UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended: September 30, 2008
OR
o | TRANSITION REPORT PURSUANT SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from: _______to _______
Commission file number: 000-31037
eRoomSystem Technologies, Inc.
(Exact name of small business issuer as specified in its charter)
Nevada | 87-0540713 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
1072 Madison Ave., Lakewood, NJ 08701
(Address of principal executive offices)
(732) 730-0116
(Issuer’s telephone number)
(Former name, former address and former fiscal year, if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES x NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer o |
Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller Reporting Company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES o NO x
The number of shares outstanding of the issuer’s common stock as of November 12, 2008 was 24,048,165 shares of common stock.
Transitional Small Business Disclosure Format (check one): YES o NO x
FORM 10-Q
TABLE OF CONTENTS
1 | |
Item 1. Financial Statements. | 1 |
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. | 6 |
Item 3. Quantitative and Qualitative Disclosures About Market Risk. | 12 |
Item 4. Controls and Procedures | 12 |
PART II - OTHER INFORMATION | 12 |
Item 1. Legal Proceedings. | 12 |
Item 1A. Risk Factors. | 12 |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. | 12 |
Item 3. Defaults Upon Senior Securities. | 12 |
Item 4. Submission of Matters to a Vote of Security Holders. | 13 |
Item 5. Other Information. | 13 |
13 | |
SIGNATURE | 14 |
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eROOMSYSTEM TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
September 30, 2008 | December 31, 2007 | ||||||
ASSETS | |||||||
CURRENT ASSETS | |||||||
Cash and cash equivalents | $ | 1,700,542 | $ | 355,970 | |||
Marketable securities available for sale | 500,000 | 1,998,002 | |||||
Accounts receivable, net of allowance for doubtful accounts of $20,415 and $32,399 at September 30, 2008 and December 31, 2007, respectively | 115,681 | 182,416 | |||||
Loan Receivable | 509,274 | - | |||||
Prepaid expenses | 9,691 | 10,831 | |||||
Total Current Assets | 2,835,188 | 2,547,219 | |||||
REFRESHMENT CENTERS IN SERVICE, net of accumulated depreciation of $1,412,773 and $2,406,453 at September 30, 2008 and December 31, 2007, respectively | 147,927 | 434,609 | |||||
PROPERTY AND EQUIPMENT | |||||||
Computer equipment and office equipment, net of accumulated depreciation of $8,512 and $6,657, at September 30, 2008 and December 31, 2007, respectively | 4,270 | 3,261 | |||||
INVESTMENT IN MARKETABLE SECURITIES | 14,075 | 14,075 | |||||
NOTE RECEIVABLE | 190,968 | 159,166 | |||||
DEPOSITS | 2,250 | 2,432 | |||||
Total Assets | $ | 3,194,678 | $ | 3,160,762 | |||
LIABILITIES AND STOCKHOLDERS' EQUITY | |||||||
CURRENT LIABILITIES | |||||||
Accounts payable | $ | 56,107 | $ | 49,070 | |||
Accrued liabilities | 42,066 | 71,289 | |||||
Deferred maintenance revenue | 11,933 | 10,462 | |||||
Total Current Liabilities | 110,106 | 130,821 | |||||
Total Liabilities | 110,106 | 130,821 | |||||
COMMITMENTS AND CONTINGENCIES | - | - | |||||
STOCKHOLDERS' EQUITY | |||||||
Preferred stock, $0.001 par value; 5,000,000 shares authorized; none outstanding | - | - | |||||
Common stock, $0.001 par value; 50,000,000 shares authorized; 24,048,165 and 23,973,165 shares outstanding at September 30, 2008 and December 31, 2007, respectively | 24,048 | 23,973 | |||||
Additional paid-in capital | 33,814,715 | 33,792,010 | |||||
Warrants and options outstanding | 341,805 | 346,585 | |||||
Accumulated deficit | (31,045,996 | ) | (31,082,627 | ) | |||
Accumulated other comprehensive loss | (50,000 | ) | (50,000 | ) | |||
Total Stockholders' Equity | 3,084,572 | 3,029,941 | |||||
Total Liabilities and Stockholders' Equity | $ | 3,194,678 | $ | 3,160,762 |
See accompanying notes to unaudited condensed consolidated financial statements
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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (UNAUDITED)
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||
2008 | 2007 | 2008 | 2007 | ||||||||||
REVENUE | |||||||||||||
Revenue-sharing arrangements | $ | 114,294 | $ | 189,530 | $ | 450,099 | $ | 625,197 | |||||
Maintenance fees | 58,590 | 63,643 | 170,088 | 196,892 | |||||||||
Product sales | - | 65,194 | 96,368 | 125,891 | |||||||||
Total Revenue | 172,884 | 318,367 | 716,555 | 947,980 | |||||||||
COST OF REVENUE | |||||||||||||
Revenue-sharing arrangements | 46,330 | 87,254 | 197,093 | 297,219 | |||||||||
Loss on impairment of refreshment centers | - | - | 64,835 | - | |||||||||
Maintenance | 16,638 | 14,716 | 62,147 | 44,558 | |||||||||
Product sales | - | 10,175 | 26,098 | 27,085 | |||||||||
Total Cost of Revenue | 62,968 | 112,145 | 350,173 | 368,862 | |||||||||
GROSS MARGIN | 109,916 | 206,222 | 366,382 | 579,118 | |||||||||
OPERATING EXPENSES | |||||||||||||
Selling, general and administrative expense, including non-cash compensation of $0, $1,907, $18,000 and $13,157, respectively | 79,158 | 84,347 | 333,125 | 298,305 | |||||||||
Research and development expense | 48,320 | - | 85,648 | - | |||||||||
Interest and other income | (28,977 | ) | (31,443 | ) | (89,022 | ) | (76,862 | ) | |||||
Net Operating Expenses | 98,501 | 52,904 | 329,751 | 221,443 | |||||||||
Income from Operations | 11,415 | 153,318 | 36,631 | 357,675 | |||||||||
Gain on forgiveness of liabilities and debt | - | - | - | 8,500 | |||||||||
Net Income | $ | 11,415 | $ | 153,318 | $ | 36,631 | $ | 366,175 | |||||
Unrealized loss on investment | $ | - | $ | (50,000 | ) | $ | - | $ | (50,000 | ) | |||
Comprehensive Income | $ | 11,415 | $ | 103,318 | $ | 36,631 | $ | 316,175 | |||||
Basic Earnings Per Common Share | $ | 0.00 | $ | 0.01 | $ | 0.00 | $ | 0.02 | |||||
Diluted Earnings Per Common Share | $ | 0.00 | $ | 0.01 | $ | 0.00 | $ | 0.02 |
See accompanying notes to unaudited condensed consolidated financial statements
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
For the Nine Months Ended September 30, | 2008 | 2007 | ||||||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||||
Net income | $ | 36,631 | $ | 366,175 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||
Depreciation | 198,948 | 299,166 | ||||||||
Gain on forgiveness of debt and liabilities | - | (8,500 | ) | |||||||
Gain on sale of refreshment centers | (71,615 | ) | (47,398 | ) | ||||||
Loss on impairment of refreshment centers | 64,835 | - | ||||||||
Interest income from other receivable | (21,076 | ) | (5,757 | ) | ||||||
Amortization of discount on note receivable | - | (897 | ) | |||||||
Non-cash compensation expense | 18,000 | 13,157 | ||||||||
Changes in operating assets and liabilities: | ||||||||||
Accounts receivable | 66,735 | 9,479 | ||||||||
Prepaid expenses | 1,140 | (31 | ) | |||||||
Accounts payable | 7,037 | (2,437 | ) | |||||||
Accrued liabilities | (29,223 | ) | (50,025 | ) | ||||||
Customer deposits and deferred maintenance revenue | 1,471 | (7,687 | ) | |||||||
Net Cash Provided By Operating Activities | 272,883 | 565,245 | ||||||||
CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||||
Purchase of fixed assets | (2,863 | ) | - | |||||||
Proceeds from sale of refreshment centers | 96,368 | 70,961 | ||||||||
Purchase of investment | (926,998 | ) | - | |||||||
Proceeds from sale of marketable securities | 2,425,000 | - | ||||||||
Purchase of notes receivable | (520,000 | ) | - | |||||||
Proceeds from note receivable | - | 17,875 | ||||||||
Change in long term deposits and restricted funds | 182 | 4,431 | ||||||||
Net Cash Provided by Investing Activities | 1,071,689 | 93,267 | ||||||||
CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||||
Net Cash Used in Financing Activities | - | - | ||||||||
Net Increase in Cash | 1,344,572 | 658,512 | ||||||||
Cash at Beginning of Period | 355,970 | 1,480,720 | ||||||||
Cash at End of Period | $ | 1,700,542 | $ | 2,139,232 | ||||||
Supplemental Cash Flows Information | ||||||||||
Cash paid for interest | $ | - | $ | - |
See accompanying notes to unaudited condensed consolidated financial statements
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eROOMSYSTEM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Condensed Financial Statements - The accompanying unaudited condensed consolidated financial statements include the accounts of eRoomSystem Technologies, Inc. and its subsidiaries (the "Company"). These financial statements are condensed and, therefore, do not include all disclosures normally required by generally accepted accounting principles. These statements should be read in conjunction with the Company's audited financial statements for the fiscal year ended December 31, 2007 included in the Company's Annual Report on Form 10-KSB/A. In particular, the Company's organization, nature of operations and significant accounting principles were presented in Note 1 to the consolidated financial statements in that annual report. In the opinion of management, all adjustments necessary for a fair presentation have been included in the accompanying unaudited condensed consolidated financial statements and consist of only normal recurring adjustments. The results of operations presented in the accompanying unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2008 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2008.
Principles of Consolidation - The accompanying unaudited condensed consolidated financial statements include the accounts of eRoomSystem Technologies, Inc. and its wholly owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.
Net Earnings Per Share of Common Stock - Basic earnings per share of common stock is computed by dividing net income by the weighted-average number of shares of common stock outstanding. Unvested shares of common stock are considered to be stock options for purposes of computing earnings per share. Diluted earnings per share of common stock are computed by dividing net income by the weighted-average number of shares of common stock and dilutive potential common stock equivalents outstanding. Potential common stock equivalents consist of shares issuable upon the exercise of stock options and warrants, and shares issuable upon the conversion of debt.
The following table is a reconciliation of the numerators and denominators used in the calculation of basic and diluted weighted-average common shares outstanding for the three and nine months ended September 30, 2008 and 2007:
For The Three Months Ended September 30, | For The Nine Months Ended September 30, | ||||||||||||
2008 | 2007 | 2008 | 2007 | ||||||||||
$ | 11,415 | $ | 153,318 | $ | 36,631 | $ | 366,175 | ||||||
Diluted net income | $ | 11,415 | $ | 153,318 | $ | 36,631 | $ | 366,175 | |||||
Basic weighted-average common shares outstanding | 24,077,835 | 23,973,165 | 24,007,928 | 23,940,198 | |||||||||
Effect of dilutive securities | |||||||||||||
Stock options and warrants | 334,964 | 130,461 | 351,410 | 116,649 | |||||||||
Diluted weighted-average common shares outstanding | 24,412,799 | 24,103,626 | 24,359,338 | 24,056,847 | |||||||||
Basic earnings per share | $ | 0.00 | $ | 0.01 | $ | 0.00 | $ | 0.02 | |||||
Diluted earnings per share | $ | 0.00 | $ | 0.01 | $ | 0.00 | $ | 0.02 |
During the three and nine months ended September 30, 2008 and 2007, there were potential common stock equivalents from options and warrants of 2,799,657, 3,045,160, 2,783,211 and 3,058,972, respectively, which were not included in the computation of diluted earnings per share because their effect would have been anti-dilutive.
NOTE 2 - BUSINESS CONDITION
During the year ended December 31, 2007 and the nine months ended September 30, 2008, the Company realized a net gain of $402,221 and $36,631, respectively. During the year ended December 31, 2007 and the nine months ended September 30, 2008, the Company's operations provided $765,270 and $272,883 of cash, respectively. The Company had a cash balance of $1,700,542 as of September 30, 2008. Up until the year ended December 31, 2004, the Company suffered recurring losses. Although the Company realized net income in the past four years, the Company is anticipating decreasing revenue as the Company’s existing hotel revenue-sharing and maintenance contracts conclude over the next couple of years. Realization of continued profitable operations is not assured. The accompanying financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern. Management would like to acquire an existing operating company to enable the Company to increase revenues and long-term viability, and is continuously performing due diligence on third party companies for this purpose. The Company has also been performing research regarding potential further investments in either privately-held or publicly traded emerging growth stage companies.
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NOTE 3 - NET INVESTMENT IN SALES-TYPE LEASE
During June 2004, the Company entered into an agreement with a hotel property owner that amended a previous revenue sharing lease agreement that had previously been non-performing. Under the terms of that agreement, the Company recovered a receivable that had been written off in the previous year.
The new lease agreement terminates on December 31, 2008 at which time the hotel property owner takes ownership of the refreshment centers. The property is to make monthly payments of $7,200. The new lease agreement has been classified as a sales-type capital lease. Because the property has a history of non-performance and is still under the supervision of a bankruptcy court, the net investment in the capital lease has been fully allowed against. The following lists the components of the net investment in the sales-type lease as of September 30, 2008:
Total minimum lease payments to be received | $ | 21,600 | ||
Less: Allowance for uncollectibles | (18,166 | ) | ||
Net minimum lease payments receivable | 3,434 | |||
Less: Unearned income | (3,434 | ) | ||
Net investment in sales-type lease | $ | - |
The Company recorded revenue sharing and maintenance fee revenue, relating to this property, in the amount of $21,600 and $64,800 for the three and nine months ended September 30, 2008.
Minimum lease payments for the three months ending December 31, 2008, the end of the lease term, is $21,600.
NOTE 4 – NOTE RECEIVABLE
On July 7, 2008, the Company funded an escrow account in the amount of $500,000 and signed an agreement to provide a secure loan to BlackBird Corporation, a Florida corporation (“BlackBird”), and an unrelated entity. The funding of the loan was contingent on completion of a transaction by BlackBird to acquire an unrelated company, USA Datanet Corporation. The acquisition took place on July 25, 2008.
The loan is evidenced by a 10% senior secured convertible promissory note, made by BlackBird in favor of the Company (the “Secured Note”). The Secured Note matures on June 30, 2009 and bears interest at an annual rate of 10%, with interest payable quarterly on the last business day of each quarter. The interest rate increases to 18% if the note is unpaid after December 31, 2008.
NOTE 5 - STOCKHOLDERS’ EQUITY
During the nine months ended September 30, 2008, options to purchase 35,000 shares of common stock expired. The Company recognized the carrying value of these options in the amount of $3,526 as additional paid in capital.
On May 14, 2008, the Company issued 75,000 shares of common stock to its Board of Directors in recognition of services rendered. These shares were valued at $18,000 ($0.24 per share).
NOTE 6 – SUBSEQUENT EVENT
On November 11, 2008, the Company granted exclusive rights to Acacia Patent Acquisition LLC (“APAC”), a Delaware limited liability company to its U.S. Patent No. 4939352, U.S. Patent No. 4883948 and U.S. Patent No. 4857714, and all related patent applications effective on the date of acceptable completion of due diligence of APAC. In consideration of which, APAC shall pay the Company a continuing royalty of 50% of all amounts received by APAC less costs.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
As used in this Form 10-Q, references to the "Company," "we," “our” or "us" refer to eRoomSystem Technologies, Inc., 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, gross margin 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. A complete discussion of these risks and uncertainties are contained in our Annual Report on Form 10-KSB/A, as filed with the Securities and Exchange Commission on April 30, 2008.
Overview
Our core business is the development and installation of an intelligent, in-room computer platform and communications network, or the eRoomSystem, for the lodging industry. The eRoomSystem is a computerized platform and processor-based system designed to collect and control data. The eRoomSystem supports our fully automated and interactive eRoomServ refreshment centers, eRoomSafes, eRoomEnergy products, and the eRoomTray. In 2005, we commenced our diversification strategy of investing in third party emerging growth companies. To this end, we have an investment totaling $10,000 in Identica Holdings Corporation (“Identica”). In addition, we have loaned Identica $150,000 in cash. The loan is secured by a security interest in all the assets of Identica and is evidenced by a promissory note. Although the loan was to be paid back in June 2008, we extended the due date to December 20, 2008. In consideration for making the loan, Identica issued a warrant to us to purchase one million (1,000,000) shares of common stock of Identica, exercisable at $0.15 per share at any time through May 20, 2010. In third quarter of 2008 we extended an additional $20,000 to Identica with the same terms. We may make additional investments in promising emerging growth companies, and potentially acquire an operating company if the opportunity arises.
On July 25, 2008, we provided a secured loan to BlackBird Corporation, a Florida corporation (“BlackBird”), an unrelated entity. The funding of the loan took place on completion of a transaction by BlackBird to acquire an unrelated company, USA Datanet Corporation. The acquisition took place on July 24, 2008. The loan is evidenced by a 10% senior secured convertible promissory note, made by BlackBird (the “Secured Note”). The Secured Note matures on June 30, 2009 and bears interest at an annual rate of 10%, with interest payable quarterly on the last business day of each quarter.
Our existing products interface with the hotel's property management system through our eRoomSystem communications network. The hotel's property management system posts usage of our products directly to the hotel guest's room account. The solutions offered by our eRoomSystem and related products have allowed us to install our products and services in several premier hotel chains, including Marriott International, Hilton Hotels and Carlson Hospitality Worldwide, in the United States and internationally.
One of the byproducts of our technology is the information we have collected since our first product installation. To date, we have collected several million room-nights of data. Through our eRoomSystem, we are able to collect information regarding the usage of our products on a real-time basis. We use this information to help our customers increase their operating efficiencies.
Description of Revenues
Historically, we have received most of our revenues from the sale or placement under a revenue-sharing program of our products in hotels. We expect that these revenues will account for a substantial majority of our revenues for the foreseeable future. In addition, we may receive revenues in the future upon the sale of securities received in consideration for our investment made in a third party company in 2005; however, the return on such investment is not assured.
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We also generate revenues from maintenance and support services relating to our existing installed products. Our dependence on the lodging industry, including its guests, makes us extremely vulnerable to downturns in the lodging industry caused by the general economic environment. Such a downturn could result in fewer purchases by hotel guests of goods and services from our products installed in hotels, and accordingly lower revenues where our products are placed pursuant to a revenue sharing agreement. Time spent by individuals on travel and leisure is often discretionary for consumers and may be particularly affected by adverse trends in the general economy. The success of our operations depends, in part, upon discretionary consumer spending and economic conditions affecting disposable consumer income such as employment, wages and salaries, business conditions, interest rates, availability of credit and taxation.
Our revenue-sharing program provides us with a seven-year revenue stream under each revenue-sharing agreement. Because many of our customers in the lodging industry traditionally have limited capacity to finance the purchase of our products, we designed our revenue-sharing program accordingly. Through our revenue-sharing plan, we have installed our products at little or no upfront cost to our customers and share in the recurring revenues generated from sales of goods and services related to our products. We retain the ownership of the eRoomServ refreshment centers and eRoomSafes throughout the term of the revenue-sharing agreements and the right to re-deploy any systems returned to us upon the expiration or earlier termination of the revenue-sharing agreements. We have failed to place any products, either on a revenue sharing or sale basis in the prior four fiscal years, and we have no present intention of placing new products in the future. We do, however, intend to continue to service and maintain our existing installed product base for the remaining life of the contracts relating thereto.
Our revenues over the past years have been declining as we have focused on service and maintenance of our existing installed products and have not installed new products at hotels and as existing revenue sharing agreements conclude. Given the foregoing, in 2005 we commenced our diversification strategy to invest in emerging growth companies. To this end, we invested in Identica Holdings Corporation, a privately held distributor and integrator of next-generation biometric security solutions, including the TechSphere hand vascular pattern biometric technology. We continue to explore opportunities and perform due diligence on third parties with respect to additional potential investments. At this time, we have not reached a definitive agreement to make further investments. In addition, we may acquire an operating company in the future if the opportunity arises. Over time, we may realize revenues from the sale of securities purchased from Identica, and other third party companies, if applicable. The timing and return on such investments, however, cannot be assured.
We anticipate that we will receive more than 50% of the recurring revenues from the sale of goods and services generated by our currently installed eRoomServ refreshment centers, eRoomSafes and eRoomTray solutions under revenue-sharing agreements. Our customers receive the remainder of the recurring revenues.
Revenue Recognition
Sales revenue from our products is recognized upon completion of installation and acceptance by the customer. We do not, however, expect to generate meaningful sales revenue as such revenues are limited to the sales of used equipment as well as replacement equipment and parts to hotel clients who previously purchased our products. Sales revenue from the placement of our eRoomServ refreshment centers and eRoomSafes under our revenue-sharing program are accounted for similar to an operating lease, with the revenues recognized as earned over the term of the agreement. In some instances, our revenue-sharing agreements provide for a guaranteed minimum daily payment by the hotel. We negotiated our portion of the revenues generated under our revenue-sharing program based upon the cost of the equipment installed and the estimated daily sales per unit for the specific customer.
We have entered into installation, maintenance and license agreements with most of our existing hotel customers. Installation, maintenance and license revenues are recognized as the services are performed, or pro rata over the service period. We defer all revenue paid in advance relating to future services and products not yet installed and accepted by our customers.
Our installation, maintenance and license agreements stipulate that we collect a maintenance fee per eRoomServ refreshment center per day, payable on a monthly basis. Our objective is to generate gross profit margins of approximately 40% from our maintenance-related revenues. We base this expectation on our historical cost of maintenance of approximately $0.04 per unit per day and, pursuant to our maintenance agreements, our projected receipt of generally not less than $0.08 per unit per day.
Description of Expenses
Cost of product sales consists primarily of production, shipping and installation costs. Cost of revenue-sharing arrangements consists primarily of depreciation of capitalized costs for the products placed in service. We capitalize the production, shipping, installation and sales commissions related to the eRoomServ refreshment centers, eRoomSafes, eRoomTrays and eRoomEnergy management products placed under revenue-sharing agreements. Cost of maintenance fee revenues primarily consists of expenses related to customer support and maintenance.
Selling, general and administrative expenses primarily consist of general and administrative expenses including professional fees, salaries and related costs for accounting, administration, finance, human resources, information systems and legal personnel.
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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 the maintenance of our existing installed products as well as research and development for new products. Our research and development expenses in the nine and three months ended September 30, 2008 were $85,648 and $48,320, respectively.
In accordance with Financial Accounting Standards Board, or FASB, Statement of Financial Accounting Standards, or SFAS, No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,” 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 consolidated statements of operations.
Results of Operations
Comparison of Three Months Ended September 30, 2008 and 2007
Revenues
Revenue Sharing Arrangements — Our revenue from revenue sharing arrangements was $114,294 for the three months ended September 30, 2008, compared to $189,530 for the three months ended September 30, 2007, representing a decrease of $75,236, or 39.7%. The decrease in revenue sharing revenue was due to the completion of a number of revenue sharing contracts in 2007 and 2008.
Maintenance Fee Revenues — Maintenance fee revenues were $58,590 for the three months ended September 30, 2008, compared to $63,643 for the three months ended September 30, 2007, representing a decrease of $5,053 or 7.9%. The decrease in maintenance fee revenue was due to the completion of a number of revenue sharing and maintenance contracts in 2007 and 2008.
Product Sales — Revenue from product sales was $0 for the three months ended September 30, 2008, compared to $65,194 for the three months ended September 30, 2007, representing a decrease of $65,194 or 100%. The decrease in product sales revenues was primarily due to the fact that there were no product sales in the three months ended September 30, 2008.
Cost of Revenue
Cost of Revenue Sharing Revenue — Cost of revenue sharing revenue was $46,330 for the three months ended September 30, 2008, compared to $87,254 for the three months ended September 30, 2007 representing a decrease of $40,924 or 46.9%. The gross margin percentage on revenue sharing revenue was 59.5% for the three months ended September 30, 2008, compared to 54.0% for the three months ended September 30, 2007. The increase in gross margin percentage relating to revenue sharing revenue is due to the completion of some revenue sharing contracts in 2007 and 2008.
Cost of Maintenance Fee Revenue — Our cost of maintenance fee revenue was $16,638 for the three months ended September 30, 2008, compared to $14,716 for the three months ended September 30, 2007, representing an increase of $1,922, or 13.1%. The gross margin percentage on maintenance fee revenues was 71.6% for the three months ended September 30, 2008, compared to 76.9% for the three months ended September 30, 2007. The increase in our cost of maintenance fee revenue was due to the aging of the equipment being serviced.
Cost of Product Sales Revenue — Our cost of product sales revenue for the three months ended September 30, 2008 was $0, compared to $10,175 for the three months ended September 30, 2007, a decrease of $10,175, or 100%. The gross margin percentage on revenue from product sales revenue was 0% for the three months ended September 30, 2008, compared to 84.4% for the three months ended September 30, 2007. The decrease in cost of product sales revenue relates to the fact that there were no product sales in the three months ended September 30, 2008 versus the three months ended September 30, 2007.
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The changes and percent changes with respect to our revenues and our cost of revenue for the three months ended September 30, 2008 and 2007 are summarized as follows:
For the Three Months | |||||||||||||
Ended September 30, | |||||||||||||
2008 | 2007 | Change | Percent Change | ||||||||||
REVENUE | |||||||||||||
Revenue-sharing arrangements | $ | 114,294 | $ | 189,530 | $ | (75,236 | ) | -39.7 | % | ||||
Maintenance fees | 58,590 | 63,643 | (5,053 | ) | -7.9 | % | |||||||
Product sales | - | 65,194 | (65,194 | ) | -100.0 | % | |||||||
Total Revenue | 172,884 | 318,367 | (145,483 | ) | -45.7 | % | |||||||
COST OF REVENUE | |||||||||||||
Revenue-sharing arrangements | 46,330 | 87,254 | (40,924 | ) | -46.9 | % | |||||||
Maintenance | 16,638 | 14,716 | 1,922 | 13.1 | % | ||||||||
Product sales | - | 10,175 | (10,175 | ) | -100.0 | % | |||||||
Total Cost of Revenue | $ | 62,968 | $ | 112,145 | $ | (49,177 | ) | -43.9 | % | ||||
GROSS MARGIN PERCENTAGE | |||||||||||||
Revenue-sharing arrangements | 59.5 | % | 54.0 | % | |||||||||
Maintenance | 71.6 | % | 76.9 | % | |||||||||
Product sales | - | 84.4 | % | ||||||||||
Total Gross Margin Percentage | 63.6 | % | 64.8 | % |
Although the preceding table summarizes the net changes and percent changes with respect to our revenues and our cost of revenue for the three months ended September 30, 2008 and 2007, 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 $79,158 for the three months ended September 30, 2008, compared to $84,347 for the three months ended September 30, 2007, representing a decrease of $5,189, or 6.2%. The decrease in our selling, general and administrative expenses was immaterial.
Research and Development—Research and development expenses were $48,320 for the three months ended September 30, 2008, compared to $0 for the three months ended September 30, 2007 representing an increase of $48,320. The increase in our research and development expenses for the three months ended September 30, 2008 reflects new product development in 2008.
Interest and other income was $28,977 for the three months ended September 30, 2008 as compared to $31,443 for the three months ended September 30, 2007 representing a decrease of $2,466 or 7.8%. The decrease was due to the interest earned on our increasing balance of cash and investments in marketable securities.
Net Income Attributable to Common Stockholders
We realized net income of $11,415 for the three months ended September 30, 2008, compared to $153,318 during the three months ended September 30, 2007. The $141,903 decrease in net income was primarily due to decreasing revenue sharing agreements, as well as research and development costs. We may incur losses in the future as existing revenue sharing agreements with our hotel clients expire.
Comparison of Nine Months Ended September 30, 2008 and 2007
Revenues
Revenue Sharing Arrangements — Our revenue from revenue sharing arrangements was $450,099 for the nine months ended September 30, 2008, compared to $625,197 for the nine months ended September 30, 2007, representing a decrease of $175,098, or 28.0%. The decrease in revenue sharing revenue was due to the completion of a number of revenue sharing contracts in 2007 and 2008.
Maintenance Fee Revenues — Maintenance fee revenues were $170,088 for the nine months ended September 30, 2008, compared to $196,892 for the nine months ended September 30, 2007, representing a decrease of $26,804, or 13.6%. The decrease in maintenance fee revenue was due to the completion of a number of revenue sharing and maintenance contracts in 2007 and 2008.
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Product Sales — Revenue from product sales was $96,368 for the nine months ended September 30, 2008, compared to $125,891 for the nine months ended September 30, 2007, representing a decrease of $29,523, or 23.5%. The decrease in product sales revenues was primarily due to the difference in sales of refreshment centers to hotels at the completion of their revenue share contracts in the nine months ended September 30, 2008.
Cost of Revenue
Cost of Revenue Sharing Revenue — Cost of revenue sharing revenue was $197,093 for the nine months ended September 30, 2008, compared to $297,219 for the nine months ended September 30, 2007 representing a decrease of $100,126 or 33.7%. The gross margin percentage on revenue sharing revenue was 56.2% for the nine months ended September 30, 2008, compared to 52.5% for the nine months ended September 30, 2007. The increase in gross margin percentage relating to revenue sharing revenue is due to the completion of some revenue sharing contracts in 2007 and 2008.
Loss on Impairment of Refreshment Centers — During 2008, the Company assessed the carrying value of certain refreshment centers that had been used by a Hotel and taken out of service and recorded a loss due to impairment of $64,835.
Cost of Maintenance Fee Revenue — Our cost of maintenance fee revenue was $62,147 for the nine months ended September 30, 2008, compared to $44,558 for the nine months ended September 30, 2007, representing an increase of $17,589, or 39.5%. The gross margin percentage on maintenance fee revenues was 63.5% for the nine months ended September 30, 2008, compared to 77.4% for the nine months ended September 30, 2007. The increase in our cost of maintenance fee revenue was due to the aging of the equipment being serviced.
Cost of Product Sales Revenue — Our cost of product sales revenue for the nine months ended September 30, 2008 was $26,098, compared to $27,085 for the nine months ended September 30, 2007, a decrease of $987, or 3.6%. The gross margin percentage on revenue from product sales revenue was 72.9% for the nine months ended September 30, 2008, compared to 78.5% for the nine months ended September 30, 2007. The difference in cost of product sales revenue relates to the remaining basis of the refreshment centers sold in the nine months ended September 30, 2008 versus the nine months ended September 30, 2007.
The changes and percent changes with respect to our revenues and our cost of revenue for the nine months ended September 30, 2008 and 2007 are summarized as follows:
For the Nine Months | |||||||||||||
Ended September 30, | |||||||||||||
2008 | 2007 | Change | Percent Change | ||||||||||
REVENUE | |||||||||||||
Revenue-sharing arrangements | $ | 450,099 | $ | 625,197 | $ | (175,098 | ) | -28.0 | % | ||||
Maintenance fees | 170,088 | 196,892 | (26,804 | ) | -13.6 | % | |||||||
Product sales | 96,368 | 125,891 | (29,523 | ) | -23.5 | % | |||||||
Total Revenue | 716,555 | 947,980 | (231,425 | ) | -24.4 | % | |||||||
�� | |||||||||||||
COST OF REVENUE | |||||||||||||
Revenue-sharing arrangements | 197,093 | 297,219 | (100,126 | ) | -33.7 | % | |||||||
Loss on impairment of refreshment centers in serivice | 64,835 | - | 64,835 | 100.0 | % | ||||||||
Maintenance | 62,147 | 44,558 | 17,589 | 39.5 | % | ||||||||
Product sales | 26,098 | 27,085 | (987 | ) | -3.6 | % | |||||||
Total Cost of Revenue | $ | 350,173 | $ | 368,862 | $ | (18,689 | ) | -5.1 | % | ||||
GROSS MARGIN PERCENTAGE | |||||||||||||
Revenue-sharing arrangements | 56.2 | % | 52.5 | % | |||||||||
Maintenance | 63.5 | % | 77.4 | % | |||||||||
Product sales | 72.9 | % | 78.5 | % | |||||||||
Total Gross Margin Percentage | 51.1 | % | 61.1 | % |
Although the preceding table summarizes the net changes and percent changes with respect to our revenues and our cost of revenue for the nine months ended September 30, 2008 and 2007, the trends contained therein are limited and should not be viewed as a definitive indication of our future results.
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Operating Expenses
Selling, General and Administrative — Selling, general and administrative expenses, including non-cash compensation expense, were $333,125 for the nine months ended September 30, 2008, compared to $298,305 for the nine months ended September 30, 2007, representing an increase of $34,820, or 11.7%. The increase in our selling, general and administrative expenses reflects the write-off of an uncollectible account.
Research and Development—Research and development expenses were $85,648 for the nine months ended September 30, 2008, compared to $0 for the nine months ended September 30, 2007 representing an increase of $85,648. The increase in our research and development expenses for the nine months ended September 30, 2008 reflects new product development in 2008.
Interest and other income was $89,022 for the nine months ended September 30, 2008 as compared to $76,862 for the nine months ended September 30, 2007 representing an increase of $12,160, or 15.8%. The increase was due to the interest earned on our loans receivable and increasing balance of cash and investments in marketable securities.
Net Income Attributable to Common Stockholders
We realized net income of $36,631 for the nine months ended September 30, 2008, compared to $366,175 during the nine months ended September 30, 2007. The $329,544 decrease in net income was primarily due to decreasing revenue sharing agreements, the loss on impairment of refreshment centers recognized, the write-off of an uncollectible account as well as research and development costs. We may incur losses in the future as existing revenue sharing agreements with our hotel clients expire.
Liquidity and Capital Resources
At September 30, 2008, our principal sources of liquidity consisted of $1,700,542 of cash and working capital of $2,725,082, as compared to $355,970 of cash and working capital of $2,416,398 at December 31, 2007. In addition, our stockholders' equity was $3,084,572 at September 30, 2008, compared to stockholders' equity of $3,029,941 at December 31, 2007, an increase of $54,631. The increase in cash reflects the increase in working capital, decrease in investments and increase in stockholders' equity.
At September 30, 2008, the Company had $500,000 invested in outstanding auction rate preferred securities (“ARPS”). ARPS are perpetual securities with dividend rates that are reset periodically—often weekly or monthly—when buyers and sellers come together at an auction. There is currently an imbalance between the number of buyers and sellers in the ARPS market that has resulted in a number of “failed auctions.” This has created a lack of liquidity for ARPS investors. However, as we have already liquidated over $2,000,000 of these securities after the auctions failed and are continuing to liquidate our securities, we do not believe this will have a negative affect on our cash flows.
Our accumulated deficit decreased from $31,082,627 at December 31, 2007 to $31,045,996 at September 30, 2008. The $36,631 decrease in accumulated deficit resulted directly from the net income realized for the nine months ended September 30, 2008. Our accumulated deficit may increase in the future as existing revenue sharing agreements with our hotel clients expire.
Our operations provided net cash of $272,883 for the nine months ended September 30, 2008, compared to $565,245 during the nine months ended September 30, 2007. The $292,362 decrease in net cash provided by our operating activities resulted primarily from the decrease in net income during the nine months ended September 30, 2008.
Investing activities for the nine months ended September 30, 2008 provided net cash of $1,071,689, compared to $93,267 of net cash provided during the nine months ended September 30, 2007. The change consisted primarily of an increase in the sale of investment securities.
There were no financing activities in the nine months ended September 30, 2008 and 2007.
Contractual Cash Obligations and Commercial Commitments
There were no significant contractual cash obligations or commercial commitments either on or off balance sheet as of September 30, 2008
Off Balance Sheet Arrangements
We have no off-balance sheet arrangements.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Smaller reporting companies are not required to provide the information required by Item 305.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our disclosure controls and procedures are designed to ensure that information required to be disclosed in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the United States Securities and Exchange Commission. Our principal executive and financial officer has reviewed the effectiveness of our "disclosure controls and procedures" (as defined in the Securities Exchange Act of 1934 Rules 13a-14(c) and 15d-14(c)) within the end of the period covered by this Quarterly Report on Form 10-Q and has concluded that the disclosure controls and procedures are effective to ensure that material information relating to the Company is recorded, processed, summarized, and reported in a timely manner. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the last day they were evaluated by our principal executive and financial officer.
Lack of Segregation of Duties
Management is aware that there is a lack of segregation of duties at the Company due to the small number of employees dealing with general administrative and financial matters. However, at this time management has decided that considering the abilities of the employees now involved and the control procedures in place, the risks associated with such lack of segregation are low and the potential benefits of adding employees to clearly segregate duties do not justify the substantial expenses associated with such increases. Management will periodically reevaluate this situation.
Changes in Internal Controls
There were no changes in our internal controls over financial reporting (as such item is defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) during the most fiscal quarter (the three months ended September 30, 2008), that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
Item 1. Legal Proceedings.
There are no pending legal proceedings to which the Company is a party or in which any director, officer or affiliate of the Company, any owner of record or beneficially of more than 5% of any class of voting securities of the Company, or security holder is a party adverse to the Company or has a material interest adverse to the Company. The Company’s property is not the subject of any pending legal proceedings.
Item 1A. Risk Factors.
General economic conditions may affect our revenue and harm our business.
As widely reported, financial markets in the United States, Europe and Asia have been experiencing extreme disruption in recent months. Unfavorable changes in economic conditions, including declining consumer confidence, inflation, recession or other changes, may lead our customers to delay or reduce purchases of our products and our results of operations and financial condition could be adversely affected thereby. Challenging economic conditions also may impair the ability of our customers or distributors to pay for products they have purchased, and as a result, our reserves for doubtful accounts and write-offs of accounts receivable could increase. Our cash flows may be adversely affected by delayed payments or underpayments by our customers. We are unable to predict the duration and severity of the current disruption in financial markets and adverse economic conditions in the U.S. and other countries.
There have been no other material changes to the risks to our business described in our Annual Report on Form 10-KSB/A for the year ended December 31, 2007 filed with the SEC on April 30, 2008.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None
Item 3. Defaults Upon Senior Securities.
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Item 4. Submission of Matters to a Vote of Security Holders.
Item 5. Other Information.
On November 11, 2008, the Company entered into an Exclusive License Agreement (the “License”) with Acacia Patent Acquisition LLC (“APAC”), a Delaware limited liability company. Pursuant to the terms of the license, the Company granted APAC worldwide exclusive rights to its U.S. Patent No. 4939352, U.S. Patent No. 4883948 and U.S. Patent No. 4857714, and all related patent applications, foreign patents and foreign patent applications. In consideration for such grant, APAC shall pay the Company a continuing royalty of 50% of all amounts received by APAC less costs.
The effective on the date of the grant will occur after, among others, the APAC has conducted its due diligence investigation of the patents during a period of up to sixty days following the effective date. During the period of APAC due diligence review, the Company has agreed not to discuss or negotiation or pursue with any third party any offers or proposals with respect to the patents.
Item 6. Exhibits.
Exhibit No. | Description | |
31.1 | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1 | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this quarterly report on Form 10-Q to be signed on its behalf by the undersigned thereunto duly authorized.
eRoomSystem Technologies, Inc. | ||
(Registrant) | ||
Date: November 17, 2008 | ||
By: | /s/ David A. Gestetner | |
Name: | David A. Gestetner | |
Title: | President, Chief Executive Officer, Secretary, | |
and Chairman of the Board | ||
(Principal Executive, Financial, | ||
and Accounting Officer) |
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