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PokerTek 10-K 2009
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

x
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2008

OR

o
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________________to______________________

Commission File Number: 000-51572


 
PokerTek, Inc.
 
(Exact name of registrant as specified in its charter)
North Carolina
 
61-1455265
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
1150 Crews Road, Suite F, Matthews, North Carolina 28105
(Address of principal executive offices) (Zip Code)
(704) 849-0860
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
Common Stock, no par value
The NASDAQ Stock Market LLC
(NASDAQ Capital Market)

Securities registered pursuant to Section 12(g) of the Act:  >None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o  No x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o  No x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x   No o

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
  o
Large accelerated filer
o 
Accelerated filer
  o
Non-accelerated filer (do not check if a smaller reporting company)
x
Smaller reporting company
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o  No x
 
The aggregate market value of the common equity held by non-affiliates of the registrant as of June 30, 2008 was $18,658,255 based upon the last reported sale price on the NASDAQ Global Market (on which our shares were traded prior to our transition to the NASDAQ Capital Market in December 2008) on June 30, 2008.

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

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

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

 
Cautionary Note Regarding Forward-Looking Statements

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

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

 
PART I

Item 1.                 Business.

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

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


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

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


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

PokerPro Gaming Products

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

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

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

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

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

 
   
2008
   
2007
   
2006
   
2005
   
2004
 
                               
Commercial Casinos
    2,631       2,381       2,354       1,722       868  
Tribal Casinos
    2,153       2,086       1,989       1,755       1,046  
Card Clubs
    1,396       1,351       1,352       1,198       1,028  
Other
    955       934       703       341       269  
Total North American Market
    7,135       6,752       6,398       5,016       3,211  
Total International Market
    3,048       2,645       2,619       2,006       1,670  
Total Global Market
    10,183       9,397       9,017       7,022       4,881  
                                         
North American Annual Growth
    5.7 %     5.5 %     27.6 %     56.2 %     11.9 %
International Annual Growth
    15.2 %     1.0 %     30.6 %     20.1 %     28.3 %
 
During late 2008 and early 2009, overall economic conditions weakened in the United States and abroad, negatively impacting attendance and consumer spending in most gaming markets. Accordingly, as casino operators experience increased financial pressure, we expect that growth in poker tables could slow or reverse in 2009.

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

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

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In Canada, there were 63 commercial casinos operating in 8 provinces.  We have regulatory approval to operate in commercial casinos in Quebec and are pursuing regulatory approval to operate in Ontario, as well as in the Canadian provinces operated by the Atlantic Lottery Corporation.
   
As of December 31, 2008, we had 87 PokerPro tables in commercial casinos in the United States and Canada.

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

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

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

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

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

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

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

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

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


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

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


We believe that our facility has sufficient capacity to meet demand and that our sources of supply are adequate. Several key components we use in the manufacture of our products are proprietary and are currently assembled by a single contract manufacturer.  Also, certain complex integrated circuits are manufactured by a single source and are critical to our product designs.  Changing manufacturers for any of these components would require significant time and effort on the part of our management team, may require additional engineering development work, and could have a disruptive impact on our operations.  
 
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In addition, as part of an initiative underway to reduce our manufacturing costs, we are transitioning more of our components to the contract manufacturer that also produces our Heads-Up Challenge product, increasing our overall dependency on this supplier.
 
The components we use are produced primarily in Taiwan and China and are subject to long lead times and other issues associated with managing an international supply chain.  Furthermore, we compete with other companies for the production capacity of third-party manufacturers and suppliers for displays and for other components.


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

Heads-Up Challenge Amusement Products


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

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




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


4

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

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

Gaming Regulations and Licensing


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

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

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


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

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


The IGRA provides a statutory basis for Native American tribes to operate certain gaming activities, depending on how a particular game is classified and whether the laws of the state where the Native American tribe is located allow or prohibit the particular game. The gaming classifications are: Class I, Class II and Class III.
·  
Class I gaming include traditional Native American social and ceremonial games and are regulated only by the tribes.
·  
Class II gaming includes bingo and certain card games such as poker, so long as the card game is not prohibited by the laws of the state where the tribe is located, the card game is played somewhere in the state and the playing of the card game conforms to any applicable state law.
·  
Class III gaming consists of all forms of gaming that are not Class I or Class II, such as video lottery games, slot machines, most table games and keno.

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

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

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




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

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

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

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

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

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

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

·  
Conformité Européenne (“CE”), a mandatory European marking for certain product groups to indicate      conformity with the essential health and safety requirements set out in European Directives;
·  
Federal Communications Commission (“FCC”), which regulates radio emissions of electronic devices;
·  
The RoHS Directive (“ROHS”), which bans the placing on the European Union market of new electrical and electronic equipment containing more than agreed levels of certain hazardous materials; and
·  
Underwriters Laboratories, Inc. (“UL”), a product safety compliance testing laboratory.

6


Corporate History

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

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

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

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

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

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

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

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

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



7

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

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

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

Seasonality and Business Fluctuations

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

Backlog

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

Customer Dependence

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

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

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

Item 1A.                      Risk Factors.

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

Casinos and other gaming operators represent a significant portion of our customers. Therefore, factors that may negatively impact the casino industry may also negatively impact our future revenues. If casinos experience reduced patronage, revenues may be reduced as our games may not perform well and may be taken off of the casino floor altogether. The level of casino patronage, and therefore our revenues, are affected by a number of factors beyond our control, including:
·  
general economic conditions;
 
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·  
levels of disposable income of casino patrons;
·  
downturn or loss in popularity of the gaming industry in general, and table and slot games in particular;
·  
the relative popularity of entertainment alternatives to casino gaming;
·  
the growth and number of legalized gaming jurisdictions; 
·  
local conditions in key gaming markets, including seasonal and weather-related factors; 
·  
increased transportation costs;
·  
acts of terrorism and anti-terrorism efforts;
·  
changes or proposed changes to tax laws; 
·  
increases in gaming taxes or fees; 
·  
legal and regulatory issues affecting the development, operation and licensing of casinos;
·  
the availability and cost of capital to construct, expand or renovate new and existing casinos;
·  
the level of new casino construction and renovation schedules of existing casinos; and
·  
competitive conditions in the gaming industry and in particular gaming markets, including the effect of such conditions on the pricing of our games and products.

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

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

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

Moreover, the market for the PokerPro system is limited; according to Casino City Press, as of December 2008, there were approximately 7,135 poker tables operating in the United States and Canada and 3,048 outside the United States and Canada.  Although we believe that this represents a significant opportunity for the PokerPro system, the number of venues in which the PokerPro system can be placed is finite, as the number of jurisdictions in which gaming is legal is limited.
 
During late 2008 and continuing into 2009, the global economy experienced a significant downturn that has impacted attendance and consumer spending on gaming and other leisure activities. Casino operators are experiencing unprecedented financial pressure which may lead them to curtail operations, close facilities, delay poker room conversions, or be unable to meet their financial obligations.  In addition, reductions in consumer spending may impact the ability of amusement operators to generate acceptable returns or continue to operate their businesses.  Our vendors are also under increased financial pressure, which could impact their ability to operate their businesses or deliver products to us.
 
We derive a significant portion of our revenues from the leasing, licensing and sale of the PokerPro system and from providing related maintenance and support.  Gaming revenues and occupancy in major gaming markets have declined significantly, causing many casino operators to reevaluate their operations, reduce expenses, and in some cases to cease operations or seek bankruptcy protection.  We also believe that operators in the amusement markets are experiencing increasing financial pressures and believe that many operators have limited financial resources and would be adversely impacted by a sustained economic downturn.  During early 2009, we believe that some smaller operators have been forced to curtail or cease operations. We also understand that electronics and other vendors in the Far East are experiencing significant declines in demand from their international customers, which could possibly impact their ability to manufacture and deliver products efficiently and at acceptable costs.
 
A prolonged decline in consumer spending on gaming and amusement activities could have a significant impact on our customers and our vendors.  Accordingly, such a prolonged downturn could have a significant impact our business operations and financial condition.
 
 We recently entered into new debt financing arrangements, which could have a material adverse effect on our financial health and our ability to obtain financing in the future, and may impair our ability to react quickly to changes in our business.>
 
9

 
We entered into a loan and two credit facilities during 2008, introducing certain risks associated with debt financing.  As of December 31, 2008, we had $4.9 million in debt outstanding. and we had the ability to borrow additional funds. Our increased exposure to debt financing could limit our ability to satisfy our obligations, limit our ability to operate our business and impair our competitive position. For example, it could:
 
 
increase our vulnerability to adverse economic and industry conditions, including interest rate fluctuations,   because a portion of our borrowings are at variable rates of interest; 
 
require us to dedicate future cash flows to the repayment of debt.  This could reduce the availability of cash to fund working capital, capital expenditures or other general corporate purposes; 
 
limit our flexibility in planning for, or reacting to, changes in our business and industry; and
 
limit our ability to obtain additional debt or equity financing due to applicable financial and restrictive covenants contained in our debt agreements.
 
Despite current indebtedness levels, we may also incur additional indebtedness in the future, which could materially increase the impact of these risks on our financial condition and results of operations.
 
Our ability to repay our debt depends on many factors beyond our control.  If we elect to raise equity capital in the future, our current shareholders could be subjected to significant dilution. If we are unable to raise capital in the future, we may seek other avenues to fund the business, including sale/leaseback arrangements, transitioning PokerPro from a capital intensive leasing strategy to a product sale strategy, or seeking to sell assets of all, or a portion of, our operations.
 
Payments on our debt will depend on our ability to generate cash or secure additional financing in the future. This ability, to an extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors beyond our control. If our business does not generate sufficient cash flow from operations, and sufficient future financing is not available to us, we may not be able to repay our debt, operate our business or fund our other liquidity needs. If we cannot meet or refinance our obligations when they become due, this may require us to attempt to raise capital, sell assets, reduce expenditures or take other actions which we may be unable to successfully complete or, even if successful, could have a material adverse effect on us. If such sources of capital are not available or not available on sufficiently favorable terms, we may seek other avenues to fund the business, including sale/leaseback arrangements, transitioning PokerPro from a capital intensive leasing strategy to a product sale strategy, or seeking to sell assets of all, or a portion of, our operations. If we decide to raise capital in the equity markets or take other actions, our shareholders could incur significant dilution or diminished valuations, or, if we are unable to raise capital, our ability to effectively operate our business could be impaired.
 
In addition, based on the recent trading price of our common stock, if we are successful in raising capital in the equity markets to repay our indebtedness, or for any other purpose in the future, our shareholders would incur significant dilution.
 
The agreements and instruments governing our debt contain restrictions and limitations which could significantly impact our ability to operate our business.
 
Our credit facility with Silicon Valley Bank contains a number of significant covenants that could adversely impact our business by limiting our ability to obtain future financing, withstand a future downturn in our business or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise.  The credit facility includes covenants requiring the achievement of specified financial ratios and thresholds and contains other terms and conditions qualifying the terms upon which Silicon Valley Bank is required to extend funds.  Our ability to comply with these provisions may be affected by events beyond our control.
 
We are dependent on a small number of key suppliers and customers.  Changes in our relationships with these parties, or changes in the economic environments in which they operate, could have a material adverse effect on our business, financial condition, results of operations and cash flows.
 
Our revenues are concentrated with a small number of customers.  As of December 31, 2008, five of our customers made up approximately 75% of our total revenues.  The loss of any of these customers or changes in our relationship with them could have a material adverse effect on our business.
 
To manufacture our casino and amusement products, we purchase components from independent manufacturers, many of whom are located in the Far East.  An extended interruption in the supply of these products or suitable substitute inventory would disrupt our operations, which could have a material adverse effect on our business, financial condition and results of operations.
 
For a number of our inventory components, and for all of our Heads-Up Challenge finished goods, we rely on a single supplier. We are currently transitioning the manufacturing of more of our components to this supplier, increasing our dependence on that third party.  We cannot estimate with any certainty the length of time that would be required to establish alternative supply relationships, or whether the quantity or quality of materials that could be so obtained would be sufficient.  Furthermore, we may incur additional costs in sourcing materials from alternative producers.  The disruption of our inventory supply, even in the short term, could have a material adverse effect on our business, financial condition and results of operations.
 
10

 
A significant portion of our business is conducted with customers and suppliers located outside of the United States.  Currency, economic, political and other risks associated with our international operations could adversely affect our operating results.
 
            Our revenues from international customers and our inventory costs from international suppliers are exposed to the potentially adverse effects of currency exchange rates, local economic conditions, political instability and other risks associated with doing business in foreign countries. To the extent that our revenues and purchases from international business partners increase in the future, our exposure to changes in foreign economic conditions and currency fluctuations will increase.
 
            Our dependence on foreign customers and suppliers means, in part, that we may be affected by changes in the relative value of the U.S. dollar to foreign currencies.  Although our receipts from foreign customers and our purchases of foreign products are principally negotiated and paid for in U.S. dollars, changes in the applicable currency exchange rates might negatively affect the profitability and business prospects of our customers and vendors.  This, in turn, might cause such vendors to demand higher prices, delay shipments, or discontinue selling to us.  This also might cause such customers to demand lower prices, delay or discontinue purchases of our products or demand other changes to the terms of our relationships.  These situations could in turn ultimately reduce our revenues or increase our costs, which could have a material adverse effect on our business, financial condition and results of operations.  
 
We have reported significant deficiencies in internal control over financial reporting, which could materially impact our financial reporting ability.

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

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

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

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

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

Our success depends to a large extent on broad market acceptance of the PokerPro system among casinos and poker players. Even if we demonstrate the effectiveness of the PokerPro system and our business model, casinos and poker players may still not use the PokerPro system for a number of other reasons, including preference for live dealers, mistrust of technology and perceived lack of reliability. We believe that increased acceptance of the PokerPro system by casinos and poker players will depend on the following factors:
·  
players becoming comfortable with using the PokerPro system; and
 
11

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

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

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

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

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

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

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

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

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

12

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

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

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

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

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

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

13

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

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

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


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

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

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

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

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

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

14

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


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

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

We have experienced rapid growth placing significant demands on our operational and financial infrastructure. If we do not effectively manage our growth, our ability to develop and market the PokerPro system and the Heads-Up Challenge products could suffer, which could negatively affect our operating results.
 
Our success will depend on the reliability and performance of third-party distributors, manufacturers and suppliers.


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

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

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

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

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

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

15

 
Item 1B.              Unresolved Staff Comments.

None.

Item 2.                 Properties.

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

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

Item 3.                 Legal Proceedings.

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

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

There was no material financial impact to PokerTek as a result of the settlement.
 
Item 4.                 Submission of Matters to a Vote of Security Holders.

None.

PART II

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

Stock Listing

As of December 8, 2008, our common stock is traded on the NASDAQ Capital Market under the symbol PTEK.  Our stock was previously traded on the NASDAQ Global Market.  The table below shows the high and low sales prices for our common stock for the periods indicated, as reported by the NASDAQ Global Market and Capital Market.
 
   
Market Prices of Common Stock
 
   
2008
   
2007
 
Quarter ended
 
High
   
Low
   
High
   
Low
 
March 31
  $ 8.54     $ 3.44     $ 11.00     $ 8.10  
June 30
    6.30       2.05       13.75       8.81  
September 30
    5.39       2.51       12.97       9.30  
December 31
    3.00       1.20       10.15       5.86  

As of March 12, 2009, there were approximately 1,100 holders of record of our common stock.
 
16

 
Transfer Agent

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

To date no cash dividends have been paid with respect to our common stock and the current policy of the Board of Directors is to retain any earnings to provide for the growth of the Company. The payment of cash dividends in the future, if any, will depend on factors such as earnings levels, capital requirements, our overall financial condition and any other factors deemed relevant by our Board of Directors.
 
Item 6.                 Selected Financial Data.

The following selected financial data has been derived from audited financial statements for the years ended December 31, 2008, 2007, 2006, 2005, and 2004. The selected financial data set forth below should be read together with Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, as well as Item 8 – “Financial Statements and Supplementary Data” and the related notes to those consolidated financial statements appearing elsewhere in this report.
 
   
Years Ended December 31,
 
   
2008
   
2007
   
2006
   
2005
   
2004
 
   
(in thousands, except per share amounts and table count/unit sales data)
 
Statement of operations data:
                             
Revenue
  $ 14,425     $ 4,005     $ 1,980     $ 314     $ -  
Operating loss
    (7,282 )     (13,414 )     (9,886 )     (3,891 )     (932 )
Net loss
    (7,639 )     (12,850 )     (9,146 )     (3,701 )     (926 )
EBITDAS(1)
    (3,274 )     (10,514 )     (8,346 )     (3,490 )     (920 )
Net cash used in operating activities
    (6,521 )     (14,394 )     (10,161 )     (5,114 )     (937 )
Net cash provided by (used in) investing activities
    1,918       1,246       6,677       (15,387 )     (66 )
Net cash provided by (used in) financing activities
    4,855       12,574       (37 )     24,501       2,306  
                                         
Loss per common share - basic and diluted:
                                       
Net loss per common share - basic and diluted(2)
  $ (0.70 )   $ (1.23 )   $ (0.97 )   $ (0.49 )   $ (0.16 )
Weighted average common shares outstanding - basic and diluted(2)
    10,941       10,463       9,471       7,517       5,744  
                                         
Balance sheet data (at end of period):
                                       
Current assets
  $ 10,742     $ 11,122     $ 11,731     $ 21,441     $ 1,354  
Total assets
    15,706       17,096       15,123       22,703       1,422  
Current liabilities
    5,533       2,429       1,003       214       15  
Total liabilities
    7,572       2,429       1,003       214       340  
Shareholders' equity
    8,134       14,667       14,120       22,489       1,082  
Working capital(3)
    5,209       8,693       10,728       21,227       1,339  
                                         
Table count/Unit sales data:
                                       
PokerPro table count end of year
    275       189       71       20       -  
Heads-Up Challenge units sold
    1,108       40       -       -       -  
 
(1)  
In addition to disclosing financial results prepared in accordance with GAAP, the Company discloses information regarding EBITDAS, which differs from the term EBITDA as it is commonly used.   In addition to adjusting net loss to exclude taxes, interest, and depreciation and amortization, EBITDAS also excludes share-based compensation expense.   EBITDA and EBITDAS are not measures of performance defined in accordance with GAAP. However, EBITDAS is used internally by PokerTek’s management and by its lenders in planning and evaluating the Company’s operating performance.  Accordingly, management believes that disclosure of this metric offers investors, lenders and other stakeholders with an additional view of the Company’s operations that, when coupled with the GAAP results, provides a more complete understanding of the Company’s financial results.  EBITDAS should not be considered as an alternative to net loss or to net cash used in operating activities as a measure of operating results or of liquidity. It may not be comparable to similarly titled measures used by other companies, and it excludes financial information that some may consider important in evaluating the Company’s performance.  A reconciliation of GAAP net loss to EBITDAS is included in the accompanying financial schedules.
 
(2)  
We were initially organized in August 2003 as a North Carolina corporation named National Card Club Corporation. From March 19, 2004 through July 27, 2004, we owned a majority interest in an affiliated limited liability company called PokerTek, LLC.  On July 27, 2004, PokerTek, LLC merged with and into National Card Club Corporation and we changed our name to PokerTek, Inc.  Pursuant to this merger, the equity interests in PokerTek, LLC that we owned were cancelled and all other equity interests in PokerTek, LLC were converted into common stock in PokerTek, Inc., as described in Part I, Item 1, “Business” of this Annual Report on Form 10-K.  The net loss per common share gives retroactive effect to the merger for the periods presented. As of December 31, 2008, 2007, 2006, 2005 and 2004, there were options to purchase an aggregate of 2,023,263, 2,034,825, 1,600,650, 1,053,650 and 471,500 shares, respectively. The options outstanding have no dilutive effect on net loss per common share.

(3)  
Working capital is defined as total current assets less total current liabilities.
 
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(4)  
A reconciliation of net loss to EBITDAS is as follows:
 
   
2008
   
2007
   
2006
   
2005
   
2004
 
EBITDAS Reconciliation
                             
     Net loss
  $ (7,638,773 )   $ (12,849,616 )   $ (9,145,718 )   $ (3,700,544 )   $ (925,837 )
     Interest income (expense), net
    94,285       (564,600 )     (740,761 )     (190,309 )     (6,041 )
     Income tax provision
    262,905       -       -       -       -  
     Other taxes
    107,752       24,126       17,198       598       -  
     Depreciation
    2,793,225       2,053,345       709,593       119,783       306  
     Stock-based compensation expense
    1,106,113       822,349       813,316       280,212       11,271  
        EBITDAS
  $ (3,274,493 )   $ (10,514,396 )   $ (8,346,372 )   $ (3,490,260 )   $ (920,301 )

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

Forward-Looking Statements

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

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

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

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


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

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


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


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

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


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

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

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

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

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


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

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

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




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

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

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

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

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


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

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


Liquidity and Capital Resources

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

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

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Discussion of Statement of Cash Flows

   
Years Ended December 31,
       
   
2008
   
2007
   
Change
 
Net cash used in operating activities
  $ (6,521,360 )   $ (14,394,111 )   $ 7,872,751  
Net cash provided by investing activities
    1,918,287       1,246,404       671,883  
Net cash provided by financing activities
    4,854,623       12,574,186       (7,719,563 )
                         
Net increase (decrease) in cash and cash equivalents
    251,550       (573,521 )     825,071  
                         
Cash and cash equivalents, beginning of year
    1,229,980       1,803,501          
                         
Cash and cash equivalents, end of year
  $ 1,481,530     $ 1,229,980          
 
For the year ended December 31, 2008, net cash used in operating activities improved $7.9 million (55%) to $6.5 million as compared to $14.4 million for the year ended December 31, 2007. The improvement in operating cash flows resulted from improvement in the company’s operating results as well as declines in the cash invested in working capital.

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

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


On April 23, 2007, we entered into a Securities Purchase Agreement, pursuant to which we issued and sold an aggregate of 1,444,444 shares of our common stock in a private placement to certain investors for a purchase price of $9.00 per share.  The private placement, which was completed on April 26, 2007, resulted in gross proceeds of approximately $13.0 million and net proceeds of approximately $12.5 million after fees and expenses associated with the private placement, including a cash placement agent fee.
 
Founders’ Loan. >On March 24, 2008, we entered into a loan agreement with Lyle A. Berman, James T. Crawford III, Arthur Lee Lomax and Gehrig H. “Lou” White.  Messrs. Crawford, Lomax and White are the founders of the Company.  Each of the lenders are also members of our board of directors, with Mr. Berman serving as Chairman and Mr. White serving as Vice Chairman. Upon closing, the lenders loaned us $2.0 million and we issued the lenders a promissory note in the principal amount of $2.0 million. The loan bears interest at an annual rate of 13% with all unpaid principal and interest payable on March 24, 2010.  We are paying and intend to continue to pay interest on a monthly basis. The loan principal may be repaid prior to maturity without penalty.  The loan contains no restrictive covenants and is collateralized by a security interest in our PokerPro systems deployed in North America and on cruise ships as of December 31, 2007.
 
SVB Credit Facility:  >On July 25, 2008, we entered into a credit facility with Silicon Valley Bank to support our working capital (the “SVB Credit Facility”).  The SVB Credit Facility is nominally denoted as a $5.0 million facility with an actual maximum availability that varies based on specified percentages of domestic and foreign accounts receivable and inventory.  Based on our accounts receivable and inventory levels on December 31, 2008, as of such date availability under the SVB Credit Facility was approximately $1.6 million, with no borrowings outstanding.   The SVB Credit Facility has a one-year term and bears interest at an annual rate of prime plus 2.0%.  The SVB Credit Facility includes covenants requiring the achievement of specified financial ratios and thresholds and contains other terms and conditions customary for this type of credit facility. 

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

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

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

·  
The pace of growth in our casino business in the North American and cruise ship markets and the related investments we may need to make in inventory and PokerPro systems.
o  
Growth in these markets require working capital as the expenditures required to manufacture and install PokerPro tables are generally incurred in advance of product placement, whereas revenues are generally earned over time on a monthly lease basis. The capital intensive nature of the PokerPro leasing business makes access to the capital markets an important component of managing and growing our business.
·  
The pace of growth in sales of our Heads-Up Challenge amusement product and the related investments we may make in inventory and purchase commitments.
o  
The Heads-Up Challenge business model is less capital intensive than PokerPro, generally resulting in upfront product margins.  However, due to long lead times associated with an international supply chain and in order to minimize manufacturing costs, we have entered into significant purchase commitments with our supplier requiring us to purchase inventory in future periods based on forecasts which may not match up with the timing of our product sales.
·  
Our ability to control our operating expenses and generate positive operating leverage as we grow.
o  
We have reorganized our overhead structure and reduced our operating costs significantly between the third quarter of 2007 and the first quarter of 2009.  Our ability to further streamline the organization and continue to reduce operating costs is not unlimited and we may need to hire additional personnel or otherwise increase our operating expenses as we grow.
·  
Our ability to negotiate favorable payment terms with our customers and vendors.
·  
The impact of the economy or other factors on our customers and suppliers, including the impact on demand for our products and our customers’ ability to pay us on a timely basis.

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

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

23


Impact of Inflation

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

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

24


Contractual Obligations

The table below sets forth our known contractual obligations as of December 31, 2008:
 
   
Total
   
Less than
1 year
   
1 - 3 years
   
3 - 5 years
   
More than
5 years
 
                               
Debt obligations
  $ 5,190,357     $ 3,125,357     $ 2,065,000     $ -     $ -  
Operating lease obligations
    637,263       258,729       378,534       -       -  
Capital lease obligations
    70,246       28,747       41,499       -       -  
Purchase obligations
    2,232,302       2,232,302       -       -       -  
Other long-term liabilities
    -       -       -       -       -  
            Total
  $ 8,130,168     $ 5,645,135     $ 2,485,033     $ -     $ -  
 
(1)  
Represents the outstanding principal amount and interest on our Founder’s Loan and UBS Credit Facility.
(2)  
Represents operating lease agreements for office and storage facilities and office equipment.
(3)  
Represents outstanding principal and interest payable under capital lease obligations related to our purchase of internal-use ERP system.
(4)  
Represents open purchase orders with our vendors, primarily purchase obligations for Heads-Up Challenge.

Critical Accounting Policies

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

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

Revenues from product sales, including sales of the PokerPro system to Aristocrat International Pty. Limited (“Aristocrat”), our international distributor for PokerPro gaming products and a significant shareholder, are recognized when all of the following have occurred:
·  
Persuasive evidence of an arrangement exists;
·  
The fee is fixed or determinable;
·  
Delivery has occurred;
·  
Collectibility is reasonably assured; and
·  
Title and risk of loss have passed to the customer.

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

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




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

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

Recent Accounting Pronouncements

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

26

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

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

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

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

In February 2007, the FASB issued Statement of Financial Accounting Standard No. 159, The Fair Value Option for Financial Assets and Liabilities (“FAS 159”). FAS 159 provides entities with the option to report selected financial assets and liabilities at fair value. Business entities adopting FAS 159 will report unrealized gains and losses in earnings at each subsequent reporting date on items for which the fair value option has been elected. We elected the fair value option for our ARS investments as of December 31, 2008 (See Note 2, Investments in Auction Rate Securities (“ARS”)).
 
Item 7A.              Quantitative and Qualitative Disclosures about Market Risk.

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

 
Our investments in ARS are subject to significant market and interest rate risk due to the failure of the auction process to provide liquidity and due to the long term maturities of the underlying investment securities.   In addition to our investment in ARS, as of December 31, 2008, we also held a Rights Option issued by UBS Financial Services, giving us the right to put the ARS investments back to UBS at par for a specified period of time beginning on January 2, 2009.  As of December 31, 2008, the estimated fair value of the Investment in ARS was $3.3 million and our cost basis was $3.9 million.  As of December 31, 2008, the estimated fair value of the Rights Option was $0.6 million and our cost basis was zero.
 
27

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

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

 
 
On January 5, 2009, subsequent to the end of 2008, we exercised our rights to put those ARS investments back to UBS at par value.  We received net cash proceeds of $1.0 million after selling our $3.9 million ARS investment to UBS and liquidating our $2.9 million in advances under the UBS Credit Facility. We no longer have any investments in ARS or debt with UBS following this transaction.
 
Foreign currency risk>.  Our revenues from international customers and our inventory costs from international suppliers are exposed to the potentially adverse effects of currency exchange rates, local economic conditions, political instability and other risks associated with doing business in foreign countries. To the extent that our revenues and purchases from international business partners increase in the future, our exposure to changes in foreign economic conditions and currency fluctuations will increase.
 
Our dependence on foreign customers and suppliers means, in part, that we are affected by changes in the relative value of the U.S. dollar to foreign currencies, particularly the British pound, Euro Canadian dollar and Taiwan dollar.  Although our receipts from foreign customers and our purchases of foreign products are principally negotiated and paid for in U.S. dollars, changes in the applicable currency exchange rates might negatively affect the profitability and business prospects of our customers and vendors.  This, in turn, might cause such vendors to demand higher prices, delay shipments, or discontinue selling to us.  This also might cause such customers to demand lower prices, delay or discontinue purchases of our products or demand other changes to the terms of our relationships.  These situations could in turn ultimately reduce our revenues or increase our costs, which could have a material adverse effect on our business, financial condition or results of operations.

We do not use derivative financial instruments for speculation, or trading purposes, or engage in any other hedging strategies with regard to our foreign currency risk.
 
Item 8.                  Financial Statements and Supplementary Data.

The information required by this Item is submitted as a separate section of this Annual Report commencing on page F-1 attached hereto.
 
Item 9.                  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.
 
28

 
Item 9A (T).         Controls and Procedures.

Disclosure Controls and Procedures

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

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

Management’s Report on Internal Control over Financial Reporting

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

The Company’s internal control over financial reporting includes those policies and procedures that:
·  
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;
·  
provide reasonable assurance that transactions are recorded properly to allow for the preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company;
·  
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements; and
·  
provide reasonable assurance as to the detection of fraud.

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

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

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

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

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

29

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

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

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

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

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

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

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

Changes in Internal Control over Financial Reporting

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

Item 9B.               Other Information.

None.
 
30

 
PART III
 
Item 10.               Directors, Executive Officers and Corporate Governance.
 
Information called for by this item may be found in our definitive Proxy Statement in connection with our 2009 Annual Meeting of Shareholders to be filed with the SEC under the headings “Board of Directors and Management,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Corporate Governance Matters” and is incorporated herein by reference.

Item 11.               Executive Compensation.
 
Information called for by this item may be found in our definitive Proxy Statement in connection with our 2009 Annual Meeting of Shareholders to be filed with the SEC under the headings “Executive Compensation” and “Corporate Governance Matters” and is incorporated herein by reference.

Item 12.               Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
 
Information called for by this item may be found in our definitive Proxy Statement in connection with our 2009 Annual Meeting of Shareholders to be filed with the SEC under the headings “Equity Compensation Plan Information” and  “Security Ownership of Certain Beneficial Owners and Management” and is incorporated herein by reference.

Item 13.               Certain Relationships and Related Transactions, and Director Independence.
 
Information called for by this item may be found in our definitive Proxy Statement in connection with our 2009 Annual Meeting of Shareholders to be filed with the SEC under the headings “Related Person Transactions” and “Corporate Governance Matters” and is incorporated herein by reference.

Item 14.               Principal Accounting Fees and Services.
 
Information called for by this item may be found in our definitive Proxy Statement in connection with our 2009 Annual Meeting of Shareholders to be filed with the SEC under the headings “Independent Registered Public Accounting Firm Fee Information” and “Audit Committee Pre-Approval Policy” and is incorporated herein by reference.

31

 
PART IV

Item 15.               Exhibits, Financial Statement Schedules.

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

1.      Financial Statements
The following financial statements are included in a separate section of this Annual Report on Form 10-K beginning on page F-1:
·  
Report of Independent Registered Public Accounting Firm;
·  
Consolidated Statements of Operations for the years ended December 31, 2008, December 31, 2007 and December 31, 2006;
·  
Consolidated Balance Sheets as of December 31, 2008 and December 31, 2007;
·  
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2008, December 31, 2007 and December 31, 2006;
·  
Consolidated Statements of Cash Flows for the years ended December 31, 2008, December 31, 2007 and December 31, 2006; and
·  
Notes to Consolidated Financial Statements.

2.      Financial Statement Schedules
 
The following financial statement schedule is included in a separate section of this Annual Report on page S-1:
·  
Valuation and Qualifying Accounts and Reserves

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

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

(b) See the Exhibit Index.

(c) Separate Financial Statements and Schedules
None.
 
32

 
SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
     
  PokerTek, Inc.  
       
Date: March 31, 2009
By:
/s/ Christopher J.C. Halligan  
   
Christopher J.C. Halligan
Chief Executive Officer
 
       
       
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
             
             
/s/
Christopher J.C. Halligan
   
Date:
March 31, 2009
 
Name:
Christopher J.C. Halligan
         
Title:
Chief Executive Officer
         
 
(Principal Executive Officer)
         
             
/s/
Mark D. Roberson
   
Date:
March 31, 2009
 
Name:
Mark D. Roberson
         
Title:
Chief Financial Officer
         
 
(Principal Financial Officer and Principal Accounting Officer)
       
             
/s/
Lyle Berman
   
Date:
March 31, 2009
 
Name:
Lyle Berman
         
Title:
Chairman of the Board of Directors
         
             
/s/
Gehrig H. White
   
Date:
March 31, 2009
 
Name:
Gehrig H. White
         
Title:
Vice Chairman of the Board of Directors
         
             
/s/
James T. Crawford, III
   
Date:
March 31, 2009
 
Name:
James T. Crawford, III
         
Title:
President, Secretary and Director
         
             
/s/
Joseph J. Lahti
   
Date:
March 31, 2009
 
Name:
Joseph J. Lahti
         
Title:
Director
         
             
/s/
Arthur Lee Lomax
   
Date:
March 31, 2009
 
Name:
Arthur Lee Lomax
         
Title:
Director
         
 
33


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

F - 1



To the Board of Directors and Shareholders
PokerTek, Inc.
Matthews, North Carolina

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

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

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

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



/s/ McGladrey & Pullen, LLP                                                      
Charlotte, North Carolina
March 31, 2009
 
F - 2

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

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

 
POKERTEK, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
                               
   
Common Stock
   
Additional
Paid-in Capital
   
Accumulated
Deficit
   
Total
Shareholders'
Equity
 
   
Shares
   
Value
                   
Balance, December 31, 2005
    9,468,020     $ -     $ 27,180,041     $ (4,691,356 )   $ 22,488,685  
                                         
Expenses from issuance of common stock
    -       -       (36,712 )     -       (36,712 )
Stock options exercised
    4,000       -       40       -       40  
Share-based compensation
    -       -       813,316       -       813,316  
Net loss
    -       -       -       (9,145,718 )     (9,145,718 )
Balance, December 31, 2006
    9,472,020       -       27,956,685       (13,837,074 )     14,119,611  
                                         
Net proceeds from private placement of common stock
    1,444,444       -       12,507,578       -       12,507,578  
Stock options exercised
    18,000       -       66,608       -       66,608  
Share-based compensation
    -       -       822,349       -       822,349  
Net loss
    -       -       -       (12,849,616 )     (12,849,616 )
Balance, December 31, 2007
    10,934,464       -       41,353,220       (26,686,690 )     14,666,530  
                                         
Stock warrants exercised
    86,965       -       -       -       -  
Share-based compensation
    -       -       1,106,113       -       1,106,113  
Net loss
    -       -       -       (7,638,773 )     (7,638,773 )
Balance, December 31, 2008
    11,021,429     $ -     $ 42,459,333     $ (34,325,463 )   $ 8,133,870  
 
The accompanying notes are an integral part of these consolidated financial statements.
F - 5

 POKERTEK, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
                   
   
Years Ended December 31,
 
   
2008
   
2007
   
2006
 
Cash flows from operating activities:
                 
Net loss
  $ (7,638,773 )   $ (12,849,616 )   $ (9,145,718 )
Adjustments to reconcile net loss to net cash used in operating activities:
                 
Depreciation
    2,793,225       2,053,345       709,593  
Share-based compensation expense
    1,106,113       822,349       813,316  
Provision for accounts and other receivables
    14,672       47,129       19,301  
Changes in assets and liabilities:
                       
Accounts and other receivables