**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-Q**





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


**For
      the Quarterly Period Ended September 30, 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)





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 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):


 ̈Large
                  accelerated filer
               ̈Accelerated
                  filer ̈Non-accelerated
                  filer (do not check if a smaller reporting company)
              xSmaller
                  reporting company





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





As
      of
      October 31, 2008, there were 10,934,464 shares outstanding of the registrant’s
      common stock.







**POKERTEK,
      INC.**


**TABLE
      OF CONTENTS**




**Page****PART
                I – FINANCIAL INFORMATION**Item 1.
            Financial
                Statements
            1Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            14Item
                3.
            Quantitative
                and Qualitative Disclosures about Market Risk
            21Item
                4T.
            Controls
                and Procedures
            22**PART
                II – OTHER INFORMATION**Item
                1.
            Legal
                Proceedings
            23Item
                1A.
            Risk
                Factors
            23Item
                5.
            Other
                Information
            25Item
                6.
            Exhibits
            26Signatures
            26Exhibit
                Index
            27





**POKERTEK,
        INC.**
 **CONSOLIDATED
        STATEMENTS OF OPERATIONS**
 **(unaudited)**
  **Three Months Ended September 30,**
              
              **Nine Months Ended September 30,****2008**
              
              **2007**
              
              **2008**
              
              **2007**Revenues:License
                  and service fees
              
              $
              1,521,341
              
              $
              621,413
              
              $
              4,463,280
              
              $
              1,731,515Product
                  sales
              
              
              2,772,144
              
              
              455,439
              
              
              6,871,791
              
              
              852,609**Total
                  revenues**
              
              
              4,293,485
              
              
              1,076,852
              
              
              11,335,071
              
              
              2,584,124Costs
                  and operating expenses:Cost
                  of product sales
              
              
              2,088,570
              
              
              379,715
              
              
              5,042,443
              
              
              697,167Selling,
                  general and administrative
              
              
              2,388,991
              
              
              3,257,939
              
              
              7,424,299
              
              
              7,181,482Research
                  and development
              
              
              716,363
              
              
              1,144,586
              
              
              2,435,596
              
              
              3,274,665Depreciation
              
              
              726,870
              
              
              563,477
              
              
              2,053,433
              
              
              1,396,728**Total
                  costs and operating expenses**
              
              
              5,920,794
              
              
              5,345,717
              
              
              16,955,771
              
              
              12,550,042**Operating
                  loss**
              
              
              (1,627,309
              )
              
              (4,268,865
              )
              
              (5,620,700
              )
              
              (9,965,918
              )Interest
                  income (expense), net
              
              
              (50,576
              )
              
              178,909
              
              
              (24,078
              )
              
              438,163**Net
                  loss before income taxes**
              
              
              (1,677,885
              )
              
              (4,089,956
              )
              
              (5,644,778
              )
              
              (9,527,755
              )Income
                  tax provision
              
              
              (75,150
              )
              
              -
              
              
              (198,623
              )
              
              -**Net
                  loss**
              
              $
              (1,753,035
              )
              $
              (4,089,956
              )
              $
              (5,843,401
              )
              $
              (9,527,755
              )Net
                  loss per common share - basic and diluted
              
              $
              (0.16
              )
              $
              (0.37
              )
              $
              (0.53
              )
              $
              (0.92
              )Weighted
                  average common shares outstanding - basic and diluted
              
              
              10,934,464
              
              
              10,920,257
              
              
              10,934,464
              
              
              10,304,001
  *The
        accompanying notes are an integral part of these consolidated financial
        statements.*
  1
  **POKERTEK,
        INC.**
 **CONSOLIDATED
        BALANCE SHEETS**
 
 **September 30, 2008**
                **(unaudited)**
              
              **December 31, 2007****Assets**Current
                  assets:Cash
                  and cash equivalents
              
              $
              2,534,767
              
              $
              1,229,980Short-term
                  investments
              
              
              -
              
              
              5,950,000Accounts
                  receivable, net
              
              
              2,015,634
              
              
              968,536Inventory
              
              
              3,156,898
              
              
              2,642,481Prepaid
                  expenses and other assets
              
              
              261,924
              
              
              331,199**Total
                  current assets**
              
              
              7,969,223
              
              
              11,122,196Other
                  assets:PokerPro
                  systems, net
              
              
              4,188,076
              
              
              4,991,634Property
                  and equipment, net
              
              
              625,943
              
              
              605,046Long-term
                  investments
              
              
              3,580,975
              
              
              -Other
                  assets
              
              
              553,413
              
              
              377,029**Total
                  assets**
              
              $
              16,917,630
              
              $
              17,095,905**Liabilities
                  and Shareholders' Equity**Current
                  liabilities:Accounts
                  payable
              
              $
              1,756,302
              
              $
              1,465,202Accrued
                  liabilities
              
              
              1,272,046
              
              
              964,173Short-term
                  debt
              
              
              2,463,143
              
              
              -**Total
                  current liabilities**
              
              
              5,491,491
              
              
              2,429,375Long-term
                  debt
              
              
              2,029,850
              
              
              -Commitments
                  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 10,934,464 shares at September 30, 2008 and December
                  31,
                  2007
              
              
              -
              
              
              -Additional
                  paid-in capital
              
              
              42,245,405
              
              
              41,353,220Accumulated
                  deficit
              
              
              (32,530,091
              )
              
              (26,686,690
              )Accumulated
                  other comprehensive loss
              
              
              (319,025
              )
              
              -**Total
                  shareholders' equity**
              
              
              9,396,289
              
              
              14,666,530**Total
                  liabilities and shareholders' equity**
              
              $
              16,917,630
              
              $
              17,095,905
  *The
        accompanying notes are an integral part of these consolidated financial
        statements.*
  2
  **POKERTEK,
        INC.**
 **CONSOLIDATED
        STATEMENTS OF CASH FLOWS**
 **(unaudited)**
 
 **Nine Months Ended September 30,****2008**
              
              **2007****Cash
                  flows from operating activities:**Net
                  loss
              
              $
              (5,843,401
              )
              $
              (9,527,755
              )Adjustments
                  to reconcile net loss to net cash used in operating
                  activities:Depreciation
              
              
              2,053,433
              
              
              1,396,728Share-based
                  compensation expense
              
              
              892,185
              
              
              588,036Provision
                  for accounts and other receivables
              
              
              11,485
              
              
              47,129Changes
                  in assets and liabilities:Accounts
                  and other receivables
              
              
              (1,058,583
              )
              
              (280,232
              )Prepaid
                  expenses and other assets
              
              
              (107,109
              )
              
              (6,891
              )Inventory
              
              
              (514,417
              )
              
              (236,317
              )PokerPro
                  systems
              
              
              (1,099,155
              )
              
              (2,920,870
              )Accounts
                  payable and accrued expenses
              
              
              598,972
              
              
              433,541**Net
                  cash used in operating activities**
              
              
              (5,066,590
              )
              
              (10,506,631
              )**Cash
                  flows from investing activities:**Purchases
                  of property and equipment
              
              
              (119,583
              )
              
              (321,607
              )Sale
                  of investments
              
              
              2,050,000
              
              
              23,850,000Purchase
                  of investments
              
              
              -
              
              
              (25,200,000
              )**Net
                  cash provided by (used in) investing activities**
              
              
              1,930,417
              
              
              (1,671,607
              )**Cash
                  flows from financing activities:**Proceeds
                  from long-term debt
              
              
              2,000,000
              
              
              -Proceeds
                  from short-term debt
              
              
              2,620,086
              
              
              -Repayments
                  of short-term debt
              
              
              (173,641
              )
              
              -Proceeds
                  from issuance of common stock, net of expenses
              
              
              -
              
              
              12,512,261Proceeds
                  from common stock options exercised
              
              
              -
              
              
              65,271Repayments
                  of capital lease
              
              
              (5,485
              )
              
              -**Net
                  cash provided by financing activities**
              
              
              4,440,960
              
              
              12,577,532**Net
                  increase in cash and cash equivalents**
              
              
              1,304,787
              
              
              399,294**Cash
                  and cash equivalents, beginning of period**
              
              
              1,229,980
              
              
              1,803,501**Cash
                  and cash equivalents, end of period**
              
              $
              2,534,767
              
              $
              2,202,795**Supplemental
                  Disclosure of Cash Flow Information****Cash
                  paid for:**Interest
              
              $
              194,811
              
              $
              4,216Income
                  taxes
              
              $
              178,055
              
              $
              -**Non-cash
                  transaction:**Capital
                  lease obligation
              
              $
              52,034
              
              $
              -
  *The
        accompanying notes are an integral part of these consolidated financial
        statements.*
  3




**POKERTEK,
      INC.**


**NOTES
      TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      1.**  **Nature
      of Business and Basis of Presentation**





**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 is an electronic poker table
      that provides a fully-automated poker-room environment to tribal casinos,
      commercial casinos, cruise ships and card clubs. Heads-Up Challenge is an
      innovative heads-up amusement poker table that enables two players to compete
      against each other in a game of Texas Hold’em poker for entertainment purposes
      in non-gambling venues such as bars and restaurants.





**Basis
      of Presentation and Significant Accounting Policies**





The
      accompanying consolidated financial statements include the accounts of PokerTek,
      Inc. and its consolidated subsidiary. All significant intercompany transactions
      and accounts have been eliminated.





These
      consolidated financial statements should be read in conjunction with the
      consolidated financial statements and related footnotes included in the
      Company’s Annual Report on Form 10-K for the year ended December 31, 2007.
      Certain reclassifications have been made to prior periods’ financial information
      to conform to the current period presentation. There were no material changes
      during the most recent fiscal quarter in the Company’s significant accounting
      policies as described in the Annual Report.





The
      accompanying consolidated financial statements have been prepared without audit
      and are presented in accordance with Article 8-03 of Regulation S-X.
      Accordingly, they do not include all of the information and footnotes required
      by generally accepted accounting principles in the United States (“U.S. GAAP”)
      for annual financial statements. In the opinion of management, these
      consolidated financial statements  include
      all adjustments, which consist only of normal recurring adjustments, necessary
      for a fair statement of the Company’s results of operations for the periods
      presented. The results of operations for the nine months ended September 30,
      2008 are not necessarily indicative of the results to be expected for the entire
      year.





***Revenue
      recognition***





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.




4




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.





**Recent
      Accounting Pronouncements**





In
      September 2006, the Financial Accounting Standards Board (“FASB”) issued
      Statement of Financial Accounting Standard No. 157 (“FAS 157”), *Fair
      Value Measurements* .
      FAS 157
      defines fair value, establishes a framework for measuring fair value in
      accordance with accounting principles generally accepted in the United States,
      and expands disclosures about fair value measurements. FAS 157 established
      a
      three-tier fair value hierarchy, which prioritizes the inputs used in measuring
      fair value. These tiers include: Level 1, defined as observable inputs such
      as
      quoted prices in active markets; Level 2, defined as inputs other than quoted
      prices in active markets that are either directly or indirectly observable;
      and
      Level 3, defined as unobservable inputs in which little or no market data
      exists, therefore requiring an entity to develop its own
      assumptions.





The
      Company adopted the provisions of FAS 157 as of January 1, 2008, for financial
      instruments measured at fair value on a recurring and nonrecurring basis.
      Although the adoption of FAS 157 did not materially impact its financial
      condition, results of operations, or cash flows, the Company is now required
      to
      provide additional disclosures as part of its financial statements.





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. Accordingly, the Company has
      applied FSP 157-3 in preparing its financial statements as of, and for the
      periods ended, September 30, 2008. FSP 157-3 amends 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. (See Note 2 – “Investments in Auction Rate Securities”
).





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.




5




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
      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 has
      not
      currently elected the fair value option for any of its assets or
      liabilities.





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





The
      Company accounts for its ARS in accordance with Statement of Financial
      Accounting Standards No. 115 (“FAS 115”), *Accounting
      for Certain Investments in Debt and Equity Securities* ,
      and
      classifies them as “available for sale.” Investments in available-for-sale
      securities are recorded at fair value, and unrealized gains or losses (that
      are
      deemed to be temporary) are recognized, net of tax, through shareholders’
equity, as a component of other comprehensive income in the Company’s
      consolidated balance sheet. The Company records an impairment charge to earnings
      when an investment has experienced a decline in value that is deemed to be
      other-than-temporary.





The
      ARS
      held by the Company are securities with long-term nominal maturities for which
      the interest rates have historically been reset through a dutch auction each
      month. The monthly auctions historically have provided a liquid market for
      these
      securities. The Company’s investments in ARS represent 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. With the liquidity issues experienced in global
      credit and capital markets, the ARS held by the Company have experienced failed
      auctions as the amount of securities submitted for sale has exceeded the amount
      of purchase orders during the first nine months of 2008.





Historically,
      given the liquidity created by the auctions, ARS were presented as current
      assets. However, given the recently failed auctions, and based on the long-term
      maturities of the underlying student loans, the Company classified its
      investment in ARS as long-term assets on the accompanying consolidated balance
      sheet as of September 30, 2008.




As
      of
      September 30, 2008, the Company concluded that the cost exceeded fair value
      for
      its investment in ARS and that this decline in fair value was temporary. Based
      on the information currently available, management believes that the underlying
      investments in the student loan portfolios remain sound and that this impairment
      is the result of the failure of the auction mechanisms to provide current
      liquidity. In addition, the Company continues to receive interest on its ARS
      on
      a timely basis, there have been no defaults on the ARS, and the ARS are insured
      by The Federal Family Education Loan Program. Therefore, the Company has
      recorded an unrealized loss of $319,025 (original cost and par value was $3.9
      million) to accumulated other comprehensive income during the
      period.





Any
      future fluctuation in fair value related to the ARS that the Company deems
      to be
      temporary, including any recoveries of previous write-downs, would be recorded
      to accumulated other comprehensive income. If the Company determines that any
      future valuation adjustment is other than temporary, or if it reclassifies
      the
      investment to trading securities, it will record an impairment charge to
      earnings.




6





As
      of
      September 30, 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 continued to utilize estimates of fair
      value based on the broker-dealer’s proprietary valuation models, which were
      prepared using level 3 inputs. Management evaluated the key assumptions being
      used by the broker dealer in their 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.





The
      Company's assets measured at fair value on a recurring basis subject to the
      disclosure requirements of FAS 157 at September 30, 2008, were as
      follows:





**Fair Value Measurements at Reporting Date Using****Quoted Prices in**
              **Active Markets**
              **for Identical**
              **Assets**
            
            **Significant Other**
              **Observable Inputs**
            
            **Significant**
              **Unobservable**
              **Inputs**Investment in
                auction rate securities
            
            $
            -
            
            $
            -
            
            $
            3,580,975Total
                assets measured at fair value
            
            $
            -
            
            $
            -
            
            $
            3,580,975




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 at September 30, 2008:





**Level 3 Auction**
              **Rate Securities**Balance
                at December 31, 2007
            
            $
            -Purchases
                and (sales), net
            
            
            -Transfers
                to Level 3
            
            
            3,900,000Included
                in accumulated other comprehensive loss
            
            
            (176,956
            )Balance
                at March 31, 2008
            
            
            3,723,044Included
                in accumulated other comprehensive loss
            
            
            (49,094
            )Balance
                at June 30, 2008
            
            
            3,673,950Included
                in accumulated other comprehensive loss
            
            
            (92,975
            )Balance
                at September 30, 2008
            
            $
            3,580,975





At
      September 30, 2008, the Company’s ARS (par value of $3.9 million and fair value
      of $3.6 million) were classified as long-term investments. At December 31,
      2007,
      the Company’s ARS ($5.95 million par value and fair value) were classified as
      short-term investments. (See Note 15 – “Subsequent Events”).


7





**Note
      3.**  **Inventory**




Inventory
      at September 30, 2008 and December 31, 2007 consists of the
      following:





**September 30,**
              **2008**
            
            **December 31,**
              **2007**Raw
                materials and components
            
            $
            1,183,444
            
            $
            1,398,752PokerPro
                systems in process
            
            
            294,841
            
            
            620,224Finished
                goods
            
            
            1,678,613
            
            
            623,505Inventory
            
            $
            3,156,898
            
            $
            2,642,481




**Note
      4.**  **Prepaid
      Expenses and Other Assets**





Prepaid
      expenses and other assets at September 30, 2008 and December 31, 2007 consist
      of
      the following:





**September 30,**
              **2008**
            
            **December 31,**
              **2007**Prepaid
                expenses
            
            $
            203,400
            
            $
            252,418Other
            
            
            58,524
            
            
            78,781Prepaid
                expenses and other assets
            
            $
            261,924
            
            $
            331,199Deferred
                licensing fees, net
            
            $
            500,981
            
            $
            329,229Other
            
            
            52,432
            
            
            47,800Other
                assets
            
            $
            553,413
            
            $
            377,029




**Note
      5.**  **PokerPro
      Systems**





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 system from the Company’s inventory
      account to the PokerPro systems account .


8





PokerPro
      systems at September 30, 2008 and December 31, 2007 consist of the
      following:





**September 30,**
              **2008**
            
            **December 31,**
              **2007**PokerPro systems
            
            $
            8,276,848
            
            $
            6,837,941Temporarily idle PokerPro systems(a)
            
            
            159,013
            
            
            501,7018,435,861
            
            
            7,339,642Less:
                accumulated depreciation(a)
            
            
            (4,247,785
            )
            
            (2,348,008
            )PokerPro
                systems, net
            
            $
            4,188,076
            
            $
            4,991,634




*(a)
      The systems will be redeployed as scheduling allows. Included in the September
      30, 2008 and December 31, 2007 accumulated depreciation is $73,842 and $206,178,
      respectively, related to the temporarily idle PokerPro
      systems.*





**Note
      6.**  **Property
      and Equipment**





Property
      and equipment at September 30, 2008 and December 31, 2007 consist of the
      following:





**September 30,**
              **2008**
            
            **December 31,**
              **2007**Equipment and software
            
            $
            844,045
            
            $
            673,188Leasehold
                improvements
            
            
            189,917
            
            
            189,1571,033,962
            
            
            862,345Less:
                accumulated depreciation
            
            
            (408,019
            )
            
            (257,299
            )Property
                and equipment, net
            
            $
            625,943
            
            $
            605,046




**Note
      7.**  **Accrued
      Liabilities**





Accrued
      liabilities at September 30, 2008 and December 31, 2007 consist of the
      following:





**September 30,**
              **2008**
            
            **December 31,**
              **2007**Deferred revenue
            
            $
            353,799
            
            $
            399,900Accrued
                professional fees
            
            
            253,990
            
            
            334,731Other
            
            
            664,257
            
            
            229,542Accrued
                liabilities
            
            $
            1,272,046
            
            $
            964,173


9





**Note
      8.**  **Comprehensive
      Loss**





Comprehensive
      loss for the three and nine months ended September 30, 2008 and September 30,
      2007 consists of the following:




**Three Months Ended September 30,**
            
            **Nine Months Ended September 30,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Net
                loss
            
            $
            (1,753,035
            )
            $
            (4,089,956
            )
            $
            (5,843,401
            )
            $
            (9,527,755
            )Unrealized
                loss on investments
            
            
            (92,975
            )
            
            -
            
            
            (319,025
            )
            
            -Comprehensive
                loss
            
            $
            (1,846,010
            )
            $
            (4,089,956
            )
            $
            (6,162,426
            )
            $
            (9,527,755
            )




**Note
      9. Debt**





The
      Company’s outstanding debt balances as of September 30, 2008 and December 31,
      2007 consist of the following:




**September 30,**
              **2007**
            
            **December 31,**
              **2007**SVB
                Credit Facility
            
            $
            **-**
            
            $
            -UBS
                Credit Facility
            
            
            2,446,445
            
            
            -Founders'
                Loan
            
            
            2,000,000
            
            
            -Capital
                Lease Obligation
            
            
            46,548
            
            
            -Total
                Debt
            
            $
            4,492,993
            
            $
            -Current
                portion of debt
            
            
            2,463,143Total
                Long-term debt
            
            $
            2,029,850
            
            $
            -




***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 September 30, 2008, as of such date
      availability under the SVB Credit Facility was approximately $2.4 million,
      with
      no borrowings outstanding. The SVB Credit Facility has a one-year term and
      bears
      interest at an annual rate of prime plus 1.5%. 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 September 30, 2008, the Company was in compliance with
      these covenants.





***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 September 30,
      2008 there was $2.8 million available under the Line of Credit, of which $2.4
      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 (see Note 15 – “Subsequent
      Events”).





***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.




10





***Capital
      Lease Obligation:*** On May
      15, 2008, the Company entered into a capital lease obligation that bears
      interest at an annual rate of 9.4% in the amount of $52,034 in connection with
      its purchase of a new internal-use ERP system. Under the terms of the capital
      lease, the Company is required to make payments of $1,696 per month for a period
      of 36 months. At the end of the lease term, the company has the option to
      purchase the software for $101. The amount of the capital lease asset is
      included in property and equipment, net on the balance sheet. The Company will
      begin depreciating this asset when the ERP system is placed into
      service.





**Note
      10. 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 three months ended September 30,
      2008 and September 30, 2007, the Company recorded contribution expense of
      $34,323 and $24,817, respectively. For the nine months ended September 30,
      2008
      and September 30, 2007, the Company recorded contribution expense of $105,475
      and $76,411, respectively.





**Note
      11. Commitments and Contingencies**





**Indemnifications**





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 arising from his service as a director of the
      Company.





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 typically agrees to pay all costs and damages,
      provided the customer provides prompt written notice of any claim and complies
      with certain other industry-standard conditions.





**Legal
      Proceedings**





***Lightning
      PokerTM:*** 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. 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 (see Note 15 – “Subsequent Events”).


11





**Note
      12.**  **Shareholders’ Equity**





**Stock
      Incentive Plan**





Option
      activity under the Company’s stock incentive plan for the nine months ended
      September 30, 2008 was as follows:





**Weighted
                Average****Shares**
            
            **Exercise**
              **Price**
            
            **Remaining**
              **Contractual**
              **Term**
            
            **Aggregate**
              **Intrinsic**
              **Value**Outstanding
                at December 31, 2007
            
            
            2,034,825
            
            $
            8.42Granted
            
            
            110,000
            
            
            3.74Exercised
            
            
            -
            
            
            -Forfeited
            
            
            (96,025
            )
            
            10.40Expired
            
            
            -
            
            
            -Outstanding
                at September 30, 2008
            
            
            2,048,800
            
            $
            8.08
            
            
            7.7
            
            $
            (10,240,269
            )Exercisable
                at September 30, 2008
            
            
            1,148,425
            
            $
            7.02
            
            
            7.0
            
            $
            (4,528,465
            )




The
      Company recorded share-based compensation expense of $368,553 and $224,955
      for
      the three months ended September 30, 2008 and September 30, 2007, respectively.
      The Company recorded share-based compensation expense of $892,185 and $588,036
      for the nine months ended September 30, 2008 and September 30, 2007,
      respectively.





**Note
      13. Income taxes**





For
      the
      three and nine months ended September 30, 2008, the Company recognized a tax
      provision of $75,150 and $198,623, respectively, based principally on the
      Company’s estimated foreign income tax withholding liability.  The
      non-recoverable withholding taxes incurred for the period ended September 30,
      2008 were attributable to the Company’s Canadian revenues. As the Company’s
      Canadian operations commenced during the current fiscal year, no such
      withholding liabilities were incurred during the nine months ended September
      30,
      2007.





The
      effective rates for the periods ending September 30, 2008 and 2007 differ from
      the U.S. federal statutory rate principally because: (1) the tax benefit arising
      from the Company’s net operating losses are fully offset by the valuation
      allowance established against the Company’s deferred tax assets: and (2) the
      Company incurs withholding taxes in Canada.





In
      accordance with FASB FIN 48, *Accounting
      for Uncertain Tax Positions, an Interpretation of SFAS No. 109* ,
      we
      evaluated our material tax positions and determined that we did not have any
      uncertain tax positions requiring recognition of a liability as a result of
      the
      adoption of FIN 48.  Our policy is to recognize interest and penalties
      accrued on uncertain tax positions as part of income tax expense.  For the
      three and nine months ended September 30, 2008, no estimated interest or
      penalties were recognized for the uncertainty of certain tax
      positions.





**Note
      14.**  **Related Party Transactions**





**Transactions
      with Aristocrat**





License
      fees from and equipment sales to Aristocrat of $157,525 and $1.4 million,
      respectively, were recorded in the three months ended September 30, 2008, while
      $93,670 and $428,912, respectively, were recorded during the three months ended
      September 30, 2007. License fees from and equipment sales to Aristocrat of
      $443,250 and $3.4 million, respectively, were recorded in the nine months ended
      September 30, 2008, while $266,951 and $803,038, respectively, were recorded
      during the nine months ended September 30, 2007. As of September 30, 2008,
      $315,329 due from Aristocrat was included in accounts receivable in the
      accompanying balance sheet.




12





**Office
      Lease**





The
      Company leases its office and manufacturing facility under an annual operating
      lease from an entity owned and controlled by the Company’s President and the
      Company’s Vice Chairman of the Board of Directors. The lease expires in August
      2011. Rent expense recorded for the leased space for the three months ended
      September 30, 2008 and September 30, 2007 was $54,900 and $45,843, respectively.
      Rent expense recorded for the leased space for the nine months ended September
      30, 2008 and September 30, 2007 was $164,700 and $116,211,
      respectively.





**Note
      15.**  **Subsequent Events**




On
      October 16, 2008, the Company announced that it had reached a mutually agreeable
      settlement of all outstanding litigation with Lightning Gaming, Inc. and
      Lightning Poker, 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.




By
      letter
      dated October 8, 2008 (the “UBS Offer”), UBS AG, through its subsidiary UBS
      Financial Services Inc., the securities brokerage firm that holds the Company’s
      ARS investments (collectively, “UBS”), offered the Company the right to sell its
      ARS to UBS during a two-year period starting January 2, 2009. The purchase
      price
      for the ARS (the “Purchase Price”) will be par plus accrued but unpaid dividends
      or interest, if any. The Company formally accepted this offer by submitting
      an
      acceptance form to UBS on November 11, 2008 (the “Acceptance Date”). By
      accepting the UBS Offer, the Company has the right, exercisable at any time
      during the two-year period, to require UBS to purchase the ARS at the Purchase
      Price. In addition, the Company has granted UBS the right to purchase the
      Company’s ARS (or sell the ARS on behalf of the Company) at any time after the
      Acceptance Date, as long as the Company receives the Purchase Price for the
      ARS.




The
      Company is currently evaluating the impact that the UBS Offer will have on
      the
      accounting treatment of the ARS under FAS 115. While the Company has not yet
      determined the proper accounting treatment applicable to its specific situation,
      Company management currently expects to account for the right as a free-standing
      financial instrument at fair value under FAS 159 and to transfer its ARS from
      available for sale securities to trading securities under FAS 115. Under that
      treatment, the losses arising from the Company’s investment in ARS would be
      transferred from accumulated other comprehensive loss to the statement of
      operations and be fully or partially offset by the resulting gain arising from
      the fair value of the newly acquired right as of December 31, 2008.


13


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




**Forward-Looking
      Statements**




This
      Quarterly Report on Form 10-Q contains forward-looking statements within the
      meaning of Section 27A of the Securities Act of 1933, as amended, and Section
      21E of the Securities Exchange Act of 1934, as amended. 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 and are made under the Private Securities
      Litigation Reform Act of 1995. These forward-looking statements include, but
      are
      not limited to, statements about our plans, objectives, representations and
      contentions and are not historical facts and typically are identified by use
      of
      terms such as "may," "will," "should," "could," "expect," "plan," "anticipate,"
      "believe," "estimate," "predict," "potential," "continue" and similar words,
      although some forward-looking statements are expressed differently.





All
      forward-looking statements are subject to the risks and uncertainties inherent
      in predicting the future. Our actual results may differ materially from those
      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, 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, amendment or termination of our loans with Silicon Valley Bank,
      disruption of our relationships with our suppliers, competitive pressures,
      general economic and political conditions, such as political instability, credit
      market uncertainty, inflationary pressures from higher energy and fuel costs
      and
      the rate of economic growth or decline in our principal geographic markets,
      each
      of which may be amplified by recent disruptions in the U.S. and global financial
      markets, the possible effect of anti-dilution provisions in our outstanding
      warrants, and our financial condition. These and other risks and uncertainties
      are described in more detail in our most recent Annual Report on Form 10-K,
      as
      well as other reports and statements that we file with the Securities and
      Exchange Commission.





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 this and other
      reports that we file with the Securities and Exchange Commission that discuss
      factors germane to our business.





**Overview**




PokerTek,
      Inc. is engaged in the development, manufacture and marketing of electronic
      poker-related products for use in the gaming and amusement markets.





We
      currently have two product lines, PokerPro gaming products and Heads-Up
      Challenge amusement products. The PokerPro system is an electronic poker table
      that provides a fully-automated poker-room environment to tribal casinos,
      commercial casinos, cruise ships and card clubs. Heads-Up Challenge is an
      innovative heads-up amusement device that enables two players to compete against
      each other in a game of Texas Hold’em poker for entertainment purposes in
      non-gambling venues such as bars and restaurants.





**Results
      of Operations for the Three Months Ended September 30, 2008 Compared to the
      Three Months Ended September 30, 2007**





***Revenues.*** Revenues
      increased by $3.2 million (299%) to $4.3 million for the three months ended September
      30, 2008 as compared to $1.1 million for the three months ended September 30,
      2007 due to increases in both license and service fees and product sales.





License
      and service fees increased by $899,928 (145%) to $1.5 million for the three
      months ended September 30, 2008 as compared to $621,413 for the three months
      ended September 30, 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.




14





Product
      sales increased by $2.3 million (509%) to $2.8 million for the three months
      ended September 30, 2008 as compared to $455,439 for the three months ended
      September 30, 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.





Sales
      of
      the Heads-Up Challenge amusement product contributed $1.5 million in revenue
      for
      the three months ended September 30, 2008, with 331 units sold as compared
      to
      $25,900 in revenue for the comparable period of 2007. Sales of casino products
      for the three months ended September 30, 2008 amounted to $1.3 million, an
      increase of $840,188 (196%) 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.





***Cost
      of Sales*** .
      Cost of
      sales increased by $1.7 million (450%) to $2.1 million for the three months
      ended September 30, 2008 as compared to $379,715 for the three months ended
      September 30, 2007. This increase in cost of sales is attributable to the 509%
      growth in product sales.





The
      resulting gross margin percentage was 25% of product sales for the three months
      ended September 30, 2008 and 17% for the comparable period in 2007. The increase
      in the gross margin percentage was primarily attributable to the change in
      product mix. Heads-Up Challenge, which carries a higher up-front margin than
      casino product sales, grew significantly to 54% of total product sales for
      the
      three months ended September 30, 2008 as compared to 6% for the three months
      ended September 30, 2007.





***Selling,
      General and Administrative Expenses.*** Selling,
      general and administrative expenses (“SG&A”) decreased by $868,948 (27%) to
      $2.4 million for the three months ended September 30, 2008 as compared to $3.3
      million for the three months ended September 30, 2007. This decrease was
      primarily the result of managements’ cost reduction initiatives which began in
      late 2007 and continued into the first three quarters of 2008. In addition,
      the
      period ended September 30, 2007 included a non-recurring charge as a result
      of
      settling the Tellis lawsuit. As a percentage of total revenues, SG&A
      expenses improved to 56% of total revenues for the three months ended September
      30, 2008, compared with 303% of total revenues for the three months ended
      September 30, 2007.





***Research
      and Development Expenses.*** **** Research
      and development expenses (“R&D”) decreased by $428,223 (37%) to $716,363 for
      the three months ended September 30, 2008 as compared to $1.1 million for the
      three months ended September 30, 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. However, as our Heads-Up Challenge and
      PokerPro products are now commercialized, spending on pre-production engineering
      and internal development has declined.





***Depreciation*** **.** Depreciation
      increased by $163,393 (29%) for the three months ended September 30, 2008 to
      $726,870 from $563,477 for the three months ended September 30, 2007. The change
      in depreciation is primarily attributable to the increase in the number of
      depreciable PokerPro tables deployed in the United States, Canada and on cruise
      ships.





***Interest
      Income (Expense), net*** **.** Interest
      income (expense), net changed by $229,485 (128%) for the three months ended
      September 30, 2008 to an expense of $50,576 from income of $178,909 for the
      three months ended September 30, 2007, primarily as a result of interest expense
      on the founders’ and UBS loans incurred during the second quarter of 2008,
      combined with lower average invested balances and lower average interest rates
      on our investments.





***Income
      Taxes.*** Income
      tax provision was $75,150 for the three months ended September 30, 2008 and
      zero
      in the comparable period of 2007. Income tax provision for 2008 was attributable
      to non-recoverable taxes incurred in Canada, where we started doing business
      during the current year.





***Net
      Loss.*** Net
      loss
      for the three months ended September 30, 2008 was $1.8 million, an improvement
      of $2.3 million (57%) from $4.1 million for the three months ended September
      30,
      2007. Net loss per share, basic and diluted, was $0.16 per share for the three
      months ended September 30, 2008, an improvement of 57% or $0.21 per share from
      $0.37 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,
      partially offset by higher cost of sales and lower operating
      expenses.





15




**Results
      of Operations for the Nine Months Ended September 30, 2008 Compared to the
      Nine
      Months Ended September 30, 2007**





***Revenues.*** Revenues
      increased by $8.8 million (339%) to $11.3 million for the nine months ended
      September 30, 2008 as compared to $2.6 million for the nine months ended
      September 30, 2007 due to increases in both license and service fees and product
      sales.





License
      and service fees increased by $2.7 million (158%) to $4.5 million for the nine
      months ended September 30, 2008 as compared to $1.7 million for the nine months
      ended September 30, 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 $6.0 million (706%) to $6.9 million for the nine months
      ended
      September 30, 2008 as compared to $852,609 for the nine months ended September
      30, 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 $3.9 million in revenue for
      the
      first nine months of 2008 with 871 units sold, as compared to revenue of $25,900
      in the comparable period of 2007. Sales of casino products amounted to $3.0
      million, an increase of $2.1 million (258%) 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.





***Cost
      of Sales*** .
      Cost of
      sales increased by $4.3 million (623%) to $5.0 million for the nine months
      ended
      September 30, 2008 as compared to $697,167 for the nine months ended September
      30, 2007. This increase in cost of sales is attributable to the 706% growth
      in
      product sales.





The
      resulting gross margin percentage was 27% of product sales for the nine months
      ended September 30, 2008 and 18% for the comparable period in 2007. The increase
      in the gross margin percentage was primarily attributable to the change in
      product mix. Heads-Up Challenge, which carries a higher up-front margin than
      casino product sales, grew significantly to 57% of total product sales for
      the
      nine months ended September 30, 2008 as compared to 3% for the nine months
      ended September 30, 2007.





***Selling,
      General and Administrative Expenses.*** SG&A
      increased by $242,817 (3%) to $7.4 million for the nine months ended September
      30, 2008 as compared to $7.2 million for the nine months ended September 30,
      2007. This increase was primarily due to higher salaries and related personnel
      costs, including non-cash share based compensation expenses, partially offset
      by
      lower legal and professional fees and other operating expenses, as well as
      the
      absence of the lawsuit settlement charges included in the prior year period.
      Cost reduction initiatives have significantly reduced SG&A from third
      quarter of 2007; however, the year-to-date comparison is impacted by lower
      expenses in the earlier periods of 2007. As a percentage of total revenues,
      SG&A expenses improved to 65% of total revenues for the nine months ended
      September 30, 2008, compared with 278% of total revenues for the nine months
      ended September 30, 2007.





***Research
      and Development Expenses.*** **** R&D
      decreased by $839,069 (26%) to $2.4 million for the nine months ended September
      30, 2008 as compared to $3.3 million for the nine months ended September 30,
      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,
      but as our Heads-Up Challenge and PokerPro products are now commercialized,
      spending on pre-production engineering and internal development has
      declined.




***Depreciation*** **.** Depreciation
      increased by $656,705 (47%) for the nine months ended September 30, 2008 to
      $2.1
      million from $1.4 million for the nine months ended September 30, 2007. The
      change in depreciation is primarily attributable to the increase in the number
      of depreciable PokerPro tables deployed in the United States, Canada and on
      cruise ships.





16




***Interest
      Income (Expense), net*** **.** Interest
      income (expense), net changed by $462,241 (105%) for the nine months ended
      September 30, 2008 to an expense of $24,078 from income of $438,163 for the
      nine
      months ended September 30, 2007, due primarily to lower average invested
      balances and lower average interest rates on our investments, as well as the
      impact of interest expense on the founders’ and UBS loans incurred during the
      second quarter of 2008.





***Income
      Taxes.*** Income
      tax provision was $198,623 for the nine months ended September 30, 2008 and
      zero
      in the comparable period of 2007. Income tax provision for 2008 was attributable
      to non-recoverable taxes incurred in Canada, where we started doing business
      during the current year.





***Net
      Loss.*** Net
      loss
      for the nine months ended September 30, 2008 was $5.8 million, an improvement
      of
      $3.7 million (39%) from $9.5 million for the nine months ended September 30,
      2007. Net loss per share, basic and diluted, was $0.53 per share for the nine
      months ended September 30, 2008, an improvement of $0.39 (42%) per share from
      $0.92 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,
      partially offset by higher cost of sales and operating expenses associated
      with
      the growth of the business.





**Liquidity
      and Capital Resources**





We
      have
      incurred net operating losses since inception and operating expenses may
      continue to exceed revenues through at least 2008 as we continue to invest
      in
      growing our installed base of PokerPro systems and increasing sales of Heads-Up
      Challenge. We have typically 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, although during the current year, we have also obtained additional
      capital through credit arrangements from financial institutions and a loan
      from
      certain members of our Board of Directors. These transactions are described
      in
      more detail below.




**Nine Months Ended September 30,****2008**
            
            **2007**
            
            **Change**Net
                cash used in operating activities
            
            $
            (5,066,590
            )
            $
            (10,506,631
            )
            $
            5,440,041Net
                cash provided by (used in) investing activities
            
            
            1,930,417
            
            
            (1,671,607
            )
            
            3,602,024Net
                cash provided by financing activities
            
            
            4,440,960
            
            
            12,577,532
            
            
            (8,136,572
            )Net
                increase in cash and cash equivalents
            
            
            1,304,787
            
            
            399,294
            
            
            905,493Cash
                and cash equivalents, beginning of period
            
            
            1,229,980
            
            
            1,803,501Cash
                and cash equivalents, end of period
            
            $
            2,534,767
            
            $
            2,202,795




For
      the
      nine months ended September 30, 2008, net cash used in operating activities
      was
      $5.1 million, as compared to $10.5 million for the nine months ended September
      30, 2007, a decrease of $5.4 million. The decrease in cash used in operating
      activities was due to reduced net losses combined with a reduction in cash
      used
      for PokerPro systems. These reductions were partially offset by increased
      accounts receivable and inventory, principally associated with the growth in
      the
      Heads-Up Challenge amusement product. We have recently focused increased
      attention on managing the level of working capital employed in the business,
      particularly with regard to reducing the level of inventory carried in our
      gaming operations, although as we are introducing new products, dealing with
      regulatory requirements and managing an international supply chain, our ability
      to accurately forecast demand is limited.





Net
      cash
      provided by investing activities was $1.9 million for the nine months ended
      September 30, 2008, compared to net cash used by investing activities of $1.7
      million for the nine months ended September 30, 2007. Cash provided by investing
      activities is primarily a function of investments and redemptions of our auction
      rate securities (“ARS”) portfolio, and to a smaller degree, capital expenditures
      for assets used in our operations.





17




Net
      cash
      provided by financing activities was $4.4 million for the nine months ended
      September 30, 2008, primarily consisting of a $2.0 million loan from certain
      members of our Board of Directors and a $2.4 million loan from UBS Financial
      Services, Inc, each described in more detail below. For the nine months ended
      September 30, 2007, net cash provided by financing activities was $12.6 million,
      consisting primarily of proceeds from an equity offering completed in April
      2007.





Our
      need
      for cash to fund our operations is determined primarily by the following
      factors: (i) the pace of growth in our casino business and the related
      investments we may make in inventory and PokerPro systems, (ii) the pace of
      growth in sales of our Heads-Up Challenge amusement product, (iii) our ability
      to generate positive operating leverage as we grow, (iv) our ability to forecast
      demand and manage working capital with an international supply chain, and (v)
      our ability to negotiate favorable payment terms with our customers and vendors.
      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 certain
      contractual obligations as set forth below and our ability to control all the
      cash needs of the business is not unlimited.





Our
      management intends to maximize revenues while carefully monitoring the impact
      on
      our cash needs and cash balances, although any reduction in our working capital
      investment may also impact our ability to increase our revenues. If we are
      unable to execute our operating plan, manage our working capital effectively
      or
      are impacted by other events, however, we may need to raise additional funds
      through additional public or private offerings of our securities, sale/leaseback
      arrangements, additional credit facilities or other available sources. If we
      decide to raise capital in the equity markets, our shareholders could incur
      significant dilution, particularly if the anti-dilution provisions in our
      outstanding warrants were triggered.





***Auction
      rate securities.*** At
      September 30, 2008, we had $3.6 million ($3.9 million par value) invested in
      ARS. The ARS held by us are securities with long-term nominal maturities for
      which the interest rates historically have been reset through a dutch auction
      each month. The monthly auctions historically have provided a liquid market
      for
      these securities. Our investments in ARS represent interests in collateralized
      debt obligations supported by pools of student loans. Consistent with our
      investment policy, the ARS investments held by us all have AAA/Aaa credit
      ratings and are backed by The Federal Family Education Loan Program. With the
      liquidity issues experienced in global credit and capital markets, the ARS
      held
      by us have experienced failed auctions as the amount of securities submitted
      for
      sale has exceeded the amount of purchase orders during early 2008.





Historically,
      given the liquidity created by the auctions, ARS were presented as current
      assets. However, given the recently failed auctions, and based on our review
      of
      the underlying collateral, current market conditions and the market prices
      indicated on the monthly statements, we determined: (i) the carrying value
      of
      our investment in ARS should be classified as long-term assets on the balance
      sheet to reflect the long-term maturities of the underlying student loans and
      (ii) the fair value of our ARS was below book value as of September 30, 2008.
      Based on the information currently available, we believe that the underlying
      investments in the student loan portfolios remain sound and that this impairment
      is temporary and the result of the failure of the auction mechanisms to provide
      current liquidity. Accordingly, the value of the investment was written down
      to
      fair value with a corresponding charge to other comprehensive income. While
      we
      believe this impairment to be temporary, the situation in the ARS market
      continues to evolve. We will continue to monitor the situation and update our
      impairment evaluation in future periods and, if the impairment is subsequently
      determined to be other than temporary or if we reclassify the investments to
      trading securities, an impairment charge to earnings would be required at that
      time.





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%. The
      line of credit replaced the $1,000,000 loan made by UBS to under the terms
      of a
      March 19, 2008 Client’s Agreement between us and UBS. At September 30, 2008
      there was $2.8 million available under the Credit Line Agreement, of which
      $2.4
      million of borrowings were outstanding.




By
      letter
      dated October 8, 2008 (the “UBS Offer”), UBS AG, through its subsidiary UBS
      Financial Services Inc., the securities brokerage firm that holds the Company’s
      ARS investments (collectively, “UBS”), offered the Company the right to sell its
      ARS to UBS during a two-year period starting January 2, 2009. The purchase
      price
      for the ARS (the “Purchase Price”) will be par plus accrued but unpaid dividends
      or interest, if any. The Company formally accepted this offer by submitting
      an
      acceptance form to UBS on November 11, 2008 (the “Acceptance Date”). By
      accepting the UBS Offer, the Company has the right, exercisable at any time
      during the two-year period, to require UBS to purchase the ARS at the Purchase
      Price. In addition, the Company has granted UBS the right to purchase the
      Company’s ARS (or sell the ARS on behalf of the Company) at any time after the
      Acceptance Date, as long as the Company receives the Purchase Price for the
      ARS.




18




We
      are
      currently evaluating the impact that the UBS Offer will have on the accounting
      treatment for the ARS under FAS 115. While we have not yet determined the proper
      accounting treatment applicable to its specific situation, we currently expect
      to account for the right as a free-standing financial instrument at fair value
      under FAS 159 and to transfer its ARS from available for sale to trading under
      FAS 115. Under that treatment, the losses arising from the investment in ARS
      would be transferred from other comprehensive loss to the statement of
      operations and be fully or partially offset by the resulting gain arising from
      the fair value of the newly acquired right as of December 31, 2008.




***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
      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 our accounts receivable and
      inventory levels on September 30, 2008, as of such date availability under
      the
      SVB Credit Facility was approximately $2.4 million, with no borrowings
      outstanding. The SVB Credit Facility has a one-year term and bears interest
      at
      an annual rate of prime plus 1.5%. 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.





**Contractual
      Obligations**





The
      table
      below sets forth our known contractual obligations as of September 30,
      2008:




**Total**
            
            **Less than**
              **1 year**
            
            **1 - 3 years**
            
            **3 - 5 years**
            
            **More than**
              **5 years**Debt
                obligations
            
            $
            4,446,445
            
            $
            2,446,445
            
            $
            2,000,000
            
            $
            -
            
            $
            -Operating
                lease obligations
            
            
            702,865
            
            
            260,030
            
            
            442,835
            
            
            -
            
            
            -Capital
                lease obligations
            
            
            67,788
            
            
            22,966
            
            
            44,822
            
            
            -
            
            
            -Purchase
                obligations
            
            
            3,796,338
            
            
            3,796,338
            
            
            -
            
            
            -
            
            
            -Other
                long-term liabilities
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Total
            
            $
            9,013,436
            
            $
            6,525,779
            
            $
            2,487,657
            
            $
            -
            
            $
            -




Contractual
      obligations increased to $9.0 million as of September 30, 2008 from $2.1 million
      as of December 31, 2007 due principally to the incurrence of new debt and
      capital lease obligations, accompanied by an increase in the level of inventory
      purchase commitments, particularly commitments associated with our anticipated
      purchases of Heads-Up Challenge amusement products from our contract
      manufacturer. Contractual obligations increased to $9.0 million as of September
      30, 2008 from $8.2 million as of June 30, 2008 primarily due to additional
      borrowings under our UBS credit facility.


19





**Customer
      Dependence**





As
      of
      September 30, 2008, four of our customers made up approximately 73% 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.





**Critical
      Accounting Policies**





We
      follow
      accounting principles generally accepted in the United States in preparing
      our
      financial statements, which require us to make certain estimates and apply
      judgments that affect our financial position and results of operations. We
      continually review our accounting policies and financial information
      disclosures. A summary of our significant accounting policies that require
      the
      use of estimates and judgments in preparing the financial statements was
      provided in our Annual Report on Form 10-K for the year ended December 31,
      2007.
      During the three months ended September 30, 2008, there were no material changes
      to the accounting policies and assumptions previously disclosed.





**Recent
      Accounting Pronouncements**





In
      September 2006, the Financial Accounting Standards Board (“FASB”) issued
      Statement of Financial Accounting Standard No. 157 (“FAS 157”), *Fair
      Value Measurements* .
      FAS 157
      defines fair value, establishes a framework for measuring fair value in
      accordance with accounting principles generally accepted in the United States,
      and expands disclosures about fair value measurements. FAS 157 established
      a
      three-tier fair value hierarchy, which prioritizes the inputs used in measuring
      fair value. These tiers include: Level 1, defined as observable inputs such
      as
      quoted prices in active markets; Level 2, defined as inputs other than quoted
      prices in active markets that are either directly or indirectly observable;
      and
      Level 3, defined as unobservable inputs in which little or no market data
      exists, therefore requiring an entity to develop its own
      assumptions.





We
      adopted the provisions of FAS 157 as of January 1, 2008, for financial
      instruments measured at fair value on a recurring and nonrecurring basis.
      Although the adoption of FAS 157 did not materially impact our financial
      condition, results of operations, or cash flows, we are now required to provide
      additional disclosures as part of our financial statements.





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 have not been issued. Accordingly, we applied FSP
      157-3 in preparing our financial statements as of and for the periods ended
      September 30, 2008. FSP 157-3 amends 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 our results of operations, financial condition, or cash flows.





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. We are not currently the holder of any derivative
      instruments; thus, adoption of FAS 161 would not currently have any effect
      on
      our 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 SFAS No. 154, *Accounting
      Changes and Error Corrections* .
      We do
      not expect FAS 162 to have a material impact on our financial
      statements.





20




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
      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 have not currently
      elected the fair value option for any of our assets or liabilities.





**Off-Balance
      Sheet Arrangements**





We
      have
      no off-balance sheet arrangements.





**Item
      3.**  **Quantitative
      and Qualitative Disclosures About Market Risk.**





Our
      market risk has changed from the disclosure in Item 7A of our Annual Report
      on
      Form 10-K for the fiscal year ended December 31, 2007, primarily due to our
      new
      debt obligations, as well as to recent events and changes in the worldwide
      credit markets, specifically those risks associated with our ARS investments.
      Because of changes in the market conditions for our ARS as discussed in
      Item 2 – “Management’s Discussion and Analysis of Financial Condition and
      Results of Operations”, we have reclassified those investments from current
      to long-term on the accompanying consolidated balance sheet, and determined
      that
      cost is no longer an accurate approximation of fair value. A further 10%
      decrease in the estimated fair value of our ARS would result in an additional
      write-down of approximately $0.4 million.





As
      of
      September 30, 2008, we had outstanding debt of $4.5 million, of which $2.4
      million was outstanding under our UBS line of credit and bears interest at
      LIBOR
      plus 1% (4.926% at September 30, 2008). We estimate that a hypothetical change
      of 100 basis points in LIBOR would have had an impact of approximately $24
      thousand on our consolidated annual interest expense. Interest under the SVB
      Credit Facility is also variable (prime plus 1.5%, or 6.5% at September 30,
      2008), and to the extent that we borrow under this facility in future periods,
      those borrowings will also subject us to additional market risk.




Our
      transactions with vendors and customers are principally denominated in US
      dollars. Accordingly, we believe that we do not have a direct material exposure
      to fluctuations in foreign currencies. However, a significant portion of our
      revenues and our purchases are from customers and vendors located outside of
      the
      United States. To the extent that those customers or vendors are impacted by
      fluctuations in the relationship of European, Canadian and Asian currencies
      to
      the US dollar, demand for our products, our ability to economically source
      inventory and/or the terms under which we conduct business may be
      affected.




We
      do not hold or issue financial instruments for speculative
      purposes.


21





**Item
      4T.**  **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
      September 30, 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 September 30, 2008, in all material respects,
      to
      enable the Company to record, process, summarize and report in a timely manner
      the information that the Company is required to disclose in its Exchange Act
      reports, 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.





**Changes
      in Internal Control Over Financial Reporting**





The
      following systems-related significant deficiencies were previously identified
      and remain unremediated as of September 30, 2008:





·
            The
                systems used in tracking and valuing inventory and PokerPro systems
                did
                not provide effective automated controls and were not integrated
                with each
                other or with the general ledger.  The lack of integration required
                manual reconciliations between the applications that were not always
                performed or reviewed on a timely basis, which previously resulted
                in an
                adjustment to the consolidated financial statements.


·
            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.





These
      significant deficiencies were reported to the Company’s Audit Committee by our
      management and to our independent registered public accounting firm as of
      December 31, 2007, and the Company has continued to provide the Audit Committee
      with additional reports regarding the status of these significant deficiencies
      with respect to each of the first three quarters of 2008.  Our management
      continues to believe that these significant deficiencies are not indicative
      of a
      material weakness in the Company’s internal control over financial reporting. As
      reported in our Annual Report on Form 10-K, we also implemented a number of
      compensating controls as of December 31, 2007, including more timely
      reconciliations, enhanced review and approval procedures, and more robust
      physical inventory counting and valuation procedures. These compensating
      controls continued to operate as of September 30, 2008.





With
      regard to these systems-related significant deficiencies that had not been
      fully
      remediated as of September 30, 2008, we have purchased and are in process of
      implementing an integrated enterprise resource planning software package, SAP
      Business One, which we believe will aid in strengthening our internal
      controls.





As
      of
      September 30, 2008, we were continuing to prepare for the implementation of
      SAP
      Business One and were still in the process of configuring the application
      software package and training our staff. Therefore, the purchase of SAP Business
      One had no impact on the operation of our internal control over financial
      reporting for the period ended September 30, 2008. We expect to implement
      certain financial modules of SAP Business One during the fourth quarter of
      2008
      and to implement the remaining modules in early 2009. However, we can provide
      no
      assurance that implementation of SAP Business One will be successful or will
      fully resolve all significant deficiencies.





22




Because
      SAP Business One has not yet been implemented, there were no changes in our
      internal control over financial reporting during the quarter ended September
      30,
      2008 that materially affected, or are reasonably likely to materially affect,
      our internal control over financial reporting.




**PART
      II – OTHER INFORMATION**





**Item
      1.****Legal
      Proceedings.**




On
      October 16, 2008, the Company announced that it had reached a mutually agreeable
      settlement of all outstanding litigation with Lightning Gaming, Inc. and
      Lightning Poker, 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.





**Item
      1A.**  **Risk
      Factors.**




In
      addition to the other information set forth in this quarterly report on Form
      10-Q and set forth below, you should carefully consider the factors discussed
      in
      Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year
      ended December 31, 2007, which could materially affect our business, financial
      condition or future results. The risks described in our Annual Report on Form
      10-K and our other reports and statements that we file with the SEC, including
      those contained in our quarterly reports on Form 10-Q, are not the only risks
      facing our Company. Additional risks and uncertainties not currently known
      to us
      or that we currently deem to be immaterial also may materially adversely affect
      our business, financial condition and/or operating results.




***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.***




We
      entered into a loan and two credit facilities during the current year,
      introducing certain risks associated with debt financing. As of September 30,
      2008, we had $4.5 million in debt outstanding and we had the ability to borrow
      additional funds. Our increased exposure to debt financing, however, 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
      attempt to raise equity capital in the future and are successful in doing so,
      our current shareholders could be subjected to significant
      dilution.***




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.




23




In
      addition, 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
      could
      incur significant dilution, particularly if the anti-dilution provisions in
      our
      outstanding warrants are triggered.




***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, many of whom are
      located in Canada, Europe and other areas outside of the United Sates.  As
      of September 30, 2008, four of our customers made up approximately 73% 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 inventory 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 currently do not
      have
      significant supply relationships with alternative sources. 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.




***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.


24





**Item
      5.**  **Other
      Information.**




By
      letter
      dated October 8, 2008 (the “UBS Offer”), UBS AG, through its subsidiary UBS
      Financial Services Inc., the securities brokerage firm that holds the Company’s
      ARS investments (collectively, “UBS”), offered the Company the right to sell its
      ARS to UBS during a two-year period starting January 2, 2009. The purchase
      price
      for the ARS (the “Purchase Price”) will be par plus accrued but unpaid dividends
      or interest, if any. The Company formally accepted this offer by submitting
      an
      acceptance form to UBS on November 11, 2008 (the “Acceptance Date”). By
      accepting the UBS Offer, the Company has the right, exercisable at any time
      during the two-year period, to require UBS to purchase the ARS at the Purchase
      Price. In addition, the Company has granted UBS the right to purchase the
      Company’s ARS (or sell the ARS on behalf of the Company) at any time after the
      Acceptance Date, as long as the Company receives the Purchase Price for the
      ARS.
      The Company expects to exercise its right to require UBS to purchase the
      Company’s ARS as soon as practicable on or after January 2, 2009, assuming the
      ARS have not been purchased prior to such date.




The
      Company has maintained a brokerage account with UBS Financial Services, Inc.
      since October 2005 and had a $1 million line of credit with UBS Financial
      Services, Inc. from March 19, 2008 until it was replaced by a line of credit
      with UBS Bank USA on August 13, 2008.


25


**Item
      6.**  **Exhibits.**





Exhibit
                No.
            
            Description10.1
            
            Loan
                and Security Agreement, effective July 25, 2008, between PokerTek,
                Inc.
                and Silicon Valley Bank (incorporated by reference to Exhibit 10.1
                to our
                quarterly report on Form 10-Q for the period ended June 30, 2008
                filed on
                August 14, 2008).10.2
            
            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 quarterly report on Form 10-Q for the period ended June 30, 2008
                filed
                on August 14, 2008).10.3
            
            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 quarterly
                report on
                Form 10-Q for the period ended June 30, 2008 filed on August 14,
                2008).10.4
            
            Credit
                Line Agreement between PokerTek, Inc. and UBS Bank USA, dated August
                13,
                2008.10.5
            
            (a)
                UBS Offer relating to Auction Rate Securities(b)
                PokerTek, Inc. Acceptance Form31.1
            
            Certification
                of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a)
                of the
                Securities Exchange Act of 1934, as adopted pursuant to Section 302
                of the
                Sarbanes-Oxley Act of 2002.31.2
            
            Certification
                of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a)
                of the
                Securities Exchange Act of 1934, as adopted pursuant to Section 302
                of the
                Sarbanes-Oxley Act of 2002.32.1
            
            Certification
                of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
                adopted
                pursuant to Section 906 of the Sarbanes-Oxley Act of
                2002.32.2
            
            Certification
                of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
                adopted
                pursuant to Section 906 of the Sarbanes-Oxley Act of
                2002.





**SIGNATURES**





Pursuant
      to the requirements 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:
                November 13, 2008By:
            /s/
                Christopher J.C. HalliganChristopher
                J.C. HalliganChief
                Executive Officer(Principal
                Executive Officer)Date:
                November 13, 2008/s/
                Mark D. RobersonMark
                D. RobersonChief
                Financial Officer(Principal
                Financial Officer and Principal
              Accounting
                Officer)


26


**POKERTEK,
      INC.**


**EXHIBIT
      INDEX**





Exhibit
                No.
            
            Description10.1
            
            Loan
                and Security Agreement, effective July 25, 2008, between PokerTek,
                Inc.
                and Silicon Valley Bank (incorporated by reference to Exhibit 10.1
                to our
                quarterly report on Form 10-Q for the period ended June 30, 2008
                filed on
                August 14, 2008).10.2
            
            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 quarterly report on Form 10-Q for the period ended June 30, 2008
                filed
                on August 14, 2008).10.3
            
            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 quarterly
                report on
                Form 10-Q for the period ended June 30, 2008 filed on August 14,
                2008).10.4
            
            Credit
                Line Agreement between PokerTek, Inc. and UBS Bank USA, dated August
                13,
                2008.10.5
            
            (a)
                UBS Offer relating to Auction Rate Securities(b)
                PokerTek, Inc. Acceptance Form31.1
            
            Certification
                of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a)
                of the
                Securities Exchange Act of 1934, as adopted pursuant to Section 302
                of the
                Sarbanes-Oxley Act of 2002.31.2
            
            Certification
                of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a)
                of the
                Securities Exchange Act of 1934, as adopted pursuant to Section 302
                of the
                Sarbanes-Oxley Act of 2002.32.1
            
            Certification
                of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
                adopted
                pursuant to Section 906 of the Sarbanes-Oxley Act of
                2002.32.2
            
            Certification
                of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
                adopted
                pursuant to Section 906 of the Sarbanes-Oxley Act of
                2002.


27