EROOMSYSTEM TECHNOLOGIES INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) As used in this Form 10-Q, references to the "Company," "we," "our" or "us" refer to eRoomSystem Technologies, Inc. and subsidiaries, unless the context otherwise indicates.

This Management's Discussion and Analysis or Plan of Operations ("MD&A") section of our Quarterly Report on Form 10-Q discusses our results of operations, liquidity and financial condition, and certain factors that may affect our future results. You should read this MD&A in conjunction with our consolidated financial statements and accompanying notes included in this Quarterly Report.

Forward-Looking Statements This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors discussed elsewhere in this report.

Certain information included herein contains statements that may be considered forward-looking statements, such as statements relating to our anticipated revenues, and operating results, future performance and operations, plans for future expansion, capital spending, sources of liquidity and financing sources.

Such forward-looking information involves important risks and uncertainties that could significantly affect anticipated results in the future, and accordingly, such results may differ from those expressed in any forward-looking statements made herein. These risks and uncertainties include, but are not limited to, those relating to our liquidity requirements, the continued growth of the lodging industry, the success of our product-development, marketing and sales activities, vigorous competition in the lodging industry, dependence on existing management, leverage and debt service (including sensitivity to fluctuations in interest rates), domestic or global economic conditions, the inherent uncertainty and costs of prolonged arbitration or litigation, and changes in federal or state tax laws or the administration of such laws.

Overview Our core business is the development and installation of an intelligent, in-room computer platform and communications network, or the eRoomSystem, for the lodging industry. The eRoomSystem is a computerized platform and processor-based system designed to collect and control data. The eRoomSystem supports our fully automated and interactive eRoomServ refreshment centers, eRoomSafes, eRoomEnergy products, and the eRoomTray. In 2009, we purchased Kooltech refreshment centers that were installed in various hotels from CPC. In addition to our core business, we have a diversification strategy in place of investing in third party emerging growth companies. We may make additional investments in promising emerging growth companies, and potentially acquire an operating company if the opportunity arises.

We are continuing to step-up our focus on the research and development of new products. Our new products incorporate cutting edge wireless technology utilizing micro-controllers that can detect information about products placed on our proprietary sensors. A cloud based system allows interaction with the data collected by the micro-controllers and sensors from any web enabled browser, which is collected by our current server software and utilized. There is no assurance that the products we are working on will be successfully completed or deployed.

Our existing products interface with the hotel's property management system through our eRoomSystem communications network. The hotel's property management system posts usage of our products directly to the hotel guest's room account.

The solutions offered by our eRoomSystem and related products have allowed us to install our products and services in several premier hotel chains, including Marriott International, Hilton Hotels and Carlson Hospitality Worldwide, in the United States and internationally.

One of the byproducts of our technology is the information we have collected since our first product installation. To date, we have collected several million room-nights of data. Through our eRoomSystem, we are able to collect information regarding the usage of our products on a real-time basis. We use this information to help our customers increase their operating efficiencies.

On July 24, 2008, we provided a secured loan of $500,000 to BlackBird Corporation, a Florida corporation ("BlackBird"), an unrelated entity. The funding of the loan took place on completion of a transaction by BlackBird to acquire an unrelated company, USA Datanet Corporation. The acquisition took place on July 24, 2008. The loan is evidenced by a 10% senior secured convertible promissory note, made by BlackBird (the "Secured Note"). The Secured Note matured on June 30, 2009 and the interest rate increased to 18% annually as of January 1, 2009, with interest payable quarterly on the last business day of each quarter. An extension to the note was provided through September 30, 2011 at an interest rate of 18%. Blackbird is presently in default of its obligations under the note due to non-payment. In light of BlackBird's inability to make payments as due, the Company agreed to lower the interest rate on the Secured Note to 10%. BlackBird is current with their interest payments as of November 13, 2012.

8 -------------------------------------------------------------------------------- Table of Contents On June 17, 2009, the Company purchased the assets of Kooltech SPE which had been acquired by Cardinal Pointe Capital ("CPC"). CPC sold the minibars, baskets and stock owned by Kooltech SPE to the Company. The Company formed a subsidiary, eFridge, LLC ("eFridge") for the purposes of this purchase. The purchase price was an amount equal to thirty percent (30%) of eFridge's EBITDA and an amount equal to thirty percent (30%) of New Equipment Cash Flow. Payment of the Purchase Price was to be made by eFridge to CPC on a monthly basis within twenty days after the end of each month, based on the eFridge's EBITDA for the month then ended. On June 29, 2011, the Company reached a final settlement of any and all obligations under the agreement.

Results of Operations Description of Revenues Historically, we have received most of our revenues from the sale or placement under a revenue-sharing program of our products in hotels. More recently we have purchased minibars and baskets already placed in hotels and setup a turnkey solution at these hotels. In these hotels we receive most of the revenues for the product sold in the minibars and baskets. We provide 3-5% of revenues to some of the hotels. We expect that these revenues will account for a substantial majority of our revenues for the foreseeable future. We also generate revenues from maintenance and support services relating to our existing installed products.

Our dependence on the lodging industry, including its guests, makes us extremely vulnerable to downturns in the lodging industry caused by the general economic environment. Such a downturn could result in fewer purchases by hotel guests of goods and services from our products installed in hotels, and accordingly lower revenues where our products are placed pursuant to a turnkey agreement. Time spent by individuals on travel and leisure is often discretionary for consumers and may be particularly affected by adverse trends in the general economy. The success of our operations depends, in part, upon discretionary consumer spending and economic conditions affecting disposable consumer income such as employment, wages and salaries, business conditions, interest rates, and availability of credit and taxation.

We continuously explore opportunities and perform due diligence on third parties with respect to potential investments. At this time, we have not reached a definitive agreement to make further investments. In addition, we may acquire an operating company in the future if the opportunity arises. The timing and return on such investments, however, cannot be assured.

Revenue Recognition Equipment sales revenue from our products is recognized upon completion of installation and acceptance by the customer. Sales revenue for product in the minibars that we sell under a turnkey solution is recognized upon completion of the sale.

We have entered into installation, maintenance and license agreements with most of our existing hotel customers. Installation, maintenance and license revenues are recognized as the services are performed or pro rata over the service period. We defer all revenue paid in advance relating to future services and products not yet installed and accepted by our customers.

Our installation, maintenance and license agreements stipulate that we collect a maintenance fee per eRoomServ refreshment center per day, payable on a monthly basis. Our objective is to generate gross profit margins of approximately 50% from our maintenance-related revenues. We base this objective on our historical cost of maintenance of approximately $0.04 per unit per day and, pursuant to our maintenance agreements, our projected receipt of generally not less than $0.08 per unit per day. There can be no assurance that such costs will not increase and that our objective will be met.

Description of Expenses Cost of product sales consists primarily of cost of goods and labor as well as remaining basis on the sale of old refreshment centers. We capitalize the production, shipping, installation and sales commissions related to the eRoomServ refreshment centers, eRoomSafes, eRoomTrays and eRoomEnergy management products placed under revenue-sharing agreements. Cost of maintenance fee revenues primarily consists of expenses related to customer support and maintenance.

Selling, general and administrative expenses primarily consist of general and administrative expenses including professional fees, salaries and related costs for accounting, administration, finance, human resources, information systems and legal personnel.

Research and development expenses consist of payroll and related costs for hardware and software engineers, quality assurance specialists, management personnel, and the costs of materials used by our consultants in the maintenance of our existing installed products as well as research and development for new products. Research and development expenses in the nine months ended September 30, 2012 and 2011 were $132,762 and $69,628, respectively.

In accordance with generally accepted accounting principles development costs incurred in the research and development of new software products to be sold, leased or otherwise marketed are expensed as incurred until technological feasibility in the form of a working model has been established. Internally generated capitalizable software development costs have not been material to date. We have charged our software development costs to research and development expense in our condensed consolidated statements of operations.

9 -------------------------------------------------------------------------------- Table of Contents Comparison of the Three Months Ended September 30, 2012 and 2011 Revenues Product Sales - Revenue from product sales was $140,873 for the three months ended September 30, 2012, compared to $126,807 for the three months ended September 30, 2011, representing an increase of $14,066, or 11.1%. The increase in product sales revenues related to the sale of some vending machines during the three months ended September 30, 2012.

Maintenance Fees- Maintenance fees were $33,836 for the three months ended September 30, 2012, compared to $39,820 for the three months ended September 30, 2011, representing a decrease of $5,984, or 15%. The decrease in maintenance fee revenue related to the termination of hotels' maintenance services.

Interest - Our income from interest was $2,785 for the three months ended September 30, 2012, compared to $8,515 for the three months ended September 30, 2011, representing a decrease of $5,730, or 67.3%. The decrease in interest income related to decreasing interest rates and fluctuations in interest earned on real property tax liens.

Cost of Revenue Cost of Product Sales Revenue - Our cost of product sales revenue for the three months ended September 30, 2012 was $101,793, compared to $66,260 for the three months ended September 30, 2011, an increase of $35,533, or 53.6%. The increase in cost of product sales revenue relates to the sale of some vending machines.

Cost of Maintenance Revenue - Our cost of maintenance revenue was $2,871 for the three months ended September 30, 2012, compared to $8,301 for the three months ended September 30, 2011, representing a decrease of $5,430, or 65.4%. The decrease in our cost of maintenance fee revenue related to fluctuations in cost of maintenance.

The changes and percent changes with respect to our revenues and our cost of revenue for the three months ended September 30, 2012 and 2011 are summarized as follows: For the Three Months Ended September 30, Percent 2012 2011 Change Change REVENUE Product sales $ 140,873 $ 126,807 $ 14,066 11.1 % Maintenance fees 33,836 39,820 (5,984 ) -15.0 % Interest income 2,785 8,515 (5,730 ) -67.3 % Total Revenue 177,494 175,142 2,352 1.3 % COST OF REVENUE Product sales 101,793 66,260 35,533 53.6 % Maintenance 2,871 8,301 (5,430 ) -65.4 % Total Cost of Revenue $ 104,664 $ 74,561 $ 30,103 40.4 % Although the preceding table summarizes the net changes and percent changes with respect to our revenues and our cost of revenue for the three months ended September 30, 2012 and 2011, the trends contained therein are limited and should not be viewed as a definitive indication of our future results.

10 -------------------------------------------------------------------------------- Table of Contents Operating Expenses Selling, General and Administrative - Selling, general and administrative expenses, including non-cash compensation expense, were $87,795 for the three months ended September 30, 2012, compared to $101,011 for the three months ended September 30, 2011, representing a decrease of $13,216, or 13.1%. The difference reflects our ongoing commitment to further reduce fixed overhead expenses.

Research and Development-Research and development expenses were $46,077 for the three months ended September 30, 2012, compared to $22,393 for the three months ended September 30, 2011 representing an increase of $23,684 or 105.8%. The increase was due to a step-up in research and development during the three months ended September 30, 2012.

Net Loss Attributable to Common Stockholders We realized a net loss of $61,042 for the three months ended September 30, 2012, compared to a net loss of $22,823 during the three months ended September 30, 2011. The $38,219 increase in net loss during the three months ended September 30, 2012 related primarily to the increase in research and development costs during the three months ended September 30, 2012.

Comparison of Nine months Ended September 30, 2012 and 2011 Revenues Product Sales - Revenue from product sales was $403,768 for the nine months ended September 30, 2012, compared to $421,994 for the nine months ended September 30, 2011, representing a decrease of $18,226, or 4.3%. The decrease in product sales revenues related to fluctuations of product sales from the minibars.

Maintenance Fees- Maintenance fees were $107,649 for the nine months ended September 30, 2012, compared to $127,681 for the nine months ended September 30, 2011, representing a decrease of $20,032, or 15.7%. The decrease in maintenance fee revenue related to the termination of hotels' maintenance services.

Interest - Our income from interest was $8,824 for the nine months ended September 30, 2012, compared to $64,358 for the nine months ended September 30, 2011, representing a decrease of $55,534, or 86.3%. The decrease in interest income related to accounting for the interest paid on the Secured Note from BlackBird Corporation as a payment of principal.

Cost of Revenue Cost of Product Sales Revenue - Our cost of product sales revenue for the nine months ended September 30, 2012 was $282,435, compared to $230,120 for the nine months ended September 30, 2011, an increase of $52,315, or 22.7%. The increase in cost of product sales revenue relates to fluctuations in cost of product and to the sale of some vending machines during the nine months ended September 30, 2012.

Cost of Maintenance Revenue - Our cost of maintenance revenue was $14,134 for the nine months ended September 30, 2012, compared to $15,818 for the nine months ended September 30, 2011, representing a decrease of $1,684, or 10.6%.

The decrease in our cost of maintenance fee revenue related to decreasing equipment under service.

11 -------------------------------------------------------------------------------- Table of Contents The changes and percent changes with respect to our revenues and our cost of revenue for the nine months ended September 30, 2012 and 2011 are summarized as follows: For the Nine Months Ended September 30, Percent 2012 2011 Change Change REVENUE Product sales $ 403,768 $ 421,994 $ (18,226 ) -4.3 % Maintenance fees 107,649 127,681 (20,032 ) -15.7 % Interest income 8,824 64,358 (55,534 ) -86.3 % Total Revenue 520,241 614,033 (93,792 ) -15.3 % COST OF REVENUE Product sales 282,435 230,120 52,315 22.7 % Maintenance 14,134 15,818 (1,684 ) -10.6 % Total Cost of Revenue $ 296,569 $ 245,938 $ 50,631 20.6 % Although the preceding table summarizes the net changes and percent changes with respect to our revenues and our cost of revenue for the nine months ended September 30, 2012 and 2011, the trends contained therein are limited and should not be viewed as a definitive indication of our future results.

Operating Expenses Selling, General and Administrative - Selling, general and administrative expenses, including non-cash compensation expense, were $309,247 for the nine months ended September 30, 2012, compared to $322,508 for the nine months ended September 30, 2011, representing a decrease of $13,261, or 4%. The difference was immaterial.

Research and Development-Research and development expenses were $132,762 for the nine months ended September 30, 2012, compared to $69,628 for the nine months ended September 30, 2011 representing an increase of $63,134 or 90.7%. The increase was due to a step-up in research and development during the nine months ended September 30, 2012.

Liquidity and Capital Resources At September 30, 2012, our principal sources of liquidity consisted of $2,028,736 of cash and working capital of $2,207,298, as compared to $2,191,396 of cash and working capital of $2,340,660 at December 31, 2011. In addition, our stockholders' equity was $2,770,261 at September 30, 2012, compared to stockholders' equity of $2,976,678 at December 31, 2011, a decrease of $206,417.

The decrease in cash reflects for the most part the net loss during the nine months ended September 30, 2012.

Our accumulated deficit increased from $31,218,740 at December 31, 2011 to $31,437,077 at September 30, 2012. The $218,337 increase in accumulated deficit resulted directly from the net loss realized for the nine months ended September 30, 2012.

Cash flow used in operations for the nine months ended September 30, 2012 was $226,300 as compared to $72,916 provided in the same period ended September 30, 2011.

Investing activities for the nine months ended September 30, 2012 provided net cash of $63,640, compared to $29,634 of net cash provided during the nine months ended September 30, 2011.

There were no financing activities in the nine months ended September 30, 2012 and 2011.

12 -------------------------------------------------------------------------------- Table of Contents Net Loss Attributable to Common Stockholders We realized a net loss of $218,337 for the nine months ended September 30, 2012, compared to a net loss of $24,041 during the nine months ended September 30, 2011. The $194,296 increase in net loss during the nine months ended September 30, 2012 related primarily to the decrease in revenue, increase in cost of goods and increase in research and development costs during the nine months ended September 30, 2012.

Contractual Cash Obligations and Commercial Commitments There were no significant contractual cash obligations or commercial commitments either on or off balance sheet as of September 30, 2012.

Off Balance Sheet Arrangements We have no off-balance sheet arrangements.

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