10QSB 1 v029205_10qsb.htm
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-QSB
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended:
September 30, 2005
 
OR
 
o
TRANSITION REPORT PURSUANT SECTION 13 OR 15(d) OF THE EXCHANGE ACT
 
For the transition period from:
   
to
    

Commission file number:
001-32161

VendingData Corporation
(Exact name of small business issuer as specified in its charter)
 
     
Nevada
 
91-1696010
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
6830 Spencer Street, Las Vegas, Nevada 89119
(Address of principal executive offices)
 
(702) 733-7195
(Issuer’s telephone number)
 
     
(Former name, former address and former fiscal year, if changed since last report)
 
 
 
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period 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
 
Check whether the issuer is a shell company (as defined by Rule 12b-2 of the Exchange Act).   Yes o  No x
 
APPLICABLE ONLY TO CORPORATE ISSUERS
 
State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 16,947,337 shares of common stock, $.001 par value, as of November 3, 2005
 
Transitional Small Business Disclosure Format (check one):   Yes o  No x

 

VENDINGDATA CORPORATION

FORM 10-QSB


 

 
 
VENDINGDATA CORPORATION
       
   
September 30,
2005
 
ASSETS
 
(unaudited)
 
Current assets:
     
Cash and cash equivalents
 
$
442,728
 
Current portion of accounts receivable, trade, net of allowance for uncollectibles of $262,066
   
1,433,894
 
Due from affiliate
   
2,557
 
Other receivables
   
179,824
 
Inventories
   
4,937,137
 
Prepaid expenses
   
1,180,529
 
     
8,176,669
 
         
Equipment rented to customers, net of accumulated depreciation of $751,946
   
212,999
 
Property and equipment, net of accumulated depreciation of $2,280,487
   
761,922
 
Intangible assets, at cost, net of accumulated amortization of $581,098
   
1,787,034
 
Due from affiliate
   
79,400
 
Accounts receivable, trade, net of current portion, less unamortized discount
   
923,734
 
Deferred expenses
   
790,350
 
Deposits
   
7,798
 
   
$
12,739,905
 
         
LIABILITIES AND STOCKHOLDERS' EQUITY
       
Current liabilities:
       
Current portion of leases payable
 
$
753,956
 
Accounts payable
   
2,613,870
 
Accrued expenses
   
1,100,099
 
Deferred revenues, current portion
   
152,613
 
Short-term debt
   
50,000
 
Customer deposits
   
188,440
 
     
4,858,978
 
         
Long -term obligations
       
Deferred revenues, net of current portion
   
153,250
 
Notes payable
   
12,000,000
 
Leases payable, net of current portion
   
496,228
 
Total liabilities
   
17,508,456
 
 
Stockholders' equity:
       
Preferred stock, $.001 par value, 10,000,000 shares authorized, no shares issued and outstanding
       
Common stock, $.001 par value, 25,000,000 shares authorized, 17,312,058 shares issued
   
17,312
 
Treasury stock 448,053 shares of common stock at cost
   
(846,820
)
Deferred expenses
   
(1,956,485
)
Additional paid in capital
   
63,410,010
 
Deficit
   
(65,392,568
)
Total stockholders’ equity
   
(4,768,551
)
Total liabilities and stockholders’ equity
 
$
12,739,905
 
         
         
See accompanying notes to financial statements.
 
 
 
VENDINGDATA CORPORATION
 
(UNAUDITED)
           
   
Three Months Ended Sept 30,
 
Nine months Ended Sept 30,
 
   
2005
 
2004
 
2005
 
2004
 
                   
Revenues:
                 
Sales
 
$
131,852
 
$
643,866
 
$
1,751,521
 
$
2,276,395
 
Rental
   
159,662
   
137,002
   
416,441
   
509,175
 
Other
   
27,469
   
42,782
   
87,909
   
152,317
 
 
   
318,983
   
823,650
   
2,255,871
   
2,937,887
 
Sales returns and allowances
   
(20,002
)
       
(310,840
)
     
     
298,981
   
823,650
   
1,945,031
   
2,937,887
 
                           
Operating costs and expenses:
                         
Cost of sales
   
338,419
   
857,733
   
1,557,872
   
2,472,313
 
Selling, general and administrative
   
2,306,338
   
1,832,645
   
7,172,331
   
4,805,598
 
Research and development
   
591,807
   
350,112
   
1,069,496
   
1,145,101
 
Inventory write down
   
2,584,290
   
575,446
   
2,584,290
   
575,446
 
     
5,820,854
   
3,615,936
   
12,383,989
   
8,998,458
 
Loss from operations
   
(5,521,873
)
 
(2,792,286
)
 
(10,438,958
)
 
(6,060,571
)
                           
Interest expense, unrelated parties
   
384,665
   
188,261
   
1,193,472
   
682,362
 
Interest expense, related parties
         
9,460
   
15,063
   
24,523
 
(Gain) loss on disposition of assets 
                 1,900      (567
)
     
384,665
   
197,721
   
1,210,435
   
706,318
 
Net loss
 
$
(5,906,538
)
$
(2,990,007
)
$
(11,649,393
)
$
(6,766,889
)
                           
Basic loss per share
 
$
(0.35
)
$
(0.17
)
$
(0.68
)
$
(0.39
)
Weighted average shares outstanding
   
16,864,005
   
17,198,198
   
17,105,093
   
17,184,127
 
                           
                           
See accompanying notes to financial statements.



VENDINGDATA CORPORATION
 
(UNAUDITED)
       
   
Nine months Ended Sept 30,
 
   
2005
 
2004
 
           
Net loss
 
$
(11,649,394
)
$
(6,766,889
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
             
Depreciation
   
582,850
   
633,146
 
Amortization of deferred interest
   
158,552
   
209,070
 
Non-cash compensation expense
   
365,126
   
113,207
 
Loss on disposition of assets
   
1,900
   
(567
)
Equipment produced and held for rental
   
0
   
(46,193
)
Write down of inventory
   
2,584,290
   
575,446
 
Equipment converted from rental to sales
   
   
6,615
 
Increase in operating assets:
             
Trade accounts receivable
   
710,717
   
(261,085
)
Other receivables
   
(32,391
)
 
(78,176
)
Inventory
   
(1,074,013
)
 
(1,858,950
)
Prepaid expenses
   
(116,516
)
 
(339,630
)
Deferred expenses
   
(2,358,931
)
 
(597,378
)
Deposits with vendors
   
(3,079
)
 
353,769
 
Other assets
   
   
265,478
 
Accounts payable
   
1,189,145
   
(617,858
)
Accrued expenses
   
668,671
   
(261,411
)
Deferred expenses
   
(132,402
)
 
90,625
 
Customer expenses
   
(5,175
)
 
17,555
 
Total adjustments
   
2,538,744
   
(1,796,337
)
Net cash used in operating activities
   
(9,110,650
)
 
(8,563,226
)
               
Cash flows from investing activities:
             
Acquisition of intangible assets
   
   
(4,900
) 
Acquisition of plant and equipment
   
(897,707
)
 
(193,043
)
Disposition of equipment produced for rental
   
   
 
Disposition of intangible assets
   
   
665
 
Proceeds from sale of plant and equipment
   
4,700
   
 
Net cash used in investing activities
   
(893,007
)
 
(197,278
)
               
Cash flows from financing activities:
             
Reimbursement of offering expense
         
36,731
 
Proceeds from sale of stock
   
3,566,852
   
 
Acquisition of treasury stock
   
(846,820
)
     
Repayment of leases payable
   
(1,743,057
)
 
(1,731,966
)
Proceeds from notes payable
   
8,750,000
   
3,250,000
 
Repayment of short-term debt
   
(188,250
)
 
(32,493
)
Repayment of convertible debt
   
   
(1,603,077
)
Net cash provided by (used in) financing activities
   
9,538,725
   
(80,805
)
               
Decrease in cash and cash equivalents
   
(464,932
)
 
(8,841,309
)
Cash and cash equivalents at beginning of period
   
907,660
   
11,526,664
 
Cash and cash equivalents at end of period
 
$
442,728
 
$
2,685,355
 
               
               
See accompanying notes to financial statements.


VENDINGDATA CORPORATION AND SUBSIDIARIES
 

Note 1—Basis of Presentation
 
The accompanying unaudited financial statements of VendingData Corporation (the "Company") have been prepared in accordance with generally accepted accounting principles for interim financial information and with the rules and regulations of the Securities and Exchange Commission applicable to interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included.
 
The results of operations for the current period presented here are not necessarily indicative of the results to be expected for the full year. The accompanying financial statements should be read in conjunction with the Company's audited financial statements for the year ended December 31, 2004, included in the Company's Annual Report on Form 10-KSB filed with the Securities and Exchange Commission. As noted below, the Company intends to restate its financial statement for the year ended December 31, 2004 and file the restated fiscal 2004 financial statements by way of an amendment to its 2004 Annual Report on Form 10-KSB. Certain reclassifications have been made to amounts presented in prior periods for comparability to the current period presentation.
 
The accompanying unaudited financial statements, including the results of operations for the three and nine month periods ended September 30, 2004, give effect to the restatements discussed in the amended Quarterly Report on Form 10-QSB/A for those periods filed on November 14, 2005.

Note 2—Segments
 
The segments identified for geographic region-based enterprise-wide data are as follows:
 
   
Three Months Ended Sept 30,
 
 Nine months Ended Sept, 30,
 
   
2005
 
 2004
 
 2005
 
2004
 
                     
North America
 
$
298,981
 
$
791,995
 
$
1,553,981
 
$
2,893,609
 
Asia
   
   
31,655
   
267,300
   
44,278
 
Europe
   
   
   
99,000
   
 
South America
   
   
   
24,750
   
 
 

 
 
The Company's revenues, depreciation and operating income distributed by product are as follows:
           
   
Three Months Ended
 
Nine months Ended
 
   
Sept 30,
 
Sept 30,
 
   
2005
 
2004
 
2005
 
2004
 
                    
Revenues
                  
Secure Drop®
 
$
8,641
 
$
106,637
 
$
81,235
 
$
236,942
 
Shuffler
   
124,957
   
106,947
   
1,289,706
   
1,148,894
 
Deck CheckerTM
   
157,916
   
567,284
   
797,021
   
1,399,734
 
Other
   
27,469
   
42,782
   
87,909
   
152,317
 
Sales returns and allowances
   
(20,002
)
       
(310,840
)
     
   
$
298,981
 
$
823,650
 
$
1,945,031
 
$
2,937,887
 
Depreciation and amortization
                         
SecureDrop®
 
$
0
 
$
0
 
$
0
 
$
0
 
Shuffler
   
55,469
   
75,526
   
159,908
   
167,386
 
Deck CheckerTM
   
9,229
   
9,229
   
27,687
   
23,096
 
Selling, general and administrative
   
106,705
   
162,594
   
395,255
   
442,664
 
   
$ 
171,403
 
$ 
247,349
 
$ 
582,850
 
$ 
633,146
 
Operating income (loss)
                         
SeSecure Drop®
 
$ 
8,412
 
$
61,691
 
$
73,262
 
$
23,598
 
Shuffler
   
(164,266
)
 
12,702
   
704,558
   
827,094
 
Deck CheckerTM 
   
149,952
   
484,115
   
711,216
   
1,200,755
 
Other costs of goods sold
   
(33,536
)
 
(592,591
)
 
(1,101,878
)
 
(1,585,873
)
Selling, general and administrative
   
(2,306,338
)
 
(1,832,645
)
 
(7,172,331
)
 
(4,805,598
)
Research and development
   
(591,807
)
 
(350,112
)
 
(1,069,496
)
 
(1,145,101
)
Inventory adjustment
   
(2,584,290
)
 
(575,446
)
 
(2,584,290
)
 
(575,446
)
   
$
(5,521,873
)
$
(2,792,286
)
$
(10,438,959
)
$
(6,060,571
)

Note 3—Loss per Share
 
The basic loss per share is computed by dividing the net loss for the period by the weighted average number of common shares outstanding for the period. Loss per share is unchanged on a diluted basis since the assumed exercise of common stock equivalents would have an anti-dilutive effect because of losses.
 
Note 4—Options
 
The Company currently has two stock option plans. The exercise price of the options ranges from $1.34 to $13.00 with a weighted average exercise price of $3.09. There were 2,943,538 options outstanding as of September 30, 2005.

 
Note 5—Contingencies
 
The Company is a party to certain claims, legal actions, and complaints, including a patent infringement action between the Company and one of its main competitors. The Company cannot predict the outcome of any such litigation or say with certainty whether any such litigation would have a material adverse effect on its business as presently conducted or as anticipated.
 
In early 2004, the State of Nevada initiated a sales/use tax audit of the Company’s equipment lessors. As of the date of this report, the State of Nevada has not determined whether there has been a shortfall in the payment of the sales/use tax. The Company has sold and leased back shufflers and Deck Checkers over the last five years. The auditor for the State of Nevada is trying to determine at what level a sales/use tax needs to be collected. The Company now collects from our customers in Nevada and remits payments to the State of Nevada. If the State of Nevada determines that the sales of the products to the leasing companies is the level at which sales/use tax should have been collected, liability of the leasing companies would be passed to the Company. The amount of this potential liability could range from zero, with a refund of up to $144,000 to the payment of sales/use tax with interest and penalties of up to $500,000. Accordingly, no provision for probable loss has been accrued. The Company intends to defend its position in this matter.
 
 
The Company records legal defense costs as period costs.
 
Note 6— Subsequent Events
 
On October 6, 2005, the Company entered into a credit agreement with two holders of the February and March Senior Notes (see, Note 4). Pursuant to the credit agreement, the lenders have agreed to loan the Company up to $5,000,000 over a 12-month period ending October 1, 2006, at which time all amounts advanced under the credit agreement will become due and payable (unless subject to mandatory prepayment as described below). The Company may request advances from the lenders from time to time in amounts not to exceed $500,000. Interest will accrue on the outstanding and principal balance of the advances at the rate of nine percent (9%) per annum, payable monthly in arrears. The Company may prepay the obligations and is required to apply against the outstanding principal and accrued interest any amounts received by the Company for the sale of its equity or debt securities or the sale of any of its assets.
 
As of November 11, 2005, the lenders had advanced an aggregate of $2,000,000 million pursuant to the credit agreement. The lenders have a one time option to terminate the credit agreement on November 15, 2005. The lenders have not indicated an intention to terminate the credit agreement on November 15th, but have requested that the Company extend the election date to December 1, 2005.
 
Amounts advanced pursuant to the credit agreement are secured by a first priority security interest in certain assets of the Company, including accounts receivable, intellectual property and inventory.

Pursuant to the credit agreement, and in consideration for the loan commitments made thereunder, the Company issued to the lenders warrants to purchase an aggregate of 3,000,000 shares of its common stock at an exercise price of $1.25 per share. The warrants are immediately exercisable and expire on October 1, 2011.
 


 

You should read the following discussion and analysis in conjunction with our unaudited condensed consolidated financial statements and the related notes thereto contained elsewhere in this report. The information contained in this quarterly report on form 10-QSB is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the Securities and Exchange Commission, or SEC, including our annual report on form 10-KSB for the year ended December 31, 2004 and subsequent reports on Forms 10-QSB and 8-K, which discuss our business in greater detail.

In this report we make, and from time to time we otherwise make, written and oral statements regarding our business and prospects, such as projections of future performance, statements of management’s plans and objectives, forecasts of market trends, and other matters that are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Statements containing the words or phrases “will likely result,”“are expected to,”“will continue,”“is anticipated,”“estimates,”“projects,”“believes,”“expects,”“anticipates,”“intends,”“target,”“goal,”“plans,”“objective,”“should” or similar expressions identify forward-looking statements, which may appear in documents, reports, filings with the Securities and Exchange Commission, news releases, written or oral presentations made by officers or other representatives made by us to analysts, stockholders, investors, news organizations and others, and discussions with management and other of our representatives. For such statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.
 
Our future results, including results related to forward-looking statements, involve a number of risks and uncertainties. No assurance can be given that the results reflected in any forward-looking statements will be achieved. Any forward-looking statement speaks only as of the date on which such statement is made. Our forward-looking statements are based upon assumptions that are sometimes based upon estimates, data, communications and other information from suppliers, government agencies and other sources that may be subject to revision. Except as required by law, we do not undertake any obligation to update or keep current either (i) any forward-looking statement to reflect events or circumstances arising after the date of such statement, or (ii) the important factors that could cause our future results to differ materially from historical results or trends, results anticipated or planned by us, or which are reflected from time to time in any forward-looking statement.
 
In addition to other matters identified or described by us from time to time in filings with the SEC, there are several important factors that could cause our future results to differ materially from historical results or trends, results anticipated or planned by us, or results that are reflected from time to time in any forward-looking statement. Some of these important factors, but not necessarily all important factors, include those matters included in the section “Risk Factors” further below.
 
 
As reported on our Form 8-K dated November 1, 2005, filed with the SEC we concluded, after consultation with our independent auditors, that errors in revenue recognition practices and in allocation of labor and overhead costs to inventory costs require us to restate previously reported financial results for fiscal 2004.
 

Accordingly, we are in the process of preparing restated 2004 financial statements and currently expect to amend our annual report on Form 10-KSB for the year ended December 31, 2004, and have previously prepared and filed an amended Quarterly Report on Form 10-QSB/A for the third quarter of 2004. We also intend to amend our quarterly reports on Form 10-QSB for the first and second quarters of both 2004 and 2005 to reflect the 2004 adjustments. Therefore, the financial statements of the Company previously issued by us for these periods should no longer be relied upon

The unaudited financial statements and other results of operations and financial condition set forth in this quarterly report, including the results of operations for the three- and nine-month periods ended September 30, 2004, and the discussion that follows below, give effect to the restatements as described therein.

Overview
 
Our strategy is to develop cost-effective niche products for the global gaming industry. We focus on products that increase the security, productivity and profitability of casino operations. Our strategy involves marketing certain of our products for sale or lease, depending on the product, the geographic location of the customer and other factors. We rely on our internal sales staff and distributor relationships for the sale and rental of our products.
 
 
Comparison of Three Months Ended September 30, 2005 and 2004 (as restated)
 
For the three months ended September 30, 2005, we generated gross revenues of $318,983 or 63% less than the three months ended September 30, 2004. Gross revenue was offset by sales returns and allowances of $20,002. Specific product line results for the three months ended September 30, 2005 compared to the three months ended September 30, 2004 are provided below.

For the three months ended September 30, 2005, our cost of sales was $338,419, or 61% less than the three months ended September 30, 2004, excluding the respective inventory write downs of $2,584,290 and $575,446. The decrease was due to reduced sales as a result of delays in getting jurisdictional approvals for our new Random Plus shuffler. We expect the manufacturing of products in China to continue to reduce cost of sales on a per unit basis through the end of this year as we identify more efficiencies and optimize vendors in China. These efforts should also result in further improvements to gross margin. The gross margin on revenue for the three months ended September 30, 2005, was ($39,437) or 16% less than the three months ended September 30, 2004, excluding the respective inventory write downs of $2,584,290 and $575,446.

   
Three months ended
Sept 30, 2005
 
Three months ended
Sept 30, 2004
 
Percentage
change
 
Secure Drop
             
Revenue
   
8,641
   
106,637
   
(92
%)
Cost of Sales
   
230
   
44,946
   
(100
%)
Gross Margin
   
8,412
   
61,691
   
(86
%)
                     
Shuffler Sales
                   
Revenue
   
38,791
   
40,970
   
(5
%)
Cost of Sales
   
19,357
   
18,719
   
3
%
Gross Margin
   
19,440
   
22,251
   
(13
%)
                     
Shuffler Rentals
                   
Revenue
   
86,167
   
65,977
   
31
%
Cost of Sales
   
269,873
   
75,526
   
257
%
Gross Margin
   
(183,706
)
 
(9,549
)
 
(1,824
%)
                     
DeckChecker Sales
                   
Revenue
   
84,420
   
496,259
   
(83
%)
Cost of Sales
   
(1,226
)
 
73,940
   
(102
%)
Gross Margin
   
85,686
   
422,319
   
(80
%)
                     
DeckChecker Rentals
                   
Revenue
   
73,495
   
71,025
   
4
%
Cost of Sales
   
9,229
   
9,229
   
 
Gross Margin
   
64,266
   
61,796
   
4
%
                     
Other
                   
Revenue
   
27,469
   
42,782
   
(36
%)
Cost of Sales
   
(56,736
)
 
6,615
   
(958
%)
Gross Margin
   
84,205
   
36,167
   
133
%
 
 
SecureDrop® Sales. Since there were no system sales generated in the three months ended September 30, 2005, due to the Company’s decision to discontinue new installations of this product line, our SecureDrop® sales consisted of supply items for systems already in place. The decrease in our costs of SecureDrop® sales revenue reflects the reduced sales from the prior period. The decrease in gross margin percentage on SecureDrop® is attributable to the reduced sales from the prior period.
 
Shuffler Sales. The decrease in revenue was due to some product returns during the three months ended September 30, 2005 and the delayed introduction of our new RandomPlus shuffler. The decrease in the cost of shuffler sales revenue was due to the fact that the PokerOne™ has a lower production cost than the Random Ejection Shuffler. Our cost of sales included cost of shuffler sales of $19,357 and shuffler service costs of $23,162 during the third quarter of 2005 compared respectively to $18,719 in cost of shuffler sales and $332,688 in shuffler service costs during the same period of the prior year.
 
Shuffler Rentals. The 31% increase in shuffler rental revenue reflects resulted from the delay in obtaining approvals for the new version of the PokerOne and of our new shuffler product, the RandomPlusÔ Shuffler, as customers accepted rentals in anticipation of the availability of the new shufflers. Our cost of sales for the three months ended September 30, 2005 included cost of shuffler rental depreciation of $54,469 compared to $75,526 during the same period of the prior year.
 
DeckCheckerTM Sales. The decrease in Deck CheckerTM sales resulted from reduced international sales. The increase in gross margin percentage resulted lowered manufacturing costs in China. Our cost of sales for the three months ended September 30, 2005 included Deck CheckerTM costs of ($1,266) compared to $73,940 during the same period of the prior year. 
 
Deck CheckerTM Rentals. Deck CheckerTM rental revenue was flat compared to the same period last year. Our cost of sales included Deck CheckerTM rental depreciation of $9,229 during the third quarter of 2005 which was identical to the same period of the prior year.
 
Other Income. The decrease in other revenues was due to a reduction of sale of supplies for various product lines. We also had sales returns and allowances of $20,002 for the quarter ended September 30, 2005, compared to $0 during the same period of the prior year.
 
 
General and Administrative Expense
 
For the three months ended September 30, 2005, our general and administrative expenses were $2,306,338, or 26% more than the three months ended September 30, 2004. The increase in general and administrative expenses related primarily to a $286,000 increase in legal costs due to defense of the Shuffle Master, Inc. lawsuits, and legal/regulatory issues pertaining to former senior management, a $183,000 increase in consulting expenses associated with the change in management team, a $18,000 increase in advertising, and a $36,000 increase in brokerage fees, offset by a $91,000 decrease in travel and entertainment expenses, a $34,000 decrease in supplies, and a $10,400 decrease in salaries.
 
Research and Development Expense
 
For the three months ended September 30, 2005, research and development expenses were $591,807, or 69% more than the period ended September 30, 2004. The increase in research and development expenses was due to additional development on our shuffler products, the RandomPlus™ Shuffler and a new version of the PokerOne™ Shuffler.
 
Interest Expense
 
For the three months ended September 30, 2005, we incurred interest expenses of $384,665, or 104% more than the three months ended September 30, 2004. This increase was attributable to the additional debt service related to our previously outstanding 9% senior secured notes and the currently outstanding 10% senior secured convertible notes. The debt service on our 10% senior secured convertible notes will continue until February and March 2008, at which time the principal amount is due.
 
Comparison of Nine months Ended September 30, 2005 and 2004 (as restated)
 
For the nine months ended September 30, 2005, we generated gross revenues of $2,255,871, or 23% less than the nine month period ended September 30, 2004. Gross revenues were offset by sales returns and allowances of $310,840. Specific product line results for the nine months ended September 30, 2005 compared to the nine months ended September 30, 2004 are provided below.

For the nine months ended September 30, 2005, our cost of sales was $4,142,161, or 36% more than the six month period ended September 30, 2004. This includes the impact of the inventory write down of $2,584,290. Cost of sales, not including the write down, for the nine months ended September 30, 2005, was $1,557,872, or 38% less than the three months ended September 30, 2004. The manufacturing of products in China is expected to continue to reduce cost of sales on a per unit basis through the end of this year as we identify more efficiencies and optimize vendors in China. These efforts should result in further improvements in gross margin.

The gross margin on revenue for the nine months ended September 30, 2005 was $387,159, excluding the impact of the inventory write down of $2,584,290, compared to the gross margin on revenue for the year ended September 30, 2004 of $465,574 a decrease in gross margin of 17%.
               
   
Nine months ended
Sept 30, 2005
 
Nine months ended
Sept 30, 2004
 
Percentage
change
 
Secure Drop
             
Revenue
   
81,235
   
236,942
   
(66
%)
Cost of Sales
   
7,923
   
213,344
   
(96
%)
Gross Margin
   
73,262
   
23,598
   
211
%
                     
Shuffler Sales
                   
Revenue
   
1,077,230
   
827,554
   
30
%
Cost of Sales
   
198,368
   
139,506
   
42
%
Gross Margin
   
878,862
   
688,048
   
28
%
                     
Shuffler Rentals
                   
Revenue
   
212,476
   
321,340
   
(34
%)
Cost of Sales
   
386,780
   
182,294
   
112
%
Gross Margin
   
(174,304
)
 
139,046
   
(225
%)
                     
DeckChecker Sales
                   
Revenue
   
593,056
   
1,211,899
   
(51
%)
Cost of Sales
   
58,118
   
175,883
   
(67
%)
Gross Margin
   
534,938
   
1,036,016
   
(48
%)
                     
DeckChecker Rentals
                   
Revenue
   
203,965
   
187,835
   
9
%
Cost of Sales
   
27,687
   
23,096
   
20
%
Gross Margin
   
176,278
   
164,739
   
7
%
                     
Other
                   
Revenue
   
87,909
   
152,317
   
(42
%)
Cost of Sales
   
41,072
   
53,067
   
(23
%)
Gross Margin
   
46,837
   
99,250
   
(53
%)
                     
 
 
SecureDrop® Sales. As a result of our decision to discontinue new installations for this product line there were no system sales generated in the nine months ended September 30, 2005. Our SecureDrop® sales consisted of supply items for systems already in place. The decrease in cost of sales to $7,923 reflects the reduced sales from the prior period.
 
Shuffler Sales. The increase in sales was due, in part, to increased sales efforts related to our shufflers and the addition of PokerOne™ to the product line during the nine months ended September 30, 2005. The increase in the cost of shuffler sales revenue was due primarily to the additional placement of shufflers during the nine months ended September 30, 2005 versus the nine months ended Sept 30, 2004 and included shuffler service costs of $778,353 compared to $1,019,699 in shuffler service costs during the same period of the prior year.
 
Shuffler Rentals. The decrease in shuffler rental revenue reflects the reduced number of shufflers placed on a rental basis as a result of the conversion of rental units to purchased units in 2003 and the failure to place additional shuffler units on a rental basis. This failure was due, in part, to the production delays related to the introduction of new shuffler products, such as the RandomPlusÔ Shuffler. Cost of sales include shuffler rental depreciation of $159,908 during the nine months ended September 30, 2005 compared to $182,294 during the prior year period
 
Deck CheckerTM Sales. The decrease in Deck CheckerTM sales resulted primarily from reduced international sales.
 
Deck CheckerTM Rentals. The small increase in Deck CheckerTM rental revenue resulted primarily from the placement of additional units. Cost of sales included rental depreciation of $27,687 during the nine months ended September 30, 2005 compared to $23,096 during the prior year period.
 
Other Income. The decrease in other revenues is due to product returns offset by the sale of products that are not produced by us and sold only on a limited basis. We also had sales returns and allowances of $310,840 for the nine months ended September 30, 2005, compared to $0 during the prior year period.
 
 
General and Administrative Expense
 
For the nine months ended September 30, 2005, our general and administrative expenses were $7,172,331, or 49% more than the nine months ended September 30, 2004. The increase in general and administrative expenses related primarily to a $1,647,000 increase in legal and regulatory costs due to defense of the Shuffle Master, Inc. lawsuits and legal/regulatory issues pertaining to former senior management, a $525,500 increase in consulting expenses related to the management change in March 2005, a $49,300 increase in insurance expense, a $103,200 increase in advisory costs, and a $543,000 increase in other expenses (including $140,000 bad debt expense, $158,000 non-cost of sales service related expenses, and $24,000 tools expense), offset by a $207,267 decrease in payroll costs, a $160,000 decrease in travel and entertainment expenses, a $28,000 decrease in supplies, and a $22,000 decrease in trade show expenses.
 
Research and Development Expense
 
For the nine months ended September 30, 2005, research and development expenses were $1,069,500, or 7% less than the nine months ended September 30, 2004.
 
Interest Expense
 
For the nine months ended September 30, 2005, we incurred interest expenses of $1,208,535 or 71% more than the nine months ended September 30, 2004. This increase was primarily attributable to the additional debt service related to our previously outstanding 9% senior secured notes and the currently outstanding 10% senior secured convertible notes. The debt service on our 10% senior secured convertible notes will continue until February and March 2008 at which time the principal amount is due.
 
 
As a result of our operating loss, our working capital has decreased from $4,865,735 at December 31, 2004 to $3,317,691 at September 30, 2005. On October 6, 2005, we negotiated a one year revolving credit facility in the amount of $5,000,000 and carrying an interest rate of 9.0%. We believe that this financing will provide us sufficient capital through the first quarter of 2006. If required, we will endeavor to raise additional required funds through various financing sources, including additional sales of our equity and debt securities and the procurement of commercial debt financing. However, there can be no guarantees that such funds will be available on commercially reasonable terms, if at all. Our ability to obtain additional sources of capital is restricted by a provision in the Security Agreement relating to the credit facility and our February and March Senior Notes that prohibits us from incurring indebtedness through loans, lines of credit, and other forms of indebtedness, including the credit facility described above and our February and March Senior Notes, in excess of $15,000,000. Accordingly, no assurances can be given that we will successfully obtain liquidity sources necessary to fund our operations in the upcoming year.
 
Net Cash Used In Investing Activities. The net cash used in investing activities reported for the nine months ended September 30, 2005 consisted primarily of $898,000 from the acquisition of plant and equipment.
 
Net Cash Provided By Financing Activities. Net cash provided by financing activities reported for the nine months ended September 30, 2005 consisted primarily of $12,000,000 provided by the issuance of 10% senior secured convertible notes (offset by the repayment of $3,250,000 of the 9% notes), proceeds from the sale of stock of $3,567,000, offset by the repayment of equipment leases of $1,743,100, and acquisition of treasury stock of $846,820.
 
 
Sources of Capital
 
During the periods ended in 2004 and 2003, our sources of capital included a public stock offering, equipment financing from a third party, short-term notes from stockholders, convertible debentures and other private sources of capital.
 
With respect to our equipment financing where we have sold and leased back most of our furniture, equipment, tooling and shufflers held for rent, we have repaid $1,743,057 for the nine months ended September 30, 2005 and repaid $1,731,966 for the nine months ended September 30, 2004. As of September 30, 2005, we had outstanding equipment financing of $1,250,184. These equipment leases have terms of 36 to 39 months and were not recorded as sales because each of the leases included a mandatory buy-back provision.
 
During the nine months ended September 30, 2005, we raised additional capital through private placements of 10% senior secured convertible notes in February 2005 (the “February Senior Notes”) and March 2005 (the “March Senior Notes” and together with the February Senior Notes, the “Senior Notes”).
 
·      
On February 15, 2005, we completed a private placement of the February Senior Notes, which mature on February 15, 2008. The February Senior Notes are secured by a first priority security interest in our assets. The February Senior Notes require semi-annual payments of interest only on August 1 and February 1 of each year, with the principal and any unpaid interest due at February 15, 2008. Any prepayments of the February Senior Notes made prior to February 2007 require the payments of premiums that decline each year. Holders of the February Senior Notes have a one-time right to convert up to 50% of the then outstanding principal of the February Senior Notes into shares of our common stock, $.001 par value, at a rate $1.65 per share. Through the private placement we issued an aggregate of $10,000,000 in February Senior Notes, in return for exchanged notes in the aggregate principal amount of $3,250,000 and gross cash proceeds of $6,750,000.
 
·      
On March 14, 2005, we completed an additional $2 million private placement of the March Senior Notes, which mature on March 14, 2008.Notes. The March Senior Notes were issued on a pari passu basis with the February Senior Notes and, as a result, are secured by a first priority security interest in our assets. The March Senior Notes require semi-annual payments of interest only on September 1 and March 1 of each year, with the principal and any unpaid interest due at March 15, 2008. Any prepayments of the March Senior Notes made prior to March 2007 require the payments of premiums that decline each year. Holders of the March Senior Notes have a one-time right to convert up to 50% of the then outstanding principal of the March Senior Notes into shares of our common stock, $.001 par value, at a conversion price of $1.65 per share.
 
A portion of the proceeds raised through these private placements was subject to the following conditions.
 
·      
One third (1/3) of the total proceeds held in escrow shall be released to us upon the execution of a distributor agreement with TCS or an affiliate thereof and the sale and service outside the United States of 100 units of our RandomPlus Shuffler™ and the PokerOne™ shuffler, where such events must occur no later than June 30, 2005;
 
·      
One-third (1/3) of the total proceeds held in escrow shall be released to us upon the hiring of a North American manager of operations or Chief Operating Officer, where such person shall be hired no later than June 30, 2005; and
 
·      
One-third (1/3) of the total proceeds held in escrow shall be released to us upon the approval of our RandomPlus™ shuffler by Gaming Laboratories International and the Nevada State Gaming Control Board and the placement of 100 units of our RandomPlus™ shuffler in North America, where such approvals and shuffler placement must occur no later than June 30, 2005.
 
 
 
By June 30, 2005, we satisfied the first and the second escrow conditions and received a waiver from the holders of the Senior Notes with respect to the third condition. Accordingly, we have access to the all of the proceeds received through the private placement of the Senior Notes.
 
 
The following is a summary of what management believes are the critical accounting policies related to operations. The application of these policies, in some cases, requires management to make subjective judgments and estimates regarding the effect of matters that are inherently uncertain. See Note 1, "Description of Business and Significant Accounting Policies," to financial statements included in our annual report on Form 10KSB for a more detailed discussion of our accounting policies. Except as described below, we do not employ any critical accounting policies selected from among available alternatives or that require the exercise of significant management judgment.,
 
Allowance for Doubtful Accounts.
 
In connection with the preparation of our financial statements, management reviews and evaluates the collectibility of our trade receivables and adjusts our allowance for estimated uncollectible accounts as deemed necessary in the circumstances. These estimates have the potential for critically affecting the determination of results of operations for any given period. Factors considered by management in making such estimates and adjustments include any concentrations among customers, changes in our relationships therewith, payment history and the apparent financial condition thereof.
 
Revenue Recognition.
 
We recognize revenue from the sale of our shuffler and Deck Checker™ products upon shipment against valid customer contracts or purchase orders. Sales are recognized immediately when shufflers that are rented are converted to purchases depending on the creditworthiness and payment history of the casino company since payment terms are from 20 to 48 months. We recognize revenue from our sales to independent distributors at the time that the distributor takes possession of our product and title transfers to the buyer. Before discontinuing to offer this product line, we recognized revenue from the sale of our SecureDrop® products upon installation and functional testing at customer locations because that is when the customer's obligation becomes fixed and certain pursuant to our standard contracts for sale. The extended warranty and maintenance components that are part of long term sales contracts are unbundled and recognized as deferred revenue amortized over the remaining life of the sales agreement after the initial 90−day warranty as required by the Emerging Issues Task Force Issue No. 00−21, Revenue Arrangements with Multiple Deliverables. The useful life of our shufflers and Deck Checkers™ is five years with proper maintenance; the life can be extended with the replacement of component parts. If the customer does not possess the required creditworthiness or an established payment history with us, we would then book the revenue as an installment sale and recognize it over time as payments are received. Revenue from shuffler rentals is recorded at the first of each month in accordance with rental contract terms. All rental contracts are cancelable upon 30−day written notice by the customer. Maintenance expense for rental units is recorded in the period it is incurred. Although sales are made with a right to return it is usually associated with unacceptable performance - sales returns and allowances are recorded after returned goods are received and inspected. We provide currently for estimated warranty repair costs associated with sales contracts. Although there are no extended warranties offered for our products, we do provide for maintenance contracts that are billed and recognized on a monthly basis.
 
 
Intangible Assets.
 
We currently amortize our intangible assets (patent and technology rights) on a straight-line basis over estimated useful lives of 10 years. Management believes that the useful life of patents and technology rights equals the full term of the patent.
 
Recent Accounting Pronouncements.
 
In December, 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (Revised 2004), Share Based Payment (“SFAS 123R”). SFAS 123R requires certain changes in the way compensation cost related to share based employee compensation transactions is recognized in the financial statements as compared to SFAS No. 123, Accounting for Stock-Based Compensation. The provisions of SFAS 123R are effective for the Company as of the first interim period that begins after December 15, 2005. Accordingly, we expect to implement the revised standard in the first quarter of fiscal year 2006, unless we decide to adopt it earlier. Since the company adopted SFAS No. 123 effective as of January 1, 2003, the effect of adopting SFAS 123R is not expected to be material.
 
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions (“SFAS 153”). The amendments made by SFAS 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. The Statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. We do not expect to enter into any transactions in the foreseeable future that would be affected by adopting SFAS 153.
 
In May 2005, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 154, Accounting Changes and Error Corrections, a Replacement of APB Opinion No. 20 and SFAS No. 3. SFAS No. 154 replaces APB Opinion No. 20, Accounting Changes and SFAS No 3, Reporting Accounting Changes in Interim Financial Statements and changes the requirement for the accounting for and reporting of a change in accounting principles. SFAS No. 154 applies to all voluntary changes in accounting principles. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. The provisions of SFAS No. 154 will be effective for accounting changes made in fiscal year beginning after December 15, 2005. We have no present expectation to make any accounting changes in the foreseeable future that would be subject to SFAS No. 154.

Risk Factors
 
We may require additional funding in the future to continue to operate our business. We had working capital of $3,317,691 as of September 30, 2005, however our working capital continues to deteriorate due to ongoing losses. In our previously filed 10-QSB for the period through June 30, 2005, we disclosed that we required approximately $3 million of additional capital to fund our operations and required expenditures through the fourth quarter of 2005. On October 6, 2005, we negotiated a one year borrowing facility in the amount of $5,000,000 and carrying an interest rate of 9.0%. We believe that this financing will provide us sufficient capital through the first quarter of 2006. The providers of the credit facility have a one time option to terminate the credit agreement on November 15, 2005. The lenders have not indicated an intention to terminate the credit agreement on November 15th, but have requested that the Company extend the election date to December 1, 2005. If required, we will endeavor to raise additional required funds through various financing sources, including additional sales of our equity and debt securities and the procurement of commercial debt financing. However, there can be no guarantees that such funds will be available on commercially reasonable terms, if at all. Our ability to seek additional sources of capital is restricted by a covenant related to our February and March Senior Notes that prohibits us from incurring indebtedness through loans, lines of credit, and other forms of indebtedness, including the credit facility described above and our February and March Senior Notes, in excess of $15,000,000. Accordingly, no assurances can be given that we will successfully obtain liquidity sources necessary to fund our operations in the upcoming year. Our inability to obtain additional capital as and when needed may materially adversely affect our ability to continue our present level of operations.
 
 
We have a history of significant operating losses and anticipate continued operating losses for at least the near term. For the nine months ended September 30, 2005 and the years ended December 31, 2004 and 2003, we have incurred net losses of $11,649,394, $7,149,194 and $7,812,089, respectively, and our operations have used $8,918,329, $10,660,133 and $11,526,665 of cash, respectively. As of September 30, 2005, December 31, 2004 and December 31, 2003, we had accumulated deficits of $65,592,839, $53,743,174 and $44,582,347, respectively. Based on our presently known commitments and plans, we believe that we have sufficient funding through the first quarter of 2006. If we are unable to generate additional funds from operational cash flow we will be required to locate additional sources of capital from private or public placements of debt or equity, or from institutional or other lending sources. If our revenues do not increase very substantially, or if our spending levels exceed our expectations, we will not become profitable. Revenues may not grow in the future, and we may not generate sufficient revenues for profitability. If we become profitable, we may not be able to sustain profitable operations.
 
We may be unable to generate sufficient demand for our products. If we fail to generate sufficient demand for our products, we may be unable to sustain operations or generate a return to investors. Until January 2000, we were in the development stage and derived minimal revenues from our products. Currently we are an operating company that continues to develop new products. Since January 2000, our activities have been limited to analyzing and consulting with persons in the gaming industry, developing and manufacturing new products, establishing distribution networks for our products, marketing our products to the gaming industry, and commencing product sales. During such time, we have derived only limited revenues, which have been insufficient to sustain our operations. We may not generate sufficient revenue to sustain our operations. No independent organization has conducted market research providing management with independent assurance from which to estimate potential demand for our products. The overall market may not be receptive to our products, and we may not successfully compete in the target market for our products.
 
Our leased shufflers are more susceptible to replacement by customers. All of our leased shufflers are placed with customers under short-term lease arrangements, which, unlike long-term leases or permanent sales of our products, can easily be terminated by a dissatisfied customer. The manner in which such short-term leases are structured puts our shufflers at greater risk of replacement due to pressure from competitors, changes in economic conditions, obsolescence and declining popularity. Casino operators may terminate the use of our products, and we may not be able to maintain and expand the number of installed shufflers through enhancement of existing shufflers, introduction of new shufflers, customer service or otherwise.
 
 
We may be unable to adequately protect our intellectual property right. Our success depends upon maintaining the confidentiality and proprietary nature of our intellectual property rights. Our ability to compete may be damaged, and our revenues may be reduced if we are unable to protect our intellectual property rights adequately. To protect these rights, we rely principally on a combination of:
 
·      
contractual arrangements providing for non-disclosure and prohibitions on use;
 
·      
patents and pending patent applications;
 
·      
trade secret, copyright and trademark laws; and
 
·      
certain built-in technical product features.
 
Patent, trade secret, copyright and trademark laws provide limited protection. The protections provided by laws governing intellectual property rights do not prevent our competitors from developing, independently, products similar or superior to our products and technologies. In addition, effective protection of copyrights, trade secrets, trademarks, and other proprietary rights may be unavailable or limited in certain foreign countries. We may be unaware of certain non-publicly available patent applications, which, if issued as patents, could relate to our services and products as currently designed or as we may modify them in the future. Legal or regulatory proceedings to enforce our patents, trademarks or copyrights could be costly, time consuming, and could divert the attention of management and technical personnel.
 
Adverse results in current litigation could result in substantial monetary damages and impacts on the manufacture and sale of certain of our shuffler products. Shuffle Master, our principal competitor in the shuffler market, filed two lawsuits against us for patent infringement. The first suit has been settled (see Part II - Item 1. Legal Proceedings). The second lawsuit has thus far resulted in a positive result. On September 26th, United States Magistrate Judge Lawrence R. Leavitt issued a Report and Recommendation siding with VendingData™'s position in a patent infringement case brought by Shuffle Master, Inc.(NASDAQ: SHFL) in United States District Court of Nevada. Shuffle Master initiated the action claiming that VendingData™'s PokerOne™ automatic shuffler infringed one of Shuffle Master's patents. Judge Leavitt, however, determined that Shuffle Master's reading of its patent was too broad. Specifically, Judge Leavitt recommended that the District Court adopt VendingData™'s view that the term "set" as used in Claim 20 of Shuffle Master’s ‘684 patent means at least one or more hands of cards within the apparatus, and not to any number of cards. Shuffle Master was seeking treble damages, which, if awarded, could result in us owing it substantial sums of money, and, if large enough, could have a material adverse effect on our liquidity and our ability to conduct operations. Although we believe our position to be meritorious, and believe that the positive Markman hearing is a step toward resolving this matter, litigation of this nature is a drain on our cash resources and our management’s time. Although Shuffle Master has asserted patent infringement claims and we believe we have reasonable defenses to the same, we cannot determine whether we will ultimately prevail in the lawsuit, nor whether damages, if awarded, would significantly impact our ability to continue to manufacture and sell particular products within the United States and its territories. If we do not prevail, we will be unable to sell the PokerOne™ shuffler products in the United States unless we change certain components used in the shuffler or obtain appropriate licenses from Shuffle Master to use the playing card shuffler apparatus. The preliminary injunction that Shuffle Master obtained against us in November 2004 prevented us from selling our PokerOne™ Shuffler in the United States. An appellate court stayed the injunction in March 2005. Similarly, we cannot determine whether Shuffle Master will assert other litigation claims based upon other patents it may currently or in the future own, nor can we determine the likely outcome of any such litigation or whether any such substantial litigation would have a material adverse effect on our business as presently conducted or as anticipated.
 
 
It is possible that our future products will be the subject of future patent litigation if the products are sold and installed in the United States and, if commenced, could subject us to continuing litigation costs and risks. Other than the allegations made by Shuffle Master discussed above, we are not aware of any claims or basis for our current products infringing on the proprietary rights of third parties. To the extent that we introduce new products that incorporate the same or similar technology, it is likely that Shuffle Master will bring one or more claims against us seeking damages, injunctive or other equitable relief, or both. We cannot predict the outcome of any present or future litigation that may occur.
 
If our future products incorporate technology that infringes the proprietary rights of third parties and we do not secure licenses from them, we could be liable for substantial damages that would cause a material reduction in revenues and impair our prospects for achieving growth and profitability.
 
In furtherance of the development of our services or products, we may need to acquire licenses for intellectual property to avoid infringement of third party rights or claims of infringement. These licenses may not be available on commercially reasonable terms, if at all. Claims for infringement, if made, could damage our business prospects, our results of operations and financial condition, whether or not the claims have merit, by:
 
·
consuming substantial time and financial resources required to defend against them;
 
·
diverting the attention of management from growing our business and managing operations;
 
·
resulting in costly litigation; and
 
·
disrupting product sales and shipments.
 
If any third party prevails in an action against us for infringement of its proprietary rights, we could be required to pay damages and either enter into costly licensing arrangements or redesign our products so as to exclude the infringing technology. As a result, we would incur substantial costs and delays in product development, sales and shipments, our revenues may decline substantially and we may not be able to achieve the growth required for us to achieve profitability
 
We rely on distributors in international markets, and our limited sales experience in foreign countries could cause us to lose sales. Substantially all sales of our products outside the United States are achieved through distributor relationships. We believe the distributors that we have engaged are experienced and reputable; however, if we are unable to manage these relationships, our ability to generate revenue and profits in the non-U.S. market may be adversely affected. To the extent that we engage in direct sales outside the United States, we have limited sales experience and history in foreign markets.
 
On January 21, 2005, we entered into an exclusive five-year agreement with TCS to market and distribute our shuffler products outside of the United States. However, if TCS is unable to place our shuffler products outside of the United States, our liquidity will be adversely affected. In July 2005 we entered into a contract with Simon Herbert to serve as our Vice President of International Sales. Mr. Simon is a 25 year senior gaming industry executive who is credited with building several multi-million dollar operations. Most notably, Mr. Herbert served as CEO of TCS Group. Mr. Herbert will oversee VendingData's global sales effort, including international markets and distribution channel management
 
Our management holds a controlling interest in our common stock, giving our management the power to control all matters submitted to our stockholders. As of September 30, 2005, our executive officers and members of our board beneficially own approximately 8,440,014 shares of common stock, or approximately 49.8% of the outstanding shares of our common stock,. Accordingly, these stockholders have the power to control all matters requiring approval by our stockholders, including the election of directors and approval of mergers and other significant corporate transactions. This concentration of ownership may make it more difficult for non management stockholders to effect substantial changes in our company, and also has the effect of delaying, preventing or expediting, as the case may be, a change in control of our company.
 
 
Controls and Procedures 
 
(a)    Evaluation of Disclosure Controls. We evaluated the effectiveness of our disclosure controls and procedures as of the end of the nine months ended September 30, 2005. This evaluation was done with the participation of Mark R. Newburg, our current President and Chief Executive Officer and Treasurer, and Arnaldo F. Galassi, our Chief Financial Officer, and Libby Lamm, our Controller. Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, as appropriate to allow timely decisions regarding required disclosure.
 
Based on this evaluation, we concluded that, subject to the limitations noted above, our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. As reported on our Form 8-K dated November 1, 2005 filed with the SEC, we concluded, after consultation with our independent auditors, that errors in revenue recognition practices and in allocation of labor and overhead costs to inventory costs require us to restate previously reported financial results for fiscal 2004. The circumstances underlying the restatements also indicate that our disclosure controls and procedures during 2004 were at times deficient, primarily in respect of certain actions by former senior management to override established financial controls and procedures. We believe that all such deficiencies were corrected prior to September 30, 2005.

Our management does not expect that our disclosure controls and procedures or our internal controls over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, but not absolute, assurance that the objectives of a control system are met. Further, any control system reflects limitations on resources, and the benefits of a control system must be considered relative to its costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. (See (b), below.)Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of a control. The design of a control system is also based upon certain assumptions about the likelihood of future events, there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.
 
 (b)    Changes in Disclosure Controls and Procedures. There were no changes in our internal controls over financial reporting that occurred during the three months ended September 30, 2005 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
 


 
 
On July 12, 2005, we entered into a Settlement Agreement with Shuffle Master, Inc., with respect to the legal proceeding filed on March 27, 2002, by Shuffle Master, Inc., against us in the United States District Court, District of Nevada (Case No. CV-S-02-0438-JCM-PAL). The complaint alleged, among other things, claims for patent infringement relating to two of Shuffle Master’s patents and requested treble damages and an injunction enjoining us from infringing on such patents. The Shuffle Master patents at issue are United States Patent Numbers 6,325,373 and 6,068,258, regarding registering use of a playing card shuffler apparatus and the displaying of the use on a display. We had denied the claims and asserted counterclaims against Shuffle Master. The trial date for this matter was set for July 25, 2005.

Pursuant to the Settlement Agreement, the parties have agreed to dismiss their claims and counter-claims in the particular action and Shuffle Master has agreed not to bring any claims against us for the infringement of the above-referenced patents for past or future use of the technology, with the exception of matters involving infringement of the following aspects of Patent No. 6,325,373: (i) a method of recovering from a card jam in an automatic card shuffler, as further described in Claim 6 of Patent No. 6,325,373; and (ii) an automatic card shuffler with a card moving mechanism to clear card jams, as further described in Claim 7 of Patent No. 6,325,373. In return, we will make settlement payments to Shuffle Master in the amount of $400,000 payable on or before July 14, 2005, and $400,000 which is due on or before May 14, 2006.

The Settlement Agreement extends only to the matters described above relating to Patent Numbers 6,325,373 and 6,068,258, and does not extend to the legal proceeding filed on October 5, 2004, by Shuffle Master, Inc., against us in the United States District Court, District of Nevada (Case No. CV-S-04-1373-JCM-LRL). Those litigation proceedings continue and are not affected by the Settlement Agreement.
 
The second lawsuit alleges that our PokerOne™ Shuffler violates a Shuffle Master patent concerning the card moving mechanism. Shuffle Master seeks treble damages. The second lawsuit has thus far resulted in a positive result. On September 26th, United States Magistrate Judge Lawrence R. Leavitt issued a Report and Recommendation siding with VendingData™'s position in a patent infringement case brought by Shuffle Master, Inc.(NASDAQ: SHFL) in United States District Court of Nevada. Shuffle Master initiated the action claiming that VendingData™'s PokerOne™ automatic shuffler infringed one of Shuffle Master's patents. Judge Leavitt, however, determined that Shuffle Master's reading of its patent was too broad. Specifically, Judge Leavitt recommended that the District Court adopt VendingData™'s view that the term "set" as used in Claim 20 of Shuffle Master’s ‘684 patent means at least one or more hands of cards within the apparatus, and not to any number of cards. However, if we do not ultimately prevail, we will be unable to sell the PokerOne™ shuffler products in the United States unless we change certain components used in the shuffler or obtain appropriate licenses from Shuffle Master to use the playing card shuffler apparatus. The preliminary injunction that Shuffle Master obtained against us in November 2004 prevented us from selling our PokerOne™ Shuffler in the United States. An appellate court stayed the injunction in March 2005.
 
On June 2, 2005, we received a summons and complaint in connection with an automobile accident involving a former employee of the company. The claim was filed in the Superior Court of California, County of San Francisco, and the amount of the lawsuit is in excess of $2 million. We have responded to the complaint and referred the case to our insurance carrier.
 
 
 
Our Annual Meeting of Stockholders was held on August 23, 2005. The following individuals were elected at the Annual Meeting to serve as directors of VendingData Corporation for terms expiring at our next Annual Meeting of Stockholders or until their successors are elected and qualified. Shares voted in favor of these directors and shares withheld were as follows:
 
Name
 
Shares voted
FOR
 
Shares
Withheld
 
Shares
Abstaining
 
Mark R. Newburg
   
15,461,067
   
43,620
   
0
 
James E. Crabbe
   
15,461,467
   
43,220
   
0
 
Ronald O. Keil
   
15,460,667
   
44,020
   
0
 
Bob L. Smith
   
15,462,967
   
41,720
   
0
 
 
Shareholders approved an amendment to our articles of incorporation to increase our authorized shares of common stock from 25,000,000 shares to 50,000,000, with shares voted as follows:
         
Shares voted FOR
   
15,460,7533
 
Shares against
   
34,434
 
Shares abstaining
   
9,500
 
 
Shareholders approved the issuance of our 10% senior secured convertible notes due 2008, with shares voted as follows:
         
Shares voted FOR
   
10,294,422
 
Shares against
   
42,547
 
Shares abstaining
   
27,468
 
 
Shareholders approved of an amendment to our 1999 stock option plan, with shares voted as follows:
         
Shares voted FOR
   
9,008,318
 
Shares against
   
1,346,594
 
Shares abstaining
   
9,525
 
       
 
 
 
     
Exhibits.
     
10.1
Credit Agreement dated October 5, 2005 among VendingData Corporation, Lampe Conway & Co., LLC and Triage Capital Management L.P
 
10.2
Amendment dated October 6, 2005 to the Security Agreement dated as of March, 2005 by and among VendingData Corporation and Premier Trust, Inc.
 
10.3
Form of Warrant
 
10.4
Employment Agreement dated September 29, 2005 between VendingData Corporation and Mark Newburg
 
10.5
Employment Agreement dated September 29, 2005 between VendingData Corporation and Arnaldo Galassi
 
31.1
Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
32.1
Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
 
 


SIGNATURE
 
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
     
 
VENDINGDATA CORPORATION
(Registrant)
 
 
 
 
 
 
Date: November 14, 2005 By:   /s/ Mark R. Newburg
   
    Mark R. Newburg
  Its:
President, Chief Executive Officer and Treasurer
 
(Principal Executive Officer)
 
 
     
Date: November 14, 2005 By:   /s/ Arnaldo F. Galassi
   
    Arnaldo F. Galassi
  Its:
Chief Financial Officer and Secretary
  (Principal Financial Officer)
 
 

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