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

August 8, 2014

As used in this Form 10-Q, references to the "Company," "we," "our" or "us" refer to eRoomSystem Technologies, Inc. and subsidiaries, unless the context otherwise indicates.

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

Forward-Looking Statements

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

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

Except to the extent required by law, we undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, a change in events, conditions, circumstances or assumptions underlying such statements, or otherwise.

Amenities Manager Platform

In January 2014, the Company introduced to the lodging industry an amenity management platform, or the Amenities Manager. The platform's core is proprietary, unique software that provides a locally hosted or cloud-based system that is intended to assist a hotel in evaluating the gross profit margin of various refreshment center products, determining which products will best sell in the hotel's particular environment, and determining which products are consistent with and could enhance the hotel's image and theme. The Amenities Manager is intended to help hotels reduce their operating costs and enhance the hotels' guest satisfaction, which would ultimately allow the hotels to charge more for their rooms and services. We believe that the solutions offered by our Amenities Manager will allow us to establish relationships with many premier hotel chains. It is our intention that our hotel customers will eventually share in revenues generated from the sale of products from our refreshment centers related to our platform. We have not yet determined the effect this change in our relationship with hotels will have, but we believe it will result in an increase in our revenue through an increase in the number of hotel customers. As an alternative solution, we also plan to offer a turnkey arrangement whereby we would provide both products and restocking services to hotels.

Results of Operations

Revenue Recognition

We generate revenues from the sale of products in hotel in-room refreshment centers, from maintenance services and the lease of equipment. Revenue from the sale of refreshments from the refreshment centers is recognized upon removal of the item from the refreshment center by the hotel guest. Maintenance revenue is recognized as the services are performed. Lease revenue is recognized over the term of the lease.

Description of Expenses

Cost of revenue consists primarily of cost of goods sold, as well as customer support and maintenance.

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

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Research and development expenses consist of payroll and related costs for hardware and software engineers, quality assurance specialists, management personnel, and the costs of materials used by our consultants in research and development for new products. Research and development expenses in the six months ended June 30, 2014 and 2013 were $24,440 and $60,153, respectively. The decrease related to a decrease in research and development in 2014 due to the research projects being significantly advanced or completed and therefore not requiring the expenditures that were required in the prior period.

In accordance with ASC Codification Topic 730, "Accounting for Research and Development Costs", development costs incurred in the research and development of new software products to be sold, leased or otherwise marketed are expensed as incurred until technological feasibility in the form of a working model has been established. Internally generated capitalizable software development costs have not been material to date. We have charged our software development costs to research and development expense in our condensed consolidated statements of operations.

Comparison of Three Months Ended June 30, 2014 and 2013

Revenue

Revenue from product sales and maintenance was $197,022 for the three months ended June 30, 2014, compared to $133,315 for the three months ended June 30, 2013, representing an increase of $63,707, or 48%. The increase in revenues related to new hotels coming on in the latter part of 2013 and in 2014.

Cost of Revenue

Our cost of product sales and maintenance revenue for the three months ended June 30, 2014 was $103,214, compared to $61,121 for the three months ended June 30, 2013, an increase of $42,093, or 69%. The increase in cost of revenue relates to the increase in revenue in the three months ended June 30, 2014. The gross margin percentage on revenue from product sales revenue was 48% in 2014 as compared to 54% in 2013. The decrease related to a decrease in the number of hotels on maintenance contracts.

The changes and percent changes with respect to our revenues and our cost of revenue for the three months ended June 30, 2014 and 2013 are summarized as follows: For the Three Months Ended June 30, Percent 2014 2013 Change Change REVENUE $ 197,022$ 133,315$ 63,707 48 % COST OF REVENUE $ 103,214$ 61,121$ 42,093 69 %



Although the preceding table summarizes the net changes and percent changes with respect to our revenues and our cost of revenue for the three months ended June 30, 2014 and 2013, the trends contained therein are limited and should not be viewed as a definitive indication of our future results.

Operating Expenses

Selling, General and Administrative - Selling, general and administrative expenses, including non-cash compensation expense, were $146,272 for the three months ended June 30, 2014, compared to $83,642 for the three months ended June 30, 2013, representing an increase of $62,630, or 75% primarily due to the writedown of equipment and loan loss allowance recorded during the second quarter. The writedown of the equipment is not expected to be representative of ongoing operations.

Research and Development-Research and development expenses were $12,075 for the three months ended June 30, 2014, compared to $22,077 for the three months ended June 30, 2013 representing a decrease of $10,002 or 45%. The decrease was primarily due to the research projects being significantly advanced or completed and therefore not requiring the expenditures that were required in the prior period. However, additional costs will be necessary for the completion of these projects.

Investment Income

Our investment income was $155,975 for the three months ended June 30, 2014, compared to $3,141 for the three months ended June 30, 2013, representing an increase of $152,834, or 4,866%. The increase in investment income related to the payback of Blackbird's Note Receivable in full as well as a sale of an investment in marketable securities. These transactions are not necessarily representative of ongoing operations of the Company.

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Net Income (Loss)

We realized a net income of $91,436 for the three months ended June 30, 2014, compared to a net loss of $30,384 for the three months ended June 30, 2013. The $121,820 change during the three months ended June 30, 2014 related primarily to the increase in sales and the related gross margin, the increase in investment income and the decrease in research and development expense offset by the writedown of equipment and loan loss allowance recorded during the three months ended June 30, 2014, as further discussed above.

Comparison of Six Months Ended June 30, 2014 and 2013

Revenue

Revenue from product sales and maintenance was $379,581 for the six months ended June 30, 2014, compared to $271,714 for the six months ended June 30, 2013, representing an increase of $107,867, or 40%. The increase in revenues in the first six months of 2014 related to new hotels coming on in the latter part of 2013 and in 2014.

Cost of Revenue

Our cost of product sales and maintenance revenue for the six months ended June 30, 2014 was $205,526, compared to $131,814 for the six months ended June 30, 2013, an increase of $73,712, or 56%. The increase in cost of revenue relates to the increase in revenue in the six months ended June 30, 2014. The gross margin percentage on revenue from product sales revenue was 46% in 2014 as compared to 51% in 2013. The decrease related to a decrease in the number of hotels on maintenance contracts.

The changes and percent changes with respect to our revenues and our cost of revenue for the six months ended June 30, 2014 and 2013 are summarized as follows: For the Six Months Ended June 30, Percent 2014 2013 Change Change REVENUE $ 379,581$ 271,714$ 107,867 40 % COST OF REVENUE $ 205,526$ 131,814$ 73,712 56 %



Although the preceding table summarizes the net changes and percent changes with respect to our revenues and our cost of revenue for the six months ended June 30, 2014 and 2013, the trends should not be viewed as a definitive indication of our future results.

Operating Expenses

Selling, General and Administrative - Selling, general and administrative expenses, including non-cash compensation expense, were $225,959 for the six months ended June 30, 2014, compared to $170,548 for the six months ended June 30, 2013, representing an increase of $55.411, or 19% primarily due to the writedown of equipment and loan loss allowance recorded during the second quarter. The writedown of the equipment is not expected to be representative of ongoing operations.

Research and Development-Research and development expenses were $24,440 for the six months ended June 30, 2014, compared to $60,153 for the six months ended June 30, 2013 representing a decrease of $35,713 or 59%. The decrease was primarily due to the research projects being significantly advanced or completed and therefore not requiring the expenditures that were required in the prior period. However, additional costs will be necessary for the completion of these projects.

Investment Income

Our investment income was $170,311 for the six months ended June 30, 2014, compared to $5,370 for the six months ended June 30, 2013, representing an increase of $164,941, or 3072%. The increase in investment income related to the payback of Blackbird's Note Receivable in full as well as a sale of an investment in marketable securities. These transactions are not necessarily representative of ongoing operations of the Company.

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Net Income (Loss)

We realized a net income of $93,967 for the six months ended June 30, 2014, compared to a net loss of $85,431 for the six months ended June 30, 2013. The $179,398 change during the six months ended June 30, 2014 related primarily to the increase in sales and the related gross margin, the increase in investment income and the decrease in research and development expense offset by the writedown of equipment and loan loss allowance recorded during the six months ended June 30, 2014, as further discussed above.

Liquidity and Capital Resources

Our accumulated deficit decreased from $31,851,020 at December 31, 2013 to $31,757,053 at June 30, 2014. The $93,967 decrease in accumulated deficit resulted directly from the net income realized for the six months ended June 30, 2014.

At June 30, 2014, our principal sources of liquidity consisted of $1,601,382 of cash and working capital of $2,380,631, as compared to $1,376,822 of cash and working capital of $1,851,734 at December 31, 2013. In addition, our stockholders' equity was $2,471,570 at June 30, 2014, compared to stockholders' equity of $2,368,432 at December 31, 2013, an increase of $103,138. The increase in cash primarily reflects payment of the Blackbird note offset by the new Note Receivable provided during second quarter 2014. We have sufficient funds for the next twelve months.

Cash flow provided in operations for the six months ended June 30, 2014 was $72,582 as compared to $151,856 used in the same period ended June 30, 2013.

Investing activities for the six months ended June 30, 2014 provided net cash of $151,978, compared to $152,738 of net cash used during the six months ended June 30, 2013.

There were no financing activities in the six months ended June 30, 2014 and 2013.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers ("ASU 2014-09"), which stipulates that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve this core principle, an entity should apply the following steps: (1) identify the contract(s) with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 will be effective for the Company retrospectively beginning January 1, 2017, with early adoption not permitted. Management is currently evaluating the impact of the pending adoption of ASU 2014-09 on the Company's consolidated financial statements.

In July 2013, the FASB issued Accounting Standards Update No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists ("ASU 2013-11"), to provide guidance on the presentation of unrecognized tax benefits. ASU 2013-11 requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows: to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. ASU 2013-11 is effective January 1, 2015 with earlier adoption permitted. ASU 2013-11 should be applied prospectively with retroactive application permitted. Management is currently evaluating the impact of the pending adoption of ASU 2013-11 on the Company's consolidated financial statements.

Contractual Cash Obligations and Commercial Commitments

There were no significant contractual cash obligations or commercial commitments either on or off balance sheet as of June 30, 2014.

Off Balance Sheet Arrangements

We have no off-balance sheet arrangements.

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