** **

**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: September 30, 2001**

** **

**OR**

** **
| o |   | **TRANSITION REPORT  PURSUANT SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|---|--------|--------------------------------------------------------------------------------------------|

** **

**Forthe transition period from: __________ to __________**

** **

**Commissionfile number: 000-31037**

 

**eRoomSystemTechnologies, Inc.**

(Exact name ofsmall business issuer as specified 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)                                           |   | (zip code)                            |
|                                                                                |   |                                  |
| **(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 by Section 13 or 15(d) of theExchange Act during the past 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.      YESý                    NOo

**Applicable Only to Issuers Involved in Bankruptcy ProceedingsDuring the Preceding Five Years**

Check whether theregistrant filed all documents and reports required to be filed by Section 12,13 or 15(d) of the Exchange Act after the distribution of securities under aplan confirmed by court.                          YESo                    NOo

**ApplicableOnly to Corporate Issuers**

State the number ofshares outstanding of each of the issuer’s classes of common equity, as of thelatest practicable date:

7,066,019 shares of common stock, $0.001 par value, asof November 13, 2001

 

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

 

** **

**FORM10-QSB**

 

**TABLE OFCONTENTS**

 

 
| **PART  I –**FINANCIAL INFORMATION   |
|-------------------------------------------|
|                                      | Item 1 | Financial Statements |
|                                      | 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. |

 

# **PART I – FINANCIAL INFORMATION**

 

**ITEM 1.  FINANCIAL STATEMENTS**

** **

**eROOMSYSTEMTECHNOLOGIES, INC. AND SUBSIDIARIES**

 

#### **CONDENSEDCONSOLIDATED BALANCE SHEETS**

 

**ASSETS (UNAUDITED)**

 
|                                                                                                        |   | **December  31,** |       | **September  30,** |       |
|-------------------------------------------------------------------------------------------------------------|--------|-------------------|------------|--------------------|------------|
|                                                                                                        |   | **2000**          |       | **2001**           |       |
| **CURRENT ASSETS**                                                                                          |   |              |       |               |       |
| Cash                                                                                                        |   | $                 | 2,811,023  |               | $          | 118,426 |   |
| Accounts receivable,  net of allowance for doubtful accounts of $24,000  and $3,011, respectively           |   | 773,715           |       | 202,800            |       |
| Inventories                                                                                                 |   | 946,318           |       | 1,485,218          |       |
| Prepaid expenses and  other                                                                                 |   | 45,056            |       | 92,100             |       |
| **Total Current Assets**                                                                                    |   | 4,576,112         |       | 1,898,544          |       |
|                                                                                                        |   |              |       |               |       |
| **REFRESHMENT CENTERS IN SERVICE**,  net of accumulated depreciation of $120,343 and $304,605, respectively |   | 1,762,245         |       | 2,569,932          |       |
|                                                                                                        |   |              |       |               |       |
| **PROPERTY AND EQUIPMENT**                                                                                  |   |              |       |               |       |
| Production equipment                                                                                        |   | 225,110           |       | 251,444            |       |
| Computer equipment                                                                                          |   | 216,482           |       | 237,966            |       |
| Vehicles and other                                                                                          |   | 67,316            |       | 78,586             |       |
|                                                                                                        |   | 508,908           |       | 567,996            |       |
| Less accumulated  depreciation and amortization                                                             |   | (323,044          | )          | (390,885           | )          |
| **Net Property and Equipment**                                                                              |   | 185,864           |       | 177,111            |       |
|                                                                                                        |   |              | ** ** |               | ** ** |
| **INVESTMENT IN WHOLLY OWNED,  UNCONSOLIDATED SUBSIDIARY**                                                  |   | 936,182           | ** ** | 693,201            | ** ** |
|                                                                                                        |   |              |       |               |       |
| **OTHER ASSETS**                                                                                            |   |              |       |               |       |
| Patents and license  rights, net of accumulated amortization of $290,208 and $340,832,  respectively        |   | 182,282           |       | 131,658            |       |
| Deposits and other                                                                                          |   | 172,464           |       | 258,965            |       |
| **Total Other Assets**                                                                                      |   | 354,746           |       | 390,623            |       |
|                                                                                                        |   |              |       |               |       |
| **Total Assets**                                                                                            |   | $                 | 7,815,149  |               | $          | 5,729,411 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements

 

**LIABILITIESAND STOCKHOLDERS' EQUITY (UNAUDITED)**

 
|                                                                                                                                                                        |   | **December  31,** |      | **September  30,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|-----------|--------------------|--------|
|                                                                                                                                                                        |   | **2000**          |      | **2001**           |   |
| **CURRENT LIABILITIES**                                                                                                                                                     |   |              |      |               |   |
| Notes payable and  current portion of long-term debt                                                                                                                        |   | $                 | 56,710    |               | $      | 67,910 |   |
| Current portion of  capital lease obligations                                                                                                                               |   | 28,091            |      | 14,333             |   |
| Accounts payable                                                                                                                                                            |   | 1,071,333         |      | 965,137            |   |
| Accrued liabilities                                                                                                                                                         |   | 856,691           |      | 554,144            |   |
| Accrued  interest                                                                                                                                                           |   | 12,906            |      | 9,371              |   |
| Customer deposits                                                                                                                                                           |   | 89,258            |      | 34,258             |   |
| Deferred maintenance  revenue                                                                                                                                               |   | 72,764            |      | 37,329             |   |
| **Total Current Liabilities**                                                                                                                                               |   | 2,187,753         |      | 1,682,482          |   |
|                                                                                                                                                                        |   |              |      |               |   |
| **LONG-TERM LIABILITIES**                                                                                                                                                   |   |              |      |               |   |
| Long-term debt, net of  current portion                                                                                                                                     |   | 2,269             |      | 577,215            |   |
| Capital lease  obligations, net of current portion                                                                                                                          |   | 25,656            |      | 7,642              |   |
| **Total Long-Term Liabilities**                                                                                                                                             |   | 27,925            |      | 584,857            |   |
|                                                                                                                                                                        |   |              |      |               |   |
| **COMMITMENTS AND CONTINGENCIES –  NOTE 5**                                                                                                                            |   |              |      |               |   |
|                                                                                                                                                                        |   |              |      |               |   |
| **STOCKHOLDERS' EQUITY**                                                                                                                                                    |   |              |      |               |   |
| Common stock, $0.001  par value; 50,000,000 shares authorized; 7,051,019 shares and 7,066,019  shares outstanding at December 31, 2000 and September 30, 2001, respectively |   | 7,051             |      | 7,066              |   |
| Additional paid-in  capital                                                                                                                                                 |   | 28,546,432        |      | 28,694,455         |   |
| Warrants and options  outstanding                                                                                                                                           |   | 2,036,324         |      | 1,956,788          |   |
| Accumulated deficit                                                                                                                                                         |   | (24,990,336       | )         | (27,196,237        | )      |
| **Total Stockholders’ Equity**                                                                                                                                         |   | 5,599,471         |      | 3,462,072          |   |
|                                                                                                                                                                        |   |              |      |               |   |
| **Total Liabilities and Stockholders'  Equity**                                                                                                                             |   | $                 | 7,815,149 |               | $      | 5,729,411 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements 

 

**eROOMSYSTEMTECHNOLOGIES, INC. AND SUBSIDIARIES**

** **

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS****(UNAUDITED)**

 
|                                                                              |   | **Three  Months Ended September 30,** |       | **Nine  Months Ended September 30,** |       |
|-----------------------------------------------------------------------------------|--------|---------------------------------------|------------|--------------------------------------|------------|
|                                                                              |   | **2000**                              | ** ** | **2001**                             | ** ** | **2000** | ** ** | **2001** | ** ** |
| **Revenue**                                                                       |   |                                  |       |                                 |       |   |   |   |   |
| Product sales                                                                     |   | $                                     | 346,501    |                                 | $          | 100,311 |   | $ | 2,012,788 |   | $ | 992,227 |   |
| Revenues sharing  arrangements                                                    |   | 92,521                                |       | 178,129                              |       | 155,156 |   | 456,224 |   |
| Maintenance fees                                                                  |   | 21,543                                |       | 137,357                              |       | 110,400 |   | 281,763 |   |
| **Total Revenue**                                                                 |   | 460,565                               |       | 415,797                              |       | 2,278,344 |   | 1,730,214 |   |
| **Cost  of Revenue**                                                              |   |                                  |       |                                 |       |   |   |   |   |
| Product sales                                                                     |   | 202,835                               |       | 41,462                               |       | 1,468,891 |   | 597,613 |   |
| Revenue sharing  arrangements                                                     |   | 27,799                                |       | 84,827                               |       | 36,136 |   | 213,537 |   |
| Maintenance                                                                       |   | 66,861                                |       | 87,241                               |       | 74,762 |   | 284,977 |   |
| **Total Cost of Revenue**                                                         |   | 297,495                               |       | 213,530                              |       | 1,579,789 |   | 1,096,127 |   |
| **Gross  Margin**                                                                 |   | 163,070                               |       | 202,267                              |       | 698,555 |   | 634,087 |   |
| **Operating  Expenses**                                                           |   |                                  |       |                                 |       |   |   |   |   |
| Selling, general and  administrative (exclusive of non-cash compensation expense) |   | 901,183                               |       | 630,621                              |       | 2,066,595 |   | 2,348,112 |   |
| Research and  development                                                         |   | 83,544                                |       | 131,212                              |       | 187,932 |   | 350,257 |   |
| Non-cash compensation  expense                                                    |   | 9,366                                 |       | —                               |       | 503,676 |   | 52,602 |   |
| **Total Operating Expenses**                                                      |   | 994,093                               |       | 761,833                              |       | 2,758,203 |   | 2,750,971 |   |
| **Loss  From Operations**                                                         |   | (831,023                              | )          | (559,566                             | )          | (2,059,648 | ) | (2,116,884 | ) |
| **Other  Income (Expense**                                                        |   |                                  |       |                                 |       |   |   |   |   |
| Interest expense                                                                  |   | (435,577                              | )          | (29,850                              | )          | (1,313,011 | ) | (42,653 | ) |
| Write-off of note  receivable from stockholder                                    |   | (390,000                              | )          | —                               |       | (390,000 | ) | — |   |
| Equity in income (loss  of unconsolidated, wholly owned subsidiary                |   | (131,636                              | )          | (48,865                              | )          | 29,998 |   | (133,703 | ) |
| Interest and other  income                                                        |   | 65,307                                |       | 3,484                                |       | 82,340 |   | 87,339 |   |
| **Other Expense, Net**                                                            |   | (891,906                              | )          | (75,231                              | )          | (1,590,673 | ) | (89,017 | ) |
| **Net  Loss**                                                                     |   | (1,722,929                            | )          | (634,797                             | )          | (3,650,321 | ) | (2,205,901 | ) |
| **Dividends Related to Convertible  Preferred Stock**                             |   | (3,457,981                            | )          | —                               |       | (5,603,931 | ) | — |   |
| **Loss Attributable to Commons  Stockholder**                                     |   | $                                     | (5,180,910 | )                                    | $          | (634,797 | ) | $ | (9,254,252 | ) | $ | (2,205,901 | ) |
| **Basic and Diluted Loss Per Common  Share**                                      |   | $                                     | (1.04      | )                                    | $          | (0.09 | ) | $ | (2.93 | ) | $ | (0.31 | ) |
| **Basic and Diluted Weighted Average  Common Shares Outstanding**                 |   | 5,002,013                             |       | 7,066,019                            |       | 3,159,200 |   | 7,062,118 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements 

 

**eROOMSYSTEMTECHNOLOGIES, INC. AND SUBSIDIARIES**

** **

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS (UNAUDITED)**

 
|                                                                                          |   | **Nine  Months Ended September 30,** |       |
|-----------------------------------------------------------------------------------------------|--------|--------------------------------------|------------|
|                                                                                          |   | **2000**                             | ** ** | **2001** | ** ** |
| **Cash Flows From Operating  Activities**                                                     |   |                                 |       |   |   |
| Net loss                                                                                      |   | $                                    | (3,650,321 | ) | $ | (2,205,901 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:                  |   |                                 |       |   |   |
| Depreciation and  amortization                                                                |   | 140,748                              |       | 332,002 |   |
| Common shares issued  for lawsuit settlement                                                  |   | —                               |       | 15,900 |   |
| Amortization of  deferred financing costs and accretion of debt discount                      |   | 500,530                              |       | 16,121 |   |
| Write-off of note  receivable from stockholder                                                |   | 390,000                              |       | — |   |
| Non-cash compensation  expense                                                                |   | 503,676                              |       | 52,602 |   |
| Interest expense paid  by issuance of preferred and common stock, warrants, and stock options |   | 221,186                              |       | — |   |
| Undistributed equity in  loss of unconsolidated subsidiary                                    |   | 169,507                              |       | 242,981 |   |
| Changes in operating  assets and liabilities, net of transfers to unconsolidated subsidiary:  |   |                                 |       |   |   |
| Accounts receivable                                                                           |   | (192,803                             | )          | 570,915 |   |
| Inventories                                                                                   |   | (160,345                             | )          | (325,894 | ) |
| Prepaid expenses,  deposits and other                                                         |   | 14,086                               |       | (104,360 | ) |
| Accounts payable                                                                              |   | (165,460                             | )          | (106,196 | ) |
| Accrued liabilities                                                                           |   | (3,641                               | )          | (306,082 | ) |
| Other liabilities                                                                             |   | 15,387                               |       | (90,435 | ) |
| **Net Cash Used In Operating  Activities**                                                    |   | (2,217,450                           | )          | (1,908,347 | ) |
| **Cash  Flows From Investing Activities**                                                     |   |                                 |       |   |   |
| Additions to  refreshment centers in service                                                  |   | (722,144                             | )          | (1,234,230 | ) |
| Purchase of property  and equipment                                                           |   | (84,029                              | )          | (42,090 | ) |
| Cash investment in  wholly-owned, unconsolidated subsidiary                                   |   | (166,621                             | )          | — |   |
| **Net Cash Used In Investing  Activities**                                                    |   | (972,794                             | )          | (1,276,320 | ) |
| **Cash  Flows From Financing Activities**                                                     |   |                                 |       |   |   |
| Proceeds from  borrowings                                                                     |   | 2,164,169                            |       | 609,490 |   |
| Principal payments on  notes payable                                                          |   | (3,393,095                           | )          | (68,650 | ) |
| Principal payments on  capital lease obligations                                              |   | (17,151                              | )          | (48,770 | ) |
| Proceeds from issuance  of common stock                                                       |   | 9,217,231                            |       | — |   |
| Proceeds from issuance  of preferred stock and warrants                                       |   | 685,831                              |       | — |   |
| Payment of dividends                                                                          |   | (152,533                             | )          | — |   |
| **Net Cash Provided By Financing  Activities**                                                |   | 8,504,452                            |       | 492,070 |   |
| **Net  Increase (Decrease) In Cash**                                                          |   | 5,314,208                            |       | (2,692,597 | ) |
| **Cash  At Beginning of Period**                                                              |   | 113,252                              |       | 2,811,023 |   |
| **Cash  At End of Period**                                                                    |   | $                                    | 5,427,460  |   | $ | 118,426 |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements

 

 
|                                                                                               |   | **Nine  Months Ended September 30,** |    |
|----------------------------------------------------------------------------------------------------|--------|--------------------------------------|---------|
|                                                                                               |   | **2000**                             |    | **2001** |   |
| **Supplemental Cash Flow Information**                                                             |   |                                 |    |   |   |
| Cash paid for interest                                                                             |   | $                                    | 314,806 |   | $ | 46,187 |   |
|                                                                                               |   |                                 |    |   |   |
| **Non-Cash  Investing And Financing Activities**                                                   |   |                                 |    |   |   |
| Property and equipment  acquired by capital lease                                                  |   | $                                    | —  |   | $ | 16,998 |   |
| Refreshment centers  under revenue sharing agreements transferred to inventory                     |   | —                               |    | 213,006 |   |
| Retirement of common  stock                                                                        |   | 450,000                              |    |   |   |
| Issuance of warrants  for advertising agreement                                                    |   | 135,512                              |    | — |   |
| Accrued interest,  accounts payable and payable to stockholder converted to notes payable          |   | 56,063                               |    | — |   |
| Beneficial conversion  feature on bridge loan                                                      |   | 448,398                              |    | — |   |
| Beneficial conversion  feature on Series A and B Preferred Stock                                   |   | 5,225,654                            |    | — |   |
| Accrual of preferred  stock dividends                                                              |   | 102,597                              |    | — |   |
| Value of shares issued  as a dividend on Series B Preferred Stock                                  |   | 275,679                              |    | — |   |
| Conversion of Series A,  B and C Preferred Stock into common Stock                                 |   | 13,265,789                           |    | — |   |
| Transfer of assets from  investment in unconsolidated subsidiary to refreshment centers in service |   | 737,337                              |    | — |   |
| Transfer of notes  payable and accrued interest to unconsolidated subsidiary                       |   | 900,895                              |    | — |   |

 

See accompanying notes to unaudited condensedconsolidated financial statements

 

**eROOMSYSTEM TECHNOLOGIES, INC. ANDSUBSIDIARIES**

** **

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

** **

**NOTE1 – ORGANIZATION AND NATURE OF OPERATIONS**

 

***Condensed FinancialStatements. ***Theaccompanying unaudited condensed consolidated financial statements include theaccounts of eRoomSystem Technologies, Inc. and its subsidiaries, excluding RSiBRE, Inc. (the “Company”). These financial statements are condensed and,therefore, do not include all disclosures normally required by generallyaccepted accounting principles.  Thesestatements should be read in conjunction with the Company’s annual financialstatements included in the Company’s December 31, 2000 Annual Report on Form10-KSB.  In particular, the Company’ssignificant 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.  Theresults of operations presented in the accompanying condensed consolidatedfinancial statements for the three and nine months ended September 30, 2001 arenot necessarily indicative of the results that may be expected for the fullyear ending December 31, 2001.

 

**NOTE2 – BUSINESS CONDITION**

 

Since inception, the Company has suffered recurringlosses. During the year ended December 31, 2000 and the three and nine monthsended September 30, 2001, the Company had net losses of  $5,702,365, $634,797 and $2,205,901, respectively.During the year ended December 31, 2000 and the nine months ended September 30,2001, the Company's operations used $4,285,183 and $1,908,347 of cash,respectively. These matters raise substantial doubt about the Company’s abilityto continue as a going concern. The Company needs to obtain additionalfinancing to provide working capital for its operations.

 

In the latter part of the nine months ended September30, 2001, management has substantially cut operating costs and, subsequent toSeptember 30, 2001, the Company has improved its cash position throughfinancing received and sales made. During the nine months ended September 30, 2001, the Company receivedfunding in the amount $659,802 related to the agreement with a financingcompany to provide funding for Refreshment Centers that the Company haspreviously placed with hotel customers under revenue sharing agreements.  The Company is anticipating the receipt ofadditional funding based upon its revenue sharing agreements in the threemonths ended December 31, 2001 and March 31, 2002.  The funding is not assured and is dependent on the ability of theCompany’s hotel customers to meet the minimum performance standards required bythe Company’s finance company.  Inaddition, management is attempting to arrange debt financing for the placementof the Company’s products during the 90-day seasoning period of the revenuesharing program.  Realization ofadditional financing is not assured.

 

The financial statements do not include anyadjustments relating to the recoverability and classification of asset carryingamounts or the amount and classification of liabilities that might resultshould the Company be unable to continue as a going concern.

 

**NOTE3 – INVESTMENT IN WHOLLY OWNED, UNCONSOLIDATED SUBSIDIARY**

 

The board of directors of RSi BRE, Inc. (“RSi BRE”) iscomprised of one appointee from the Company, one appointee from RSGInvestments, LLC (“RSG”) and one independent appointee. All operatingdecisions, including disbursements, of RSi BRE require unanimous consent of RSiBRE's board of directors. As a result, RSG has substantive participative rightsand the Company does not control RSi BRE. In accordance with EITF 96–16,"Investor's Accounting for an Investee When the Investor has a Majority ofthe Voting Interest But the Minority Shareholder or Shareholders Have CertainApproval or Veto Rights," the Company has determined that RSi BRE does notqualify for consolidation in the Company's financial statements. The Company'sinvestment in RSi BRE is reflected as an "Investment in Wholly Owned,Unconsolidated Subsidiary" in the accompanying consolidated balance sheetand is being accounted for under the equity method of accounting.

At December 31, 2000 and September 30, 2001, theassets and liabilities of RSi BRE consisted of the following:

 
|                                                                             |   | **December 31,** |    | **September 30,** |       |
|----------------------------------------------------------------------------------|--------|------------------|---------|-------------------|------------|
|                                                                             |   | **2000**         |    | **2001**          | ** ** |
| Cash                                                                             |   | $                | 170,288 |              | $          | 79,743 |   |
| Accounts receivable,  net of $36,175 and $10,000 allowance for doubtful accounts |   | 137,406          |    | 101,825           |       |
| Refreshment centers in  service                                                  |   | 2,090,118        |    | 2,090,118         |       |
| Accumulated  depreciation                                                        |   | (492,510         | )       | (701,314          | )          |
| Accrued liabilities                                                              |   | (54,505          | )       | (73,961           | )          |
| Notes payable                                                                    |   | (914,615         | )       | (803,210          | )          |
| **Net  Assets**                                                                  |   | $                | 936,182 |              | $          | 693,201 |   |

 

On August 15, 2000, RSi BRE held 750 units valuedat $737,337 that were transferred to the Company.  Also on August 15, a $914,615 obligation was transferred to andassumed by RSi BRE. Accordingly, depreciation expense was less and interestexpense was higher for the nine months ended September 30, 2001 compared to thenine months ended September 30, 2000. For the nine months ended September 30, 2000 and 2001, the revenues andexpenses of RSi BRE consisted of the following:

 
|                              |   | **September  30,** |    |
|-----------------------------------|--------|--------------------|---------|
|                              |   | **2000**           |    | **2001** | ** ** |
| Revenue sharing agreement revenue |   | $                  | 474,846 |   | $ | 314,690 |   |
| Depreciation                      |   | (246,984           | )       | (208,803 | ) |
| Other operating expenses          |   | (83,803            | )       | (83,459 | ) |
| Interest expense                  |   | (118,010           | )       | (166,364 | ) |
| Interest income                   |   | 3,949              |    | 3,126 |   |
| Other income                      |   | —             |    | 7,107 |   |
| **Net  Income (Loss)**            |   | $                  | 29,998  |   | $ | (133,703 | ) |

 

**NOTE4 – FINANCING AGREEMENT**

 

Under the terms of a financing agreement with afinance company, the finance company has agreed to fund up to 150% of theCompany's product costs for each Refreshment Center that has been in servicefor 90 days, subject to the hotel customer meeting certain requirements andother conditions during that period.  Aspart of the financing agreement, the Company formed a wholly owned consolidatedsubsidiary, eRoomSystem SPE, Inc., a Nevada corporation.  eRoomSystem SPE, Inc. owns, and willcontinue to own, all of the Refreshment Centers funded by the finance companyas well as the related revenue sharing agreements. The finance company has andwill take a senior security interest in the Refreshment Centers financed underthe financing agreement and the corresponding revenue sharing agreements.  eRoomSystem SPE, Inc. is obligated to repaythe amount borrowed under the terms of a note payable corresponding to eachfunding, pursuant to the financing agreement over seven years, plus interest,at a variable interest rate determined at the time of each funding.

During the nine months ended September 30, 2001,eRoomSystem SPE, Inc. borrowed  $659,802under the financing arrangement against the Refreshment Centers placed by theCompany with hotel customers under qualified revenue sharing agreements.  The outstanding notes payable accrueinterest at the seven-year U.S. Treasury rate plus 12.5% per annum.  The increment over the treasury rate will decreaseas total borrowing in place exceeds $10,000,000.  The outstanding payable are collateralized by Refreshment Centerswith a value of $1,074,558.

 

Annual maturities of notes payable related to thefinancing agreement at September 30, 2001 for each of the next five years areas follows:

 
| **Year  Ending:** |   |    |   |
|-------------------|--------|---------|--------|
| **December  31**  |   |    |   |
| 2001              |   | $       | 15,891 |   |
| 2002              |   | 70,916  |   |
| 2003              |   | 84,334  |   |
| 2004              |   | 100,291 |   |
| 2005              |   | 119,267 |   |
| 2006              |   | 141,835 |   |
|                   |        |         |        |  |

 

**NOTE5 – COMMITMENTS AND CONTINGENCIES**

 

**Capital Leases**

 

In January 2001, the Company entered into a capitallease agreement to purchase computer equipment with a value of  $16,998. The lease has a term of two years. The lease payments are $300 per month for the first twelve months of thelease and $743 per month for the final twelve months of the lease.

 

During January 2001, the Company also paid theremaining obligation of $36,288 relating to its capital lease of various officeand computer equipment.

 

**Legal Matters**

 

On March 12, 2001, the Company reached a settlement ofa lawsuit filed by a former supplier during March 1999. Under the terms of thissettlement, the Company paid $85,000 in cash and issued 15,000 restrictedcommon shares, with a value of $15,900, or $1.06 per share.

 

On March 28, 2001, the Company received a letterfrom the Company’s former chairman and chief executive officer, in which heclaims he is due certain severance and other payments in the aggregate amountof approximately $1,700,000 pursuant to the terms of his terminated employmentagreement.  The Company intends tovigorously contest the allegations against it. The matter has been submitted tobinding arbitration per the terms of the terminated employment agreement withthe arbitration hearing to occur in February 2002.  The estimated settlement amount has been accrued in theaccompanying financial statements. Although the resolution of the claim is notexpected to have a material effect on the Company’s financial position orfuture results of operations, there is no assurance that the results of thebinding arbitration will be favorable to the Company or that the results willnot have an adverse effect on the Company.

 

On September 7, 2001, a vendor filed suit against theCompany alleging that the Company failed to make payment of more than $299,111for services and labor provided to the Company pursuant to a letter agreementwhereby the vendor agreed to act as the advertising and marketing agency forthe Company.

The vendor claims the services outlined in the letteragreement were provided and that the Company breached the agreement and failedto honor its obligation to the vendor. The vendor is seeking payment fordamages in excess of $10,000 including additional costs and attorneys’fees.  On October 9, 2001, the Companyfiled an answer and a counterclaim against the vendor. The Company denied thatthe agreement was breached and alleged that the vendor breached theagreement.  The Company is seekingpayment for damages in excess of $10,000 including additional costs andattorney’s fees.  Although the Company intendsto vigorously defend the lawsuit and prosecute its claims against the vendor,the Company has held two settlement conferences with the vendor and may reach asettlement with the vendor.  Since thematter is in the early stages, the Company is unable to determine the potentialimpact of an adverse decision on its financial condition or future results ofoperations.

 

**NOTE6 – STOCK OPTIONS AND WARRANTS**

 

**Amendment to Warrant Agreement**

 

On April 6, 2001, the Company amended its agreementwith an advertising agency whereby the Company originally issued the agency awarrant to purchase 125,000 common shares at $4.80 per share.  The amendment reduced the exercise price to$0.90 per share.   The re-pricing of thewarrants caused the fair value of the warrants to increase by $22,702 on thedate of the amendment as measured by the Black–Scholes option pricingmodel with the following assumptions: risk–free interest rate of 3.9 percent, expected dividend yield of0 percent, volatility of 89.60 percent and estimated life of 0.74 year. TheCompany charged the additional fair value of these warrants to selling, generaland administrative expense during the nine months ended September 30, 2001.

 

**Non-Employee Grants**

 

On June 28, 2001, the Company issued options topurchase 65,000 shares of common stock to a software development company forconsulting services related to research and development. The exerciseprice  is $1.01 per share. These optionswere valued in accordance with SFAS 123 (utilizing the Black–Scholesoption pricing model with the following weighted average assumptions: risk freeinterest rate of  4.5 percent, expecteddividend yield of 0 percent, volatility of 87.99 percent and expected life of three years) at $0.46 per share. TheCompany recognized $29,900 in research and development expense relating to thegrant of these options during the nine months ended September 30, 2001.

 

**Employee Grants**

 

During the nine months ended September 30, 2001, theCompany issued options pursuant to its 2000 Stock Option and Incentive Plan toemployees to purchase a total of 430,700 shares of common stock. Fifty percentof these options vested on June 30, 2001 and the remaining fifty percent veston December 31, 2001. These options are exercisable from $1.01 to $1.91 pershare and expire three years from the date of issuance. The granting of the optionshad no financial effect due to the exercise price being equal to or greaterthan the market value of the common stock on the date of grant. The fair valueof the options ranged from $0.46 to $0.88 per share, based on the Black-Scholesoption pricing model with the following assumptions: risk free interest ratefrom 4.5 to 5.7 percent, volatility from 62.5 to 87.99 percent, expecteddividend yield of 0 percent and an expected life of three years.

 

Pursuant to the terms of the Company’s 2000 StockOption and Incentive Plan, vested options held by terminated employees, thatare unexercised 90 days after the date of termination or resignation, will becancelled.  As of September 30, 2001,there were 215,558 unexercised options held by terminated employees that havebeen cancelled.  These options had nointrinsic value at the date of issuance; therefore, no adjustment to an expensewas recognized in relation to the cancellation of these options.

**Expired Warrants**

 

During the nine months ended September 30, 2001, 287,917unexercised warrants have expired with a value of $132,138, which has been recorded  as additional paid-in capital.

 

After taking into account the above option and warrant activity,the Company had 2,968,785 options and warrants outstanding at September 30,2001, of which 2,732,563 were exercisable.

 

**NOTE7 – SUBSEQUENT EVENTS**

 

During October 2001, the Company received $296,058 of fundingrelating to the Refreshment Centers previously placed by the Company with ahotel customer under a qualified revenue sharing agreement. This fundingaccrues interest at the seven-year U.S. treasury rate plus 12.5%, or 17.02% perannum. This funding is collateralized by refreshment centers with a value of$367,062.

##  

| **ITEM 2****.** |   | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS 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-looking statementsthat involve risks and uncertainties. Our actual results could differ materially from those anticipated inthese 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 asstatements relating to plans for future expansion, capital spending, futureoperations, sources of liquidity and financing sources.  Such forward-looking information involvesimportant risks and uncertainties that could significantly affect anticipatedresults in the future, and accordingly, such results may differ from thoseexpressed in any forward-looking statements made herein.  These risks and uncertainties include, butare not limited to, those relating to our ability to maintain the liquidityrequirements under our financing arrangements, slowdowns in the economy or thelodging industry as a result of terrorist activities or other events, thesuccess of our product-development, marketing and sales activities, vigorouscompetition in the lodging industry, dependence on existing management,leverage and debt service (including sensitivity to fluctuations in interestrates), domestic or global economic conditions, the inherent uncertainty andcosts of prolonged arbitration or litigation, the acceptance by the industry ofour upright vending and dry goods rack solutions to be introduced in the firstquarter of 2002 and changes in federal or state tax laws or the administrationof such laws.  A complete discussion ofthese risks and uncertainties are contained in our Registration Statement onForm SB-2, as filed with the Securities and Exchange Commission onApril 25, 2000 (Commission File No. 333–59492).

 

###### **OVERVIEW**

 

eRoomSystemTechnologies, Inc. is a Nevada corporation incorporated on August 31, 1999.  Our core business is the development andinstallation of an intelligent, in–room computer platform andcommunications network, or the eRoomSystem, for the lodging industry.  The eRoomSystem is a computerized platformand processor-based system designed to collect and control data.  The eRoomSystem supports our fully-automatedand interactive eRoomServ Refreshment Centers, or Refreshment Centers,electronic room safes, or eRoomSafes, in–room energy managementcapabilities, or eRoom Energy, and other proposed applications.  These other applications will includeinformation management services, credit card/smart card capabilities for directbilling and remote engineering and maintenance services.

 

Our interactiveRefreshment Centers provide hotel guests with a selection of up to 33 differentbeverages and snacks and offer the lodging industry an opportunity to captureadditional in–room revenues and reduce operating costs.  Our eRoomSafes have sufficient storage spacefor large items such as laptop computers, personal video cameras and briefcasesand generate additional revenue.  Ourproducts interface with the hotel’s property management system through oureRoomSystem communications network.  Thehotel’s property management system posts usage of our products directly to thehotel guest’s room account.

 

The solutionsoffered by our eRoomSystem and related products have allowed us to install ourproducts and services in several premier hotels and hotel chains, includingMarriott International, Renaissance Hotels, Hilton Hotels, Doubletree Hotels,Carlson Hospitality Worldwide and Bass Hotels. Our hotel relationships and expandable platform will continue to provideus with the opportunity to install our eRoomSystem and related products inpremier hotels.

One of thebyproducts of our technology is the information we have collected since ourfirst product installation.  To date, wehave collected over fifteen million room-nights of data.  Through our eRoomSystem, we are able tocollect information regarding the usage of our products on a real-timebasis.  We use this information to helpour customers increase their operating efficiencies through optimization ofproduct pricing and selection.  We alsointend to market this information to suppliers of goods sold in our RefreshmentCenters and to other users desiring information on the buying patterns of hotelguests for goods and services.

 

We believe thatour eRoomSystem and developing technologies will provide a foundation forexpansion into the healthcare and time-share industries.  We propose to provide healthcare facilitieswith a comprehensive room information and management system that will allowthese facilities to provide patients with a wide array of in–roomamenities not available to them in the past. The list of proposed amenities includes Refreshment Centers, eRoomSafes,one-plus direct dial long distance, on–demand movies, video games andother products and services commonly found in a hotel room.  Similar opportunities exist in thetime-share industry.  By offering adirect credit card billing system, a healthcare or time-share facility canoffer similar services available in hotels.

 

###### **RESULTS OF OPERATIONS**

 

###### **COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2000 AND2001**

 

**Revenues**

 

Product Sales —Revenues from product sales were $100,311 for the three months ended September30, 2001 compared to $346,501 for the three months ended September 30, 2000,representing a decrease of $246,190, or 71%. The decrease in revenues from product sales was due to the reducednumber of Refreshment Centers and eRoomSafes sold during the three monthsending September 30, 2001 as compared to the three months endedSeptember 30, 2000 and our focus on placing our products on a revenuesharing basis.

 

Revenue SharingArrangements — Our revenue from revenue sharing arrangements was $178,129 forthe three months ended September 30, 2001 compared to $92,521 for the threemonths ended September 30, 2000, representing an increase of $85,608, or93%.  The increase in revenue fromrevenue sharing arrangements was due primarily to the increased placement ofRefreshment Centers and eRoomSafes pursuant to our revenue sharing programduring the twelve months ended September 30, 2001.  The increase in revenue from revenue sharing arrangements and thedecrease in revenue from product sales are consistent with the shift of ourbusiness model from a product sales to a revenue sharing program.

 

Maintenance FeeRevenues — Our maintenance fee revenues were $137,357 for the three monthsended September 30, 2001 compared to $21,543 for the three months endedSeptember 30, 2000, representing an increase of $115,814, or 538%.  The increase was due primarily to anincrease in the number of maintenance contracts entered into by us during thetwelve months ended September 30, 2001.

 

**Cost of Revenue**

 

Cost of ProductSales Revenue — Our cost of product sales revenue for the three months endedSeptember 30, 2000 was $202,835 compared to $41,462 for the three months endedSeptember 30, 2001, a decrease of $161,373, or 80%.  The decrease was due to the lower costs associated with thedecrease in sales from the three months ended September 30, 2001 to the threemonths ended September 30, 2000 and increased efficiency in our productionprocess.  The gross margin percentage onrevenue from product sales revenue was 59% for the three months ended September30, 2001 compared to 41% for the three months ended September 30, 2000.  The increase in gross margin percentage onrevenue from product sales revenue was due primarily to increased efficiency inour production process.

 

Cost of RevenueSharing Revenue — Our cost of revenue sharing revenue was $27,799 for the threemonths ended September 30, 2000 and $84,827 during the three months endedSeptember 30, 2001, representing an increase of $57,028.  The increase in the cost of revenue sharingrevenue was due to the increased placement of units pursuant to our revenuesharing program.  The gross marginpercentage on revenue sharing revenue was 70% for the three months ended September30, 2000 and 52% for the three months ended September 30, 2001. The decrease ingross margin percentage on revenue sharing revenue from the three months endedSeptember 30, 2000 to the three months ended September 30, 2001 resulted fromthe transfer of 750 refreshment centers and requisite depreciation in August2000 from RSi BRE to us.  Prior toAugust 2000, and in accordance with the terms of certain agreements, thedepreciation for these units, which is the primary component in the cost ofrevenue sharing revenue, was realized in RSi BRE and the associated revenuesharing revenue was realized in eRoomSystem Technologies.  Since we now own the units unencumbered,both the depreciation and revenue will be recognized on our financialstatements for future periods.

 

Cost ofMaintenance Revenue — Our cost of maintenance revenue was $66,861 for the threemonths ended September 30, 2000 and $87,241 for the three months endedSeptember 30, 2001 representing an increase of $20,380, or 30%.  The gross margin percentage on maintenancerevenues was (210%) for the three months ended September 30, 2000 and 36% forthe three months ended September 30, 2001. The increases in our cost of maintenance revenue and gross margin percentagefrom the three months ended September 30, 2000 to the three months endedSeptember 30, 2001 were primarily due to increased maintenance revenue andincreased maintenance efficiencies.

 

**Operating Expenses**

 

Selling, Generaland Administrative — Selling, general and administrative expenses, exclusive ofnon-cash compensation expense, were $901,183 for the three months endedSeptember 30, 2000 and $630,621 for the three months ended September 30, 2001,representing a decrease of $270,562, or 30%. The decrease in our selling, general and administrative expenses fromthe three months ended September 30, 2000 to the three months ended September30, 2001 was primarily due to the decreased operating expenses related to thereduction-in-force effected on January 24, 2001 and other cost-cutting measures.

 

Researchand Development Expenses — Researchand development expenses were $83,544 for the three months ended September 30,2000 and $131,212 for the three months ended September 30, 2001, representingan increase of $47,668, or 57%. Research and development expenses represented 18% of our total revenuefor the three months ended September 30, 2000 and 32% of our total revenue forthe three months ended September 30, 2001. The increase in research and development expenses was primarily due tothe costs associated with fixing legacy software problems and upgrading ourexisting hotel properties to the same database environment, fees paid to TyberaDevelopment Group, Inc. and other consultants for our Version 4 operatingsystem, database software development and development of upright vending anddry-goods rack solutions for our Refreshment Centers.

 

Non-CashCompensation Expense  — Non-cash compensation expense was$9,366 for the three months ended September 30, 2000 and $0 for the threemonths ended September 30, 2001.  The$9,366 decrease in non-cash compensation expense during the three months endedSeptember 30, 2001 as compared to the three months ended September 30,2000 was a result of the absence of any options or warrants issued during thethree months ended September 30, 2001.

 

**OtherExpense, Net**

 

Other expense, netwas $891,906 for the three months ended September 30, 2000 and $75,231 for thethree months ended September 30, 2001, representing a decrease of $816,675, or92%.  Despite the equity in loss, ratherthan income, from RSi BRE, other expense, net decreased primarily because of asubstantial decrease in interest expense resulting from the repayment of asubstantial portion of our loans from the net proceeds of our initial publicoffering and the absence of any write-offs of note receivables fromstockholders.

 

**Loss Attributable to Common Stockholders**

 

We incurred losses attributable to common stockholdersof $5,180,910 and $634,797 during the three months ended September 30, 2000 and2001, respectively.  The $4,546,113decrease in the loss attributable to common stockholders was due primarily todecreased interest expense, decreased operating expenses, the absence of anywrite-offs of note receivables from stockholders and the absence of anydividends related to convertible preferred stock.  We have continued to incur losses subsequent to September 30,2001 and, as a result, have experienced an increase in accumulated deficit.  We believe that we will continue to incurlosses for a period of time.

 

###### **COMPARISON OF NINE MONTHS ENDEDSEPTEMBER 30, 2000 AND 2001**

 

**Revenues**

 

Product Sales —Revenues from product sales were $992,227 for the nine months ended September30, 2001 compared to $2,012,788 for the nine months ended September 30, 2000, representinga decrease of $1,020,561, or 51%.  Thedecrease in revenues from product sales was due to the reduced number ofRefreshment Centers and eRoomSafes sold for the nine months endingSeptember 30, 2001 as compared to the nine months ended September 30,2000 and our focus on placing our products on a revenue sharing basis.

 

Revenue SharingArrangements — Our revenue from revenue sharing arrangements was $155,156 forthe nine months ended September 30, 2000 and $456,224 for the nine months endedSeptember 30, 2001, representing an increase of $301,068, or 194%.  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 the twelvemonths ended September 30, 2001.  Theincrease in revenue from revenue sharing arrangements and the decrease inrevenue from product sales are consistent with the shift of our business modelfrom a product sales to a revenue sharing program.

 

Maintenance FeeRevenues — Our maintenance fee revenues were $110,400 for the nine months endedSeptember 30, 2000 and $281,763 for the nine months ended September 30, 2001,representing an increase of $171,363, or 155%. The increase was due primarily to an increase in the number ofmaintenance contracts entered into by us during the twelve months endedSeptember 30, 2001.

 

**Cost of Revenue**

 

Cost of ProductSales Revenue — Our cost of product sales revenue for the nine months endedSeptember 30, 2000 was $1,468,891 compared to $597,613 for the nine monthsended September 30, 2001, a decrease of $871,278, or 59%.  The decrease was due to the lower costsassociated with the decrease in sales during the nine months ended September30, 2001 to the nine months ended September 30, 2000.  The gross margin percentage on revenue from product sales revenuewas 40% for the nine months ended September 30, 2001 compared to 27% for thenine months ended September 30, 2000. The increase in gross margin percentage on revenue from product salesrevenue was due primarily to increased efficiency in our production process anda reduction in production personnel.

 

Cost of RevenueSharing Revenue — Our cost of revenue sharing revenue was $36,136 for the ninemonths ended September 30, 2000 and $213,537 during the nine months endedSeptember 30, 2001, representing an increase of $177,401.  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 77% for the nine months ended September 30, 2000and 53% for the nine months ended September 30, 2001.  The decrease in gross margin percentage on revenue sharingrevenue from the nine months ended September 30, 2000 to the nine months endedSeptember 30, 2001 resulted from the transfer of 750 refreshment centers andrequisite depreciation in August 2000 from RSi BRE to us.  Prior to August 2000, and in accordance withthe terms of certain agreements, the depreciation for these units, which is theprimary component in the cost of revenue sharing revenue, was realized in RSiBRE and the associated revenue sharing revenue was realized in eRoomSystemTechnologies.  Since we now own theunits unencumbered, both the depreciation and revenue will be recognized on ourfinancial statements for future periods.

 

Cost ofMaintenance Revenue — Our cost of maintenance revenue was $74,762 for the ninemonths ended September 30, 2000 and $284,977 for the nine months endedSeptember 30, 2001 representing an increase of $210,215.  The gross margin percentage on maintenancerevenues was 32% for the nine months ended September 30, 2000 and (1%) for thenine months ended September 30, 2001. The increase in our cost of maintenance revenue and the decrease ingross margin percentage from the nine months ended September 30, 2000 to thenine months ended September 30, 2001 were primarily due to increasedmaintenance costs associated with increased sales and increased expensesassociated with the repair of a third party manufacturing defect and theupgrade of software for all of our units during the nine months endedSeptember 30, 2001.

 

**Operating Expenses**

 

Selling, Generaland Administrative — Selling, general and administrative expenses, exclusive ofnon-cash compensation expense, were $2,066,595 for the nine months endedSeptember 30, 2000 and $2,348,112 for the nine months ended September 30, 2001,representing an increase of $281,517, or 14%. The modest increase in our selling, general and administrative expensesfrom the nine months ended September 30, 2000 to the nine months endedSeptember 30, 2001 was primarily due to the material increases in payroll andadvertising expenditures by prior management and increased accounting, investorrelations and legal expenses for the nine months ended September 30, 2001,offset, in part, by the recent reduction in operating expenses as a result ofthe reduction-in-force effected on January 24, 2001 and other cost-cuttingmeasures.

 

Research and Development Expenses —Research and development expenses were $187,932 for the nine months endedSeptember 30, 2000 and $350,257 for the nine months ended September 30, 2001,representing an increase of $162,325, or 86%. Research and development expenses represented 8% of our total revenuefor the nine months ended September 30, 2000 and 20% of our total revenue forthe nine months ended September 30, 2001. The increase in research and development expenses during the nine monthsended September 30, 2001 was primarily due to the costs associated with fixinglegacy software problems and upgrading our existing hotel properties to thesame database environment, fees paid to Tybera Development Group, Inc. andother consultants for our Version 4 operating system, database softwaredevelopment and development of upright vending and dry-goods rack solutions forour Refreshment Centers.

 

Non-Cash CompensationExpense  — Non-cash compensation expense was $503,676 for the ninemonths ended September 30, 2000 and $52,602 for the nine months ended September30, 2001.  The $451,074 decrease innon-cash compensation expense during the nine months ended September 30,2001 as compared to the nine months ended September 30, 2000 resulted from theissuance of significantly fewer options and warrants to consultants during thenine months ended September 30, 2001.

 

**OtherExpense, Net**

 

Other expense was$1,590,673 for the nine months ended September 30, 2000 and $89,017 for thenine months ended September 30, 2001, representing a decrease of $1,501,656, or94%.  The decrease is due primarily tothe primarily because of a substantial decrease in interest expense resultingfrom the repayment of a substantial portion of our loans from the net proceedsof our initial public offering and the absence of any write-offs of notereceivables from stockholders.

 

**Loss Attributable to Common Stockholders**

 

We incurred lossesattributable to common stockholders of $9,254,252 and $2,205,901 during thenine months ended September 30, 2000 and 2001, respectively.  The $7,048,351, or 76%, decrease in the lossattributable to common stockholders was due primarily to decreased interestexpense and non-cash compensation expense, increased interest and other income,and the absence of a write-off of a note receivable and any dividends relatedto convertible preferred stock, offset in part by increased loss fromoperations and equity income loss from RSi BRE.  We have continued to incur losses subsequent to September 30, 2001and, as a result, have experienced an increase in accumulated deficit.  We believe that we will continue to incurlosses for a period of time.

 

###### **LIQUIDITY AND CAPITAL RESOURCES**

 

On August 9, 2000, weconsummated our initial public offering for 1,800,000 shares of commonstock.  We received gross proceeds of$11,700,000 and, after deducting the underwriting discounts and commissions andthe offering expenses, net proceeds of approximately $9,860,000.  The net offering proceeds have been used forfunding the production and installation of our products and services, therepayment of a substantial portion of our outstanding indebtedness and relatedaccrued interest, the payment of cash dividends on our Series A andSeries C convertible preferred stock, our advertising and promotional expenses,additional research and development to improve our existing products andservices and to develop our future products and services, and general corporatepurposes and working capital, including the payment of accounts payableincurred prior to the closing of our initial public offering.

 

At September 30, 2001,our principal source of liquidity consisted of $118,426 of cash and $216,062 ofworking capital compared to $2,811,023 of cash and $2,388,359 of workingcapital at December 31, 2000.  In addition,our stockholders’ equity was $3,462,072 at September 30, 2001, compared tostockholders’ equity of $5,599,471 at December 31, 2000, a decrease of$2,137,399.  The decrease in cash,working capital and stockholders’ equity reflects the continued use of cash byour operations since our initial public offering in August 2000 and the currentinability to generate sufficient revenue to sustain our operations.

 

Our accumulated deficitincreased from $24,990,336 at December 31, 2000 to $27,196,237 atSeptember 30, 2001.  The increase inaccumulated deficit resulted primarily from the net loss from operations forthe year ended December 31, 2000 and for the nine months endedSeptember 30, 2001.  We anticipatethat our accumulated deficit will continue to increase for a period of time.

 

We used net cash of$2,217,450 in operating activities during the nine months ended September 30,2000 compared to $1,908,347 of net cash used by operating activities during thenine months ended September 30, 2001. The modest decrease in the use of net cash for operating activitiesprimarily resulted from the increases in accounts receivable, depreciation andamortization and undistributed equity in loss of RSi BRE, offset, in part, bythe decreases in net loss from operations, amortization of deferred financingcosts, non-cash compensation expense, interest expense paid by the issuance ofour securities, inventories, prepaid expenses and deposits and accruedliabilities.  Upon completion of ourdatabase software development and the upright vending and dry-goods racksolutions, we believe that we will realize a reduction of up to $10,000 permonth in associated research and development consulting fees.

 

Investing activities forthe nine months ended September 30, 2000 used $972,794 of net cash compared to$1,276,320 used during the nine months ended September 30, 2001.  The increase in net cash used in investingactivities resulted primarily from the $512,086 increase in additions toRefreshment Centers in service, offset by the $41,939 decrease in purchase ofproperty and equipment and the $166,621 decrease in our cash investment in RSiBRE.

 

Financing activitiesprovided $8,504,452 during the nine months ended September 30, 2000 compared tonet cash of $492,070 provided during the nine months ended September 30, 2001.The primary source of cash during the nine months ended September 30, 2001 wasour borrowings from AMRESCO Leasing Corporation, or AMRESCO, under the terms ofour long-term equipment financing agreement, revenue generated by units installedpursuant to our revenue sharing program and revenue from outstandingmaintenance agreements.  The decrease innet cash provided by financing activities during the nine months endedSeptember 30, 2001 resulted primarily from the $9,217,231 received from ourinitial public offering and the $685,831 received from the issuance ofpreferred stock and warrants during the nine months ended September 30, 2000.

 

The placement of productsunder revenue sharing arrangements is capital intensive.  We estimate that we must place approximately16,000 units pursuant to our revenue sharing program in order to becomeprofitable.  As of November 13, 2001, wehad 3,612 units placed pursuant to our revenue sharing program.  The first funding pursuant to our long-term equipmentfinancing arrangement with AMRESCO was in the principal amount of $294,220,before finance costs, and occurred on March 22, 2001.  Since our initial funding and through November 13, 2001, wereceived additional fundings from AMRESCO in the aggregate principal amount of$661,640.  We anticipate that additionalfundings of up to $525,000 will be completed by the end of April 2002;provided, however, the minimum performance standards of AMRESCO must be met by ourrespective hotel clients during the 90-day seasoning period for such funding tooccur, and AMRESCO has the ability to provide the funding.

 

Although we receiveproceeds from our financing arrangement with AMRESCO, we currently do not havesufficient cash on hand to finance our planned expansion and meet our capitalexpenditure requirements.  The need foradditional working capital is due, in part, to the 90-day (or longer) seasoningperiod prior to the receipt of funding from AMRESCO.  We are exploring financing alternatives that may include institutionalor other lending sources and public or private placements of debt orequity.  There is no assurance that wewill be able to obtain additional financing in order to fund our operationsduring the 90-day (or longer) seasoning period or that our customers will meetthe minimum performance criteria established by AMRESCO as a pre-requisite toreceiving any funding from AMRESCO.  Ifwe are unsuccessful in obtaining financing to fund operations during the 90-day(or longer) seasoning period or if we do not receive sufficient financing fromAMRESCO, we may have to shift more placements of our units from revenue sharingarrangements to product sales.  Noassurance can be given that we will be able to shift the placement of asufficient number of our units from revenue sharing arrangements to productsales in order to provide adequate liquidity. These matters raise doubt about our ability to continue as a goingconcern.

 

On October 11, 2001, weentered into an agreement with the newly renovated, 637-room RenaissanceHollywood Hotel in Hollywood, California in the amount of $886,000 with respectto the sale of 637 Refreshment Centers and 637 eRoomSafes.  We have targeted December 15, 2001 as theinstallation date on the Renaissance Hollywood Hotel.  Based on our existing inventories, we will realize an estimated$650,000 of positive cash flow from this installation. Based on the foregoing,we believe that we will have sufficient cash-on-hand and cash from futurefundings with AMRESCO to sustain our routine business operations (excludingcapital expenditures to meet our planned expansion) through the second quarterof 2002.

 

On January 26, 2001, weterminated the employment of seventeen employees in an effort to maximizeoperational efficiencies and reduce monthly expenses.  In addition, we expanded the responsibilities of other positionsto account for the terminations.  Wehave taken a one-time restructuring charge of $418,606 in the fourth quarter of2000, but estimate that the restructuring will result in an approximate $1.1million reduction in annual overhead over the twelve months following therestructuring.  Subsequently, on October11, 2001, we announced a reduction-in-force and other cost-cutting measures drivenby the uncertainties in the weakening United States economy and the lodgingindustry.  We terminated the employmentof eight employees and modified the compensation of our sales positions tostraight commissions.  We estimate thatthe measures taken should result in a monthly reduction in overhead ofapproximately $51,000.

 

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

 

Due to the weakeningeconomy and the events of September 11, 2001, the travel and lodging industrieshave experienced unprecedented downturns. More specifically, the lodging industry has experienced lower hoteloccupancy 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 products require alimited amount of assembly at our facility in the United States.  We purchase refrigerators from suppliers inthe United States, Canada, Italy 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 expand operationsinternationally, we will continue to evaluate our foreign currency exposuresand risks and develop appropriate hedging or other strategies to manage thoserisks.  We have not revised our currentbusiness practices to conform to Europe’s conversion to the Euro.

 

# **PART II –OTHER INFORMATION**

 

## **ITEM 1.  LEGAL PROCEEDINGS**.

 

On March 28,2001, we  received a letter from ourformer chairman and chief executive officer, Steven Sunyich, in which he claimshe is due certain severance and other payments pursuant to the terms of histerminated employment agreement.  Mr.Sunyich claims that he is owed approximately $200,000 in severance payments andapproximately $1,500,000 in payments related to a repurchase clause containedin his terminated employment agreement. The matter has been submitted to binding arbitration, to be administeredby the American Arbitration Association pursuant to the terms of the terminatedemployment agreement.  The parties tothe arbitration have selected the arbitrator. The arbitration hearing is set for February 2002.  In October 2001, the arbitrator issued adiscovery order pursuant to which the parties have been exchanging documents andwitness lists in preparation for the arbitration hearing.  The settlement amount estimated by us hasbeen accrued in the accompanying financial statements.  Although we intend to vigorously argue ourposition in the arbitration hearing and although the resolution of the claim isnot expected to have a material effect on our financial position or futureresults of operations, there is no assurance that the results of the bindingarbitration will be favorable to us or that the results will not have a materialadverse effect on the Company.

 

On September 7,2001, Hall Communications, Inc., a Nevada corporation, brought an actionagainst us that is currently pending in District Court, Clark County, Nevada,Case No. A436907, Department XVII.  HallCommunications alleges that we failed to make payment of more than $299,111 forservices and labor provided to us pursuant to a Letter Agreement wherein HallCommunications agreed to act as the Advertising and Marketing Agency of Recordfor us pursuant to the terms of the agreement. In its complaint, Hall Communications alleges that (i) we breached theagreement; (ii) we have been unjustly enriched as a result of such breach; and(iii) we breached the implied covenant of good faith and fair dealing.  Hall Communications seeks payment fordamages in excess of $10,000, exemplary or punitive damages in excess of$10,000, attorneys’ fees and costs and such further and other relief, as thecourt deems proper.  On October 9, 2001,we filed an answer and counterclaim to Hall Communications’ complaint in whichwe denied the allegations and alleged that Hall Communications breached theagreement and the implied covenant of good faith and fair dealing.  We are seeking payment for damages in excessof $10,000, exemplary or punitive damages in excess of $10,000, attorneys’ feesand costs and such further and other relief, as the court deems proper.  Although we intend to vigorously defend thelawsuit and prosecute our claims against Hall Communications, we have held twosettlement conferences with Hall Communications and may reach a settlement withHall Communications.  Since the matteris in the early stages, we are unable to determine the potential impact of anadverse decision on our financial condition or future results of operations.

 

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

 

**Useof Proceeds. **On August 9, 2000, we completed theinitial public offering of our common stock. The managing underwriter in the offering was Donald & Co. SecuritiesInc.  Our shares of common stock sold inthe offering were registered under the Securities Act in a RegistrationStatement on Form SB-2, as amended (File No. 333-34882), or the RegistrationStatement.  The Securities and ExchangeCommission, or the Commission, declared the Registration Statement effective onAugust 2, 2000.

 

The initial publicoffering price was $6.50 per share for an aggregate sales price of$11,700,000.  We paid underwritingdiscounts and commissions of $906,750 and a non-accountable expense allowanceof $117,000 to our underwriter and offering expenses of approximately$820,000.  None of the expenses relatedto the initial public offering were paid directly or indirectly to any of ourdirectors, officers, general partners or their associates, or to any persons owning10% or more of any class of our equity securities, or to any of ouraffiliates.  We received net proceedsfrom the initial public offering of approximately $9,860,000 after deductingthe underwriting discounts and commissions and the offering expenses.

 

From the effectivedate of the Registration Statement through the nine months ended September 30,2001, we have used all of the $9,860,000 of net proceeds from the initialpublic offering as follows:

 
| **Use of Proceeds to Date**                                                                                             |   | **Amount** |          |
|-------------------------------------------------------------------------------------------------------------------------|--------|------------|---------------|
| Funding for production and installation of  eRoomSystems, Refreshment Centers and eRoomSafes                            |   | $          | 2,893,285     |   |
| Repayment of a substantial portion of our  outstanding indebtedness and related accrued interest                        |   | 3,794,000  |          |
| Payment of cash dividends on our Series A  convertible preferred stock                                                  |   | 226,917    |          |
| Payment of cash dividends on our Series C  convertible preferred stock                                                  |   | 9,677      |          |
| Advertising and promotional expenses                                                                                    |   | 267,917    |          |
| Research and development to improve our existing  products and services and to develop our future products and services |   | 258,745    |          |
| General corporate purposes and working capital                                                                          |   | 2,409,558  |          |
| **Total**                                                                                                               |   | **$**      | **9,860,000** | ** ** |

 

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

 

None.

 

## **ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS.**

 

None.

 

## **ITEM 5.  OTHERINFORMATION.**

 

**StockPurchase Plans. **During the first quarter of 2001, thefollowing officers adopted “plans” under Rule 10b5-1 of the Securities ExchangeAct of 1934, as amended, for the purchase of shares of our common stock: David S. Harkness, Derek K. Ellis, and Gregory L. Hrncir.   In general, the plans for these officersprovide for the purchase of shares of our common stock on a monthly basis inthe aggregate amount of up to $2,000 per month.  Messrs. Harkness, Ellis and Hrncir have voluntarily elected to terminatetheir respective stock purchase plans.

 

**Resignationof Stephen M. Nelson. **On August 28, 2001, Stephen M. Nelsonresigned as our President and Chief Operating Officer.  The board of directors subsequentlyappointed David S. Harkness, the Chief Executive Officer and Chairman of theBoard, as our President.  The positionof Chief Operating Officer remains unfilled.

 

**ListingRequirements. **Our common stock has been publicly tradedon the Nasdaq SmallCap Market since August 3, 2000.  Since June 22, 2001, our common stock has failed to meet theminimum bid price requirement of $1.00 as required by the continued listingrules of the Nasdaq SmallCap Market. Under the continued listing rules, a company whose securities fall belowthe minimum bid price or the minimum public float requirements for 30consecutive business days are given a 90-day grace period to regaincompliance.  A company may demonstratecompliance by meeting the applicable standard for a minimum of 10 consecutivebusiness days.  If a company fails toregain compliance within the applicable timeframe, that company is subject todelisting.  On September 26, 2001, theNasdaq Board of Directors approved an across-the-board moratorium on theminimum bid and public float requirements for continued listing on Nasdaqeffective as of such date and until January 2, 2002.  Under the temporary relief provided by the new rules, companieswill not be cited for bid price or market value of public float deficiencies.Companies currently under review for deficiencies or in the hearings processwill be taken out of the process with respect to the bid price or market valueof public float requirements.  Nodeficiencies will accrue during the proposed suspension process.  During this time, Nasdaq will consider whetherit is appropriate to recommend further and more permanent action.  As a result of the foregoing, our commonstock remains listed on the Nasdaq SmallCap Market despite failing to meet theminimum bid price requirement for continued listing thereon in effect prior toSeptember 26, 2001.

 

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

 

(a)   Exhibits.

 

None.

 

(b)    Reports on Form 8-K.

 

On September 7,2001, we filed a Current Report on Form 8-K dated August 28, 2001 with respectto the resignation of Stephen M. Nelson as our President and Chief OperatingOfficer.

 

**SIGNATURE**

 

In accordance withthe requirements of the Securities Exchange Act of 1934, the registrant causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
|   |               | **eRoomSystem  Technologies, Inc.** |
|--------|--------------------|-------------------------------------|
|   |               | (Registrant)                        |
|   |               |                                |   |
| Date:  | November 13,  2001 | By:                                 | /s/ David S.  Harkness |
|   |               |                                | David S.  Harkness |
|   |               | Its:                                | President, Chief  Executive Officer and Chairman |