Edgar Filing: ESSENTIAL REALITY INC

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB

(Mark One)

[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.

For the fiscal year ended December 31, 2003

[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.

Commission file number 000-32319

ESSENTIAL REALITY, INC.
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(Name of small business issuer in its charter)

NEVADA 33-0851302
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)

Change of Address
263 Horton Highway, Mineola, New York 11501
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(Address of principal executive offices, including zip code)
Change of Phone Number

(516) 742-3100
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(Issuer's telephone number, including area code)

Securities registered under Section 12(b) of the Exchange Act: NONE

Securities registered under Section 12(g) of the Exchange Act:

COMMON STOCK, PAR VALUE $.001 PER SHARE
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(Title of Class)

Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 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 [ ] No [X ]

Check if no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is contained in this form, and no disclosure will be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendments to this Form 10-KSB. [X]

State issuer's revenues for its most recent fiscal year: $234,600

Based upon the closing price of the issuer's Common Stock on March 31,
2004, the aggregate market value of the shares of Common Stock held by
non-affiliates of the issuer was $896,008. Solely for the purposes of this
calculation, shares held by directors and officers of the issuer have been
excluded. Such exclusion should not be deemed a determination or an admission by
the issuer that such individuals are, in fact, affiliates of the issuer.

As of May 31, 2004, there were 18,588,110 shares of the issuer's Common
Stock issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE: None

TABLE OF CONTENTS

PAGE NO.
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PART I

Item 1. Description of Business 3

Item 2. Description of Property 7

Item 3. Legal Proceedings 7

Item 4. Submission of Matters to a Vote of Security Holders 8

PART II

Item 5. Market for Common Equity and Related Stockholder Matters 9

Item 6. Management's Discussion and Analysis or Plan of Operation 10

Item 7. Financial Statements 17

Item 8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 18

PART III

Item 9. Directors and Executive Officers of the Registrant 18

Item 10. Executive Compensation 22

Item 11. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters... 23

Item 12. Certain Relationships and Related Transactions 25

Item 13. Exhibits, List and Reports on Form 8-K 26

Item 14. Controls and Procedures 26

Signatures 27

Section 302 Certifications 28

THE DISCLOSURE CONTAINED IN THIS ANNUAL REPORT ON FORM 10-KSB IS HISTORICAL IN
NATURE AND DOES NOT REFLECT THE CURRENT STATE OF OUR BUSINESS. FOR AN UPDATE AS
TO THE MOST RECENT DEVELOPMENTS RELATING TO ESSENTIAL REALITY, INC., SEE THE
SECTION ENTITLED "SUBSEQUENT EVENTS" ON PAGE 8 OF THIS REPORT.

CERTAIN INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS FILING WITH
THE SECURITIES AND EXCHANGE COMMISSION ON FORM 10-KSB THAT IS NOT PURELY
HISTORICAL ARE FORWARD-LOOKING STATEMENTS, WITHIN THE MEANING OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995, THAT ARE BASED ON MANAGEMENT'S
BELIEFS, CERTAIN ASSUMPTIONS AND CURRENT EXPECTATIONS. THESE STATEMENTS MAY BE
IDENTIFIED BY THEIR USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS THE WORDS
"EXPECTS," "PROJECTS," "ANTICIPATES," "INTENDS" AND OTHER SIMILAR WORDS. SUCH
FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES THAT COULD CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED. THESE RISKS AND
UNCERTAINTIES INCLUDE, BUT ARE NOT LIMITED TO, GENERAL ECONOMIC, BUSINESS AND
MARKET CONDITIONS, COMPETITIVE PRICING PRESSURES, TIMELY DEVELOPMENT AND
ACCEPTANCE OF NEW PRODUCTS, AND THE HIGHLY COMPETITIVE MARKET IN WHICH WE
OPERATE. CERTAIN OF THESE RISKS AND UNCERTAINTIES ARE DISCUSSED MORE FULLY IN
PART II, "MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION - FACTORS
AFFECTING OPERATING RESULTS" AND ELSEWHERE IN THIS REPORT. THE FORWARD-LOOKING
STATEMENTS CONTAINED HEREIN ARE MADE AS OF THE DATE HEREOF AND WE, EXCEPT AS MAY
BE REQUIRED BY LAW, DO NOT UNDERTAKE ANY OBLIGATION TO UPDATE ANY
FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF FUTURE EVENTS, NEW
INFORMATION OR OTHERWISE.

PART I

ITEM 1. DESCRIPTION OF BUSINESS.

BACKGROUND

Essential Reality, Inc., a Nevada corporation formerly known as JPAL,
Inc. was incorporated on March 31, 1999. Our original line of business was to
provide vacation rental properties and services for the Year 2000 New Year's Eve
celebration in Las Vegas. Afterwards, we continued as an Internet-based provider
of vacation rental properties and services. In August 2001, we suspended
operations and the development of our website, in order to focus our attention
on our business combination with Essential Reality, LLC.

Essential Reality, LLC was organized in 1999 as a developer of
real-time tracking and sensory technologies. From its formation through the date
of its dissolution as a result of the business combination, it was involved in
research and development, marketing, entering into strategic relationships and
hiring key employees in connection with the final production, sale and
distribution of the P5(TM). The P5(TM), a virtual controller, is a glove-like
peripheral device that enables users to control the action on a screen through
simple hand movements, rather than complicated keystroke and mouse combinations.
This product is based on patented, and several patent-pending, technologies that
address technological limitations of current devices, such as the mouse,
hand-held game controllers and joysticks. The P5(TM) is engineered to capture
five-finger bend sensitivity enabling gesture recognition, combined with an
optical tracking technology that captures the movement of the hand in 3D space,
without the use of a mouse, joystick, keyboard or the like. For example, if a
user is trying to open a door while playing an adventure game, the P5TM allows
the user to make the hand motion of opening a door and see the door open
simultaneously with the motion, as opposed to the user pressing a button and
seeing the door open immediately thereafter. To date, the P5(TM) is the only
product that we have developed and marketed.

On June 20, 2002, we consummated the business combination and began
operating Essential Reality, LLC's line of business exclusively. The purpose of
the transaction was to allow us to acquire and carry on Essential Reality's
business as a public company, thereby enhancing the business' visibility and
providing a means through the public markets to additional sources of capital.

We have focused on combining our patented and patent pending
technologies into products that enhance the interaction between human beings and
personal computers, game consoles, computer tablets and other related devices,
collectively known as computer platforms. The P5(TM) was the only product sold
to retailers and offered to consumers.

Essential Reality, LLC engaged developers in 1999 to create a
peripheral device based on Essential Reality, LLC's belief that the consumer and
commercial markets were ripe for a product with the capabilities of the P5(TM).
The P5(TM) has been engineered to capture five-finger bend sensitivity enabling
gesture recognition, combined with an optical tracking technology that will
capture the movement of the hand in 3D space with six degrees of freedom (X, Y,
Z, yaw, pitch and roll), without the use of the mouse, joystick, keyboard or the
like.

The P5(TM) is a lightweight and comfortable peripheral, which is a
Universal Serial Bus (USB) based product that will allow for direct "plug and
play" in personal computers as well as the Sony PlayStation2 game console.

Due to less than expected sales of the P5(TM), we changed our focus
and on November 6, 2003, the Board of Directors passed a unanimous resolution to
discontinue the operations of the P5(TM) Unit because of the lack of capital and
the inability to obtain additional financing. We have since focused on finding
alternative sources of revenue.

BUSINESS STRATEGY

Through November 6, 2003 our strategy had been to establish ourselves
as a leading developer of real-time tracking and sensory technologies by
establishing and fostering demand for our initial product, the P5(TM), in three
distinct markets - electronic gaming, commercial markets and personal
applications both domestically and internationally. As of November, 2003, the
Company only sold products in the electronic gaming markets. We attempted to
promote content integration and development across numerous markets through
various incentives such as providing free software development kits (SDKs),
allocating resources for content integration initiatives, and bundling product
with new content that is P5(TM)-enabled. By leveraging the unique functionality
of the P5(TM) at a mass market price point, we attempted to differentiate
ourselves from our competitors. Unfortunately, market acceptance of the P5(TM)
was less than we had projected.

INDUSTRY OVERVIEW

MARKET SIZING AND KEY DRIVERS

Electronic Gaming. We have operated as part of the global video game
console, peripheral, and software industry, which is currently estimated at over
$28 billion worldwide and over $9.4 billion in the U.S., based on estimates from
Global Information Inc. The global electronic gaming peripheral segment alone
generated approximately $4.2 billion in sales in 2001 and is expected to reach
$5.8 billion in 2003. Gaming software sales in the U.S., which are expected to
drive demand for gaming-related peripherals, grew to $1.42 billion in 2002 from
$1.36 billion in 2000, despite the overall decline in a variety of technology
segments. Key drivers affecting the growth of this industry have been the broad
acceptance of next generation game platforms with faster processing power,
advances in technology that make games more realistic and interactive, greater
memory, online capabilities and DVD media formats - all of which offer new
opportunities to electronic entertainment software companies and peripherals
manufacturers.

SALES & MARKETING

We have utilized numerous sales and marketing channels in an attempt to build a
brand and capture a mass market for the P5(TM), as well as our other planned
products. We have sold the P5(TM) into multiple channels, including but not
limited to domestic and international retailers, e-commerce outlets, and direct
marketing partnerships. In addition to those units which were shipped to
retailers or sold directly to end users, we expected to receive additional
orders for the P5(TM), based on positive media reviews, strong word of mouth,
games being designed to be compatible with the P5(TM) and discussions with
multiple software developers who had indicated an interest in making future
software offerings compatible with the P5(TM). We offered consumers a $40
"sell-through" rebate (deducted immediately at point of sale) in an effort to
improve slower than expected sell-through from retailers to end users. Other
adjustments to our business model included a restructured manufacturing
schedule, deferral of marketing programs, licensing contracts and product
development expenditures. Additionally, due to lower than expected sales we
reserved the inventory to the lower of cost or market at a per unit price of $10
for the year ended December 31, 2002. Included in the statement of operations in
2002 is a $1,883,207 impairment of net realizable value related to this
inventory. For the year ended December 31, 2003, we valued the inventory at
market, at a per unit price of, $6.00 which was the selling price of the
remaining inventory sold in January 2004.

BUSINESS DEVELOPMENT

We worked to execute a comprehensive business development plan designed
to stimulate demand for our P5(TM) product in electronic gaming, commercial
markets and other applications. In addition to those games which are already
P5(TM) enabled, we signed letters of intent with various software development
firms to incorporate the P5(TM) into applications including electronic gaming
and commercial markets. These letters of intent, however, only represented
expressions of interest and were not binding commitments. Definitive agreements
with such developers have been finalized and we don't expect to realize any
revenues from such relationships.

We entered into agreements with Eidos, Infogames, Lionhead Studios,
Croteam, Ubisoft and others to gain access to underlying source code to enhance
games for P5(TM) functionality. Two popular game patches, which enabled games
for use with the P5(TM), were launched in December 2002 and March 2003, for
Serious Sam (published by Take 2 Interactive) and Black and White (published by
Lion Head Studios), respectively.

In December 2000, Essential Reality, LLC entered into a consulting
agreement with BusinessDevelopment.com, LLC (BDC) pursuant to which BDC provided
general consulting and business development services to Essential Reality LLC,
and then to us, in return for a monthly cash retainer. See Item 12 "Certain
Relationships and Related Transactions" below. Such services consisted of
forming revenue-generating opportunities, including without limitation
distribution agreements, licensing agreements, joint ventures, strategic
alliances and partnerships. The amount of the retainer originally was $6,000 per
month, increased to as much as $15,000 per month from July 2002 to September
2002 and $7,500 per month from October 2002 to June 2003. The consulting expense
for the years ended December 31, 2003 and 2002 were $45,000 and $203,479
respectively.

In addition to the monthly retainer, we also are obligated to pay to
BDC a potential revenue share of up to four percent (4.0%) on transactions
facilitated by BDC. Either BDC or we were able to cancel this agreement with
thirty (30) days prior notice. After June 2003, BDC ceased to provide services
to us.

In March 2000, Essential Reality, LLC entered into a Settlement and
Release Agreement with Rose Ganguzza, a consultant to Essential Reality, LLC, on
behalf of herself and Hollywood Productions, Ltd., which requires Essential
Reality, LLC to pay to Rose Ganguzza, a royalty of $0.25 for each of the first
150,000 units of the P5TM sold. As partial consideration for entering into such
agreement, the other parties released Essential Reality, LLC from any and all
claims they may have against Essential Reality, LLC relating to the Power Glove,
a predecessor product developed by a third party pursuant to the patent we now
own. The royalty expense for the year ended December 31, 2003 and 2002 was
$2,035 and $153 respectively.

MANUFACTURING

We utilized V-Tech Communications Ltd. as our manufacturing partner for
the P5(TM). V-Tech is one of Southeast Asia's leading manufacturers of consumer
electronics, toys and other mass market devices under its own name and on a
private label basis for some of the world's foremost electronics,
telecommunications and retail concerns. V-Tech worked with us under a
"work-for-hire" agreement on, amongst other things, establishing manufacturing
schemes, developing quality control procedures, arranging (and in some cases
executing) vendor agreements with our preferred vendors, identifying
cost-reduction opportunities, and preparing for the integration of our machine
tooling for production. The initial unit cost for the P5(TM) was approximately
$45. Implementation of two ASIC designs could potentially yield further cost
reductions. Regardless, we do not intend on producing additional P5(TM)'s until
we sell our existing inventory and we anticipate using smaller independent
manufacturing facilities for any additional products we develop.

Certain key components used in the manufacture of the P5(TM) were
purchased directly by V-Tech from single or limited sources that specialize in
these components. Single-sourced components included certain of our
application-specific integrated circuits, sensors (also known as bend sensors)
and other components. Due to the precise nature of these components, there are
relatively few companies capable of manufacturing the same or similar components
at a competitive price.

PRODUCT DEVELOPERS AND SUPPLIERS

As of July 1, 2001, Essential Reality, LLC entered into an agreement
with VR Yad Development Group, Ltd.,("VR Yad") a third-party developer with
expertise in virtual reality systems, for the creation and design of all of our
products and software. Through this arrangement, VR Yad worked exclusively for
Essential Reality, LLC (and following the business combination, for us) and was
reimbursed for their services at cost. This agreement remained in force until
terminated by either party, upon not less than thirty days' notice. We had
previously reimbursed them approximately up to $40,000 per month for salaries
and benefits, plus expenses. To date, the only product that VR Yad has developed
for us is the P5(TM). VR Yad is entitled to a royalty of 1.0% of net sales, and
an additional 0.5% royalty because it timely completed all portions of its
development work. These royalties are not payable until we actually collect the
associated revenue, but are payable indefinitely. The royalty expense for the
year ended December 31, 2003 and 2002 was $3,538 and $917 respectively. During
the period of engagement by us, and for two years after termination of the
relationship, VR Yad is prohibited from developing, manufacturing, marketing or
selling any product similar to the products it developed for us.

As of July 1, 2001, Essential Reality, LLC entered into a loan
agreement with VR Yad pursuant to which Essential Reality, LLC agreed to loan VR
Yad up to $2,000,000 modified June 10, 2002 to $2,700,000. The loan was
non-interest bearing, was payable two years after the date of the loan and was
collateralized by all personal property of VR Yad.

On September 16, 2003 the Company terminated the agreement and
executed a Settlement and Mutual Release Agreement where the parties agreed to
waive all rights and claims against each other for its past due and present
services under the agreement including severance obligations assumed by the
developer and the Company applied against the outstanding Tax Credit Receivable
equal amount owed to the developer.

As of September 16, 2003, the loan balance had been reduced by
$1,960,012 of qualified development expenses and $418,773 of research and
development credits from the Canadian Government. The remaining loan receivable
of $477,311 was applied against the outstanding trade payable balance of
$366,642 owed at September 16, 2003. The Company has recorded a contract
termination expense of $110,669 at December 31, 2003 which is included as part
of the discontinued operations.

In January 2001, Essential Reality, LLC entered into a memorandum of
understanding with Apjay Technologies for the development of certain components
of the P5(TM). Pursuant to the memorandum of understanding, we were required to
pay royalties of 1% of P5(TM)'s net sales to Apjay Technologies indefinitely.
The Company was required to pay a royalty advance of $50,000, of which $15,000
has previously been paid and $35,000 of which is now due because we have
incorporated the component developed pursuant to the memorandum of understanding
into the P5(TM). Included in the settlement with VR Yad was the assumption by
the developer of the outstanding amount owed by the Company to Apjay.

In July 2000, Essential Reality, LLC entered into a consulting
agreement with MC Squared Incorporated to help manage the relationship with
product developers. This consulting agreement replaced a previous Development
Agreement executed between Essential Reality, LLC and MC Squared in November
1999. In connection with these agreements we paid MC Squared $250,000. We are no
longer making payments to MC Squared. In September 2000 the consulting agreement
terminated and the development process was managed by us internally. MC Squared
is a company owned by a person related to certain members of our Board of
Directors. Pursuant to such agreement, we are required to pay royalties of 1.8%
on net sales of the P5(TM) and 9% of the license fee collected by us with
respect to P5(TM), indefinitely. MC Squared has sued us in connection with these
agreements. On October 15, 2003 the case was settled for $53,643 payable as
follows: $3,643 in full for royalties due as of July 30, 2003 and $ 50,000 for
"Non-Royalty Settlement" payable in consecutively monthly installments of $2,000
commencing November 15, 2003. The Company may prepay the outstanding balance
within 4 months and deduct 25% or within 8 months and deduct 20%. The
outstanding balance due MC Square as of December 31, 2003 is $46,643. The amount
owed for royalties was reduced from 1.8% to 1% for the first $2,500,000 in sales
and 5% license revenues. After the first $2,500,000 of such sales and licenses
Revenues, the royalties shall revert to 1% and 9% respectively. The royalty owed
as of December 31, 2003 amounted to $1,047.

EMPLOYEES

As of December 31, 2003 we had 1 full-time salaried employee and no
part-time employees and one financial consultant.

WEBSITE DISCLOSURE

The public may read and copy any materials we file with the SEC at the
SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549.
The public may also obtain information on the operation of the Public Reference
Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site
that contains reports, proxy and information statements, and other information
regarding the Company and other issuers that file electronically with the SEC at
HTTP://WWW.SEC.GOV.

ITEM 2. DESCRIPTION OF PROPERTY.

As of December 31, 2003, we leased from a third-party landlord on a
month to month basis, approximately 4,500 square feet of office space at 263
Horton Highway, Mineola, New York 11501, at a price of $4,500 per month. The
lease provides for annual increases in the monthly rent to a maximum monthly
rental price of $5,300 and terminates on February 29, 2008.

ITEM 3. LEGAL PROCEEDINGS.

On November 21, 2002, a complaint was filed by MC Squared in United
States District Court for the Southern District of New York against us, Humbert
Powell, Chairman of our Board of Directors, Steven Francesco, our ex-Chief
Executive Officer, David Devor, an officer and Brian Jedwab, a member of our
Board of Directors, alleging breach of a development agreement between us
(originally Essential Reality, LLC) and MC Squared. Specifically, the complaint
alleges a failure by us to provide a design credit to MC Squared on the
packaging for the P5(TM). The complaint seeks specific performance and a recall
of all P5(TM) products shipped to date without the design credits on the
packaging. We submitted an answer with counterclaims and made a motion to
dismiss this complaint.

On October 15, 2003 the case was settled for $53,643 payable as
follows: $3,643 in full for royalties due as of July 30, 2003 and $ 50,000 for
"Non-Royalty Settlement" payable in consecutively monthly installments of $2,000
commencing November 15, 2003. The Company may prepay the outstanding balance
within 4 months and deduct 25% or within 8 months and deduct 20%. The
outstanding balance due MC Square as of December 31, 2003 is $46,643. The amount
owed for royalties was reduced from 1.8% to 1% for the first $2,500,000 in sales
and 5% license revenues. After the first $ 2,500,000 of such sales and licenses
Revenues, the royalties shall revert to 1% and 9% respectively. The royalty owed
as of December 31, 2003 amounted to $1,047.

On January 21, 2003 a complaint was filed by RDA International, Inc. in
the Supreme Court of the State of New York against us seeking payment of
$203,264 or work, labor and services performed in connection with advertising,
marketing and multimedia programs for the P5(TM).subsequently on December 3rd
2003 a judgment was filed for $220,105 which includes interest. This amount has
been accrued at December 31, 2003.

On February 28, 2003, a complaint was filed by Aaron Gavios, a former
employee of ours, in The United States District Court for the Southern District
of New York against us, Humbert Powell, Chairman of our Board of Directors and
Brian Jedwab, a member of our Board of Directors, alleging breach of a contract.
Specifically, the complaint alleges failure to provide for severance pay,
failure to provide stock options and failure to reimburse for automobile lease
totaling $120,000, plus interest and legal fees. $50,000 has been accrued as of
December 31, 2003 as this is the amount the Company believes is actually owed.

On April 16, 2003, a complaint was filed by Ziff Davis Media, Inc. in the
Supreme Court of the State of New York against the Company (originally, ER LLC)
seeking payment of $27,443 for print advertising for the P5(TM). On July 3, 2003
the case was settled for $10,000 payable in 4 installments as follows: $4,000
due July 10, 2003, and the balance of $6,000 in 3 equal installments of $2,000
each payable August 10, September 10 and October 10, 2003. The amount has been
paid in full at December 31, 2003.

On December 4, 2003 a complaint was filed by the CIT Communications
Finance Corporation d/b/a/ Avaya Financial Services in the Supreme Court of the
State of New York, County of New York against Essential Reality, Inc seeking
payment of $38,084 plus interest and legal fees for default in paying the Phone
Equipment Lease Agreement Dated January 7, 2002. On April 29, 2004 CIT was
granted a summary judgment and the right of repossession of the telephone
equipment. The Company has accrued $537 as of December 31, 2003 as this
represents the total unpaid lease payments at December 31, 2003.

On December 4, 2003 a complaint was filed by the Shapland Creative
Design, Inc. in the District Court of the County of Nassau, New York, County of
New York against the Company seeking payment of $6,300 plus interest and legal
fees for default in paying for work labor and services for March through May
2003. This amount has been accrued as of December 31, 2003.

On January 26, 2004 a complaint was filed by Empire Inter-Freight Corp.
in the Civil Court of the City of New York, County of New York against Essential
Reality Inc. seeking payment of $12,419 plus interest and legal fees for default
in paying for freight services in December 19, 2002. The full amount has been
accrued at December 31, 2003.

On February 5, 2004 a complaint was filed by the UBI Soft
Entertainment Seeking payment of $93,750 plus interest and legal fees for
services and furnished materials provided in September 2002. This amount has
been accrued as of December 31, 2003.

On April 2, 2004 CCH Incorporated filed a Restraining Notice with the
Company's bank HSBC for one year. They are seeking payment of $6,639 for
services rendered in 2003 and 2002. This amount has been accrued as of December
31, 2003.

Except for the complaint filed by Aaron Gavios, for which we believe we
owe $50,000, and for the claims which have been fully adjudicated or settled, we
believe we have valid defenses to these claims and intend to vigorously defend
ourselves; however, there can be no assurance that we will be successful. The
costs associated with these litigations, including the time required to defend
ourselves, as well as the potential cost should there be an adverse judgment
against us, may have a material adverse effect on our financial condition and
results of operation.

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

None

SUBSEQUENT EVENTS

On January 29, 2004, the Company signed a letter of intent with AllianceCorner
Distributors Inc. ("Alliance") relating to a proposed share exchange and related
transactions between the Company and Alliance. As a result, a Share Exchange
Agreement between the Company and Alliance was executed on June 17, 2004,
pursuant to which Alliance will become our wholly-owned subsidiary (the
"Exchange") upon the satisfaction of certain closing conditions. These
conditions include the raising by the Company of approximately $2,900,000 of net
proceeds through a private placement offering, the extinguishment of all
outstanding debt of the Company except for $30,000 of trade payables, the
execution of a voting proxy by certain investors in the Company as a result of
which the current management of Alliance will obtain voting control of the
Company, and the filing of all SEC reports necessary to bring the Company
current in its filings. As of the date hereof, and upon the filing of this Form
10-KSB and the Company's 10-QSB, also to be filed on the date hereof, all
conditions to the closing of the exchange will have been satisfied and the
Exchange will be deemed to have taken place. For a more detailed description of
the terms of the Exchange and the related transactions, see the Company's
Current Report on Form 8-K, expected to be filed shortly after the date hereof.

PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

MARKET INFORMATION

We are currently not in compliance with Nasdaq and SEC regulations
which requires the Company to file its quarterly reports on a timely basis. We
have not filed as required the form 10QSB as of March 31, 2004. Our stock is
currently quoted on the pink sheets.

Our current listing status makes trading more difficult for investors,
which has lead to further decline in our share price.

Our common stock became eligible for trading on the Over-the-Counter
Bulletin Board ("Bulletin Board") on April 19, 2001. Since we did not timely
file our reports with the SEC our common stock became ineligible for trading on
the Bulletin Board on April 19, 2001 and in July 2003 our common stock started
trading on the Pink Sheets. On June 26, 2002, the ticker symbol was changed from
JPAL to ESSR. The following table sets out the high and low closing bid prices
of our common stock during the periods indicated as quoted on the Bulletin
Board. Prices reflect inter-dealer prices, without retail mark-up, mark-down or
commissions, and may not represent actual transactions.

HIGH LOW
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2002
First Quarter $4.30 $4.05
Second Quarter $4.05 $2.25
Third Quarter $3.22 $1.41
Fourth Quarter $1.95 $0.80

2003
First Quarter $0.65 $0.55
Second Quarter $0.25 $0.25
Third Quarter $0.17 $0.07
Fourth Quarter $0.11 $0.11

CHANGE IN SECURITIES

On March 10, 2003, the Company entered into an Investment
Banking/Advisory Agreement with First Securities USA, Inc. through its SBI USA
division engaging SBI as exclusive advisor and agreed to pay the Investment
Banker a retainer of 25,000 shares of common stock of the Company. These shares
have not been issued to date.

On March 12, 2003, the Company sold 100,000 shares of Common Stock to a
private investor for $1.00 per share totaling $100,000. These shares have not
been issued as of December 31, 2003.

Holders

As of May 31, 2004, we had 101 holders of record of our common stock.

DIVIDEND POLICY

We have never declared or paid dividends on our common stock and do not
anticipate declaring or paying any cash dividends on our common stock in the
near future. We plan to retain any future earnings for the development of our
business. The payment of future dividends will be at the discretion of our board
of directors and will depend, among other things, upon our future earnings,
capital requirements, financial condition and general business conditions.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.

OVERVIEW

On June 20, 2002, Essential Reality, LLC, a Delaware Limited Liability
Company ("ER LLC"), completed a business combination with JPAL, Inc., a Nevada
corporation and an SEC registrant ("JPAL") pursuant to an Amended Contribution
Agreement between ER LLC and JPAL, whereby all of the members of ER LLC
contributed their membership interests in ER LLC to the Company in exchange for
an aggregate of 16,874,784 shares of the Company's common stock (the
"Transaction"). Concurrent with the Transaction, the shareholders of JPAL
canceled 7,564,326 of their shares of JPAL common stock and were left with
1,080,934 shares of common stock representing 6.02% of the Company. Following
the Transaction, JPAL changed its name to Essential Reality, Inc.

Defaults Upon Senior Securities

The Company has defaulted in payments of the principal and accrued interest on
unsecured convertible debentures totaling $1,717,070 issued as result of the
Recapitalization with "JPAL" and additional unsecured convertible debentures
totaling $180,500 issued during 2003. Secured convertible debentures totaling
$1,000,000 issued with 8% Secured Notes are also in default.

Notes that had a convertible feature expired on the maturity date of the notes.

In connection with the Transaction, (i) holders of certain bridge notes
issued by the Registrant received, as additional consideration, two-year
warrants ("Bridge Warrants") to purchase up to an aggregate of 840,000 shares of
Common Stock and 15,000 shares of Common Stock (collectively, the "Bridge
Warrant Shares"), at a purchase price of $1.90 and $1.30 per share,
respectively, (ii) holders of certain bridge notes issued by the Registrant
exchanged them for convertible promissory notes of the Company ("Convertible
Notes"), which were convertible for a period of six months at a conversion price
of $1.90 into an aggregate of 263,158 shares of Common Stock (the "Convertible
Note Shares"), and (iii) the Company issued warrants ("Additional Warrants") to
purchase up to an aggregate of 331,211 shares of Common Stock (the "Additional
Warrant Shares") at a purchase price of $1.30 per share.

When the offer expired, a total of $250,000 of the outstanding notes
had been tendered for conversion into 217,391 common shares. The holders of
these shares were granted the following registration rights (1) the Company
became obligated to file a registration statement covering 60% of the underlying
shares of common stock and (2) piggyback registration rights were granted for
the remaining 40% of the shares granted.

The Transaction was accounted for as a capitalization in which ER LLC
is the accounting acquirer and JPAL is the legal acquirer. The management of ER
LLC remained as the management of the Company. Since the Transaction was
accounted for as a capitalization and not a business combination, no goodwill
has been recorded in connection with the Transaction and the costs incurred in
connection with the Transaction have been accounted for as a reduction of
additional paid-in capital. As a result of the capitalization, (i) the
historical financial statements of the Company for periods prior to the date of
the Transaction are the historical financial statements of JPAL, and, therefore,
JPAL's historical financial statements are no longer presented; (ii) all
references to the financial statements of the "Company" apply to the historical
financial statements of ER LLC prior to the Transaction and to the financial
statements of the Company subsequent to the Transaction; and (iii) any reference
to the Company applies solely to ER LLC and Essential Reality, Inc.

Founded in 1999, ER LLC was a developer of real-time tracking and
sensory technologies. We focused on combining these technologies into products
that enhance the interaction between human beings and computer platforms, with
initial emphasis on a product called the P5(TM). The P5(TM) enables
three-dimensional movement of the cursor as well as pitch, yaw and roll. The
user moving his hand and/or bending his fingers controls the P5(TM).

The Company began product shipments in October of 2002, and has not yet
generated significant revenue, but continues to incur significant losses from
operations. Inventory sold with the right of price protection and/or right of
return is reported as inventory on consignment in accordance with the below
stated accounting policy for revenue recognition. The attainment of profitable
operations are dependent upon future events, including obtaining adequate
financing to fulfill our future development activities, and achieving a level of
revenue adequate to support its cost structure. There can be no assurance that
such future events shall occur.

We have spent a significant portion of the year looking for an alternative
business plan and streamlining operations.

CRITICAL ACCOUNTING POLICIES

We have identified the following as critical accounting policies:

PRODUCT DEVELOPMENT - Product development costs include expenses
incurred by the Company to research and develop the P5TM product. Product
development costs are expensed until such time as it is determined that a
product is technologically feasible. Product development costs are capitalized
from such date until such time as product development is substantially complete.
Product development costs capitalized were to be amortized on the straight-line
basis over the lesser of the estimated useful life of the product or three
years.

REVENUE RECOGNITION - The Company recognizes under SAB 104 gross
revenue when the earnings process is complete, as evidenced by an agreement with
the customer, transfer of title and the rights and risks of ownership have
passed to the customer, the product is delivered, the price is fixed and
determinable, and collection of the resulting receivable is reasonably assured.
Because the Company allows many of its distributors price protection and/or
right of return, recognition of revenue in the accompanying financial statements
has been deferred until the distributors sell the merchandise and the cash is
collected by the Company. Inventory at distributors is reported as consigned in
the balance sheet.

In cases where sales are made to certain distributors and title has
transferred, risks of ownership has passed and collection is assured, sales have
been recorded and an account receivable has been recorded. The Company records
an allowance for uncollectible accounts on a customer-by-customer basis as
appropriate.

The Company bundled product offerings from third-party vendors along
with the P5(TM) product and soled the P5 independently. The software is
incidental to the product as a whole and according to FASB 86, Accounting for
the Costs of Computer Software To Be Sold, Leased or Marketed, all revenue will
be allocated to the P5. As such, the Company recorded the gross amount of the
purchase price of the P5(TM) product as revenue and reflected the royalty to be
paid to the third-party vendor as a component of cost of sales.

INVENTORY - Inventory is valued at the lower of cost or market, with
cost being determined on the first in-first out basis. The inventory represents
high-technology parts that maybe subject to rapid technology obsolescence and
which are sold in a highly competitive industry. If the actual product demand or
selling prices are less favorable than we estimate, the Company establishes an
allowance account based on net realizable values. Inventory sold with the right
of price protection and/or right of return is reported as inventory on
consignment. There was no inventory on consignment as of December 31, 2003.
During the years ended December 31, 2003 and 2002, the Company recorded
inventory valuation adjustments in the amount of $78,395 and $1,883,207,
respectively.

RESULTS OF OPERATIONS

THE YEAR ENDED DECEMBER 31, 2003 COMPARED TO THE YEAR ENDED DECEMBER 31, 2002

On November 6, 2003, the Board of Directors passed a unanimous
resolution to discontinue the operations of the P5(TM) Unit because of the lack
of capital and the inability to obtain additional financing. The consolidated
financial statements and related notes reflect the financial position, results
of operations and cash flows of the Company for these discontinued operations
includes allocations of certain expenses for the P5(TM) Unit. The following
shows the comparison of the information that is included in the discontinued
operations as if the operations were continuing.

REVENUE. For the year ended December 31, 2003, the Company recognized
product-related revenues in the amount of $234,600 as compared to $112,602 for
the year ended December 31, 2002. The increase in our revenue resulted from the
launch of our first product, the P5(TM), in November 2002.

COST OF REVENUE. For the year ended December 31, 2003, cost of revenue totaled
$230,867 compared to $304,023 for the year ended December 31, 2002. The Company
was considered a development stage company through September 30, 2002. The
increase in cost of revenue resulted from the Company transitioning from a
development stage company to an operating company effective October 1, 2002.

OPERATING EXPENSES. For the year ended December 31, 2003, operating expenses
totaled $4,387,918 compared to $7,507,066 for the year ended December 31, 2002.
The decrease in operating expenses resulted from the decrease in sales and
marketing, product development, general and administrative expenses, and stock
based compensation.

Product Development Expense. Included in discontinued operations for the year
ended December 31, 2003 product development expenses decreased from $1,037,396
for the year ended December 31, 2002 to $527,015 for 2003, a net decrease of
$510,382. The decrease was primarily due to a decrease of approximately $102,887
in fees paid to third party developers, which includes materials used in the
development and manufacturing of our P5(TM) product, and $296,729 in payroll
costs. Included in product development costs are $25,000, and $33,700 for years
ended December 31, 2003 and 2002, respectively, paid to Abrams Gentile
Entertainment, Inc. an entity owned by certain shareholders of the Company.

Sales and Marketing Expense. Included in discontinued operations, for the year
ended December 31, 2003 sales and marketing expense decreased from $1,711,894
for the year ended December 31, 2002 to $524,512 for 2003, a net decrease of
$1,187,382. The decrease in sales and marketing expense is primarily due to
$140,660 in marketing related salaries and employee benefits, $153,000 in
marketing related supplies and services, $355,800 in trade shows and related
travel, $211,685 in advertising and $326,237 in consulting.

General and Administrative Expenses. For the year ended December 31, 2003
general and administrative expenses decreased from $1,924,823 to $879,747, a net
decrease of $1,045,076 as compared to the year ended December 31, 2002. The
decrease in general and administrative expenses is primarily due to an decrease
of approximately $642,827 in salaries and benefits, decrease in consulting fees
of $275,193, decrease in professional fees of $76,154, and decrease in office
expense of $50,901. Included in general and administrative expenses are costs
incurred of approximately $50,781 and $203,479 for the years ended December 31,
2003 and 2002, respectively, by Business Development.com Inc. and Hymax Group,
LLC, companies that are related to certain members of LCG Capital Group. Such
costs include consulting fees, employee salaries, occupancy, telephone and
computer leases. In the case of employee salaries, costs were allocated to the
Company based on the time each employee conducted business specific to the
Company. In the case of the other expenses, costs are allocated based on a
percentage of resources used by the Company. In our opinion, allocated expenses
incurred from related parties approximate fair market value.

Stock Based Compensation for the year ended December 31, 2003 was $2,407,336 as
compared to $880,885 for the year ended December 31, 2002. The non-cash charge
was related to amortization of deferred compensation for stock options issued to
employees, directors, advisors and consultants, and deferred consulting costs
incurred.

OTHER INCOME(EXPENSE) Interest income for the year ended December 31, 2003,
decreased from $17,025 to $1,213, a net decrease of $15,812 as compared to the
year ended December 31, 2002. Interest earned from the note receivable for
Essential Reality, LLC's members' capital was $0 for the year ended December 31,
2003 compared to $2,536 for the year ended December 31, 2002. The other reason
for the decrease was due to lower cash balances during 2003.

Interest expense for the year ended December 31, 2003 increased from $1,173,944
to $1,491,671, a net increase of $317,727 as compared to the year ended December
31, 2002. In 2003, interest expense related primarily to bridge loans (unsecured
convertible debentures) of $59,385, a non cash charge of $269,238, resulting
from the beneficial conversion feature on July 17, 2002 primarily due to the
warrants and the convertible notes issued at the time of the merger and
subsequent financing during 2003, described in "Liquidity and Capital Resources"
below.

Net loss for the years ended December 31, 2003 and 2002 were $6,739,390 and
$8,853,480, respectively.

LIQUIDITY AND CAPITAL RESOURCES

Since its inception through December 31, 2003 we had accumulated
deficit of $20,365,112 and expect to continue to incur losses for the
foreseeable future. We have financed our operations primarily through bridge
loans and private placements described in the overview.

For the year ended December 31, 2003 net cash used in operating
activities decreased from $6,598,959 to $1,617,746 a net decrease of $4,981,213
as compared to the year ended December 31, 2002. Net cash and cash equivalents
used in operations for the year ended December 31, 2003 consisted of net loss of
$6,739,390 less non cash items consisting primarily, impairment of fixed assets
and intangible assets of $419,235, non-cash compensation of $2,407,336,imputed
interest on conversion of debt instrument $1,058,908 amortization of deferred
interest of $195,594, decrease in inventories of $108,539, decrease in account
receivable of $38,679, increase in other assets of $156,761 and net increase in
liabilities of $550,730. As of December 31, 2003 the Company's had no available
cash in banks and had a book overdraft in the amount of $1,457 compared to Cash
in banks as of December 31, 2002, of $188,858.

Net cash used in investing activities for the year ended December 31,
2003 decreased from $693,495 to $13,642 a net decrease of $679,853 as compared
to the year ended December 31, 2002.

Net cash provided by financing activities for the year ended
December 31, 2003 decreased from $7,467,449 to $1,442,530 a net decrease of
$6,024,919 as compared to the year ended December 31, 2002 primarily as follows:

On November 20, 2002, we received $500,000 partial bridge financing
(the "Financing") from a subscription agreement for $1,000,000 consisting of a
six month 8% Secured Convertible Debenture (the" Debenture") due on May 20,
2003. The Debenture was convertible into units at a various prices per unit,
each such unit consisting of one share of Common Stock and a warrant to purchase
a number shares of Common Stock at various exercise prices per warrant. The
Black Scholes value of the warrants and the beneficial conversion feature will
be amortized to interest expense over the life of the debt. The Financing was
intended to assist the Company with its cash flow as it seeks to raise
additional financing through the sale of equity securities or private
placements. An additional $500,000 was received in connection with this
subscription in 2003 and the company issued additional 8% Secured Convertible
Debentures.

In June 2003 the Company issued an 8% Unsecured Convertible
Debenture for $40,000. The debenture which matures in six months contains a
conversion feature at a conversion price of $0.40. The debenture contains
detachable warrants to acquire 33,000 common stock at an exercise price of $0.40
per share expiring in five years.

From July 2003 through September 2003, the Company issued an 8%
Unsecured Convertible for $73,000. The Debentures matures in six months contains
a conversion feature at various exercise prices. The debenture also contains
detachable warrants to acquire 71,820 of common stock at an exercises price of
$0.25 per share expiring in 5 years.

In October 2003, the Company issued an 8% Unsecured Convertible
Debenture for $33,000. The debenture which matures in six months contains a
conversion feature at a conversion price of $0.40. The debenture contains
detachable warrants to acquire 52,800 shares of common stock at an exercise
price of $0.25 per share expiring in five years.

In November 2003, the Company issued an 6% Unsecured Convertible
Debenture for $500,000. The debenture which matures in six months contains a
beneficial conversion feature at a conversion price of $0.02. The conversion
right may only be exercised upon the earlier of to occur of: (i) an offering of
debt or equity capital of at least $3,000,000 or 180 days from the Closing as
defined in the Note Purchase Agreement. The Company received $310,715 as of
December 31, 2003.

On November 20, 2003, in connection with the Term Sheet signed
November 6, 2003 subsequently replaced with the Term Sheet dated February 6,
2004, $225,000 was deposited in the escrow account with Counsel to Alliance.
Alliance shall be entitled to draw on such funds to pay expenses for accounting,
legal and other expenses related to the exchange. As of December 31, 2003 the
balance amounted to $205,135 and is included in prepaid and other current
assets.

If the transaction is terminated by any party for any reason, Alliance shall
direct the escrow agent to release to Essential Reality any remaining balance.

Alliance shall also refund to Essential Reality any portion of the $225,000 that
was released form escrow if both the following conditions have occurred:

1. After December 31, 2003 Alliance has withdrawn from the
transaction due to any non-material adverse changes, and

2. Essential Reality has made securely funded arrangements to
fund expenses that exceed the $225,000 deposited in escrow.

We will require substantial funding to continue our website
development, marketing, sales, and administrative activities. We have raised
funds in the past through the sale of securities, and may raise funds in the
future through public offerings or private placements of securities,
collaborative arrangements or from other sources.

However, there can be no assurance that we will be able to raise any
additional funds. If additional funding is not available to us when needed, we
may be required to cease operations.

Based on the market conditions for the P5(TM) Glove and our
inability to sell the product at a reasonable price we have had to liquidate the
inventory at $6.00 per glove and suspended operations.

As the Company was unable to raise their projected cash requirements as of
December 31, 2003. The Company hopes to raise the additional cash needed in
connection with the pending share exchange (as noted in the Term Sheet signed
February 6, 2004), as noted below and the exercise of certain warrants and/or
through additional offerings of its securities.

POTENTIAL PRIVATE PLACEMENT.

On February 6, 2004 we executed a binding term sheet (the "Term Sheet")
which sets forth the preliminary terms and conditions of a proposed exchange
transaction between Essential and AllianceCorner Distributors Inc. ("Alliance").
This Term Sheet supersedes and replaces the Letter of Intent dated November 6,
2003. As proposed, the shareholders of Alliance would exchange their shares of
capital stock in Alliance for shares of common stock of Essential.

The consummation of the transaction is contingent on a number of
factors, including but not limited to, the completion of due diligence and the
execution of a definitive agreement. There can be no assurance that the exchange
will be consummated or, if consummated, that it will be consummated on the terms
set forth in the Term Sheet.

Commitments

Payments Due By Period
-----------------------------------
Less Than 1 to 4 to After
Total One year 3 Years 5 years 5 years
------- ------- ------- ------- -------

Long-term debt $ -- $ -- $ -- $ -- $ --
Employment Contract -
Mr. Devor -- -- -- -- --

Other Employment Contracts
- Non Officers -- -- -- -- --

Capital Lease Obligations -- -- -- -- --

Operating Lease -- -- -- -- --
------- ------- ------- ------- -------
Total Cash Commitments $ -- $ -- $ -- $ -- $ --
======= ======= ======= ======= =======

RECENT ISSUED ACCOUNTING PRONOUNCEMENTS

In December 2003, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 104, "Revenue Recognition." SAB 104 supersedes
SAB 101, "Revenue Recognition in Financial Statements." SAB 104's primary
purpose is to rescind accounting guidance contained in SAB 101 related to
multiple element revenue arrangements, superseded as a result of the issuance of
EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables."
Additionally, SAB 104 rescinds the SEC's Revenue Recognition in Financial
Statements Frequently Asked Questions and Answers ("the FAQ") issued with SAB
101 that had been codified in SEC Topic 13, Revenue Recognition. Selected
portions of the FAQ have been incorporated into SAB 104. While the wording of
SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue
recognition principles of SAB 101 remain largely unchanged by the issuance of
SAB 104, which was effective upon issuance. The adoption of SAB 104 did not
impact the consolidated financial statements.

FACTORS THAT MAY AFFECT FUTURE RESULTS

A LIMITED OPERATING HISTORY MAKES EVALUATING OUR BUSINESS DIFFICULT.

Prior to our business combination with ER LLC, their operations
consisted primarily of organizational activities and product development. There
can be no assurance that we will be able to develop our products as we envision,
raise additional capital to develop our business, generate revenues or become a
viable business.

DUE TO OUR OPERATING REQUIREMENTS AND LESS THAN EXPECTED REVENUES, WE REQUIRE
ADDITIONAL FINANCING OR WE WILL BE UNABLE TO CONTINUE AS A GOING CONCERN.

ER LLC had no revenues prior to its business combination with us since
its products had not yet been offered to the public. We received limited cash
proceeds from sales of the P5(TM), but sales have been slower than we
anticipated due, in part, to general economic conditions and weaker than
expected sales of PCs, PC games and the peripherals associated therewith. We
have not sold any other products in our other divisions. We anticipate that we
will need to raise additional capital in the immediate future to continue
business operations. However, there can be no assurance that such financing, or
any additional financing, will be available to us when needed, on commercially
reasonable terms or at all. Any inability to obtain additional financing when
needed could have a material adverse effect on us, requiring us to curtail and
possibly cease our operations.

WE EXPECT TO INCUR OPERATING LOSSES AND NEGATIVE CASH FLOW FOR THE FORESEEABLE
FUTURE.

We have incurred and expect to incur significant net losses and
negative cash flow for the foreseeable future. The auditors' opinion attached
hereto indicates substantial doubt about our ability to continue as a going
concern. Our success depends on developing additional products, establishing and
strengthening our lines of business, as well as establishing distribution
channels for our products and relationships with retailers. There can be no
assurance that we will ever achieve revenues or profitable operations. However,
due to less than expected sales of the P5(TM) we have decided to focus on
additional products but have focused on finding additional business plans and
source of revenue.

WE ARE UNDER THE CONTROL OF CERTAIN SHAREHOLDERS, WHICH COULD PREVENT THE TAKING
OF CERTAIN ACTIONS WHICH MAY BE BENEFICIAL TO THE OTHER SHAREHOLDERS.

LCG Capital Group, LLC, one of the original members of Essential
Reality, LLC who received shares of our common stock pursuant to our business
combination with Essential Reality, LLC, may be deemed to beneficially own a
substantial majority of our common stock by virtue of a voting agreement with
certain other of our other shareholders. Consequently, LCG will control the
outcome of substantially all matters submitted to a vote of our security
holders, including but not limited to the selection of members to our Board of
Directors and the adoption of measures that could delay or prevent a change in
control or impede a exchange, takeover or other business combination we may
potentially be involved in. LCG is controlled by Winchester Capital Group, LLC,
which is controlled by Michael Alpert.

OUR COMMON STOCK IS SUBJECT TO PENNY STOCK REGULATION, WHICH MAY LIMIT THE
LIQUIDITY OF OUR COMMON STOCK AND THE ABILITY OF OUR SHAREHOLDERS TO SELL OUR
SHARES.

Our common stock is subject to regulations of the SEC relating to the
market for penny stocks. These regulations generally require that a disclosure
schedule explaining the penny stock market and the risks associated with the
penny stock market be delivered to purchasers of penny stocks and impose various
sales practice requirements on broker-dealers who sell penny stocks to persons
other than established customers and accredited investors. The regulations
applicable to penny stocks may severely limit the market liquidity for our
securities and could reduce our shareholder's ability to sell our securities in
the market.

IF WE ARE NOT CURRENT IN OUR PERIODIC FILINGS WITH THE SEC, WE COULD LOSE OUR
ELIGIBILITY TO TRADE OUR SECURITIES ON THE OTC BULLETIN BOARD, WHICH WOULD HAVE
AN ADVERSE AFFECT ON OUR ABILITY TO RAISE ADDITIONAL FUNDS.

We are required to file annual and quarterly reports with the SEC,
pursuant to the Securities Exchange Act of 1934, as amended, and the rules
promulgated there under. To the extent we have not timely file such reports, our
securities arey no longer permitted to be traded on the OTC Bulletin Board and
are listed on the Pink Sheets Such action would have an adverse affect on our
ability to raise additional funds in the future since many potential investors
will not invest in companies whose securities are traded on the "pink sheets."

ITEM 7. FINANCIAL STATEMENTS.

See our financial statements beginning on page F-1.

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

Effective March 13, 2003 ("Termination Date") we terminated our
relationship with Deloitte & Touche LLP ("D&T") the Company's principal
independent accountant. On such date the Company engaged Stonefield Josephson,
Inc. ("Stonefield") to serve as the Company's new principal independent
accountant. During the two most recent years and through December 31, 2002, the
Registrant has not consulted with Stonefield Josephson, Inc. on items regarding
the application of accounting principles to a specified transaction, either
completed or proposed, or the type of audit opinion which might be rendered on
the Registrant`s financial statements. Our Audit Committee and Board of
Directors participated in and approved the decision relating to the change in
independent auditors' from D&T to Stonefield.

During the two fiscal years ended December 31, 2001 and any subsequent
interim period through March 13, 2003 there were no disagreements between us,
Essential Reality LLC and D&T on any matter of accounting principles or
practices, financial statement disclosure or auditing scope or procedure, which,
if not resolved to their satisfaction, would have caused them to make reference
to the subject matter of the disagreement in connection with their report,
except for material weaknesses in internal control.

ITEM 8A. CONTROLS AND PROCEDURES

In accordance with Exchange Act Rules 13a-15 and 15d-15, we carried out
an evaluation, under the supervision and with the participation of management,
including our Chief Executive Officer and our Chief Financial Officer, of the
effectiveness of our disclosure controls and procedures as of the end of the
period covered by this report. Based on that evaluation, our Chief Executive
Officer and our Chief Financial Officer concluded that our disclosure controls
and procedures were effective as of December 31, 2003 to provide reasonable
assurance that information required to be disclosed in our reports filed or
submitted under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms.

There has been no change in our internal controls over financial
reporting that occurred during the three months ended December 31, 2003 that has
materially affected, or is reasonably likely to materially affect, our internal
controls over financial reporting.

PART III

ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

Pursuant to the terms of our business combination with ER LLC, upon
consummation of the transaction, each of the officers and directors of ER LLC
became our officers and directors. We have since decided to streamline our
management team and they are focused on finding an alternative business
EXECUTIVE OFFICERS AND OTHER SIGNIFICANT EMPLOYEES

Set forth below for each of our executive officers and other
significant employees and consultants is his name, age, positions and offices
held with us, and his principal occupations during the past five years.

NAME AGE TITLE
---- --- -----

Humbert B. Powell, III 63 Chairman of the Board

John Gentile 45 Interim President and Chief Operating Officer

George Mellides 62 Chief Financial Officer

David Devor 41 Vice President, Marketing & Sales

HUMBERT B. POWELL, III, CHAIRMAN OF THE BOARD
Mr. Powell had been ER LLC's acting Chief Executive Officer and had worked for
us in the same capacity following the consummation of our business combination
with ER LLC until July 1, 2002. Since July 1, 2002, he has served as Chairman of
our Board of Directors. Mr. Powell also has been a Managing Director at Sanders
Morris Harris, a regional investment-banking firm headquartered in Houston,
Texas, with a branch in New York City, where he resides, since November 1996.
Mr. Powell served as Chairman of Marleau, Lemire USA and Vice Chairman of
Marleau, Lemire Securities, Inc. between 1994 and 1996. Prior to his employment
with Marleau, Lemire he served as a Senior Managing Director in the Corporate
Finance Department of Bear Stearns & Co., from 1984 to 1994, with
responsibilities for the investment banking effort both domestically and
internationally. Prior to his employment with Bear Stearns, Mr. Powell served as
a Senior Vice President and Director of E.F. Hutton & Co., where he was employed
in various capacities for 18 years. He is also a Director of Lawman Armour
Corp., Bikers Dream Inc., World Water Corp., and a trustee of Salem-Teikyo
University.

JOHN GENTILE, INTERIM PRESIDENT AND CHIEF OPERATING OFFICER
Mr. Gentile has served as our Interim President and Chief Operating Officer
since December 31, 2002. Mr. Gentile has also served as President of Abrams
Gentile Entertainment (AG), a New York-based entertainment technology and
marketing firm since its inception in 1986. He also is a principal and board
member of T-INK Technologies, Inc.(TM), a company founded in December 2000 that
develops and markets high tech conductive inks for both interactive consumer and
industrial applications. Mr. Gentile, along with his brother Anthony, holds many
patents and trademarks for technology and toy applications, as well as technical
and process technologies they have created for joint ventures with Hasbro,
Kenner and Mattel, which collectively generated over a billion dollars of retail
sales. Prior to AG, he was a founder and Chief Executive Officer of The Instar
Group from 1973 to 1986, an entertainment design firm where he created many
successful campaigns and film design for Paramount Pictures, Universal Studios
and Columbia Pictures. John Gentile, our interim President, Chief Operating
Officer and Director, is the brother of Anthony Gentile, another Director of
ours. There are no other family relationships among our directors and executive
officers.

GEORGE MELLIDES, CHIEF FINANCIAL OFFICER
Mr. Mellides has served as our Acting Chief Financial Officer since March 24,
2003. Previously, from May 2000 to February 2003, Mr. Mellides served as Chief
Financial Officer of James Barclay Alan, a small-cap Investment Banking Company.
From January 1999 to April 2000 he served as Chief Financial Officer of Dreman
Value Management, Investment Advisors and from January 1996 through December
1998 he served as Chief Financial Officer of Laidlaw Global Securities.

DAVID DEVOR, VICE PRESIDENT, SALES & MARKETING
Mr. Devor had been with ER LLC since November 1999, and since November 2001 has
been our Vice President of Marketing, responsible for marketing and branding of
our products. Prior to joining ER LLC, Mr. Devor managed private equity
investments from February 1991 to October 1999 through his principal position
with Devor Capital Investments LLC, which is an investment firm specializing in
high-tech companies, with a primary focus on interactive entertainment,
electronic gaming and Internet -related opportunities. Prior to that, from
October 1983 to January 1991, Mr. Devor founded and managed a large chain of
home entertainment furnishings centers. On February 27, 1996, Mr. Devor pleaded
guilty to the crime of offering a false instrument for filing. He received a
three-year conditional discharge, paid $10,000, and was obligated to perform 40
hours of community service.

BOARD OF DIRECTORS

Set forth below for each of the five members of our Board of Directors is his
name, age, the term during which he has served as one of our directors, his
principal occupations during the past five years and any additional
directorships he has held in publicly-held companies.

MARC A. FRIES, age 35
Mr. Fries has been the President of The Raynor Group ("Raynor"), an established
national sales and marketing firm in the office furniture industry, since
February 1998. Mr. Fries is responsible for the development and implementation
of sales strategies for each of the distribution channels Raynor services. These
channels include big box retail, mail order, Internet sales, national buying
groups, regional distributors and independent dealers. Mr. Fries has headed the
licensed product division at Raynor since its inception two years ago. Currently
this division is launching its Technomesh(TM) seating and accessories product
line under license agreements with National Football League Properties and the
National Hockey League. Raynor is in the process of signing agreements with the
National Basketball Association and the NCAA Collegiate Licensing Committee. Mr.
Fries has been responsible for all product development including design, global
sourcing and manufacturing for Raynor. He has been instrumental in developing
its marketing plan and coordinating sales and distribution with key retail
partners across the country. Prior to being appointed President of Raynor, Mr.
Fries was the National Sales Manager responsible for Raynor's outside sales
force. Mr. Fries began his career in sales with Raynor in October 1990. Mr.
Fries received his Bachelor of Arts in Economics from Yeshiva University in New
York.

BRIAN D. JEDWAB, ESQ., AGE 33
Mr. Jedwab has served as general counsel to Hymax Group, LLC, a private equity
investment company with investments in numerous public and private companies,
primarily Internet and technology related, since 1997. In such capacity, he has
been responsible for the direction and management of all legal and
administrative affairs. Mr. Jedwab has practiced law in the areas of commercial
litigation and real estate, is a member of the Bar of the States of New York and
New Jersey and is a member of the New York State Bar Association. Mr. Jedwab
received his B.A. in History cum laude from Queens College and received a J.D.
from the Benjamin N. Cardozo School of Law.

ANTHONY GENTILE, AGE 45
Mr. Gentile has served as Vice-President of AG since its inception in 1986. He
also is a principal and Board member of T-INK Technologies, Inc.(TM), a company
founded in December 2000 that develops and markets high tech conductive inks for
both interactive consumer and industrial applications. Mr. Gentile, along with
his brother John, holds many patents and trademarks for technology and toy
applications, as well as technical and process technologies they have created
for joint ventures with Hasbro, Kenner, and Mattel, which collectively have
generated over a billion dollars of retail sales. Prior to AG, he was a founder
and Vice-President of The Instar Group from 1973 to 1986, an entertainment
design firm where he created many successful campaigns and film design for
Paramount Pictures, Universal Studios and Columbia Pictures.

For Humbert B. Powell, III's and John Gentile's information, see "Executive
Officers and Other Significant Employees" above.

COMMITTEES

In June 2002, our Board of Directors established an audit committee and a
compensation committee. The Board has assigned certain responsibilities to the
committees and the committees approve actions and make recommendations to the
Board. The audit committee works with the chief financial officer and outside
auditors, in connection with various auditing and accounting matters, including
the recommendation of auditors, the scope and accuracy of the annual audits,
fees to be paid to the auditors, the independence of the auditors, and our
internal controls and accounting practices. The members of the audit committee
currently are Humbert B. Powell, III (Chairman) and Marc Fries. Mr. Humbert B.
Powell, III is qualified as an "Audit Committee Financial Expert" within the
meaning of the applicable SEC Regulations. The compensation committee reviews
the budget and recommends, reviews and oversees the salaries, benefits and stock
option plans for our employees, consultants, directors and other individuals
compensated by us. The members of the compensation committee currently are
Humbert B. Powell, III (Chairman), Brian D. Jedwab and Anthony Gentile. The
Board and its committees currently are examining the impact of the
Sarbanes-Oxley Act of 2002 on their structure and operations. Our Board of
Directors may from time to time establish other committees to facilitate our
management.

ADVISORY BOARD
In January 2001, ER, LLC established an advisory board for the purpose of
providing it with strategic advice. The members of the advisory board meet
periodically with and advise our employees, customers and third-party
consultants. Set forth below for each member is his or her name, age and
principal occupations during the past five years.

PAUL EIBELER, AGE 45
Mr. Eibeler was the President of Take-Two Interactive, an integrated global
developer, marketer, distributor, and publisher of interactive entertainment
software games and accessories for the Sony PlayStation2, Nintendo 64, and
Microsoft Xbox. He had been with Take-Two interactive, from July 2000 to 2003.
Previously, Mr. Eibeler held various consulting positions for Microsoft's Xbox
launch team, W-Trade Inc. and Essential Reality, LLC from January 1999 to June
2000. Mr. Eibeler also served as Acclaim Entertainment's executive vice
president and General Manager from June 1996 to January 1999. Mr. Eibler
graduated from Loyola University in 1978.

JOSHUA I. SMITH, AGE 61
Mr. Smith is an internationally distinguished entrepreneur and lecturer. Since
1998, Mr. Smith has been Chairman and Managing Partner of The Coaching Group. In
that capacity he is the "coach," senior advisor/consultant, to the CEO's of the
portfolio companies and assumes active roles with these companies which includes
serving as Chairman or Vice Chairman of the Board, Board member, or Advisory
Board member. Previously he was Founder, Chairman and CEO of the MAXIMA
Corporation, a 20 year-old firm that achieved a national reputation as one of
the top African American owned firms in the United States. In addition, Mr.
Smith presently serves on the Boards of Directors for Caterpillar, Inc.
(CAT-NYSE), FedEx Corp (FDX-NYSE) and Allstate Corporation (ALL-NYSE).

GLENN WONG, AGE 45
Mr. Wong has been the principal of Catalyst Solutions Ltd., a consulting
company, since February 2001. Mr. Wong provided strategic consulting services to
Mike's Hard Lemonade(TM), the number one hard lemonade in the US and Canada.
Previously, Mr. Wong served as President & General Manager for Electronic Arts
(Canada), Inc., the world's largest video game studio, from January 1998 to
January 2001. In this capacity, he oversaw development of the full line of
interactive computer and video game entertainment software for Electronic Arts
studios in Burnaby, BC and Bellevue, WA. Prior to joining Electronic Arts, he
was President of Rogers Cable TV for British Columbia from November 1995 to
January 1998, where he concentrated his efforts on the quickly changing
environment of the cable and telecommunications industry. From 1993 to 1995, Mr.
Wong served as President and Chief Executive Officer of B.C. Hothouse, Ltd., a
Canadian produce company. Mr. Wong also served as Vice President of Marketing at
Nabob Foods from January 1984 to January 1993, where he oversaw several
successful campaigns and received his first AMA "Marketer of the Year" Award and
"Top Marketer" from Strategy Magazine. He began his professional career in 1980
as a Brand Manager at Procter and Gamble Inc. Mr. Wong has served on a number of
boards including the Insurance Corporation of B.C., Canadian Cable Labs, Mohawk
Oil Ltd., and the Dragon Boat Festival Society. Mr. Wong graduated from the
University of British Columbia in 1980 with a Bachelor of Commerce and Business
Administration.

DAVID H. STARR, AGE 51
Mr. Starr is currently the Managing Director of NRW Holdings, a voice over
implementations company. Prior to NRW, Mr. Starr served as Chief Information
Officer for 3COM Corporation for two years, where he was responsible for over
800 information technology professionals in 43 countries and was involved in
managing the Palm and U.S. Robotics spin-offs. From May 1993 to August 1999, he
served as Chief Information Officer at Knight Ridder, Reader's Digest
Association and the ITT Corporation, and also has held senior officer titles at
Mastercard International, Citicorp and Price Waterhouse. His published works
have appeared in CIO Magazine and he has been a guest lecturer at various
universities and professional networks, including MIT. Mr. Starr has and/or
currently sits on the Boards of Directors of Best Buy Corporation, BoysHope
GirlsHope, ePurpose, GenerationPix, AdvisorTeam and NRW Corporation. Mr. Starr
holds an MBA from Harvard University and received his Bachelor of Arts in
Physics in 1972 from Florida State University.

MARVIN IGELMAN, AGE 40
From 1995 through March 2002, Mr. Igelman was President and CEO of BrandEra
Inc., a publicly traded company that owned and operated a business-to-business
destination for the marketing communications industry. Since April 2002, Mr.
Igelman has been a director of National Construction Inc., a multi-trade
industrial construction and maintenance contracting services company primarily
servicing Eastern Canada and Alberta. In 1983, Mr. Igelman received his law
degree from Osgoode Hall Law School located in Toronto.

ELI LEVITIN, AGE 38
Eli Levitin is Managing Director and General Counsel of Acta Realty Corp. and
affiliated companies, which hold a substantial portfolio consisting of real
estate, various investment funds, including private equity and hedge funds, and
a variety of other investments. In addition to his management responsibilities,
Mr. Levitin is actively involved in developing Acta's financial structure
associated with its investment portfolio and entities. Prior to joining Acta in
December 1993, Mr. Levitin practiced law at the law firms of White & Case and
Stroock, Stroock & Lavan, where his primary areas of practice were corporate
reorganization and structured finance. Mr. Levitin was a contributing editor of
Collier Bankruptcy Practice Guide. Mr. Levitin graduated with a bachelor of
science from Brooklyn College in 1985 and received a JD from Columbia Law School
in 1988.

HUMBERT B. POWELL, III, AGE 63
For Humbert B. Powell, III's information, see "Executive Officers and Other
Significant Employees" above.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Securities Exchange Act of 1934 requires our directors and
executive officers, and persons who own more than 10% of our common stock, to
file with the Securities and Exchange Commission (the "Commission") initial
reports of ownership and reports of changes in ownership of our common stock.
Such persons are required by the Commission's regulations to furnish us with
copies of all Section 16(a) forms they file. Based solely upon a review of
copies of such forms received by us, or written representation from certain
reporting persons, we believe, during the fiscal year ended December 31, 2003,
that there was compliance with all Section 16(a) filing requirements applicable
to our officers, directors and 10% shareholders.

CODE OF ETHICS

The Company does not have currently a Code of Ethics because during the year
2003 the Company had only one employee.

On December 23, 2002 Rubin Levine, President and Chief Operating officer
resigned.

ITEM 10. EXECUTIVE COMPENSATION.

During our fiscal year ended December 31, 2002, we had three chief executive
officers. Frank Drechsler served as our chief executive officer until our
business combination with ER LLC on June 20, 2002. Mr. Drechsler did not earn or
receive any compensation for services he rendered to us. Following the business
combination, Humbert Powell, III had acted as our chief executive officer until
July 1, 2002. Mr. Powell did not earn or receive any compensation for services
he rendered to us in such capacity. Steven T. Francesco served as our chief
executive officer from July 1, 2002 until February 5, 2003. Since the
resignation of Mr. Francesco on February 5, 2003, John Gentile, as Interim
President, has been serving as our principal executive officer.

On January 9, 2003, Stanley Friedman, Vice President of Manufacturing
was terminated. The Company will pay severance to Mr. Friedman in the amount of
$37,500. The payment was contingent upon the Company obtaining $1,000,000 in
financing excluding bridge loans by June 30, 2003. The Company executed a
confession of judgment to be filed if the severance payment is not made by June
30, 2003. No payment has been made to date. In addition, Mr. Friedman had until
January 9, 2004 to exercise stock options with an exercise price of $.75 per
share for 85,666 shares of the Company's common stock, which have already
vested. The options were forfeited in January, but have been accounted for as
forfeited at December 31, 2003. The Company paid the first months Cobra for
January 2003.

On January 10, 2003, Aaron Gavios, Vice President of Sales was terminated. The
Company agreed to pay severance to Mr. Gavios in the amount of $50,000. The
payment is to be paid in equal installments contingent upon the Company
obtaining $3,000,000 in financing excluding bridge loans. In the event that
the company fails to make any payments after receiving financing, then the
unpaid severance shall become immediately due and payable. In addition, Mr.
Gavios had until January 10, 2004 to exercise stock options for 43,000 shares of
the Company's common stock with an exercise of $1.04 per share, which have
already vested. The options were forfeited in January, but have been accounted
for as forfeited at December 31, 2003. The agreement was not signed and is in
litigation.

On February 6, 2003 Steven T. Francesco Chief Executive Officer, was terminated.
The Company will pay severance to Mr. Francesco in the amount of $41,010. The
payment is contingent upon the Company obtaining financing in the amount of two
million dollars excluding bridge loans. The Company paid for the insurance
coverage for two months and issued a five-year warrant to purchase 250,000
shares of the Company's common stock at an exercise price of $.75 with Mr.
Francesco. It is the intent of the Company to enter into a written agreement
with Mr. Francesco in the near future.

On February 24, 2003, Richard Rubin, Vice President of Product Development was
terminated. The Company will pay severance to Mr. Rubin in the amount of
$47,500. The payment is contingent upon the Company obtaining financing on the
amount of two million dollars not including bridge loans. In addition, Mr. Rubin
has until February 24, 2005 to exercise stock options with an exercise price of
$.80 per share for 33,000 shares of the Company's common stock which have
already vested. If he fails to exercise, the options will be forfeited.

On April 7, 2003, Martin Currie, Vice President of Marketing was terminated. As
noted in the employment agreement, Mr. Currie is eligible to receive $25,000 as
severance. In addition, Mr. Currie had until April 7, 2004 to exercise stock
options with an exercise price of $0.90 per share for 20,000 shares of the
Company's common stock, which have already vested. The options have been
forfeited in 2004. No agreement has been signed to date.

On July 31, 2003, the Company settled with a former consultant for $20,000
payable as follows: $5,000 payable no later than August 30, 2003, $5,000 payable
no later than December 12, 2003 and the final payment of $10,000 payable no
later than January 30, 2004. The full amount has been paid.

In November 2003, pursuant to a letter of intent amended February 6, 2004, the
Company issued a 6% Unsecured Convertible Debenture for $500,000, and the
Company raised $310,715 as of December 31, 2003. The debenture, which matures
February 13, 2004, contains a beneficial conversion feature at a conversion
price of $0.02. The conversion right may only be exercised upon the earlier of
an offering of debt or equity capital of at least $3,000,000 or 180 days from
the Closing as defined in the Note Purchase Agreement.

SUMMARY COMPENSATION TABLE

LONG-TERM
ANNUAL COMPENSATION COMPENSATION
------------------------------------- ------------------------
OTHER ANNUAL SECURITIES
NAME AND SALARY BONUS COMPENSATION UNDERLYING OPTIONS
PRINCIPAL POSITION YEAR ($) ($) ($) (1) (SHARES)
------------------- ------ ----------- --------- ------------------------ --------------------

John Gentile 2003 None None None None
Principal Executive Officer

(1) The aggregate amount of perquisites and other personal benefits paid to
each of the individuals listed on this table did not exceed the lesser of ten
percent (10%) of such officer's annual salary and bonus for each fiscal year
indicated or $50,000.

During the fiscal year ended December 31, 2003, we did not grant any
options to our named executive officers nor do any of them own any options to
purchase shares of our common stock, except for Humbert B. Powell, III who was
granted 10,000 options as a member of our Board of Directors and Advisory Board.

With respect to our current officers, the status of their employment
agreements are as follows:

DAVID DEVOR, VICE PRESIDENT, MARKETING AND SALES. On September 5, 2002, Mr.
Devor signed an employment agreement which provides for a base salary of
$150,000 per year. He was also granted the following options to purchase shares
of our common stock: (i) 200,000 shares at an exercise price of $.65 per share,
which vested immediately; (ii) 100,000 shares at an exercise price of $0.65 per
share, 25,000 of which vest on February 29,2003 and 75,000 in five equal monthly
installments commencing March 29, 2003; (iii) 200,000 shares at an exercise
price of $1.00 per share which vest when either of the following conditions
occur: (a) our market capitalization, based on the public float, equals or
exceeds $150 million for a period of sixty consecutive business days and the
average daily volume of our common stock traded during those sixty days is no
less than 125,000 or (b) we sell all or substantially all of our assets for a
minimum of $125 million.

Neither John Gentile, Interim President and Chief Operating Officer, nor George
Mellides, our acting Chief Financial Officer, have employment agreements with
the Company.

DIRECTOR COMPENSATION
As compensation for their services as members of the Board, each member
receives annual compensation of $10,000, plus options to purchase 10,000 shares
of our common stock at an exercise price equal to the closing price of our
common stock on the date of the grant. The options vest over a one-year period
in equal quarterly amounts, so long as the director completes service for such
quarter. Non-employee directors are reimbursed for reasonable expenses in
connection with serving as a director and member of a committee.

ADVISORY BOARD COMPENSATION
As compensation for serving on the advisory board, the members have
received options to purchase an aggregate of 270,000 shares of our common stock
at exercise prices ranging from $0.75 to $1.60. All of these options were
granted in June 2002 and vest equally on the first, second and third
anniversaries of the date of grant, so long as the advisory board member
completes service for such period. The issuance of the options resulted in
deferred stock-based compensation expense of $610,448 of which 313,705 was
expensed for the year ended December 31, 2003 using the Black-Scholes pricing
model.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED

STOCKHOLDER MATTERS.

The following table sets forth information concerning ownership of our common
stock as of March 31, 2004, by (i) each person known by us to be the beneficial
owner of more than five percent of the outstanding shares of our common stock,
(ii) each director, and (iii) all of our directors and executive officers as a
group.

NUMBER OF SHARES PERCENTAGE OF OUTSTANDING
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIALLY OWNED SHARES BENEFICIALLY OWNED (1)
------------------------------------ ------------------ -----------------------------

LCG Capital Group, LLC 9,600,000 (2) 51.6%
Hamilton Resources Group, LLC
Winchester Capital Group, LLC
Michael Alpert
c/o 335 Central Avenue, 2nd Floor
Lawrence, NY 11559

Martin Abrams 2,400,480 12.9%
c/o Abrams Gentile Entertainment, Inc.
244 West 54th Street, 9th Floor
New York, NY 10017

Michael B. Schwab 2,041,933 (3) 11.0%
c/o 1219 Lombard Street
San Francisco, CA 94109

Big Sky Partners 2,004,312 (4) 10.8%
c/o 1219 Lombard Street
San Francisco, CA 94109

Anthony Gentile 1,129,260 (5) 6.1%
c/o Abrams Gentile Entertainment, Inc.
244 West 54th Street, 9th Floor
New York, NY 10017

John Gentile 1,129,260 (5) 6.1%
c/o Abrams Gentile Entertainment, Inc.
244 West 54th Street, 9th Floor
New York, NY 10017

Jayvee & Co., for AGF Canadian Growth Equity 1,113,800 6.0%
c/o Jayvee & Co.
P.O. Box 9
Commerce Court West
Securities Level
Toronto, Ontario M5H 4A6

Humbert B. Powell, III 52,500 (5)(6) *

Marc A. Fries 17,500 (5) *

Brian D. Jedwab 17,500 (5) *

All executive officers and directors as a group 2,346,020 12.6%
(5 persons)

--------------
o Less than 1%

(1) Unless otherwise indicated, we believe that all persons named in the above
table have sole voting and investment power with respect to all shares of
voting stock beneficially owned by them. A person is deemed to be the
beneficial owner of securities that can be acquired by such person within
60 days from the date hereof upon the exercise of options, warrants or
convertible securities. Each beneficial owner's percentage ownership is
determined by assuming that options, warrants and convertible securities
held by such person (but not those held by any other person) and which are
exercisable or convertible within 60 days have been exercised and
converted. Assumes a base of 18,558,110 shares of common stock
outstanding.

(2) Includes 4,800,000 shares of common stock held by LCG Capital Group, LLC
(LCG) and an additional 4,800,000 shares of common stock held collectively
by Martin Abrams, John Gentile, Anthony Gentile and MSH Entertainment
Corporation, who have agreed to vote their shares in the same manner as
LCG votes its shares with respect to certain matters (including but not
limited to the election of directors). LCG may be deemed to beneficially
own such shares whose vote it controls but it disclaims beneficial
ownership of such shares except to the extent of its pecuniary interest.
Hamilton Resources Group, LLC currently owns a majority of the equity in
LCG and may be deemed to beneficially own the shares held by LCG.
Winchester Capital Group, LLC, as the managing member of LCG, may be
deemed to beneficially own the shares held by LCG. Michael Alpert, as the
managing member of Winchester Capital Group, may be deemed to beneficially
own the shares held by LCG. Hamilton Resources Group, Winchester Capital
Group and Michael Alpert each disclaims beneficial ownership of the shares
beneficially owned by LCG, except to the extent of its pecuniary interest
therein.

(3) Includes 37,621 shares of common stock held by Mr. Schwab, 1,897,234
shares of common stock held directly by Big Sky Partners, and 107,078
shares of common stock held indirectly by Big Sky Partners through its
ownership in LCG Capital Group. Mr. Schwab, as managing partner of Big Sky
Partners, may be deemed to beneficially own the shares held by Big Sky
Partners, but he disclaims beneficial ownership of such shares, except to
the extent of his pecuniary interest therein.

(4) Includes 1,897,234 shares of common stock held directly by Big Sky
Partners and 107,078 shares of common stock held indirectly by Big Sky
Partners through its ownership in LCG Capital Group. Big Sky Partners
disclaims beneficial ownership of the shares held by LCG Capital Group,
except to the extent of its pecuniary interest therein.

(5) Includes 17,500 shares of common stock issuable upon currently exercisable
directors options.

(6) Includes 35,000 shares of common stock suuable upon quarterly exerceiable
firectors optionsm

SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS

The following table sets forth certain information regarding our
equitycompensation plans at December 31, 2003:

NUMBER OF
SECURITIES
REMAINING AVAILABLE
NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE FOR FUTURE ISSUANCE
ISSUED UPON EXERCISE OF EXERCISE PRICE OF UNDER EQUITY
PLAN CATEGORY OUTSTANDING OPTIONS OUTSTANDING OPTIONS COMPENSATION PLANS
------------------ --------------------------- -------------------- -----------------------

Equity compensation plans approved
by security holders 981,000 $1.08 981,000
Equity compensation plans not
approved by security holders
N/A N/A N/A
--------- -------- -----------
Total 981,000 $1.08 981,000
========= ===== =======

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

ESSENTIAL REALITY, LLC

On June 20, 2002, we consummated a business combination with ER LLC.
Pursuant to the terms of the transaction, all of the members of ER LLC
contributed their membership interests to us in exchange for an aggregate of
16,874,784 shares of our common stock. LCG Capital Group, LLC, Martin Abrams,
John Gentile and Anthony Gentile, all of whom were members of ER LLC at the
consummation of the transaction, are now significant shareholders of ours. See
"Security Ownership of Certain Beneficial Owners and Management". Following the
transaction, ER LLC, then our wholly-owned subsidiary, was merged with and into
us. We owe an aggregate of $218,737 in accrued salaries to certain affiliates of
ER LLC for services rendered to ER LLC. We currently owe $39,600 to Abrams
Gentile Entertainment Corporation, $60,000 to Anthony Gentile for unpaid salary
as a Senior Vice President of ER LLC, $60,000 to John Gentile in connection with
services rendered as Executive Vice President of ER LLC, and $59,137 to Michael
Alpert in connection with services rendered as President and Chief Executive
Officer of ER LLC.

LCG CAPITAL GROUP, LLC

LCG Capital Group, LLC (LCG) is a founding member of ER LLC and, after
our business combination, beneficially owns approximately 53.5% of our
outstanding common stock. ER LLC received interest-free loans from LCG in the
aggregate amount of $70,912, which are payable on demand.

BUSINESSDEVELOPMENT.COM, LLC

BusinessDevelopment.com, LLC (BDC) is an entity controlled by Michael
Alpert, an affiliate of LCG. LCG does not directly own any interest in BDC,
although certain people are affiliated with both LCG and BDC. BDC entered into
an agreement with ER LLC on December 13, 2000, pursuant to which BDC provides
general consulting services to ER LLC, and now to us, in return for a monthly
cash retainer. Such services consist of forming revenue-generating
opportunities, including without limitation distribution agreements, licensing
agreements, joint ventures, strategic alliances and partnerships. The amount of
the retainer originally was $6,000 per month, increased to $15,000 per month
from July 1, 2002 to September 30, 2002 and from January 1, 2003 to June 30
,2003 to $7,500 per month. After June 2003 BDC ceased to provide services to us.
To date, together with ER LLC, we have incurred $238,000 of consulting fees from
BDC under the terms of such agreement. Included in general and administrative
expenses is $45,000 and $117,000 at December 31, 2003 and 2002 respectively.

In addition to the monthly retainer, we also are obligated to pay to
BDC a potential revenue share of up to four percent (4.0%) on transactions
facilitated by BDC. Either BDC or we may cancel this agreement with thirty (30)
days prior notice. BDC is not registered as a broker-dealer. BDC does not
participate in document preparation or marketing, nor do they perform due
diligence. In determining suitability for potential business opportunities, BDC
necessarily analyzes the parties involved, but no analyses of sophistication or
other broker-dealer type functions are performed by BDC on our behalf.

Until November 30, 2001, ER LLC shared office space with BDC. This is
no longer the case. There was an allocation of general expenses in connection
with such office space, whereby BDC paid 70% and ER LLC paid 30% of such
expenses. Certain items, such as office supplies and computer leases, were
assumed by ER LLC and taken to its new offices.

The Company owes BDC a total $100,662 at December 31, 2003 which is included in
due to related parties.

OTHER RELATIONSHIPS AND RELATED TRANSACTIONS

Abrams Gentile Entertainment Corporation (AGE), a company owned by
certain founding members of ER LLC, including Anthony and John Gentile, who are
directors of ours, and Martin Abrams, a shareholder of ours who owns 13.4% of
our outstanding common stock, has provided services to ER LLC and the Company as
a general consultant and advisor with respect to developing business
relationships. Anthony Gentile owns 24.995% of AGE, John Gentile owns 24.995%
and Martin Abrams owns 50.01%. We have incurred fees (including, but not limited
to, accrued compensation and accounts payable) to AGE and may incur additional
expenses as services are performed. Services performed to date include
assistance with the product logo design, advertising, planning, production and
other business development activities. Included in product and development
expense is $25,000 and $33,700 for the years ended December 31, 2003 and 2002.
Included in due to related parties is $19,030 at December 31, 2003

We are allocated the costs of various computer and related equipment
leases assumed by Hymax Group, LLC, an affiliate of LCG. LCG does not own any
interest in Hymax Group, LLC, but Hymax Group, LLC is affiliated with BDC and
Michael Alpert. Such payments are due through August 2003. Hymax also made
certain of its employees available to provide operational support services to ER
LLC, and now us, and reimbursed for a portion of such employees' compensation,
based on the percentage of time worked for us. Such reimbursement amount
aggregated approximately $4,500 per month from January 1, 2002 to June 30, 2002
and were then reduced to $2,500 per month from July 1, 2002 to December 31,
2002. Effective January 2003 such services have ceased. At December 31, 2003,
the outstanding balance due is $4,039.

Advances from affiliated companies are from entities that are
affiliated with certain shareholders of the Company. The advances are payable on
demand and bear interest at the rate of 10% per annum. Certain of these advances
were satisfied in September 2002, by granting the Company's interest in "other
assets" of $22,500 to these entities. At December 31, 2003, $1,712 remains
outstanding.

Included in general and administrative expenses is $80,000 and $7,500
at December 31, 2003 and 2002, respectively, of directors fees and $1,107 at
December 31, 2003 for expenses incurred on behalf of the Company by a director.
Included in due to related parties is $88,607 at December 31, 2003.

We currently do not have a policy with respect to future related party
transactions. Accordingly, we have frozen all future related party transactions
until such a policy is in place, but continue to make payments pursuant to the
related party transactions set forth herein.

ITEM 13. EXHIBITS, LIST AND REPORTS ON FORM 8-K.

(a) Exhibits

See the Exhibit Index immediately following the Financial Statements.

(b) Reports on Form 8-K:

None.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

In connection with the calendar years ended December 31, 2003 and 2002
respectively, Stonefield Josephson provided various audit to the Company and
billed the Company for these services as follows:

(a) Audit Fees. Fees for audit services relating to the annual audit and
reviews of the Company's quarterly reports on Form 10-QSB totaled
$122,800 for 2003 and 2002, respectively. No other accountant fees were
incurred during the calendar years ended December 31, 2002 and 2003.

The Audit Committee pre-approves all audit and permissible non-audit
services provided by the independent auditors on a case-by-case basis. The Audit
Committee has approved 100% of the services described under Audit Fees. The
Audit Committee has considered whether the provision of the Audit Fees were
compatible with maintaining the Independence of Stonefield Josephson and
determined that such services did not adversely affect the independence of
Stonefield Josephson.

[SIGNATURE PAGE FOLLOWS]

SIGNATURES

In accordance with Section 13 or 15(d) of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.

ESSENTIAL REALITY, INC. Date: June 29, 2004

By: /s/ Humbert B. Powell, III
-----------------------------------
Name: Humbert B. Powell, III
Title: Chairman of the Board

POWER OF ATTORNEY

Essential Reality, Inc. and each of the undersigned do hereby appoint
Humbert B. Powell, III and John Gentile, and each of them singly, its or his
true and lawful attorney to execute on behalf of Essential Reality, Inc. and the
undersigned any and all amendments to the Annual Report on Form 10-KSB and to
file the same with all exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission.

In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities and on the dates indicated.

/s/ John Gentile Date: June 29, 2004
-----------------------------------------------------
John Gentile, Interim President, Chief Operating OFFICER AND DIRECTOR (principal
executive officer)

/s/ George Mellides Date : June 29, 2004
-----------------------------------------------------
George Mellides, Acting Chief Financial Officer
(principal financial and accounting officer)

/s/ Humbert B. Powell, III Date: June 29, 2004
-----------------------------------------------------
Humbert B. Powell, III, CHAIRMAN OF THE BOARD

/s/ Marc A. Fries Date: June 29, 2004
-----------------------------------------------------
Marc A. Fries, DIRECTOR

/s/ Brian D. Jedwab Date: June 29, 2004
-----------------------------------------------------
Brian D. Jedwab, DIRECTOR

/s/ Anthony Gentile Date: June 29, 2004
-----------------------------------------------------
Anthony Gentile, DIRECTOR

INDEX TO FINANCIAL STATEMENTS

PAGE
-------

Reports of Independent Certified Public Accountants F-2

Balance Sheet as of December 31, 2003 F-3

Statements of Operations for the Years Ended December 31, 2003 and 2002 F-4

Statements of Stockholders' Equity (Deficit) for the Years Ended
December 31, 2003 and 2002 F-5

Statements of Cash Flows for the Years Ended December 31, 2003 and 2002 F-7

Notes to Financial Statements F-9

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors
Essential Reality, Inc.
New York, New York

We have audited the accompanying balance sheet of Essential Reality, Inc. (the
"Company") as of December 31, 2003, and the related statements of operations,
stockholders' deficit, and cash flows for the years ended December 31, 2003
and 2002. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on the financial
statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Essential Reality, Inc. as of
December 31, 2003, and the results of its operations and its cash flows for the
two years ended December 31, 2003 and 2002, in conformity with accounting
principles generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. At December 31, 2003 the Company`s
current liabilities exceeded its current assets $5,414,731. As discussed in Note
1 to the accompanying financial statements, the Company's significant operating
losses raise substantial doubt about its ability to continue as a going concern.
Management's plans concerning these matters are also described in Note 1. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.

/s/Stonefield Josephson, Inc.
-----------------------------
Certified Public Accountants
Irvine, California
JUne 15, 2004

F-2

ESSENTIAL REALITY, INC. (FORMERLY JPAL, INC.)

BALANCE SHEET - DECEMBER 31, 2003

ASSETS

CURRENT ASSETS:

Assets of discontinued operations $ 117,594
Other current assets 274,755
------------
Total current assets $ 392,349
============

LIABILITIES AND STOCKHOLDERS' DEFICIT

CURRENT LIABILITIES:
Book overdraft $ 1,457
Accounts payable and accrued expenses 2,191,924
Due to related parties 503,699
Unsecured loan payable 25,000
Secured convertible debenture 1,000,000
Unsecured convertible debentures (net of deferred interest of $156,285) 2,085,000
------------
Total current liabilities 5,807,080
------------

COMMITMENTS AND CONTINGENTIES -

STOCKHOLDERS' DEFICIT:
Common stock, $0.001 par value; 50,000,000 shares authorized;
18,588,110 issued and outstanding 18,588
Additional paid-in capital 15,003,142
Deferred exchange costs ( 71,349)
Accumulated deficit (20,365,112)
------------
Total stockholders' deficit (5,414,731)
------------
$ 392,349
============

The accompanying notes are an integral part of these financial statements.

F-3

ESSENTIAL REALITY, INC (FORMERLY JPAL, INC.)

STATEMENTS OF OPERATIONS

Year ended December 31,
----------------------------
2003 2002
------------ ------------

REVENUE $ - $ -

COST OF REVENUE - -
------------ ------------
GROSS LOSS - -
------------ ------------
OPERATING EXPENSES:
Sales and marketing - -
Product development - -
General and administrative expenses 879,747 1,924,823
Depreciation and amortization - -
Impairment on inventory realization - -
Severance Compensation - -
Stock-based compensation 2,407,336 880,885
------------ ------------
TOTAL OPERATING EXPENSES 3,287,083 2,805,708
------------ ------------
LOSS FROM OPERATIONS (3,287,083) (2,805,708)
------------ ------------
OTHER INCOME (EXPENSE):
Interest income 1,213 17,025
Interest expense (1,491,671) (1,173,944)
Miscellaneous 21,418 1,926
------------ ------------
Total other income (expense) (1,469,040) (1,154,993)
------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES (4,756,123) (3,960,701)

PROVISION FOR INCOME TAXES - -
------------ ------------
NET LOSS FROM CONTINUING OPERATIONS (4,756,123) (3,960,701)

DISCONTINUED OPERATIONS:
Loss from operations, net of tax effect of $0 (1,983,267) (4,892,779)
------------ ------------
NET LOSS $ (6,739,390) $ (8,853,480)
============ ============

NET LOSS PER SHARE - BASIC AND DILUTED
Loss per share - continuing operations $ (0.25) $ (0.22)
Loss per share - discontinued operations (0.11) (0.27)
------------ ------------
$ (0.36) $ (0.49)
============ ============

NUMBER OF WEIGHTED AVERAGE SHARES - BASIC AND DILUTED 18,505,497 18,056,987
============ ============

The accompanying notes are an integral part of these financial statements.

F-4

ESSENTIAL REALITY, INC (FORMERLY JPAL, INC.)

STATEMENTS OF STOCKHOLDERS' DEFICIT

FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002

Additional
Members Common Stock Paid-In
Capital Shares Amount Capital
----------------------------------------------------------------------

Balance January 1, 2002 $ 2,500,000 $ -- $ -- $ --

Exchange of members capital to common stock (2,500,000) 9,600,000 9,600 2,490,400

Proceeds received from private placement, net of
offering costs of $988,103 -- 7,011,626 7,012 6,083,076

Conversion of convertible note payable -- 263,158 263 499,737

Isssuance of shares for JPAL -- 1,080,934 1,081 (1,081)

Conversion of 8 1/2% notes payable -- 217,392 217 250,000

Shares issued for professional services -- 50,000 50 69,950

Benefical conversion features related to
convertible notes -- -- -- 593,747

Warrants issued related to convertible notes -- -- -- 290,701

Warrants issued to non-convertible note holders -- -- -- 497,490

Warrants issued for services -- -- -- 152,962

Options issued to directors and employees -- -- -- 2,123,305

Options issued to consultants -- -- -- 610,448

Excess of fair value of shares over the face value
of the notes payable -- -- -- 402,173

Accretion of deferred compensation expense -- -- -- --

Def. Consulting Total
Deferred And Deferred Accumulated Stockholders
Compensation Merger Expense Deficit Deficit
-------------------------------------------------------------------

Balance January 1, 2002 $ -- $ -- ($4,772,242) ($2,272,242)

Exchange of members capital to common stock -- -- -- --

Proceeds received from private placement, net of
offering costs of $988,103 -- -- -- 6,090,088

Conversion of convertible note payable -- -- -- 500,000

Isssuance of shares for JPAL -- -- -- --

Conversion of 8 1/2% notes payable -- -- -- 250,217

Shares issued for professional services -- -- -- 70,000

Benefical conversion features related to
convertible notes -- -- -- 593,747

Warrants issued related to convertible notes -- -- -- 290,701

Warrants issued to non-convertible note holders -- -- -- 497,490

Warrants issued for services -- -- -- 152,962

Options issued to directors and employees (2,123,305) -- -- --

Options issued to consultants (610,448) -- -- --

Excess of fair value of shares over the face value
of the notes payable -- -- -- 402,173

Accretion of deferred compensation expense 682,923 -- -- 682,923

The accompanying notes are an integral part of these financial statements.

F-5

ESSENTIAL REALITY, INC (FORMERLY JPAL, INC.)

STATEMENTS OF STOCKHOLDERS' DEFICIT

FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002

Additional
Members Common Stock Paid-In
Capital Shares Amount Capital
---------------------------------------------------------------------

Excess note payable assumed by Essential Reality -- -- -- (139,039)
Partners, LLC assets in reverse merger

Net Loss -- -- -- --
---------------------------------------------------------------------

Balance December 31, 2002 -- 18,223,110 18,223 13,923,869

Shares issued for investment banking fees 25,000 25 25,225 --

Shares issued for cash 100,000 100 99,900 --

Shares issued for consulting services 240,000 240 143,760 --

Warrants issued for consulting services -- -- -- 88,785

Beneficial conversion features related to
convertible notes -- -- -- 427,471

Warrants issued related to convertible notes -- -- -- 176,722

Warrants issued for severance payment -- -- -- 117,410

Accretion for deferred compensation -- -- -- --

Accretion for deferred consulting -- -- -- --

Merger expenses -- -- -- --

Net Loss -- -- -- --
---------------------------------------------------------------------

Balance December 31, 2003 $ -- 18,588,110 $ 18,588 $ 15,003,142
===================================================================

Def. Consulting Total
Deferred And Deferred Accumulated Stockholders
Compensation Merger Expense Deficit Deficit
-------------------------------------------------------------------------

Excess note payable assumed by Essential Reality -- -- -- (139,039)
Partners, LLC assets in reverse merger

Net Loss -- -- (8,853,480) (8,853,480)
-------------------------------------------------------------------------

Balance December 31, 2002 (2,050,830) -- (13,625,722) (1,734,460)

Shares issued for investment banking fees -- -- 25,250

Shares issued for cash -- -- 100,000

Shares issued for consulting services (144,000) -- --

Warrants issued for consulting services -- -- -- 88,785

Beneficial conversion features related to
convertible notes -- -- -- 427,471

Warrants issued related to convertible notes -- -- -- 176,722

Warrants issued for severance payment -- -- -- 117,410

Accretion for deferred compensation 2,050,830 -- -- 2,050,830

Accretion for deferred consulting -- 144,000 -- 144,000

Merger expenses -- (71,349) -- (71,349)

Net Loss -- -- (6,739,390) (6,739,390)
-------------------------------------------------------------------------

Balance December 31, 2003 $ -- $ (71,349) ($20,365,112) $ (5,414,731)
=========================================================================

The accompanying notes are an integral part of these financial statements.

F-6

ESSENTIAL REALITY, INC. (FORMERLY JPAL, INC.)

Year ended December 31,
--------------------------
2003 2002
----------- -----------

Cash flows used for operating activities:
Net loss $(6,739,390) $(8,853,480)

Adjustments to reconcile net loss to net cash
used for operating activities:
Depreciation and amortization 233,332 68,861
Contract termination 110,667 -
Reserve for collectability of notes receivable - 102,121
Amortization of deferred interest 195,594 208,302
Non-cash compensation 2,407,336 880,885
Imputed interest on conversion of debt instrument 1,058,908 789,670
Change in inventory reserve 78,395 1,363,361
Impairment of fixed assets and intangible assets in
Relation to discontinued operations 419,235 -
Changes in assets and liabilities:
(Increase) decrease in assets:
Accounts receivable 38,679 (38,679)
Inventories 108,539 (1,667,890)
Deferred financing cost -- 217,755
Notes receivable (502,121)
Other current assets (156,761) (61,157)
Other assets 58,050 -
Increase (decrease) in liabilities:
Accounts payable and accrued expenses 569,670 950,698
Accrued compensation - (28,611)
Due to related parties - (28,674)
----------- ------------

Net cash used for operating activities (1,617,746) (6,598,959)
----------- ------------

Cash flows used for investing activities:
Payments for capitalized product development - (260,000)
Payments for tools, dies, and molds - (337,331)
Payments for capitalized website - (22,300)
Payments for purchases of equipment (13,642) (73,864)
----------- -----------
Net cash used for investing activities (13,642) (693,495)
----------- -----------

Cash flows provided by financing activities:
Book overdraft 1,457 -
Proceeds for insurance notes payable 81,477
Proceeds from sale of securities 100,000 -
Net proceeds from issuance of members capital -- 6,083,706
Proceeds from loan payable - unsecured 25,000 -
Proceeds from Secured Convertible Debenture 500,000 500,000
Proceeds from notes payable 524,215 1,825,000
Proceeds from repayment of notes receivable from
developer - 82,971

F-7

ESSENTIAL REALITY, INC. (FORMERLY JPAL, INC.)

STATEMENTS OF CASH FLOWS (CONTINUED)(UNAUDITED)

Year ended December 31,
-----------------------
2003 2002
----------- -----------

Due to related parties 73,337 -
Repayment of bridge loans - (550,000)
Repayment of notes payable (81,479) (550,000)
Escrow Deposits 300,000
Net advances from LCG Capital, Inc. -- (5,705)
----------- -----------

Net cash provided by financing activities 1,442,530 7,467,449

Net increase (decrease) in cash (188,858) 174,995
Cash and cash equivalents, beginning of year 188,858 13,863
----------- -----------

Cash and cash equivalents, end of year $ -- $ 188,858
=========== ===========

Supplemental disclosure of cash flow information:

Interest paid $ 6,088 $ 22,500
=========== ===========

Income tax paid $ -- $ -
=========== ===========

Supplemental disclosure of non-cash investing and
financing activities:
Bridge loans converted to member units $ -- $ 500,000
=========== ===========
Elimination of bridge loans and accrued interest on merger $ -- $ 2,378,431
=========== ===========
Assumption of notes on merger $ -- $ 2,517,070
=========== ===========
Issuance of common stock for consulting fees $ 144,000 $ 45,000
=========== ===========
Reduction of accounts payable with note receivable $ 366,642 $ --
=========== ===========
Discount recorded related to warrants and beneficial
conversion feature of convertible debentures $ 604,192 $ 975,471
=========== ===========

F-8

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 2003 AND 2002

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

BUSINESS ACTIVITY:
Essential Reality, LLC ("ER LLC" or the "Company") was formed as
Freedom Multimedia, LLC in the State of Delaware on July 9, 1998 and
began active operations on June 1, 1999. The Company changed its name
to Essential Reality, LLC ("ER LLC") on December 29, 1999. On June 20,
2002, ER LLC completed a business combination (recapitalization) with
JPAL, Inc. ("JPAL"), a Nevada Corporation (the "Transaction"), whereby,
all of the members of ER LLC contributed their membership interests in
ER LLC to the Company in exchange for 16,874,784 shares of the
Company's common stock. The shareholders of JPAL canceled 7,564,326 of
their shares of JPAL common stock and were left with 1,080,934 shares
of common stock representing 6.02% of the Company. Upon the business
combination, ER LLC was dissolved and all of its assets and liabilities
were transferred into JPAL. Following the Transaction, JPAL changed its
name to Essential Reality, Inc.

The Company was formed to develop, manufacture, and market computer
peripheral devices, with an initial emphasis on a product called
"P5(TM)." However, due to less than expected sales of the P5(TM), the
Company has decided to discontinue its operations and focus on merging
with an operating entity.

GOING CONCERN:

The accompanying financial statements have been prepared in conformity
with accounting principles generally accepted in the United States of
America that contemplate continuation of the Company as a going
concern. However, the Company has reported a net loss of $5,853,225 for
the year ended December 31, 2003, and has an accumulated deficit of
$19,478,947, and at year end the Company`s current liabilities exceeded
its current assets by $5,484,351. Without realization of additional
capital, it would be unlikely for the Company to continue as a going
concern. This factor raises substantial doubt about the Company's
ability to continue as a going concern. The financial statements do not
include any adjustments that might result from the outcome of the
uncertainty.

Management plans to take the following steps that it believes will be
sufficient to provide the Company with the ability to continue in
existence.

The Company has limited capital resources and has incurred, significant
recurring losses and negative cash flows from operations, and the
Company does not believe its cash on hand along with existing sources
of cash are sufficient to fund its cash needs over the next twelve
months under the current capital structure to continue as a going
concern. In order to address this situation, the Company executed a
binding term sheet which sets forth the preliminary terms and
conditions of a proposed exchange transaction between the Company and
AllianceCorner Distributors Inc., which is contingent on a number of
factors (see Note 19). There can be no assurance that the Company will
be successful in completing the transaction. These circumstances raise
substantial doubt about the Company's ability to continue as a going
concern.

REVENUE RECOGNITION:

The Company recognizes under Staff Accounting Bulletin 104, gross
revenue when the earnings process is complete, as evidenced by an
agreement with the customer, transfer of title and the rights and risks
of ownership have passed to the customer, the product is delivered, the
price is fixed and determinable, and collection of the resulting
receivable is reasonably assured. Because the Company allows many of
its distributors price protection and/or right of return, recognition
of revenue in the accompanying financial statements has been deferred
until the distributors sell the merchandise and the cash is collected
by the Company. Inventory at distributors is reported as consigned in
the balance sheet.

F-9

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2003 AND 2002

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:

REVENUE RECOGNITION, Continued:

The Company records an allowance for uncollectible accounts on a
customer-by-customer basis as appropriate.

The Company may bundle product offerings from third-party vendors along
with the P5(TM) product or may sell the P5(TM) independently. The
software is incidental to the product as a whole and according to
Financial Accounting Standards Board No 86, Accounting for the Costs of
Computer Software To Be Sold, Leased or Marketed, all revenue is
allocated to the P5(TM). As such, the Company recorded the gross amount
of the purchase price of the P5(TM) product as revenue and has
reflected the royalty to be paid to the third-party vendor as a
component of cost of sales.

USE OF ESTIMATES:

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingent liabilities
at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could
differ from those estimates.

CASH AND CASH EQUIVALENTS:

For purposes of the statement of cash flows, cash equivalents include
all highly liquid debt instruments with original maturities of three
months or less that are not securing any corporate obligations. The
Company had no cash equivalents at December 31, 2003.

The Company maintains its cash in bank deposits accounts that, at
times, may exceed federally insured limits. At December 31, 2003, the
Company did not have any cash in excess of FDIC insured limits. The
Company has not experienced any losses in such accounts.

ACCOUNTS RECEIVABLE:

The Company provides an allowance for doubtful accounts equal to the
estimated uncollectible amounts. The Company's estimate is based on a
review of the current status of trade accounts receivable. It is
reasonably possible that the Company's estimate of the allowance for
doubtful accounts will change. The Company has not experienced any
losses in accounts receivable and has provided no allowance at December
31, 2003.

INVENTORIES:

Inventories are valued at the lower of cost or market, with cost being
determined on the first-in first-out basis. The inventory represents
high-technology parts that may be subject to rapid technology
obsolescence or limited sales cycle and which are sold in a highly
competitive industry. If the actual product demand or selling prices
are less than cost, the Company establishes an allowance account based
on net realizable value. During the years ended December 31, 2003 and
2002, the Company wrote down its inventory to market. The inventory
valuation adjustment totaled $78,395 and $1,883,207 at December 31,
2003 and 2002, respectively.

F-10

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2003 AND 2002

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:

INVENTORIES, Continued:

Inventory sold with the right of price protection and/or right of
return is reported as inventory on consignment. There was no consigned
inventory at December 31, 2003.

PRODUCT WARRANTY:

Due to effective product testing and the short time between the product
shipment and the detection and correction of production failures, the
warranty accrual and the related expense were not significant for the
year ended December 31, 2003.

EQUIPMENT AND IMPROVEMENTS:

Equipment and improvements are valued at cost. Depreciation and
amortization are provided using the straight-line method. Leasehold
improvements are amortized on a straight-line basis over the shorter of
the lease term or the length of the lease, which is five years.

The estimated service lives of equipment and improvements are as
follows:

Office equipment 5 years
Testing equipment 3 years
Furniture and fixtures 5 years
Computers 3 years
Leasehold improvements 5 years

WEBSITE DEVELOPMENT COSTS:

In March 2000 the Emerging Issues Task Force ("EITF") of the Financial
Accounting Standards Board ("FASB") reached a consensus on Issue No.
00-2 for Web Site Development Costs. Website development costs for the
years ended December 31, 2003 and 2002 were $-0- and $22,320,
respectively.

CAPITALIZED DEVELOPMENT COSTS:

Product development costs include costs incurred by the Company to
research and develop the P5(TM) product. Product development costs are
expensed until such time as the Company determines that a product is
technologically feasible. Product development costs are capitalized
from such date until such time as product development is substantially
complete. Product development costs capitalized will be amortized on
the straight-line basis over the estimated useful life of the product,
which is estimated to be three years. The Company attained
technological feasibility in 2002. No amounts were capitalized after
obtaining technological feasibility.

F-11

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2002 AND 2001

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:

LONG-LIVED ASSETS:

In October 2001, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets." This statement supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed of." Although retaining many of the fundamental
recognition and measurement provisions of SFAS 121, the new rules
significantly change the criteria that would have to be met to classify
an asset as held-for-sale. The statement also supersedes certain
provisions of Accounting Principles Board Opinion No. 30, "Reporting
the Results of Operations-Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," and will require expected future
operating losses from discontinued operations to be displayed in
discontinued operations in the period or periods in which the losses
are incurred rather than as of the measurement date, as presently
required. We concluded that the effect of adopting this statement had a
material impact on our financial position, results of operations, or
cash flows. In November 2003, when the Company decided to discontinue
its operations, all of the intangible assets and fixed assets that were
previously capitalized have been written off as part of the loss from
discontinued operations.

ADVERTISING:

The Company expenses advertising costs when incurred. Advertising
expense totaled $80,730 and $289,400 for the years ended December 31,
2003 and 2002, respectively.

RESEARCH AND DEVELOPMENT:

Research and development costs are expensed in the year incurred. These
costs totaled $527,000, net of loan receivable of $400,000 (see Note 3)
and $1,579,100 for the years ended December 31, 2003 and 2002,
respectively. The costs incurred during the year ended December 31,
2003 related to follow-up of the product and final testing of products
manufactured. These costs are included in discontinued operations on
the statement of operations.

INCOME TAXES:

Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets, including tax loss and
credit carryforwards, and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates
is recognized in income in the period that includes the enactment date.
Deferred income tax expense represents the change during the period in
the deferred tax assets and deferred tax liabilities. The components of
the deferred tax assets and liabilities are individually classified as
current and non-current based on their characteristics. Realization of
the deferred tax asset is dependent on generating sufficient taxable
income in future years. Deferred tax assets are reduced by a valuation
allowance when, in the opinion of management, it is more likely than
not that some portion or all of the deferred tax assets will not be
realized.

FAIR VALUE OF FINANCIAL INSTRUMENTS:

The carrying amount of the Company's cash and cash equivalents,
accounts receivable, inventories, accounts payable, and accrued
expenses (non of which are held for trading) approximates their
estimated fair values due to the short-term maturities of those
financial instruments. Also, the carrying amounts for secured and
unsecured convertible debentures approximate fair value, because the
terms offered to the Company are at current market rates.

F-12

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2003 AND 2002

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:

COMPREHENSIVE INCOME:

SFAS No. 130, "Reporting Comprehensive Income," establishes standards
for the reporting and display of comprehensive income and its
components in the financial statements. As of December 31, 2003 and
2002, the Company has no items that represent other comprehensive
income and, therefore, has not included a schedule of comprehensive
income in the financial statements.

STOCK BASED COMPENSATION

The Company has elected to follow Financial Accounting Standards Board
Statement No. 123 (Accounting for Stock-Based Compensation) and
accordingly the Company determined compensation costs based on the fair
value at the grant date for its stock options.

A schedule of activity with respect to the Company's stock option plans
is as follows:

Weighted
Number Average of
of Shares Exercise Price
---------- --------------

Outstanding at December 31, 2002 1,357,000 $ 1.08
Granted Directors and Employees 50,000 .35
Exercised -- --
Cancelled (297,334) .88
Forfeited (128,666) .85
---------- ----------
Outstanding a December 31, 2003 981,000 $ 1.13
========== ==========

Options exercisable at December 31, 2003 683,764 $ 1.09
========== ==========

The following tables summarize information about stock options
outstanding and exercisable at December 31, 2003:

Weighted Outstanding
Average Options Options Exercisable
Range of Number of Remaining Weighted Number of Weighted
Exercise Outstanding Contractual Life Average Shares Average
Prices Options in Year Exercise Price Exercisable Exercise Price
---------------------------------------------------------------------------------------------------------------

$0.65 to $1.00 825,600 7.78 $ 0.71 579,957 $ 0.70
$1.01 to $4.00 155,400 8.48 3.36 103,807 3.32
--------- --------- -------------- --------
981,000 7.89 $ 1.13 683,764 $ 1.09
========= ========= ============== ========= ============

BASIC AND DILUTED LOSS PER SHARE:

In accordance with SFAS No. 128, "Earnings Per Share," the basic loss
per common share is computed by dividing net loss available to common
stockholders by the weighted average number of common shares
outstanding. Diluted loss per common share is computed similarly to
basic loss per common share, except that the denominator is increased
to include the number of additional common shares that would have been
outstanding if the potential common shares had been issued and if the
additional common shares were dilutive. At December 31, 2003 and 2002,
the Company did not include the effects of common stock components
because their effect would have been anti-dilutive. As of December 31,
2003 and 2002, the Company had approximately 21,357,746 and 3,406,369,
respectively of anti-dilutive securities.

F-13

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2003 AND 2002

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:

SEGMENT REPORTING:

Based on the Company's integration and management strategies, the
Company operated in a single business segment. For the years ended
December 31, 2003 and 2002, all revenues have been derived from
domestic operations.

NEW ACCOUNTING PRONOUNCEMENTS:

In December 2003, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition." SAB
104 supersedes SAB 101, "Revenue Recognition in Financial Statements."
SAB 104's primary purpose is to rescind accounting guidance contained
in SAB 101 related to multiple element revenue arrangements, superseded
as a result of the issuance of EITF 00-21, "Accounting for Revenue
Arrangements with Multiple Deliverables." Additionally, SAB 104
rescinds the SEC's Revenue Recognition in Financial Statements
Frequently Asked Questions and Answers ("the FAQ") issued with SAB 101
that had been codified in SEC Topic 13, Revenue Recognition. Selected
portions of the FAQ have been incorporated into SAB 104. While the
wording of SAB 104 has changed to reflect the issuance of EITF 00-21,
the revenue recognition principles of SAB 101 remain largely unchanged
by the issuance of SAB 104, which was effective upon issuance. The
adoption of SAB 104 did not impact the consolidated financial
statements.

(2) BUSINESS COMBINATION:

On June 20, 2002, Essential Reality, LLC, a Delaware Limited Liability
Company, completed a business combination with JPAL, Inc., a Nevada
corporation and an SEC registrant pursuant to an Amended Contribution
Agreement between ER LLC and JPAL, whereby all of the members of ER LLC
contributed their membership interests in ER LLC to the Company in
exchange for an aggregate of 16,874,784 shares of the Company's common
stock. Concurrent with the Transaction, the shareholders of JPAL
canceled 7,564,326 of their shares of JPAL common stock and were left
with 1,080,934 shares of common stock representing 6.02% of the
Company. Following the Transaction, JPAL changed its name to Essential
Reality, Inc. and ER LLC, a wholly owned subsidiary of the Company, was
merged into the Company. Subsequently, ER LLC was liquidated and the
assets became assets of Essential Reality, Inc.

The Transaction was accounted for as a recapitalization of ER LLC. The
management of ER LLC remained as the management of the Company. Since
the Transaction was accounted for as a recapitalization and not a
business combination, no goodwill has been recorded in connection with
the Transaction and the costs incurred in connection with the
Transaction have been accounted for as a reduction of additional
paid-in capital. As a result of the recapitalization: (i) the
historical financial statements of the Company for periods prior to the
date of the Transaction are no longer the historical financial
statements of JPAL, and, therefore, JPAL's historical financial
statements are no longer presented; (ii) the historical financial
statements of the Company for periods prior to the date of the
Transaction are those of ER LLC; (iii) all references to the financial
statements of the "Company" apply to the historical financial
statements of ER LLC prior to the Transaction and to the financial
statements of the Company subsequent to the Transaction; and (iv) any
reference to the Company applies solely to ER LLC and Essential
Reality, Inc.

(3) DISCONTINUED OPERATIONS

On November 6, 2003, the Board of Directors passed a unanimous
resolution to discontinue the operations of the P5(TM) Unit because of
the lack of capital and the inability to obtain additional financing.
The consolidated financial statements and related notes reflect the
financial position, results of operations and cash flows of the
Company for these discontinued includes allocations of certain
expenses for the P5(TM) Unit.

F-14

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2003 AND 2002

(3) DISCONTINUED OPERATIONS, Continued:

A summary of the income (loss) from discontinued operations for the
year ended December 31, 2003 is as follows:

Revenue $ 234,600
Cost of revenue 230,867
----------
Gross profit 3,733

Operating expenses
Impairment of fixed assets and
Intangible assets 419,235
Sales and marketing 524,512
Product development 527,015
Severance compensation 204,511
Depreciation and amortization 233,332
Inventory valuation adjustment 78,395
----------
Total operating expenses 1,987,000
----------

Loss from discontinued operations ($1,983,267)
==========

(4) NOTES RECEIVABLE:

Notes receivable as of December 31, 2003 consisted of the following:

Due from former employee $ 50,000
Less : reserve for collectibility 50,000
---------
$ -
=======

In July 2001, the Company signed an agreement with a third party for
the development of the P5(TM). In connection with the agreement, the
Company agreed to provide loan advances up to $2,000,000, later
increased to $2,700,000, to cover approved development costs. The loan
is non-interest bearing and is reduced by qualified development
expenses incurred by the developer, and is further reduced by tax
credits from a division of the Canadian Government for research, earned
by the developer and passed through to the Company. The Company
received a General Security Agreement that created a security interest
in the developer's equipment, inventory, accounts receivable,
intangibles, etc. The loan is payable within two years after each
advance unless on demand after the two years at the discretion of ER.

For the year ended December 31, 2002, the loan balance has been reduced
by $1,403,325 of qualified development expenses and $535,092 of
research and development credits from the Canadian Government. At
December 31, 2002, the remaining receivable was $400,000 and was
recorded net of an allowance for reduced tax credits of $52,121.

On September 16, 2003 the Company executed a Settlement Agreement and
Mutual Release where the parties agreed to waive all rights and claims
against each other for its past and present services under the
Agreement including severance obligations assumed by the developer; and
the Company applied against the outstanding Tax Credit Receivable equal
to the amount to the developer.

F-15

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2003 AND 2002

(4) NOTES RECEIVABLE, CONTINUED:

As of September 16, 2003 the loan balance has been reduced $1,960,012
of Qualified expenses and $418,773 of research and development credits
from The Canadian Government. After taking into account the credits,
the remaining receivable totalled $477,309. Included in accounts
payable on the agreement date was $366,642 of amounts owed for services
rendered. As part of the agreement the receivable was offset against
thepayable and a contract termination expense in the amount of $110,669
was recorded and included in product development expense in
discontinued operations at December 31, 2003.

In July, 2002 the Company loaned the former President and COO $50,000
due in one year with interest accruing at 6%. This loan was an advance
for a potential bonus the employee may have received in connection with
an employment agreement assuming he met all the terms of the agreement.
The Company terminated the employee due to cause and accordingly has
reflected the advance as still outstanding. However, the Company is
unsure of its collectability and has reserved the loan in full at
December 31, 2003.

(5) INVENTORIES:

Inventories as of December 31, 2003 consisted of finished goods
totalling $117,594.

Subsequent to December 31, 2003, the Company experienced difficulty in
selling its P5(TM) glove at its suggested retail pricing and was not
able to sell the majority of its inventory at cost to manufacture.
Accordingly, it has taken a permanent write down to reflect the selling
price in 2004 to market against the remaining finished goods inventory.
Included in cost of sales is an impairment adjustment of $78,395 of
finished goods for December 31, 2003 and for December 31, 2002 included
in operating expenses is impairment of inventory realization of
$1,883,207.

(6) OTHER CURRENT ASSET

Included in other current assets are amounts totaling $205,135
representing funds deposited in an escrow account for the exchange with
Alliance (see Note 19 Subsequent Events)

(7) EQUIPMENT AND IMPROVEMENTS:

A summary as of December 31, 2003 is as follows:

Furniture and fixtures $ 3,257
Leasehold improvements 7,569
Computers 17,947
Office equipment 10,433
Tooling, molds, dies, and equipment 392,267
--------
431,473
Less: accumulated depreciation and amortization 178,028
Less: Impairment charge (See Note 3) 253,445
--------
$ --
========

Depreciation and amortization expense amounted to $138,468 and $29,194
for the years ended December 31, 2003 and 2002, respectively. When the
Company changed its business strategy at the end of 2003, the Company
recorded the unamortized balance of $253,445 as an impairment loss
because the asset was not fully recoverable.

F-16

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2003 AND 2002

(8) INTANGIBLE ASSETS:

Intangible assets as of December 31, 2003 are as follows:

Domain name $ 18,000
Leasehold Improvements 7,569
Product development 260,000
Website 22,320
--------
307,889
Less: accumulated depreciation and amortization 142,100
Less: Impairment charge (See Note 3) 165,789
--------
Intangible, net $ --
========

Amortization expense for intangible assets amounted to $94,864 and
$39,667 for the years ended December 31, 2003 and 2002, respectively.
When the Company changed its business strategy at the end of 2003, the
Company recorded the unamortized balance of $165,789 as an impairment
loss because the asset was not fully recoverable.

(9) SECURED CONVERTIBLE DEBENTURE:

In November 2002, the Company opened a Subscription Agreement to raise
$1,000,000 under an 8% Secured Convertible Debenture (the "Debenture")
for a period of 6-months from the date funds are received. As of
December 31, 2003, the Company had raised $1,000,000 ($500,000 raised
in each year ended December 31, 2003 and 2002). The debenture for
$1,000,000 contains a beneficial conversion feature for six months at a
conversion price of $1.00. The debenture also contains detachable
warrants to acquire 310,500 shares of common stock at an exercise price
of $1.00 per share expiring in five years. The Debenture is
collateralized by the Company's right, title, and interest in and to
all present and future rights to payment of goods and services.

During the year ended December 31,2003 the Company issued an additional
700,000 warrants to one debt holder under the same terms as the
original warrants. The estimated value of the warrants totaled $115,198
and was determined using the Black-Scholes pricing model with the
following assumptions: (i) no expected dividends; (ii) a risk-free
interest rate of 4.04%; (iii) expected volatility of 83%; and (iv) an
expected life of two years. The amount was expensed immediately as the
underlying debt has matured.

In connection with the Debenture in accordance with EITF 00-27, the
Company first determined the value of the notes and the fair value of
the detachable warrants issued in connection with this convertible
debenture. The estimated value of the 310,500 warrants (exclusive of
the additional 700,000 warrants discussed above) of $196,187 was
determined using the Black-Scholes pricing model with the following
assumptions: (i) no expected dividends; (ii) a risk-free interest rate
of 4.04%; (iii) expected volatility of 83%; and (iv) an expected life
of two years. The face amount of the notes payable of $1,000,000, which
had a conversion feature for six months, was proportionately allocated
to the note payable and the warrants in the amount of $840,087 and
$159,913 ($50,465 for 2003), respectively. The amount allocated to the
warrants of $159,913 was recorded as a discount on the note payable.
The value of the note payable was then allocated between the note and
the beneficial conversion feature, which amounted to $448,331 and
$391,756 ($116,756 for 2003), respectively. The combined total discount
is $551,670, is being accreted into notes payable as additional
interest expense over the remaining life of the note of six months. As
of December 31, 2003, the entire $551,670 has been amortized to
expense. None of the note balance under this agreement has been
converted into common stock as of December 31, 2003.

As of December 31, 2003, the Company has defaulted on the debt. The
debt is no longer convertible as the conversion feature expired on the
maturity date of the notes.

F-17

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2003 AND 2002

(10) UNSECURED CONVERTIBLE DEBENTURE:

As of December 31,2003, the Company has $1,717,070 of notes payable
that were assumed during the Transaction (as described in Note 1,
Nature of Business). These notes bear interest at 8 1/2% per annum. As
of December 31, 2003, the Company has accrued $186,735 of interest and
it is included in accounts payable and accrued expenses at December 31
2003. The Company has defaulted on these loans.

In May 2003, the Company issued an 8% Unsecured Convertible debenture
for $67,500. The debenture which matures in six months contains a
conversion feature at a conversion price of $0.40. The debenture also
contains detachable warrants to acquire 42,188 shares of common stock
at an exercise price of $0.25 per share expiring in five years. In
accordance with EITF 00-27, the Company first determined the value of
the notes and the fair value of the detachable warrants issued in
connection with this convertible debenture. The estimated value of the
42,188 warrants of $3,746 was determined using the Black-Scholes
pricing model with the following assumptions: (i) no expected
dividends; (ii) a risk-free interest rate of 4.04%; (iii) expected
volatility of 83%; and (iv) an expected life of two years. The proceeds
were proportionately allocated to the note payable and the warrants in
the amount of $63,951 and $3,549, respectively. The amount allocated to
the warrants of $3,549 was recorded as a discount on the note payable.
Due to the market price being less than the conversion price no
beneficial conversion exists. The discount is being accreted into notes
payable as additional interest expense over the remaining life of the
note. As of December 31, 2003, all of the $3,549 discount has been
amortized to expense. None of the note balance under this agreement has
been converted into common stock as of December 31, 2003. The debt and
convertibility featured expired without repayment or conversion.

In June 2003, the Company issued an 8% Unsecured Convertible Debenture
for $40,000. The debenture, which matures in six months, contains a
conversion feature at a conversion price of $0.40. The debenture
contains detachable warrants to acquire 33,000 shares of common stock
at an exercise price of $0.25 per share expiring in five years. In
accordance with EITF 00-27, the Company first determined the value of
the notes and the fair value of the detachable warrants issued in
connection with this convertible debenture. The estimated value of the
33,000 warrants of $5,631 was determined using the Black-Scholes
pricing model with the following assumptions: (i) no expected
dividends; (ii) a risk-free interest rate of 4.04%; (iii) expected
volatility of 83%; and (iv) an expected life of two years. The proceeds
were proportionately allocated to the note payable and the warrants in
the amount of $35,064 and $4,936, respectively. The amount allocated to
the warrants of $4,936 was recorded as a discount on the note payable.
Due to the market price being less than the conversion price no
beneficial conversion exists. The discount is being accreted into notes
payable as additional interest expense over the remaining life of the
note. As of December 31, 2003, all of the $4,936 discount has been
amortized to expense. None of the note balance under this agreement has
been converted into common stock as of December 31, 2003.

From July 2003 to December 31,2003 the Company issued an 8% Unsecured
Convertible Debenture for $106,000. The debenture, which matures in six
months, contains a conversion feature at a conversion price of $0.40.
The debenture contains detachable warrants to acquire 136,228 shares of
common stock at an exercise price of $1.25 per share expiring in five
years. In accordance with EITF 00-27, the Company first determined the
value of the notes and the fair value of the detachable warrants issued
in connection with this convertible debenture. The estimated value of
the 136,228 warrants of $2,615 was determined using the Black-Scholes
pricing model with the following assumptions: (i) no expected
dividends; (ii) a risk-free interest rate of 4.04%; (iii) expected
volatility of 83%; and (iv) an expected life of five years. The face
amount of the notes payable of $106,000 which has a conversion feature
of six months, was proportionately allocated to the note payable and
the warrants in the amount of $103,422 and $2,574, respectively. The
amount allocated to the warrants of $2,574 was recorded as a discount
on the note payable. Due to the market price being less than the
conversion price no beneficial conversion exits. The discount is being
accreted into notes payable as additional interest expense over the
remaining life of the note. Of the $2,574 discount, as of December 31,
2003, $1,738 has been amortized to expense. None of the note balance
under this agreement has been converted into common stock as of
December 31, 2003.

F-18

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2003 AND 2002

(10) UNSECURED CONVERTIBLE DEBENTURE, CONTINUED:

From October 2003 to December 31,2003 the Company issued an 6%
Unsecured Convertible Debenture for $310,715. The debenture, which
matures in three months, contains a beneficial conversion feature at a
conversion price of $0.02. In accordance with EITF 00-27, the Company
determined the estimated value of the conversion feature to be
$310,715. This estimate was determined using the Black-Scholes pricing
model with the following assumptions: (i) no expected dividends; (ii) a
risk-free interest rate of 4.04%; (iii) expected volatility of 83%; and
(iv) an expected life of 1 year. The discount is being accreted into
notes payable as additional interest expense over the remaining life of
the note. Of the $310,715 discount, as of December 31, 2003, $155,357
has been amortized to expense. None of the note balance under this
agreement has been converted into common stock as of December 31, 2003.

(11) EQUITY

In November 2002, the Company issued 50,000 shares in exchange for
deferral of payment of legal services valued at $70,000 based on the
market price of the Company's stock when the services had been
completed. An amount of $70,000 of expense was charged to equity-based
compensation. The law firm resigned in the first quarter of 2003 before
completing the deferred legal services and the Company paid $25,000 to
settle the outstanding amount owned. The Company may pursue the return
of the shares because the law firm did not complete the agreed-upon
services.

On June 20, 2002, ER LLC completed a private placement (the "Offering")
whereby it issued 7,274,784 membership units for gross proceeds of
$7,577,900. Included in the gross proceeds was $500,000 of bridge loans
that were converted to 480,000 membership units of the Company.
$250,000 of the bridge loans converted was owed to JPAL and $250,000
was due to a third-party lender. JPAL exchanged the membership interest
in ER LLC for the reduction of $250,000 in notes payable it owed to
third-party lenders.

In connection with the Offering, the Company issued to its financial
advisors warrants to purchase an aggregate of 331,211 shares of common
stock (the "Additional Warrants"). Such warrants shall have an exercise
price of $1.30 per membership unit and shall be exercisable for a
period of up to five years. As a result of the Transaction, warrants to
purchase membership units in ER LLC have become warrants to purchase
common shares of the Company. The value of the warrants issued above
was priced using the Black-Scholes pricing model. (Refer to footnote
12.)

On March 12, 2003, the Company sold to a private investor 100,000
shares for $1.00 per share totaling $100,000.

On March 10, 2003, the Company entered into an Investment
Banking/Advisory Agreement with First Securities USA, Inc. through its
SBI USA division ("SBI") engaging SBI as the exclusive financial
advisor, for six months in connection with the management of a "PIPE"
(private investment in public equity) of equity securities, which may
or may not include common stock and warrants to purchase common stock
of the Company, on a best efforts basis up to $5,000,000 with a minimum
of $3,000,000. The private placement will be structured as a
transaction exempt from section 5 of the Securities Act of 1933 and
shall comply with section 4(2) of the Securities Act and Regulation D
and to permit the initial closing upon the receipt and acceptance by
the Company of $3,000,000 for irrevocable subscriptions for the
securities up to $5,000,000. The Company paid the Investment Banker a
retainer of 25,000 shares of common stock of the Company with a total
fair market value, based on the close price of the stock, of $25,250.
In addition, the Company will pay a commission in cash equal to 10% of
the aggregate gross proceeds of the securities sold, as well as
warrants for the purchase of a number of securities equal to 10% of the
number of securities sold in the private placement. The warrants will
be exercisable for five years at a price equal to 110% of the offering
price per security. The agreement was terminated by mutual consent on
December 17, 2003. Included in accounts payable is $3,822 for expenses
at December 31, 2003.

F-19

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2003 AND 2002

(11) EQUITY, CONTINUED:

On March 14, 2003 the Company retained a consultant for institutional
financial public relations for at least two years. As compensation, the
Company will issue a five year warrant to purchase up to 250,000 shares
of the Company's common stock at a strike price of $1.00 per share; in
addition the Company will pay a $10,000 retainer per month for 24
months in the form of the Company's common stock for 240,000 shares in
advance and to be registered by the Company at its expense at the
earliest time. No services have been performed to date and no warrants
or shares have been issued.

The Company will reimburse the consultant for reasonable out-of-pocket
expenses not to exceed $250, without the consent of the Company. The
Company will prepay $5,000 and will replenish this monthly to maintain
the $5,000 level. No payments have been made to date. The balance owed
is in included in accounts payable as of December 31, 2003.

On April 1, 2003, the Company issued 240,000 shares of common stock to
a consultant for services to be rendered over a two year period. The
fair market value of the stock of $144,000 was determined based on the
closing price of the stock on the date of issuance. The contract amount
will be amortized over the contract period. The amount has been offset
against equity due to the stock being issued before the services have
been rendered. No services have been rendered to date and no shares
have been issued.

(12) INCOME TAXES:

Realization of deferred tax assets is dependent on future earnings, if
any, the timing and amount of which is uncertain. Accordingly, a
valuation allowance, in an amount equal to the net deferred tax asset
as of December 31, 2003, has been established to reflect these
uncertainties. As of December 31, 2002, the deferred tax asset before
valuation allowances is approximately $2,032,700 for federal purposes.

Utilization of the net operating loss carryforwards may be subject to a
substantial annual limitation due to ownership change and continuity of
business change limitations provided by the Internal Revenue Code of
1986. The annual limitations may result in the expiration of net
operating loss carryforwards before utilization.

Income tax provision amounted to $-0- for the years ended December 31,
2003 and 2002. A reconciliation of the provision (benefit) for income
taxes with amounts determined by applying the statutory U.S. federal
income tax rate to income before income taxes as of December 31, 2003
and 2002 is as follows:

2003 2002
----------- -----------

Computed tax at federal statutory rate of 34% $(1,990,000) $(2,908,200)
Reduction for loss from ER LLC -- 875,500
Change in valuation allowance 1,990,000 2,032,700
----------- -----------
$ -- $ --
=========== ===========

F-20

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2003 AND 2002

(12) INCOME TAXES, Continued:

Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax
purposes. Significant components of the Company's deferred tax assets
and liabilities as of December 31, 2003 are as follows:

Deferred tax asset -
Net operating losses carry forwards $ 1,687,000

Deferred tax liability -
Deferred compensation 517,000
-----------
Net deferred assets before valuation alloance (1,170,000)
-----------

Valuation allowance 1,170,000
-----------
Net deferred tax assets $ --
===========

At December 31, 2003, the Company has available unused net operating
losses carry forwards of approximately $7,600,000 for purposes that may
be applied against future taxable income and that, if unused, expire
through 2023.

(13) RETIREMENT PLAN:

The Company sponsors a 401(k) contributory plan (the "Plan") for the
benefits of employees who are at least 21 years of age. The Company's
management determines, at its discretion, any annual contributions. The
Company elected not to contribute to the Plan for the years ended
December 31, 2003 and 2002.

(14) WARRANTS:

A schedule of warrant activity as December 31, 2003 is as follows:

Weighed
Number Average
of Shares Exercise Price
--------- ---------------
Outstanding at December 31, 2002 1,286,211 $ 1.68
Granted 1,621,916 1.68
Exercised -- --
Cancelled -- --
--------- ---------
Outstanding and exercisable at
December 31, 2003 2,908,127 $ 1.68
========= =========

All of the warrants granted in conjunction with secured convertible
debentures and notes payable are disclosed in Notes 8 and 9.

In connection with the termination of the CEO in February 2003, the
Company issued five year warrants to purchase 250,000 shares of common
stock. The fair value of the warrants of $117,410 was determined using
the Black-Scholes pricing model with the following assumptions: (i) no
expected dividends; (ii) a risk free interest rate of 4%; (iii)
expected volatility of 80%; and (iv) expected life of five years.

F-21

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2003 AND 2002

(14) WARRANTS, CONTINUED:

In connection with the consulting contract for public relation services
entered into in March 2003, the Company issued five year warrants to
purchase 250,000 shares of common stock. The fair value of the warrants
of $88,785 was determined using the Black-Scholes pricing model with
the following assumptions: (i) no expected dividends; (ii) a risk free
interest rate of 4%; (iii) expected volatility of 80%; and (iv)
expected life of five years.

(15) COMMITMENTS AND CONTINGENCIES:

In April 2003, the Company entered into an operating lease for office
and warehouse space in Mineola, New York. The operating lease is
effective for 5 years with an option to renew for 3 years. The minimum
monthly base rental is $4,500 with annual increases of two hundred per
month plus 20% of the increase in real estate taxes over the base year.
The lease was terminated on January 31, 2004

The Company defaulted under its previous location in New York, NY and
terminated the lease by forfeiting the security deposit in the amount
of $58,050 which satisfied the outstanding debt as of June 30, 2003.

Rent expense for the years ended December 31, 2003 and 2002 totaled
$98,646 and $114,338, respectively.

The Company is allocated certain equipment lease costs under leases
assumed by a company related to a certain member of LCG. The Company is
not obligated under the leases but is allocated a portion the minimum
payments under the leases. Computer lease expense for the years ended
December 31, 2003 and 2002 amounted to $18,137 and $47,667,
respectively.

Employment Agreement

The Company has an employment agreement with the vice president of
marketing and sales. The agreement provides for an annual base salary
of $150,000 per year and four months of severance compensation.

Litigation

On November 21, 2002, a complaint was filed by MC Squared in United
States District Court for the Southern District of New York against us,
Humbert Powell III, Chairman of the Board of Directors, Steven
Francesco, ex-Chief Executive Officer, David Devor, an officer, and
Brian Jedwab, a member of the Board of Directors, alleging breach of a
development agreement between us (originally Essential Reality, LLC)
and MC Squared. Specifically, the complaint alleges a failure by us to
provide a design credit to MC Squared on the packaging for the P5(TM).
The complaint seeks specific performance and a recall of all P5(TM)
products shipped to date without the design credits on the packaging.
We have submitted an answer with counterclaims and have made a motion
to dismiss this complaint. On October 15, 2003 the case was settled for
$53,643 payable as follows: $3,643 in full payment for royalties due as
of July 30, 2003 and $50,000 for "Non-Royalty Settlement" payable in
consecutively monthly installments of $2,000 commencing November 15,
2003. The Company may prepay the outstanding balance within 4 months
and deduct 25% or within 8 months and deduct 20%. Included in accounts
payable at December 31, 2003 is $43,643 related to this transaction.

On January 21, 2003 a complaint was filed by RDA International, Inc. in
the Supreme Court of the State of New York against us seeking payment
of $203,264 for work, labor and services performed in connection with
advertising, marketing and multimedia programs for the P5(TM). This
amount has been accrued at December 31, 2002.

F-22

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2003 AND 2002

(15) COMMITMENTS AND CONTINGENCIES, Continued:

Litigation, continued

On February 28, 2003, a complaint was filed by Aaron Gavios, a former
employee, in The United States District Court for the Southern District
of New York against us, Humbert Powell III, Chairman of the Board of
Directors, and Brian Jedwab, a member of the Board of Directors,
alleging breach of a contract. Specifically, the complaint alleges
failure to provide for severance pay, failure to provide stock options
and failure to reimburse for automobile lease totaling $120,000, plus
interest and legal fees. The Company has accrued $50,000 as of December
31, 2003 for severance to this former employee.

On April 16, 2003, a complaint was filed by Ziff Davis Media, Inc. in
the Supreme Court of the State of New York against the Company
(originally, ER LLC) seeking payment of $27,443 for print advertising
for the P5(TM). On July 3, 2003 the case was settled for $10,000
payable in 4 installments as follows: $4,000 due July 10, 2003, and the
balance of $6,000 in 3 equal installments of $2,000 each payable August
10, September 10, and October 10, 2003. The $10,000 was paid in full as
of December 31, 2003.

On October 10, 2003 a complaint was filed by the Future Network USA
f/k/a/ Imagine Media Inc in the Supreme Court of the State of New York,
County of New York against Essential Reality, LLC seeking payment of
$33,405 plus interest and legal fees for advertising in one of their
magazines. The full amount is included in accounts payable and accrued
expenses as of December 31, 2003 as no payments have been made.

On December 4, 2003 a complaint was filed by the CIT Communications
Finance Corporation d/b/a/ Avaya Financial Services in the Supreme
Court of the State of New York, County of New York against Essential
Reality, Inc seeking payment of $38,084 plus interest and legal fees
for default in paying the Phone Equipment Lease Agreement dated January
7, 2002. This amount is the total due under the lease agreement.
Included in accounts payable and accrued expenses is a total of $537
which is the total of the lease payments owed at December 31, 2003.

On December 4, 2003 a complaint was filed by the Shapland Creative
Design, Inc in the Supreme Court of the State of New York, County of
Nassau against Essential Reality, LLC seeking payment of $6,300 plus
interest and legal fees for services and materials. The full amount is
included in accounts payable and accrued expenses as of December 31,
2003 as no payments have been made.

We believe we have valid defenses to these claims and intend to
vigorously defend ourselves. However, there can be no assurance that we
will be successful. The costs associated with these litigations,
including the time required to defend ourselves, as well as the
potential cost should there be an adverse judgment against us, may have
a material adverse effect on our financial condition and results of
operation.

(16) RELATED-PARTY TRANSACTIONS:

The Company had the following related-party transactions for the years
ended December 31, 2003 and 2002:

a. The Company accrued compensation expense of $218,737 and
$257,103 for certain officers and shareholders for the years
ended December 31, 2003 and 2002, respectively. These amounts
are included in due to related parties at December 31, 2003.

b. Advances from affiliated companies are from entities that are
affiliated with certain shareholders of the Company. The
advances are payable on demand and bear interest at the rate
of 10% per annum. Certain of these advances were satisfied in
September 2002, by granting the Company's interest in "other
assets" of $22,500 to these entities. At December 31, 2003,
$1,712 remains outstanding.

F-23

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2003 AND 2002

(16) RELATED-PARTY TRANSACTIONS, CONTINUED:

c. Non-interest bearing advances from an affiliate of certain
shareholders, LCG Capital Group, LLC, were made in 2001 of
which $5,705 was paid in 2002 leaving a balance of $70,912
outstanding at December 31, 2003.

d. Included in product and development expense is $25,000 and
$33,700 for the years ended December 31, 2003 and 2002,
respectively, to a company owned by certain shareholders of
the Company that have consulted with the Company in the areas
of product strategy, design, and development. Balance
outstanding at December 31, 2003 equalled $19,030.

e. Included in general and administrative expenses are costs
incurred of $1,323 and $57,672 for the years ended December
31, 2003 and 2002, respectively, by two entities that are
related to certain members of LCG Capital Group. Such costs
were determined to be allocable costs to the Company and
include consulting fees related to business development,
employee salaries, occupancy, telephone, and computer leases.
In the case of employee salaries, costs are allocated to the
Company based on the time each employee conducts business
specific to the Company. In the case of the other expenses,
costs are allocated based on a percentage of resources used by
the Company. Balance at December 31, 2003 equaled $4,039.

f. Included in general and administrative expenses is $48,116 and
$72,000 at December 31, 2003 and 2002, respectively, of
marketing expense payable to a company owned by a person
related to certain members of the Company who assisted in
establishing and executing its marketing programs. Included in
accounts payable-related parties is $100,662 of this expense
at December 31, 2003.

g. Included in general and administrative expenses is $80,000 and
$7,500 at December 31, 2003 and 2002 for director's fees and
$1,107 for out of pocket expenses for December 31, 2003.
Included in due to related parties is $88,607 at December 31,
2003.

(17) CONTRACTUAL OBLIGATIONS/GAME PUBLISHERS-LICENSING AGREEMENTS:

a. In March 2000, the Company entered into a consulting
agreement, which requires the Company to pay the consultant,
$0.25 for each of the first 150,000 units of the P5(TM) sold.

b. In July 2000, Essential Reality, LLC entered into a consulting
agreement with MC Squared Incorporated to help manage the
relationship with product developers. This consulting
agreement replaced a previous Development Agreement executed
between Essential Reality, LLC and MC Squared in November
1999. In connection with these agreements MC Squared was paid
$250,000. Payments are no longer being made to MC Squared. In
September 2000 the consulting agreement terminated and the
development process was managed by us internally. MC Squared
is a company owned by a person related to certain members of
our Board of Directors. Pursuant to such agreement, royalty
payments of 1.8% on net sales of the P5(TM)and 9% of the
license fees collected with respect to P5(TM) are to be paid
indefinitely. As of December 31, 2002, $1,098 was due to MC
Squared. MC Squared has sued us in connection with these
agreements. On October 15, 2003 the case was settled for
$53,643 payable as follows: $3,643 in full for royalties due
as of July 30, 2003 and $ 50,000 for "Non-Royalty Settlement"
payable in consecutively monthly installments of $2,000
commencing November 15, 2003. The Company may prepay the
outstanding balance within 4 months and deduct 25% or within 8
months and deduct 20%. The outstanding balance due MC Square
as of December 31, 2003 is $ 46,643. The amount owed for
royalties was reduced from 1.8% to 1% for the first $2,500,000
in sales and 5% license revenues. After the first $ 2,500,000
of such sales and licenses Revenues, the royalties shall
revert to 1.% and 9% respectively. The royalty owed as of
December 31, 2003 amounted to $1,047.

F-24

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2003 AND 2002

(17) CONTRACTUAL OBLIGATIONS/GAME PUBLISHERS-LICENSING AGREEMENTS,
CONTINUED:

c. In January 2001, Essential Reality, LLC entered into a
memorandum of understanding with Apjay Technologies for the
development of certain components of the P5(TM). Pursuant to
the memorandum of understanding, we are required to pay
royalties of 1% of P5(TM)'s net sales to Apjay Technologies
indefinitely. The Company was required to pay a royalty
advance of $50,000, of which $15,000 has previously been paid
and $35,000 of which is now due because we have incorporated
the component developed pursuant to the memorandum of
understanding into the P5(TM). Included in the settlement with
VR Yad (see Note 4) was the assumption by them of outstanding
amount owed by the Company to Apjay.

d. In July 2001, the Company entered into a development agreement
with VR Yad (developer) for the development of certain
components of P5(TM). The developer accomplished the
objectives set forth in the agreement to complete development
of the P5(TM)by June 2002. Consequently, the Company is
required to pay base royalties of 1% of net sales generated
from P5(TM), indefinitely and additional 0.5% of net sales
generated from P5(TM),indefinitely. The royalty expense for
the year ended December 31, 2003 and 2002 was $3,538 and $917,
respectively. During the period of engagement, and for two
years after termination of the relationship, VR Yad was
prohibited from developing, manufacturing, marketing or
selling any product similar to the products it developed for
the Company. The Company expected to utilize the services of
VR Yad in the development of additional products, however,
alternative sources of development capability have been
identified in the event a change of developer is necessary. A
settlement and mutual release agreement was entered into the
VR Yad during the year ended December 31, 2003 (see Note 4).

e. In May 2002, the Company placed an order for the manufacture
of approximately 35,000 P5(TM)s with a third-party
manufacturer. Under the terms of the order, the Company paid a
deposit of $100,000 upon placing the order and posted letters
of credit in the amount of $2,000,000. As of September 30,
2002, there was $2,000,000 in restricted cash, upon which the
letters of credit could be drawn. Beginning in October 2002,
the Company began accepting receipt of these goods from the
manufacturer, and as of December 24, 2002, $1,842,234 has been
drawn against the letters of credit, as payment. The balance
of $157,766 was paid on January 30, 2003.

f. In May 2002, the Company entered into an agreement with a game
developer. Under the agreement the game developer was to
disclose to the Company the source code for two specific games
so that the P5(TM) software can be integrated with the game
and use their best efforts to provide reasonable technical
assistance to the Company and its developer during the
integration process. In addition, the developer was to release
software updates enabling current users of the games to use
P5(TM). The Company was to be responsible for integration and
payment to the game developer of $100,000. As of December 31,
2003 the Company has paid $66,665 and the balance of $33,335
is included in accounts payable.

g. In August 2002, the Company committed to pay a game publisher
a minimum of $35,000. At December 31, 2003, $17,500 was paid
with $17,500 included in accounts payable.

h. In August 2002, the Company committed to pay royalties to a
game publisher at the rate of $5.00 per unit. A minimum
commitment of $125,000 was required. At December 31, 2003,
$62,500 was paid with $62,500 included in accounts payable.

i. In September 2002, the Company committed to pay royalties to a
game publisher at the rate of $1.50 per unit. A minimum of
$37,500 was required. At December 31, 2003, $18,750 was paid
with $18,750 included in accounts payable.

j. In September 2002, the Company committed to pay royalties to a
game publisher at the rate of $5.00 per unit. A minimum
commitment of $187,500 was required. At December 31, 2003,
$93,750 is included in accounts payable and the remaining
$93,750 agreed to be reversed and not due.

F-25

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2003 AND 2002

(18) SEVERANCE AGREEMENTS:

In January 2003, the Company terminated six personnel consisting of
various officers and support staff. The Company is obligated for
$291,000 of severance pay contingent upon the Company obtaining
installment financing of $1,000,000 minimum, excluding bridge loans.
There were no payments as of December 31, 2003.

In addition, in connection with these severance agreements, the Company
is obligated to issue to one of its former officers, five-year warrants
to purchase 250,000 shares of common stock at an exercise price of
$0.75 per share. See Note 14.

(19) SUBSEQUENT EVENTS:

On January 26, 2004 a compliant was filed by Empire Inter - Freight
Corp. in the Civil Court of the City of New York, County of New York
against Essential Reality, Inc. seeking payment of $12,419 plus
interest and legal fees for default in paying for freight services in
December 19 , 2002. The case was settled for $4,000 in May 2004.

On February 5, 2004 a complaint was filed by the UBI Soft Entertainment
in the Supreme Court of the State of New York, County of Nassau against
Essential Reality, LLC seeking payment of $93,750 plus interest and
legal fees for services and materials. The full amount is included in
accounts payable and accrued expenses as of December 31, 2003 as no
payments have been made.

On April 2, 2004 CCH Incorporated filed a Restraining Notice with the
Company's bank HSBC for one year. They are seeking payment of $6,639
for services rendered in 2003 and 2002. This amount has been accrued as
of December 31, 2003.

On May 21, 2004, GE Capital, pursuant to an equipment lease dated
October 4, 2002 for 60 months, filed with a collection agent to collect
the full amount of the lease in the amount of $21,340. This was due to
the Company being behind in its payments for 7 months starting November
1, 2003. The monthly payments in the amount of $450 have been accrued
in accounts payable for the payments that are due. The Company has 30
days to respond before a judgment is filed.

BINDING TERM SHEET AND PRIVATE PLACEMENT

On February 6, 2004 the Company executed a binding term sheet (the
"Term Sheet"), which sets forth the preliminary terms and conditions of
a proposed exchange transaction between Essential and AllianceCorner
Distributors, Inc ("Alliance" or "ACDI"). This Term Sheet supersedes
and replaces the Letter of Intent dated November 6, 2003. As proposed,
the shareholders of Alliance would exchange their shares of capital
stock in Alliance for shares of common stock of Essential.

Upon the closing of the exchange, as currently contemplated, the
shareholders of Alliance will own common stock representing
approximately 49.36% of the outstanding capital stock of the Company
before dilution.

The consummation of the transaction is contingent on a number of
factors, including but not limited to, the completion of due diligence
and the execution of a definitive agreement. There can be no assurance
that the exchange will be consummated or, if consummated, that it will
be consummated on the terms set forth in the Term Sheet.

F-26

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2003 AND 2002

(19) SUBSEQUENT EVENTS, CONTINUED

As part of the exchange, the Company is required to raise funds to
complete the transaction. The Company, therefore, is offering 1,174,486
shares of Series A 6% Convertible Non Redeemable Preferred Shares (the
"Preferred Shares"), through a private placement offering ("PPO"). Each
Preferred Share shall entitle the holder the right to receive seven
hundred (700) shares of common stock of the Company. The Preferred
Shares shall convert automatically upon the effectiveness of a
certificate of amendment to the Company's Articles of Incorporation
duly filed with the Secretary of State of Nevada authorizing a
sufficient number of shares of common stock of the Company to enable
the conversion of all Preferred Shares to convert in to common stock of
the Company. The Preferred Shares shall pay a 6% payable in kind
dividend until such time as the Company has enough common shares to
convert all the Preferred Shares being offered into common stock of the
Company. The Preferred Shares shall be entitled to vote one vote per
share on an as converted basis on all matters on which holders of the
Company's common stock are entitled to vote.

If all shares are sold, the approximate net proceeds to the Company
would be $2,890,000.

The investors in the stated PPO shall agree to grant to ACDI an
irrevocable proxy (the "Voting Proxy") with the power to vote any and
all of the Company's common stock held by the Investors received
directly in conjunction with the PPO either through conversion of debt
or the issuance of new Units. The Voting Proxy shall apply pro rata to
the Specific Investors and only to those shares of ESSR common stock
held by the Specific Investors necessary to give ACDI control of 50.1%
of the voting stock of ESSR outstanding at all relevant times. The
Voting Proxy shall remain in effect so long as the Specific Investors
hold any shares of ESSR common stock received directly in conjunction
with the transactions contemplated herein and for the avoidance of
doubt the Voting Proxy shall apply only to such shares.

All securities issued pursuant to the exchange will be "restricted"
stock and be subject to all applicable re-sale restrictions specified
by federal and state securities laws.

The exchange shall include closing conditions including the following:
(i) consummation of all required definitive instruments and agreements,
including, but not limited to, the Exchange Agreement all in a form
reasonably satisfactory to the parties thereto; (ii) obtaining all
necessary board and third party consents, (iii) satisfactory completion
by ESSR and ACDI of all necessary technical and legal due diligence,
and (iv) receipt of the Voting Proxy.

There can be no assurance that the exchange will be consummated or, if
consummated, that it will be consummated on the terms set forth in the
Term Sheet.

The change in business conditions in the fourth quarter and the
execution of the letter of intent resulted in the recognition of
operations of the Company as related to the P5(TM), as discontinued
operations in accordance with SFAS 144 and the sale of the entire
inventory that was on hand as of December 31, 2003 at a value of $6.00
per unit in the first quarter of 2004.

On November 20, 2003 $225,000 was deposited in the escrow account with
Counsel to Alliance pursuant to the Letter of Intent dated November 6,
2003. Alliance shall be entitled to draw on such funds to pay expenses
for accounting, legal and other expenses related to the binding term
sheet noted above.

If the transaction is terminated by any party for any reason, Alliance
shall direct the escrow agent to release to Essential Reality any
remaining balance.

F-27

ESSENTIAL REALITY, INC.

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 2003 AND 2002

(19) SUBSEQUENT EVENTS, CONTINUED:

Alliance shall also refund to Essential Reality any portion of the
$225,000 that was released from escrow if both the following conditions
have occurred:

1. After December 31, 2003 Alliance has withdrawn from the
transaction due to any non-material adverse changes, and

2. Essential Reality has made securely funded arrangements to
fund expenses that exceed the $225,000 deposited in escrow.
The balance is $158,088 as of March 31, 2004.

Pursuant to the Binding Term Sheet the Company signed an Investment
Banking Agreement with Sunrise Securities Corp. a registered
broker/dealer with National Association of Securities Dealers. Sunrise
will use its "bests efforts" to raise the money provided for in the PPO
a minimum of $2,500,000 under the terms and conditions of the PPO. We
will pay the Investment Banker a $25,000 nonrefundable retainer fee and
financing fees equal to 10% of the gross proceeds of such financing
payable to Sunrise in cash and warrants issued to Sunrise to purchase
on the same terms 10% of the securities in such financing. Upon closing
the Financing, the company shall pay Sunrise a financing fee payable in
a form at the sole election of Sunrise of either (i) cash fee equal to
10% of the gross proceeds or (ii) the Company shall issue the number of
shares of Common Stock equal to 11% of the aggregate number of fully
diluted and/or converted shares of Common Stock and/or Commmon Stock
equivalents (including but not limited to Units) purchased by Investors
. In addition , the Company shall issue warrants to purchase Common
Stock equal to 10% of the aggregate number of the fully diluted and or
converted shares of Common Stock equivalents. The warrants shall be
purchased for a nominal sum and shall be exercisable for a period five
years from the date of closing with an exercise price per share equal
to the effective per share price paid by the Investors for the
securities. In the event the agreement is not renewed or terminated,
Sunrise will be entitled to a full fee for which discussions were
conducted during the term of the agreement by the Company or by Sunrise
within twelve months. In addition to the fees, Sunrise will be
reimbursed for all reasonable fees and disbursements of Sunrise outside
counsel and Sunrise travel and out of pocket expenses associated with
the financing up to $25,000 without Company approval. The Company shall
also reimburse the reasonable fees and disbursements of small business
Investment counsel, if any, incurred in connection with Financing not
to exceed 1% of the SBIC's allocation in such financing.

The Company has signed a retainer agreement with Gottlieb & Partners,
LLP as its special counsel for drafting and filing all required
regulatory documents pursuant to the terms and conditions set forth in
the Binding Term Sheet dated January 2004. The company agrees to pay a
flat fee for legal services in the amount of $60,000 to be payable at
the closing from the escrow of the Private Placement Offering.

The Company has retained Jackson Steinem, Inc. for non-legal services
in connection with the Company's proposed reorganization transaction.
The Company agrees to deliver after the closing 30,000 shares of the
Company's Common Stock as compensation for services rendered.

F-28

EXHIBIT INDEX

NUMBER DESCRIPTION
--------- -----------

2.1 Amended Contribution Agreement, dated as of April 24, 2002, by and
among Essential Reality, LLC, the Registrant (f/k/a JPAL, Inc.), Martin
Abrams, John Gentile, Anthony Gentile and LCG Capital Group, LLC.
Incorporated herein by reference from Exhibit A to the Registrant's
Proxy Statement on Schedule 14A filed on May 21, 2002.

2.2 Amendment to Amended Contribution Agreement, dated as of June 14, 2002,
by and among Essential Reality, LLC, the Registrant (f/k/a JPAL, Inc.),
Martin Abrams, John Gentile, Anthony Gentile and LCG Capital Group,
LLC. Incorporated herein by reference from Exhibit 2.2 to the
Registrant's Current Report on Form 8-K filed on July 3, 2002.

3.1 Amended and Restated Articles of Incorporation of the Registrant.
Incorporated herein by reference from Exhibit 3.1 to the Registrant's
Registration Statement on Form SB-2 filed on August 18, 2000 ("2000
SB-2").

3.2 Amendment to Articles of Incorporation filed June 20, 2002 with the
State of Nevada. Incorporated herein by reference from Exhibit 3.2 to
the Registrant's Registration Statement on Form SB-2 filed on July 19,
2002 ("2002 SB-2").

3.3 Amendment to Articles of Incorporation filed June 21, 2002 with the
State of Nevada. I incorporated herein by reference from Exhibit 3.3 to
the 2002 SB-2.

3.4 Bylaws of the Registrant. Incorporated herein by reference from Exhibit
3.2 to the 2000 SB-2.

10.1 JPAL, Inc. 2001 Stock Incentive Plan. Incorporated herein by reference
from Exhibit C to the Registrant's Proxy Statement on Schedule 14A
filed on January 18, 2002.

10.2* Manufacturing Agreement with V-Tech Communications Ltd entered into as
of May 15, 2002.

10.3* Development Agreement with VR Yad dated as of July 1, 2001.

10.4* Consulting / Advisor Agreement with Abrams Gentile Entertainment, Inc.
dated as of February 1, 2001.

10.5* Agreement with BusinessDevelopment.com LLC dated as of December 13,
2000. Amendment with Business Development.com LLC dated as of December
1,2001

10.6* Investment Banking/Advisor Agreement with SBI USA, a division of First
Securities USA, Inc., dated March 10, 2003.

10.7* Form of Investment Banking Agreement between Sunrise Security Corp. and
Essential Reality Inc.

11. Statement re Computation of Per Share Earnings.**

21. Subsidiaries of Registrant.* - None

24.1* Power of Attorney (included on signature page hereto).

31.1* Certification of Chief Executive Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.

31.2* Certification of Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.

32.1* Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.

32.2* Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.

--------------
* Filed herewith.
** Information required to be presented in Exhibit 11 is now provided in
note 1 to the 2003 Annual Report to Shareholders in accordance with the
provisions of FASB Statement of Financial Accounting Standards (SFAS) No. 128,
Earnings per Share.