##### 



Managements Discussion and Analysis INTRODUCTION The following report contains managements discussion and analysis (MD&A) of CryptoLogics
consolidated results of operations and financial condition for the year ended December 31, 2004 in
comparison with the year ended December 31, 2003, and should be read in conjunction with the
audited consolidated financial statements and accompanying notes. This MD&A is dated March 14,
2005 · CryptoLogic and our subsidiaries are referred to collectively as CryptoLogic, the Company,
we, us, and our throughout this MD&A, unless otherwise specified. All currency amounts are in US dollars, unless otherwise indicated. Some figures and percentages
may not total exactly due to rounding. It should be noted that the forward-looking statements in this document are based on managements
best estimates of the current operating environment. These statements are related to, but not
limited to, our operations, anticipated financial performance, business prospects and strategies.
Statements in this document, which are not historical, are forward-looking statements made pursuant
to the safe harbour provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking information typically contains statements with words such as may, would,
could, will, intend, seek, propose, anticipate, believe, expect, plan or similar
expressions suggesting future outcomes. Such forward-looking statements are subject to risks,
uncertainties and other factors, which could cause actual results to differ materially from future
results expressed, projected or implied by such forward-looking statements. Such factors include,
but are not limited to, risks associated with the Companys financial conditions, legal risks
associated with Internet gaming and risks of government legislation and regulation, market
acceptance and technological changes, dependence on licensees and key licensees, international
operations and increased competition. A description of these factors can be found in the section
contained herein titled Risks and Uncertainties. CryptoLogic does not intend, and does not
assume any obligations, to update these forward-looking statements. BUSINESS OVERVIEW Founded in 1995, CryptoLogic is a pioneer and a global leading software and services provider
to the Internet gaming market. Today, we are the worlds largest publicly traded online gaming
software developer and supplier. Headquartered in Toronto, CryptoLogic has software development
operations in Canada. Our wholly-owned subsidiary, WagerLogic Limited (WagerLogic), provides
licensing, e-cash management and customer support services for our Internet gaming software to
third-party gaming operators around the world through offices in Cyprus and the UK. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -1-




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##### 



CryptoLogic offers a complete online gaming solution, which is comprised of: 1. A broad, turn-key Internet-based game suite featuring:  
    more than 100 casino table and slot games
    player-to-player poker
    multi-player bingo
    multi-languages (English, Spanish, Japanese, Chinese, French, German, Italian)
    multi-currencies (US dollars, British pound sterling and Euros)
    multi-platforms (download, non-download (Java and Flash), wireless); 2. An integrated, proprietary e-cash management system; and 3. 24/7 multi-language customer support. Since inception, our software has processed in excess of $25 billion in secure wagers for more than
2 million players in 240 countries worldwide. WagerLogic is responsible for the licensing of our software products and services to an
international, blue-chip client base (licensees or customers). As at December 31,
2004, we had 11 licensees located around the world, including strong UK brand name and land-based
gaming organizations. Our licensees operate under government authority where their Internet
business subsidiaries are domiciled, principally in the Netherlands Antilles, and Alderney, in the
British Isles. Substantially all of our revenue is of a recurring nature. WagerLogics licensees pay an ongoing
fee for the licensing and support of our software, calculated as a percentage of each licensees
level of activity. In 2004, approximately 4 percent of our revenue came from other sources,
including software customization and advertising services. Historically, we experience seasonality with slower sales in the summer months (second and third
quarters), when players tend to spend less time indoors and at their computers. Typically, our
first and fourth quarters (during the winter and fall seasons) are our strongest revenue periods. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -2-




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##### 



STRATEGY UPDATE CryptoLogic has a growth strategy designed to capitalize on the rapid growth of the global
online gaming industry, and to produce cash earnings despite continuing regulatory uncertainty and
a competitive business environment. Our strategy has been and continues to be based on three core
imperatives:  1.
    International Diversification  by sustaining key sources of revenue and maximizing
profitability through international growth with existing and new customers;  2.
    Market-Oriented Solutions - by enhancing our product offering to create value for customers
and their players, and drive incremental revenue; and  3.
    Regulatory Leadership  through our commitment to the highest standards of transparency and
regulatory compliance. International Diversification  In 2004, we achieved our target of a geographically-diversified
business, with more than 60% of our licensees revenue derived from international players
(non-North America), up from over 55% in 2003. In our view, the current geographic mix represents
a well-diversified business that mitigates regulatory uncertainty in any one jurisdiction, while
maximizing market opportunities around the world. Market-Oriented Solutions  In 2004, we capitalized on our core online casino software business and
increased our market position in the lucrative Internet poker segment. We broadened our casino
suite with an array of new games throughout the year  especially in the highly popular slot
category. We also grew the fees from online poker to approximately 20% of revenue  up from over
10% in 2003, and exceeding our 2004 target of 15%. Regulatory Leadership  We continued to follow disciplined regulatory practices, and are one of the
few suppliers whose gaming software is government-certified to comparable land-based regulatory
standards. We supply an Internet casino offering for The Ritz Club London Online licensed under
the strictly regulated jurisdiction of Alderney, which subjects our company, key personnel, systems
and software product to ongoing independent review. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -3-




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##### 



Strategic Performance Measures CryptoLogic delivers profitable growth, positive operating cash flow and improving returns. The
following table sets out key financial performance indicators as measures of our progress: (In thousands of US dollars, except per share data)
    
    
    2004
    
    
    
    2003
    
    
    
    2002Income StatementRevenue
    
    
    $
    63,714
    
    
    
    $
    44,211
    
    
    
    $
    34,427EBITDA(1)
    
    
    $
    17,337
    
    
    
    $
    11,496
    
    
    
    $
    8,609Earnings
    
    
    $
    13,668
    
    
    
    $
    9,441
    
    
    
    $
    7,728
    (2)Fully Diluted EPS
    
    
    $
    1.01
    
    
    
    $
    0.75
    
    
    
    $
    0.60
    (2)Financial PositionCash Flow From Operating Activities
    
    
    $
    18,919
    
    
    
    $
    38,700
    
    
    
    $
    9,431Total Cash(3)
    
    
    $
    85,964
    
    
    
    $
    67,307
    
    
    
    $
    40,257Working Capital
    
    
    $
    62,818
    
    
    
    $
    44,733
    
    
    
    $
    35,812Dividend Per Share/Quarter(4)
    
    
    $
    0.05
    
    
    
    $
    0.03
    
    
    
    
    Value MeasureReturn on Equity
    
    
    
    22
    %
    
    
    
    21
    %
    
    
    
    18
    %(2)
   (1)
    
    Management believes that EBITDA (earnings before interest, taxes, depreciation
and amortization) is a useful supplemental measure of performance. However, EBITDA is not a
recognized earnings measure under generally accepted accounting principles (GAAP) and does not
have a standardized meaning. Therefore, EBITDA may not be comparable to similar measures
presented by other companies. EBITDA is reconciled to earnings as follows: (In thousands of US dollars)
    
    2004
    
    
    2003
    
    
    2002Earnings (loss)
    
    $
    13,668
    
    
    $
    9,441
    
    
    $
    (2,129
    )Income taxes (recovery)
    
    
    2,873
    
    
    
    1,213
    
    
    
    (82
    )Special charge
    
    
    
    
    
    
    
    
    
    
    10,506Interest and other income
    
    
    (1,293
    )
    
    
    (691
    )
    
    
    (672
    )Amortization
    
    
    2,089
    
    
    
    1,533
    
    
    
    986EBITDA
    
    $
    17,337
    
    
    $
    11,496
    
    
    $
    8,609
  (2)
    
    Before non-recurring special charge in 2002.(3)
    
    Total cash includes cash and cash equivalents, security deposits and short term
investments.(4)
    
    CryptoLogics inaugural quarterly dividend of $0.03 per share (annual rate of $0.12)
was declared on September 10, 2003, and paid on November 24, 2003. On November 4, 2004,
CryptoLogics Board approved an increase in our quarterly dividend from $0.03 to $0.05 per
share (annual rate of $0.20), commencing with the quarterly dividend paid on December 15,
2004. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -4-




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##### 



ABILITY TO DELIVER RESULTS In executing our strategy, we are guided by a return on effort approach. We dedicate our
time and resources to those opportunities that generate the highest return to us, our customers and
our shareholders. This discipline is reflected in CryptoLogics competitive advantages, outlined
below, which are integral to achieving our growth plans and profitable results to date and for the
long term. Blue-chip customer base WagerLogic carefully selects our licensees, emphasizing quality over quantity, and has
rationalized from 21 customers in 2003 to 11 in 2004. We plan to target only one or two major new
licensees each year. As a result, we have one of most enviable rosters of trusted international
brand name customers in the industry. Since player trust is critical in the online gaming market,
we seek customers with a trusted brand name and a well-established base of gamers that provide
opportunities to cross-market new game offerings. Also, our licensees need and have the financial
resources and drive to market their gaming site in a global and competitive environment. By
focusing on a core group of substantial leading operators with these criteria for success  the
brand strength, player reach and marketing commitment  we have achieved strong results and
continue to capitalize on the vast potential of the global online gaming market. Diversified and comprehensive product portfolio We offer a diversified and comprehensive portfolio of market-oriented products across the casino,
poker and bingo markets that enable our licensees to reach broad gaming audiences worldwide and
profit from these major segments of online gaming. Our product strategy emphasizes our return on
effort discipline. While we are evaluating early stage, new opportunities such as gaming on
mobile devices and interactive TV, our primary focus remains firmly on the proven and lucrative
Internet casino and poker models, which are producing strong results. Internet casino Online casino accounts for over 20% of the global online gaming revenue,
according to Global Betting and Gaming Consultants. It is our core business and largest profit
contributor. We continually invest in market research and product research and development (R&D)
to ensure a succession of new game concepts, themes and variations to create marketing
opportunities for our licensees, which help to re-energize players and increase revenue potential.
We experienced a more than 30% growth in 2004 casino revenue over 2003, despite casino being a
more developed and competitive sector. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -5-




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Internet poker In the fast-growing online poker sector, the key to attracting and retaining
players is critical mass (or liquidity) of a site, i.e. the continuous presence of many players in
the virtual room. This ensures that players will always find a game at the stake they want, when
they want, around the clock. Not only are we expanding the variety of games and tournament
capabilities, we are investing in system scalability to support thousands of additional
simultaneous players online and provide the capacity for increasing traffic at our licensees poker
sites. By having our nine poker licensees, who are some of the largest online gaming brands on the
Web and among the most prominent land-based brands, direct players to a central poker room, we have
a liquid and expansive poker network that has translated into a more than 145% growth in our poker
fees in 2004 compared to the prior year. We anticipate that the strongest incremental growth in
our business will be driven by Internet poker. Customer service and support In todays competitive and increasingly sophisticated environment, players want more than the
newest games. We are investing significantly in our customer relationship management solution to
help our licensees with player retention and re-activation of lapsed accounts, reporting tools and
an enhanced customer support system for the purpose of helping our licensees better understand,
service and build one-on-one relationships with their players. Regulatory leadership and public company transparency Regulatory leadership We have long advocated a regulated market to foster a transparent,
trustworthy and enduring online gaming industry. CryptoLogic is one of the few software providers
in the world whose gaming software is government-certified in multiple, tier-one jurisdictions,
comparable to strict land-based standards. We are subject to intensive government probity review
of our directors, senior management and key personnel, as well as rigorous independent third-party
testing and ongoing review of our gaming software. CryptoLogics regulatory compliance is a
competitive advantage because we can offer existing and future licensees the choice of regulated
markets for their online businesses. This enhances both our credibility and marketability as more
jurisdictions, such as the UK, see regulation as the best solution for the safe and responsible use
of this form of entertainment. Public company transparency CryptoLogic is publicly traded on three senior exchanges  the
Toronto Stock Exchange, Nasdaq National Market and the Main Market of the London Stock Exchange 
which subjects us to the highest standards in corporate governance and disclosure. We are one of
the few publicly traded online gaming software companies in the world. The transparency of our
business and products, differentiates CryptoLogic from the competition. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -6-




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##### 



Financial strength and track record CryptoLogic has consistently generated positive operating profit, healthy cash flow and maintained
strong cash reserves. The strength of our balance sheet provides customers with the assurance that
we have the resources to continue investing in our product solutions today and for the long run.
Our solid financial position also means we can consider potential acquisitions to accelerate our
growth plans. OVERVIEW OF RESULTS CryptoLogic generated another year of strong results in 2004, with both earnings and revenue
up significantly from 2003. This excellent performance reflected the continued benefits of our
focused strategy, which remained centered on international diversification, product expansion and
regulatory compliance. Revenue for the year rose 44% to $63.7 million (2003: $44.2 million). The increase was, in part,
due to the continued strength of our core casino software business. We benefited from the release
of more than 30 new casino game variations during the year, particularly in the popular slot and
jackpot categories, which created marketing and incremental revenue opportunities for licensees.
Excellent top-line performance was also attributed to strong growth in online poker fees, which
rose to approximately 20% of overall revenue in 2004 (2003: over 10%) as our poker licensees gained
increasing momentum, and profited from the spectacular rise in popularity of Internet poker around
the world. EBITDA(1) increased by 51% to $17.3 million in 2004 (2003: $11.5 million). EBITDA
margin for 2004 improved to 27% (2003: 26%), which reflected strong revenue generation tempered by
ongoing expenditures including a major investment program initiated in Q3 2004 to drive long term
growth. Furthermore, earnings grew by 45% to $13.7 million in 2004 (2003: $9.4 million) with
earnings per diluted share rising to $1.01 (2003: $0.75 per diluted share). 2004 earnings

highlighted a positive year-over-year increase, which we will strive to continue . As the major
investment program is expected to be completed largely in the first half of 2005, we aim to
gradually improve EBITDA and net margins towards the end of 2005 and into 2006. We finished the year with a strong balance sheet. Cash, cash equivalents and short term
investments grew to $86.0 million, including security deposits of $7.0 million. Due to consistent generation of positive operating cash flow, working capital grew 40% to $62.8
million (2003: $44.7 million), after the payment of quarterly dividends totaling $1.8 million
(2003: $0.4 million). Revenue growth and associated rise in earnings enhanced our cash position,
which provides us with the financial strength to invest in our product offering, and drive overall
expansion of our business. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -7-




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##### 



In 2005, we intend to continue our major investment plans and focus our efforts on a highly
selective customer group to further strengthen our position in the major online poker and casino
markets  all aimed at delivering positive results. The following table presents selected financial data for each of the three most recent financials
years of the Company on a consolidated basis: %
    
    
    
    
    
    
    %
    
    
    
    
    
    
    %For the years ended December 31,
    
    2004
    
    
    of Revenue
    
    
    2003
    
    
    of Revenue
    
    
    2002
    
    
    of Revenue(In thousands of US
dollars, except per share data)Revenue
    
    $
    63,714
    
    
    
    100
    %
    
    $
    44,211
    
    
    
    100
    %
    
    $
    34,427
    
    
    
    100
    %ExpensesOperating costs
    
    
    39,975
    
    
    
    62.7
    %
    
    
    27,204
    
    
    
    61.5
    %
    
    
    19,439
    
    
    
    56.5
    %General and administrative
    
    
    6,028
    
    
    
    9.5
    %
    
    
    5,161
    
    
    
    11.7
    %
    
    
    5,914
    
    
    
    17.2
    %Finance
    
    
    374
    
    
    
    0.6
    %
    
    
    350
    
    
    
    0.8
    %
    
    
    465
    
    
    
    1.3
    %Amortization
    
    
    2,089
    
    
    
    3.3
    %
    
    
    1,533
    
    
    
    3.5
    %
    
    
    986
    
    
    
    2.9
    %48,466
    
    
    
    76.1
    %
    
    
    34,248
    
    
    
    77.5
    %
    
    
    26,804
    
    
    
    77.9
    %Earnings from operations
    
    
    15,248
    
    
    
    23.9
    %
    
    
    9,963
    
    
    
    22.5
    %
    
    
    7,623
    
    
    
    22.1
    %Interest and other income
    
    
    1,293
    
    
    
    2.1
    %
    
    
    691
    
    
    
    1.6
    %
    
    
    672
    
    
    
    2.0
    %Earnings before undernoted
    
    
    16,541
    
    
    
    26.0
    %
    
    
    10,654
    
    
    
    24.1
    %
    
    
    8,295
    
    
    
    24.1
    %Special charge
    
    
    
    
    
    
    0
    %
    
    
    
    
    
    
    0
    %
    
    
    (10,506
    )
    
    
    (30.5
    %)Earnings (loss) before taxes
    
    
    16,541
    
    
    
    26.0
    %
    
    
    10,654
    
    
    
    24.1
    %
    
    
    (2,211
    )
    
    
    (6.4
    %)Income taxes (recovery)Current
    
    
    1,033
    
    
    
    1.6
    %
    
    
    1,213
    
    
    
    2.7
    %
    
    
    (82
    )
    
    
    (0.2
    %)Future
    
    
    1,840
    
    
    
    2.9
    %
    
    
    
    
    
    
    0
    %
    
    
    
    
    
    
    0
    %2,873
    
    
    
    4.5
    %
    
    
    1,213
    
    
    
    2.7
    %
    
    
    (82
    )
    
    
    (0.2
    %)Earnings (loss)
    
    $
    13,668
    
    
    
    21.5
    %
    
    $
    9,441
    
    
    
    21.4
    %
    
    $
    (2,129
    )
    
    
    (6.2
    %)EBITDA(1)
    
    $
    17,337
    
    
    
    27
    %
    
    $
    11,496
    
    
    
    26
    %

    
    $
    8,609
    
    
    
    25
    %Total assets
    
    $
    124,222
    
    
    
    
    
    
    $
    86,066
    
    
    
    
    
    
    $
    52,530Dividend per share/quarter(4)
    
    $
    0.05
    
    
    
    
    
    
    $
    0.03
    
    
    
    
    
    
    
    
   (1)
    
    Refer to EBITDA note on page 4.(4)
    
    Refer to Dividend note on page 4. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -8-




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##### 



Increasing transaction processing volumes reflected the growing strength of CryptoLogics
business and the proven performance of our software solutions. Number of Registered Users
(millions)


    
    Number of Transactions
(millions)(BAR CHART)
    
    (BAR CHART)
 Processing Volumes
(US$ billions) (BAR CHART)    RESULTS OF OPERATIONS Revenue In 2004, revenue grew 44% due to our expansion in the high-growth online poker market and the
continued solid performance of our core Internet casino business. Revenue increased to $63.7
million (2003: $44.2 million), with 96% of this amount represented by recurring software licensing
fees (2003: 95%). Other revenue sources, accounting for 4% of revenue (2003: 5%), included the
provision of software customization and advertising services. Our long term goal is to continue to
grow total revenue 20% or more year-over-year. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -9-




---



##### 



Fee revenue from our casino and bingo businesses are calculated as a percentage of a licensees
level of activity in its online casino or bingo site. By contrast, fees from online poker are
based on a percentage of the licensees rake per hand in regular or ring games (the rake is
typically 5% of the pot, up to a maximum amount per hand) or fixed fees for entry into poker
tournaments. 75% of our revenue was derived from our casino business in 2004 (2003: 82%); while
approximately 20% was attributable to online poker (2003: over 10%) and approximately 2% from bingo
(2003: 2%). In 2004, extension of our game offering into poker and bingo continued to produce encouraging
results. Fees from our online poker product, in particular, have become an increasingly
significant revenue stream. Online
casino

Online casino revenue in 2004 was up more than 30% over last year. This growth was due to our
investment in a succession of new games, which contributed to increased player traffic, and the
continued strength of our existing, internationally-diversified licensee base. While total casino revenue was up in 2004, it declined as a percentage of total revenue for two
reasons: reduced prices, mainly reflecting competitive pressures, on contracts with renewed casino
customers taking effect this year; and significant expansion in the high-growth online poker
market. Online casino continues to be our core business, and a major segment of the global Internet gaming
market. While this sector is more mature and highly competitive, we expect continued growth by
investing significantly in our casino platform. As a result, online casino is expected to remain a
meaningful proportion of our overall revenue. Online
poker

In 2004, fees from online poker grew more than 145% over 2003, and were at approximately 20% of
total revenue for the year, exceeding the 15% target we set at the beginning of the year. Our
growth in this market was driven by two key factors:  
    new poker software releases that added multi-table and satellite
tournament capabilities, thereby enabling our licensees to attract
players with large scale tournaments and chances to win bigger
cash prizes; and  
    the growing popularity of our prominent, brand-name customers,
including existing poker licensees  William Hill, InterPoker,
PokerPlex and ukbetting  and the building momentum of recent
additions  Littlewoods Gaming, The Ritz Club London Online and
Betfair. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -10-




---



##### 



Since online poker is played with other live players in real-time, liquidity is vital. To ensure
that there are always an adequate number of players at different stake levels and around the clock,
all our poker licensees players are directed into a common poker room. Due to the combination of
our enhanced poker software and the growing popularity of our licensees sites, the traffic to our
licensees central poker room has exceeded 5,400 players online simultaneously to date. The growth of our Internet poker fees in absolute dollars accelerated each successive quarter in
2004. We expect growth will continue as our poker licensees benefit from ongoing enhancements to
our poker offering and capitalize on the rapidly expanding online poker market. We aim to grow
online poker to become an increasingly meaningful revenue stream and to exceed the industry growth
rate. Online
bingo

Our remaining licensing fee revenue from game offerings was derived from online bingo, which
remained fairly consistent at approximately 2% of revenue in 2004 and 2003. With CryptoLogics
priority focus on the major growth areas of Internet casino and poker, bingo is expected to remain
at similar levels as a percentage of overall revenue. Product Diversification (PERFORMANCE GRAPH)   20%
 International
diversification

Given the ongoing legislative uncertainty in the US, foreign markets outside of North America
continue to present the best near-term growth opportunities. Revenue from overseas markets
increased to more than 60% of licensees revenue, up from over 55% in 2003 and 40% in 2002. The UK
and Continental Europe remained core markets, accounting for more than 30% and 20% respectively of
revenue. Our increasing penetration in these international markets are attributed to the growing
businesses of our strong roster of European gaming customers. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -11-




---



##### 



CryptoLogics global strategy, through our WagerLogic subsidiary, has resulted in a
geographically-diversified business. The UK is expected to continue to be a growing and favourable
market, particularly as the British government aims to regulate online gaming, which a new law
could be enacted as early as 2005. A regulated industry will foster a transparent and credible
market for the protection of players, which will encourage increasing consumer confidence to drive
market expansion. We expect our current geographic mix to remain fairly consistent going forward
as our licensees continue to capitalize on opportunities on both sides of the Atlantic. Licensees International Revenue (BAR CHART)   60%
 CryptoLogics strong recurring revenue stream reflects the strength of our revenue model,
which focuses on building long standing relationships with a key number of premium customers. In
2004, 96% of CryptoLogics revenue was of a recurring nature, generated from software licensing and
services contracts that generally extend three to five years, although more recent contracts have
been closer to three years. Our top seven licensees accounted for approximately 93% of 2004
revenue. Most of our major contracts were either renegotiated and extended or recently signed
toward the end of 2003 for multi-year and generally exclusive agreements. This is intended to
bring a measure of stability to our revenue stream going forward. Expenses The Companys expenditures are classified into four categories: operating costs, general and
administrative, finance and amortization. Total expenses amounted to $48.5 million in 2004 (2003:
$34.2 million). These costs were consistent with our plans to invest significantly in strategic
areas to maintain our competitive advantage and support long term growth. Total 2004 expenses
remained fairly consistent as a percentage of revenue compared with the prior year. We expect the
trend to continue in 2005 as we continue to invest in our business, while managing expenses in
proportion to revenue growth, with a gradual decline in expenditures towards the end of 2005
following the completion of our major investment program. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -12-




---



##### 



Operating
Costs

Operating costs comprise software development and support costs that include all personnel and
equity compensation costs for employee stock options, licensee support, customer service costs and
compliance-related expenditures. Development costs are expensed as incurred unless costs meet the criteria for deferral and
amortization under generally accepted accounting principles. Total operating costs were $40.0 million in 2004 (2003: $27.2 million) or 63% of revenue in 2004
(2003: 62%). Increased expenses were due to:  
    development of new casino games and enhancement of the poker offering to drive revenue growth;  
    expansion of our systems infrastructure and scalability to service the increased requirements of network and system
demand, particularly to support the growth in user traffic in the licensees central poker room;  
    enhancement of our customer support, back-office processing and analytical tools to improve the effectiveness of
licensees marketing strategies;  
    increased facility and other related costs for an expanding company;  
    continued regulatory compliance initiatives; and  
    increased processing fees associated with growing financial transaction volumes. Some of the above initiatives were also part of CryptoLogics major investment program, which is
above and beyond our normal course expenditures, to significantly upgrade our gaming platform and
system and service infrastructure, across these multiple areas of our business. This program,
estimated at $10.0 million, commenced in the third quarter of 2004. Approximately 70% or $7.1 million of the program was invested in 2004. Of the $7.1 million, we
spent $2.6 million in operating costs, $3.2 million for purchases of capital assets and $1.3
million was capitalized software development associated with the program. Given CryptoLogics strong cash position and financial performance, we view this is the best time
to invest significantly in our future. We are already seeing the early returns highlighted in our
performance in 2004. By investing in our core casino business, the fast-growing online poker
market and customer support, we expect to drive increasing revenue generation, and ensure
CryptoLogics growth and competitive advantage continue. We anticipate the vast majority of this
program will be completed by the end of the first half of 2005, and operating costs will
progressively decline as a percentage of revenue towards the end of the year. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -13-




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##### 



In a competitive and increasingly sophisticated market, innovation, customer responsiveness and
commitment to compliance efforts are vital as reflected in our employee segmentation. In 2004,
CryptoLogic had 61% of our employees in development and compliance, and through our subsidiary,
WagerLogic, we had 23% in sales, licensee and customer support in Cyprus and the UK. Given the importance of our strategic investment focus to ensure our long term competitiveness and
growth, we have augmented our staffing to 291 people by year end. Having invested materially in
our employee base in 2004, we anticipate that future growth in numbers of employees will moderate. In 2004, we also began to organize our Company into dedicated teams to specialize in those
strategic areas highlighted above. Of the Companys development staff, 51% was in casino software,
19% in poker software, 14% in product and back-office support and the remaining 16% in global IT
and operations support. Employee Breakdown 2003: 175 Staff
    
    2004: 291 Staff(PIE CHART)
    
    (PIE CHART)
   80%
 General
and Administrative Costs

General and administrative costs include overhead and administrative costs, travel expenses and
professional fees relating to our business development, infrastructure and public company listings. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -14-




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##### 



General and administrative (G&A) expenses increased moderately to $6.0 million (2003: $5.2
million), but declined to 9% of revenue in 2004 (2003: 12%) due to strong revenue generation in
2004. The increase in G&A was primarily due to higher facilities costs of supporting our expanding
organization, as well as a full year of costs associated with our London Stock Exchange listing,
which commenced in September of 2003. Given our larger company, G&A expenses will rise modestly,
although remain fairly consistent as a percentage of revenue. In 2004, G&A costs also included two items, which amounts largely offset each other: receipt of a
settlement related to the departure of the previous Chief Financial Officer, the details of which
are confidential; and the expensing of a vacated UK facility due to the relocation of our call
center to Cyprus. Finance
Costs

Finance costs include bank charges and fees for bank drafts and letters of credit. All letters
of credit are secured by cash deposits. These cash deposits are classified as security deposits on
our balance sheet. Finance costs were $0.37 million in 2004 (2003: $0.35 million) due to the increased usage of bank
drafts for user withdrawals. Finance costs remained less than one percent of revenue in both 2004
and 2003. Amortization

Amortization costs are based on the estimated useful lives of the assets and include the
amortization of our investments in computer equipment, software and software licenses to support
our business activities. Amortization expense was $2.1 million (2003: $1.5 million). The increase was attributed to higher
investments in computer equipment, software and licenses to support our growing organization and
strategic investment plans to significantly advance our gaming platform and network infrastructure,
and enhancement of back-office systems. Accordingly, these expenses are expected to continue to
grow in absolute terms, but increase moderately as a percentage of revenue, due to the growth of
our company and as amortization for capital expenditures related to our major investment program
begin towards the latter half of 2005. EBITDA(1) Earnings before interest, taxes, depreciation and amortization (EBITDA(1)) grew 51% to
$17.3 million in 2004 (2003: $11.5 million.) 
EBITDA(1) margin improved to 27% as a
percentage of revenue (2003: 26%). This reflected the management of ongoing expenditures as well
as higher costs associated with our major investment program in proportion to revenue generation to
remain competitive and to produce appropriate returns for sustainable growth. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -15-




---



##### 



EBITDA(1) is expected to continue to deliver healthy growth in absolute dollar terms as
strategic investments translate into higher revenue generation. However, EBITDA(1)
margin is expected to decline modestly as major investments carry over largely into the first half
of 2005 as we complete our major investment program initiatives. EBITDA(1)
(US$ millions) (BAR CHART)  (1) $17.3 million
 Interest Income Interest income rose to $1.3 million in 2004 (2003: $0.7 million). The increase was attributable
to an increased level of our cash position combined with higher interest yield. Provision for Income Taxes Income taxes were $2.9 million in 2004 (2003: $1.2 million). This increase was due to the increase
in pre-tax earnings and generation of taxable income in higher tax jurisdictions. Of the $2.9 million income tax provision in 2004, $1.9 million related to net future income tax
liabilities for unrealized foreign exchange gains that were capital in nature. Earnings Earnings grew 45% to $13.7 million in 2004 (2003: $9.4 million), reflecting strong revenue growth
as described above. This translated to fully diluted earnings per share of $1.01 (2003: $0.75) 
an increase of 35%. Improved 2004 earnings compared to the prior year, benefited from revenue growth of our licensees
in both the Internet casino and poker software segments. While we continue to invest in strategic
areas for long term growth, our improving bottom line performance reflected our focus on making the
right investments to produce appropriate returns. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -16-




---



##### 



Earnings are expected to continue to trend positively as a result of higher revenue generation.
However, near term net margins (or earnings as a percentage of revenue) will be affected by higher
costs due to our major investment program, which are above and beyond our usual expenditures, and
will continue at least into the first half of 2005. Significant investments today are aimed at
driving increasingly stronger top line results in subsequent quarters and years. We strive for a
long term goal in excess of 20% net margins, particularly once major strategic investments come to
an end. Return on Equity CryptoLogics consistent track record of profitability and operating cash generation continued to
translate into a solid return on equity to shareholders, which rose to 22% in 2004. 2004

    
    2003

    
    2002Return on equity
    
    
    22%
    
    
    
    21%
    
    
    
    18%*
   *
    
    Before non-recurring special charge in 2002.    Summary of Quarterly Results  CryptoLogics results may vary on a quarterly basis due to the seasonal nature of the online gaming
industry. Historically, sales are slower in the second and third quarters, as Internet usage
moderates in the summer months when players tend to be outdoors. Typically, our first and fourth
quarters (during the winter and fall seasons) are our strongest revenue periods.While seasonality continues to play a factor as reflected in Q2 2004 results, performance in Q3
2004 benefited from significant gains attributed to the tripling of online poker fees in that
quarter compared to the previous year quarter. This growth was driven by a combination of new
tournament capabilities introduced in our poker software, which enable large scale events to
attract players, and the increasing popularity of WagerLogics poker licensees, which are among the
most prominent gaming brands in the UK.The upward trend and substantial year-over-year quarterly growth recorded in 2003 reflected
re-establishing positive revenue and earnings momentum following a challenging year for both the
industry and the Company, in which 2002 revenues were impacted by both the restrictive use of
certain US credit cards being faced by the entire industry  this continues to be an industry
issue, which CryptoLogic has been addressing through new payment alternatives and a focus on
international growth. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -17-




---



##### 



We continue to expect seasonality in our business, although as online gaming has become
competitive and more sophisticated, the industry has become more market-oriented with new games,
features and marketing initiatives that are increasingly important contributors to driving
performance. The following table sets out selected unaudited financial information of CryptoLogic on a
consolidated basis for the last eight quarters. Quarterly results for 2003 have been restated to
reflect the adoption of the amended recommendations of the Canadian Institute of Chartered
Accountants with respect to accounting for stock-based compensation and other stock-based payments. For more information, readers may refer to CryptoLogics 2004 and 2003 quarterly financial reports. Fiscal 2004 Quarters
    
    
    First
    
    
    
    Second
    
    
    
    Third
    
    
    
    Fourth
    
    
    
    Annual(In thousands of US dollars, except per share data)Revenue
    
    
    $
    15,224
    
    
    
    $
    14,925
    
    
    
    $
    15,616
    
    
    
    $
    17,949
    
    
    
    $
    63,714Stock option expense
    
    
    
    263
    
    
    
    
    274
    
    
    
    
    326
    
    
    
    
    337
    
    
    
    
    1,200Interest income
    
    
    
    244
    
    
    
    
    262
    
    
    
    
    361
    
    
    
    
    426
    
    
    
    
    1,293Earnings
    
    
    
    3,821
    
    
    
    
    3,197
    
    
    
    
    2,856
    
    
    
    
    3,794
    
    
    
    
    13,668Before stock option expense:Basic earnings per share
    
    
    $
    0.32
    
    
    
    $
    0.27
    
    
    
    $
    0.24
    
    
    
    $
    0.32
    
    
    
    $
    1.14Diluted earnings per share
    
    
    $
    0.30
    
    
    
    $
    0.25
    
    
    
    $
    0.23
    
    
    
    $
    0.29
    
    
    
    $
    1.10After stock option expense:Basic earnings per share
    
    
    $
    0.30
    
    
    
    $
    0.25
    
    
    
    $
    0.22
    
    
    
    $
    0.29
    
    
    
    $
    1.05Diluted earnings per share
    
    
    $
    0.28
    
    
    
    $
    0.23
    
    
    
    $
    0.21
    
    
    
    $
    0.27
    
    
    
    $
    1.01Basic weighted average number of shares (000s)
    
    
    
    12,641
    
    
    
    
    12,979
    
    
    
    
    13,076
    
    
    
    
    13,185
    
    
    
    
    12,971Diluted weighted average number of shares (000s)
    
    
    
    13,419
    
    
    
    
    13,734
    
    
    
    
    13,642
    
    
    
    
    13,871
    
    
    
    
    13,586
 Fiscal 2003 Quarters(5)
    
    
    First
    
    
    
    Second
    
    
    
    Third
    
    
    
    Fourth
    
    
    
    Annual(In thousands of US dollars, except per share data)Revenue
    
    
    $
    8,901
    
    
    
    $
    10,826
    
    
    
    $
    10,944
    
    
    
    $
    13,540
    
    
    
    $
    44,211Stock option expense
    
    
    
    58
    
    
    
    
    105
    
    
    
    
    127
    
    
    
    
    148
    
    
    
    
    438Interest income
    
    
    
    161
    
    
    
    
    174
    
    
    
    
    196
    
    
    
    
    160
    
    
    
    
    691Earnings
    
    
    
    1,773
    
    
    
    
    2,478
    
    
    
    
    2,157
    
    
    
    
    3,033
    
    
    
    
    9,441Before stock option expense:Basic earnings per share
    
    
    $
    0.15
    
    
    
    $
    0.21
    
    
    
    $
    0.19
    
    
    
    $
    0.26
    
    
    
    $
    0.81Diluted earnings per share
    
    
    $
    0.15
    
    
    
    $
    0.21
    
    
    
    $
    0.18
    
    
    
    $
    0.25
    
    
    
    $
    0.78After stock option expenseBasic earnings per share
    
    
    $
    0.15
    
    
    
    $
    0.20
    
    
    
    $
    0.18
    
    
    
    $
    0.25
    
    
    
    $
    0.77Diluted earnings per share
    
    
    $
    0.15
    
    
    
    $
    0.20
    
    
    
    $
    0.17
    
    
    
    $
    0.23
    
    
    
    $
    0.75Basic weighted average number of shares (000s)
    
    
    
    12,206
    
    
    
    
    12,237
    
    
    
    
    12,256
    
    
    
    
    12,280
    
    
    
    
    12,245Diluted weighted average number of shares (000s)
    
    
    
    12,216
    
    
    
    
    12,395
    
    
    
    
    12,696
    
    
    
    
    12,972
    
    
    
    
    12,604
   (5)
 CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -18-




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##### 



LIQUIDITY AND CAPITAL RESOURCES In 2004, as in previous years, CryptoLogic maintained a strong financial position. We generated
healthy operating cash flow to meet working capital needs, pay quarterly dividends, implement our
strategic plan and fund our major investment program to ensure our long term growth. We continue to be debt-free with ample cash resources and unutilized credit capacity to meet
working capital needs, further our strategic plans and pay quarterly dividends for the foreseeable
future. Total Cash Position As of December 31, 2004, our total cash position grew to $86.0 million or $6.33 per diluted share
(2003: $67.3 million or $5.34 per diluted share), which comprised cash and cash equivalents, short
term investments, and included security deposits of $7.0 million (2003: $6.6 million). The overall level of cash and cash equivalents were relatively unchanged, although short term
investments nearly doubled. There was a shift in asset mix away from cash in favour of short term
investments during the year to take advantage of higher interest rates in longer term investments
extending beyond 90 days. As a result, cash accounted for $43.2 million of current assets in 2004
and short term investments accounted for $35.8 million (2003: $44.0 million and $16.7 million,
respectively). The Company had $7.0 million pledged as security deposits at year end (2003: $6.6 million), up
slightly from the end of 2003 and reflected higher deposit levels. We maintain security on deposits
as collateral granted to foreign banks and payment processors that process deposit and credit card
transactions on our behalf. Total Cash and Short Term Investment Position*
(US$ millions) (BAR CHART)   *Includes security deposits
   $86.0 million*
 CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -19-




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##### 



Operating Activities CryptoLogics cash generation enables us to self fund our investment initiatives to drive long
term growth. We generated positive cash flow from operations of $18.9 million in 2004 (2003: $38.7
million), reflecting a return to more traditional levels. The primary reasons for the
year-over-year decline were due to:  1.
    Increased receivables resulting from two licensees assuming responsibility for their own
e-cash processing in 2004.  2.
    More favourable security deposit arrangements beginning in 2003, which reduced reserve
requirements with payment processors in that year. Security deposits remained relatively
unchanged in 2004; and  3.
    The year-over-year change of $12.5 million in accounts payable and accrued liabilities. This
decline was largely attributed to:  
    renegotiated frequency of payments to licensees, which extended timing of payables
starting in 2003;
    a growing jackpot provision for prizes not yet won and new progressive games;
    an increase in our chargeback provision due to higher exposure in 2003 relating to
increased user funds held on deposit  a sign of a growing business  which chargeback
levels declined in 2004 due to enhanced fraud control initiatives; and
    a continued increase in trade payables and accruals associated with the growth of the
Company. Financing Activities $6.7 million (2003: ($0.4 million)) in cash arose from financing activities in 2004. $8.5 million
was raised from the exercise of stock options during the year (2003: $0.6 million). In 2004, the Company paid $1.8 million (2003: $0.4 million) in quarterly cash dividends. This
increase was attributed to a full year of quarterly dividends paid in 2004, compared to our
inaugural quarterly dividend of $0.03 per share paid on November 24, 2003. Also in 2004, the Board
approved an increase in our quarterly dividend to $0.05 per share (an annual rate of $0.20),
commencing with the first quarterly payment at this higher rate made on December 15, 2004. Financing activities in 2003 also included a net cash outlay of $0.7 million related to the listing
of the Companys stock on the London Stock Exchange. While each future quarterly dividend is subject to Board approval based on our financial results
for that period, we expect our track record of strong revenue generation, consistent earnings and
positive cash flow will allow us to continue our regular dividend policy. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -20-




---



##### 



Investing Activities Investing activities used cash of $26.4 million in 2004 (2003: $7.9 million.). The increase over
2003 is due in part to a larger portion of cash, amounting to $19.0 million (2003: $5.9 million),
invested in short term money market instruments and corporate bonds (over 90 days) in order to earn
higher interest income. Additionally, cash used for capital expenditures amounted to $7.3 million in 2004 (2003: $2.6
million). Higher capital expenditures in 2004 included $2.8 million in purchases in the normal
course of business related to hardware, software licenses and leasehold improvements  plus $4.5
million in capital expenditures made over and above our usual initiatives arising from our major
investment program as discussed earlier. Working Capital CryptoLogic continued to have a highly liquid financial position in 2004. Working capital
increased by 40% to $62.8 million or $4.62 per diluted share as at December 31, 2004 (2003: $44.7
million or $3.55 per diluted share). The year-over-year increase was primarily due to $18.9
million in cash generated from operations. Our strong liquidity gives us the financial means to significantly invest in our business to
continue to capitalize on the major growth opportunities in online gaming. CryptoLogic believes
that our working capital is sufficient for our present requirements and investment initiatives. We
expect foreseeable cash needs to be funded through existing cash resources, unutilized credit
capacity and operating cash flow. Working Capital
(US$ millions) (BAR CHART) 
 $62.8 million
 CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -21-




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##### 



User funds held on deposit User funds held on deposit doubled to $18.9 million at the end of 2004 (2003: $9.4 million). This
increase reflected player confidence together with the increasing popularity and growth of our
licensees online gaming businesses in both casino and poker. Cash related to user funds on
deposit is segregated and shown separately as an asset and liability on the balance sheet, and does
not form part of CryptoLogics total cash position. Capitalization CryptoLogic had no debt at year-end 2004, and undrawn credit facilities. As of December 31, 2004, the Company had 13,311,498 common shares outstanding, 1,427,661 issued and
outstanding options and 30,000 outstanding warrants for the purchase of common shares. In the
third quarter of 2004, the Board of Directors renewed a Normal Course Issuer Bid, which authorizes
the Company to repurchase and cancel up to 1,250,000 common shares between September 23, 2004 and
September 22, 2005. No shares have been repurchased under this Normal Course Issuer Bid as of the
date of this MD&A. Cash commitments and contractual obligations The following table summarizes our outstanding cash commitments as of December 31, 2004: Less than
    
    
    
    2-3
    
    
    
    4-5
    
    
    
    After 5(In thousands of US dollars)
    
    
    Total
    
    
    
    1 year
    
    
    
    years
    
    
    
    years
    
    
    
    yearsLong term debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Capital lease obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Facility leases
    
    
    $
    13,330
    
    
    
    $
    1,149
    
    
    
    $
    3,229
    
    
    
    $
    2,428
    
    
    
    $
    6,524Purchase obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other long term liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total outstanding cash commitments
    
    
    $
    13,330
    
    
    
    $
    1,149
    
    
    
    $
    3,229
    
    
    
    $
    2,428
    
    
    
    $
    6,524
 Total cash commitments at the end of fiscal 2004 was $13.3 million (2003: $2.0 million). This
increase was due to larger facilities required for an expanding organization and associated longer
term lease arrangements, compared to short term commitments and a much smaller employee base in
2003. The Company has entered into lease agreements for premises expiring at various periods up to
July 2015. RESEARCH AND DEVELOPMENT CryptoLogic makes significant investments in research and development to lead or remain
competitive with technology advancements and product evolution in the global online gaming market.
Approximately 61% of our workforce was comprised of research and development personnel at 2004 year
end (2003: 54%). CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -22-




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##### 



CRITICAL ACCOUNTING POLICIES CryptoLogics accounting policies are specified in the notes to our financial statements, in
particular note 1. CHANGES IN ACCOUNTING POLICIES On December 18, 2003, the Canadian Accounting Standards Board (AcSB) announced that effective
January 1, 2004, public companies are required to expense all stock-based compensation awards
(including stock options). Starting fiscal 2003, we adopted these amended recommendations with
respect to accounting for stock-based compensation and other stock-based payments as noted earlier. Further details of the above new standard and other recent accounting pronouncements are addressed
in the notes to the Companys financial statements, in particular note 1. OFF-BALANCE SHEET ARRANGEMENTS The Company enters into forward foreign exchange contracts to manage a portion of our exposure
to currency fluctuations. The forward foreign exchange contracts are marked to market and the
resulting net gain or loss of the forward foreign exchange contract is recognized in operating
costs in the statement of operations. RISKS AND UNCERTAINTIES CryptoLogic operates in a rapidly changing environment that involves numerous risks and
uncertainties, many of which are beyond our control and which could have a material adverse effect
on our business, revenues, operating results and financial condition. The following discussion
highlights some of these risks and uncertainties. In addition, readers should carefully review the
risk factors described in the Annual Information Form the Company files with various Securities
Commissions. Industry Risks Government Regulation The Company and our licensees are subject to applicable laws in the jurisdictions in which they
operate. At the present time, our licensees hold government licenses to operate Internet gaming
sites in two jurisdictions: Alderney in the British Isles and the Netherlands Antilles. Some
jurisdictions have introduced regulations attempting to restrict or prohibit Internet gaming, while
other jurisdictions have taken the position that Internet gaming is legal and/or have adopted or
are in the process of considering legislation to regulate Internet gaming. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -23-




---



##### 



Currently, the UK intends to establish a regulated market for online gaming. The Isle of Man
and Alderney  both part of the British Isles  are already fully regulated environments for
Internet gaming, based on high standards consistent with land-based gaming. The British government
has introduced legislation to create a regulated and licensed jurisdiction for Internet gaming with
the goal to enacting the new law as early as 2005. However, there is no assurance the UK gambling
bill will be passed into law. Opposing views are developing in Europe. Some European countries, including Italy, Germany and
Holland where there are state-owned monopolies, are taking action aimed at banning foreign online
gaming operators. Such actions by these European Union member states are in contrast with a
favourably-viewed ruling from the European Court of Justice and have prompted the European
Commission to look at creating new legislation that could harmonize online gaming within the EU, in
line with the ECs goal to encourage a free and open cross-border market. As companies and consumers involved in Internet gaming are located around the globe, including our
licensees and their players, there is uncertainty regarding which government has authority to
regulate or legislate the industry. However, legislation and legal action designed to restrict or
prohibit Internet gaming may be adopted in the future in the United States or other jurisdictions. Future decisions may have a material impact on our operations and financial results. Existing
legislation, including US federal and state statutes, have been and could continue to be construed
to prohibit or restrict gaming through the use of the Internet, and there is a risk governmental
authorities may view us or our licensees as having violated such statutes. Therefore, there is a
risk that criminal and civil proceedings, including class actions brought by or on behalf of public
entities or private individuals, could be initiated against us, our licensees, Internet service
providers, credit card processors, advertisers and others involved in the Internet gaming industry
and could involve substantial litigation expense, penalties, fines, injunctions or other remedies
or restrictions being imposed upon us or our licensees or others while diverting the attention of
key executives. Such proceedings could have a material adverse effect on our business, revenues,
operating results and financial condition. Given the legislative uncertainty particularly in the US, we have geographically diversified our
business and customer base in global markets that embrace online gaming. Nevertheless, there can be
no assurances that additional legislation or the burdens associated with complying with them will
not be proposed and passed in the United States or in other potentially relevant jurisdictions to
legislate or regulate various aspects of the Internet or the Internet gaming industry. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -24-




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##### 



Payment Processing Starting in December 2001, certain financial institutions in the United States ceased to accept
online gaming transactions through their credit cards due to the uncertainty regarding the
legislation of Internet gaming in that country. This event has had a negative impact on the
Internet gaming industry as a whole, on our licensees, and on the Company, as evidenced by lower
revenues in 2002. There can be no assurance that other financial institutions or credit card
issuers in the United States and/or other countries will not enact additional restrictions. Such
developments would have a material adverse effect on our business, revenues, operating results and
financial condition. However, this risk has been mitigated with ongoing expansion of the Companys
alternate payment solutions and our focus on Europe. In addition, the loss of a major payment
option could have a material adverse affect on our business. There can be no assurance that our systems and measures in place will or can guarantee protection
against fraudulent activities and unauthorized access from minors, which could have a material
effect on our reputation, business, revenue, operating results and financial conditions. We
mitigate these concerns with systematic controls and a dedicated fraud team. There is an audit
trail of every transaction. As well, we establish relationships with financial institutions that
are subject to stringent banking regulations in their respective jurisdictions. E-commerce Law In addition to regulations pertaining specifically to online gaming, we may become subject to any
number of laws and regulations that may be adopted with respect to the Internet and electronic
commerce. As well, current laws, which predate or are incompatible with Internet commerce, may be
enforced in a manner that restricts the electronic commerce market. However, the application of
such pre-existing Canadian, US and international laws regulating communications or commerce in the
context of the Internet and electronic commerce is uncertain. Moreover, it may take years to determine the extent to which existing laws relating to issues such
as intellectual property ownership and infringement, libel and personal privacy are applicable to
the Internet. New laws and regulations that address issues such as user privacy, pricing, online content
regulation, taxation, advertising, intellectual property, information security, and the
characteristics and quality of online products and services may be enacted. The adoption of new laws or regulations relating to the Internet, or particular applications or
interpretations of existing laws, could decrease the growth in the use of the Internet, decrease
the demand for our products and services, increase our cost of doing business or could otherwise
have a material adverse affect on our business, revenues, operating results and financial
condition. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -25-




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Business Risks E-commerce Adoption The success of our electronic commerce services will depend in large part on the widespread
adoption of the Internet for commercial transactions. The marketplace for electronic commerce
continues to develop, and is subject to frequent and rapid technological changes. It is not
possible to fully predict any trend and therefore any eventual impact on our operations and
financial results. Internet Viability and System Infrastructure and Reliability The growth of Internet usage has caused frequent interruptions and delays in processing and
transmitting data over the Internet. There can be no assurance that the Internet infrastructure or
the Companys own network systems will continue to be able to support the demands placed on it by
the continued growth of the Internet, the overall online gaming industry or that of our customers. The Internets viability could be affected due to delays in the development or adoption of new
standards and protocols to handle increased levels of Internet activity or due to increased
government regulation. If critical issues concerning the commercial use of the Internet are not
favorably resolved (including security, reliability, cost, ease of use, accessibility and quality
of service), if the necessary infrastructure is not sufficient, or if other technologies and
technological devices eclipse the Internet as a viable channel, this may negatively affect Internet
usage, and our business, revenues, financial condition and operating results will be materially
adversely affected, and we may be forced to cease operations. End-users of our software depend on Internet service providers, online service providers and our
system infrastructure for access to the Internet gaming sites operated by our licensees. Many of
these services have experienced service outages in the past and could experience service outages,
delays and other difficulties due to system failures, stability or interruption. Our licensees may
lose customers as a result of delays or interruption in service, including delays or interruptions
relating to high volumes of traffic or technological problems. As a result, we may not be able to
meet a level of service that we have contracted for, and we may be in breach of our contractual
commitments, which could materially adversely affect our business, revenues, operating results and
financial condition. Market Demand The Internet gaming industry continues to rapidly evolve and is characterized by an increasing
number of market entrants. The demand and acceptance for new products and services are subject to
a level of uncertainty and growing competition. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -26-




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Substantially all of our revenues to date have been derived from the licensing of our Internet
gaming software and the support of our associated services through our licensing subsidiary. If
the market develops more slowly than expected, or becomes saturated with competitors or competitive
products or if our services do not achieve market acceptance, our business, revenues, operating
results and financial condition could be materially adversely affected. Security Our Internet gaming software and electronic commerce services are reliant on technologies and
network systems to securely handle transactions and user information over the Internet, which may
be vulnerable to system intrusions, unauthorized access or manipulation. As users become
increasingly sophisticated and devise new ways to commit fraud, our security and network systems
may be tested and subject to attack. We have experienced such system attacks in the past and
implemented measures to protect against these intrusions. However, there is no assurance that all
such intrusions/attacks will or can be prevented in the future, and any system intrusion/attack may
cause a delay, interruption or financial loss, which could have a material effect on our business,
revenue, operating results and financial condition. Reliance on Other Parties Our electronic commerce product relies on Internet Service Providers (ISPs) to allow our licensees
customers and servers to communicate with each other. If ISPs experienced service interruptions, it
may prevent communication over the Internet and impair our ability to carry on business. Our ability to process e-commerce transactions depends on bank processing and credit card systems.
In order to prepare for system problems, we are strengthening and enhancing our current facilities
and the redundancy of our system infrastructure and support. Nevertheless, any system failure,
including network, software or hardware failure, which causes a delay or interruption in our
e-commerce services could have a material adverse effect on our business, revenues, operating
results and financial condition. Competition Licensees of our software compete with existing and established recreational services and products,
in addition to other forms of entertainment. Our success will depend, in part, upon our ability to
enhance our products and services to keep pace with technological developments, respond to evolving
customer requirements and achieve continued market acceptance. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -27-




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We compete with a number of public and private companies, which provide electronic commerce
and/or Internet gaming software. In addition to known current competitors, traditional land-based
casino operators and other entities, many of which have significant financial resources, an
entrenched position in the market and name-brand recognition, may provide Internet gaming services
in the future, and thus become our competitors. As well, such companies may be able to require
that their own software, rather than the software of others, including our ECash software and
services, be used in connection with their payment mechanisms. The barriers to entry into most Internet markets are relatively low, making them accessible to a
wide number of entities and individuals. We believe the principal competitive factors in our
industry that create certain barriers to entry include reputation, technology, financial stability
and resources, proven track record, critical mass (particularly relating to online poker),
regulatory compliance, independent oversight and transparency of business practices. While these
barriers will limit those able to enter or compete effectively in the market, it is most likely
that several new competitors may be established in the near future, in addition to our known
competitors. Increased competition from current and future competitors has and will result in price reductions
and reduced margins, or could result in the loss of market share, any of which could materially
adversely affect our business, revenues, operating results and financial condition. Dependence on Licensees In fiscal 2004, our top 7 licensees accounted for approximately 93% of our total revenue, a similar
concentration to 2003, although representing a different mix of licensees. In addition, a large
majority of key licensees operate from one licensing jurisdiction. The loss of one or more of
these key licensees or their license in their respective jurisdiction could have a material adverse
effect on our business, revenues, operating results and financial condition. Chargebacks As a result of increasing player deposit levels, we are subject to higher exposure to charge backs,
which may also result in possible penalties. Chargebacks are any deposit transaction credited to a
users account that is later reversed or repudiated. While the Company has a provision for
chargebacks, this factor could have a material adverse effect on our business, revenues, operating
results and financial conditions. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -28-




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Foreign Operations A significant portion of our revenues is derived from licensing and support fees in non-North
American countries. The Company and our licensees are subject to local laws and regulations in
those jurisdictions in which they operate. While some jurisdictions have introduced regulations
designed to restrict Internet gaming, others have demonstrated acceptance of such activities.
Currently, approximately 85 jurisdictions worldwide regulate or are in the process of legalizing
some form of Internet gaming according to the River City Group, a consultancy group that provides
research to the interactive gaming industry. As companies and consumers involved in Internet gaming, including the players of our licensees, are
located around the globe, there is uncertainty regarding exactly which government has jurisdiction
or authority to regulate or legislate with respect to various aspects of the industry. The
uncertainty surrounding the regulation of Internet gaming in the various jurisdictions in which we
operate could have a material adverse effect on our business, revenues, operating results and
financial condition. In addition, there are certain difficulties and risks inherent in doing business internationally,
including the burden of complying with multiple and conflicting regulatory requirements, foreign
exchange controls, potential restrictions or tariffs on gaming activities that may be imposed,
potentially adverse tax consequences and tax risks. Changes in the political and economic
stability, regulatory and taxation structures, and the interpretation thereof, of jurisdictions in
which we, our subsidiaries and our licensees operate, and in which our licensees customers are
located could have a material adverse effect on our business, revenues, operating results and
financial condition. Our ability to expand our business in certain countries will require modification of our products,
particularly domestic language and currency support. Once a licensee has posted its gaming site on
the Internet, the site is available to users around the world. However, there can be no assurance that we will be able to sustain or increase revenue derived from
international operations or that we will be able to penetrate linguistic, cultural or other
barriers to new foreign markets. Foreign Exchange Our financial results are reported in US currency, which is subject to fluctuations in respect of
the currencies of the countries in which we operate, including US dollars, British pound sterling,
Euros, and Canadian dollars. Accordingly, fluctuations in the exchange rate of world currencies
could have a positive or negative effect on our reported results. We utilize a hedging program to
mitigate a portion of our currency risks, but there can be no assurance that we will not experience
currency losses in the future, which could have a material adverse effect on our business,
revenues, operating results and financial condition. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -29-




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Legal Proceedings We, and certain of our subsidiaries, are involved in litigation arising in the ordinary course and
conduct of business. The outcome of such matters cannot be predicted with certainty, and could have
a material adverse effect on our business, revenues, operating results and financial condition. Moreover, from time to time, third parties have asserted and may continue to assert patent,
trademark, copyright and other intellectual property rights to technologies or business methods
that we consider important. There can be no assurance that the assertion of such claims will not
result in litigation or that we would prevail in such litigation or be able to obtain a license for
the use of any infringed intellectual property from a third party or, if such a license is
required, that it would be available on terms acceptable to us. Intellectual Property We rely on a combination of laws and contractual provisions to establish and protect our rights in
our software and proprietary technology. We believe that much of our competitive position is
dependent upon our ability to protect our proprietary technology. We generally enter into
non-disclosure and invention agreements with employees, licensees, consultants and customers, and
historically have restricted access to our software products source codes. We regard our source
codes as proprietary information, and attempt to protect the source code versions of our products
as trade secrets and unpublished copyrighted works. Despite our precautions and measures
implemented to protect against such attempts, unauthorized parties may have or could in the future
copy or otherwise reverse engineer portions of our products or otherwise obtain and use information
that we regard as proprietary. We do not possess any patent or copyright registrations in Canada, the United States or any other
jurisdiction. However, our company and subsidiaries have trademarks in certain jurisdictions and
are in the process of applying for further trademark registrations and patents, which would provide
such protection in relevant jurisdictions. Certain provisions of our license agreements, including
provisions protecting against unauthorized use, transfer and disclosure, may be unenforceable in
certain jurisdictions. We believe that patent, trademark, copyright and other legal protections are less significant to
our success than other factors such as the knowledge, ability and experience of our personnel, new
product and service developments, frequent product enhancements, customer service and ongoing
product support. We also have a proprietary interest in our name. The names CryptoLogic and WagerLogic have
become well known in the Internet gaming industry. Accordingly, our competitive position could be
affected if our name was misappropriated and our reputation in any way compromised. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -30-




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There can be no assurance that the steps we have taken to protect our proprietary rights will
be adequate to deter misappropriation of our technology or independent development by others of
technologies that are substantially equivalent or superior to our technology. Any misappropriation
of our name, technology or development of competitive technologies could have a material adverse
effect on our business, revenues, operating results and financial condition. Hiring and Retaining Employees Our future success is dependent on certain key management and technical personnel. The loss of
them or the inability to attract and retain highly qualified staff and advisors could have a
material adverse effect on our business, revenues, operating results and financial condition. Managing Growth We have a history of growth. The expansion of our business and the increasing complexity of our
product offerings, coupled with the rapid evolution of our markets, and increasing competition that
will put pressure on margins have placed, and are expected to continue to place, a significant
strain on our management and operational resources and to increase demands on our internal systems,
procedures and controls. Our future operating results will depend on managements ability to
develop and manage growth, enhance our products and services to respond to market demand, deal with
competition and evolving customer requirements, manage our system infrastructure and requirements
to meet the growing demands of our business, hire and retain significant numbers of qualified
employees, accurately forecast revenues and control expenses. A decline in the growth rate of our
revenues without a corresponding and timely slowdown in our expenses or our inability to manage or
build future growth efficiently could have a material adverse effect on our business, revenues,
operating results and financial condition. Future Acquisitions and Investments As part of our business strategy, we may make acquisitions of or significant investments in
businesses or technology that offer complementary products, services, and technologies. Any
acquisition or investment will be accompanied by common risks, including the difficulty of
assimilating the operations and personnel of the acquired businesses; the potential disruption of
management from our business; the inability of management to maximize the financial and strategic
position of our company or returns from the investment or acquired businesses; the maintenance of
uniform standards, controls, procedures and policies; and the impairment of relationships with
employees and clients as a result of and integration of the investment, acquisition or new
management personnel. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -31-




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Stock Volatility The market price of our common shares has experienced significant fluctuations and may continue to
fluctuate significantly. The market price of our common shares may be adversely affected by
various factors affecting us and our competitors, such as proposed Internet gaming legislation or
enforcement of existing laws, the announcement of new products or enhancements, innovation and
technological changes, quarterly variations in revenue and results of operations, changes in
earnings estimates by financial analysts, speculation in the press or analyst community and general
market conditions or market conditions specific to particular industries, including the Internet
and gaming. In addition, the stock market has from time to time experienced extreme price and volume
fluctuations. These company-specific or broad market fluctuations may adversely affect the market
price for our common shares. Anti-online gaming legislation could also impact our ability to
remain listed. Although our common shares are listed and traded on the Toronto Stock Exchange, the Nasdaq National
Market and the London Stock Exchanges Main Market, this should not imply that there will always be
a liquid market in our common shares and an investment in our common shares may be difficult to
realize. OUTLOOK CryptoLogics focused strategy and investment in key markets and fast-growing product segments
offering vast market potential have continued to translate into revenue growth, solid earnings and
positive operating cash flow despite a competitive online gaming industry marked by continued US
uncertainty. Vast Market Potential of Online Gaming The global Internet gaming industry is estimated to be reach $12.0 billion6 in 2005 
yet this is less than 5% of the global land-based gaming market and suggests considerable growth
potential. Casino continues to be a major pillar accounting for more than 20% of the online gaming
market. Poker is emerging as a rapidly-expanding game segment and gaining popularity around the
world. Online poker has risen 20-fold since 2002, is now about 15% of the Internet gaming
industry, and is forecasted to double next year7. New games, enhanced product
functionality and continued growth of our existing customers in these major game areas are expected
to continue to add favourably to our financial performance.   6
    Global Betting and Gaming Consultants March 20057
    PokerPulse, Global Betting and Gaming Consultants March 2005 CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -32-




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Focused Strategy, Disciplined Execution Management continues to be excited about the prospects and outlook for CryptoLogic. By staying
disciplined in our execution, which remains centered on our three core imperatives  (i)
international diversification, (ii) market-oriented solutions, and (iii) regulatory leadership  we
intend to strengthen our global position and continue to deliver profitable returns. In committing to this growth plan, we emphasize a return on effort approach in everything we do.
This means we devote our time and resources to those strategic activities that generate the highest
return. CryptoLogics growth strategy is focused on both our core casino business and fast-rising
online poker arena  major Internet game segments that are proven, profitable markets with
excellent upside. International Diversification In keeping with our return on effort approach, we have become very selective and only target one
or two new substantial customers a year. In addition to new licensees, CryptoLogic is equally
focused on driving organic growth and increasing the profitability of our existing customers.
There remains considerable upside to help expand our licensees online casino businesses through
new games, enhanced customer support and new back-office/data mining tools for more effective
player retention and re-activation, and to help them increase their position in online poker  an
emerging and incremental revenue stream. We are realizing profitable returns by working with a select group of high quality, international
brand name customers that offer the best prospects for online gaming. We set out to diversify our
business in key geographies, and we have achieved that goal. In 2004, more than 60% of our
licensees revenue was derived from international markets, up from over 55% last year. The UK and
Continental Europe continued to represent key markets at more than 30% and 20% respectively of
overall revenue last year. Today, we are well-diversified in major markets and expect our current
geographic mix to be appropriate as we maximize opportunities around the world. Market-Oriented Solutions We will continue to invest in our core casino business to build on our market strength in this
mainstay segment of online gaming. This is why in 2004, we introduced more than 30 new casino slot
and table games, which are helping licensees attract and retain players, and ultimately increase
revenue  and in turn contributes to our continued casino growth. We have achieved excellent results from our online poker product. In 2004, fees from online poker
increased more than 145% over last year, at approximately 20% of overall revenue, and up from over
10% of revenue in 2003. Online poker is rapidly growing into a major pillar of online gaming.
While the game is currently US-dominated, we feel the UK and Europe lag 12 or more months behind
and are the next big growth regions for online poker. Given our strong UK-oriented licensees with
a substantial percentage of their online poker revenue derived from international markets, our
customers are well positioned to increase market share in Internet poker. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -33-




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CryptoLogic aims to continue to develop new technologies and games and enhance our e-cash
application, fraud control initiatives and customer support to offer a comprehensive game suite and
enriching player experience. These initiatives will help our licensees attract, retain and
re-activate players in an increasingly sophisticated and global marketplace. Management aims to
exceed industry growth rates in both online casino and poker, and not measure our success solely on
increasing the contribution of these segments as a percentage of total revenue. Regulatory Leadership As the UK government proceeds to regulate online gaming with the new law possibly enacted as early
as 2005, and fully operational by 2007, CryptoLogic will continue to emphasize investment in our
compliance efforts. As one of the worlds few software providers already certified to high
regulatory standards, we are experienced and well positioned to offer licensees the choice of
regulated markets for their online businesses. Our regulatory leadership is a key differentiator
for CryptoLogic, and strategically important as more governments move to regulate interactive
gaming. Investing for the Future Given CryptoLogics growing revenue, cash generation and strong financial position, this is the
best time for us to invest in our future. To that end, our major investment program will continue
at least into the first half of 2005 and remain directed at strategic areas of our business 
casino and poker software offering, system infrastructure and scalability, and back-office and
customer care  all aimed at maintaining our competitive advantage, strengthening our position in
our core markets of casino and poker, and generating increasing returns in the near and long term. We set out to diversify our business by customer, geography and products. We are achieving these
objectives as reflected in our 2004 performance. By delivering on our focused strategy and
investment plans, we will continue to work with a quality group of major international customers to
drive revenue growth, profitability and healthy cash flow. With increasing industry consolidation,
we also have the financial strength to carefully consider potential acquisitions, if appropriate,
to accelerate our growth plans. CryptoLogic Managements Discussion & Analysis
For the year ended December 31, 2004 -34-