performance of the PokerPro system could reduce players’ gaming experience,
adversely affect the casinos’ or card clubs’ satisfaction with automated gaming
devices in general and delay or prevent market acceptance of the PokerPro
system.





The
use of the PokerPro system could result in product liability claims that could
be expensive and that could damage our reputation and harm our
business.





Our
business exposes us to the risk of product liability claims. Subject to
contractual limitations, we will face financial exposure to product liability
claims if the PokerPro system fails to work properly and causes monetary damage
to either poker players or casinos and card clubs. In addition, defects in the
design or manufacture of the PokerPro system might require us to recall each
PokerPro system that has been licensed. Although we maintain product liability
insurance, the coverage limits of policies available to us may not be adequate
to cover future claims. If a successful claim brought against us is in excess or
outside of our insurance coverage, we may be forced to divert resources from the
development of the PokerPro system, the pursuit of regulatory approvals and
other working capital needs in order to satisfy such claims.





14


The loss of key
personnel or the inability of replacements to quickly and successfully perform
in their new roles could adversely affect our
business.





All of
our existing personnel, including our executive officers, are employed on an
“at-will” basis. If we lose or terminate the services of one or more of our
current executives or key employees or if one or more of our current or former
executives or key employees joins a competitor or otherwise competes with us, it
could impair our business and our ability to successfully implement our business
plan. Additionally, if we are unable to timely hire qualified replacements for
our executive and other key positions, our ability to execute our business plan
would be harmed. Even if we can timely hire qualified replacements, we would
expect to experience operational disruptions and inefficiencies during any
transition.





Our management team’s limited experience in this market could
increase costs, hamper our marketing strategies and delay our
expansion.





The
limited experience of our management team in the gaming industry and the market
for automated game technology could result in increased operating and capital
costs, difficulties in executing our operating and marketing strategies and
delays in our expansion strategy. We may not successfully address any or all of
the risks posed by this limited experience, and our failure to do so could
seriously harm our business and operating results.





If
we fail to manage our growth, our business and operating results could be
harmed.





We have
experienced rapid growth placing significant demands on our operational and
financial infrastructure. If we do not effectively manage our growth, our
ability to develop and market the PokerPro system and the Heads-Up Challenge
products could suffer, which could negatively affect our operating
results.




Our
success will depend on the reliability and performance of third-party
distributors, manufacturers and suppliers.





We
compete with other companies for the production capacity of third-partysuppliers for components. Certain of these competing companies
have substantially greater financial and other resources than we have and thus
we may be at a competitive disadvantage in seeking to procure production
capacity. Our inability to contract with third-party manufacturers and suppliers
to provide a sufficient supply of our products on acceptable terms and on a
timely basis could negatively impact our relationships with existing customers
and cause us to lose revenue-generating opportunities with potential
customers.





We also
currently rely on Aristocrat, a third-party distributor, to obtain regulatory
approvals, market and distribute our PokerPro system outside of the United
States and Canada. If Aristocrat is unsuccessful in marketing and distributing
our products, we may miss revenue-generating opportunities that might have been
recognized by another third-party distributor.





We also
rely on Aristocrat and our other distributors to market and distribute our
Heads-Up Challenge product.  If our distributors are unsuccessful in
marketing and distributing our product, we may miss revenue-generating
opportunities that might otherwise have been recognized.





Our
failure to obtain any necessary additional financing would have a material
adverse effect on our business.





In order
to execute our business plan, we may need to seek additional equity or debt
financing. We may not be able to obtain such additional equity or debt financing
when we need it or at all. Even if such financing is available, it may not be
available on terms that are favorable to us or in sufficient amounts to satisfy
our requirements. If we require, but are unable to obtain, sufficient additional
financing in the future we may be unable to further protect our intellectual
property sufficiently, meet customer demand for PokerPro systems or withstand
adverse operating results. More importantly, if we are unable to raise further
financing when required, our continued operations may have to be scaled down or
even terminated and our ability to generate revenues would be negatively
affected.





Enforcement of
remedies or contracts against Native American tribes could be
difficult.





Contracts
with Native American tribes are subject to sovereign immunity and tribal
jurisdiction. If a dispute arises with respect to any of those agreements, it
could be difficult for us to protect our rights. Native American tribes
generally enjoy sovereign immunity from suit similar to that enjoyed by
individual states and the United States. In order to sue a Native American tribe
(or an agency or instrumentality of a Native American tribe), the tribe must
have effectively waived its sovereign immunity with respect to the matter in
dispute. Moreover, even if a Native American tribe were to waive sovereign
immunity, such waiver may not be valid and in the absence of an effective waiver
of sovereign immunity by a Native American tribe, we could be precluded from
judicially enforcing any rights or remedies against that tribe.





15




Item
1B.              Unresolved
Staff Comments.





None.





Item
2.                 Properties.





We
currently lease our corporate office and manufacturing facility. This facility
is approximately 21,600 square feet and is located in Matthews, North Carolina.
Our leased space is in good order and condition, and is adequate to satisfy our
current needs.  This facility is leased from an entity owned and
controlled by our President and our Vice Chairman of the Board of Directors
(see Note 12 – “Related Party Transactions”).





We also
leased a small storage facility in Matthews, North Carolina during
2008.  This lease was terminated as of January 31, 2009.





Item
3.                 Legal
Proceedings.





On March
17, 2008, we were served with a complaint filed on March 6, 2008, in the United
States District Court for the District of New Jersey by Lightning Gaming, Inc.
and Lightning Poker, Inc. The complaint alleged that PokerTek infringed United
States Patent No. 7,306,516, owned by Lightning Poker, Inc. The complaint sought
unspecified monetary damages from PokerTek as well as a permanent injunction
enjoining PokerTek from infringing the patent or unfairly competing with the
plaintiffs.  PokerTek believes that either its products do not violate
the patent that forms the basis of the lawsuit, that the patent is invalid, or
both.





On
October 16, 2008, PokerTek announced that it had reached a mutually agreeable
settlement of all outstanding litigation with Lightning Gaming, Inc. The
settlement resulted in all lawsuits between the parties being withdrawn with
prejudice.





There was
no material financial impact to PokerTek as a result of the
settlement.




Item
4.                
Submission of Matters to a Vote of Security Holders.





None.





PART
II





Item
5. Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities.





Stock
Listing





As of December 8, 2008, our common
stock is traded on the NASDAQ Capital Market under the symbol
PTEK.  Our stock was previously traded on the NASDAQ Global
Market.  The table below shows the high and low sales prices for our
common stock for the periods indicated, as reported by the NASDAQ Global Market
and Capital Market.




Market
      Prices of Common Stock2008
                
                
                2007Quarter ended
                
                High
                
                
                Low
                
                
                High
                
                
                LowMarch
      31
                
                $
                8.54
                
                
                $
                3.44
                
                
                $
                11.00
                
                
                $
                8.10June
      30
                
                
                6.30
                
                
                
                2.05
                
                
                
                13.75
                
                
                
                8.81September
      30
                
                
                5.39
                
                
                
                2.51
                
                
                
                12.97
                
                
                
                9.30December
      31
                
                
                3.00
                
                
                
                1.20
                
                
                
                10.15
                
                
                
                5.86





As of
March 12, 2009, there were approximately 1,100 holders of record of our common
stock.




16




Transfer
Agent





Our
transfer agent is American Stock Transfer & Trust Company, located at 59
Maiden Lane, Plaza Level, New York, New York 10038, (800) 937-5449.




Dividends





To date
no cash dividends have been paid with respect to our common stock and the
current policy of the Board of Directors is to retain any earnings to provide
for the growth of the Company. The payment of cash dividends in the future, if
any, will depend on factors such as earnings levels, capital requirements, our
overall financial condition and any other factors deemed relevant by our Board
of Directors.




Item
6.                 Selected
Financial Data.





The
following selected financial data has been derived from audited financial
statements for the years ended December 31, 2008, 2007, 2006, 2005, and 2004.
The selected financial data set forth below should be read together with Item 7
– “Management’s Discussion and Analysis of Financial Condition and Results of
Operations”, as well as Item 8 – “Financial Statements and Supplementary Data”
and the related notes to those consolidated financial statements appearing
elsewhere in this report.




Years
      Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006
                  
                  
                  2005
                  
                  
                  2004(in
      thousands, except per share amounts and table count/unit sales
      data)Statement
      of operations data:Revenue
                  
                  $
                  14,425
                  
                  
                  $
                  4,005
                  
                  
                  $
                  1,980
                  
                  
                  $
                  314
                  
                  
                  $
                  -Operating
      loss
                  
                  
                  (7,282
                  )
                  
                  
                  (13,414
                  )
                  
                  
                  (9,886
                  )
                  
                  
                  (3,891
                  )
                  
                  
                  (932
                  )Net
      loss
                  
                  
                  (7,639
                  )
                  
                  
                  (12,850
                  )
                  
                  
                  (9,146
                  )
                  
                  
                  (3,701
                  )
                  
                  
                  (926
                  )EBITDAS(1)
                  
                  
                  (3,274
                  )
                  
                  
                  (10,514
                  )
                  
                  
                  (8,346
                  )
                  
                  
                  (3,490
                  )
                  
                  
                  (920
                  )Net
      cash used in operating activities
                  
                  
                  (6,521
                  )
                  
                  
                  (14,394
                  )
                  
                  
                  (10,161
                  )
                  
                  
                  (5,114
                  )
                  
                  
                  (937
                  )Net
      cash provided by (used in) investing activities
                  
                  
                  1,918
                  
                  
                  
                  1,246
                  
                  
                  
                  6,677
                  
                  
                  
                  (15,387
                  )
                  
                  
                  (66
                  )Net
      cash provided by (used in) financing activities
                  
                  
                  4,855
                  
                  
                  
                  12,574
                  
                  
                  
                  (37
                  )
                  
                  
                  24,501
                  
                  
                  
                  2,306Loss
      per common share - basic and diluted:Net
      loss per common share - basic and diluted(2)
                  
                  $
                  (0.70
                  )
                  
                  $
                  (1.23
                  )
                  
                  $
                  (0.97
                  )
                  
                  $
                  (0.49
                  )
                  
                  $
                  (0.16
                  )Weighted
      average common shares outstanding - basic and diluted(2)
                  
                  
                  10,941
                  
                  
                  
                  10,463
                  
                  
                  
                  9,471
                  
                  
                  
                  7,517
                  
                  
                  
                  5,744Balance
      sheet data (at end of period):Current
      assets
                  
                  $
                  10,742
                  
                  
                  $
                  11,122
                  
                  
                  $
                  11,731
                  
                  
                  $
                  21,441
                  
                  
                  $
                  1,354Total
      assets
                  
                  
                  15,706
                  
                  
                  
                  17,096
                  
                  
                  
                  15,123
                  
                  
                  
                  22,703
                  
                  
                  
                  1,422Current
      liabilities
                  
                  
                  5,533
                  
                  
                  
                  2,429
                  
                  
                  
                  1,003
                  
                  
                  
                  214
                  
                  
                  
                  15Total
      liabilities
                  
                  
                  7,572
                  
                  
                  
                  2,429
                  
                  
                  
                  1,003
                  
                  
                  
                  214
                  
                  
                  
                  340Shareholders'
      equity
                  
                  
                  8,134
                  
                  
                  
                  14,667
                  
                  
                  
                  14,120
                  
                  
                  
                  22,489
                  
                  
                  
                  1,082Working
      capital(3)
                  
                  
                  5,209
                  
                  
                  
                  8,693
                  
                  
                  
                  10,728
                  
                  
                  
                  21,227
                  
                  
                  
                  1,339Table
      count/Unit sales data:PokerPro
      table count end of year
                  
                  
                  275
                  
                  
                  
                  189
                  
                  
                  
                  71
                  
                  
                  
                  20
                  
                  
                  
                  -Heads-Up
      Challenge units sold
                  
                  
                  1,108
                  
                  
                  
                  40
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -




(1)
            In
      addition to disclosing financial results prepared in accordance with GAAP,
      the Company discloses information regarding EBITDAS, which differs from
      the term EBITDA as it is commonly used.   In addition to
      adjusting net loss to exclude taxes, interest, and depreciation and
      amortization, EBITDAS also excludes share-based compensation
      expense.   EBITDA and EBITDAS are not measures of
      performance defined in accordance with GAAP. However, EBITDAS is used
      internally by PokerTek’s management and by its lenders in planning and
      evaluating the Company’s operating performance.  Accordingly,
      management believes that disclosure of this metric offers investors,
      lenders and other stakeholders with an additional view of the Company’s
      operations that, when coupled with the GAAP results, provides a more
      complete understanding of the Company’s financial
      results.  EBITDAS should not be considered as an alternative to
      net loss or to net cash used in operating activities as a measure of
      operating results or of liquidity. It may not be comparable to similarly
      titled measures used by other companies, and it excludes financial
      information that some may consider important in evaluating the Company’s
      performance.  A reconciliation of GAAP net loss to EBITDAS is
      included in the accompanying financial
  schedules.




(2)
            We
      were initially organized in August 2003 as a North Carolina corporation
      named National Card Club Corporation. From March 19, 2004 through July 27,
      2004, we owned a majority interest in an affiliated limited liability
      company called PokerTek, LLC.  On July 27, 2004, PokerTek, LLC
      merged with and into National Card Club Corporation and we changed our
      name to PokerTek, Inc.  Pursuant to this merger, the equity
      interests in PokerTek, LLC that we owned were cancelled and all other
      equity interests in PokerTek, LLC were converted into common stock in
      PokerTek, Inc., as described in Part I, Item 1, “Business” of this Annual
      Report on Form 10-K.  The net loss per common share gives
      retroactive effect to the merger for the periods presented. As of December
      31, 2008, 2007, 2006, 2005 and 2004, there were options to purchase an
      aggregate of 2,023,263, 2,034,825, 1,600,650, 1,053,650 and 471,500
      shares, respectively. The options outstanding have no dilutive effect on
      net loss per common share.





(3)
            Working
      capital is defined as total current assets less total current
      liabilities.




17




(4)
            A
      reconciliation of net loss to EBITDAS is as
  follows:




2008
                    
                    
                    2007
                    
                    
                    2006
                    
                    
                    2005
                    
                    
                    2004EBITDAS
      ReconciliationNet
      loss
                    
                    $
                    (7,638,773
                    )
                    
                    $
                    (12,849,616
                    )
                    
                    $
                    (9,145,718
                    )
                    
                    $
                    (3,700,544
                    )
                    
                    $
                    (925,837
                    )Interest
      income (expense), net
                    
                    
                    94,285
                    
                    
                    
                    (564,600
                    )
                    
                    
                    (740,761
                    )
                    
                    
                    (190,309
                    )
                    
                    
                    (6,041
                    )Income
      tax provision
                    
                    
                    262,905
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Other
      taxes
                    
                    
                    107,752
                    
                    
                    
                    24,126
                    
                    
                    
                    17,198
                    
                    
                    
                    598
                    
                    
                    
                    -Depreciation
                    
                    
                    2,793,225
                    
                    
                    
                    2,053,345
                    
                    
                    
                    709,593
                    
                    
                    
                    119,783
                    
                    
                    
                    306Stock-based
      compensation expense
                    
                    
                    1,106,113
                    
                    
                    
                    822,349
                    
                    
                    
                    813,316
                    
                    
                    
                    280,212
                    
                    
                    
                    11,271EBITDAS
                    
                    $
                    (3,274,493
                    )
                    
                    $
                    (10,514,396
                    )
                    
                    $
                    (8,346,372
                    )
                    
                    $
                    (3,490,260
                    )
                    
                    $
                    (920,301
                    )





Item
      7.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations.





Forward-Looking
Statements





This
Annual Report on Form 10-K contains forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended.
Forward-looking statements sometimes include the words “may,” “will,”
“estimate,” “intend,” “continue,” “expect,” or “anticipate,” and other similar
words. Statements expressing expectations regarding our future (including
pending gaming and patent approvals) and projections relating to products,
sales, revenues and earnings are typical of such statements.





All
forward-looking statements are subject to the risks and uncertainties inherent
in predicting the future. Our actual results may differ materially from those
projected, stated or implied in these forward-looking statements as a result of
many factors, including, but not limited to, overall industry environment,
customer acceptance of our products, delay in the introduction of new products,
the further approvals of regulatory authorities, adverse court rulings,
production and/or quality control problems, the denial, suspension or revocation
of permits or licenses by governmental authorities, competitive pressures and
general economic conditions and our financial condition.  Please see
Item 1A, “Risk Factors” for additional information regarding some of the risks
and uncertainties to which we are subject.





Forward-looking
statements speak only as of the date they are made. We undertake no obligation
to update or revise such statements to reflect new circumstances or
unanticipated events as they occur, and you are urged to review and consider
disclosures that we make in this and other reports that discuss factors germane
to our business.




Overview





We are
engaged in the development, manufacture and marketing of electronic products for
use in the gaming and amusement markets.   We currently have two
product lines – PokerPro and Heads-Up Challenge:





PokerPro®-The PokerPro system
consists of electronic poker table(s) and related peripheral equipment providing
commercial casinos, tribal casinos, cruise ships and card clubs with a
fully-automated poker-room environment designed to improve the profitability of
poker by enhancing the operator’s revenue opportunities and decreasing their
startup and operating costs.   We first introduced PokerPro in
late 2005 and have continued to invest in features and innovations to enhance
the player and operator experience. We distribute PokerPro using our internal
sales force to customers in the United States, Canada and cruise ships,
generally on a recurring revenue lease model.





Internationally,
we sell PokerPro to Aristocrat for distribution in most markets outside North
America.  Aristocrat is a leading global provider of gaming solutions
including video slot machines, progressive systems and casino management systems
and a significant shareholder of the company, owning approximately 16.4% of our
common stock as of December 31, 2008.  Aristocrat purchases the
PokerPro tables from us and assumes responsibility for all marketing,
regulatory, distribution and support in their markets.





As of
December 31, 2008, there were 275 PokerPro tables, consisting of 177
PokerPro tables on lease with 16 gaming customers at 75 sites in the United
States, Canada, and on major cruise lines and 98 PokerPro tables sold to
Aristocrat for lease to its customers internationally.





Heads-Up
ChallengeTM.  Heads-Up Challenge is an innovative amusement
platform that enables two players to compete head to head against each other for
entertainment purposes in non-gambling venues such as bars and
restaurants.  We introduced Heads-Up Challenge in late 2007 as a Texas
Hold’em Poker amusement game. We intend to develop other games to take advantage
of the unique heads-up platform and to enhance our operators’ revenue
opportunities.  Bocce was added to the product offering in late
2008.





18




We sell
our Heads-Up Challenge product through a network of independent distributors
throughout the world.  We have signed arrangements with 15
distributors for the United States, Canada, the United Kingdom and the United
States Military.  In Australia and New Zealand, Aristocrat serves as
our distributor for Heads-Up Challenge.   As of December 31,
2008, we had sold an aggregate of 1,148 units since product launch.





General Economic and Industry
Conditions:   During the second half of 2008, global
macroeconomic conditions deteriorated rapidly and significantly as a result of
challenges in the banking industry, the crisis in the housing market, the
decline in the stock market, tightening in the credit markets, inflationary
pressures from higher energy, food and fuel costs, disappointing labor market
conditions, and an uncertain geopolitical environment. Consumer confidence has
suffered and spending on discretionary purchases, including gaming and amusement
activities, has declined significantly.





Despite
deteriorating economic conditions during 2008, we experienced significant growth
in both of our product lines, increasing our PokerPro table count by 46% to 275
and launching Heads-Up Challenge, selling 1,108 units in 2008 as compared to 40
in 2007.  However, we expect economic weakness will continue through
the first half of 2009, if not longer, which may impact revenues from existing
customers as well as our ability to attract new customers. Changes in consumer
confidence and spending and/or significant changes in the gaming and amusement
markets could have a material impact on our future consolidated financial
position, results of operations or cash flows.





Results
of Operations for the Year Ended December 31, 2008 Compared to the Year Ended
December 31, 2007





Revenue.Revenue increased by $10.4 million (260%) to $14.4 million for the year
ended December 31, 2008 as compared to $4.0 million for the year ended December
31, 2007 due to increases in both license and service fees and product
sales.





License
and service fees increased by $3.9 million (155%) to $6.4 million for the year
ended December 31, 2008 as compared to $2.5 million for the year ended December
31, 2007.  The increase in license and service fees was driven
primarily by growth in the number of PokerPro systems deployed in casinos in the
United States, Canada and on cruise ships.





Product
sales increased by $6.6 million (434%) to $8.1 million for the year ended
December 31, 2008 as compared to $1.5 million for the year ended December 31,
2007.  Product sales consist of casino products, primarily PokerPro
systems sold to Aristocrat for deployment in international casinos, as well as
sales of our Heads-Up Challenge amusement product.  The growth in
product sales was attributable to both the successful launch of the new Heads-Up
Challenge amusement product in late 2007 and growth of Aristocrat’s PokerPro
business internationally.  Heads-Up Challenge contributed $4.8 million
in revenue for the year ended December 31, 2008 with 1,108 units sold, as
compared to product sales revenue of $185,399 and 40 units sold for the year
ended December 31, 2007.  Sales of casino products amounted to $3.3
million, an increase of $2.0 million (150%) over the comparable period in
2007.  Sales of casino products increased largely due to Aristocrat’s
increasing penetration in several European markets, notably Bulgaria where poker
was just recently legalized.





Direct Cost of
Revenue.  Direct cost of revenue consist of depreciation of
PokerPro systems and the cost of PokerPro systems sold primarily to Aristocrat
and the cost of Heads-Up Challenge product sales.  Total direct costs
increased by $5.4 million (167%) to $8.7 million for the year ended December 31,
2008.  Depreciation of PokerPro systems increased by $674,337 (35%) to
$2.6 million for the year ended December 31, 2008 as compared to $1.9 million
for the year ended December 31, 2007.  The increase in depreciation of
PokerPro systems resulted from the growth in the balance of PokerPro systems as
additional tables were leased in North American casinos during the
year.  Cost of product sales increased by $4.7 million (354%) to $6.1
million for the year ended December 31, 2008 as compared to $1.3 million for the
year ended December 31, 2007.  This increase in cost of sales is
attributable to the 434% growth in product sales.





As a
percentage of total revenues, direct cost of revenues improved to 60% of total
revenues for the year ended December 31, 2008, compared with 81% of total
revenues for the year ended December 31, 2007.  The improvements were
driven by the combination of increased sales of Heads-Up Challenge, which
carried higher relative product margins than sales of the PokerPro system, and
the increase in casino license and service fees.  In addition, casino
license fees increased at a faster rate than depreciation expense as we improved
our utilization of leased PokerPro assets during the year.





Selling, General
and Administrative Expenses.  Selling, general and
administrative expenses (“SG&A”) decreased by $247,598 (3%) to $9.0 million
for the year ended December 31, 2008 as compared to $9.2 million for the year
ended December 31, 2007. This decrease was primarily due to lower legal and
professional fees and other operating expenses.  The prior year
included $263.087 for legal fees  related to the Tellis lawsuit and
there were no comparable settlement charges in the current year.




19




Cost
reduction initiatives have significantly reduced the SG&A run rates on a
quarterly basis since 2007, although relatively lower expenses during the first
half of 2007 affect the year-over-year comparison.  As a percentage of
total revenues, SG&A expenses improved to 62% of total revenues for the year
ended December 31, 2008, compared with 230% of total revenues for the year ended
December 31, 2007.





Research and
Development Expenses.Research and Development
Expenses(“R&D”) decreased by
$1.2 million (31%) to $2.8 million for the year ended December 31, 2008 as
compared to $4.0 million for the year ended December 31, 2007. We continue to
invest in software and hardware development to improve our gaming and amusement
products through the addition of new games and features and to improve
manufacturability.  However, as our Heads-Up Challenge and PokerPro
products are now fully commercialized, we have been able to reduce spending on
pre-production engineering and internal development efforts.





Depreciation.Depreciation
increased by $65,543 (45%) for the year ended December 31, 2008 to $210,260 from
$144,717 for the year ended December 31, 2007.





Interest Income
(Expense), net.Interest income
(expense), net changed by $658,885 (117%) for the year ended December 31, 2008
to an expense of $94,285 from income of $564,600 for the year ended December 31,
2007.  We incurred interest expense in 2008 on the loan from our
founders, advances under the UBS Credit Facility, as well as origination and
unused line fees associated with the credit line from Silicon Valley
Bank.





In
addition, we earned higher amounts of interest income during 2007 than we did in
2008 as our average invested balances were higher in 2007 and the interest rates
earned on our auction rate securities (“ARS”) declined from an average of 5.4%
during 2007 to 2.9% during 2008 as a result of deteriorating conditions in the
credit markets and the disruptions in the ARS market.





Income
Taxes.Income tax provision was $262,905 for the year ended
December 31, 2008 and zero in the comparable period of 2007.  The
income tax provision is attributable to taxes incurred in Canada which cannot be
recovered or offset against domestic net operating loss
carryforwards.





Net
Loss.Net loss for the year ended December 31, 2008 was $7.6
million, an improvement of $5.2 million (41%) from $12.8 million for the year
ended December 31, 2007.  Net loss per share, basic and diluted, was
$0.70 per share for the year ended December 31, 2008, an improvement of $0.53
(43%) per share from $1.23 for the comparable period of
2007.   Net loss and net loss per share improved over the prior
year period due primarily to the combination of significantly higher revenues
from the casino and amusement product lines and lower operating expenses,
partially offset by higher direct cost of revenue.





Results
of Operations for the Year Ended December 31, 2007 Compared to the Year Ended
December 31, 2006 Revenue.Revenue increased by $2.0 million (102%) to $4.0 million for the year
ended December 31, 2007 as compared to $2.0 million for the year ended December
31, 2006.





License
and service fees increased by $1.7 million (203%) to $2.5 million for the year
ended December 31, 2007 as compared to $823,986 for the year ended December 31,
2006.  The increase in license and service fees was primarily due to
an increase in the number of PokerPro systems deployed under product licensing
agreements.





Product
sales increased by $354,052 (31%) to $1.5 million for the year ended December
31, 2007 as compared to $1.2 million for the year ended December 31,
2006.  Product sales consist primarily of PokerPro systems sold to
Aristocrat for deployment in international casinos.  Product sales
also include $185,399 in revenues attributable to the launch of the Heads-Up
Challenge product line, which was launched in late 2007 and had no revenues
during the 2006 period.





Direct Cost ofRevenue.  Direct
cost of revenue consists of depreciation of PokerPro systems and the cost of
PokerPro systems sold primarily to Aristocrat and the cost of Heads-Up Challenge
product sales.  Total direct costs increased by $1.5 million (86%) to
$3.2 million for the year ended December 31, 2007.  Depreciation of
PokerPro systems increased by $1.3 million (209%) to $1.9 million for the year
ended December 31, 2007 as compared to $618,657 for the year ended December 31,
2006.  The increase in depreciation of PokerPro systems resulted from
the growth in the balance of PokerPro systems as additional tables were leased
in North American casinos during the year.  Cost of product sales
increased by $210,046 (19%) to $1.3 million for the year ended December 31, 2007
as compared to $1.1 million for the year ended December 31,
2006.  This increase in cost of sales is attributable to the 31%
growth in product sales.





20




As a
percentage of total revenues, direct cost of revenues improved to 81% of total
revenues for the year ended December 31, 2007, compared with 88% of total
revenues for the year ended December 31, 2006.  The improvements were
driven by the combination of the launch of sales of Heads-Up Challenge, which
carried higher relative product margins than sales of the PokerPro system, and
the increase in casino license and service fees.





Selling, General
and Administrative Expenses.  SG&A expenses increased by
$3.5 million (62%) to $9.2 million for the year ended December 31, 2007 as
compared to $5.7 million for the year ended December 31, 2006. This increase was
primarily the result of an increase of $1.3 million related to the addition of
personnel and infrastructure to support our growth strategy, an increase of
$861,307 for legal and professional fees related to our regulatory and
intellectual property efforts, $263,087 for legal fees related to the Tellis
lawsuit, an increase in travel expenses of $346,121, an increase in licenses and
permits of $144,580 and an increase in non-cash stock option expense of
$123,451.  During 2007, we established our North American sales team
to market our products directly to casinos in North America and invested in
intellectual property.  These investments and others caused our
SG&A to increase over the prior period, but also enabled us to more
effectively grow market share while protecting our proprietary
technology.  As a percentage of total revenues, SG&A expenses
improved to 230% of total revenues for the year ended December 31, 2007,
compared with 286% of total revenues for the year ended December 31,
2006.





Research and
Development Expenses.R&D increased by
$447,193 (13%) to $4.0 million for the year ended December 31, 2007 as compared
to $3.5 million for the year ended December 31, 2006. The increase was primarily
the result of R&D activity related to developing the new Heads-Up Challenge
product. We also continued to invest resources on further enhancements to the
PokerPro system, including new games and other features to enhance the
marketability and functionality of the product.





Depreciation.Depreciation
increased by $53,781 (59%) for the year ended December 31, 2007 to $144,717 from
$90,936 for the year ended December 31, 2006.





Interest Income,
net.Interest income,
net decreased by $176,161 (24%) for the year ended December 31, 2007 to $564,600
from $740,761 for the year ended December 31, 2006 primarily due to a lower
average invested balance. The interest income principally relates to the
interest earned from our investments.





Net
Loss.Net loss for the year ended December 31, 2007 was $12.8
million, an increase of $3.7 million (40%) from $9.1 million for the year ended
December 31, 2006.  Net loss per share, basic and diluted, was $1.23
per share for the year ended December 31, 2007, an increase of $0.26 (27%) per
share from $0.97 for the comparable period of 2006.   Net loss
and net loss per share increased over the prior year period due primarily to the
higher cost of sales and operating expenses associated with the growth of the
business.





Liquidity
and Capital Resources





We have
incurred net losses since inception as we continue to invest in growing our
installed base of PokerPro systems and launching the Heads-Up Challenge
amusement product.





Prior to
2008, we have historically funded our operating costs, research and development
activities, working capital investments and capital expenditures associated with
our growth strategy with proceeds from the issuances of our common
stock.   During 2008, we also began using debt as a means to
finance our operations, including the credit facilities and loans described
below.





21




Discussion
of Statement of Cash Flows





Years
      Ended December 31,2008
              
              
              2007
              
              
              ChangeNet
      cash used in operating activities
              
              $
              (6,521,360
              )
              
              $
              (14,394,111
              )
              
              $
              7,872,751Net
      cash provided by investing activities
              
              
              1,918,287
              
              
              
              1,246,404
              
              
              
              671,883Net
      cash provided by financing activities
              
              
              4,854,623
              
              
              
              12,574,186
              
              
              
              (7,719,563
              )Net
      increase (decrease) in cash and cash equivalents
              
              
              251,550
              
              
              
              (573,521
              )
              
              
              825,071Cash
      and cash equivalents, beginning of year
              
              
              1,229,980
              
              
              
              1,803,501Cash
      and cash equivalents, end of year
              
              $
              1,481,530
              
              
              $
              1,229,980


For the
year ended December 31, 2008, net cash used in operating activities improved
$7.9 million (55%) to $6.5 million as compared to $14.4 million for the year
ended December 31, 2007. The improvement in operating cash flows resulted from
improvement in the company’s operating results as well as declines in the cash
invested in working capital.





Net cash
provided by investing activities increased $671,883 (54%) to $1.9 million for
the year ended December 31, 2008, from $1.2 million for the year ended December
31, 2007.  Cash provided by investing activities is primarily a
function of investments and redemptions of our auction rate securities
portfolio, and to a smaller degree, capital expenditures for assets used in our
operations.





Net cash
provided by financing activities was $4.9 million for the year ended December
31, 2008, compared to cash provided by financing activities of $12.6 million
during the year ended December 31, 2007.   During 2008, cash
provided from financing activities consisted primarily of proceeds from our loan
to our founders ($2 million), and net advances from the UBS line of credit ($2.9
million).  During 2007, cash provided by financing activities was
primarily attributable to $12.5 million received in connection with the private
placement in April 2007.





Equity
Offerings.  We completed our initial public offering on October
13, 2005 by selling 2.25 million shares of common stock at $11.00 per share,
including the partial exercise of the underwriter’s over-allotment option. The
initial closing of the offering occurred on October 19, 2005 and we received
proceeds of approximately $19.6 million, net of offering expenses and
underwriting discounts. On November 29, 2005, the underwriter exercised its
over-allotment option, resulting in the receipt of additional net proceeds of
approximately $2.2 million.





On April
23, 2007, we entered into a Securities Purchase Agreement, pursuant to which we
issued and sold an aggregate of 1,444,444 shares of our common stock in a
private placement to certain investors for a purchase price of $9.00 per
share.  The private placement, which was completed on April 26, 2007,
resulted in gross proceeds of approximately $13.0 million and net proceeds of
approximately $12.5 million after fees and expenses associated with the private
placement, including a cash placement agent fee.




Founders’ Loan.On March 24, 2008, we entered into a loan agreement with Lyle A. Berman,
James T. Crawford III, Arthur Lee Lomax and Gehrig H. “Lou”
White.  Messrs. Crawford, Lomax and White are the founders of the
Company.  Each of the lenders are also members of our board of
directors, with Mr. Berman serving as Chairman and Mr. White serving as Vice
Chairman. Upon closing, the lenders loaned us $2.0 million and we issued the
lenders a promissory note in the principal amount of $2.0 million. The loan
bears interest at an annual rate of 13% with all unpaid principal and interest
payable on March 24, 2010.  We are paying and intend to continue to
pay interest on a monthly basis. The loan principal may be repaid prior to
maturity without penalty.  The loan contains no restrictive covenants
and is collateralized by a security interest in our PokerPro systems deployed in
North America and on cruise ships as of December 31, 2007.




SVB Credit
Facility:On July 25, 2008, we entered into a credit facility
with Silicon Valley Bank to support our working capital (the “SVB Credit
Facility”).  The SVB Credit Facility is nominally denoted as a $5.0
million facility with an actual maximum availability that varies based on
specified percentages of domestic and foreign accounts receivable and
inventory.  Based on our accounts receivable and inventory levels on
December 31, 2008, as of such date availability under the SVB Credit Facility
was approximately $1.6 million, with no borrowings
outstanding.   The SVB Credit Facility has a one-year term and
bears interest at an annual rate of prime plus 2.0%.  The SVB Credit
Facility includes covenants requiring the achievement of specified financial
ratios and thresholds and contains other terms and conditions customary for this
type of credit facility.





22




UBS Credit
Facility.On August 13, 2008, we entered into a Credit Line
Agreement with UBS Bank USA for a demand revolving line of credit with respect
to our ARS held in an account with UBS.  Advances under the line of
credit, to be made at the sole discretion of UBS Bank USA at up to 80% of the
value of our ARS, bear interest at LIBOR plus 1.0%.  This line of
credit replaced a $1,000,000 loan made by UBS to us under the terms of a March
19, 2008 Client’s Agreement between us and UBS.  At December 31, 2008,
we had $3.9 million invested in ARS and $2.9 million in loans collateralized by
those securities.  At December 31, 2008 there was $2.9 million
available under the credit line, of which $2.9 million of borrowings were
outstanding.




On
October 8, 2008, UBS offered us the right to sell our ARS at par value to
UBS during a two-year period starting January 2, 2009.  We formally
accepted this offer on November 11, 2008.  On January 5, 2009,
subsequent to the end of 2008, we exercised our rights to put those ARS
investments back to UBS at par value.  We received net cash proceeds
of $1.0 million after selling our $3.9 million ARS investment to UBS and
liquidating our $2.9 million in advances under the UBS Credit
Facility.





We no
longer have any investments in ARS or debt with UBS following this
transaction.





Operations and
Liquidity Management.  The level of additional cash needed to
fund our operations is influenced primarily by the following factors, please see
Item 1A, “Risk Factors” for discussion of other risks and uncertainties that may
also impact our liquidity:





·
            The
      pace of growth in our casino business in the North American and cruise
      ship markets and the related investments we may need to make in inventory
      and PokerPro systems.


o
            Growth
      in these markets require working capital as the expenditures required to
      manufacture and install PokerPro tables are generally incurred in advance
      of product placement, whereas revenues are generally earned over time on a
      monthly lease basis. The capital intensive nature of the PokerPro leasing
      business makes access to the capital markets an important component of
      managing and growing our business.


·
            The
      pace of growth in sales of our Heads-Up Challenge amusement product and
      the related investments we may make in inventory and purchase
      commitments.


o
            The
      Heads-Up Challenge business model is less capital intensive than PokerPro,
      generally resulting in upfront product margins.  However, due to
      long lead times associated with an international supply chain and in order
      to minimize manufacturing costs, we have entered into significant purchase
      commitments with our supplier requiring us to purchase inventory in future
      periods based on forecasts which may not match up with the timing of our
      product sales.


·
            Our
      ability to control our operating expenses and generate positive operating
      leverage as we grow.


o
            We
      have reorganized our overhead structure and reduced our operating costs
      significantly between the third quarter of 2007 and the first quarter of
      2009.  Our ability to further streamline the organization and
      continue to reduce operating costs is not unlimited and we may need to
      hire additional personnel or otherwise increase our operating expenses as
      we grow.


·
            Our
      ability to negotiate favorable payment terms with our customers and
      vendors.


·
            The
      impact of the economy or other factors on our customers and suppliers,
      including the impact on demand for our products and our customers’ ability
      to pay us on a timely basis.





We have
the ability to impact the timing and extent of our cash needs primarily by
managing the pace of growth in both our PokerPro and Heads-Up-Challenge products
and managing our operating expenses. However, we also have significant
contractual obligations and our ability to control both the timing and extent of
the cash needs of the business is not unlimited, particularly in light of the
current economic climate and the capital intensive nature of the PokerPro
business.





Our
management’s strategy is to balance revenue growth with operating expense and
working capital management, while carefully monitoring the impact of growth on
our cash needs and cash balances. Accordingly, reductions in our working capital
investments or declines in demand for our products or continued deterioration in
general economic conditions could impact our ability to grow or to effectively
manage our liquidity needs.  If we are unable to execute our operating
plan, manage our working capital effectively or are impacted by other events, we
may need to attempt to raise additional funds through public or private
offerings of our securities, additional credit facilities or other sources
which may not be available on favorable terms, if at all. If such sources
of capital are not available or not available on sufficiently favorable terms,
we may seek other avenues to fund the business, including sale/leaseback
arrangements, transitioning PokerPro from a capital intensive leasing strategy
to a product sale strategy, or seeking to sell assets of all, or a portion
of, our operations. If we decide to raise capital in the equity markets or
take other actions, our shareholders could incur significant dilution or
diminished valuations, or, if we are unable to raise capital, our ability to
effectively operate our business could be impaired.





23





Impact
of Inflation





To date,
inflation has not had a material effect on our net sales, revenues or income
from continuing operations.





Off-Balance
Sheet Arrangements





We have
no off-balance sheet arrangements.





24





Contractual
Obligations





The table
below sets forth our known contractual obligations as of December 31,
2008:




Total
                
                
                Less
      than
                  1
      year
                
                
                1
      - 3 years
                
                
                3
      - 5 years
                
                
                More
      than
                  5
      yearsDebt
      obligations
                
                $
                5,190,357
                
                
                $
                3,125,357
                
                
                $
                2,065,000
                
                
                $
                -
                
                
                $
                -Operating
      lease obligations
                
                
                637,263
                
                
                
                258,729
                
                
                
                378,534
                
                
                
                -
                
                
                
                -Capital
      lease obligations
                
                
                70,246
                
                
                
                28,747
                
                
                
                41,499
                
                
                
                -
                
                
                
                -Purchase
      obligations
                
                
                2,232,302
                
                
                
                2,232,302
                
                
                
                -
                
                
                
                -
                
                
                
                -Other
      long-term liabilities
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Total
                
                $
                8,130,168
                
                
                $
                5,645,135
                
                
                $
                2,485,033
                
                
                $
                -
                
                
                $
                -


(1)
            Represents
      the outstanding principal amount and interest on our Founder’s Loan and
      UBS Credit Facility.


(2)
            Represents
      operating lease agreements for office and storage facilities and office
      equipment.


(3)
            Represents
      outstanding principal and interest payable under capital lease obligations
      related to our purchase of internal-use ERP
  system.


(4)
            Represents
      open purchase orders with our vendors, primarily purchase obligations for
      Heads-Up Challenge.





Critical
Accounting Policies





The
discussion and analysis of our financial condition and results of operations are
based on our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these consolidated financial statements requires us to make
certain estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses and related disclosures. On an ongoing basis,
we evaluate these estimates. We base our estimates on historical experience and
on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.





We
believe that of our significant accounting policies, which are described in Note
1 – “Nature of Business and Significant Accounting Policies” to our consolidated
financial statements appearing elsewhere in this report, the following
accounting policies involve a greater degree of judgment and complexity.
Accordingly, these are the policies we believe are the most critical to aid in
fully understanding and evaluating our consolidated financial condition and
results of operations.




Revenuerecognition: We
recognize revenue in accordance with Statement of Position No. 97-2 (“SOP
97-2”),Software Revenue
Recognition (as amended by SOP No. 98-4 and SOP No. 98-9), and Staff
Accounting Bulletin No. 101 (“SAB 101”), Revenue Recognition in Financial
Statements, as updated by SAB 104, Revenue Recognition.  If
multiple product deliverables are included under a sale or license agreement, we
allocate revenue to each product based upon their respective fair values in
relation to the total contract value and defer revenue recognition on those
deliverables that have not met all requirements of revenue
recognition.





Revenues
from product sales, including sales of the PokerPro system to
Aristocrat International Pty. Limited (“Aristocrat”), our international
distributor for PokerPro gaming products and a significant shareholder, are
recognized when all of the following have occurred:


·
            Persuasive
      evidence of an arrangement exists;


·
            The
      fee is fixed or determinable;


·
            Delivery
      has occurred;


·
            Collectibility
      is reasonably assured; and


·
            Title
      and risk of loss have passed to the
customer.





In many
cases, arrangements include recurring fees based on either a fixed monthly fee
or a pre-determined percentage of the amount the casino or card club charges for
each hand of poker (the “rake”).  In some cases, we may also charge
separately for installation, training and post contract customer support
(“PCS”).  Where we are responsible for performing initial installation and
training, all revenue is deferred until such time as those services have been
rendered.  Following installation, we account for hardware, software
license, PCS and other elements in accordance with SOP 97-2 and consistent with
the guidance provided by the American Institute of Certified Public Accountants’
Technical Practice Aid 5100.76, Fair Value in Multiple-Element
Arrangements That Include Contingent Usage-Based Fees and Software Revenue
Recognition.  License and service fees are recognized when
persuasive evidence of an arrangement exists, services have been rendered, the
price is fixed and determinable and collectability is reasonably assured. This
normally occurs on a monthly basis as the amounts contractually due are computed
and invoiced, PCS is delivered and all other revenue recognition criteria are
satisfied.





25




Investments in
Auction Rate Securities (“ARS”): We account for auction rate securities
in accordance with Statement of Financial Accounting Standards No. 115 (“FAS
115”), Accounting for Certain
Investments in Debt and Equity Securities.





Research and
development:
Research and development costs are charged to expense when incurred and are
included in the consolidated statements of operations, except when certain
qualifying expenses are capitalized in accordance with Statement of Financial
Accounting Standards No. 86 (“FAS 86”), Accounting for the Costs of Computer
Software to Be Sold, Leased or Otherwise Marketed. Capitalization of
development costs of software products begins once the technological feasibility
of the product is established.  Capitalization ceases when such
software is ready for general release, at which time amortization of the
capitalized costs begins.  As of December 31, 2008 and 2007, no
amounts were capitalized as technological feasibility is generally established
at or near the time of general release.





Inventories: Inventories are stated at
the lower of cost or market, where cost is determined on a first-in, first-out
basis.  We include an allocation of direct labor, indirect labor and
overhead for each PokerPro system. Costs not clearly related to the procurement,
manufacture or implementation are expensed as incurred. Repairs, maintenance and
rework are expensed as incurred.





PokerPro systems
and property andequipment: PokerPro systems and
property and equipment are stated at cost, less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful life of the asset. Estimated useful lives are generally three years for
PokerPro systems and five years for equipment and office furniture. Leasehold
improvements are amortized over the shorter of the term of the lease or the
useful life of the improvement.  Expenditures for maintenance and
repairs are expensed as incurred.





Share-based
compensation:Weaccount for share-based compensation in
accordance withStatement
of Financial Accounting Standards No. 123R(“FAS 123R”),Share Based
Payment, whichwas adoptedeffective January 1, 2006,replacingStatement of Financial Accounting
Standards No. 123 (“FAS 123”),Accounting for
Stock-Based Compensationand supersedingAPB Opinion No. 25(“APB 25”),Accounting for
Stock Issued to Employees.”





Under FAS
123R, we value stock options issued based upon the Black-Scholes option pricing
model and recognize the compensationover the period in which
the options vest.  There are inherent estimates made by management
regarding the calculation of stock option expense, including volatility,
expected life and forfeiture rate (see Note 10 – “Shareholders’ Equity – Stock
Incentive Plan”).





As of the
adoption of FAS 123R, we began recognizing compensation expense for options that
vest over time using the straight-line attribution approach.  For
time-based options issued prior to the adoption of FAS 123R, we continue to use
the graded attribution approach. For performance-based options issued to third
parties, compensation expense is determined at each reporting date in accordance
with the fair value method prescribed by the provisions of Emerging Issues Task
Force Issue No. 96-18, Accounting for Equity Instruments
That Are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services ("EITF 96-18"). Until the measurement date is
reached, the total amount of compensation expense remains uncertain.
Compensation expense is recorded based on the fair value of the award at the
reporting date and then revalued, or the total compensation is recalculated,
based on the current fair value at each subsequent reporting date.





Recent
Accounting Pronouncements





In March
2008, the Financial Accounting Standards Board (“FASB”) issued Statement of
Financial Accounting Standard No. 161 (“FAS 161”), Disclosures about Derivative Instruments and
Hedging Activities. FAS 161 improves
financial reporting on derivative instruments and hedging activities by
requiring enhanced disclosures to enable investors to better understand their
effects on an entity’s financial position, financial performance and cash flows.
The new standard is effective for financial statements issued for fiscal years
and interim periods beginning after November 15, 2008.  We do not
currently hold any derivative instruments; thus, adoption of
FAS 161 would not currently have any effect on our results of
operations, financial condition, or cash flows.





26




In May
2008, the FASB issued Statement of Financial Accounting Standard No. 162, The Hierarchy of Generally Accepted
Accounting Principles (“FAS 162”). FAS 162 identifies the sources of
accounting principles and the framework for selecting principles to be used in
the preparation of financial statements that are presented in conformity with
U.S. GAAP. The U.S. GAAP hierarchy was previously set forth in the American
Institute of Certified Public Accountants (“AICPA”) Statement on Auditing
Standards No. 69, The Meaning
of Present Fairly in Conformity With Generally Accepted Accounting
Principles. Though the FASB does not expect a change in current practice,
the Board issued this statement in order for the U.S. GAAP hierarchy to reside
in the accounting literature established by the FASB. FAS 162 is effective 60
days following the SEC’s approval of the Public Company Accounting Oversight
Board amendments to AU Section 411, The Meaning of Present Fairly in
Conformity With Generally Accepted Accounting Principles. Any effect of
applying the provisions of FAS 162 shall be reported as a change in accounting
principle in accordance with Statement of Financial Accounting Standard No. 154,
Accounting Changes and Error
Corrections. We do not expect FAS 162 to have a material impact on our
financial statements.





In June
2008, the FASB issued FSP No. EITF 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities
(“FSP EITF 03-6-1”). The FASB concluded in this FSP that unvested share-based
payment awards that contain nonforfeitable rights to dividends or dividend
equivalents are participating securities and shall be included in the
calculation of earnings per share pursuant to the two-class method. This FSP is
effective for financial statements issued for fiscal years beginning after
December 15, 2008, requiring all prior-period earnings per share data presented
to be adjusted retrospectively. We do not expect FSP EITF 03-6-1 to have a
material impact on our calculation of earnings per share.





In June
2008, the FASB issued EITF 07-05, DeterminingWhether an Instrument (or Embedded
Feature) Is Indexed to an Entity’s Own Stock, (“EITF 07-05”). EITF 07-05
provides guidance on determining what types of instruments or embedded features
in an instrument held by a reporting entity can be considered indexed to its own
stock for the purpose of evaluating the first criteria of the scope exception in
paragraph 11(a) of SFAS 133. EITF 07-05 is effective for financial statements
issued for fiscal years beginning after December 15, 2008 and early
application is not permitted if an entity has previously adopted an alternative
policy. We are currently evaluating the effect, if any, of EITF 07-05 on our
financial statements.





In
December 2007, the FASB issued Statement of Financial Accounting Standard
No. 160 (“FAS 160”), Noncontrolling Interest in
Consolidated Financial Statements – an amendment of ARB No. 51. FAS
160 changes reporting standards for noncontrolling interests in a subsidiary.
The standard is effective for fiscal years beginning on or after
December 15, 2008. We do not expect the adoption of FAS No. 160 to have a
material impact on our results of operations, financial condition, or cash
flows.





In
February 2007, the FASB issued Statement of Financial Accounting Standard No.
159, The Fair Value Option for
Financial Assets and Liabilities (“FAS 159”). FAS 159 provides entities
with the option to report selected financial assets and liabilities at fair
value. Business entities adopting FAS 159 will report unrealized gains and
losses in earnings at each subsequent reporting date on items for which the fair
value option has been elected. We elected the fair value option for our ARS
investments as of December 31, 2008 (See Note 2, Investments in Auction Rate
Securities (“ARS”)).




Item
7A. Quantitative
and Qualitative Disclosures about Market Risk.





We are
exposed to market risks from both changes in interest rates and foreign exchange
rates.  A discussion of our primary market risks is presented
below:





Cash and investments. Our cash
and cash equivalents are not subject to significant interest rate risk due to
the short maturities of these instruments. As of December 31, 2008, the carrying
value of our cash and cash equivalents approximated fair value.




Our
investments in ARS are subject to significant market and interest rate risk due
to the failure of the auction process to provide liquidity and due to the long
term maturities of the underlying investment securities.   In
addition to our investment in ARS, as of December 31, 2008, we also held a
Rights Option issued by UBS Financial Services, giving us the right to put the
ARS investments back to UBS at par for a specified period of time beginning on
January 2, 2009.  As of December 31, 2008, the estimated fair value of
the Investment in ARS was $3.3 million and our cost basis was $3.9
million.  As of December 31, 2008, the estimated fair value of the
Rights Option was $0.6 million and our cost basis was zero.




27




On
January 5, 2009, subsequent to the end of 2008, we exercised our rights to put
those ARS investments back to UBS at par value.  We received net cash
proceeds of $1.0 million after selling our $3.9 million ARS investment to UBS
and liquidating our $2.9 million in advances under the UBS Credit Facility. We
no longer have any investments in ARS or debt with UBS following this
transaction





We do not
use derivative financial instruments for speculation, or trading
purposes.





Fixed rate debt. Our founders’
loan bears interest at a fixed annually rate of 13%.  As market
interest rates fluctuate, the fair value of our founders’ debt will also
fluctuate.  The estimated fair value of our founders’ loan as of
December 31, 2008 was $1.9 million.  We estimate a 10% increase in
interest rates would decrease the fair value by approximately $0.1
million.  These changes would impact the fair value disclosures for
this financial instrument, but would have no impact on interest expense paid or
recognized in the consolidated statement of operations as the loan bears a fixed
interest rate.




Variable rate
debt.  Our UBS Credit Facility and SVB Credit Facility both
bear interest at variable rates, based on spreads over LIBOR and Prime,
respectively.  As of December 31, 2008, we had approximately $2.9
million of variable rate debt outstanding under the UBS Credit Facility and
nothing drawn under the SVB Credit Facility.  A change in average
interest rates would not have had a significant effect on net interest expense
during 2008, as there were no balances outstanding under the SVB Credit Facility
and any change in interest rates impacting the UBS Credit Facility would be
largely offset by changes to interest income received on the ARS
investments.  As of December 31, 2008, the carrying value of our
variable rate debt instruments approximated fair value.




On
January 5, 2009, subsequent to the end of 2008, we exercised our rights to put
those ARS investments back to UBS at par value.  We received net cash
proceeds of $1.0 million after selling our $3.9 million ARS investment to UBS
and liquidating our $2.9 million in advances under the UBS Credit Facility. We
no longer have any investments in ARS or debt with UBS following this
transaction.




Foreign currency
risk.  Our revenues from international customers and our
inventory costs from international suppliers are exposed to the potentially
adverse effects of currency exchange rates, local economic conditions, political
instability and other risks associated with doing business in foreign countries.
To the extent that our revenues and purchases from international business
partners increase in the future, our exposure to changes in foreign economic
conditions and currency fluctuations will increase.




Our
dependence on foreign customers and suppliers means, in part, that we are
affected by changes in the relative value of the U.S. dollar to foreign
currencies, particularly the British pound, Euro Canadian dollar and Taiwan
dollar.  Although our receipts from foreign customers and our
purchases of foreign products are principally negotiated and paid for in U.S.
dollars, changes in the applicable currency exchange rates might negatively
affect the profitability and business prospects of our customers and
vendors.  This, in turn, might cause such vendors to demand higher
prices, delay shipments, or discontinue selling to us.  This also might
cause such customers to demand lower prices, delay or discontinue purchases of
our products or demand other changes to the terms of our relationships. 
These situations could in turn ultimately reduce our revenues or increase our
costs, which could have a material adverse effect on our business, financial
condition or results of operations.





We do not
use derivative financial instruments for speculation, or trading purposes, or
engage in any other hedging strategies with regard to our foreign currency
risk.




Item
8.                  Financial
Statements and Supplementary Data.





The
information required by this Item is submitted as a separate section of this
Annual Report commencing on page F-1 attached hereto.




Item
9.                  Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure.





None.




28




Item
9A (T).         Controls and
Procedures.





Disclosure
Controls and Procedures





The
Company maintains disclosure controls and procedures (as defined in Rule
13a-15(e) under the Exchange Act), which are designed to ensure that information
required to be disclosed by the Company in the reports it files or submits under
the Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission’s rules and forms,
and that such information is accumulated and communicated to the Company’s
management, including its Chief Executive Officer and Chief Financial Officer,
as appropriate to allow timely decisions regarding required
disclosure.





As of
December 31, 2008, an evaluation of the effectiveness of the Company’s
disclosure controls and procedures was conducted under the supervision of, and
reviewed by, the Company’s Chief Executive Officer and Chief Financial Officer.
Based on that evaluation, the Company’s Chief Executive Officer and Chief
Financial Officer have concluded that the Company’s disclosure controls and
procedures were effective as of December 31, 2008,  to enable us to
record, process, summarize and report in a timely manner the information that we
are required to disclose in our Exchange Act reports, and that such information
is accumulated and communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure.





Management’s
Report on Internal Control over Financial Reporting





Management
is responsible for establishing and maintaining adequate internal control over
financial reporting. Our internal control system was designed to provide
reasonable assurance to the Company’s management and Board of Directors
regarding the preparation and fair presentation of the Company’s consolidated
financial statements in accordance with accounting principles generally accepted
in the United States.





The
Company’s internal control over financial reporting includes those policies and
procedures that:


·
            pertain
      to the maintenance of records that, in reasonable detail, accurately and
      fairly reflect the transactions and dispositions of the assets of the
      Company;


·
            provide
      reasonable assurance that transactions are recorded properly to allow for
      the preparation of financial statements in accordance with generally
      accepted accounting principles, and that receipts and expenditures of the
      Company are being made only in accordance with authorizations of
      management and directors of the
Company;


·
            provide
      reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use or disposition of the Company’s assets that
      could have a material effect on the financial statements;
    and


·
            provide
      reasonable assurance as to the detection of
  fraud.





All
internal controls, no matter how well designed, have inherent limitations.
Therefore, even those systems determined to be effective can only provide
reasonable assurance with respect to financial statement preparation and
presentation and may not prevent or detect misstatements.





Our
management assessed the effectiveness of the Company’s internal control over
financial reporting as of December 31, 2008. In making this assessment, our
management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (“COSO”) in Internal Control –
Integrated Framework and in accordance with the interpretive guidance issued by
the SEC in Release No. 34-55929. Based on that evaluation,management concluded
that the Company’s internal control over financial reporting was effective as of
December 31, 2008.





During
the course of management’s assessment, our management identified the following
significant deficiencies in our internal control over financial reporting which
had been identified as of December 31, 2007 and had not been fully remediated as
of December 31, 2008:





·
            The
      systems used in tracking and valuing inventory and PokerPro systems do not
      provide effective automated controls and are not integrated with each
      other or with the general ledger.  The lack of integration
      requires manual reconciliations between the
  applications.





·
            The
      Company utilized a software package for its general ledger that did not
      provide certain automated general controls, such as the presence of edit
      reports and workflow approvals.  The Company replaced its
      general ledger and other financial systems during the fourth quarter of
      2008, however the new system was not functioning for a sufficient period
      of time to affect management’s assessment of the effectiveness of internal
      control over financial reporting.





29




In
addition, the following new significant deficiencies in our internal control
over financial reporting have been identified and have not been fully remediated
as of December 31, 2008:





·
            The
      Company’s procedures for establishing and modifying system user access
      privileges was not sufficiently documented and subjected to management
      review to ensure that only authorized users have access to the Company’s
      sensitive applications, and that those authorized users only have access
      to appropriate functions within those
systems.





·
            Due
      to the relatively small size of the finance department, the Company lacked
      an effective segregation of duties between the disbursement of funds and
      the reconciliation of its bank
accounts.





All
identified deficiencies, including the significant deficiencies listed above,
were reported to the Company’s Audit Committee by our management and to our
independent registered public accounting firm.





We are
currently implementing a new enterprise resource planning (“ERP”) system,
including integrated inventory and fixed asset applications to further
strengthen our internal controls. During the fourth quarter of 2008, the finance
modules of that ERP system were successfully implemented, including general
ledger, accounts receivable and accounts payable.  We are currently
finalizing the application configuration, documentation and testing phases
required to implement the remaining modules of the integrated ERP
system.  In connection with the new system implementation, management
also plans to formalize its user access procedures and improve the documentation
and management review to ensure proper access.  We have also separated
responsibility for bank reconciliations from the accounts payable
function. However, we can provide no assurance that a new ERP system will
be fully deployed or that the implementation of new systems and other procedures
will fully resolve all significant deficiencies or that we will not create or
discover additional significant deficiencies during that
transition.





Compensating
controls, including more timely reconciliations, enhanced review and approval
procedures, as well as more robust physical inventory counting and valuation
procedures were implemented in the fourth quarter of 2007 and continued to be
performed throughout 2008 as the new ERP system was being developed and readied
for deployment.  Although the process of establishing and maintaining
user access levels for our overall systems lacked adequate formal documentation,
we carefully reviewed access to our general ledger, accounts payable and
accounts receivable system in connection with the implementation of the new ERP
system to ensure that user access was appropriate for those sensitive
applications. In addition, we changed responsibility for the preparation of bank
reconciliations during the fourth quarter of 2008. Accordingly, our
management believes that these significant deficiencies are not indicative of a
material weakness in internal control over financial reporting and thus, as
noted above, our management concluded that, as of December 31, 2008, our
internal control over financial reporting was effective.





This
annual report does not include an attestation report of our registered public
accounting firm regarding internal control over financial
reporting.  Management’s report was not subject to attestation by our
registered public accounting firm pursuant to temporary rules of the Securities
and Exchange Commission that permit the Company to provide only management’s
report in this annual report.





Changes
in Internal Control over Financial Reporting





During
the fourth quarter ended December 31, 2008, our management completed the
implementation of the finance modules of the Company’s new ERP system, with the
remaining modules expected to be implemented during 2009, as discussed in
“Management’s Report on Internal Control over Financial
Reporting.”  There were no other  changes in internal
control over financial reporting during the quarter ended December 31, 2008 that
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.





Item
9B.               Other
Information.





None.




30




PART
III




Item
10.               Directors,
Executive Officers and Corporate Governance.




Information
called for by this item may be found in our definitive Proxy Statement in
connection with our 2009 Annual Meeting of Shareholders to be filed with the SEC
under the headings “Board of Directors and Management,” “Section 16(a)
Beneficial Ownership Reporting Compliance” and “Corporate Governance Matters”
and is incorporated herein by reference.





Item
11.               Executive
Compensation.




Information
called for by this item may be found in our definitive Proxy Statement in
connection with our 2009 Annual Meeting of Shareholders to be filed with the SEC
under the headings “Executive Compensation” and “Corporate Governance Matters”
and is incorporated herein by reference.





Item
12. Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters.




Information
called for by this item may be found in our definitive Proxy Statement in
connection with our 2009 Annual Meeting of Shareholders to be filed with the SEC
under the headings “Equity Compensation Plan Information”
and  “Security Ownership of Certain Beneficial Owners and Management”
and is incorporated herein by reference.





Item
13.               Certain
Relationships and Related Transactions, and Director Independence.




Information
called for by this item may be found in our definitive Proxy Statement in
connection with our 2009 Annual Meeting of Shareholders to be filed with the SEC
under the headings “Related Person Transactions” and “Corporate Governance
Matters” and is incorporated herein by reference.





Item
14.               Principal
Accounting Fees and Services.




Information
called for by this item may be found in our definitive Proxy Statement in
connection with our 2009 Annual Meeting of Shareholders to be filed with the SEC
under the headings “Independent Registered Public Accounting Firm Fee
Information” and “Audit Committee Pre-Approval Policy” and is incorporated
herein by reference.





31




PART
IV





Item
15.               Exhibits,
Financial Statement Schedules.





(a)           The
following documents are filed as a part of this Form 10-K:





1.      Financial
Statements


The
following financial statements are included in a separate section of this Annual
Report on Form 10-K beginning on page F-1:


·
            Report
      of Independent Registered Public Accounting
  Firm;


·
            Consolidated
      Statements of Operations for the years ended December 31, 2008, December
      31, 2007 and December 31, 2006;


·
            Consolidated
      Balance Sheets as of December 31, 2008 and December 31,
    2007;


·
            Consolidated
      Statements of Shareholders’ Equity for the years ended December 31, 2008,
      December 31, 2007 and December 31,
2006;


·
            Consolidated
      Statements of Cash Flows for the years ended December 31, 2008, December
      31, 2007 and December 31, 2006; and


·
            Notes
      to Consolidated Financial
Statements.





2.      Financial
Statement Schedules


The
      following financial statement schedule is included in a separate section
      of this Annual Report on page S-1:


·
            Valuation
      and Qualifying Accounts and
Reserves





Other
      financial statement schedules are omitted because they are not required or
      are not applicable, or the required information is provided in the
      consolidated financial statements or notes described in Item 15(a)(1)
      above.





3.      Exhibits


The
      Exhibits listed in the Exhibit Index, which appears immediately following
      the Financial Statement Schedules and is incorporated herein by reference,
      are filed as part of this Annual Report on Form
  10-K.





(b) See
the Exhibit Index.





(c)  Separate
Financial Statements and Schedules


None.




32




SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.


PokerTek,
      Inc.Date:
      March 31, 2009
              By:
              /s/ Christopher
      J.C. HalliganChristopher
      J.C. Halligan
                Chief
      Executive Officer


Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.


/s/
              Christopher J.C. Halligan
              
              
              Date:
              March 31, 2009Name:
              Christopher
      J.C. HalliganTitle:
              Chief
      Executive Officer(Principal
      Executive Officer)/s/
              Mark D. Roberson
              
              
              Date:
              March 31, 2009Name:
              Mark
      D. RobersonTitle:
              Chief
      Financial Officer(Principal
      Financial Officer and Principal Accounting Officer)/s/
              Lyle Berman
              
              
              Date:
              March 31, 2009Name:
              Lyle
      BermanTitle:
              Chairman
      of the Board of Directors/s/
              Gehrig H. White
              
              
              Date:
              March 31, 2009Name:
              Gehrig
      H. WhiteTitle:
              Vice
      Chairman of the Board of Directors/s/
              James T. Crawford, III
              
              
              Date:
              March 31, 2009Name:
              James
      T. Crawford, IIITitle:
              President,
      Secretary and Director/s/
              Joseph J. Lahti
              
              
              Date:
              March 31, 2009Name:
              Joseph
      J. LahtiTitle:
              Director/s/
              Arthur Lee Lomax
              
              
              Date:
              March 31, 2009Name:
              Arthur
      Lee LomaxTitle:
              Director




33





INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS




PageReport
      of Independent Registered Public Accounting Firm
              
              F-2Consolidated
      Statements of Operations for the years ended December 31, 2008, 2007 and
      2006
              
              F-3Consolidated
      Balance Sheets as of December 31, 2008 and 2007
              
              F-4Consolidated
      Statements of Shareholders’ Equity for the years ended December 31, 2008,
      2007 and 2006
              
              F-5Consolidated
      Statements of Cash Flows for the years ended December 31, 2008, 2007 and
      2006
              
              F-6Notes
      to Consolidated Financial Statements
              
              F-7Consolidated
      Financial Statement Schedules:II.  Valuation
      and Qualifying Accounts and Reserves
              
              S-1





F -
1





REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM





To the
Board of Directors and Shareholders


PokerTek,
Inc.


Matthews,
North Carolina





We have
audited the accompanying consolidated balance sheets of PokerTek, Inc. and
Subsidiary (together, “PokerTek” or the “Company”) as of December 31, 2008 and
2007, and the related consolidated statements of operations, shareholders'
equity, and cash flows for each of the three years in the period ended December
31, 2008.  Our audits also included the financial statement schedules
of PokerTek, Inc. listed in Item 15(a). These financial statements and financial
statement schedule are the responsibility of the Company's
management.  Our responsibility is to express an opinion on these
financial statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of PokerTek as of December 31,
2008 and 2007, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 2008, in conformity with
U.S. generally accepted accounting principles.  Also, in our opinion,
the related financial statement schedules, when considered in relation to the
basic consolidated financial statements taken as a whole, present fairly in all
material respects the information set forth therein.





We were
not engaged to examine management's assessment of the effectiveness of
PokerTek’s internal control over financial reporting as of December 31, 2008,
included in the accompanying “Management’s Report on Internal
Control over Financial Reporting” and, accordingly, we do not express an
opinion thereon.











/s/ McGladrey & Pullen,
LLP


Charlotte,
North Carolina


March 31,
2009




F -
2
 
 POKERTEK,
INC.
 CONSOLIDATED
STATEMENTS OF OPERATIONS


Years
      Ended December 31,2008
                      
                      
                      2007
                      
                      
                      2006Revenue:License
      and service fees
                      
                      $
                      6,354,981
                      
                      
                      $
                      2,494,708
                      
                      
                      $
                      823,986Product
      sales
                      
                      
                      8,069,743
                      
                      
                      
                      1,509,983
                      
                      
                      
                      1,155,931Total
      revenue
                      
                      
                      14,424,724
                      
                      
                      
                      4,004,691
                      
                      
                      
                      1,979,917Direct
      cost of revenue:Depreciation
      of PokerPro systems
                      
                      
                      2,582,965
                      
                      
                      
                      1,908,628
                      
                      
                      
                      618,657Cost
      of product sales
                      
                      
                      6,075,303
                      
                      
                      
                      1,338,043
                      
                      
                      
                      1,127,997Total
      direct cost of revenue
                      
                      
                      8,658,268
                      
                      
                      
                      3,246,671
                      
                      
                      
                      1,746,654Operating
      Expenses:Selling,
      general and administrative
                      
                      
                      8,965,123
                      
                      
                      
                      9,212,721
                      
                      
                      
                      5,670,234Research
      and development
                      
                      
                      2,766,543
                      
                      
                      
                      3,992,449
                      
                      
                      
                      3,545,256Share-based
      compensation expense
                      
                      
                      1,106,113
                      
                      
                      
                      822,349
                      
                      
                      
                      813,316Depreciation
                      
                      
                      210,260
                      
                      
                      
                      144,717
                      
                      
                      
                      90,936Total
      operating expenses
                      
                      
                      13,048,039
                      
                      
                      
                      14,172,236
                      
                      
                      
                      10,119,742Operating
      loss
                      
                      
                      (7,281,583
                      )
                      
                      
                      (13,414,216
                      )
                      
                      
                      (9,886,479
                      )Interest
      income (expense), net
                      
                      
                      (94,285
                      )
                      
                      
                      564,600
                      
                      
                      
                      740,761Net
      loss before income taxes
                      
                      
                      (7,375,868
                      )
                      
                      
                      (12,849,616
                      )
                      
                      
                      (9,145,718
                      )Income
      tax provision
                      
                      
                      (262,905
                      )
                      
                      
                      -
                      
                      
                      
                      -Net
      loss
                      
                      $
                      (7,638,773
                      )
                      
                      $
                      (12,849,616
                      )
                      
                      $
                      (9,145,718
                      )Net
      loss per common share - basic and diluted
                      
                      $
                      (0.70
                      )
                      
                      $
                      (1.23
                      )
                      
                      $
                      (0.97
                      )Weighted
      average common shares outstanding - basic and diluted
                      
                      
                      10,941,117
                      
                      
                      
                      10,462,912
                      
                      
                      
                      9,471,423




The
accompanying notes are an integral part of these consolidated financial
statements.




F -
3


POKERTEK,
      INC.CONSOLIDATED
      BALANCE SHEETSDecember
      31,Assets
                
                2008
                
                
                2007Current
      assets:Cash
      and cash equivalents
                
                $
                1,481,530
                
                
                $
                1,229,980Investments
                
                
                3,900,000
                
                
                
                5,950,000Accounts
      receivables, net
                
                
                1,600,464
                
                
                
                968,536Inventory
                
                
                3,547,099
                
                
                
                2,642,481Prepaid
      expenses and other assets
                
                
                213,222
                
                
                
                331,199Total
      current assets
                
                
                10,742,315
                
                
                
                11,122,196Other
      assets:PokerPro
      systems, net
                
                
                3,821,376
                
                
                
                4,991,634Property
      and equipment, net
                
                
                599,772
                
                
                
                605,046Other
      assets
                
                
                542,214
                
                
                
                377,029Total
      assets
                
                $
                15,705,677
                
                
                $
                17,095,905Liabilities
      and Shareholders' EquityCurrent
      liabilities:Accounts
      payable
                
                $
                1,590,681
                
                
                $
                1,465,202Accrued
      liabilities
                
                
                1,053,230
                
                
                
                964,173Long-term
      debt, current portion
                
                
                2,889,261
                
                
                
                -Total
      current liabilities
                
                
                5,533,172
                
                
                
                2,429,375Long-term
      debt
                
                
                2,038,635
                
                
                
                -Total
      liabilities
                
                
                7,571,807
                
                
                
                2,429,375Commitments
      and contingenciesShareholders'
      equity:Preferred
      stock, no par value per share; authorized 5,000,000, none issued and
      outstanding
                
                
                -
                
                
                
                -Common
      stock, no par value per share; authorized 100,000,000 shares, issued and
      outstanding 11,021,429 and 10,934,464 shares at December 31, 2008 and
      December 31, 2007, respectively
                
                
                -
                
                
                
                -Additional
      paid-in capital
                
                
                42,459,333
                
                
                
                41,353,220Accumulated
      deficit
                
                
                (34,325,463
                )
                
                
                (26,686,690
                )Total
      shareholders' equity
                
                
                8,133,870
                
                
                
                14,666,530Total
      liabilities and shareholders' equity
                
                $
                15,705,677
                
                
                $
                17,095,905




The accompanying notes are an integral part of these
consolidated financial statements.




F -
4


POKERTEK,
      INC.CONSOLIDATED
      STATEMENTS OF SHAREHOLDERS’ EQUITYCommon
      Stock
                
                
                Additional
                  Paid-in
      Capital
                
                
                Accumulated
                  Deficit
                
                
                Total
                  Shareholders'
                  EquityShares
                
                
                ValueBalance,
      December 31, 2005
                
                
                9,468,020
                
                
                $
                -
                
                
                $
                27,180,041
                
                
                $
                (4,691,356
                )
                
                $
                22,488,685Expenses
      from issuance of common stock
                
                
                -
                
                
                
                -
                
                
                
                (36,712
                )
                
                
                -
                
                
                
                (36,712
                )Stock
      options exercised
                
                
                4,000
                
                
                
                -
                
                
                
                40
                
                
                
                -
                
                
                
                40Share-based
      compensation
                
                
                -
                
                
                
                -
                
                
                
                813,316
                
                
                
                -
                
                
                
                813,316Net
      loss
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (9,145,718
                )
                
                
                (9,145,718
                )Balance,
      December 31, 2006
                
                
                9,472,020
                
                
                
                -
                
                
                
                27,956,685
                
                
                
                (13,837,074
                )
                
                
                14,119,611Net
      proceeds from private placement of common stock
                
                
                1,444,444
                
                
                
                -
                
                
                
                12,507,578
                
                
                
                -
                
                
                
                12,507,578Stock
      options exercised
                
                
                18,000
                
                
                
                -
                
                
                
                66,608
                
                
                
                -
                
                
                
                66,608Share-based
      compensation
                
                
                -
                
                
                
                -
                
                
                
                822,349
                
                
                
                -
                
                
                
                822,349Net
      loss
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (12,849,616
                )
                
                
                (12,849,616
                )Balance,
      December 31, 2007
                
                
                10,934,464
                
                
                
                -
                
                
                
                41,353,220
                
                
                
                (26,686,690
                )
                
                
                14,666,530Stock
      warrants exercised
                
                
                86,965
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Share-based
      compensation
                
                
                -
                
                
                
                -
                
                
                
                1,106,113
                
                
                
                -
                
                
                
                1,106,113Net
      loss
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (7,638,773
                )
                
                
                (7,638,773
                )Balance,
      December 31, 2008
                
                
                11,021,429
                
                
                $
                -
                
                
                $
                42,459,333
                
                
                $
                (34,325,463
                )
                
                $
                8,133,870




The
accompanying notes are an integral part of these consolidated financial
statements.





F -
5


POKERTEK,
      INC.CONSOLIDATED
      STATEMENTS OF CASH FLOWSYears
      Ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Cash
      flows from operating activities:Net
      loss
                    
                    $
                    (7,638,773
                    )
                    
                    $
                    (12,849,616
                    )
                    
                    $
                    (9,145,718
                    )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
                    
                    
                    2,793,225
                    
                    
                    
                    2,053,345
                    
                    
                    
                    709,593Share-based
      compensation expense
                    
                    
                    1,106,113
                    
                    
                    
                    822,349
                    
                    
                    
                    813,316Provision
      for accounts and other receivables
                    
                    
                    14,672
                    
                    
                    
                    47,129
                    
                    
                    
                    19,301Changes
      in assets and liabilities:Accounts
      and other receivables
                    
                    
                    (646,600
                    )
                    
                    
                    (743,276
                    )
                    
                    
                    (140,490
                    )Prepaid
      expenses and other assets
                    
                    
                    (47,208
                    )
                    
                    
                    (158,373
                    )
                    
                    
                    (231,505
                    )Inventory
                    
                    
                    (904,618
                    )
                    
                    
                    (741,485
                    )
                    
                    
                    (1,300,321
                    )PokerPro
      systems
                    
                    
                    (1,412,707
                    )
                    
                    
                    (4,250,373
                    )
                    
                    
                    (1,673,909
                    )Accounts
      payable and accrued expenses
                    
                    
                    214,536
                    
                    
                    
                    1,426,189
                    
                    
                    
                    788,721Net
      cash used in operating activities
                    
                    
                    (6,521,360
                    )
                    
                    
                    (14,394,111
                    )
                    
                    
                    (10,161,012
                    )Cash
      flows from investing activities:Proceeds
      from sale of equipment
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    44,907Purchases
      of property and equipment
                    
                    
                    (131,713
                    )
                    
                    
                    (353,596
                    )
                    
                    
                    (867,622
                    )Sale
      of investments
                    
                    
                    2,050,000
                    
                    
                    
                    28,600,000
                    
                    
                    
                    17,550,000Purchase
      of investments
                    
                    
                    -
                    
                    
                    
                    (27,000,000
                    )
                    
                    
                    (10,050,000
                    )Net
      cash provided by investing activities
                    
                    
                    1,918,287
                    
                    
                    
                    1,246,404
                    
                    
                    
                    6,677,285Cash
      flows from financing activities:Proceeds
      from long-term debt
                    
                    
                    2,000,000
                    
                    
                    
                    -
                    
                    
                    
                    -Proceeds
      from short-term debt
                    
                    
                    3,060,443
                    
                    
                    
                    -
                    
                    
                    
                    -Repayments
      of short-term debt
                    
                    
                    (195,086
                    )
                    
                    
                    -
                    
                    
                    
                    -Proceeds
      from issuance of common stock, net of expenses
                    
                    
                    -
                    
                    
                    
                    12,507,578
                    
                    
                    
                    (36,712
                    )Proceeds
      from common stock options exercised
                    
                    
                    -
                    
                    
                    
                    66,608
                    
                    
                    
                    40Repayments
      of capital lease
                    
                    
                    (10,734
                    )
                    
                    
                    -
                    
                    
                    
                    -Net
      cash provided by (used in) financing activities
                    
                    
                    4,854,623
                    
                    
                    
                    12,574,186
                    
                    
                    
                    (36,672
                    )Net
      increase (decrease) in cash and cash equivalents
                    
                    
                    251,550
                    
                    
                    
                    (573,521
                    )
                    
                    
                    (3,520,399
                    )Cash
      and cash equivalents, beginning of year
                    
                    
                    1,229,980
                    
                    
                    
                    1,803,501
                    
                    
                    
                    5,323,900Cash
      and cash equivalents, end of year
                    
                    $
                    1,481,530
                    
                    
                    $
                    1,229,980
                    
                    
                    $
                    1,803,501Supplemental
      Disclosure of Cash Flow InformationCash
      paid for:Interest
                    
                    $
                    265,375
                    
                    
                    $
                    4,450
                    
                    
                    $
                    1,171Income
      taxes
                    
                    $
                    242,337
                    
                    
                    $
                    -
                    
                    
                    $
                    -Non-cash
      transaction:Capital
      lease obligation
                    
                    $
                    73,273
                    
                    
                    $
                    -
                    
                    
                    $
                    -




The
accompanying notes are an integral part of these consolidated financial
statements.




F -
6




POKERTEK,
INC.




NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2008





Note
1.  Nature of Business and Significant Accounting Policies




Nature
of Business





PokerTek,
Inc. (“PokerTek” or the “Company”) is engaged in the development, manufacture
and marketing of electronic poker-related products for use in the gaming and
amusement markets.





The
Company currently has two product lines, PokerPro® gaming products and Heads-Up
ChallengeTM amusement products.





The
PokerPro system consists of electronic poker table(s) and related peripheral
equipment providing commercial casinos, tribal casinos, cruise ships and card
clubs with a fully-automated poker-room environment designed to improve the
profitability of poker by enhancing the operator’s revenue opportunities and
decreasing their startup and operating costs.  Heads-Up
Challenge  is an innovative amusement platform that enables two
players to compete head to head against each other for entertainment purposes in
non-gambling venues such as bars and restaurants.




Basis
of Presentation and Principles of Consolidation





These consolidated
financial statements include the accounts of PokerTek, Inc. and its consolidated
subsidiary.  They have been prepared by the Company in accordance with
accounting principles generally accepted in the United States.  The
financial statements of the Company’s foreign subsidiary are measured using the
U.S. dollar as the functional currency. All significant intercompany
transactions and accounts have been eliminated in consolidation.




Significant
Accounting Policies




Accounting
estimates: The
preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.





Revenuerecognition: The
Company recognizes revenue in accordance with Statement of Position No. 97-2
(“SOP 97-2”),Software Revenue
Recognition (as amended by SOP No. 98-4 and SOP No. 98-9), and Staff
Accounting Bulletin No. 101 (“SAB 101”), Revenue Recognition in Financial
Statements, as updated by SAB 104, Revenue Recognition.  If
multiple product deliverables are included under a sale or license agreement,
the Company allocates revenue to each product based upon their respective fair
values in relation to the total contract value and defers revenue recognition on
those deliverables that have not met all requirements of revenue
recognition.





Revenues
from product sales, including sales of casino products to
Aristocrat International Pty. Limited (“Aristocrat”), the Company’s
international distributor for PokerPro gaming products and a significant
shareholder, are recognized when all of the following have
occurred:


·
            Persuasive
      evidence of an arrangement exists;


·
            The
      fee is fixed or determinable;


·
            Delivery
      has occurred;


·
            Collectibility
      is reasonably assured; and


·
            Title
      and risk of loss have passed to the
customer.





In many
cases, arrangements include recurring fees based on either a fixed monthly fee
or a pre-determined percentage of the amount the casino or card club charges for
each hand of poker (the “rake”).  In some cases, the Company may also
charge separately for installation, training and post contract customer support
(“PCS”).  Where the Company is responsible for performing initial
installation and training, all revenue is deferred until such time as those
services have been rendered.  Following installation, the Company
accounts for hardware, software license, PCS and other elements in accordance
with SOP 97-2 and consistent with the guidance provided by the American
Institute of Certified Public Accountants’ Technical Practice Aid 5100.76, Fair Value in Multiple-Element
Arrangements That Include Contingent Usage-Based Fees and Software Revenue
Recognition.  License and service fees are recognized when
persuasive evidence of an arrangement exists, services have been rendered, the
price is fixed and determinable and collectability is reasonably assured. This
normally occurs on a monthly basis as the amounts contractually due are computed
and invoiced, PCS is delivered and all other revenue recognition criteria are
satisfied.





F -
7




Cash andcashequivalents: The
Company considers all cash accounts and highly liquid debt instruments purchased
with an original maturity of three months or less to be cash
equivalents.





Investments in
Auction Rate Securities (“ARS”): The Company accounts for its auction
rate securities in accordance with Statement of Financial Accounting Standards
No. 115 (“FAS 115”), Accounting for Certain Investments
in Debt and Equity Securities.





Concentrations of
credit risk: Financial instruments that subject the Company to credit
risk primarily consist of cash and cash equivalents, marketable securities and
accounts receivables. The Company’s credit risk is managed by investing
primarily in high-quality money market instruments and securities guaranteed by
the U.S. government and its agencies.





Receivables and
allowance for doubtful accounts: The Company monitors its exposure for
credit losses on its customer receivable balances and the credit worthiness of
its customers on an ongoing basis and records related allowances for doubtful
accounts. Allowances are estimated based upon specific customer balances, where
a risk of default has been identified, and also include a provision for
non-customer specific defaults based upon historical experience. As of December
31, 2008 and December 31, 2007, the Company recorded reserves of $81,403 and
$21,062, respectively. If circumstances related to specific customers change,
estimates of the recoverability of receivables could also change.





Deferred
licensing fees:Deferred licensingfees
consist of amounts paid to various regulatory agencies. As approvals are
obtained, the Company begins expensing the fees over the estimated term of the
license.  Deferred licensing fees are included in other assets on the
consolidated balance sheets.





Patents.Legal fees and
application costs related to the Company’s patent application process are
expensed. There is a high degree of uncertainty in the outcome of approval for
any of the Company’s patents.





Research and
development:
Research and development costs are charged to expense when incurred and are
included in the consolidated statements of operations, except when certain
qualifying expenses are capitalized in accordance with Statement of Financial
Accounting Standards No. 86 (“FAS 86”), Accounting for the Costs of Computer
Software to Be Sold, Leased or Otherwise Marketed. Capitalization of
development costs of software products begins once the technological feasibility
of the product is established.  Research and development costs include
salaries, benefits, travel and other internal costs allocated to software and
hardware development efforts, as well as purchased components, engineering
services and other third party costs. Capitalization ceases when such
software is ready for general release, at which time amortization of the
capitalized costs begins.  As of December 31, 2008 and 2007, no
amounts were capitalized as technological feasibility is generally established
at or near the time of general release.





Advertising: Advertising
and promotional costs are expensed as incurred. Advertising costs for the years
ended December 31, 2008, 2007 and 2006 were $41,859, $129,625 and $143,918,
respectively.




Inventories: Inventories are stated at
the lower of cost or market, where cost is determined on a first-in, first-out
basis.  The Company includes an allocation of direct labor, indirect labor
and overhead for each PokerPro system. Costs not clearly related to the
procurement, manufacture and implementation are expensed as incurred. We
regularly review inventory for slow moving, obsolete and excess characteristics
and evaluate whether inventory is stated at the lower of cost or net realizable
value.





PokerPro systems
and property andequipment: PokerPro systems
represent equipment owned by PokerTek.  The majority of this equipment
is operated at customer sites pursuant to contractual license
agreements.  PokerPro systems may also include temporarily idle
equipment returned from customer locations and equipment used by the Company for
demonstration or testing purposes.





PokerPro systems are transferred from
the Company’s inventory account to the PokerPro systems account at the time the
units are fully assembled, configured, tested and otherwise ready for use by a
customer.  Because the configuration of each PokerPro system is unique
to the specific customer environment in which it is being placed, the final
steps to configure and test the unit generally occur immediately prior to
shipment.  Depreciation expense for PokerPro systems begins in the
month of transfer of each PokerPro systemfrom the Company’s inventory account
to the PokerPro systems account.





F -
8




PokerPro
systems and property and equipment are stated at cost, less accumulated
depreciation. Depreciation is computed using the straight-line method over the
estimated useful life of the asset. Estimated useful lives are generally three
years for PokerPro systems and five years for equipment and office furniture.
Leasehold improvements are amortized over the shorter of the term of the lease
or the useful life of the improvement.  Expenditures for maintenance
and repairs are expensed as incurred.





The
Company reviews its property and equipment in accordance with Statement of
Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the
Impairment or Disposal of Long-Lived Assets”. SFAS No. 144 requires
the Company to evaluate property and equipment as an event occurs or
circumstances change that would more likely than not reduce the fair value of
the property and equipment below the carrying amount. If the carrying amount of
property and equipment is not recoverable from its undiscounted cash flows, then
the Company would recognize an impairment loss for the difference between the
carrying amount and the current fair value. Further, the Company evaluates the
remaining useful lives of property and equipment at each reporting period to
determine whether events and circumstances warrant a revision to the remaining
depreciation periods.





Offering
costs: Offering
costs incurred in connection with the Company’s equity offerings, consisting
principally of legal, accounting and underwriting fees, have been charged to
additional paid in capital.  As of December 31, 2008, approximately
$3.2 million of offering costs, on a cumulative basis, has been
incurred.




Income
taxes: The
Company accounts for income taxes in accordance with Statement of Financial
Accounting Standards No. 109 (“FAS 109”),Accounting for Income Taxes.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in the period that
includes the enactment date.





The Company has also adopted FASB
Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income
Taxes – an interpretation of FASB Statement No. 109as of January 1,
2007.





The
accounting for income taxes involves significant judgments and estimates and
deals with complex tax regulations. The recoverability of certain deferred tax
assets is based in part on estimates of future income and the timing of
temporary differences (see Note 11 – “Income Taxes”).




Earnings (loss)
per share: The
Company computes earnings (loss) per share in accordance with Statement of
Financial Accounting Standards No. 128 (“FAS 128”),Earnings per Share. FAS 128
requires presentation of both basic and diluted earnings per share (“EPS”) on
the face of the statement of operations. Basic EPS is computed by dividing net
income (loss) available to common shareholders by the weighted-average number of
shares outstanding during the period. Diluted EPS reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted to common stock. In computing Diluted EPS, the
average stock price for the period is used in determining the number of shares
assumed to be purchased from the exercise of stock options or warrants. Diluted
EPS excludes all potential dilutive shares due to their anti-dilutive
effect.




Share-based
compensation:TheCompany accounts for share-based compensation in
accordance withStatement
of Financial Accounting Standards No. 123R(“FAS 123R”),Share Based
Payment, whichwas adoptedeffective January 1, 2006,replacingStatement of Financial Accounting
Standards No. 123 (“FAS 123”),Accounting for
Stock-Based Compensationand supersedingAPB Opinion No. 25(“APB 25”),Accounting for
Stock Issued to Employees.”





Under FAS
123R, the Company values its stock options issued based upon the Black-Scholes
option pricing model and recognizes the compensationover the period in which
the options vest.  There are inherent estimates made by management
regarding the calculation of stock option expense, including volatility,
expected life and forfeiture rate (see Note 10 – “Shareholders’ Equity – Stock
Incentive Plan”).





As of the
adoption of FAS 123R, the Company began recognizing compensation expense for
options that vest over time using the straight-line attribution
approach.  For time-based options issued prior to the adoption of FAS
123R, the Company continues to use the graded attribution approach. For
performance based options issued to third parties, compensation expense is
determined at each reporting date in accordance with the fair value method
prescribed by the provisions of Emerging Issues Task Force Issue No. 96-18,
Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services (“EITF 96-18”). Until the
measurement date is reached, the total amount of compensation expense remains
uncertain. Compensation expense is recorded based on the fair value of the award
at the reporting date and then revalued, or the total compensation is
recalculated, based on the current fair value at each subsequent reporting
date.





F -
9




Warrants:The Company evaluates its outstanding warrants at issuance and at each
quarter-end using the guidance set forth in Emerging Issues Task Force (“EITF”)
No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company’s Own Stock” (“EITF No. 00-19”).  In
evaluating the classification of the warrants under EITF 00-19 and the related
registration rights, the Company also considers the guidance of Financial
Accounting Standards Board (“FASB”) Staff Position No. 00-19-02, “Accounting for
Registration Payment Arrangements.”





As a
result of its evaluation and analysis, management determined that its warrants
should be classified as equity instruments in the accompanying consolidated
balance sheets.





Fair Value of
Financial Instruments.  On January 1,
2008, the Company adopted SFAS No. 157, “Fair Value Measurements”
(“SFAS No. 157”), for its financial assets and liabilities.
SFAS No. 157 defines fair value, establishes a framework for
measuring fair value and expands disclosures about fair value measurements.
SFAS No. 157 defines fair value as “the price that would be received
to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.” SFAS No. 157
further defines a fair value hierarchy for measurement and disclosure of the
fair value for financial instruments, as follows: Level 1 inputs as quoted
prices in active markets for identical assets or liabilities; Level 2
inputs as observable inputs other than Level 1 prices, such as quoted
market prices for similar assets or liabilities or other inputs that are
observable or can be corroborated by market data; and Level 3 inputs as
unobservable inputs that are supported by little or no market activity and that
are financial instruments whose value is determined using pricing models or
instruments for which the determination of fair value requires significant
management judgment or estimation.





On
October 10, 2008, the FASB issued FSP No. FAS 157-3, “Determining the Fair Value
of a Financial Asset When the Market for That Asset Is Not Active” (“FSP
157-3”). FSP 157-3 was effective upon issuance, including prior periods for
which financial statements had not been issued.  FSP 157-3 amended FAS
157 by providing an illustrative example to demonstrate how fair value should be
determined when the market for that financial asset is not
active.  The adoption of FSP 157-3 did not have any effect on the
Company’s results of operations, financial condition, or cash
flows.





The fair
value of financial assets and liabilities is determined at each balance sheet
date and future declines in market conditions, the future performance of the
underlying investments or new information could affect the recorded values of
the Company’s investments.





Reclassifications:
Certain reclassifications of previously reported balances have been made to
conform with the current presentation. These reclassifications primarily relate
to the presentation of depreciation and share-based compensation expense on the
accompanying consolidated statements of operations. Such reclassifications had
no impact on previously reported net loss or shareholders’ equity.




Recent
Accounting Pronouncements





In March
2008, the FASB issued Statement of Financial Accounting Standard
No. 161 (“FAS 161”), Disclosures about Derivative Instruments and
Hedging Activities. FAS 161 improves
financial reporting on derivative instruments and hedging activities by
requiring enhanced disclosures to enable investors to better understand their
effects on an entity’s financial position, financial performance and cash flows.
The new standard is effective for financial statements issued for fiscal years
and interim periods beginning after November 15, 2008.  The
Company is not currently the holder of any derivative instruments; thus,
adoption of FAS 161 would not currently have any effect on the
Company's results of operations, financial condition, or cash
flows.





In May
2008, the FASB issued Statement of Financial Accounting Standard No. 162, The Hierarchy of Generally Accepted
Accounting Principles (“FAS 162”). FAS 162 identifies the sources of
accounting principles and the framework for selecting principles to be used in
the preparation of financial statements that are presented in conformity with
U.S. GAAP. The U.S. GAAP hierarchy was previously set forth in the American
Institute of Certified Public Accountants (“AICPA”) Statement on Auditing
Standards No. 69, The Meaning
of Present Fairly in Conformity With Generally Accepted Accounting
Principles. Though the FASB does not expect a change in current practice,
the Board issued this statement in order for the U.S. GAAP hierarchy to reside
in the accounting literature established by the FASB. FAS 162 is effective 60
days following the SEC’s approval of the Public Company Accounting Oversight
Board amendments to AU Section 411, The Meaning of Present Fairly in
Conformity With Generally Accepted Accounting Principles. Any effect of
applying the provisions of FAS 162 shall be reported as a change in accounting
principle in accordance with Statement of Financial Accounting Standard No. 154,
Accounting Changes and Error
Corrections. The Company does not expect FAS 162 to have a material
impact on its financial statements.





F -
10




In June
2008, the FASB issued FSP No. EITF 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities
(“FSP EITF 03-6-1”). The FASB concluded in this FSP that unvested share-based
payment awards that contain nonforfeitable rights to dividends or dividend
equivalents are participating securities and shall be included in the
calculation of earnings per share pursuant to the two-class method. This FSP is
effective for financial statements issued for fiscal years beginning after
December 15, 2008, requiring all prior-period earnings per share data presented
to be adjusted retrospectively. The Company does not expect FSP EITF 03-6-1 to
have a material impact on its calculation of earnings per share.




In June
2008, the FASB issued EITF 07-05, DeterminingWhether an Instrument (or Embedded
Feature) Is Indexed to an Entity’s Own Stock, (“EITF 07-05”). EITF 07-05
provides guidance on determining what types of instruments or embedded features
in an instrument held by a reporting entity can be considered indexed to its own
stock for the purpose of evaluating the first criteria of the scope exception in
paragraph 11(a) of SFAS 133. EITF 07-05 is effective for financial statements
issued for fiscal years beginning after December 15, 2008 and early
application is not permitted if an entity has previously adopted an alternative
policy. The Company is currently evaluating the effect, if any, of EITF 07-05 on
our financial statements.





In
December 2007, the FASB issued Statement of Financial Accounting Standard
No. 160 (“FAS 160”), Noncontrolling Interest in
Consolidated Financial Statements – an amendment of ARB No. 51. FAS
160 changes reporting standards for noncontrolling interests in a subsidiary.
The standard is effective for fiscal years beginning on or after
December 15, 2008. The Company does not expect the adoption of FAS No. 160
to have a material impact on the Company's results of operations, financial
condition, or cash flows.





In
February 2007, the FASB issued Statement of Financial Accounting Standard No.
159, The Fair Value Option for
Financial Assets and Liabilities (“FAS 159”). FAS 159 provides entities
with the option to report selected financial assets and liabilities at fair
value. Business entities adopting FAS 159 will report unrealized gains and
losses in earnings at each subsequent reporting date on items for which the fair
value option has been elected. The Company elected the fair value option for its
ARS investments as of December 31, 2008 (See Note 2, Investments in Auction Rate
Securities (“ARS”).





Note
2. Investments in Auction Rate
Securities (“ARS”)





The
Company has historically invested its excess cash in ARS, which are interests in
collateralized debt obligations supported by pools of federally backed student
loans. Consistent with the Company’s investment policy, the ARS investments held
by the Company all have AAA/Aaa credit ratings and are backed by The Federal
Family Education Loan Program. The investments are securities with long-term
nominal maturities for which the interest rates were previously reset through
monthly dutch auctions. These auctions also served to provide a short-term
liquid market for these investments until early 2008, when the Company’s ARS
investments began to experience failed auctions.





As of
December 31, 2008, the Company also held a Rights Option issued by UBS Financial
Services, giving the Company the right to put the ARS investments back to UBS at
par for a specified period of time beginning on January 2, 2009  (see
Note 16, Subsequent Events).





As of
December 31, 2008, the Company’s investments in ARS were required to be measured
at fair value on a recurring basis in accordance with FAS 157.  In
addition, the Company utilized the guidance set forth in FSP 157-3 in evaluating
fair value. FSP 157-3 clarified that a fair value measurement should not be
based on a distressed sale or forced liquidation, but instead contemplates an
orderly transaction between market participants even if there is little or no
market activity for the asset at the measurement date.  In evaluating
the fair value of its ARS, Company management reviewed estimates of fair value
prepared by its broker-dealer based on their proprietary valuation models and
management also prepared  its own calculations of fair value based on
current interest rates and the estimated term of the investments underlying its
ARS investment.  Management evaluated the key assumptions being used
by the broker-dealer in its model, as well as other pieces of information
available, including, but not limited to, factors such as tax status, credit
quality, duration, the portfolio composition of The Federal Family Education
Loan Program loans, market interest rates, distressed transactions observed in
secondary markets, and current status of the specific ARS
investments.  Both the broker-dealer’s estimates and management’s
calculation were prepared using level 3 inputs.





F -
11




The
Company also accounted for the Rights Option at fair value, using the fair value
option available under FAS 159.  Because the Rights Option provided
the Company with the unilateral opportunity to put the ARS back to UBS at par
immediately following year-end, the intrinsic value of the Rights Option was
determined to be equal to the difference in the fair value of the ARS and the
par value of the ARS.  The ARS and the Rights Option are presented in
the caption “Investments’” in the accompanying consolidated balance
sheets.





The
Company's assets measured at fair value on a recurring basis subject to the
disclosure requirements of FAS 157 at December 31, 2008, were as
follows:


Fair
      Value Measurements at Reporting Date UsingLevel
      1
                
                
                Level
      2
                
                
                Level
      3Quoted
      Prices
                  in
      Active
                  Markets
      for
                  Identical
      Assets
                
                
                Significant
      Other Observable Inputs
                
                
                Significant
                  Unobservable
                  InputsInvestment
      in auction rate securities
                
                $
                -
                
                
                $
                -
                
                
                $
                3,275,710Investment
      in rights option
                
                
                
                
                
                
                
                
                
                $
                624,290Total
      assets measured at fair value
                
                $
                -
                
                
                $
                -
                
                
                $
                3,900,000


The following table presents
information about the Company's financial assets measured at fair value on a
recurring basis using significant unobservable inputs (Level 3) as defined in
FAS 157:


Level
      3 Auction
                  Rate
      Securities
                
                
                Level
      3 Rights
                  Option
                
                
                Level
      3
                  TotalBalance
      at December 31, 2006
                
                $
                -
                
                
                $
                -
                
                
                $
                -Purchases
      and (sales), net
                
                
                -
                
                
                
                -
                
                
                
                -Transfers
      to Level 3
                
                
                -
                
                
                
                -
                
                
                
                -Included
      in accumulated other comprehensive loss
                
                
                -
                
                
                
                -
                
                
                
                -Balance
      at December 31, 2007
                
                
                -
                
                
                
                -
                
                
                
                -Purchases
      and (sales), net
                
                
                -
                
                
                
                -
                
                
                
                -Transfers
      to Level 3
                
                
                3,275,710
                
                
                
                624,290
                
                
                
                3,900,000Included
      in accumulated other comprehensive loss
                
                
                -
                
                
                
                -
                
                
                
                -Balance
      at December 31, 2008
                
                $
                3,275,710
                
                
                $
                624,290
                
                
                $
                3,900,000


Note
3. Inventory




Inventory
at December 31, 2008 and 2007 consist of the following:




2008
              
              
              2007Raw
      materials and components
              
              $
              1,341,933
              
              
              $
              1,468,194PokerPro
      systems in process
              
              
              611,974
              
              
              
              620,224Finished
      goods
              
              
              1,859,515
              
              
              
              623,505Reserve
              
              
              (266,323
              )
              
              
              (69,442
              )Inventory,
      net
              
              $
              3,547,099
              
              
              $
              2,642,481
  F -
12




Note
4. Prepaid Expenses and Other Assets





Prepaid
expenses and other assets at December 31, 2008 and 2007 consist of the
following:




2008
              
              
              2007Prepaid
      expenses
              
              $
              162,249
              
              
              $
              252,418Other
              
              
              50,973
              
              
              
              78,781Prepaid
      expenses and other assets
              
              $
              213,222
              
              
              $
              331,199Deferred
      licensing fees, net
              
              $
              488,280
              
              
              $
              329,229Other
              
              
              53,934
              
              
              
              47,800Other
      assets
              
              $
              542,214
              
              
              $
              377,029





Note
5.  PokerPro Systems





PokerPro
systems at December 31, 2008 and 2007 consist of the
following:





2008
              
              
              2007PokerPro
      systems
              
              $
              8,217,515
              
              
              $
              6,837,941Temporarily
      idle PokerPro systems (a)
              
              
              531,899
              
              
              
              501,7018,749,414
              
              
              
              7,339,642Less:
      accumulated depreciation (a)
              
              
              (4,928,038
              )
              
              
              (2,348,008
              )PokerPro
      systems, net
              
              $
              3,821,376
              
              
              $
              4,991,634





(a)
The systems will be redeployed as scheduling allows.  Included in the
December 31, 2008 and December 31, 2007 accumulated depreciation is $272,799 and
$206,178, respectively, related to the temporarily idle PokerPro
systems.





Note
6. Property and Equipment





Property
and equipment at December 31, 2008 and 2007 consist of the
following:




2008
              
              
              2007Equipment
              
              $
              722,027
              
              
              $
              673,188Leasehold
      improvements
              
              
              189,917
              
              
              
              189,157Capitalized
      software
              
              
              155,387
              
              
              
              -1,067,331
              
              
              
              862,345Less:
      accumulated depreciation
              
              
              (467,559
              )
              
              
              (257,299
              )Property
      and equipment, net
              
              $
              599,772
              
              
              $
              605,046





Capitalized software consists of
purchased software, consulting and capitalized internal costs related to the
purchase and implementation of a new internal-use enterprise resource
management system. Accumulated depreciation on capitalized software at
December 31, 2008 was $8,668. The software portion of this systems
investment was financed through a capital lease obligation (see Note 8,
Debt).





F -
13





Note
7. Accrued Liabilities





Accrued
liabilities at December 31, 2008 and 2007 consist of the
following:




2008
              
              
              2007Deferred
      revenue
              
              $
              194,051
              
              
              $
              399,900Accrued
      professional fees
              
              
              117,167
              
              
              
              334,731Other
              
              
              742,012
              
              
              
              229,542Accrued
      liabilities
              
              $
              1,053,230
              
              
              $
              964,173





Note
8. Debt





The
Company’s outstanding debt balances as of December 31, 2008 and December 31,
2007 consist of the following:




2008
              
              
              2007SVB
      Credit Facility
              
              $
              -
              
              
              $
              -UBS
      Credit Facility
              
              
              2,865,357
              
              
              
              -Founders'
      Loan
              
              
              2,000,000
              
              
              
              -Capital
      lease obligation
              
              
              62,539
              
              
              
              -Total
      debt
              
              $
              4,927,896
              
              
              $
              -Current
      portion of debt
              
              
              2,889,261
              
              
              
              -Long-term
      portion of debt
              
              $
              2,038,635
              
              
              $
              -





SVB Credit
Facility:On July 25, 2008, the Company entered into a credit
facility with Silicon Valley Bank to support the Company’s working capital (the
“SVB Credit Facility”).  The SVB Credit Facility is nominally denoted
as a $5.0 million facility with an actual maximum availability that varies based
on specified percentages of domestic and foreign accounts receivable and
inventory.  Based on the Company’s accounts receivable and inventory
levels on December 31, 2008, as of such date availability under the SVB Credit
Facility was approximately $1.6 million, with no borrowings
outstanding.  The SVB Credit Facility has a one-year term and bears
interest at an annual rate of prime plus 2.0%.  The SVB Credit
Facility includes covenants requiring the achievement of specified financial
ratios and thresholds and contains other terms and conditions customary for this
type of credit facility.  As of December 31, 2008, the Company was in
compliance with these covenants. The SVB Credit Facility is collateralized by
security interests in substantially all of the assets of the Company, except for
the Company's investments in ARS.





UBS Credit
Facility:On August 13, 2008, the Company entered into a Credit Line
Agreement (the “Line of Credit”) with UBS Bank USA for a demand revolving line
of credit with respect to the Company’s ARS held in an account with
UBS.   Advances under the Line of Credit, to be made at the sole
discretion of UBS Bank USA at up to 80% of the value of the Company’s ARS, bear
interest at LIBOR plus 1%.  At December 31, 2008 there was
approximately $2.9 million available under the Line of Credit, of which $2.9
million of borrowings were outstanding.  The Line of Credit replaced
the $1,000,000 loan made by UBS to the Company under the terms of a March 19,
2008 Client’s Agreement between the Company and UBS. The UBS Credit Facility is
collateralized by the Company's investments in ARS.





As of
December 31, 2008, the carrying value of the UBS Credit Facility approximated
its fair value.





F -
14





Founders’ Loan:On March 24, 2008, the Company entered into a loan agreement with Lyle A.
Berman, James T. Crawford III, Arthur Lee Lomax and Gehrig H. “Lou”
White.  Messrs. Crawford, Lomax and White are the founders of the
Company.  Each of the lenders are also members of our board of
directors, with Mr. Berman serving as Chairman and Mr. White serving as Vice
Chairman.   Upon closing, the lenders loaned the Company $2.0
million and the Company issued the lenders a promissory note in the principal
amount of $2.0 million. The loan bears interest at 13% with all unpaid principal
and interest payable on March 24, 2010.  The Company intends to pay
interest on a monthly basis and the loan may be repaid prior to maturity without
penalty.  The loan contains no restrictive covenants and is
collateralized by security interests in the Company’s PokerPro systems deployed
in North America and on cruise ships as of December 31, 2007.





As of
December 31, 2008, the carrying value of the Founders’ Loan was $2.0 million and
its fair value was approximately $1.9 million.





Capital Lease
Obligation:  During 2008, the Company entered into capital
lease obligations totaling $73,273 to finance the purchase of a new internal-use
ERP system. These capital lease obligations bear interest at an annual rate of
9.4% and have a term of 36 months, resulting in monthly payments of
$2,396.  At the end of the lease term, the Company has the option to
purchase the software for $101.





Note
9. Employee Benefit Plan




The
Company has established a salary deferral plan under Section 401(k) of the
Internal Revenue Code covering substantially all employees. The plan allows
eligible employees to defer 3% to 5% of their annual compensation. The Company
matches the contributions equal to 100% on the first 3% of the deferral and 50%
on the deferral from 3% to 5%. For the years ended December 31, 2008,
2007 and 2006 the Company’s contributions were $134,478, $110,473 and
$49,150, respectively.





Note
10. Shareholders’ Equity




Common
and Preferred Stock





Common
Stock: There are 100,000,000 authorized shares of the Company’s common
stock of which 11,021,429 and 10,934,464 were outstanding as of December 31,
2008 and December 31, 2007, respectively.





On April
23, 2007, the Company entered into a Securities Purchase Agreement, pursuant to
which the Company issued and sold an aggregate of 1,444,444 shares of common
stock in a private placement to certain investors for a purchase price of $9.00
per share.  The private placement, which was completed on April 26,
2007, resulted in gross proceeds of approximately $13.0 million and net proceeds
of approximately $12.5 million after fees and expenses associated with the
private placement including a cash placement agent fee.





Preferred Stock:There are 5,000,000 authorized shares of preferred stock, none of which
are outstanding as of December 31, 2008 and December 31, 2007.




Warrants





As part
of the initial public offering, the Company issued to the underwriter, for a
purchase price of $50.00, a warrant (the “Underwriter’s Warrant”) to purchase up
to 200,000 shares of common stock. The Underwriter’s Warrant is exercisable at a
price of $17.60 per share for a period of four years. The Underwriter’s Warrant
contains customary anti-dilution provisions and certain demand and participatory
registration rights. The Underwriter’s Warrant also includes a “cashless”
exercise provision entitling the Underwriter to convert the Underwriter’s
Warrant into shares of the Company’s common stock. The fair value of the
Underwriter’s Warrant was computed at the time of issue and was
nominal.





As part
of the April 2007 private placement, the Company issued each Investor a warrant
(the “Warrants”) to acquire additional shares of the Company’s common stock
(together, the “Warrant Shares”).  The Warrants, which expire on April
26, 2012, were convertible into an aggregate of 505,555 Warrant Shares at an
exercise price of $10.80 per Warrant Share. The Warrants contain customary
anti-dilution provisions and certain demand and participatory registration
rights. The Warrants also include a “cashless” exercise provision entitling the
Investors to convert the Warrants into shares of the Company’s common
stock.





On
November 24, 2008, the Company entered into agreements (the “Warrant
Modification Agreements”) with each of the holders of the Warrants.Pursuant to the Warrant
Modification Agreements, the Company and each of the Warrant holders agreed to
amend the Warrants so that (1) the Original Exercise Price would be reduced to
$0.50 per share (the “New Exercise Price”), and (2) the proportionate
anti-dilution adjustment to increase the number of shares of the Company’s
common stock issuable upon exercise of the Warrants under certain circumstances
would be eliminated in all cases except upon payment of stock dividends, or
subdivision or combination of shares (such as through stock splits or reverse
stock splits).  While the New Exercise Price is considerably below the
Company’s trading price generally over the last eighteen months, the Company
determined that such a negotiated reduction was appropriate in order to
obtain each Warrant holder’s agreement to eliminate the Proportionate Share
Increase under most circumstances. Accordingly, the New Exercise Price was
reached through independent negotiation with the holders of the Warrants in
consideration of the elimination of the Proportionate Share Increase and not in
any manner as an indication of the perceived value of the Company’s common
stock.





F -
15




Following
the modification of the Warrants, one of the parties redeemed 131,885 Warrants
and elected to receive Common Shares using the cashless exercise provision,
resulting in the issuance of 86,965 shares of common stock, and reducing the
number of Warrants outstanding to 373,670 as of December 31, 2008.





Stock
Incentive Plans





In 2004, the Company’s Board of
Directors approved the 2004 Stock Incentive Plan (the “2004 Plan”), which
provided for the issuance of up to 825,000 shares of common stock. On July 29,
2005, the Company adopted the 2005 Stock Incentive Plan (the “2005 Plan”). The
2005 Plan authorized the issuance of up to (i) 800,000 shares of common stock,
plus (ii) any shares remaining available for issuance as of the effective date
of the 2005 Plan under any prior plan, plus (iii) any shares of common stock
subject to an award granted under a prior plan, in which the award was
forfeited, cancelled, terminated, expired or lapsed for any reason without the
issuance of shares.  On May 23, 2007 the Company adopted the 2007
Stock Incentive Plan (the “2007 Plan”), which authorized the issuance of up to
(i) 500,000 shares of common stock, plus (ii) any shares remaining available for
issuance as of the effective date of the 2007 Plan under any prior plan, plus
(iii) any shares of common stock subject to an award granted under a prior plan,
in which the award was forfeited, cancelled, terminated, expired or lapsed for
any reason without the issuance of shares.





The fair value of each option award
is estimated on the date of grant using the Black-Scholes option pricing model.
Options granted under the plans generally vest over periods ranging from date of
grant to four years and expire in ten years. Principal assumptions are as
follows: (a) expected future volatility for the Company's stock price is based
on a combination of the Company’s historical volatility and observed volatility
rates of other companies in the gaming industry, (b) expected term is based on
historical exercise data and forfeitures, (c) the forfeiture rate is derived
from an expectation of future forfeitures and (d) the risk-free rate is the rate
on U.S. Treasury securities with a maturity equal to, or closest to, the
expected life of the options.





At
December 31, 2008 and December 31, 2007, options to purchase 2,023,263 and
2,034,825 shares of common stock, respectively, were outstanding and held by
certain directors, officers, employees and independent contractors of the
Company. The amount of related expense calculated using the Black-Scholes option
pricing model and recognized in 2008, 2007 and 2006 was $1,106,113, $822,349 and
$813,316, respectively.




2008
              
              2007
              
              2006Expected
      Volatility
              45%
      - 111%
              
              45%
              
              30%
      - 45%Expected
      Dividends
              0%
              
              0%
              
              0%Expected
      Term
              6
      yrs
              
              5 -
      6 yrs
              
              5
      yrsRisk-free
      Rate
              1.52%
      - 3.49%
              
              3.49%
      - 4.92%
              
              4.59%
      - 5.1%




A summary
of option activity and changes during the year for the year ended December 31,
2008 is as follows:




Weighted
      AverageShares
                          
                          
                          Exercise
                            Price
                          
                          
                          Remaining
      Contractual
                            Term
                          
                          
                          Aggregate
                            Intrinsic
                            ValueOutstanding
      at January 1, 2008
                          
                          
                          2,034,825
                          
                          
                          $
                          8.42Granted
                          
                          
                          110,000
                          
                          
                          
                          3.74Exercised
                          
                          
                          -
                          
                          
                          
                          -Forfeited
                          
                          
                          (121,562
                          )
                          
                          
                          10.27Expired
                          
                          
                          -
                          
                          
                          
                          -Outstanding
      at December 31, 2008
                          
                          
                          2,023,263
                          
                          
                          $
                          8.06
                          
                          
                          
                          7.4
                          
                          
                          $
                          (13,670,489
                          )Exercisable
      at December 31, 2008
                          
                          
                          1,227,800
                          
                          
                          $
                          7.06
                          
                          
                          
                          6.8
                          
                          
                          $
                          (7,069,246
                          )




F -
16




The
weighted-average grant-date fair value of options granted during the years 2008,
2007 and 2006 was $1.43, $4.68 and $4.21, respectively. The total intrinsic
value of options exercised during the years ended December 31, 2008, 2007 and
2006 were $0, $114,138 and $46,920, respectively.





A summary
of the status of non-vested shares as of December 31, 2008, and changes during
the year ended December 31, 2008 is presented below:




Shares
              
              
              Weighted
                Average
                Grant
      Date
                Fair
      ValueBalance
      at January 1, 2008
              
              
              1,227,210
              
              
              $
              3.51Granted
              
              
              110,000
              
              
              
              1.43Forfeited
              
              
              (95,000
              )
              
              
              4.00Vested
              
              
              (446,748
              )
              
              
              2.87Balance
      at December 31, 2008
              
              
              795,462
              
              
              $
              3.52





As of
December 31, 2008, there was $2,397,865 of total unrecognized compensation cost
related to non-vested options.  This cost is expected to be recognized
over a weighted-average period of 27.9 months.





The total
fair value of options vested during the years ended December 31, 2008, 2007 and
2006 was $1,197,370, $912,879 and $441,417, respectively.





Note
11. Income Taxes




The total
income tax expense (benefit) provided on pretax income and its significant
components were as follows:




2008
                
                
                2007
                
                
                2006Current
      tax expense:Federal
                
                $
                -
                
                
                $
                -
                
                
                $
                -State
                
                
                -
                
                
                
                -
                
                
                
                -Foreign
                
                
                262,905
                
                
                
                -
                
                
                
                -262,905
                
                
                
                -
                
                
                
                -Deferred
      tax expense (benefit):Federal
                
                
                -
                
                
                
                -
                
                
                
                -State
                
                
                -
                
                
                
                -
                
                
                
                -Foreign
                
                
                -
                
                
                
                -
                
                
                
                --
                
                
                
                -
                
                
                
                -Total
      income tax expense (benefit):Federal
                
                
                -
                
                
                
                -
                
                
                
                -State
                
                
                -
                
                
                
                -
                
                
                
                -Foreign
                
                
                262,905
                
                
                
                -
                
                
                
                -$
                262,905
                
                
                $
                -
                
                
                $
                -
  F -
17


A
reconciliation of the statutory federal income tax expense (benefit) at 34% to
loss before income taxes and the actual income tax expense (benefit) is as
follows:




2008
                
                
                2007
                
                
                2006Federal
      statutory income tax benefit
                
                $
                (2,507,795
                )
                
                $
                (4,368,870
                )
                
                $
                (3,109,544
                )Increases
      (reductions) in taxes due to:Nondeductible
      stock-based compensation
                
                
                357,614
                
                
                
                230,415
                
                
                
                226,401State
      taxes, net of federal benefit
                
                
                (59,450
                )
                
                
                (220,264
                )
                
                
                (266,537
                )Research
      & experimentation credits
                
                
                -
                
                
                
                (73,171
                )
                
                
                (237,448
                )Increase
      in valuation allowance
                
                
                2,102,751
                
                
                
                4,234,797
                
                
                
                3,319,063FIN
      48 and other
                
                
                106,880
                
                
                
                202,115
                
                
                
                18,776Prior
      year true-up
                
                
                -
                
                
                
                (5,022
                )
                
                
                49,289Foreign
      income tax
                
                
                262,905
                
                
                
                -
                
                
                
                -Income
      tax expense
                
                $
                262,905
                
                
                $
                -
                
                
                $
                -





Deferred
income taxes result from temporary differences between the reporting of amounts
for financial statement purposes and income tax purposes.  The net
deferred tax assets and liabilities included in the consolidated financial
statements include the following amounts:




2008
                
                
                2007Deferred
      tax asset:Start-up
      costs capitalization
                
                $
                137,681
                
                
                $
                157,100Loss
      carryforwards
                
                
                8,964,573
                
                
                
                8,539,053Depreciation
                
                
                1,733,491
                
                
                
                205,109Tax
      credit carryforwards
                
                
                286,244
                
                
                
                225,135Share-based
      compensation expense
                
                
                156,904
                
                
                
                139,134Inventory
                
                
                32,094
                
                
                
                19,485Other
                
                
                30,430
                
                
                
                9,01911,341,417
                
                
                
                9,294,035Deferred
      tax liability:Accounts
      receivable
                
                
                (31,045
                )
                
                
                (62,810
                )Prepaid
      expenses
                
                
                (40,413
                )
                
                
                (64,017
                )(71,458
                )
                
                
                (126,827
                )11,269,959
                
                
                
                9,167,208Less
      valuation allowance
                
                
                (11,269,959
                )
                
                
                (9,167,208
                )Net
      deferred tax asset
                
                $
                -
                
                
                $
                -





As of
December 31, 2008 and December 31, 2007, the Company has federal net operating
loss carryforwards of approximately $24,427,000 and $19,330,000, respectively,
North Carolina net economic loss carryforwards of approximately $11,311,000 and
$9,588,000, respectively, California net operating losses in the amounts of
approximately $431,000 and $330,000, respectively, and Canadian net operating
losses in the amounts of $32,000 and zero, respectively. Included in the
federal net operating loss carryforward is a deduction for the exercise of
nonqualified stock options. However, the net operating loss attributable to the
excess of the tax deduction for the exercised nonqualified stock options over
the cumulative deduction recorded pursuant to FAS 123R in the consolidated
financial statements is not recorded as a deferred tax asset. The benefit of the
excess deduction of $37,000 will be recorded to additional paid in capital when
the Company realizes a reduction in its current taxes payable. These
carryforwards can be used to offset taxable income in future years, which expire
through 2028. The Company also has research and experimentation tax credit
carryforwards for both federal and North Carolina of approximately $538,000 and
$35,000, respectively. These credit carryforwards may be used to offset both
federal and North Carolina income taxes in future years through their expiration
in 2027.





The
Company records a valuation allowance when it is more likely than not that some
portion or all of the deferred tax assets will not be realized. The Company has
assessed its earnings history and anticipated earnings, the expiration date of
the carryforwards and other factors and has determined that valuation allowances
should be established against the deferred tax assets as of December 31, 2008
and 2007.  The change in the valuation allowance of $2,102,751 for the year
ended December 31, 2008 was due to the increase in net deferred tax assets,
principally driven by increases in deferred tax assets related to depreciation
of PokerPro systems, and loss carryforwards.





F -
18




FIN
48





The
Company adopted the provisions of Statement of Financial Accounting Standards
Board Interpretation No. 48, Accounting for Uncertainty in Income
Taxes,an interpretation of SFAS 109 (“FIN 48”), on January 1, 2007. As a
result of the adoption of FIN 48, the Company recognized an $118,725 decrease in
the deferred tax assets for the unrecognized income tax benefits that existed at
December 31, 2006. The amount was fully offset by a valuation allowance. 
As such, this decrease had no impact on retained earnings in accordance with FIN
48.  At the adoption date, the Company had $118,725 of unrecognized
tax benefits, all of which would affect the effective tax rate if recognized,
without consideration of the related valuation allowance previously recorded.
The Company did not recognize any adjustment to reserves for uncertain tax
positions as a result of the related implementation of FIN 48.





During
2007 and 2008, following adoption of FIN 48, the Company recognized decreases in
the deferred tax asset for the unrecognized tax benefits related to tax
positions taken in the current period.  As a result, as of December 31,
2008, the Company’s unrecognized tax benefits increased to $537,706. The
increase in unrecognized tax benefits related to tax positions from prior
periods resulted from a change in management’s assessment that its tax positions
would be more likely than not to be sustained.  The change in the Company’s
unrecognized tax benefits was fully offset by changes to the valuation allowance
attributable to the related deferred tax assets. Accordingly, there was no
impact on the tax provision, or on net loss.





The
Company's policy is to include interest and penalties recognized in accordance
with FIN 48 in the consolidated financial statements as a component of income
tax expense. However, the unrecognized tax benefits at December 31, 2007 would
not result in any interest or penalties to date as the amounts did not result in
a reduction of income taxes previously payable by the Company.





The
following table summarizes the changes to the amount of unrecognized tax
benefits for the years ended December 31, 2008 and 2007:




2008
                
                
                2007Unrecognized
      tax benefits at January 1
                
                $
                191,896
                
                
                $
                118,725Gross
      increases—tax positions in prior period
                
                
                191,896
                
                
                
                -Gross
      decreases—tax positions in prior period
                
                
                -
                
                
                
                -Gross
      increases—tax positions in current period
                
                
                153,914
                
                
                
                73,171Gross
      decreases—tax positions in current period
                
                
                -
                
                
                
                -Settlements
                
                
                -
                
                
                
                -Unrecognized
      tax benefits at December 31
                
                $
                537,706
                
                
                $
                191,896





The
Company files U.S. federal, U.S. state and Canadian tax returns. 2004 through
2008 tax years remain subject to examination by the IRS for U.S. federal tax
purposes, as do U.S. state tax returns by the appropriate state taxing
authorities and the Canadian tax returns by Revenue Canada.





Note
12.  Related Party Transactions




Transactions
with Aristocrat





During
2006, Aristocrat International Pty. Limited and its affiliates (“Aristocrat”)
purchased shares of the Company’s common stock.  Aristocrat is a
wholly owned subsidiary and affiliate of Aristocrat Leisure Limited, a leading
global provider of gaming solutions that focuses primarily on video slot
machines, progressive systems and casino management systems.  As of
December 31, 2008 and December 31, 2007 Aristocrat owned 16.4% and
16.5%, respectively, of shares of the Company’s common stock.





F -
19




The
Company’s distribution agreement provides Aristocrat with the sole and exclusive
right to globally (excluding the United States and Canada) distribute, market,
enter into license agreements and, under certain circumstances, manufacture the
PokerPro system.  Aristocrat purchases PokerPro systems manufactured
by the Company and pays the Company a portion of the license fees received from
each customer in connection with Aristocrat’s licensing of the PokerPro
system.  License fees and equipment sales to Aristocrat of $608,724
and $3,777,862, respectively, were recorded in 2008, while $388,611 and
$1,337,342, respectively, were recorded during 2007. As of December
31, 2008, accounts receivable balances totaling $114,053 were due from
Aristocrat and included in the accompanying Consolidated Balance
Sheets.





Office
Lease





The
Company currently leases its office and manufacturing facility from an entity
owned and controlled by the Company’s President and Vice Chairman of the Board
of Directors.  The entity purchased the building while the Company was
already a tenant.  The lease terms were negotiated and are consistent
with the rent paid by other tenants in the building.  Rent expense
recorded for the leased space for the year ended December 31, 2008, 2007,
and 2006 was $219,600, $160,766, and $147,090, respectively, of which $45,490
was paid to the related party during 2006.





Founders’
Loan





On
March 24, 2008, the Company entered into a loan agreement with Lyle A. Berman,
James T. Crawford III, Arthur Lee Lomax and Gehrig H. “Lou”
White.  Messrs. Crawford, Lomax and White are the founders of the
Company.  Each of the lenders are also members of our board of
directors, with Mr. Berman serving as Chairman and Mr. White serving as Vice
Chairman.  Upon closing, the lenders loaned the Company $2.0 million
and the Company issued the lenders a promissory note in the principal amount of
$2.0 million.  The loan bears interest at 13% with all unpaid
principal and interest payable on March 24, 2010.  The Company intends
to pay interest on a monthly basis and the loan may be repaid prior to maturity
without penalty.  The loan contains no restrictive covenants and is
collateralized by security interests in the Company’s PokerPro systems deployed
in North America and on cruise ships as of December 31, 2007.  During
2008, the Company made $176,477 in aggregate interest payments and $0 in
aggregate principal payments.




Note
13. Commitments and Contingencies





Leases





The
Company leases its corporate office and manufacturing facility under a
lease agreement with a term of 4 years. The lease requires the Company to pay
property taxes, insurance and maintenance. This facility is approximately 21,600
square feet and is located in Matthews, North Carolina. This facility is
leased by an entity owned and controlled by the Company’s President and Vice
Chairman of the Board of Directors (see Note 10 – “Related Party
Transactions”).





The
Company also leases certain equipment under lease agreements with terms up to 3
years and a storage facility with a one-year term.





The
following is a schedule by year of the future minimum lease payments due under
agreements with terms extending beyond one year:




Year Ending December 31,
                
                Amount2009
                
                $
                258,7292010
                
                
                232,1342011
                
                
                146,400Thereafter
                
                
                -$
                637,263





Rent
expense for the years ended December 31, 2008, 2007 and 2006 was $261,688,
$192,636 and $151,809, respectively.




F -
20





Employment
Agreements





The
Company has entered into employment agreements with certain officers that
include commitments related to base salaries and certain benefits. These
agreements have terms of two years.





Reviews
and Audits by Regulatory Authorities





The
Company’s operations are subject to a number of regulatory authorities,
including various gaming regulators, the Internal Revenue Service, and other
state and local authorities.  From time to time, the Company is notified by
such authorities of reviews or audits they wish to conduct.  To date,
reviews have been resolved with minimal, if any, financial impact to the
Company.  The state of North Carolina is currently performing a routine
sales and use tax audit covering periods from 2004 through 2007.  The
Company may be subject to other income, property, sales and use, or franchise
tax audits in the normal course of business.  The Company believes it has
complied with relevant regulations, and based on facts presently known, does not
believe the outcome of the current audit will have a material adverse effect on
the Company’s financial condition or results of operations.





Indemnification





The
Company maintains directors’ and officers’ liability insurance for the benefit
of its directors and certain of its officers. The Company has entered into a
separate indemnification agreement with Lyle Berman, the Chairman of the Board
of Directors, which provides for indemnification for related expenses including
attorneys’ fees, judgments, fines and settlement amounts incurred by Mr. Berman
in any action or proceeding.





The
Company also indemnifies its casino customers from any claims or suits brought
by a third party alleging infringement of a United States patent, copyright or
mask work right.  The Company agrees to pay all costs and damages,
provided the customer provides prompt written notice of any claim.





Legal
Proceedings





The
Company is subject to claims and assertions in the ordinary course of
business.  Legal matters are inherently unpredictable and the
Company’s assessments may change based on future unknown or unexpected
events.





Tellis:  On
February 5, 2007, Tellis Software, Inc. (“Tellis”) filed a Complaint against the
Company and Gehrig “Lou” White, the Company’s Vice Chairman of the Board of
Directors and former Chief Executive Officer, in the United States District
Court for the Southern District of Texas.  The Complaint alleged that
the Company breached a Software Development Agreement (the “Development
Agreement”), that the Company and Mr. White committed fraud in connection with
the Development Agreement and that the Company had been unjustly enriched and/or
that Tellis was entitled to a quantum merit
recovery.  As to all counts, Tellis sought damages equivalent to a 2%
equity interest in the Company and bonuses of up to $730,000, plus attorneys’
fees, costs, and interest.  For the fraud count, Tellis also sought
unspecified exemplary damages.





In
December 2007, the parties settled the lawsuit, which was withdrawn with
prejudice.





Lightning
PokerTM: On August 2, 2006, the Company was served with a complaint filed
on July 25, 2006, in the United States District Court for the Eastern District
of Pennsylvania, by Pokermatic, Incorporated, d/b/a Lightning
Poker.  The complaint alleged antitrust violations, unfair
competition, civil conspiracy, trade slander, tortious interference and
defamation, and sought a declaration of non-infringement of the Company’s design
patent. The complaint sought treble damages, attorneys' fees and declaratory and
injunctive relief.





On August
17, 2006, the Company asked the United States District Court in Philadelphia,
Pennsylvania to dismiss the case or transfer venue and to award costs and
attorneys’ fees. On September 27, 2006, the judge granted the Company’s request
regarding improper venue and ordered the casetransferred
to the United States District Court for the Western District of North
Carolina.The case
arrived in United States District Court for the Western District of North
Carolina on or about November 8, 2006.





On
November 16, 2006, the case was dismissed without prejudice.





On March
17, 2008, the Company was served with a complaint filed on March 6, 2008, in the
United States District Court for the District of New Jersey by Lightning Gaming,
Inc. and Lightning Poker, Inc. The complaint alleges that the Company infringes
United States Patent No. 7,306,516, owned by Lightning Poker, Inc. The complaint
is seeking unspecified monetary damages from the Company as well as a permanent
injunction enjoining the Company from infringing the patent or unfairly
competing with the plaintiffs.  The Company believes that either its
products do not violate the patent that forms the basis of the lawsuit, that the
patent is invalid, or both.





F -
21




On
October 16, 2008, the Company announced that it had reached a mutually agreeable
settlement of all outstanding litigation with Lightning Gaming, Inc. The
settlement resulted in all lawsuits between the parties being withdrawn with
prejudice, including Lightning Gaming, Inc.’s lawsuit alleging patent
infringement filed in Federal District Court in New Jersey.





There was
no material financial impact to the Company as a result of the
settlement.





Note
14. Summarized Quarterly Financial Information (Unaudited)





2008Q1
                  
                  
                  
                  Q2
                  
                  
                  
                  Q3
                  
                  
                  
                  Q4
                  
                  
                  TotalRevenue:License
      and service fees
                  
                  $
                  1,521,676
                  
                  
                  $
                  1,420,263
                  
                  
                  $
                  1,521,341
                  
                  
                  $
                  1,891,701
                  
                  
                  $
                  6,354,981Product
      sales
                  
                  
                  1,679,822
                  
                  
                  
                  2,419,827
                  
                  
                  
                  2,772,144
                  
                  
                  
                  1,197,950
                  
                  
                  
                  8,069,743Total
      revenue
                  
                  
                  3,201,498
                  
                  
                  
                  3,840,090
                  
                  
                  
                  4,293,485
                  
                  
                  
                  3,089,651
                  
                  
                  
                  14,424,724Direct
      cost of revenue:Depreciation
      of PokerPro systems
                  
                  
                  567,995
                  
                  
                  
                  658,583
                  
                  
                  
                  676,135
                  
                  
                  
                  680,252
                  
                  
                  
                  2,582,965Cost
      of product sales
                  
                  
                  1,228,933
                  
                  
                  
                  1,724,940
                  
                  
                  
                  2,088,570
                  
                  
                  
                  1,032,860
                  
                  
                  
                  6,075,303Total
      direct cost of revenue
                  
                  
                  1,796,928
                  
                  
                  
                  2,383,523
                  
                  
                  
                  2,764,705
                  
                  
                  
                  1,713,112
                  
                  
                  
                  8,658,268Operating
      Expenses:Selling,
      general and administrative
                  
                  
                  2,395,116
                  
                  
                  
                  2,303,225
                  
                  
                  
                  2,132,956
                  
                  
                  
                  2,133,826
                  
                  
                  
                  8,965,123Research
      and development
                  
                  
                  866,340
                  
                  
                  
                  666,228
                  
                  
                  
                  603,845
                  
                  
                  
                  630,130
                  
                  
                  
                  2,766,543Share-based
      compensation expense
                  
                  
                  295,828
                  
                  
                  
                  227,804
                  
                  
                  
                  368,553
                  
                  
                  
                  213,928
                  
                  
                  
                  1,106,113Depreciation
                  
                  
                  49,463
                  
                  
                  
                  50,522
                  
                  
                  
                  50,735
                  
                  
                  
                  59,540
                  
                  
                  
                  210,260Total
      operating expenses
                  
                  
                  3,606,747
                  
                  
                  
                  3,247,779
                  
                  
                  
                  3,156,089
                  
                  
                  
                  3,037,424
                  
                  
                  
                  13,048,039Operating
      loss
                  
                  
                  (2,202,177
                  )
                  
                  
                  (1,791,212
                  )
                  
                  
                  (1,627,309
                  )
                  
                  
                  (1,660,885
                  )
                  
                  
                  (7,281,583
                  )Interest
      income (expense), net
                  
                  
                  65,855
                  
                  
                  
                  (39,357
                  )
                  
                  
                  (50,576
                  )
                  
                  
                  (70,207
                  )
                  
                  
                  (94,285
                  )Net
      loss before income taxes
                  
                  
                  (2,136,322
                  )
                  
                  
                  (1,830,569
                  )
                  
                  
                  (1,677,885
                  )
                  
                  
                  (1,731,092
                  )
                  
                  
                  (7,375,868
                  )Income
      tax provision
                  
                  
                  -
                  
                  
                  
                  (123,473
                  )
                  
                  
                  (75,150
                  )
                  
                  
                  (64,282
                  )
                  
                  
                  (262,905
                  )Net
      loss
                  
                  $
                  (2,136,322
                  )
                  
                  $
                  (1,954,042
                  )
                  
                  $
                  (1,753,035
                  )
                  
                  $
                  (1,795,374
                  )
                  
                  $
                  (7,638,773
                  )Net
      loss per common share - basic and diluted
                  
                  $
                  (0.20
                  )
                  
                  $
                  (0.18
                  )
                  
                  $
                  (0.16
                  )
                  
                  $
                  (0.16
                  )
                  
                  $
                  (0.70
                  )Weighted
      average common shares outstanding - basic and diluted
                  
                  
                  10,934,464
                  
                  
                  
                  10,934,464
                  
                  
                  
                  10,934,464
                  
                  
                  
                  10,960,932
                  
                  
                  
                  10,941,117




F -
22
 
  2007Q1
                    
                    
                    
                    Q2
                    
                    
                    
                    Q3
                    
                    
                    
                    Q4
                    
                    
                    TotalRevenue:License
      and service fees
                    
                    $
                    508,111
                    
                    
                    $
                    601,991
                    
                    
                    $
                    621,413
                    
                    
                    $
                    763,193
                    
                    
                    $
                    2,494,708Product
      sales
                    
                    
                    83,465
                    
                    
                    
                    313,705
                    
                    
                    
                    455,439
                    
                    
                    
                    657,374
                    
                    
                    
                    1,509,983Total
      revenue
                    
                    
                    591,576
                    
                    
                    
                    915,696
                    
                    
                    
                    1,076,852
                    
                    
                    
                    1,420,567
                    
                    
                    
                    4,004,691Direct
      cost of revenue:Depreciation
      of PokerPro systems
                    
                    
                    335,003
                    
                    
                    
                    444,874
                    
                    
                    
                    516,739
                    
                    
                    
                    612,012
                    
                    
                    
                    1,908,628Cost
      of product sales
                    
                    
                    73,587
                    
                    
                    
                    243,865
                    
                    
                    
                    379,715
                    
                    
                    
                    640,876
                    
                    
                    
                    1,338,043Total
      direct cost of revenue
                    
                    
                    408,590
                    
                    
                    
                    688,739
                    
                    
                    
                    896,454
                    
                    
                    
                    1,252,888
                    
                    
                    
                    3,246,671Operating
      Expenses:Selling,
      general and administrative
                    
                    
                    1,750,204
                    
                    
                    
                    1,973,595
                    
                    
                    
                    3,134,214
                    
                    
                    
                    2,354,708
                    
                    
                    
                    9,212,721Research
      and development
                    
                    
                    917,288
                    
                    
                    
                    1,049,454
                    
                    
                    
                    1,043,356
                    
                    
                    
                    982,351
                    
                    
                    
                    3,992,449Share-based
      compensation expense
                    
                    
                    202,499
                    
                    
                    
                    160,582
                    
                    
                    
                    224,955
                    
                    
                    
                    234,313
                    
                    
                    
                    822,349Depreciation
                    
                    
                    30,805
                    
                    
                    
                    22,569
                    
                    
                    
                    46,738
                    
                    
                    
                    44,605
                    
                    
                    
                    144,717Total
      operating expenses
                    
                    
                    2,900,796
                    
                    
                    
                    3,206,200
                    
                    
                    
                    4,449,263
                    
                    
                    
                    3,615,977
                    
                    
                    
                    14,172,236Operating
      loss
                    
                    
                    (2,717,810
                    )
                    
                    
                    (2,979,243
                    )
                    
                    
                    (4,268,865
                    )
                    
                    
                    (3,448,298
                    )
                    
                    
                    (13,414,216
                    )Interest
      income, net
                    
                    
                    90,832
                    
                    
                    
                    168,422
                    
                    
                    
                    178,909
                    
                    
                    
                    126,437
                    
                    
                    
                    564,600Net
      loss before income taxes
                    
                    
                    (2,626,978
                    )
                    
                    
                    (2,810,821
                    )
                    
                    
                    (4,089,956
                    )
                    
                    
                    (3,321,861
                    )
                    
                    
                    (12,849,616
                    )Income
      tax provision
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Net
      loss
                    
                    $
                    (2,626,978
                    )
                    
                    $
                    (2,810,821
                    )
                    
                    $
                    (4,089,956
                    )
                    
                    $
                    (3,321,861
                    )
                    
                    $
                    (12,849,616
                    )Net
      loss per common share - basic and diluted
                    
                    $
                    (0.28
                    )
                    
                    $
                    (0.27
                    )
                    
                    $
                    (0.37
                    )
                    
                    $
                    (0.30
                    )
                    
                    $
                    (1.23
                    )Weighted
      average common shares outstanding - basic and diluted
                    
                    
                    9,472,020
                    
                    
                    
                    10,503,810
                    
                    
                    
                    10,920,257
                    
                    
                    
                    10,934,464
                    
                    
                    
                    10,462,912




a)
            Note
      that selling, general and administrative expenses for the third quarter of
      2007 included higher than normal legal expenses, including a $250,000
      accrual for settlement of the Tellis lawsuit discussed in Note
      13.




F -
23


2006Q1
                  
                  
                  
                  Q2
                  
                  
                  
                  Q3
                  
                  
                  
                  Q4
                  
                  
                  TotalRevenue:License
      and service fees
                  
                  $
                  360,000
                  
                  
                  $
                  133,178
                  
                  
                  $
                  135,424
                  
                  
                  $
                  195,384
                  
                  
                  $
                  823,986Product
      sales
                  
                  
                  112,516
                  
                  
                  
                  181,086
                  
                  
                  
                  104,018
                  
                  
                  
                  758,311
                  
                  
                  
                  1,155,931Total
      revenue
                  
                  
                  472,516
                  
                  
                  
                  314,264
                  
                  
                  
                  239,442
                  
                  
                  
                  953,695
                  
                  
                  
                  1,979,917Direct
      cost of revenue:Depreciation
      of PokerPro systems
                  
                  
                  96,079
                  
                  
                  
                  131,029
                  
                  
                  
                  158,710
                  
                  
                  
                  232,839
                  
                  
                  
                  618,657Cost
      of product sales
                  
                  
                  109,688
                  
                  
                  
                  172,613
                  
                  
                  
                  98,153
                  
                  
                  
                  747,543
                  
                  
                  
                  1,127,997Total
      direct cost of revenue
                  
                  
                  205,767
                  
                  
                  
                  303,642
                  
                  
                  
                  256,863
                  
                  
                  
                  980,382
                  
                  
                  
                  1,746,654Operating
      Expenses:Selling,
      general and administrative
                  
                  
                  925,388
                  
                  
                  
                  1,402,104
                  
                  
                  
                  1,481,112
                  
                  
                  
                  1,861,630
                  
                  
                  
                  5,670,234Research
      and development
                  
                  
                  987,161
                  
                  
                  
                  782,787
                  
                  
                  
                  746,398
                  
                  
                  
                  1,028,910
                  
                  
                  
                  3,545,256Share-based
      compensation expense
                  
                  
                  120,786
                  
                  
                  
                  243,587
                  
                  
                  
                  240,772
                  
                  
                  
                  208,171
                  
                  
                  
                  813,316Depreciation
                  
                  
                  19,844
                  
                  
                  
                  20,978
                  
                  
                  
                  23,309
                  
                  
                  
                  26,805
                  
                  
                  
                  90,936Total
      operating expenses
                  
                  
                  2,053,179
                  
                  
                  
                  2,449,456
                  
                  
                  
                  2,491,591
                  
                  
                  
                  3,125,516
                  
                  
                  
                  10,119,742Operating
      loss
                  
                  
                  (1,786,430
                  )
                  
                  
                  (2,438,834
                  )
                  
                  
                  (2,509,012
                  )
                  
                  
                  (3,152,203
                  )
                  
                  
                  (9,886,479
                  )Interest
      income, net
                  
                  
                  195,695
                  
                  
                  
                  206,849
                  
                  
                  
                  192,647
                  
                  
                  
                  145,570
                  
                  
                  
                  740,761Net
      loss before income taxes
                  
                  
                  (1,590,735
                  )
                  
                  
                  (2,231,985
                  )
                  
                  
                  (2,316,365
                  )
                  
                  
                  (3,006,633
                  )
                  
                  
                  (9,145,718
                  )Income
      tax provision
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Net
      loss
                  
                  $
                  (1,590,735
                  )
                  
                  $
                  (2,231,985
                  )
                  
                  $
                  (2,316,365
                  )
                  
                  $
                  (3,006,633
                  )
                  
                  $
                  (9,145,718
                  )Net
      loss per common share - basic and diluted
                  
                  $
                  (0.17
                  )
                  
                  $
                  (0.24
                  )
                  
                  $
                  (0.24
                  )
                  
                  $
                  (0.32
                  )
                  
                  $
                  (0.97
                  )Weighted
      average common shares outstanding - basic and diluted
                  
                  
                  9,469,598
                  
                  
                  
                  9,472,020
                  
                  
                  
                  9,472,020
                  
                  
                  
                  9,472,020
                  
                  
                  
                  9,471,423




Note
15. Segment Information




In
accordance with SFAS No. 131, “Disclosures about Segments of an
Enterprise and Related Information”, the Company reports segment
information based on the “management approach”. The management approach
designates the internal reporting used by management for making decisions and
assessing performance as the source of the Company’s reportable
segments.




The
Company’s business is organized and reported in two segments,  PokerPro®
and Heads-Up ChallengeTM, which are described in Note 1,Nature of Business and
Significant Accounting Policies.    The Heads-Up Challenge
amusement product was launched and began operations during 2007 and the
company’s operations during 2006 consisted solely of operating the PokerPro
business; therefore no segment information has been presented for the year ended
2006. The Company evaluates the performance of its two segments primarily
based on revenues and direct costs of revenue.   The accounting
policies of the segments are the same as those described in the "Summary of
Significant Accounting Policies."




F -
24


The table
below presents information about reported segments for the years ending December
31:




Casino
      Products
              
              
              Amusement
                Products
              
              
              Corporate
                and
      Other
              
              
              Total2008Revenue
              
              $
              9,668,656
              
              
              $
              4,756,068
              
              
              $
              -
              
              
              $
              14,424,724Cost
      of product sales
              
              
              2,722,533
              
              
              
              3,352,770
              
              
              
              -
              
              
              
              6,075,303Depreciation
      and amortization
              
              
              2,582,965
              
              
              
              56,217
              
              
              
              154,043
              
              
              
              2,793,225Capital
      Expenditures
              
              
              -
              
              
              
              39,420
              
              
              
              92,293
              
              
              
              131,713Indentifiable
      assets at December 31, 2008
              
              
              7,349,974
              
              
              
              2,537,691
              
              
              
              5,818,012
              
              
              
              15,705,677
  2007Revenue
              
              $
              3,807,244
              
              
              $
              197,447
              
              
              $
              -
              
              
              $
              4,004,691Cost
      of product sales
              
              
              1,060,631
              
              
              
              277,412
              
              
              
              -
              
              
              
              1,338,043Depreciation
      and amortization
              
              
              1,908,628
              
              
              
              23,531
              
              
              
              121,186
              
              
              
              2,053,345Capital
      Expenditures
              
              
              -
              
              
              
              248,217
              
              
              
              105,379
              
              
              
              353,596Indentifiable
      assets at December 31, 2007
              
              
              8,107,046
              
              
              
              1,444,591
              
              
              
              7,544,268
              
              
              
              17,095,905




Amounts
presented in the column labeled “Corporate and Other” primarily consist of
assets that are not specifically associated with either segment, principally
cash equivalents, investments and other corporate assets.




REVENUE
BY GEOGRAPHIC AREA





Revenues
by geographic area are determined based on the location of our customers. For
fiscal 2008, 2007 and 2006, sales to customers outside the United States
accounted for 63%, 44% and 55% of consolidated revenue, respectively. The
following is revenues and long-lived assets by geographic area as of and for the
years ended December 31:




2008
              
              
              2007
              
              
              2006Revenue
      by Geographic AreaUnited
      States
              
              $
              5,299,984
              
              
              $
              2,235,738
              
              
              $
              821,353Europe
              
              
              3,173,800
              
              
              
              452,969
              
              
              
              140,764Canada
              
              
              3,054,253
              
              
              
              43,000
              
              
              
              -Australia
              
              
              2,678,414
              
              
              
              1,155,180
              
              
              
              1,017,800Other
      International
              
              
              218,273
              
              
              
              117,804
              
              
              
              -$
              14,424,724
              
              
              $
              4,004,691
              
              
              $
              1,979,917
  2008
              
              
              2007
              
              
              2006Long-lived
      assets, end of yearUnited
      States
              
              $
              3,513,275
              
              
              $
              4,216,568
              
              
              $
              3,204,301Canada
              
              
              1,231,518
              
              
              
              1,506,245
              
              
              
              134,134Other
              
              
              218,569
              
              
              
              250,896
              
              
              
              53,259$
              4,963,362
              
              
              $
              5,973,709
              
              
              $
              3,391,694





F -
25




Note
16. Subsequent Events





On January 5, 2009, the Company
exercised its rights under the UBS Rights Offering to sell the ARS investments
to UBS at par.  As a result, the Company received $1.0 million in net
proceeds and liquidated its outstanding UBS Credit Facility in the amount of
$2.9 million.  Since the investments were redeemed at par, there was
no realized gain or loss associated with this transaction.  The
Company has no remaining ARS investments and the UBS Credit Facility has been
terminated.





F -
26





SCHEDULE
II—VALUATION AND QUALIFYING ACCOUNTS AND RESERVES




Balance
      at
                Beginning
      of
                Period
              
              
              Additions
                Charged
      to
                Costs
      and
                Expenses
              
              
              Charged
      to
                Other
                Accounts
              
              
              Deductions
                for
      Amounts
                Written
      Off
              
              
              Balance
      at
                End
      of
                PeriodALLOWANCE FOR DOUBTFUL
      ACCOUNTSYear
      ended December 31, 2008
              
              $
              21,062
              
              
              $
              14,672
              
              
              $
              45,669
              
              
              $
              -
              
              
              $
              81,403Year
      ended December 31, 2007
              
              
              19,301
              
              
              
              47,129
              
              
              
              -
              
              
              
              45,368
              
              
              
              21,062Year
      ended December 31, 2006
              
              
              -
              
              
              
              19,301
              
              
              
              -
              
              
              
              -
              
              
              
              19,301
  S -
1




EXHIBIT
      INDEX




Exhibit
      No.
              Description2.1
              Plan
      of Merger of PokerTek, LLC with and into PokerTek, Inc. (f/k/a National
      Card Club Corporation), dated July 27, 2004 (incorporated by reference to
      Exhibit 2.1 to our Registration Statement on Form S-1 filed on August 4,
      2005 (No. 333-127181)).3.1
              Restated
      Articles of Incorporation (incorporated by reference to Exhibit 3.1 to our
      Registration Statement on Form S-1 filed on August 4, 2005 (No.
      333-127181)).3.2
              Bylaws
      (as amended and restated through July 29, 2005) (incorporated by reference
      to Exhibit 3.2 to our Registration Statement on Form S-1 filed on August
      4, 2005 (No. 333-127181)).4.1
              Specimen
      Common Stock certificate (incorporated by reference to Exhibit 4.1 to
      Amendment No. 2 to our Registration Statement on Form S-1 filed on October
      5, 2005  (No. 333-127181)).4.2
              Securities
      Purchase Agreement by and among PokerTek, Inc. and the investors listed on
      the Schedule of Buyers attached thereto, dated as of April 23, 2007
      (incorporated by reference to Exhibit 4.1 to our Current Report on Form
      8-K filed on April 27, 2007).4.3
              Form
      of Warrant to Purchase Common Stock (incorporated by reference to Exhibit
      4.2 to our Current Report on Form 8-K filed on April 27,
      2007).4.4
              Registration
      Rights Agreement, by and among PokerTek, Inc. and the Buyers listed
      therein, dated as of April 26, 2007 (incorporated by reference to Exhibit
      4.3 to our Current Report on Form 8-K filed on April 27,
      2007).10.1
              Option
      Agreement between World Poker Tour, LLC and PokerTek, Inc. (as successor
      to PokerTek, LLC), dated April 7, 2004 (incorporated by reference to
      Exhibit 10.1 to our Registration Statement on Form S-1 filed on August 4,
      2005 (No. 333-127181)).10.2
              Amendment
      to Option Agreement between World Poker Tour, LLC and PokerTek, Inc. (as
      successor to PokerTek, LLC), dated as of June 10, 2004 (incorporated by
      reference to Exhibit 10.2 to our Registration Statement on Form S-1 filed
      on August 4, 2005 (No. 333-127181)).10.3
              Amendment
      Two to Option Agreement between PokerTek, Inc. and WPT Enterprises, Inc.,
      dated as of April 23, 2007 (incorporated by reference to Exhibit 10.1 to
      our Current Report on Form 8-K filed on May 14, 2007).10.4
              Non-Exclusive
      Software License Agreement between PokerTek, Inc. and Standing Stone
      Gaming, LLC, dated as of January 26, 2005 (incorporated by reference to
      Exhibit 10.3 to our Registration Statement on Form S-1 filed on August 4,
      2005 (No. 333-127181)).10.5
              Office/Warehouse
      Lease Agreement between PokerTek, Inc. and AdBel, Ltd., dated March 28,
      2005 (incorporated by reference to Exhibit 10.4 to our Registration
      Statement on Form S-1 filed on August 4, 2005 (No.
      333-127181)).10.6
              Trademark
      Assignment Agreement among PokerTek, Inc., James Crawford and Gehrig H.
      White, effective July 13, 2005 (incorporated by reference to Exhibit 10.5
      to our Registration Statement on Form S-1 filed on August 4, 2005 (No.
      333-127181)).10.7
              PokerTek,
      Inc. 2007 Stock Incentive Plan (incorporated by reference to Exhibit 99 to
      our Registration Statement on Form S-8 filed on June 6, 2007 (No.
      333-143552)).*10.8
              Form
      of Employee Incentive Stock Option Agreement for PokerTek, Inc. 2007 Stock
      Incentive Plan (incorporated by reference to Exhibit 10.3 to our Form 10-Q
      for the quarterly period ending June 30, 2007 filed on August 14,
      2007).*10.9
              Form
      of Employee Nonqualified Stock Option Agreement for PokerTek, Inc. 2007
      Stock Incentive Plan (incorporated by reference to Exhibit 10.4 to our
      Form 10-Q for the quarterly period ending June 30, 2007 filed on August
      14, 2007).*
  
  Exhibit
      No.
              Description
 10.10
              Form
      of Director Nonqualified Stock Option Agreement for PokerTek, Inc. 2007
      Stock Incentive Plan (incorporated by reference to Exhibit 10.5 to our
      Form 10-Q for the quarterly period ending June 30, 2007 filed on August
      14, 2007).*10.11
              Form
      of Independent Contractor Nonqualified Stock Option Agreement for
      PokerTek, Inc. 2007 Stock Incentive Plan (incorporated by reference to
      Exhibit 10.6 to our Form 10-Q for the quarterly period ending June 30,
      2007 filed on August 14, 2007).*10.12
              Form
      of Restricted Stock Award Agreement for PokerTek, Inc. 2007 Stock
      Incentive Plan (incorporated by reference to Exhibit 10.7 to our Form 10-Q
      for the quarterly period ending June 30, 2007 filed on August 14,
      2007).*10.13
              PokerTek,
      Inc. 2005 Stock Incentive Plan (incorporated by reference to Exhibit 10.6
      to our Registration Statement on Form S-1 filed on August 4, 2005 (No.
      333-127181)).*10.14
              Form
      of Stock Option Agreement for PokerTek, Inc. 2005 Stock Incentive Plan
      (incorporated by reference to Exhibit 10.7 to Amendment No. 1 to our
      Registration Statement on Form S-1 filed on September 13, 2005 (No.
      333-127181)).*10.15
              Form
      of Non-Employee Director Stock Option Agreement for PokerTek, Inc. 2005
      Stock Incentive Plan (incorporated by reference to Exhibit 99.2 to our
      Current Report on Form 8-K filed on March 6, 2006).*10.16
              PokerTek,
      Inc. 2004 Stock Incentive Plan (as amended and restated through July 29,
      2005) (incorporated by reference to Exhibit 10.8 to our Registration
      Statement on Form S-1 filed on August 4, 2005 (No.
      333-127181)).*10.17
              Form
      of Stock Option Agreement for 2004 Stock Incentive Plan (incorporated by
      reference to Exhibit 10.9 to our Registration Statement on Form S-1 filed
      on August 4, 2005  (No. 333-127181)).*10.18
              Employment
      Agreement by and between PokerTek, Inc. and Christopher J.C. Halligan,
      dated January 17, 2008 (incorporated by reference to Exhibit 10.18 to our
      Form 10-K for the fiscal year ended December 31, 2007 filed on March 31,
      2008).*10.19
              Employment
      Agreement by and between PokerTek, Inc. and Mark D. Roberson, dated
      January 17, 2008 (incorporated by reference to Exhibit 10.19 to our Form
      10-K for the fiscal year ended December 31, 2007 filed on March 31,
      2008)..*10.20
              Key
      Employee Agreement between PokerTek, Inc. and Hal Shinn, dated as of
      August 9, 2004 (incorporated by reference to Exhibit 10.12 to our
      Registration Statement on Form S-1 filed on August 4, 2005 (No.
      333-127181)).*10.21
              Amendment
      to Key Employee Agreement between PokerTek, Inc. and Hal Shinn, effective
      as of July 1, 2005 (incorporated by reference to Exhibit 10.13 to our
      Registration Statement on Form S-1 filed on August 4, 2005  (No.
      333-127181)).*10.22
              Extension
      to Key Employee Agreement between PokerTek, Inc. and Hal Shinn, effective
      as of August 9, 2006 (incorporated by reference to Exhibit 10.1 to our
      Current Report on Form 8-K filed on April 13, 2007).*10.23
              Indemnification
      Agreement between PokerTek, Inc. and Lyle Berman, effective as of January
      31, 2005 (incorporated by reference to Exhibit 10.14 to our Registration
      Statement on Form S-1 filed on August 4, 2005 (No.
      333-127181)).*10.24
              Board
      Member Agreement between PokerTek, Inc. and Lyle Berman, dated January 31,
      2005 (incorporated by reference to Exhibit 10.20 on our Form 10-K for the
      fiscal year ended December 31, 2005 filed on March 16,
    2006).*10.25
              Board
      Member Agreement between PokerTek, Inc. and Joe Lahti, dated March 2, 2006
      (incorporated by reference to Exhibit 99.1 to our Current Report on Form
      8-K filed on March 6, 2006).*10.26
              Form
      of Subscription Agreement for PokerTek, Inc. (incorporated by reference to
      Exhibit 10.16 to our Registration Statement on Form S-1 filed on August 4,
      2005 (No. 333-127181)).10.27
              Form
      of Warrant Agreement between PokerTek, Inc. and Feltl and Company
      (incorporated by reference to Exhibit A to Exhibit 1.1 to Amendment No. 1
      to our Registration Statement on Form S-1 filed on September 13, 2005 (No.
      333-127181)).
  
  Exhibit
      No.
              Description
 10.28
              PokerPro
      Software Licensing Agreement between PokerTek, Inc. and Seminole Tribe of
      Florida, dated September 1, 2005 (incorporated by reference to Exhibit
      10.19 to Amendment No. 2 to our Registration Statement on Form S-1 filed
      on October 5, 2005 (No. 333-127181)).10.29
              Distribution
      Agreement between PokerTek, Inc. and Aristocrat International Pty. Limited
      and its Affiliates, dated January 20, 2006 (incorporated by reference to
      Exhibit 10.1 to our Current Report on Form 8-K filed on January 26,
      2006).10.30
              Client’s
      Agreement by and between PokerTek, Inc. and UBS Financial Services, Inc.,
      entered into on March 19, 2008 (incorporated by reference to Exhibit 10.3
      to our Form 10-Q for the quarterly period ended March 31, 2008 filed on
      May 15, 2008).10.31
              Note
      Purchase Agreement by and between PokerTek, Inc. and Lyle A. Berman, James
      T. Crawford, III, Arthur Lee Lomax and Gehrig H. “Lou” White, dated March
      24, 2008 (incorporated by reference to Exhibit 10.4 to our Form 10-Q for
      the quarterly ended March 31, 2008 filed on May 15,
  2008).10.32
              Loan
      and Security Agreement, effective July 25, 2008, between PokerTek, Inc.
      and Silicon Valley Bank (incorporated by reference to Exhibit 10.1 to our
      Form 10-Q for the quarterly period ended June 30, 2008 filed August 14,
      2008).10.33
              Export-Import
      Bank Loan and Security Agreement, dated July 25, 2008, between PokerTek,
      Inc. and Silicon Valley Bank (incorporated by reference to Exhibit 10.2 to
      our Form 10-Q for the quarterly period ended June 30, 2008 filed August
      14, 2008).10.34
              Borrower
      Agreement, dated July 25, 2008, made and entered into by PokerTek, Inc. in
      favor of the Export-Import Bank of the United States and Silicon Valley
      Bank (incorporated by reference to Exhibit 10.3 to our Form 10-Q for the
      quarterly period ended June 30, 2008 filed on August 14,
      2008).10.35
              Credit
      Line Agreement between PokerTek, Inc. and UBS Bank USA, dated August 13,
      2008 (incorporated by reference to Exhibit 10.4 to our Form 10-Q for the
      quarterly period ended September 30, 2008 filed on November 13,
      2008).10.36
              (a)
      UBS Offer relating to Auction Rate Securities; (b) PokerTek, Inc.
      Acceptance Form (incorporated by reference to Exhibit 10.5 to our Form
      10-Q for the quarterly period ended September 30, 2008 filed on November
      13, 2008).10.37
              Letter
      Agreement, dated November 17, 2008 and accepted by PokerTek, Inc. on
      November 24, 2008, between PokerTek, Inc. and each of Janus Venture Fund
      (a series of Janus Investment Fund), Janus US Venture Fund (a series of
      Janus Capital Funds Plc), and Small Cap Growth Portfolio (a series of Ohio
      National Fund Inc.) (incorporated by reference to Exhibit 10.1 to our
      Current Report on Form 8-K filed on December 2, 2008).10.38
              Letter
      Agreement, dated November 13, 2008 and accepted by PokerTek, Inc. on
      November 24, 2008, between PokerTek, Inc. and each of SRB Greenway Capital
      (QP), L.P., SRB Greenway Capital, L.P. and SRB Greenway Offshore Operating
      Fund, L.P. (incorporated by reference to Exhibit 10.2 to our Current
      Report on Form 8-K filed on December 2, 2008).10.39
              Letter
      Agreement, dated November 17, 2008 and accepted by PokerTek, Inc. on
      November 24, 2008, between PokerTek, Inc. and Warrant Strategies Fund, LLC
      (incorporated by reference to Exhibit 10.3 to our Current Report on Form
      8-K filed on December 2, 2008).10.40
              Distribution
      Agreement between PokerTek, Inc. and Aristocrat International Pty. Limited
      and its Affiliates, dated November 24, 2008.21
              List
      of Subsidiaries.23.1
              Consent
      of McGladrey & Pullen, LLP.31.1
              Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.31.2
              Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.
  
 Exhibit
      No.
              Description
 32.1
              Certification
      of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.32.2
              Certification
      of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.*
              Compensatory
      plan or arrangement or management
contract