** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-QSB**

 

| **(Mark  One)** |
|-----------------|
| **ý**      |   | **QUARTERLY REPORT  PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|            |   |   |
|            |   | **For  the quarterly period  ended:                                                          June  30, 2002** |
|            |   | **OR** |
|            |   |   |
| **o**           |   | **TRANSITION REPORT  PURSUANT SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|            |   |   |
|            |   | **For  the transition period  from:                                                  to                                                  ** |
|            |   |   |
|            |   | **Commission  file  number:                                                    000-31037** |

 

**eRoomSystem Technologies, Inc.**

(Exact name of smallbusiness issuer asspecified in its charter)

 
| **Nevada**                                                                          |   | **87-0540713**                        |
|-------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction  of incorporation or organization)                    |   | (I.R.S. Employer  Identification No.) |
|                                                                                |   |                                  |
| **390 North 3050 East, St. George, Utah 84790**                                     |
| (Address of principal  executive offices)                                           |
|                                                                                |   |                                  |
| **(800****) 316-3070**                                                              |
| (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 bySection 13 or 15(d) of the Exchange Act during the past 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90days.   YES ý NO o

** **

**ApplicableOnly to Issuers Involved in Bankruptcy Proceedings During the Preceding FiveYears**

 

Check whether the registrant filed all documents and reports requiredto be filed by Section 12, 13 or 15(d) of the Exchange Act after thedistribution of securities under a plan confirmed by court.  YES o NO o

** **

**ApplicableOnly to Corporate Issuers**

 

State the number of shares outstanding of each of the issuer’s classesof common equity, as of the latest practicable date:

 

10,754,158 sharesof common stock, $0.001 par value, as of August 1, 2002

** **

**Transitional Small Business Disclosure Format (checkone):  **YES o NO ý

 

 

----

 

**FORM 10-QSB**

 

**TABLE OF CONTENTS**

 
| **PART I – FINANCIAL  INFORMATION** |
|------------------------------------------|
|                                     |
|                                     | Item 1. | Financial Statements. |
|                                     |   |
|                                     | Condensed  Consolidated Balance Sheets (Unaudited) |
|                                     |   |
|                                     | Condensed  Consolidated Statements of Operations (Unaudited) |
|                                     |   |
|                                     | Condensed  Consolidated Statements of Cash Flows (Unaudited) |
|                                     |   |
|                                     | Notes  to Condensed Consolidated Financial Statements (Unaudited) |
|                                     |
|                                     | Item  2. | Management’s  Discussion and Analysis of Financial Condition and Results of Operations. |
|                                     |
| **PART II – OTHER INFORMATION**     |
|                                     |
|                                     | Item 1. | Legal Proceedings. |
|                                     |   |   |
|                                     | Item  2. |  Changes in Securities and Use of Proceeds. |
|                                     |   |   |
|                                     | Item 3. | Defaults Upon  Senior Securities. |
|                                     |   |   |
|                                     | Item  4. | Submission  of Matters to a Vote of Security Holders. |
|                                     |   |   |
|                                     | Item 5. | Other Information. |
|                                     |   |   |
|                                     | Item 6. | Exhibits and  Reports on Form 8-K. |
|                                          |  |  |  |

 

i

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**PART I – FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements.**

 

**eROOMSYSTEM TECHNOLOGIES, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)**

 

**ASSETS**

 
|                                                                                                                                 |   | **June 30,  2002** | ** ** | **December  31,  2001** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|-------------------------|------------|
|                                                                                                                                 |   |               |       |                    |       |
| **CURRENT ASSETS**                                                                                                                   |   |               |       |                    |       |
| Cash                                                                                                                                 |   | $                  | 852,844    |                    | $          | 1,031,232 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $23,638  at June 30, 2002 and $23,638 at December 31, 2001           |   | 531,731            |       | 424,343                 |       |
| Inventories                                                                                                                          |   | 1,434,603          |       | 1,221,995               |       |
| Prepaid expenses                                                                                                                     |   | 209,044            |       | 274,477                 |       |
| **Total Current Assets**                                                                                                             |   | 3,028,222          |       | 2,952,047               |       |
|                                                                                                                                 |   |               |       |                    |       |
| **REFRESHMENT CENTERS IN SERVICE**, net of accumulated  depreciation of $585,996 at June 30, 2002 and $396,258 at  December 31, 2001 |   | 2,209,122          |       | 2,489,016               |       |
|                                                                                                                                 |   |               |       |                    |       |
| **PROPERTY AND EQUIPMENT**                                                                                                           |   |               |       |                    |       |
| Production equipment                                                                                                                 |   | 277,429            |       | 276,844                 |       |
| Computer equipment                                                                                                                   |   | 239,333            |       | 237,966                 |       |
| Vehicles and other                                                                                                                   |   | 78,586             |       | 78,586                  |       |
|                                                                                                                                 |   | 595,348            |       | 593,396                 |       |
| Less accumulated depreciation and amortization                                                                                       |   | (459,162           | )          | (412,447                | )          |
| **Net Property and Equipment**                                                                                                       |   | 136,186            |       | 180,949                 |       |
|                                                                                                                                 |   |               |       |                    |       |
| **INVESTMENT IN WHOLLY OWNED,  UNCONSOLIDATED SUBSIDIARY**                                                                           |   | 573,448            |       | 619,091                 |       |
|                                                                                                                                 |   |               |       |                    |       |
| **OTHER ASSETS**                                                                                                                     |   |               |       |                    |       |
| Patents and license rights, net of accumulated  amortization of  391,456 and $357,707, respectively                                  |   | 81,034             |       | 114,783                 |       |
| Deposits                                                                                                                             |   | 73,688             |       | 67,405                  |       |
| **Total Other Assets**                                                                                                               |   | 154,722            |       | 182,188                 |       |
|                                                                                                                                 |   |               |       |                    |       |
| **Total Assets**                                                                                                                     |   | $                  | 6,101,700  |                    | $          | 6,423,291 |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

 

1

----

 

**LIABILITIES AND STOCKHOLDERS’ EQUITY (UNAUDITED)**

 

 
|                                                                                                                                                                     |   | **June 30,  2002** |      | **December  31,  2001** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|-----------|-------------------------|--------|
|                                                                                                                                                                     |   |               |      |                    |   |
| **CURRENT LIABILITIES**                                                                                                                                                  |   |               |      |                    |   |
| Notes payable and current portion of long-term debt                                                                                                                      |   | $                  | 183,165   |                    | $      | 153,006 |   |
| Current portion of capital lease obligations                                                                                                                             |   | 10,716             |      | 12,875                  |   |
| Accounts payable                                                                                                                                                         |   | 362,579            |      | 705,370                 |   |
| Accrued liabilities                                                                                                                                                      |   | 361,389            |      | 506,939                 |   |
| Accrued interest                                                                                                                                                         |   | —             |      | 21,941                  |   |
| Customer deposits                                                                                                                                                        |   | 38,080             |      | 292,481                 |   |
| Deferred maintenance revenue                                                                                                                                             |   | 125,251            |      | 58,467                  |   |
| **Total Current Liabilities**                                                                                                                                            |   | 1,081,180          |      | 1,751,079               |   |
|                                                                                                                                                                     |   |               |      |                    |   |
| **Long-Term Liabilities**                                                                                                                                                |   |               |      |                    |   |
| Long-term debt, net of current portion                                                                                                                                   |   | 1,396,970          |      | 1,356,415               |   |
| Capital lease obligations, net of current portion                                                                                                                        |   | —             |      | 6,075                   |   |
| **Total Long-Term Liabilities**                                                                                                                                          |   | 1,396,970          |      | 1,362,490               |   |
|                                                                                                                                                                     |   |               |      |                    |   |
| **COMMITMENTS AND CONTINGENCIES**                                                                                                                                        |   |               |      |                    |   |
|                                                                                                                                                                     |   |               |      |                    |   |
| **STOCKHOLDERS’ EQUITY**                                                                                                                                            |   |               |      |                    |   |
| Preferred stock, $0.001 par value; 5,000,000 shares  authorized;  no shares outstanding                                                                                  |   | —             |      | —                  |   |
| Common stock, $0.001 par value; 50,000,000 shares  authorized;  10,754,158 shares and 8,016,019 shares outstanding at June 30, 2002  and December 31, 2001, respectively |   | 10,754             |      | 8,016                   |   |
| Additional paid-in capital                                                                                                                                               |   | 30,746,285         |      | 29,098,351              |   |
| Warrants and options outstanding                                                                                                                                         |   | 1,670,632          |      | 1,885,102               |   |
| Notes receivable from shareholders                                                                                                                                       |   | (226,480           | )         | (247,000                | )      |
| Accumulated deficit                                                                                                                                                      |   | (28,577,641        | )         | (27,434,747             | )      |
| **Total Stockholder’s Equity**                                                                                                                                      |   | 3,623,550          |      | 3,309,722               |   |
|                                                                                                                                                                     |   |               |      |                    |   |
| **Total Liabilities and Stockholders’  Equity**                                                                                                                     |   | $                  | 6,101,700 |                    | $      | 6,423,291 |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

 

2

----

 

**eROOMSYSTEM TECHNOLOGIES, INC. AND SUBSIDIARY**

** **

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS****(UNAUDITED)**

 
|                                                                              |   | **For the  Three Months Ended  June 30,** |       | **For the  Six Months Ended  June 30,** |       |
|-----------------------------------------------------------------------------------|--------|-------------------------------------------|------------|-----------------------------------------|------------|
|                                                                              |   | **2002**                                  |       | **2001**                                |       | **2002** |   | **2001** |   |
|                                                                              |   |                                      | ** ** |                                    | ** ** |   |   |   |   |
| **REVENUE**                                                                       |   |                                      |       |                                    |       |   |   |   |   |
| Product sales                                                                     |   | $                                         | 847,453    |                                    | $          | 864,651 |   | $ | 857,692 |   | $ | 891,916 |   |
| Revenue-sharing arrangements                                                      |   | 193,454                                   |       | 144,028                                 |       | 381,837 |   | 278,095 |   |
| Maintenance fees                                                                  |   | 64,259                                    |       | 88,003                                  |       | 119,248 |   | 144,406 |   |
| **Total Revenue**                                                                 |   | 1,105,166                                 |       | 1,096,682                               |       | 1,358,777 |   | 1,314,417 |   |
|                                                                              |   |                                      |       |                                    |       |   |   |   |   |
| **COST OF REVENUE**                                                               |   |                                      |       |                                    |       |   |   |   |   |
| Product sales                                                                     |   | 645,026                                   |       | 540,501                                 |       | 646,252 |   | 556,151 |   |
| Revenue-sharing arrangements                                                      |   | 94,869                                    |       | 69,801                                  |       | 189,737 |   | 128,710 |   |
| Maintenance                                                                       |   | 89,275                                    |       | 57,407                                  |       | 201,772 |   | 197,736 |   |
| **Total Cost of Revenue**                                                         |   | 829,170                                   |       | 667,709                                 |       | 1,037,761 |   | 882,597 |   |
|                                                                              |   |                                      |       |                                    |       |   |   |   |   |
| **Gross Margin**                                                                  |   | 275,996                                   |       | 428,973                                 |       | 321,016 |   | 431,820 |   |
|                                                                              |   |                                      |       |                                    |       |   |   |   |   |
| **OPERATING EXPENSES**                                                            |   |                                      |       |                                    |       |   |   |   |   |
| Selling, general and administrative (exclusive of  non-cash compensation expense) |   | 630,065                                   |       | 799,620                                 |       | 1,038,295 |   | 1,717,491 |   |
| Research and development                                                          |   | 66,921                                    |       | 106,025                                 |       | 130,953 |   | 219,045 |   |
| Non-cash compensation                                                             |   | (39,597                                   | )          | 52,602                                  |       | 57,019 |   | 52,602 |   |
| **Total Operating Expenses**                                                      |   | 6557,389                                  |       | 958,247                                 |       | 1,226,267 |   | 1,989,138 |   |
|                                                                              |   |                                      |       |                                    |       |   |   |   |   |
| **Loss From Operations**                                                          |   | (381,393                                  | )          | (529,274                                | )          | (905,251 | ) | (1,557,318 | ) |
|                                                                              |   |                                      |       |                                    |       |   |   |   |   |
| **OTHER INCOME (EXPENSE)**                                                        |   |                                      |       |                                    |       |   |   |   |   |
| Interest expense                                                                  |   | (65,401                                   | )          | (5,726                                  | )          | (114,523 | ) | (12,803 | ) |
| Loss on disposal of refreshment centers                                           |   | (90,156                                   | )          | —                                  |       | (90,156 | ) | — |   |
| Equity in loss from unconsolidated, wholly owned  subsidiary                      |   | (23,941                                   | )          | (22,440                                 | )          | (45,642 | ) | (84,838 | ) |
| Interest and other income                                                         |   | 7,477                                     |       | 20,439                                  |       | 12,678 |   | 83,855 |   |
| **Other Expense, Net**                                                            |   | (172,021                                  | )          | (7,727                                  | )          | (237,643 | ) | (13,786 | ) |
|                                                                              |   |                                      |       |                                    |       |   |   |   |   |
| **Net Loss**                                                                      |   | $                                         | (553,414   | )                                       | $          | (537,001 | ) | $ | (1,142,894 | ) | $ | (1,571,104 | ) |
|                                                                              |   |                                      |       |                                    |       |   |   |   |   |
| **Basic and Diluted Loss Per Common  Share**                                      |   | $                                         | (0.05      | )                                       | $          | (0.08 | ) | $ | (0.12 | ) | $ | (0.22 | ) |
| **Basic and Diluted Weighted-Average  Common**                                    |   |                                      |       |                                    |       |   |   |   |   |
| **Shares Outstanding**                                                            |   | 10,553,828                                |       | 7,066,019                               |       | 9,489,067 |   | 7,060,135 |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

 

3

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**eROOMSYSTEM TECHNOLOGIES, INC. AND SUBSIDIARY**

** **

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)**

 
|                                                                                          |   | **For the  Six Months Ended  June 30,** |       |
|-----------------------------------------------------------------------------------------------|--------|-----------------------------------------|------------|
|                                                                                          |   | **2002**                                |       | **2001** |   |
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                                                     |   |                                    |       |   |   |
| Net loss                                                                                      |   | $                                       | (1,142,894 | ) | $ | (1,571,104 | ) |
| Adjustments to reconcile  net loss to net cash used in operating activities:                  |   |                                    |       |   |   |
| Depreciation and  amortization                                                                |   | 270,202                                 |       | 208,062 |   |
| Interest income from  shareholder receivables                                                 |   | (5,480                                  | )          | — |   |
| Loss on disposal of assets                                                                    |   | 90,156                                  |       | — |   |
| Shares and options issued  for lawsuit settlement                                             |   | —                                  |       | 15,900 |   |
| Amortization of deferred  offering costs and accretion of debt discount                       |   | 2,262                                   |       | 10,545 |   |
| Non-cash compensation  expense                                                                |   | 57,018                                  |       | 52,602 |   |
| Distributions in excess of  (undistributed) equity in income  from unconsolidated subsidiary  |   | 45,643                                  |       | 194,116 |   |
| Changes in operating  assets and liabilities, net of transfers to  unconsolidated subsidiary: |   |                                    |       |   |   |
| Accounts receivable                                                                           |   | (107,388                                | )          | 508,567 |   |
| Inventories                                                                                   |   | (212,608                                | )          | (282,271 | ) |
| Prepaid expenses                                                                              |   | 65,433                                  |       | (121,921 | ) |
| Accounts payable                                                                              |   | (276,362                                | )          | (213,638 | ) |
| Accrued liabilities                                                                           |   | (167,491                                | )          | (199,259 | ) |
| Customer deposits and  deferred maintenance revenue                                           |   | (187,617                                | )          | 8,625 |   |
| **Net Cash  Used In Operating Activities**                                                    |   | (1,569,126                              | )          | (1,389,776 | ) |
|                                                                                          |   |                                    |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES**                                                     |   |                                    |       |   |   |
| Additions to refreshment  centers in service                                                  |   | —                                  |       | (850,917 | ) |
| Purchase of property and  equipment                                                           |   | (1,952                                  | )          | (42,090 | ) |
| **Net Cash  Used In Investing Activities**                                                    |   | (1,952                                  | )          | (893,007 | ) |
|                                                                                          |   |                                    |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES**                                                     |   |                                    |       |   |   |
| Proceeds from issuance of  common stock                                                       |   | 1,297,605                               |       | — |   |
| Proceeds from exercise of  warrants                                                           |   | 15,150                                  |       | — |   |
| Proceeds from collection  of notes receivable from shareholders                               |   | 26,000                                  |       | — |   |
| Proceeds from borrowings                                                                      |   | 140,489                                 |       | 268,065 |   |
| Principal payments on  notes payable                                                          |   | (78,320                                 | )          | (61,344 | ) |
| Principal payments on  capital lease obligations                                              |   | (8,234                                  | )          | (45,863 | ) |
| **Net Cash  Provided by Financing Activities**                                                |   | 1,392,690                               |       | 160,858 |   |
|                                                                                          |   |                                    |       |   |   |
| **Net  Increase (Decrease) in Cash**                                                          |   | (178,388                                | )          | (2,121,925 | ) |
|                                                                                          |   |                                    |       |   |   |
| **Cash at  Beginning of Period**                                                              |   | 1,031,232                               |       | 2,811,023 |   |
|                                                                                          |   |                                    |       |   |   |
| **Cash at  End of Period**                                                                    |   | $                                       | 852,844    |   | $ | 689,098 |   |
|                                                                                          |   |                                    |       |   |   |
| **Supplemental  Cash Flows Information**                                                      |   |                                    |       |   |   |
| Cash paid for interest                                                                        |   | $                                       | 132,055    |   | $ | 25,709 |   |
|                                                                                          |   |                                    |       |   |   |
| **Supplemental  Disclosure of Noncash Investing and Financing  Activities**                   |   |                                    |       |   |   |
| Conversion of accounts payable into common stock                                              |   | $                                       | 66,429     |   | $ | — |   |
| Property and equipment acquired by capital lease                                              |   | —                                  |       | 16,998 |   |

 

See accompanying notes tounaudited condensed consolidated financial statements.

 

4

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**eROOMSYSTEM TECHNOLOGIES, INC. AND SUBSIDIARY**

 

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

**NOTE 1 – ORGANIZATION AND NATURE OFOPERATIONS**

** **

**Condensed Financial Statements**

 

The accompanyingunaudited condensed consolidated financial statements include the accounts ofeRoomSystem Technologies, Inc. and its subsidiaries (the “Company”). Thesefinancial statements are condensed and, therefore, do not include alldisclosures normally required by generally accepted accountingprinciples.  These statements should be read in conjunction with theCompany’s annual financial statements included in the Company’s December 31,2001 Annual Report on Form 10-KSB.  In particular, the Company’sorganization and nature of operations were presented in Note 1 and itssignificant accounting principles were presented as Note 2 to the consolidatedfinancial statements in that report. In the opinion of management, alladjustments necessary for a fair presentation have been included in theaccompanying condensed consolidated financial statements and consist of onlynormal recurring adjustments.  The results of operations presented in theaccompanying condensed consolidated financial statements for the six monthsended June 30, 2002 are not necessarily indicative of the results that may beexpected for the full year ending December 31, 2002.

 

**Net Loss per Common Share**

 

Basic loss percommon share is computed by dividing net loss attributable to commonstockholders by the weighted average number of common shares outstanding.  Unvested common shares are considered to bestock options for purposes of computing loss per share and are not included inthe weighted-average number of common shares outstanding.  Diluted loss per common share is computed bydividing net loss attributable to common stockholders by the weighted averagenumber of common shares and dilutive potential common share equivalentsoutstanding. Potential common share equivalents consist of shares issuable uponthe exercise of stock options and warrants.

 

As of June 30,2002, there were options and warrants outstanding to purchase 1,670,631 commonshares and 200,000 unvested common shares that were not included in thecomputation of diluted loss per common share as their effect would have beenanti–dilutive, thereby decreasing the loss per common share.

** **

**NOTE 2 – BUSINESS CONDITION**

 

Since inception,the Company has suffered recurring losses. During the year ended December 31,2001 and the six months ended June 30, 2002, the Company had net lossesof  $2,444,411 and $1,142,894, respectively. During the year ended December 31,2001 and the six months ended June 30, 2002, the Company’s operations used$1,725,729 and $1,569,126 of cash, respectively. These matters raisesubstantial doubt about the Company’s ability to continue as a going concern.Management is attempting to raise debt and equity financing for use in operations.In February 2002, the Company completed a private placement offering by issuing2,723,139 shares of common stock for net proceeds of $1,364,034.  Although the Company presently intends toconduct a private placement of common stock during 2002, if market conditionspermit, realization of additional financing is not assured.

 

The accompanyingfinancial statements do not include any adjustments relating to therecoverability and classification of asset carrying amounts or the amount andclassification of liabilities that might result should the Company be unable tocontinue as a going concern.

 

5

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**NOTE 3 – INVESTMENT IN RSi BRE**

 

RSi BRE is awholly-owned, bankrupt-remote subsidiary of the Company that holds and operates2,050 Refreshment Center Units and has an obligation to RSG Investments LLC, anrelated entity (“RSG”), as a result of a troubled debt restructuring under theterms of an Equipment Transfer Agreement with RSG. The Refreshment Center Unitsare subject to seven-year revenue sharing agreements held by RSi BRE.  Under the terms of the Equipment TransferAgreement, RSG receives $0.57 per unit per day of the revenue from the revenuesharing agreements, if earned, which is applied to the obligation to RSG.  The obligation to RSG is being amortizedover the remaining life of the revenue sharing agreements using an estimatedeffective interest rate of approximately 41%. This rate could fluctuate in the future depending upon the level andtiming of revenues generated from the Refreshment Center Units.

 

The board ofdirectors of RSi BRE is comprised of one appointee from the Company, oneappointee from RSG and one independent appointee. All operating decisions,including disbursements, of RSi BRE require unanimous consent of RSi BRE’sboard of directors. As a result, the Company does not control RSi BRE. Inaccordance with EITF 96-16, “Investor’s Accounting for an Investee When theInvestor has a Majority of the Voting Interest But the Minority Shareholder orShareholders Have Certain Approval or Veto Rights,” the Company has determinedthat RSi BRE does not qualify for consolidation in the Company’s financialstatements. Rather, the Company’s investment in RSi BRE is reflected as an“Investment in Wholly Owned, Unconsolidated Subsidiary” in the accompanyingconsolidated balance sheet and is being accounted for under the equity methodof accounting.

 

At June 30, 2002and December 31, 2001, the assets and liabilities of RSi BRE consisted of thefollowing:

 
|                                                         |   | **June 30,  2002** |    | **December  31,  2001** |   |
|--------------------------------------------------------------|--------|--------------------|---------|-------------------------|--------|
| Cash                                                         |   | $                  | 19,413  |                    | $      | 39,742 |   |
| Accounts receivable, net of allowance for doubtful  accounts |   | 128,192            |    | 72,276                  |   |
| Refreshment centers in service                               |   | 2,090,118          |    | 2,090,118               |   |
| Accumulated depreciation                                     |   | (910,117           | )       | (770,914                | )      |
| Accrued liabilities                                          |   | (28,005            | )       | (16,803                 | )      |
| Obligation payable to RSG                                    |   | (726,153           | )       | (795,328                | )      |
|                                                         |   |               |    |                    |   |
| Net Assets                                                   |   | $                  | 573,448 |                    | $      | 619,091 |   |

 

For the six monthsended June 30, 2002 and 2001, the revenues and expenses of RSi BRE consisted ofthe following:

 
|                               |   | **Six Months  Ended June 30,** |    |
|------------------------------------|--------|--------------------------------|---------|
|                               |   | **2002**                       |    | **2001** |   |
| Revenue-sharing agreement revenues |   | $                              | 233,373 |   | $ | 210,257 |   |
| Late fee revenue                   |   | 22,327                         |    | — |   |
| Depreciation                       |   | (139,203                       | )       | (139,202 | ) |
| Other operating expenses           |   | (40,903                        | )       | (32,470 | ) |
| Interest expense                   |   | (121,745                       | )       | (125,665 | ) |
| Interest income                    |   | 508                            |    | 2,242 |   |
|                               |   |                           |    |   |   |
| Net Loss                           |   | $                              | (45,643 | ) | $ | (84,838 | ) |

 

The FinancialAccounting Standards Board has issued the exposure draft *Consolidation of Certain Special-Purpose Entities, aninterpretation of ARB No. 51*. Though the exposure draft is 

 

6

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currently in the comment period, as the exposure draft stands,consolidation of RSi BRE will not be required because the Company is not theprimary beneficiary of the special-purpose entity.

 

Due to theuncertainty of these potential changes in accounting standards and othercurrent issues in the reporting environment, the Company has presented thefollowing proforma financial information of the Company prepared as though theinvestment is RSi BRE had been accounted for on a consolidated basis as of June30, 2002:

 

| Current Assets        |   | $          | 3,175,827 |   |
|-----------------------|--------|------------|-----------|--------|
| Long-term Assets      |   | 3,680,031  |      |
| Current Liabilities   |   | (1,223,079 | )         |
| Long-Term Liabilities |   | (2,009,229 | )         |

 

**NOTE 4 – FINANCING AGREEMENT**

 

Under the terms ofa financing agreement with a finance company, the Company received $150,000 offunding relating to the Refreshment Centers placed by the Company with a hotelcustomer under a qualified revenue sharing agreement. This funding accruesinterest at the seven-year treasury rate plus 12.5%, or 17.19% per annum atJune 30, 2002.  This funding iscollateralized by refreshment centers with a book value of $400,795.

** **

**NOTE 5 – COMMITMENTS ANDCONTINGENCIES**

 

**Legal Matters**

 

On March 28,2001, the Company received a letter from the Company’s former chairman andchief executive officer, in which he claims he is due certain severance andother payments in the aggregate amount of approximately $1,700,000 pursuant tothe terms of his terminated employment agreement.  The matter has been submitted to binding arbitration per theterms of the terminated employment agreement. There is no assurance that the results of the binding arbitration willnot have a material adverse effect on the Company’s financial position orresults of operations.  In the eventthat the arbitrator finds in favor of the former chairman and chief executiveofficer, the Company may be exposed to a liability of up to approximately$1,700,000, the amount claimed by the former chairman and chief executive officer.

 

The Company isalso the subject of certain legal matters, which it considers incidental to itsbusiness activities. It is the opinion of management, after discussion withlegal counsel, that the ultimate disposition of these legal matters should nothave a material impact on the consolidated financial condition or results ofoperations of the Company.

 

**NOTE 6 – STOCKHOLDERS’ EQUITY**

 

In February 2002,the Company issued 2,723,139 shares of common stock in a private placementoffering for $1,416,029 of proceeds, or $0.52 per share, which includes a$66,429 conversion of accounts payable into common stock, before offering costsand commissions of $51,995. The net proceeds from the private placement, afteroffering costs and commissions totaled $1,364,034.

 

Under the terms ofthe offering, the Company is obligated to include the common shares issued inany registration filed by the Company within one year of the date the commonshares are issued.  After one year therelated stockholders have the right, at the Company’s expense, to demand thatthe common shares be registered with the Securities and Exchange Commission.

 

7

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On December 31,2001, officers (and a related entity owned by a director to whom an officerassigned 300,000 options), directors and a non-employee consultant exercisedoptions to purchase 950,000 shares of common stock (including 636,578 variableoptions) at $0.26 per share under the terms of options granted on December 31,2001, by payment of $26,000 in February 2002 and by issuing $221,000 of 5%full-recourse promissory notes to the Company. Principal and accrued intereston the promissory notes is due on December 31, 2005. In addition to the sharespurchased with the notes, the notes are secured by 637,500 shares of commonstock that were held by the officers or the related entity for more than sixmonths at the date of exercise and by other assets.

 

The optionsexercised on December 31, 2001 included the early exercise of 400,000 unvestedoptions. The common shares issued upon the early exercise are subject tocontingent repurchase call options held by the Company that will lapse at thetime, and to the extent, the options vest. The options vest through December 31, 2002. The Company may exercise therepurchase call option on the unvested portion of the common shares if therelated officer terminates employment with the Company prior to the date therelated options vest. Each call option is exercisable at the lesser of the fairvalue of the common stock on the date exercised or $0.26 per share. Theunvested common shares issued upon the early exercise of the options have beenincluded in common stock outstanding from December 31, 2001. During the sixmonths ended June 30, 2002, 200,000 of these options vested.

 

**NOTE 7 – STOCK OPTIONS AND WARRANTS**

** **

**Tender Offer and Variable Options**

 

On January 7,2002, the Company offered to exchange all options held by current employees,directors, independent sales representatives and key consultants to purchaseshares of the Company’s common stock with an exercise price per share of $1.50or more for new options to be granted under the Company’s 2000 Plan. Under theterms of the tender offer, the new options will be granted on or promptly afterthe first trading day that is at least six months and one day after the datethe tendered options were accepted for exchange and cancelled.  The exercise price of the new options willbe equal to the closing market price of the common stock on the date of grant.Each new option will preserve the vesting schedule and the vesting commencementdate of the option it replaces, if any, so that on the date the new option isgranted and on any date thereafter, the holder will be vested in the new optionto the same extent they would have been vested on that date had they retainedtheir tendered option. As a result of the tender offer, options to purchase1,367,855 shares of common stock exercisable from $1.51 to $9.60 per share werecancelled during January 2002 and the Company granted new options on July 23,2002 for the purchase of 1,367,855 shares of common stock exercisable at thethen market price of $0.37 per share, subject to the continued employment ofthe respective option holders on such date.

 

In accordance withFAS Interpretation No. 44, the Company indirectly reduced the exercise price of100,125 stock options by canceling options in January 2002 in connection withthe tender offer and by granting options to the same persons at lower exerciseprices on December 31, 2001. As a result, the options granted in December 2001are being accounted for as variable options until they are exercised, forfeitedor expire. During the six months ended June 30, 2002, the Company recognizedcompensation expense relating to the variable options of $57,018.

 

**Stock Options and Warrants**

 

During the sixmonths ended June 30, 2002, the Company granted options to purchase 18,643shares of common stock to employees, directors and independent salescontractors. These options vest immediately through December 31, 2002, haveexercise prices ranging from $0.90 to $1.55 per share and expire between April2012 and June 2012.

 

8

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During the sixmonths ended June 30, 2002, options to purchase 15,000 options at $1.01 wereexercised.  Also during the six monthsended June 30, 2002 options and warrants to purchase 67,524 shares of commonstock, with exercise prices ranging from $0.26 to $2.67, expired.

 

At June 30, 2002, the Company had 1,918,349 options andwarrants outstanding at an average exercise price of $4.08 per share.  Options and warrants exercisable at June 30,2002 totaled 1,836,687 and had an average exercise price of $4.22 per share.

 

**NOTE 8 – SUBSEQUENT EVENT**

 

During July 2002, the shareholders of the Companyapproved an amendment to the 2000 Stock Option Plan to increase the authorizednumber of options from 2,400,000 to 2,700,000.

 

9

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**ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS.**

 

The followingdiscussion should be read in conjunction with our financial statements andnotes to our financial statements, included elsewhere in this report.  This discussion contains forward-lookingstatements that involve risks and uncertainties.  Our actual results could differ materially from those anticipatedin these forward-looking statements as a result of various factors discussedelsewhere in this report.

 

Certaininformation included herein contains statements that may be consideredforward-looking statements within the meaning of Section 27A of the SecuritiesAct of 1933, as amended, or the Securities Act, and Section 21E of theSecurities Exchange Act of 1934, as amended, or the Exchange Act, such as statementsrelating to our anticipated revenues, gross margin and operating results,future performance and operations, plans for future expansion, capitalspending, sources of liquidity and financing sources.  Such forward-looking information involves important risks anduncertainties that could significantly affect anticipated results in thefuture, and accordingly, such results may differ from those expressed in anyforward-looking statements made herein. These risks and uncertainties include, but are not limited to, thoserelating to our liquidity requirements, the continued growth of the lodgingindustry, the success of our product-development, marketing and salesactivities, vigorous competition in the lodging industry, dependence onexisting management, leverage and debt service (including sensitivity tofluctuations in interest rates), domestic or global economic conditions, theinherent uncertainty and costs of prolonged arbitration or litigation, andchanges in federal or state tax laws or the administration of such laws.  A complete discussion of these risks anduncertainties are contained in our Annual Report on Form 10-KSB, as filed withthe Securities and Exchange Commission on April 1, 2002.

 

**OVERVIEW**

 

eRoomSystemTechnologies, Inc. is a Nevada corporation incorporated on August 31,1999.  We have developed and introducedto the lodging industry an intelligent, in–room computerized platform andcommunications network, or the eRoomSystem. The eRoomSystem is a computerized platform and processor-based systemthat is installed within our eRoomServ refreshment centers and designed tocollect and control data.  TheeRoomSystem also supports our eRoomSafe, an electronic in–room safe.  As part of our expanding line of products,we announced eRoomTray, an in–room ambient tray that can sell a widevariety of products at room temperature, and eRoomEnergy, an in-room digitalthermostat that is designed to control virtually any fan coil unit orpackaged-terminal air conditioner found in hotel rooms.  We also intend to develop other applicationsand extensions to the eRoomSystem, including information management servicesand direct credit card billing and remote engineering and maintenance services.

 

**ACCOUNTING POLICIES**

 

The preparation offinancial statements in conformity with generally accepted accountingprinciples requires our management to make estimates and assumptions thataffect reported amounts and disclosures, some of which may require revision infuture periods.  The most sensitiveestimates affecting our financial statements include future volatility used invaluing equity instruments, allowance for bad debts, depreciable lives ofrefreshment centers in service and property and equipment, amortization life ofpatents, deferred maintenance revenue and accrued liabilities.  By their nature, these judgments are subjectto an inherent degree of uncertainty. Our judgments are based on our historicalexperience, terms of existing contracts, our observance of industry trends,information provided by or gathered from our customers and informationavailable from other outside sources, as appropriate. There can be no assurancethat actual results will not differ from our estimates.  The following is a summary of whatmanagement believes are the critical accounting policies related to ouroperations.  The application of 

 

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these policies, in somecases, requires our management to make subjective judgments regarding theeffect of matters that are inherently uncertain.

 

**Descriptionof Revenues**

 

Historically, wehave received substantially all of our revenues from the sale or placementunder a revenue-sharing program of our products in hotels.  We expect that these revenues will accountfor a substantial majority of our revenues for the foreseeable future.  We also generate limited revenues frommaintenance and support services.  Ourdependence on the lodging industry makes us vulnerable to downturns in thelodging industry caused by the general economic environment.  Such a downturn could result in some hotelsdelaying or declining to purchase or place our products or failing to renew ourmaintenance agreements, or it could result in fewer purchases by hotel guestsof goods and services from our products installed in hotels.  Time spent by individuals on travel andleisure is typically discretionary for consumers and may be particularlyaffected by adverse trends in the general economy.  The success of our operations depends, in part, upondiscretionary consumer spending and economic conditions affecting disposableconsumer income such as employment, wages and salaries, business conditions,interest rates, availability of credit and taxation.

 

Through ourrevenue-sharing program, we install our products at little or no upfront costto our customers and share in the recurring revenues generated from sales ofgoods and services related to our products. We retain the ownership of the eRoomServ refreshment centers andeRoomSafes throughout the term of the revenue-sharing agreements and the rightto re-deploy any systems returned to us upon the expiration or earliertermination of the revenue-sharing agreements. We believe that our revenue-sharing program will increase futureplacements of our products; however, we cannot assure you that we will besuccessful in this effort.

 

We haveexperienced substantial fluctuations in revenues from period-to-period as aresult of limited working capital to fund the development and assembly of ourproducts and to maintain sufficient component inventories.  In addition to limited working capital,fluctuations in revenues have partially resulted from the transition to ourrevenue-sharing program under which revenues are recognized over the seven-yearlife of the contract instead of immediately upon installation of theproduct.  We anticipate that over thenext several years the majority of our revenues will result from the placementof our products pursuant to our revenue-sharing program, followed by sales and,to a lesser extent, from maintenance agreements.  We project that we will receive approximately 60% of therecurring revenues from the sale of goods and services generated by oureRoomServ refreshment centers, eRoomSafes and eRoomTray solutions placed underthe revenue-sharing agreements.  Ourcustomers receive the remainder of the recurring revenues.  AMRESCO Leasing Corporation, or AMRESCO, hasagreed to finance up to 150% of the cost of our products placed under ourrevenue-sharing program, subject to the satisfaction of funding requirements,and, as a result, will be paid from our portion of the revenues.

 

**RevenueRecognition**

 

Sales revenue fromour products is recognized upon completion of installation and acceptance bythe customer.  Sales revenue from theplacement of our eRoomServ refreshment centers and eRoomSafes under ourrevenue-sharing program are accounted for similar to an operating lease, withthe revenues recognized as earned over the term of the agreement.  In some instances, our revenue-sharingagreements provide for a guaranteed minimum daily payment by the hotel.  We negotiate our portion of the revenuesgenerated under our revenue-sharing program based upon the cost of theequipment installed and the estimated daily sales per unit for the specificcustomer.  We seek a gross profit marginof 40% on the sale and placement through our revenue-sharing program ofeRoomServ refreshment centers and eRoomSafes.

 

We typically enterinto installation, maintenance and license agreements with our customers.  Installation, maintenance and licenserevenues are recognized as the services are performed, or pro rata 

 

11

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over the serviceperiod.  We defer all revenue paid inadvance relating to future services and products not yet installed and acceptedby our customers.

 

**Descriptionof Expenses**

 

Cost of productsales consists primarily of production, shipping and installation costs.  Cost of revenue-sharing arrangementsconsists primarily of depreciation of capitalized costs for the products placedin service.  We capitalize theproduction, shipping, installation and sales commissions related to theeRoomServ refreshment centers and eRoomSafes placed under revenue-sharingagreements.  Cost of maintenance feerevenues primarily consists of expenses related to customer support andmaintenance and legacy issues related to installations made before January2001.

 

Selling, generaland administrative expenses include selling expenses consisting primarily ofadvertising, promotional activities, trade shows, travel and personnel-relatedexpenses and general and administrative expenses consisting primarily ofprofessional fees, salaries and related costs for accounting, administration,finance, human resources, information systems and legal personnel.

 

Research anddevelopment expenses consist of payroll and related costs for hardware andsoftware engineers, quality assurance specialists, management personnel, andthe costs of materials used by these employees in the development of new orenhanced product offerings.

 

In accordance withFinancial Accounting Standards Board, or FASB, Statement of FinancialAccounting Standards, or SFAS, No. 86, “Accounting for the Costs ofComputer Software to be Sold, Leased or Otherwise Marketed,” development costsincurred in the research and development of new software products to be sold,leased or otherwise marketed are expensed as incurred until technologicalfeasibility in the form of a working model has been established.  Internally generated capitalizable softwaredevelopment costs have not been material to date.  We have charged our software development costs to research anddevelopment expense in our consolidated statements of operations.

 

**RESULTS OF OPERATIONS**

 

**COMPARISON OF THREE MONTHS ENDED JUNE30, 2002 AND 2001**

 

**Revenues**

 

Product Sales—  Revenues from product sales were$847,433 for the three months ended June 30, 2002, compared to $864,651for the three months ended June 30, 2001, representing a decrease of $17,198,or 2.0%.  The de minimus decreasein revenues from product sales was due to the reduced number of RefreshmentCenters and eRoomSafes sold during the three months ending June 30, 2002as compared to the three months ended June 30, 2001.

 

Revenue SharingArrangements — Our revenue from revenue sharing arrangements was $193,454 forthe three months ended June 30, 2002, compared to $144,028 for the three monthsended June 30, 2001, representing an increase of $49,426, or 34.3%.  The increase in revenue from revenue sharingarrangements was due primarily to the increased placement of RefreshmentCenters and eRoomSafes pursuant to our revenue sharing program during thetwelve months ended June 30, 2002.

 

Maintenance FeeRevenues — Our maintenance fee revenues were $64,259 for the three months endedJune 30, 2002, compared to $88,003 for the three months ended June 30, 2001,representing a decrease of $23,744, or 27.0%. The decrease was due primarily to the expiration and/or temporarysuspension of certain maintenance agreements outstanding.

 

12

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**Costof Revenue**

 

Cost of ProductSales Revenue — Our cost of product sales revenue for the three months endedJune 30, 2002 was $645,026 compared to $540,501 for the three months ended June30, 2001, an increase of $104,525, or 19.3%. The gross margin percentage on revenue from product sales revenue was23.9% for the three months ended June 30, 2002 compared to 37.5% for thethree months ended June 30, 2001.  Theincrease in our cost of product sales revenue and the decrease on our grossmargin percentage on revenue from product sales revenue was due to the sale ofcomponents at reduced margins in an effort to stimulate sales.

 

Cost of RevenueSharing Revenue — Our cost of revenue sharing revenue was $94,869 for the threemonths ended June 30, 2002, compared to $69,801 during the three months endedJune 30, 2001, representing an increase of $25,068, or 36.0%.  The increase in the cost of revenue sharingrevenue was due to increased placement of units pursuant to our revenue sharingprogram.  The gross margin percentage onrevenue sharing revenue was 51.0% for the three months ended June 30, 2002 and51.5% for the three months ended June 30, 2001.  The de minimus decrease in gross margin percentage on revenuesharing revenue from the three months ended June 30, 2000 to the three monthsended June 30, 2001 reflects the consistency of our gross margin percentage onrevenue sharing revenue.

 

Cost ofMaintenance Fee Revenue — Our cost of maintenance fee revenue was $89,275 for thethree months ended June 30, 2002, compared to $57,407 for the three monthsended June 30, 2001, representing an increase of $31,868, or 55.5%.  The gross margin percentage on maintenancefee revenues was (38.9)% for the three months ended June 30, 2002 and 34.8% forthe three months ended June 30, 2001. The increase in our cost of maintenance fee revenue and the decrease ingross margin percentages from the three months ended June 30, 2001 to the threemonths ended June 30, 2002 was primarily due to the maintenance of non-revenueproducing units installed for test purposes.

 

The changes andpercent changes with respect to our revenues and our cost of revenue for thethree months ended June 30, 2002 and 2001 are as follows:

 
|                              |   | **For the  Three Months  Ended June 30,** |      |     |   |       |   |
|-----------------------------------|--------|-------------------------------------------|-----------|----------|--------|------------|--------|
|                              |   | **2002**                                  |      | **2001** |   | **Change** |   | **Percent  Change** |   |
| **REVENUE**                       |   |                                      |      |     |   |       |   |   |   |
| Product sales                     |   | $                                         | 847,453   |     | $      | 864,651    |   | $ | (17,198 | ) | (2.0 | )% |
| Revenue-sharing arrangements      |   | 193,454                                   |      | 144,028  |   | 49,426     |   | 34.3 | % |
| Maintenance fees                  |   | 64,259                                    |      | 88,003   |   | (23,744    | )      | (27.0 | )% |
| **Total Revenue**                 |   | $                                         | 1,105,166 |     | $      | 1,096,682  |   | $ | 8,484 |   | 0.8 | % |
|                              |   |                                      |      |     |   |       |   |   |   |
| **COST OF REVENUE**               |   |                                      |      |     |   |       |   |   |   |
| Product sales                     |   | $                                         | 645,026   |     | $      | 540,501    |   | $ | 104,525 |   | 19.3 | % |
| Revenue-sharing arrangements      |   | 94,869                                    |      | 69,801   |   | 25,068     |   | 36.0 | % |
| Maintenance                       |   | 89,275                                    |      | 57,407   |   | 31,868     |   | 55.5 | % |
| **Total Cost of Revenue**         |   | $                                         | 829,170   |     | $      | 667,709    |   | $ | 161,461 |   | 24.2 | % |
|                              |   |                                      |      |     |   |       |   |   |   |
| **GROSS MARGIN PERCENTAGE**       |   |                                      |      |     |   |       |   |   |   |
| Product sales                     |   | 23.9                                      | %         | 37.5     | %      |       |   |   |   |
| Revenue-sharing arrangements      |   | 51.0                                      | %         | 51.5     | %      |       |   |   |   |
| Maintenance                       |   | (38.9                                     | )%        | 34.8     | %      |       |   |   |   |
| **Total Gross Margin Percentage** |   | 25.0                                      | %         | 39.1     | %      |       |   |   |   |

 

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Although thepreceding table summarizes the net changes and percent changes with respect toour revenues and our cost of revenue for the three months ended June 30, 2002and 2001, the trends contained therein are limited and should not be viewed asa definitive indication of our future results.

 

**OperatingExpenses**

 

Selling, Generaland Administrative — Selling, general and administrative expenses, exclusive ofnon-cash compensation expense, were $630,065 for the three months ended June30, 2002, compared to $799,620 for the three months ended June 30, 2001,representing a decrease of $169,555, or 21.2%. The decrease in our selling, general and administrative expenses fromthe three months ended June 30, 2002 to the three months ended June 30, 2001reflects, in part, our restructurings in January 2001 and October 2001 and ourattempts to reduce overhead over the past twelve months.

 

Research andDevelopment Expenses — Research and development expenses were $66,921 for thethree months ended June 30, 2002, compared to $106,025 for the three monthsended June 30, 2001, representing a decrease of $39,104, or 36.9%.  Research and development expensesrepresented 6.1% of our total revenue for the three months ended June 30, 2002and 9.7% of our total revenue for the three months ended June 30, 2001.  The decrease in research and developmentexpenses was primarily due to the completion of the research and developmentfor our new windows-based platform and other products.

 

Non-CashCompensation Expense  — Non-cashcompensation expense was $(39,597) for the three months ended June 30, 2002,compared to $52,602 for the three months ended June 30, 2001, a decrease of$92,199.  The decrease in non-cashcompensation expense during the three months ended June 30, 2002 ascompared to the three months ended June 30, 2001 was a result of there-valuation of previously issued stock options.

** **

**Other Expense, Net**

 

Other expense, netwas $172,021 for the three months ended June 30, 2002, compared to $7,727 forthe three months ended June 30, 2001, representing an increase of$164,294.  The increase was dueprimarily to the increased interest expenses related to our borrowings pursuantto our financing arrangement with AMRESCO, a decrease in our interest and otherincome and the disposal of refreshment centers.

 

**LossAttributable to Common Stockholders**

 

We incurred lossesattributable to common stockholders of $553,414 and $537,001 during the threemonths ended June 30, 2002 and 2001, respectively.  The $15,413 increase in the loss attributable to commonstockholders was due primarily to increased total cost of revenue and otherexpense, net, offset in part by reduced total operating expenses.  We have continued to incur losses subsequentto June 30, 2002 and, as a result, have experienced an increase in accumulateddeficit.  We believe that we willcontinue to incur losses for a period of time.

 

**COMPARISON OF SIX MONTHS ENDED JUNE30, 2000 AND 2001**

 

**Revenues**

 

Product Sales—  Revenues from product sales were$857,692 for the six months ended June 30, 2002, compared $891,916 for the sixmonths ended June 30, 2001, representing a decrease of $34,224, or 3.8%.  The decrease in revenues from product saleswas due to the reduced number of Refreshment Centers and eRoomSafes sold forthe six months ending June 30, 2002 as compared to the six months endedJune 30, 2001.

 

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Revenue SharingArrangements — Our revenue from revenue sharing arrangements was $381,837 forthe three months ended June 30, 2002, compared to $278,095 for the six monthsended June 30, 2001, representing an increase of $103,742, or 37.3%.  The increase in revenue from revenue sharingarrangements was due primarily to the increased placement of RefreshmentCenters and eRoomSafes pursuant to our revenue sharing program during thetwelve months ended June 30, 2001.

 

Maintenance FeeRevenues — Our maintenance fee revenues were $119,248 for the three monthsended June 30, 2002, compared to $144,406 for the six months ended June 30,2001, representing a decrease of $25,158, or 17.4%.  The decrease was due primarily to the expiration and/or temporarysuspension of certain maintenance agreements outstanding.

 

**Costof Revenue**

 

Cost of ProductSales Revenue — Our cost of product sales revenue for the six months ended June30, 2002 was $646,252, compared to $556,151 for the six months ended June 30,2001, an increase of $90,101, or 16.2%. The increase was due to the higher costs associated with product salesduring the six months ended June 30, 2002, as compared to the six months endedJune 30, 2001.  The gross marginpercentage on revenue from product sales revenue was 24.7% for the six monthsended June 30, 2002 compared to 37.6% for the six months ended June 30,2001.  The decrease in gross marginpercentage on revenue from product sales revenue was due the sale of componentsat reduced margins in an effort to stimulate sales, offset, in part, by theavailability of inventory-on-hand during the six months ended June 30, 2002.

 

Cost of RevenueSharing Revenue — Our cost of revenue sharing revenue was $189,737 for the sixmonths ended June 30, 2002, compared to $128,710 during the six months endedJune 30, 2001, representing an increase of $61,027, or 47.4%.  The increase in the cost of revenue sharingrevenue was due to increased placement of units pursuant to our revenue sharingprogram.  The gross margin percentage onrevenue sharing revenue was 50.3% for the six months ended June 30, 2002 and53.7% for the six months ended June 30, 2001. The minor decrease in gross margin percentage on revenue sharing revenuefrom the six months ended June 30, 2001 to the six months ended June 30, 2002resulted from, in part, the increased cost of product mix under our revenuesharing agreements.

 

Cost ofMaintenance Fee Revenue — Our cost of maintenance fee revenue was $201,772 forthe six months ended June 30, 2002, compared to $197,736 for the six monthsended June 30, 2001, representing an increase of $4,036, or 2.0%.  The gross margin percentage on maintenancefee revenues was (69.2)% for the six months ended June 30, 2002 and (36.9)% forthe six months ended June 30, 2001.  Theincrease in our cost of maintenance fee revenue and the decrease in grossmargin percentages from the six months ended June 30, 2001 to the six monthsended June 30, 2002 was primarily due to the maintenance of non-revenueproducing units installed for test purposes.

 

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The changes andpercent changes with respect to our revenues and our cost of revenue for thesix months ended June 30, 2002 and 2001 are as follows:

 
|                              |   | **For the  Six Months  Ended June 30,** |      |     |   |       |   |
|-----------------------------------|--------|-----------------------------------------|-----------|----------|--------|------------|--------|
|                              |   | **2002**                                |      | **2001** |   | **Change** |   | **Percent  Change** |   |
| **REVENUE**                       |   |                                    |      |     |   |       |   |   |   |
| Product sales                     |   | $                                       | 857,692   |     | $      | 891,916    |   | $ | (34,224 | ) | (3.8 | )% |
| Revenue-sharing arrangements      |   | 381,837                                 |      | 278,095  |   | 103,742    |   | 37.3 | % |
| Maintenance fees                  |   | 119,248                                 |      | 144,406  |   | (25,158    | )      | (17.4 | )% |
| **Total Revenue**                 |   | $                                       | 1,358,777 |     | $      | 1,314,417  |   | $ | 44,360 |   | 3.4 | % |
|                              |   |                                    |      |     |   |       |   |   |   |
| **COST OF REVENUE**               |   |                                    |      |     |   |       |   |   |   |
| Product sales                     |   | $                                       | 646,252   |     | $      | 556,151    |   | $ | 90,101 |   | 16.2 | % |
| Revenue-sharing arrangements      |   | 189,737                                 |      | 128,710  |   | 61,027     |   | 47.4 | % |
| Maintenance                       |   | 201,772                                 |      | 197,736  |   | 4,036      |   | 2.0 | % |
| **Total Cost of Revenue**         |   | $                                       | 1,037,761 |     | $      | 882,597    |   | $ | 155,164 |   | 17.6 | % |
|                              |   |                                    |      |     |   |       |   |   |   |
| **GROSS MARGIN PERCENTAGE**       |   |                                    |      |     |   |       |   |   |   |
| Product sales                     |   | 24.7                                    | %         | 37.6     | %      |       |   |   |   |
| Revenue-sharing arrangements      |   | 50.3                                    | %         | 53.7     | %      |       |   |   |   |
| Maintenance                       |   | (69.2                                   | )%        | (36.9    | )%     |       |   |   |   |
| **Total Gross Margin Percentage** |   | 23.6                                    | %         | 32.9     | %      |       |   |   |   |

 

Although thepreceding table summarizes the net changes and percent changes with respect toour revenues and our cost of revenue for the six months ended June 31, 2002 and2001, the trends contained therein are limited and should not be viewed as adefinitive indication of our future results.

 

**OperatingExpenses**

 

Selling, Generaland Administrative — Selling, general and administrative expenses, exclusive ofnon-cash compensation expense, were $1,038,295 for the six months ended June30, 2002, compared to $1,717,491 for the six months ended June 30, 2001,representing a decrease of $679,196, or 39.5%. The decrease in our selling, general and administrative expenses fromthe six months ended June 30, 2000 to the six months ended June 30, 2001reflects, in part, our restructurings in January 2001 and October 2001 and ourattempts to reduce overhead over the past twelve months.

 

Research andDevelopment Expenses — Research and development expenses were $130,953 for thesix months ended June 30, 2002, compared to $219,045 for the six months endedJune 30, 2001, representing a decrease of $88,092, or 40.2%.  Research and development expensesrepresented 9.6% of our total revenue for the six months ended June 30, 2002and 16.7% of our total revenue for the six months ended June 30, 2001.  The decrease in research and developmentexpenses was primarily due to the completion of the research and developmentfor our new windows-based platform and other products.

 

Non-CashCompensation Expense  — Non-cashcompensation expense was $57,019 for the six months ended June 30, 2002,compared to $52,602 for the six months ended June 30, 2001, representing anincrease of $4,417, or 8.4%.  Theincrease in non-cash compensation expense during the six months endedJune 30, 2002 as compared to the six months ended June 30, 2001 resultedfrom the initial valuation of variable stock options.

 

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**Other Expense, Net**

 

Other expense was$237,643 for the six months ended June 30, 2002, compared to $13,786 for thesix months ended June 30, 2001, representing an increase of $223,857.  The increase is due primarily to theincrease in interest expense related to our borrowings pursuant to our financingarrangement with AMRESCO and a loss on the disposal of refreshment centers.

 

**LossAttributable to Common Stockholders**

 

We incurred lossesattributable to common stockholders of $1,142,894 and $1,571,104 during the sixmonths ended June 30, 2002 and 2001, respectively.  The $428,210, or 27.3%, decrease in the loss attributable tocommon stockholders was due primarily to reduced total operating expenses,offset in part by increased total cost of revenue and other expense net.  We have continued to incur losses subsequentto June 30, 2002 and, as a result, have experienced an increase in accumulateddeficit.  We believe that we willcontinue to incur losses for a period of time.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

During the sixmonths ended June 30, 2002, our principal capital resources were $140,489 infundings through our financial arrangement with AMRESCO and $1,416,029 in grossproceeds from our private placement of common stock in March 2002.  In addition, during the fiscal year 2001, wereceived $1,427,495 in fundings from AMRESCO. The funds from AMRESCO and our private placement have been and will beused to fund working capital and general corporate purposes.

 

At June 30, 2002,our principal sources of liquidity consisted of $852,844 of cash and $1,947,042of working capital compared to $1,031,232 of cash and $1,200,968 of workingcapital at December 31, 2001.  Inaddition, our stockholders’ equity was $3,623,550 at June 30, 2002, compared tostockholders’ equity of $3,309,722 at December 31, 2001, an increase of$313,828.  The increase in cash, workingcapital and stockholders’ equity reflects the proceeds from our privateplacement of common stock in March 2002, offset, in part, by the continued useof cash by our operations and our current inability to generate sufficientrevenue to sustain our operations.

 

Our accumulateddeficit increased from $27,434,747 at June 30, 2001 to $28,577,641 at June 30,2002.  The increase in accumulateddeficit resulted primarily from the net loss from operations for the six monthsended December 31, 2001 and for the six months ended June 30, 2002.  We anticipate that our accumulated deficitwill continue to increase for the foreseeable future.

 

We used net cashof $1,569,126 in operating activities during the six months ended June 30,2002, compared to $1,389,776 of net cash used in operating activities duringthe six months ended June 30, 2001.  The$179,350 increase in the use of net cash in operating activities primarilyresulted from, in part, the $148,473 decrease in distributions in excess ofequity from RSi BRE, Inc., the $615,955 decrease in net cash received fromaccounts receivable, the $62,724 increase in net cash paid for accounts payableand $196,242 decrease in customer deposits and deferred maintenance revenue,offset by, in part, the $428,210 decrease in net loss and the $187,354 increasein prepaid expenses.

 

Investingactivities for the six months ended June 30, 2002 used net cash of $1,952,compared to $893,007 used during the six months ended June 30, 2001.  The decrease in net cash used in investingactivities resulted the $40,138 decrease in the purchase of property andequipment and the absence of additions to refreshment centers in service.  Notwithstanding the decrease in net cashused in investing activities, we expect our investing activity to increasethrough the end of 2002 due to the proposed increase in the placement of ourproducts under our revenue-sharing program. Additionally, we anticipate that we will experience a modest increase inour capital expenditures and lease commitments

 

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for property andequipment consistent with anticipated growth in operations, infrastructure andpersonnel.

 

Financingactivities provided $1,392,690 during the six months ended June 30, 2002compared to net cash of $160,858 provided during the six months ended June 30,2001.  The primary sources of cashduring the six months ended June 30, 2002 was our private placement ofcommon stock for gross proceeds of $1,416,029. As a result, the increase in net cash provided by financing activitiesresulted primarily from $1,312,755 in proceeds from the issuance of commonstock and warrants, offset in part by principal payments on notes payable andprincipal payments on capital lease obligations.

 

The placement ofproducts under revenue-sharing arrangements is capital intensive.  We estimate that we must place approximately16,000 units pursuant to our revenue-sharing program, along with the continuedsale and placement of our products, in order to provide adequate cash tosustain our operations.  As of June 30,2002, we had 3,435 equivalent units placed pursuant to our revenue-sharingprogram.  Although we received proceedsfrom our financing arrangement with AMRESCO and, in March 2002, from ourprivate placement of common stock, we will require additional cash to financeour planned expansion and capital expenditures.  The need for additional working capital is due, in part, to the90-day seasoning period prior to the receipt of funding from AMRESCO.  We are exploring financing alternatives thatmay include institutional or other lending sources and private placements ofdebt or equity.  There is no assurancethat we will be able to obtain additional financing in order to fund ouroperations during the 90-day (or longer) seasoning period or that our customerswill meet the minimum performance criteria established by AMRESCO as apre-requisite to receiving any funding from AMRESCO.  If we are unsuccessful in obtaining financing to fund operationsduring the 90-day (or longer) seasoning period or if we do not receivesufficient financing from AMRESCO, we may have to shift more placements of ourunits from revenue-sharing arrangements to product sales.  No assurance can be given that we will beable to shift the placement of a sufficient number of our units fromrevenue-sharing arrangements to product sales in order to provide adequateliquidity.  Based on the foregoing, webelieve that we will have sufficient cash-on-hand and cash from future fundingswith AMRESCO to sustain our routine business operations (excluding capitalexpenditures to meet our planned expansion) through the third quarter of2002.  In addition, although we expectto raise additional funds for working capital through private offerings of ourequity or convertible debt securities, we have no assurance that adequate fundswill be available on terms favorable to us, or at all.  Further, due to our cash position of the $211,000as of August 12, 2002, we presently intend to conduct a private placement ofcommon stock towards the end of the third quarter of 2002.  However, in light of current marketconditions, the realization of additional financing is not assured.  These matters raise substantial doubt aboutour ability to continue as a going concern.

 

**CONTRACTUAL CASH OBLIGATIONS ANDCOMMERCIAL COMMITMENTS**

 

The followingtable presents our contractual cash obligations and commercial commitments asof June 30, 2002.  We have no othersignificant contractual obligations or commercial commitments either on or offbalance sheet as of this date.  

 
|                             |   | **PAYMENTS  DUE BY PERIOD** |      |
|----------------------------------|--------|-----------------------------|-----------|
| **CONTRACTUAL CASH OBLIGATIONS** |   | **TOTAL**                   |      | **< 1  YEAR** |   | **1-3 YEARS** |   | **4-5  YEARS** |   | **> 5  YEARS** |   |
| Long-term Debt                   |   | $                           | 2,289,088 |   | $ | 404,424 |   | $ | 808,848 |   | $ | 786,171 |   | $ | 289,645 |   |
| Capital Lease Obligations        |   | 10,716                      |      | 10,716 |   | — |   | — |   | — |   |
| Operating Leases                 |   | 838,992                     |      | 179,784 |   | 359,568 |   | 344,586 |   | — |   |
| Other Long-term Obligations*     |   | 1,430,754                   |      | 336,648 |   | 673,296 |   | 504,972 |   | — |   |
| **TOTAL**                        |   | $                           | 4,569,550 |   | $ | 931,572 |   | $ | 1,841,712 |   | $ | 1,506,621 |   | $ | 289,645 |   |

 

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* Assumes we receive $0.57 per unit per day of the revenue from therevenue sharing agreements which is applied to the obligation incurred by RSiBRE, Inc., our wholly-owned, unconsolidated subsidiary.

 

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**RECENT DOWNTURNS IN THE AIRLINE,TRAVEL AND LODGING INDUSTRIES**

 

Due to theweakening economy and the events of September 11, 2001, the travel and lodgingindustries have experienced unprecedented downturns.  More specifically, the lodging industry has experienced lowerhotel occupancy rates due to reduced business and leisure travel.  Since the success of our business isdirectly linked to the performance of the travel and lodging industries, thesubstantial layoffs in these industries, the postponement of future hotelrenovations and projects, the substantial drop-off in guest occupancy and thedramatic reduction in business and leisure travel, including conventiontraffic, have hurt our ability to finalize contracts with hotel properties withwhich we have been meeting and negotiating. In this regard, there is no assurance that we will be able to closecontracts with our current potential customers or that we will be successful instarting discussions with other hotel properties.

 

**QUALITATIVE AND QUANTITATIVEDISCLOSURES ABOUT MARKET RISK**

 

Our productsrequire a limited amount of assembly at our facility in the United States.  We purchase refrigerators from suppliers inthe United States, Canada and China on a purchase order basis in U.S.Dollars.  All other components for ourproducts are purchased from suppliers based in the United States.  Our products are primarily marketed in theUnited States, but we eventually intend to further expand our marketing to theinternational lodging market and to other industries domestically andinternationally.  As a result, ourfinancial results could be affected by weak economic conditions in foreignmarkets.  Because all of our revenueswill be denominated in U.S. Dollars, a strengthening of the dollar could makeour products less competitive in foreign markets.

 

As we expandoperations internationally, we will continue to evaluate our foreign currencyexposures and risks and develop appropriate hedging or other strategies tomanage those risks.  We have not revisedour current business practices to conform to Europe’s conversion to the Euro.

 

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**PART II****– OTHER INFORMATION**

** **

**ITEM1.  LEGAL PROCEEDINGS.**

 

On March 28,2001, we received a letter from our former chairman and chief executiveofficer, Steven Sunyich, in which he claims he is due certain severance andother payments pursuant to the terms of his terminated employmentagreement.  Mr. Sunyich claims that heis owed approximately $200,000 in severance payments and approximately$1,500,000 in payments related to a repurchase clause contained in histerminated employment agreement.  Thematter has been submitted to binding arbitration, to be administered by theAmerican Arbitration Association pursuant to the terms of the terminatedemployment agreement.  In October 2001,the arbitrator issued a discovery order pursuant to which the parties have beenexchanging documents and witness lists in preparation for the arbitrationhearing.  Although originally scheduledfor February 2002, the arbitration hearing was conducted on August 12, 2002 andAugust 13, 2002.  Upon the submission ofclosing briefs by the parties, the arbitrator will make a determination on theclaims made by Mr. Sunyich.

 

**ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS.**

 

Not applicable.

 

**ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.**

 

Not applicable.

 

**ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.**

 

On July 29, 2002,we held our annual meeting of stockholders at Thanksgiving Point, 3003 NorthThanksgiving Way, Lehi, Utah 84043.  Wesubmitted three proposals to our stockholders:

 
| • | the  election of Dr. Alan C. Ashton, S. Leslie Flegel,  David S. Harkness, Herbert A. Hardt, John J. Prehn, James C. Savas  and Lawrence S. Schroeder as our directors;                                           |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                            |
| • | the approval of an  amendment to the eRoomSystem Technologies 2000 Stock Option and Incentive  Plan to increase the number of shares of our common stock authorized for  issuance under the plan from 2,400,000 shares to 2,700,000 shares; and |
|   |                                                                                                                                                                                                                                            |
| • | the ratification of the  issuance of stock options to purchase 1,200,000 shares of our common stock to  our executive officers, directors, consultants and employees.                                                                           |

 

The record date ofour annual meeting was June 14, 2001 on which we had a total of 10,754,158shares of common stock outstanding.  Atotal of 7,599,794 shares, or 70.7% of the total number of outstanding sharesof our common stock, were voted, representing a sufficient number of shares toconstitute a quorum.  The results of ourannual meeting are as follows:

** **

**Proposal One: Election of Directors**

 
| **Name**                     |   | **Votes For**    |   | **Votes  Withheld** |   |
|------------------------------|--------|------------------|--------|---------------------|--------|
| Dr. Alan C. Ashton |   | 7,509,595 shares |   | 90,199 shares       |   |
| S. Leslie Flegel        |   | 7,509,595 shares |   | 90,199 shares       |   |
| David S. Harkness       |   | 7,509,595 shares |   | 90,199 shares       |   |
| Herbert A. Hardt             |   | 7,509,595 shares |   | 90,199 shares       |   |
| John J. Prehn           |   | 7,509,595 shares |   | 90,199 shares       |   |
| James C. Savas               |   | 7,509,595 shares |   | 90,199 shares       |   |
| Lawrence S. Schroeder   |   | 7,509,595 shares |   | 90,199 shares       |   |

 

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| **Proposal  Two:  Amendment to the 2000 Stock  Option and Incentive Plan** |   |
|---------------------------------------------------------------------------------|--------|
|                                                                            |   |
| **Votes For**                                                                   |   | **Votes  Against** |   | **Abstentions** |   |
| 6,668,269 shares                                                                |   | 926,730 |   | 4,795 shares |   |

 
| **Proposal  Three:  Amendment to the 2000 Stock  Option and Incentive Plan** | ** ** |
|-----------------------------------------------------------------------------------|------------|
|                                                                              |       |
| **Votes For**                                                                     |       | **Votes  Against** | ** ** | **Abstentions** | ** ** |
| 6,660,935 shares                                                                  |       | 938,609 |   | 250 shares |   |

 

As a result of thevotes cast by our stockholders at our annual meeting, the three proposalssubmitted to our stockholders were passed.

 

**ITEM5.  OTHER INFORMATION.**

 

Not applicable.

 

**ITEM6.  EXHIBITS****AND REPORTS ON FORM 8-K.**

 

(a)  Exhibits.

 

Not applicable.

 

(b)  Reports on Form 8-K.

 

On June 25, 2002,we filed a Current Report on Form 8-K dated February 21, 2001 with respect tothe date and time of our 2002 Annual Meeting of Stockholders, the amendment andrestatement of our bylaws and the appointment of additional directors.

 

On August 14,2002, we filed a Current Report on Form 8-K, concurrently with the filing ofthis Quarterly Report on Form 10-QSB, with respect to the certifications by ourchief executive officer and our chief financial officer pursuant to 18 U.S.C.Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of2002.

 

**SIGNATURE**

 

In accordance withthe requirements of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.

 
|   | **eROOMSYSTEM TECHNOLOGIES, INC.** |
|--------|------------------------------------|
|   | (Registrant)                       |
|   |                               |
| Date:  | August 14, 2002                    | By: | /s/ David S. Harkness |   |
|   |                               | David S. Harkness |
|   | Its:                               | Chief Executive  Officer, President and  Chairman |
|        |                                    |  |  |  |

 

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