sec document
As filed with the Securities and Exchange Commission on July 19, 2002
Registration No. 333-_______
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM SB-2
REGISTRATION STATEMENT
UNDER THE SECURITIES ACT OF 1933
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ESSENTIAL REALITY, INC.
(Exact name of registrant as specified in its charter)
Nevada 334119 33-0851302
(State or Other Jurisdiction (North American (I.R.S. Employer
of Incorporation or Industry Classification Identification Number)
Organization) System Code Number)
49 West 27th Street, Suite 7E
New York, New York 10001
(212) 244-3200
(Address and Telephone Number of Principal Executive Offices and
Principal Place of Business)
------------------------------
Steven Francesco
Chief Executive Officer
Essential Reality, Inc.
49 West 27th Street
Suite 7E
New York, New York 10001
(212) 244-3200
(Name, Address and Telephone Number of Agent for Service)
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Copies to:
Steven Wolosky, Esq.
Olshan Grundman Frome Rosenzweig & Wolosky LLP
505 Park Avenue, New York, New York 10022
(212) 753-7200
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Approximate date of commencement of proposed sale to the public:
As soon as practicable after the effective date of this registration statement.
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If any of the securities being registered on this Form are to be
offered on a delayed or continuous basis pursuant to Rule 415 under the
Securities Act of 1933, check the following box. |X|
If this Form is filed to register additional securities for an
offering pursuant to Rule 462(b) under the Securities Act, check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. |_|
If this Form is a post-effective amendment filed pursuant to Rule
462(c) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. |_|
If this Form is a post-effective amendment filed pursuant to Rule
462(d) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. |_|
If delivery of the prospectus is expected to be made pursuant to
Rule 434, please check the following box. |_|
CALCULATION OF REGISTRATION FEE
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Proposed Proposed
Amount Maximum Maximum Amount Of
Title of Each Class of Securities to To Be Offering Price Aggregate Registration
be Registered Registered Per Share Offering Price Fee
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Common Stock, par value $.001 per
share............................ 6,764,870 $3.025 (1) $20,463,732 (1) $1,882.66
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Shares of Common Stock underlying
warrants issued to holders of bridge
notes............................ 855,000 $3.025 (2)(3) $2,586,375 (2) $237.95
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Shares of Common Stock underlying
warrants issued to agents........ 331,211 $3.025 (2)(3) $1,001,913 (2) $92.18
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Shares of Common Stock underlying
outstanding convertible promissory
notes............................ 263,158 $3.025 (2)(3) $796,053 (2) $73.24
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TOTAL.................... 8,214,239 $24,848,073 $2,286.03
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(1) Estimated solely for the purpose of calculating the registration fee in
accordance with Rule 457(c) under the Securities Act of 1933, as
amended, based on the average of the high and low price of $3.05 and
$3.00, respectively, of the common stock on July 15, 2002.
(2) Estimated solely for the purpose of calculating the registration fee in
accordance with Rule 457(g) under the Securities Act of 1933, as
amended, based on the price of the common stock determined in accordance
with Rule 457(c).
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(3) Pursuant to Rule 416 promulgated under the Securities Act of 1933, as
amended, this Registration Statement includes an indeterminate number of
additional shares of common stock as may from time to time become
issuable upon the exercise of certain warrants or conversion of certain
convertible notes by reason of stock splits, stock dividends and other
similar transactions.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH
DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE
REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE
REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION,
ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
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EXPLANATORY NOTES
On June 20, 2002, Essential Reality, Inc., a Nevada corporation
formerly known as JPAL, Inc. (the "Company"), consummated a business combination
(the "Transaction") with Essential Reality, LLC, a Delaware limited liability
company ("ER LLC"). Pursuant to the terms of the Transaction, 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 "Common Stock"). Such shares consisted of 9,600,000 shares of Common Stock
issued to the original members of ER LLC (the "Contribution Shares") and
7,274,784 shares of Common Stock issued to new investors who purchased
membership interests in ER LLC in a recently completed private placement (the
"Private Placement Shares"). Following the Transaction, ER LLC, then a
wholly-owned subsidiary of the Company, was merged with and into the Company.
In connection with the Transaction, (i) holders of certain bridge
notes issued by the Company received, as additional consideration for the loans,
two-year warrants to purchase up to 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 Company exchanged them for convertible promissory notes of
the Company, which are 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 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.
In addition, the Company agreed to register (i) 60% of the Private
Placement Shares, (ii) 25% of the Contribution Shares, and (iii) all of the
Bridge Warrant Shares, Convertible Note Shares and Additional Warrant Shares.
The Company has prepared this Registration Statement, in accordance with the
requirements of Form SB-2 under the Securities Act of 1933, as amended, to
register the shares of Common Stock set forth in the immediately preceding
sentence. Notwithstanding the registration of such shares, a number of such
Contribution Shares may not be sold currently since they are subject to various
lock-up agreements.
-4-
The information in this prospectus is not complete and may be changed. We may
not sell these securities until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus is not an offer
to sell these securities and it is not soliciting an offer to buy these
securities in any state where the offer or sale is not permitted.
PRELIMINARY PROSPECTUS--SUBJECT TO COMPLETION,
DATED JULY 19, 2002
PROSPECTUS
ESSENTIAL REALITY, INC.
8,214,239 shares of Common Stock
o All of the shares of common stock offered by this prospectus are
being sold by the selling shareholders.
o We will not receive any proceeds from the sale of these shares. We
will receive proceeds from the exercise of warrants and those
proceeds will be used for our general corporate purposes.
o Our common stock is traded on the OTC Bulletin Board under the
symbol ESSR.
o On July 17, 2002, the last reported sale for our common stock was
$3.15 per share.
Investing in our common stock involves a high degree of risk. You should
carefully consider the factors described under the heading "Risk Factors"
beginning on page 5 of this prospectus.
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Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon
the adequacy or accuracy of this prospectus. Any representation to the
contrary is a criminal offense.
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________ ___, 2002
TABLE OF CONTENTS
Page
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PROSPECTUS SUMMARY............................................................1
RISK FACTORS..................................................................5
USE OF PROCEEDS..............................................................12
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.....................12
DESCRIPTION OF BUSINESS......................................................14
MANAGEMENT'S PLAN OF OPERATION...............................................23
MANAGEMENT...................................................................28
EXECUTIVE COMPENSATION.......................................................35
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...............................35
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT..........................................................37
DESCRIPTION OF CAPITAL STOCK.................................................39
SELLING SHAREHOLDERS.........................................................41
PLAN OF DISTRIBUTION.........................................................47
LEGAL MATTERS................................................................48
EXPERTS......................................................................48
DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION
FOR SECURITIES ACT LIABILITIES..........................................48
WHERE YOU CAN FIND MORE INFORMATION..........................................49
INDEX TO FINANCIAL STATEMENTS...............................................F-1
i
PROSPECTUS SUMMARY
THIS SUMMARY HIGHLIGHTS SELECTED INFORMATION ABOUT ESSENTIAL
REALITY, INC. THIS SUMMARY MAY NOT CONTAIN ALL OF THE INFORMATION THAT YOU
SHOULD CONSIDER BEFORE INVESTING IN OUR COMMON STOCK. YOU SHOULD READ THE ENTIRE
PROSPECTUS CAREFULLY, INCLUDING THE INFORMATION UNDER "RISK FACTORS" BEGINNING
ON PAGE 5, BEFORE MAKING AN INVESTMENT DECISION.
Recent Developments
On June 20, 2002, we consummated a business combination with
Essential Reality, LLC. Pursuant to the terms of the transaction, all of the
members of Essential Reality, LLC contributed their membership interests in
Essential Reality, LLC to us in exchange for an aggregate of 16,874,784 shares
of our common stock. Following such exchange, Essential Reality, LLC, then our
wholly-owned subsidiary, was merged with and into us and we began operating
Essential Reality, LLC's business exclusively. Therefore, any historical
discussion about our business would be meaningless and potentially misleading,
so all discussions in this prospectus relating to our business shall mean
Essential Reality, LLC's business.
The Business
General
Founded in 1999, Essential Reality, LLC was a developer of real-time
tracking and sensory technologies. We will focus on combining these 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.
We expect to have our first product, the P5(TM), available for sale
during the second half of 2002. The P5(TM) is a glove-like peripheral device
that could substantially improve the way individuals interact with computer
platforms. The P5(TM), which can be offered at a mass market price point,
addresses technological limitations of current input devices. We expect the
P5(TM) to be suitable for multiple applications including:
o Electronic Gaming - games produced for play on personal
computers, game consoles and location-based entertainment sites;
o Commercial Applications - such as animation, computer aided
design (CAD), simulation training, disability and education; and
o Other Computer Interactions - Internet browsing and navigation,
and general computer interaction.
The P5(TM) Product Family
Since the advent of the mouse, relatively little has changed in the
way of computer input devices, despite the fact that computers and applications
have changed dramatically, growing increasingly complex and specialized.
Applications, particularly in the electronic gaming and commercial markets, have
migrated from flat two-dimensional (2D) interfaces to intuitive,
three-dimensional (3D) environments. However, input devices continue to be
dominated by 2D products including mouse controllers and gaming-specific
peripherals such as joysticks, steering wheels, proprietary console controllers
and the like.
The P5(TM) is based on our patented and several patent-pending
technologies, one of which was incorporated in the "Power Glove." The Power
Glove was introduced to the market in the late 1980s as an alternative
controller for use only with the 8-bit Nintendo Entertainment System, part of
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the first generation of game consoles sold to the mass market. The product
eventually sold approximately one million units in the United States, Europe and
Japan. Subsequent to a decline in consumer demand for first-generation gaming
consoles in the early 1990s, such Nintendo system ceased sales. Therefore, the
Power Glove technology was not used nor further developed awaiting the return of
computer platforms and applications that could benefit from its utility.
With the significant increase in sales of computer platforms and
applications in the late 1990s, 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) is a glove-like peripheral that 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. We
anticipate compatibility with additional computer platforms, such as the
Microsoft Xbox, in the future. According to a Dataquest Inc. market study, 100%
of personal computer shipments in 2001 were USB-compatible units, with an
installed base of over 500 million personal computer units. There are
approximately 27 million computer peripherals that are USB-compatible and the
growth of these products is anticipated to reach over 400 million by the year
2003.
Research & Product Development
Currently, product research and development is conducted via an
exclusive arrangement between us and a Canadian based entity that currently
employs a team of eleven technicians who spend all of their time working on our
products. We have planned for future products that will take the initial P5(TM)
through several stages of evolution, which may include a wireless product, a
two-handed version, the ability to incorporate biometrics, and a product with
tactile feedback. We are also seeking to develop other products, of which
several are currently in initial phases of development, that will utilize one or
more of our technologies. The combination of future generations of the P5(TM)
and the creation of new products will increase our commercial opportunities in
both existing and new markets.
Sales and Marketing
We have identified numerous sales and marketing channels to build a
brand and capture a mass market for the P5(TM), as well as other planned
products. We anticipate that the sales distribution of the P5(TM) will initially
utilize an electronic gaming market retail strategy, expanding into an Original
Equipment Manufacturer (OEM) and direct sales effort for penetration of
commercial and other markets. We plan on selling the P5(TM) into multiple
channels, including but not limited to domestic and international retail,
e-commerce outlets, direct marketing and OEM/private label partnerships.
The P5(TM) was formally introduced at the 2000 Electronic
Entertainment Expo (E3, May 2000) to enthusiastic responses from game developers
and publishers. As of this date, the P5(TM) has appeared, and in some cases been
featured, in over 125 print/online publications and on over 25 television, radio
and online segments. In recent months alone, the P5(TM) has been covered by
publications including CNN, Wired Magazine, Popular Science, MAC World,
MACAddict, Kiplingers, The History Channel, KTLA's Curt The Cyberguy, Discovery
Channel (Canada), Newsweek (Japan) and the Regis and Kelly Show.
We have signed 20 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
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represent expressions of interest and are not binding commitments. There can be
no assurance that any definitive agreements with such developers will be
finalized or that we will realize any revenues from such relationships.
Furthermore, Essential Reality, LLC briefly advertised the
availability of a limited number of software development kits (SDKs) to the
developer community, and in less than one month received in excess of 450 SDK
applications from game developers and from numerous commercial software
developers, including in the areas of 3D Animation, CAD, education and research,
Internet/multimedia, military and other commercial markets. We have begun to
selectively respond to those applications by beginning to offer SDKs to the most
promising software developers, including premier electronic game development
companies. However, there can be no assurance that any developers will want to
integrate or create content that is P5(TM) compatible.
Lastly, we have received multiple indications of significant
interest from major retailers to begin shipping during the second half of 2002.
While there have been no definitive final agreements with any such retailers, we
expect to start receiving actual purchase orders, pending the successful
completion of vendor integration and the final contractual negotiations with the
respective retailers. Such process has already commenced with several key
retailers. We continue to solicit other retailers and/or distributors, both
domestically and internationally, for P5(TM) volume commitments.
Our headquarters are located at 49 West 27th Street, Suite 7E, New
York, New York 10001 and our telephone number at that address is (212) 244-3200.
We maintain a Web site at www.essentialreality.com. Information contained on our
Web site is not a part of this prospectus.
The Offering
Shares Being Offered
This prospectus relates to the offering by the selling shareholders
of an aggregate of 8,214,239 shares of our common stock, consisting of
o an aggregate of 6,764,870 shares that we issued in connection
with our business combination with Essential Reality LLC;
o an aggregate of 855,000 shares underlying certain warrants that
we issued in connection with the business combination to holders
of certain bridge notes;
o an aggregate of 331,211 shares underlying certain additional
warrants that we issued in connection with the business
combination; and
o an aggregate of 263,158 shares underlying our outstanding
convertible promissory notes.
Use of Proceeds
We will receive no proceeds from the sale of the shares of common
stock by the selling shareholders listed in this prospectus. We will receive
proceeds from the exercise of warrants and those proceeds will be used for our
general corporate purposes.
-3-
Capitalization
Shares of common stock being offered.............................8,214,239
Shares of common stock outstanding prior to this offering.......17,955,718
Shares of common stock outstanding following this offering......19,405,087 (1)
(1) Assumes the exercise of outstanding warrants to purchase 1,186,211 shares
of common stock and the conversion of outstanding convertible promissory
notes into 263,158 shares of common stock. Does not include the exercise of
outstanding options to purchase 1,032,000 shares of common stock.
-4-
RISK FACTORS
An investment in our common stock involves a high degree of risk.
You should carefully consider the risks described below before making an
investment decision. If any of the following circumstances occur, our business,
financial condition or results of operations could be materially adversely
affected. In that event, the trading price of our common stock could decline,
and you may lose part or all of your investment.
Limited Operating History Makes Evaluating Our Business Difficult.
Prior to our business combination with Essential Reality, LLC, their
operations had consisted primarily of organizational activities and product
development. Accordingly, there is very limited operating history upon which an
evaluation of our prospects and future performance can be based. 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. Our prospects must be considered in the light of the risks,
uncertainties, expenses and difficulties frequently encountered by companies in
their early stages of development, particularly companies in new and rapidly
evolving markets, such as electronic gaming.
We Require Additional Financing.
Essential Reality, LLC had no revenues prior to our business
combination. We anticipate, based on currently proposed plans and assumptions
relating to the implementation of our business plan (including the timetable of
costs and expenses associated with, and success of, our marketing efforts), that
the net proceeds of Essential Reality, LLC's recent securities offering together
with projected revenues from operations will be sufficient to satisfy our
operations and capital requirements until the end of fiscal 2002. There can be
no assurance, however, that such funds will not be expended prior thereto due to
unanticipated changes in economic conditions or other unforeseen circumstances.
In the event our plans change or our assumptions change or prove to be
inaccurate (due to unanticipated expenses, difficulties, delays or otherwise) or
the net proceeds of the offering and projected revenues otherwise prove to be
insufficient to fund the implementation of our business plan or working capital
requirements, we could be required to seek additional financing sooner than
currently anticipated. We have no current arrangements with respect to any
additional financing. Consequently, there can be no assurance that 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. In addition, any additional equity financing may
involve substantial dilution to the interests of our then existing security
holders.
We Expect to Incur Operating Losses and Negative Cash Flow for the Foreseeable
Future.
We expect to incur significant net losses and to experience negative
cash flow for the foreseeable future. The auditors opinion for the year ended
December 31, 2001 indicates substantial doubt about our ability to continue as a
going concern. Our success depends on the further development of our products,
establishing and strengthening our brand, as well as establishing distribution
channels for our products and relationships with retailers. Accordingly, we
intend to make significant capital expenditures to market, promote, manufacture
and develop our products and to execute our business model. As a result of such
expenditures, we will need to generate significant revenues to achieve
profitability. There can be no assurance that we will ever achieve revenues or
profitable operations.
-5-
We Need to Manage Our Growth Effectively.
We believe that our growth through the development and
implementation of our business plan will result in an increase in
responsibilities on our management team and will place added pressures on our
operating and financial resources. To manage this anticipated growth, we must
implement systems and train, manage and integrate our employees as we expand our
employee base. We cannot assure you that we have made adequate allowances for
the costs and risks associated with this growth, that our procedures or controls
will be adequate to support our operations, or that our management will be able
to successfully offer and expand our products. If we are unable to manage our
growth effectively, our business could be materially adversely affected.
If Content Developers Do Not Integrate Our Code and the Console Companies Do Not
Accept Us for Licensing or Support, the Full Capabilities of the P5TM May Not Be
Realized.
The full capabilities of the P5TM cannot initially be realized on
its own. However, it is anticipated that PC or Mac users will be able to achieve
mouse and joystick default. In order to achieve the full P5TM experience, a
content developer must integrate our code into their content. We also must be
accepted into a console-licensing program, and we may need to make hardware
and/or software modifications based on the consoles specifications, in order for
the P5TM to achieve compatibility with such consoles. Certain content developers
can receive our code as part of our software developer kit. Once they integrate
our code, we will need to be technologically compatible with the various
consoles. We have applied for participation in certain licensing programs. There
can be no assurance that the content developers will integrate our code, that we
will be accepted into the various console licensing/support programs or that the
P5TM will be able to achieve compatibility with such consoles.
Rapidly Changing Technology Could Hurt Our Operating Results.
The electronic gaming market, the computer peripherals market, as
well as other commercial markets such as education, design and web browsing,
generally are associated with rapidly changing technology and frequent new
product introductions, which often leads to obsolescence and significant price
erosion over the life of a product. The introduction of new technologies can
render existing products obsolete or unmarketable. In addition, a broad range of
competing and incompatible emerging technologies may lead consumers to postpone
buying decisions until a particular platform gains widespread acceptance. As a
result, our products developed for such platforms may not generate sufficient
sales to make such products profitable. Obsolescence of software or platforms
could leave us with increased inventories of unsold products, which would have a
material adverse effect on our operating results.
We need to anticipate technological changes and continually adapt
our new products to emerging industry standards to remain competitive in terms
of price and performance. The development of new, technologically-advanced
products and enhancements is a complex and uncertain process requiring high
levels of innovation as well as the anticipation of technology and market
trends. We may not be able to identify, develop, manufacture, market, sell, or
support new products and enhancements successfully, new products or enhancements
may not achieve market acceptance, or we may not be able to respond effectively
to technology changes, emerging industry standards or product announcements by
competitors. In addition, some of our competitors may have patents or
intellectual property rights that prevent us from being able to respond
effectively to new or emerging technologies and changes in customer
requirements. New product announcements by us could cause our customers to defer
purchases of existing products or cause distributors to request price protection
credits or stock rotations. Any of these events could materially harm our
business, financial condition and results of operations.
-6-
The Electronic Gaming Market is Cyclical, and We May Fail To Anticipate Changing
Consumer Preferences.
Our business is subject to all of the risks generally associated
with the electronic gaming markets, which have been cyclical in nature. Our
future operating results will depend on numerous factors beyond our control that
change rapidly and cannot be predicted, including:
o The popularity and timing of new games and software being
released and distributed that are compatible with our products;
o International, national and regional economic conditions,
particularly economic conditions adversely affecting
discretionary consumer spending;
o Changes in consumer demographics;
o The availability of other forms of entertainment;
o Critical reviews and public tastes and preferences;
o Acceptance of the P5TM code by global content companies, gaming
and other secondary market developers; and
o Our inability to expand our product mix beyond the P5(TM) rapidly
enough to diversify and insulate our revenue model from a
premature downturn in the computer gaming industry.
We must anticipate and respond to rapid changes in consumer tastes
and preferences. A decline in the popularity of video and computer games
requiring 3D-software manipulation could cause sales of our product to decline
dramatically.
3D Environments, On Which We Have Based Our First Product Launch and Near-Term
Business Focus, May Not Achieve Significant Market Acceptance.
Our development efforts with respect to the P5(TM) may not lead to
marketable products that generate sufficient revenues to recover their
development and marketing costs, especially if games using the 3D environment do
not reach a significant level of market acceptance. This risk may increase in
the future, as continuing increases in development costs require corresponding
increases in net sales in order for us to maintain profitability.
We have devoted and will continue to devote significant development
and marketing resources on products designed for USB-compatible systems. If such
systems do not achieve wide acceptance by consumers or such manufacturers are
unable to ship a significant number of such units in a timely fashion, or if the
sale of our product fails to meet our expectations, we will experience lower
than expected sales.
Our Quarterly Operating Results May Vary Significantly, Which Could Cause the
Price of Our Securities to Decline.
We may experience wide fluctuations in quarterly operating results.
The electronic gaming market is highly seasonal, with sales of games and related
devices typically higher during the holiday buying season. Our failure or
inability to produce products on a timely basis to meet seasonal fluctuations in
demand will harm our business and operating results. These fluctuations could
also cause the price of our securities to decline. Other factors that cause
fluctuations include, but are not limited to:
o Volume and timing of orders received during the quarter;
o Timing of new product introductions by us and our industry and
their acceptance by the market;
o Impact of competition on our average selling prices and operating
expenses;
o Our inventory levels or inventory levels in the distribution
channels;
o Product returns from customers; and
-7-
o Changes in technologies and their acceptance by the market.
Our expense levels are based, in part, on our expectations regarding
future sales and therefore, our operating results would be harmed by a decrease
in sales or a failure to meet our sales expectations. The uncertainties
associated with peripheral devices design, development and manufacturing make it
difficult to predict the quarter in which our products will be shipped and
therefore, may cause us to fail to meet financial expectations. In future
quarters our operating results may fall below the expectations of securities
analysts and investors. In this event, the trading price of our securities could
significantly decline.
The Peripheral Input Device Market Is Highly Competitive.
The market for peripheral input devices, including mouses and
joysticks, is very competitive. In addition, Microsoft, Sony and Nintendo, who
currently dominate the interactive entertainment hardware and software industry,
may determine to develop their own 3D peripheral port device or limit the
functionality of input devices utilizing their USB ports, and have the financial
resources to withstand significant price competition and to implement extensive
advertising campaigns. Many of our competitors have far greater financial,
technical, personnel and other resources than we do, and many are able to carry
larger inventories and adopt more aggressive pricing policies. Prolonged price
competition or reduced operating margins would cause our profits to decrease
significantly.
Increased Competition for Limited Shelf Space and Promotional Support From
Retailers Could Affect the Success of Our Business and Require Us to Incur
Greater Expenses to Market Our Products.
Retailers typically have limited shelf space and promotional
resources, and competition is intense among an increasing number of newly
introduced interactive entertainment software products and related items for
adequate levels of shelf space and promotional support. Competition for retail
shelf space is expected to increase, which may require us to increase our
marketing expenditures. Competitors with more extensive lines, popular products
and financial resources frequently have greater bargaining power with retailers.
Accordingly, we may not be able to achieve the levels of support and shelf space
that such competitors receive.
Product Returns That Exceed Our Accruals or Products Delivered But Not Sold May
Significantly Impact Our Financial Results.
As a manufacturer of consumer products, we are exposed to the risk
of product returns, either through the exercise by customers of contractual
return rights or as a result of our assistance in balancing inventories of
retailers and distributors, as well as the risk of products delivered to
retailers not being sold to consumers. A portion of our net sales may result in
increased inventory at our distributors and resellers, which could lead to
reduced orders by these customers in future periods. Overstocking by our
distributors and retailers may lead to higher than normal returns or a deduction
based on the amount of product not sold. The difficulty in predicting future
sales increases the risk that new product introductions, price reductions or
other factors affecting the electronic gaming market would result in significant
product returns. In addition, we intend to introduce product upgrades,
enhancements and improved packaging, and thus may experience higher rates of
return on our older products.
We expect to recognize revenue upon product shipment, less amounts
for estimated returns. We expect that amounts provided for returns will be
estimated based upon historical and anticipated experience and our assessment of
inventory in the channels. Although we believe that we will provide adequate
amounts for projected returns, from time to time we may experience return levels
in excess of amounts provided and our amounts provided may not be sufficient for
actual returns in future periods.
-8-
Our Products Are Susceptible to Errors That Can Harm Our Financial Results And
Reputation.
The technology incorporated into our products may contain defects or
errors that do not become apparent until after commercial introduction.
Remedying such errors may delay our plans, cause us to incur additional costs
and adversely affect our operations. The technological advancements of new
platforms also allow more complex software products. As software products become
more complex, the risk of undetected errors in our products when first
introduced increases. If, despite testing, errors are found in our products
after shipments have been made, we could experience a loss of or delay in timely
market acceptance, product returns, loss of revenues and damage to our
reputation.
Our Business is Dependent on Third-Parties Creating Content for Which Our
Products Will Be Needed.
Our success depends on our ability to identify and support the
P5(TM) enabled specific games and other type of content. We have non-binding
letters of intent with several companies and we are currently reviewing several
potential agreements, but have not yet entered into binding agreements with any
third parties to develop games that are specific to our products. Therefore,
there can be no assurance that a sufficient number of such games shall be
developed. To the extent that such games are not created in a timely fashion, it
could have a material adverse affect on our ability to promote our products
and/or achieve our planned selling price.
We Are Dependent On Third-Party Developers to Complete Our Products.
We rely on third-party developers for the development of our
products' technology. Quality third-party developers are continually in high
demand. Due to the lack of control that we exercise over them, as well as
technical difficulties, these developers may not be able to complete the
products for us on a timely basis or within acceptable quality standards, if at
all. Also, if developers experience financial difficulties, additional costs or
unanticipated development delays, we will not be able to sell our products
according to our schedule and may incur losses.
We Rely On Suppliers of Components Used in Our Products.
Certain key components used in the manufacture of our products, as
well as certain products, are currently purchased by us from single or limited
sources that specialize in these components or products. At present,
single-sourced components include certain of our application-specific integrated
circuits, sensors (also known as bend sensors) and components. We generally do
not have long-term agreements with our single or limited sources of supply. Lead
times and prices for materials and components ordered by us or our contract
manufacturers can vary significantly and depend on factors such as the specific
supplier, contract terms and demand for a component at a given time. From time
to time we may experience supply excesses, shortages and fluctuation in
component prices. Shortages or interruptions in the supply of components or
subcontracted products, or our inability to procure these components or products
from alternate sources at acceptable prices in a timely manner, could delay
shipment of our products or increase our productions costs, which could decrease
our revenue or gross margin. Delays could also adversely affect our business
relationships.
Our Success Will Depend on the Continued Viability and Financial Stability of
Our Distributors and Resellers, As Well As Continued Demand By These Customers
for Our Products.
We plan on selling our products not only directly, but also through
a domestic and/or international network of distributors, sales representatives,
retailers and resellers, and our success will depend on the continued viability
and financial stability of these customers, as well as continued demand by these
customers for our products. The distribution and reseller industries have been
historically characterized by rapid change, including periods of widespread
financial difficulties and consolidations, and disruptions from the emergence of
alternative distribution channels. Our distributor, retailer and reseller
-9-
customers generally offer products of several different companies, including
products competitive with our products. Accordingly, there is a risk that these
distributors, retailers and resellers may give higher priority, including
greater retail shelf space, to products of other suppliers, which would reduce
demand for, and sales of, our products.
We Rely on Arrangements with Independent Third Parties for the Delivery and
Manufacturing of Our Products.
We rely on a number of independent third parties for the manufacture
and delivery of our products, ranging from manufacturing, shipping, fulfillment,
and customer and technical support. The termination of our arrangements with one
or more of these independent companies, or the failure or inability of one or
more of these independent companies to timely complete their duties could
adversely affect our results of operations.
We Are Subject to the Risk That Our Inventory Values May Decline.
The electronic gaming market is subject to rapid technological
change, new and enhanced generations of products, and evolving industry
standards. These changes may cause inventory to decline substantially in value
or to become obsolete.
We Are Subject to Credit and Collection Risks.
Our sales will typically be made on credit and letters of credit,
with terms that vary depending upon the country and the customer. As a result,
we are subject to credit risks, particularly in the event that any of our
receivables represent sales to a limited number of customers or are concentrated
in foreign markets. If we are unable to collect on accounts receivable as they
become due and such accounts are not covered by insurance, it could adversely
affect our financial condition.
Our Inability to Secure Purchase Order Financing or Factor Our Receivables Would
Have an Adverse Effect on Our Financial Condition.
We anticipate obtaining purchase order financing to finance up to
100% of the letters of credit required to order product from the factory. In
addition, we expect to factor up to 80% of our accounts receivable. In the event
we were unable to obtain such financing or factoring arrangements on reasonable
terms, or at all, that would have a material adverse effect on our cash flow
from operations and would require us to obtain alternative sources of funds in
order to implement our business plan.
We May Not Be Able to Protect Our Proprietary Rights or Avoid Claims That We
Infringe on the Proprietary Rights of Others.
We attempt to protect our technology and production techniques under
copyright, trademark and trade secret laws as well as through contractual
restrictions on disclosure, copying and distribution. However, unauthorized
third parties may be able to copy or to reverse engineer our technology. In
addition, our competitors could independently develop technologies substantially
equivalent or superior to our technologies.
As the type of peripherals to computer and game consoles increases
and the functionality of the products overlap, we believe that peripherals will
increasingly become the subject of claims that such technology infringes the
copyrights or patents of others. Although we believe that our technologies and
the technologies of third-party developers with whom we have contractual
relations do not and will not infringe or violate proprietary rights of others,
it is possible that infringement of proprietary rights of others may occur. Any
-10-
claims of infringement, with or without merit, could be time-consuming, costly
and difficult to defend.
We Are Dependent Upon Our Key Executives and Hiring Additional Personnel.
Our success is largely dependent on the personal efforts of certain
key personnel and the hiring of additional management personnel. We are
currently attempting to hire a full-time chief financial officer. The loss of
the services of one or more of these key employees, or the inability to hire
additional management, could adversely affect our business and prospects. Our
success is also dependent upon our ability to hire and retain additional
qualified operating, marketing, technical and financial personnel. Competition
for qualified personnel in the electronic gaming market is intense, and we may
have difficulty hiring or retaining necessary personnel in the future. If we
fail to hire and retain necessary personnel as needed, our business will be
significantly impaired.
We Are Under the Control of Certain Shareholders.
Certain of our shareholders who received shares in the business
combination with Essential Reality, LLC own a substantial majority of our
outstanding common stock. Consequently, they will control the outcome of
substantially all matters submitted to a vote of our security holders including
but not limited to the adoption of measures that could delay or prevent a change
in control or impede a merger, takeover or other business combination we may
potentially be involved in. In addition, pursuant to a voting agreement with
certain other shareholders, one such shareholder has the ability to choose the
members of our Board of Directors.
The Price of Our Securities is Likely to Experience Significant Price and Volume
Fluctuations.
The market price of our securities is likely to be highly volatile
and could be subject to wide fluctuations. Disclosures of our operating results,
announcements of various events by us or our competitors and the developing and
marketing of new products affecting the electronic gaming market may cause the
market price of our securities to change significantly over short periods of
time. Therefore, investors may be unable to resell their shares of common stock
at or above the purchase price.
Future Sales of Our Securities May Affect the Market Price of Our Securities.
We currently have the following securities outstanding:
o 17,955,718 shares of common stock;
o warrants to purchase 1,186,211 shares of common stock;
o convertible promissory notes convertible into 263,158 shares of
common stock; and
o 3,500,000 shares of common stock reserved for issuance under our
option plan.
We cannot predict the effect, if any, that future sales of our
securities or the availability of our securities for future sale will have on
the market price of our securities prevailing from time to time. Sales of
substantial amounts of our securities (including shares issued upon the exercise
of stock options and warrants or conversion of promissory notes), or the
perception that such sales could occur (based on registration rights or
otherwise), may materially and adversely affect prevailing market prices for our
securities.
-11-
If the Price of Our Securities is Volatile, We May Become Subject to Securities
Litigation Which is Expensive and Could Result in Diversion of Resources.
In the past, following periods of volatility in the market price of
a particular company's securities, securities class action litigation has often
been brought against that company. We may also become involved in this type of
litigation. Litigation is often expensive and diverts management's attention and
resources, which could materially and adversely affect our business, financial
condition and results of operations.
Our Forward-Looking Statements May Prove to be Incorrect.
This prospectus includes forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. In some cases, you can identify forward-looking
statements by words such as "may," "will," "should," "could," "expect," "plan,"
"anticipate," "believe," "estimate," "intend," "project," "seek," "predict,"
"potential" or "continue" or the negative of these terms or other comparable
terminology. These statements are contained principally under the headings
"Prospectus Summary," "Risk Factors," "Description of Business" and
"Management's Discussion and Analysis or Plan of Operation." These statements
are only predictions and actual events or results may differ materially. In
evaluating these statements, you should specifically consider various factors,
including the risks outlined under "Risk Factors." Although we believe that the
expectations reflected in the forward-looking statements are reasonable, we
cannot guarantee future results, levels of activity, performance or
achievements. We are under no duty to update any of the forward-looking
statements after the date of this prospectus to conform these statements to
actual results, except as required by laws and regulations.
USE OF PROCEEDS
The shares of common stock offered hereby are being registered for
the account of the selling shareholders identified in this prospectus. See
"Selling Shareholders." We will not receive any proceeds from the sale of such
shares. All net proceeds from the sale of the common stock will go to the
shareholders that offer and sell such shares. We will, however, receive proceeds
from the exercise of warrants and those proceeds will be used for our general
corporate purposes.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock has been eligible for trading on the
Over-the-Counter Bulletin Board since April 19, 2001. 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.
2001 High Low
---- ---- ---
Second Quarter * $1.00 $0.263
Third Quarter $7.00 $1.00
Fourth Quarter $6.05 $2.97
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2002
----
First Quarter $4.30 $4.05
Second Quarter $4.05 $2.25
Third Quarter (through July 17, 2002) $3.20 $2.95
* Restated for 5 for 1 stock split effective July 2, 2001.
According to information furnished by our transfer agent, as of July
16, 2002 we had 85 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 upon our, among other things, future earnings,
capital requirements, financial condition and general business conditions.
-13-
DESCRIPTION OF BUSINESS
General
We were 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 the business combination with Essential Reality, LLC. On
June 20, 2002, we consummated the business combination and began operating
Essential Reality, LLC's business exclusively. Therefore, any historical
discussion about our business would be meaningless and potentially misleading,
so all discussions in this prospectus relating to our business shall mean
Essential Reality, LLC's business.
Essential Reality, LLC was organized in 1999 as a developer of
real-time tracking and sensory technologies. We will focus on combining these
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.
We expect to have our first product, the P5(TM), available for sale
during the second half of 2002. The P5(TM) is a glove-like peripheral device
that could substantially improve the way individuals interact with computer
platforms. The P5(TM), which can be offered at a mass market price point,
addresses technological limitations of current input devices. We expect the
P5(TM) to be suitable for multiple applications including:
o Electronic Gaming - games produced for play on personal
computers, game consoles and location-based entertainment sites;
o Commercial Applications - such as animation, computer aided
design (CAD), simulation training, disability and education; and
o Other Computer Interactions - Internet browsing and navigation,
and general computer interaction.
Since the advent of the mouse, relatively little has changed in the
way of computer input devices, despite the fact that computers and applications
have changed dramatically, growing increasingly complex and specialized.
Applications, particularly in the electronic gaming and commercial markets, have
migrated from flat two-dimensional (2D) interfaces to intuitive,
three-dimensional (3D) environments. However, input devices continue to be
dominated by 2D products including mouse controllers and gaming-specific
peripherals such as joysticks, steering wheels, proprietary console controllers
and the like.
The P5(TM) is based on our patented and several patent-pending
technologies, one of which was incorporated in the "Power Glove." The Power
Glove was introduced to the market in the late 1980s as an alternative
controller for use only with the 8-bit Nintendo Entertainment System, part of
the first generation of game consoles sold to the mass market. The product
eventually sold approximately one million units in the United States, Europe and
Japan. Subsequent to a decline in consumer demand for first-generation gaming
consoles in the early 1990s, such Nintendo system ceased sales. Therefore, the
Power Glove technology was not used nor further developed awaiting the return of
computer platforms and applications that could benefit from its utility.
With the significant increase in sales of computer platforms and
applications in the late 1990s, 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) is a glove-like peripheral that has been
engineered to capture five-finger bend sensitivity enabling gesture recognition,
-14-
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. We
anticipate compatibility with additional computer platforms, such as the
Microsoft Xbox, in the future. According to a Dataquest Inc. market study, 100%
of personal computer shipments in 2001 were USB-compatible units, with an
installed base of over 500 million personal computer units. There are
approximately 27 million computer peripherals that are USB-compatible and the
growth of these products is anticipated to reach over 400 million by the year
2003.
Business Strategy
Our strategy is 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 other applications. In order to achieve this, we
expect to promote content integration and development across all applicable
markets through various initiatives such as providing free SDKs, allocating
resources for content integration initiatives, and by 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 expect to differentiate ourselves from
our competitors. Furthermore, we are pursuing a product development plan for
enhanced versions of the P5(TM) and new products that leverage our core
technologies.
We expect to have multiple revenue streams based on our current and
future product initiatives via retail sales, direct sales and/or royalty
streams, depending on the target market. Over time, these multiple revenue
streams are expected to diversify our customer base and reduce operating risk.
Industry Overview
Market Sizing and Key Drivers
Electronic Gaming. We operate 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 2001 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.
Commercial Markets. Our future sales will also be driven by the
growth and changes in the computer-aided design, engineering, and manufacturing
(CAD, CAE, and CAM) as well as 3D animation software markets. According to
Penton Digital Media Research, the 3D CAD market is expected to grow by over 34%
annually to reach $2.3 billion in 2005. In the 3D content creation segment,
which includes the tools used in 3D content applications in film, game, Web and
design segments, the world-wide market is estimated to be $384 million, growing
25% annually and expected to reach over $1.17 billion by 2005. Key drivers
affecting these markets include improvements in data sharing, storage of complex
CAD files and increased design collaboration over the Internet throughout a
product's lifecycle.
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Evolving Trends
Current trends in the peripheral industry include:
o Increased complexity of peripheral devices, including tactile
feedback and 3D capabilities;
o Wireless communication between peripherals and devices;
o Increased precision that is enabling more robust commercial
applications in CAD and robotics;
o Game production cycles are getting shorter, requiring 3D tool
vendors to deliver better, more integrated tools to software
developers;
o Decreases in component prices and innovations in product design
and construction; and
o Development of more natural interaction between man and machine.
Product Overview
The P5(TM) is designed as a low-cost and intuitive man-machine
interface for both 2D and 3D software applications. We anticipate that the
P5(TM) will serve as a peripheral to personal computers, game consoles and other
USB-compatible platforms.
Figure 1: The P5(TM) Glove and Optical Tracker
[GRAPHIC OMITTED - PICTURE OF GLOVE AND OPTICAL TRACKER]
Bend-Sensor Capabilities
The P5(TM) consists of a hand-worn glove-like device with embedded
electronics. The product utilizes our patented bend sensor technology to
accurately determine the bend of the user's five fingers. The sensing of the
finger bend is accomplished via conductive inks with variable electrical
resistance, detected by position changes of hand digits above a baseline bias
voltage and resistance. The P5(TM) is capable of gesture recognition of specific
placement of thumb/finger digits and can detect whether or not your digits are
in the same position as previously recorded.
Motion-Capture Capabilities
The P5(TM) also tracks the relative position of the hand in space
using a patent-pending optical tracking technology. Utilizing triangulation, the
P5(TM) optical tracking receptor tracks the starting position and movement of
the glove-like device with electronics and firmware/software supporting X, Y, Z,
yaw, pitch and roll positioning. The tracking technology is line-of-sight
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infrared optical using a sufficient number of high/low glove-mounted LED's to
enable a complete six-degrees-of-freedom positioning solution. Two pairs of
horizontal and vertical detector clusters will receive the LED transmissions. In
addition, these same components will provide 3D positioning information. The
P5(TM) will measure yaw, pitch and roll as defined below:
Figure 2: Yaw, Pitch and Roll Diagram
[GRAPHIC OMITTED - PICTURE Definition of Terms
OF HAND WITH ARROWS
SHOWING MOVEMENTS]
Yaw is defined as movement along a plane
parallel to the ground. Yaw motion is
achieved by holding the hand
palm-downward and parallel to the ground,
and pivoting the hand side to side on a
horizontal plane.
Pitch is defined as movement along an
axis that is parallel to the top of the
hand and perpendicular to the wrist, such
that it would enter the wrist below the
thumb and exit below the little finger.
Pitch is accomplished by pivoting the
hand up and down while holding the
forearm parallel to the ground.
Roll is defined as rotation of the hand
about an axis parallel to the ground,
entering the hand at the tip of the
middle finger and running through the
wrist parallel to the forearm. Roll is
accomplished by holding the hand flat
with the palm facing the ground and
turning the arm such that the thumb rises
and the little finger falls or vice
versa.
Compatibility
The first generation P5(TM) is initially designed for compatibility
with the following personal computer operating systems: Microsoft Windows 95,
98, ME, XP and 2000, as well as the Apple Mac OS9 and OS10. In addition, we
expect the P5(TM) to be compatible with the Linux operating system. The P5(TM)
is compatible with the Sony PlayStation2 game console and we anticipate that it
will be compatible with the Microsoft Xbox and other Computer Platforms in 2003
and beyond.
Integration
Our technology allows software developers to easily integrate the
P5(TM) into new and existing applications. Although the P5(TM) emulates the
mouse and the joystick right out-of-the-box in certain computer platforms, in
order to fully penetrate our target markets, it requires that the applications
have the appropriate technological capabilities to support the P5(TM), which is
primarily a matter of having application drivers (instructions which translate
commands into an action or movement with the P5(TM)) written for existing or new
applications. We will employ our content development strategy to promote
software developers to integrate the code.
Pricing Strategy
We are targeting an initial manufacturer's suggested retail price
(MSRP) of between $129-$149 for the P5(TM), depending upon whether an electronic
game bundle is included. We believe that this price point compares favorably
with alternative mass-market peripherals. Based upon initial feedback from
specialty and mass retailers, we believe that the P5(TM) is within the tolerable
price range for products in each of the target markets. We also plan on offering
the P5(TM) for sale together with bundled software titles and will increase the
MSRP to as much as $149 based on the value of the software titles as they are
selling individually at the time. With the cost of electronic games between
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$20-$60, this price point of $149 with a bundled title represents a significant
value to the mass market consumer. In addition, we have received a positive
response from the retail community to the planned MSRP.
We fully expect to achieve higher price points and profit margins
for the P5(TM), enhanced versions, or new products derived from the P5(TM)'s
core technology, when sold in conjunction with higher-value commercial
applications.
Target Markets
We will focus on three broad market opportunities: electronic
gaming, commercial applications and other computer interactions. We expect to
initially focus on the electronic gaming market and expect to begin generating
sales of the P5(TM) in the second half of 2002. In the second phase, we will
concentrate on the market for commercial applications, where we expect users
including engineers, educators, computer animators and others to benefit from
using the P5(TM) technology. Lastly, we expect to target broader computer
applications, which include Internet navigation and general computer
interaction.
Electronic Gaming Market
According to NPD Group, Inc., U.S. sales of video game hardware,
software and accessories, such as hand controllers, jumped 43% to $9.4 billion
in 2001 from $6.6 billion in 2000. During the same period, sales of
computer-game software rose 4.4% to $1.42 billion from $1.36 billion. Much of
this growth is due largely to the successful launch of the Sony PlayStation2,
Microsoft Xbox and the Nintendo GameCube; and the growth in the popularity of
games produced by such leading developers as Electronic Arts, Activision,
TakeTwo Interactive and Infogames. The electronic gaming industry had prompted
the need for significant developments in the man-machine interface with computer
platforms. The desire for more realistic scenes and interaction has led to the
majority of electronic games being developed with 3D environments. Thus, this
market presents an opportunity for an improved interface device capable of
meeting the interaction and intuitive manipulation needs of today's users. Input
devices play an important role in extending the overall video game experience.
As users seek more compelling gaming experiences, they often look to peripherals
as a way to deepen the feeling of immersion in the game.
As games have evolved, peripheral devices have been developed to
accommodate the actions of the user. Games are generally categorized by the type
of action taking place. Mouse controllers, joysticks and other devices have been
developed to meet specific needs: "Simulators" such as flying or driving games
have spawned steering wheels and joysticks that emulate the real tools used by
pilots or drivers. "First-person shooter" games require `fast-twitch' response:
the ability to turn and look rapidly around a room, and the ability to fire
rapidly at a target. Mouse controllers with multiple programmable buttons have
been developed to replace the many keystrokes required to move through the game.
Similarly, roller balls in mouse controllers using different technologies to
increase the accuracy of the pointer have been developed to enable quick turns
and spins within these gaming environments. "Strategy" and "role-playing" games
put the user in the role of a character that walks through an environment to
explore areas and pick up objects. Again, mouse controllers with specific
buttons and ball designs are targeted at these game users to facilitate their
game play.
Ultimately, none of the devices designed for these game types
provide the optimal functionality that a 3D environment requires, namely, the
ability to move in a natural manner and replicate that movement in a character
or action within the application itself. Furthermore, traditional game
controllers do not offer the control and speed (reaction time) that gamers
require. For this reason, 3D gamers have typically settled for game pads and/or
a combination of the keyboard and mouse controllers, which remain today's most
common computer input devices.
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Commercial Software Applications
Professionals use 3D visualization tools in a wide range of CAD
applications. Architects, game designers, product designers, mechanical
designers, construction engineers and animators all use PC-based design software
to create, manipulate and animate in 3D. This market's needs are distinct from
those of the gaming market in that the users seek to create 3D objects, rather
than simply manipulate them, which traditionally requires a time-consuming,
multi-action process.
While the tasks that are enabled by certain devices (i.e., drawing
with digitizing tablets) are useful, the software in general has proven
consistently frustrating to its user base, primarily because it is so difficult
to learn. The primary need in the professional market is to enable the designers
to do their jobs without much wasted time in learning and implementing a
program. Architects, for example, want to solve architectural problems, not
computer problems. It is expected that demonstration of the effectiveness of the
P5(TM) to this market through associations with leading software manufacturers
and trade groups could lead to rapid adoption of our product.
There are opportunities for us to partner with leading software
firms in this industry to provide the interface device that will rapidly address
this market's needs. Applications for this market can be distilled into four
segments based upon the software used and the functionality requirements. These
segments are the Architecture, Engineering and Construction (AEC), Mechanical
Engineering (ME, or MCAD for Mechanical Computer-Aided Design), the Game
Developer and the Film/Video markets. Software vendors operating in these
markets include AutoDesk, Dassault Systems and Agile Software.
According to Cadence Magazine, the AEC market alone is comprised of
roughly 300,000 architects, engineers and construction professionals that
utilize CAD systems for 2D drafting and 3D modeling and visualization. It is
estimated that 60% of this market works primarily in 2D, though the leading
architects have identified a need for software to move beyond today's limited 3D
modeling to the development of `live' parametric models that would allow faster
and easier establishment of design intent and support all phases of project
development. The ME market includes designers of machinery, equipment or any
other product that requires computer schematics for production. The ME market
utilizes CAD systems and 3D design software for the creation and manipulation of
objects. This market is estimated at over 3 million users and is growing at a
rate of approximately 10% a year. This recent growth spurt is a result of the
move from expensive Unix-based platforms to PCs, making it more affordable for
users to purchase and deploy CAD systems.
Game developers use 3D animation programs in the creation of both PC
and console games. 3D design programs are used in a range of commercial video
productions, everything from high-end film creation including movies such as
"Toy Story," to much simpler 3D-logo design on the evening news. The software is
run primarily on Macintosh and Windows platforms and all use high-end,
USB-compatible systems as a matter of necessity. Other markets for 3D design
include Web design and education, geographic mapping, imaging, scientific
visualization, augmented reality and medicine.
Other Computer Interactions
The development of 3D Internet and User interface environments are
closely tied to the proliferation of graphics-related hardware. Graphics-related
hardware includes advanced video cards, video RAM, and 3D accelerator cards, as
well as graphics capabilities built into the main processor. Such hardware
affects the online experience in that it governs the resolution of Web graphics
and the speed at which they render. In addition, some interactive environments
outside of the browser, such as a 3D software engine, require high-end hardware
acceleration. Currently, very few Web ventures outside of the gaming world use
such environments. However, 3D graphics capabilities once limited to high-end
systems have become commonplace in consumer PCs.
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The P5(TM) replicates the existing mouse or joystick commands built
into current PC applications. However, with the awareness of the enhanced
capabilities of the P5(TM), a developer will be able to create entirely new
experiences (commands, gestures, etc.) and user interfaces for existing and
future applications.
We believe that the expansion of broadband use will drive developers
to produce content for the average Internet user. This will enable web
developers to incorporate real-looking objects into e-commerce sites, create
desktops and browsers, which look like real rooms and require manipulation
through a 3D space, and ultimately change the entire Internet experience for the
user. The P5(TM) will enable all users to work intuitively within this
environment. According to a Broadband Report from eMarketer, there is expected
to be approximately 90 million broadband households world-wide by the end of
2004, a 350% increase from the 20 million recorded in 2000.
Research & Product Development
We have planned for future products that will take the initial
P5(TM) through several stages of evolution, which may include a wireless
product, a two-handed version, the ability to incorporate biometrics, and a
product with tactile feedback. We are also seeking to develop other products, of
which several are currently in initial phases of development, that will utilize
one or more of our technologies. The combination of future generations of the
P5(TM) and the creation of new products will increase the commercial
opportunities for us in both existing and new markets.
Moreover, our patent pending optical tracker offers a highly
functional, low-cost alternative to current tracking technologies, which will
enable us to expand our product mix. We intend to develop additional products
that would include areas where current products are hindered by sub-optimal
remote tracking functionality and costly factors. By combining innovative
sensory technologies with these optical tracking advancements, we have the
potential to quickly diversify beyond our current offering. Additionally, we
have filed a provisional patent on an e-writing product, which is a
non-glove-based product. With future products, we hope to diversify beyond the
electronic gaming industry into a broader suite of applications.
Development Company
We have developed our first product, in part by working exclusively
via an exclusive arrangement between us and a Canadian based entity that
currently employs a team of eleven technicians who spend all of their time
working on our products. The development company is headed by an individual who
has extensive experience in design and development of consumer electronics and
virtual reality hardware and software.
Intellectual Property
We have been awarded one U.S. patent regarding its bend sensor
technology, have two patents pending for (i) our shadow-based optical tracking
technology and (ii) a wearable electronic interface device that emits an optical
signal for use in tracking six degrees of motion, and have filed a provisional
patent regarding proprietary software that converts 8-bit analog data stream to
a more precise 12-bit digital data stream for improved motion tracking accuracy
and intend on filing a patent in a timely fashion.
The integration of these technologies into the P5(TM), combined with
proprietary software, firmware and drivers, has resulted in a superior product
that can be offered at a mass market price point not previously achieved in the
market. We have filed a provisional patent on an e-writing product, which is a
non-glove-based product. With future products, we hope to diversify beyond the
electronic gaming industry into a broader suite of applications.
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Sales & Marketing
We are executing on a comprehensive sales and marketing plan
designed to create brand awareness in advance of the 2002 holiday season with
pull through into 2003. We have identified numerous sales and marketing channels
to build a brand and capture a mass market for the P5(TM), as well as its other
planned products. We anticipate that the sales distribution of the P5(TM) will
initially utilize an electronic gaming market retail strategy, expanding into an
OEM and direct sales effort for penetration of commercial and other markets. We
plan to sell the P5(TM) into multiple channels, including but not limited to
domestic and international retail, e-commerce outlets, direct marketing and
OEM/private label partnerships.
Content-Bundling Strategy
In order to achieve product sell through at launch and beyond, we
intend to offer specific electronic gaming and/or non-gaming bundles with the
P5(TM). We anticipate that these bundles will have enhanced gesture recognition
functionality made possible through the use of the P5(TM). We have already
identified our first potential bundling opportunity, which is an upcoming
software title from a leading game developer. The theme of the game supports a
popular movie series scheduled for release in the second half of 2002. Other
bundling opportunities have been identified and we are in the process of
negotiating with the relevant software developers. There can be no assurance,
however, that a definitive agreement will be reached with any of such
developers.
Retailer Community Strategy
In addition to direct discussions with key retailers globally, we
have established arrangements with sales representative firms that are
responsible for sales into regionally-headquartered retailers throughout the
United States. We are also in discussion with geographically-based distributors
around the world that would be responsible for sales, distribution and
fulfillment in each of their respective markets.
We have received multiple indications of significant interest from
major retailers to begin shipping during the second half of 2002. While there
have been no definitive final agreements with any such retailers, we expect to
start receiving actual purchase orders, pending the successful completion of
vendor integration and the final contractual negotiations with the respective
retailers. Such process has already commenced with several key retailers. We
continue to solicit other retailers and/or distributors, both domestically and
internationally, for P5(TM) volume commitments.
Media Coverage / Consumer Awareness
The P5(TM) has gained considerable media acclaim. As of the date of
this prospectus, the P5(TM) has appeared, and in some cases been featured, in
over 125 print/online publications and on over 25 television, radio and online
segments. In recent months alone, the P5(TM) has been covered by publications
including CNN, Wired Magazine, Popular Science, MAC World, MACAddict,
Kiplingers, The History Channel, KTLA's Curt The Cyberguy, Discovery Channel
(Canada), Newsweek (Japan) and the Regis and Kelly Show.
Business Development
We are executing on a comprehensive business development plan
designed to stimulate product demand in electronic gaming, commercial markets
and other applications. We have signed 20 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
represent expressions of interest and are not binding commitments. There can be
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no assurance that any definitive agreements with such developers will be
finalized or that we will realize any revenues from such relationships.
Furthermore, Essential Reality, LLC briefly advertised the
availability of a limited number of software development kits (SDKs) to the
developer community, and in less than one month received in excess of 450 SDK
applications from game developers and from numerous commercial software
developers, including in the areas of 3D Animation, CAD, education and research,
Internet/multimedia, military and other commercial markets. We have begun to
selectively respond to those applications by beginning to offer SDKs to the most
promising software developers, including premier electronic game development
companies. However, there can be no assurance that any developers will want to
integrate or create content that is P5(TM) compatible.
The non-gaming SDK applications have come from an array of
commercial software developers in the areas of: 3D animation/CAD, education and
research, Internet/Multimedia, Military and other vertical markets. We intend to
assist developers in using the SDK to enhance their applications. Although our
primary focus for the next nine to twelve months is to establish a significant
presence in the PC/MAC and console gaming market, these other non-cyclical
vertical markets will provide us with some initial market diversification until
other non-P5(TM) products are introduced to the market later in 2003.
Manufacturing
We have concluded a selection process for our initial manufacturing
partner and selected V-Tech Communications Ltd., 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 is currently working
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. In addition, we are in the final stages of negotiating a
long-term manufacturing agreement with V-Tech that will include capacity
commitments, ramp-up and production schedules, as well as other key
manufacturing terms. We expect to attain volume capacity with V-Tech of
approximately 20,000 units per week per set of machine tools we provide.
Moreover, we have identified alternative sources of manufacturing to complement
or back-up our arrangements with V-Tech. Current estimates indicate an initial
unit cost for the P5(TM) of approximately $40, before the anticipated
implementation of two ASIC designs that will be introduced over the next twelve
months, which should yield further cost reductions.
Competition
We face competition in the electronic gaming peripheral market from
high-end mouse controller and joystick manufacturers such as Logitech and
Microsoft. While several peripherals provide high levels of precision, user
programmability and in some cases a limited amount of tactile feedback, we are
not aware of any peripherals that offer the combination of tracking and gesture
recognition that is found in the P5(TM).
Companies such as Immersion, Gyration, Fifth Dimension Technologies
and Ascension Technologies provide various higher-priced peripherals and
motion-capture products for commercial applications. These entities produce
systems for relatively complex commercial applications. Prices of these
competing products typically run in excess of $1,000 and can exceed $10,000 for
advanced models.
We believe the P5(TM) possesses unique competitive advantages due in
part to (i) the functionality derived from its patented and patent-pending
technologies, (ii) its ease of integration and (iii) its mass market price
point. We believe these advantages will enable it to penetrate its target
markets.
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Employees
As of the date of this prospectus, we have nine full-time salaried
employees and two part-time employees. We believe that our relationship with our
employees is satisfactory. We plan on adding additional staff in areas of senior
management, business development, customer and product support.
Property
We currently lease approximately 4,300 square feet of office space
at 49 West 27th Street, New York, New York 10001, at a price of $10,570 per
month. The five-year lease provides for annual increases in the monthly rent to
a maximum monthly rental price of $11,575. We believe that the office space will
adequately accommodate our expected growth during the upcoming year.
Legal Proceedings
We are not a party to any pending legal proceeding nor, to the
knowledge of our management and board of directors, to any governmental
proceeding.
MANAGEMENT'S PLAN OF OPERATION
Overview
We were 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 the business combination with Essential Reality, LLC. On
June 20, 2002, we consummated the business combination and began operating
Essential Reality, LLC's business exclusively. Therefore, any historical
discussion about our business would be meaningless and potentially misleading,
so all discussions in this prospectus relating to our business shall mean
Essential Reality's business.
Founded in 1999, Essential Reality, LLC is a developer of real-time
tracking and sensory technologies. We are focusing on combining these
technologies into products that enhance the interaction between human beings and
computer platforms, with initial emphasis on a product called "P5(TM)." P5(TM)
is a device shaped in the form of a glove that controls the movement of the
cursor on a computer screen. P5(TM) enables three-dimensional movement of the
cursor as well as pitch, yaw and roll. P5(TM) is controlled by the user moving
his hand or bending his fingers.
We are in the development stage. Successful completion of our
development program and, ultimately, the attainment of profitable operations are
dependent upon future events, including obtaining adequate financing to fulfill
our development activities, and achieving a level of revenue adequate to support
our cost structure.
Since its commencement, Essential Reality, LLC has not generated
revenues and has incurred significant recurring losses from operations, working
capital deficit and deficit in its members' capital. We believe that we have
sufficient resources to operate until the end of fiscal 2002 and thereafter we
will require additional funds in order to reach self-sufficiency. Should we be
unable to obtain the necessary additional funds, we would not be able to
continue as a going concern.
Product development costs are expensed until such time as we
determine that a product is technologically feasible. Product development costs
are capitalized from such date until such time as product development is
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substantially complete. Capitalized product development costs will be amortized
on the straight-line basis over the lesser of the estimated useful life of the
product or three years. For the cumulative period from June 1, 1999 (Date of
Commencement) to March 31, 2002, Essential Reality expensed all product
development costs.
For the three months ended March 31, 2002
The unaudited financial statements have been prepared with generally
accepted accounting principles for interim financial information. In our
opinion, we have included all adjustments (consisting only of normal recurring
accruals) considered necessary for a fair presentation.
Revenue. For the three months ended March 31, 2002, Essential
Reality did not recognize product-related revenues. We do not anticipate
recognizing product-related revenue until the second half of 2002, at the
earliest.
Interest income, which historically was earned from a note
receivable for Essential Reality, LLC's members' capital (as described in
"Liquidity and Capital Resources" below), was $0 in the three months ended March
31, 2002 as compared to $12,878 for the three months ended March 31, 2001.
During the three months ended March 31, 2002, there was no such note receivable
outstanding.
Operating expenses. For the three months ended March 31, 2002,
operating expenses totaled $1,311,513 compared to $314,289 for the three months
ended March 31, 2001. The increase in operating expenses resulted from the
increase in product development, marketing and general and administrative
expenses as described below.
Product development expense for the three months ended March 31,
2002 was $480,822 compared with $133,357 for the three months ended March 31,
2001. The increase in product development reflects increases in salaries and
benefits, fees paid to third party developers and materials used in the
development and manufacturing our P5(TM) product. Included in product
development costs are $37,000 and $8,300 for three months ended March 31, 2002
and 2001, respectively, paid to a company owned by certain of our shareholders.
Marketing expense for the three months ended March 31, 2002 was
$287,588 compared with $83,261 for the three months ended March 31, 2001. The
increase is due to an increase in public relations, corporate identity, trade
shows and related travel.
General and administrative expenses for the three months ended March
31, 2002 was $539,688 compared to $97,506 for the three months ended March 31,
2001. The increase is due to an increase in administrative personnel and the
increased resources required in order to support our development and marketing
activities. Included in general and administrative expenses are costs incurred
of approximately $79,000 and $38,000 for the three months ended March 31, 2002
and 2001, respectively, by two entities that are related to certain members of
LCG Capital Group, LLC, a significant shareholder. Such costs include consulting
fees, employee salaries, occupancy, telephone and computer leases. In the case
of employee salaries, costs are allocated to us based on the time each employee
conducts business specific to us. In the case of the other expenses, costs are
allocated based on a percentage of resources used by us. In our opinion,
allocated expenses incurred from related parties approximates fair market value.
Interest expense. Interest expense for the three months ended March
31, 2002 was $48,585 compared with $513 for the three months ended March 31,
2001. $586 of the interest incurred in 2002 was interest on advances from
entities that are affiliated with LCG Capital Group, and $48,000 was incurred in
relation to the bridge loans described in "Liquidity and Capital Resources"
below.
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Net loss for the three months ended March 31, 2002 and March 31,
2001 were $1,360,098 and $301,924, respectively.
For the year ended December 31, 2001
Revenue. For the year ended December 31, 2001, Essential Reality did
not recognize product-related revenues. We do not anticipate recognizing
product-related revenue until the second half of 2002, at the earliest.
Interest income for the year ended December 31, 2001, which was
earned from the note receivable for Essential Reality, LLC's members' capital,
was $20,465 compared to $104,652 for the year ended December 31, 2000. The
decrease in interest income resulted from the decreases in notes receivable
during the year ended December 31, 2001.
Operating expenses. For the year ended December 31, 2001, operating
expenses totaled $3,131,444 compared to $1,521,672 for the year ended December
31, 2000. The increase in operating expenses resulted from the increase in
product development, marketing and general and administrative expenses as
described below.
Interest expense for the year ended December 31, 2001 was $20,505
compared with $1,934 for the year ended December 31, 2000. $3,819 of the
interest incurred in 2001 was interest on advances from entities that are
affiliated with LCG Capital Group, LLC, a significant shareholder, and $16,686
was incurred in relation to the bridge loans described in "Liquidity and Capital
Resources" below.
Product development expense for the year ended December 31, 2001 was
$1,579,129 compared with $679,891 for the year ended December 31, 2000. The
increase in product development reflects increases in salaries and benefits,
fees paid to third party developers and materials used in the development and
manufacturing of our P5(TM) product. Included in product development costs are
$91,300 and $0 for years ended December 31, 2001 and 2000, respectively, paid to
a company owned by certain of our shareholders. In addition, included in product
development costs are $0 and $105,000 for the years ended December 31, 2001 and
2000, respectively, paid to a company owned by an individual affiliated with
certain of our shareholders.
Marketing expense for the year ended December 31, 2001 was $716,674
compared with $349,851 for the year ended December 31, 2000. The increase is due
to an increase in public relations, corporate identity, trade shows and related
travel.
General and administrative expenses for the year ended December 31,
2001 was $823,791 compared to $491,930 for the year ended December 31, 2000. The
increase is due to increased resources required to support our development and
marketing activities. Included in general and administrative expenses are costs
incurred of approximately $242,000 and $148,000 for the years ended December 31,
2001 and 2000, respectively, by two entities 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 are allocated to us based on the time each employee conducts business
specific to us. In the case of the other expenses, costs are allocated based on
a percentage of resources used by us.
Net loss for the years ended December 31, 2001 and 2000 were
$3,131,484 and $1,418,954, respectively.
Liquidity and Capital Resources
Since inception, Essential Reality, LLC has not generated revenues
and has incurred significant recurring losses from operations, working capital
deficit and deficit in its members' capital. For the period from June 1, 1999
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(date of commencement) to March 31, 2002, Essential Reality, LLC incurred losses
of $6,132,340 and negative cash flow from operating activities and investing
activities of $5,310,383 and $40,001, respectively. Included in the losses for
the period from June 1, 1999 to March 31, 2002 were $2,961,366 of product
development expenses, $1,354,113 of marketing expenses and $1,855,869 of general
and administrative expenses. For the period from June 1, 1999 to March 31, 2002,
the difference between losses and cash flows from operating activities was
$821,957, principally resulting from an increase in accounts payable of
$687,486.
In December 1999, LCG Capital Group acquired a 50% interest in
Essential Reality, LLC for an aggregate purchase price of $2,500,000. The
consideration received was comprised of $500,000 in cash and a $2,000,000
promissory note. The note bore interest at the rate of 6% per annum, had a
maturity date of December 13, 2002 and was secured by the membership interests
of LCG. The debt due under the note was fully repaid in July 2001.
Cash provided by financing activities for the period from June 1,
1999 to March 31, 2002 was $5,627,532, which was derived principally from
proceeds from the issuance of members' capital of $500,000, proceeds from the
repayments of the note receivable for members' capital in the amount of
$2,000,000 and bridge loans in the amount of $3,025,000.
Through March 31, 2002, Essential Reality, LLC received total bridge
loans of $3,025,000. From April 1, 2002 through June 20, 2002, Essential
Reality, LLC received an additional $300,000 in bridge loans. All such loans are
unsecured and bear interest at rates of between 8 1/2% and 18% per annum, and
mature on April 30, 2004. Interest on the bridge loans from JPAL in the amount
of $250,750 and $411,022 has been imputed and accrued representing the interest
payable on the bridge loans advanced from inception through December 31, 2001
and March 31, 2002, respectively, and will be amortized over the life of the
loans through April 30, 2004. Deferred interest will be amortized on a daily
basis from the date of the loan to April 30, 2004, which resulted in a charge to
earnings in the amount of $18,361 and $40,499 for year ended December 31, 2001
and for the three months ended March 31, 2002 (unaudited), respectively.
Essential Reality, LLC recently raised approximately $7.5 million in
gross proceeds through a private placement. We anticipate, based on currently
proposed plans and assumptions relating to the implementation of our business
plan (including the timetable of costs and expenses associated with, and success
of, our marketing efforts), the net proceeds of the recently completed private
placement together with purchase order financing, accounts receivable factoring
and projected revenues from operations, will be sufficient to satisfy our
operations for the nine months ending December 31, 2002. We hope to raise the
additional cash required from the exercise of certain warrants and/or through
additional offerings of our securities.
Plan of Operations
We do not anticipate recognizing product-related revenue until the
second half of 2002, at the earliest.
Product development expenses for the period from April 1, 2002 to
March 31, 2003 are expected to be approximately $3.2 million. The increase in
product development is related to expenses incurred for tooling, ASIC design and
new game development.
Marketing expense is expected to be approximately $3.5 million for
the period from April 1, 2002 to March 31, 2003. The significant increase in
marketing expense is due to anticipated increases in the number of marketing and
sales employees, as well as increases in advertising and promotion, trade shows
and commission expenses.
-26-
General and administrative expenses are expected to be approximately
$2.8 million for the period from April 1, 2002 to March 31, 2003. The increase
in general and administrative is due to anticipated increases in the number of
administrative employees required to support our product development and
marketing activities.
We expect interest expense to be approximately $560,000 for the
period from April 1, 2002 to March 31, 2003. In addition to interest on the
bridge loans, we will incur interest on purchase order financing and accounts
receivable factoring.
We expect that approximately $11.5 million will be required to order
and/or purchase inventory and product related costs.
We expect that bridge loan principal and interest in the net amount
of approximately $2.3 million will be repaid or converted to equity in the
period from April 1, 2002 to March 31, 2003. To date, bridge loans have been
reduced by a net amount of approximately $1.1 million.
Essential Reality, LLC recently raised approximately $7.5 million in
gross proceeds through a private placement. In addition, during the period from
April 1, 2002 to March 31, 2003, we anticipate arranging purchase order
financing, accounts receivable factoring and other trade financing which will
provide cash resources of approximately $8 million. We expect to arrange such
financing prior to the end of fiscal 2002.
For the period from April 1, 2002 to March 31, 2003, it is expected
that we will require a total of approximately $24 million in cash or cash
equivalents, before taking into account projected revenues, in order to repay
the bridge loans, complete our development plan and to begin to produce, market
and sell our primary product. We anticipate, based on currently proposed plans
and assumptions relating to the implementation of our business plan (including
the timetable of costs and expenses associated with, and success of, our
marketing efforts), the net proceeds of the recently completed private placement
together with purchase order financing, accounts receivable factoring and
projected revenues from operations, will be sufficient to satisfy our operations
for the nine months ending December 31, 2002. We hope to raise the additional
cash required from the exercise of certain warrants and/or through additional
offerings of our securities.
-27-
MANAGEMENT
Pursuant to the terms of our business combination with Essential
Reality, LLC, upon consummation of the transaction in June 2002, each of the
officers and directors of Essential Reality, LLC became our officers and
directors.
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. We plan
on hiring additional management personnel in the future including but not
limited to a full-time Chief Financial Officer.
Name Age Title
---- --- -----
Steven Francesco 46 Chief Executive Officer
Humbert B. Powell, III 63 Co-Chief Executive Officer
Reuben Levine 36 President and Chief Operating Officer
Stanley Friedman 59 Vice President, Manufacturing
Richard Rubin 44 Vice President, Product Development
Aaron Gavios 43 Vice President, Sales and Distribution
David Devor 39 Vice President, Marketing
Ian Benoliel 38 Vice President, Finance (Acting)
Martin Currie 36 Vice President, Business Development
Steven Francesco, Chief Executive Officer
Mr. Francesco has been our Chief Executive Officer since July 1, 2002. He brings
over 20 years of experience in the financial services, information technologies
and telecommunications sectors. From January 2001 to February 2002, Mr.
Francesco served as an investment advisor to the venture capital firms of E-Goo
and HFS VC. From April 1999 through November 2000 he served as Chief Executive
Officer of Netrix Corporation (NASD: NXWX), where he refocused the company
toward providing end-to-end packetized voice/data telecommunications solutions,
as well as facilitated the strategic merger with OpenRoute Corporation and
acquisition of Aetherworks Inc. The resulting company, re-named Nx Networks,
offered a comprehensive suite of secure voice communications over Internet
Protocol and partnered with industry leaders, such as Motorola, Siemens, and
Alcatel. Mr. Francesco provided overall strategic direction and helped position
Nx Networks as an industry leader in the Internet-based voice communications
market. During his tenure, the company's market capitalization rose from $18
million to its peak of $1.32 billion. Prior to joining Nx Networks, Mr.
Francesco launched SmartServ Online, Inc. (NASD:SSOL), serving as its President
and Chief Operating Officer from January 1993 to February 1997, where he was
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responsible for business and product development, as well as its marketing
strategy of the firm's products and services. After launching SmartServ, Mr.
Francesco founded and was President of Darien Development Corporation, a
technology consulting firm specializing in the financial sector, from February
1997 to April 1999. While at Darien Development, his clients included GTE
Advanced Network Services, KeyTrade, e-Tel, AT&T, GTE, Citibank, Chemical Bank,
Chase Manhattan Bank, J.J. Kenny, ADP, Telerate, and the Chicago Mercantile
Exchange. From January 1998 to August 2001, Mr. Francesco has served as a
consultant to a number of firms, including DSLI, a privately held company
offering nationwide DSL services, and Sideware Systems, a publicly traded
Electronic Customer Relationship Management (eCRM) firm. From 1989 to 1991, Mr.
Francesco held the position of Senior Vice President of Strategic Planning and
Operations for a division of Cantor-Fitzgerald Securities. This unit offered
processing services to major brokerage and lending institutions, including
clearance and settlement for mortgage-backed securities and derivative products.
In February 1986, Mr. Francesco launched Market Technology Group, a computer and
technology services firm providing financial systems and market data retrieval
technologies to the financial services industry and worked there until March
1989. Mr. Francesco began his career with IBM as a systems engineer. He is also
a veteran of the United States Navy, maintaining ship board Terrier missile
systems. Mr. Francesco served as a member of Net2000's (NASD:NTKK) Board of
Directors from May 2000 to September 2001. He was also a member of their
compensation and nomination committees. In addition, he was Chairman of the
Advisory Board of iBrite, a privately held firm specializing in enabling
technology for handheld devices, as well as a member of its Board of Directors.
Humbert B. Powell, III, Co-Chief Executive Officer
Mr. Powell had been Essential Reality, LLC's acting Chief Executive Officer and
has worked for us in the same capacity since the consummation of the business
combination with Essential Reality, LLC. As of July 1, 2002, he now serves as
our Co-Chief Executive Officer. 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.
Reuben Levine, President and Chief Operating Officer
Mr. Levine had been with Essential Reality, LLC since November 2001, and has
served as our President and Chief Operating Officer since January 1, 2002,
responsible for our day-to-day operations. Prior to joining Essential Reality,
LLC, Mr. Levine was Executive Vice President of ClosingGuard.com Incorporated,
an application service provider for advanced residential real estate closing
technology, from March 2000 to December 2001. Prior to that, he spent six years
at Chase Manhattan Bank, leading some of the company's mission critical business
and technology transformation initiatives in their retail and wholesale
operations. Most recently, he served as the Director of Business Development for
the bank's Internet Division, Chase.com. While at Chase.com, Mr. Levine managed
ongoing business development activities relating to numerous lines of business,
which included initiating, screening and coordinating all aspects of over a
dozen transactions. Additionally, Mr. Levine managed teams of over 30 internal
staff members and external consultants for numerous high-priority process
reengineering initiatives. Throughout Chase's (and formerly Chemical Bank's)
mergers, Mr. Levine managed organization-wide milestones throughout the bank's
retail division that contained high-risk implications in the event of failure.
He began his career in investment banking, with four years in Fortune 500
structured finance and trade finance while at Bankers Trust Company and Bank
Leumi Trust Company of New York. Prior to joining Essential Reality, he served
as an advisor to over a dozen technology start-ups in a broad range of
industries. Mr. Levine holds professional certifications in the areas of
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strategic design and operational modeling/simulation, developed and facilitated
by MIT and Stanford University graduate level programs. Mr. Levine earned his
Bachelor of Arts degree in Economics in 1989 from Yeshiva University in New
York.
Stanley Friedman, Vice President, Manufacturing
Mr. Friedman had been Essential Reality, LLC's, and now is our, our Vice
President of Manufacturing since February 2000 and manages manufacturing and
production control for us. Previously, Mr. Friedman served as Head of Purchasing
and Production at Gund, Inc. from July 1998 to September 1999 and Eden, LLC from
February 1991 to May 1998, where he managed overseas vendors while directing
daily purchasing, production, inventory control, quality assurance and logistics
operations. He was also involved in such company's product forecasting and
source selection, negotiation of purchase orders as well as recruiting, training
and supervising managerial staff. Prior to those positions, Mr. Friedman was at
Megastar Inc. as its Production Controller from August 1970 to December 1990. He
graduated with a Bachelor of Science degree in Accounting from Duquesne
University in Pennsylvania and has completed graduate courses in Industrial
Management and Cost Estimating. Mr. Friedman holds advanced licenses from the
FAA and FCC, as well as USAF training in electronics.
Richard Rubin, Vice President, Product Development
Mr. Rubin has twenty years of experience in engineering management positions. He
had been Essential Reality, LLC's, and now is our, Vice President of Product
Development since April 2001. Prior to joining Essential Reality, LLC, he was
Vice President of Product Development for Akrion, a semiconductor equipment
manufacturer since November 1999 and Vice President of Engineering &
Manufacturing for ActiMed Laboratories, a producer of medical devices from June
1998 to June 1999. Before that he was the Senior Engineering Program Manager/
Operations Manager for Materials Research Corporation/Veeco Industries, Inc., a
manufacturer of state-of-the-art sputtering cluster systems for the thin film
industry, from November 1995 to February 1998. Mr. Rubin also served as Director
of Engineering for Eden Toys, a global manufacturer and distributor of
interactive toys, from August 1992 to November 1995 and as engineering manager
for Machine Technology, Inc., a developer of wafer processing equipment, from
June 1980 to February 1992. He has a Bachelor of Industrial Design degree from
Rhode Island School of Design and has done advanced study in design in the
United Kingdom at the City of London Polytechnic.
Aaron Gavios, Vice President, Sales and Distribution
Mr. Gavios had been Essential Reality, LLC's, and now is our, Vice President of
Sales and Distribution since November 2001. Mr. Gavios has nearly twenty years
of experience managing marketing and sales for large companies. Most recently,
he was Vice President of Business Development at K2 Digital, a leading Internet
business strategy firm, from September 2000 to November 2001. In that position,
Mr. Gavios headed up K2's marketing and business development efforts, including
the areas of public relations and strategic alliances. Prior to joining K2, Mr.
Gavios served as Vice President of Global Sales for MondoSoft, a Danish
developer and marketer of Web site search engine technology (ASP solution), from
March 1999 to September 2000. Prior to MondoSoft, he was the Executive Vice
President of DSTV Holdings from September 1996 to March 1999, where he developed
and executed a successful marketing strategy for the sale of digital satellite
television in a joint marketing effort with electric utility companies. Prior to
DSTV, Mr. Gavios was National Sales Manager at Rolodex from February 1994 to
September 1996, where he oversaw the sales growth of the Electronic Organizer
Division. Prior to Rolodex, Mr. Gavios was the Regional Sales Manager of the
Eastern Region at Casio from February 1993 to February 1994, where he helped
successfully introduce several products including "My Magic Diary" and the
"Z-7000 PDA." Prior to working at Casio, Mr. Gavios worked at Nintendo as an
Area Sales Manager for the Eastern Region from July 1988 to February 1993, and
helped manage some of the firm's largest accounts, including Toys R Us, Kmart,
and KB Toys. While at Nintendo, he played an important role in rolling out the
"World of Nintendo" store within a store concept. Mr. Gavios received his B.A.
in Sociology from Brandeis University and his M.B.A. in Marketing/International
Business from New York University (Stern) Graduate School of Business
Administration.
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David Devor, Vice President, Marketing
Mr. Devor had been with Essential Reality, LLC since November 1999, and he is
now our Vice President of Marketing since November 2001 and is responsible for
marketing and branding of our products. Prior to joining Essential Reality, 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. Mr. Devor also has over
eight years' experience managing private equity investments through his
principal position with Devor Capital Investments LLC, which investment firm
specializes in high-tech companies with a primary focus on interactive
entertainment, electronic gaming and internet-related opportunities. 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.
Ian Benoliel, Acting Vice President, Finance
Mr. Benoliel had been Essential Reality, LLC's, and now is our, Acting Vice
President of Finance since February 2000. Mr. Benoliel has over 15 years of
business, finance and accounting experience. Mr. Benoliel has been a Principal
of NumberCruncher.com, Inc., a company that develops business decision software
for small businesses and provides outsourced CFO services to small and mid-size
companies, since November 1999. In this capacity, Mr. Benoliel has provided
financial consulting services to us since February 2000. From May 1999 to
February 2000, Mr. Benoliel served as the CFO of Cortex Telecom International,
Inc., a VOIP technology company. From May 1996 to April 1999, Mr. Benoliel was
the CFO and Treasurer of BrandEra, Inc. (NASDAQ-BRND), formerly Warp 10
Technologies, Inc. BrandEra's web site serves as the business-to-business
destination for the marketing communications industry. Mr. Benoliel was
responsible for all of BrandEra's SEC filings, accounting and taxation as well
as administration and investor relations. During a one-year period while at
BrandEra he also acted as the company's COO. From October 1990 to April 1996 Mr.
Benoliel was a partner at Benoliel, Kay - Chartered Accountants. Mr. Benoliel is
a Certified Public Accountant and a Chartered Accountant and NumberCruncher.com,
Inc. is a member of the Intuit Developer Network.
Martin Currie, Vice President, Business Development
Mr. Currie had been Essential Reality, LLC's, and now is our, Vice President of
Business Development since June 2001. Mr. Currie is a seasoned marketing
executive who has been immersed in the video game industry for over seven years.
In his last position, Mr. Currie was Director of Marketing for Infogames, Inc.
(formally GT Interactive) from January 1998 to February 2001, where he oversaw
the launch of titles such as Driver 2, Duke Nukem Time To Kill and Duke Nukem
Zero Hour. Driver 2 won the prestigious award of "Favorite Video Game of the
Year" at the annual Blockbuster Awards and Duke Nukem Time to Kill was awarded
the title of "Best Shooter of the Year" by Sony PlayStation. Prior to this, Mr.
Currie was Marketing Director for RDA International, advertising agency for
Acclaim Entertainment and GT Interactive, from February 1995 to January 1998,
where he took a lead role in the development of major marketing campaigns such
as Unreal, Total Annihilation, Turok Dinosaur Hunter and the Acclaim Sports
franchise. Mr. Currie has also helped such companies as Mad Katz, Titus, Kesmai
and Microsoft Games with their marketing efforts. Before entering the video game
industry, Mr. Currie honed his marketing skills at a number of prestigious
advertising and design agencies in New York City, including the Arnell Group
where he worked on the Donna Karan and DKNY accounts, and Frankfurt Balkind
Partners, where he worked on many high-profile projects.
There are no family relationships among our directors and executive
officers.
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Board of Directors
Set forth below for each of the 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.
For Humbert B. Powell, III's information, please see "Executive Officers and
Other Significant Employees".
Marc A. Fries, age 34
Mr. Fries has been the President of The Raynor Group, 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. He has been instrumental in developing the 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 31
Mr. Jedwab has served as General Counsel to The Hymax Group, a private equity
investment company with investments in numerous public and private companies,
primarily Internet and technology related, for more than five years. In such
capacity, he has been responsible for the direction and management of all legal
and administrative affairs for The Hymax Group. 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.
John Gentile, age 45
Mr. Gentile has served as President of Abrams Gentile Group (ACG), 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 AGG, 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.
Anthony Gentile, age 45
Mr. Gentile has served as Vice-President of Abrams Gentile Group (ACG), 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 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 AGG, he was a
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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.
Committees
In June 2002, the 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 Marc Fries (Chairman), Humbert B. Powell, III and John
Gentile. 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 of Directors may from time to time establish other
committees to facilitate our management.
Director Compensation
As compensation for their services as members of the Board of
Directors, each of the Board members 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 the 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
In January 2001, Essential Reality, 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 is 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 has been with Take-Two interactive, since July 2000.
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.
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
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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 currently provides 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.
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.
In addition, John R. Costantino, who has not yet signed an advisory
agreement with us, has been providing advice to us and is expected to execute an
advisory agreement in the near future. Mr. Costantino has been a principal in
Walden Partners Ltd., a merchant bank, since 1992, and a founder of Walden
Capital Partners since 1996. From 1987 through 1992, Mr. Costantino was a
partner in Costantino, Melamede & Greenberg, an investment partnership that
acquired and managed a number of companies in manufacturing, distribution and
service industries. From 1985 through 1987, he served as the chief operating
officer of Conair Corporation where he was involved in the company's leverage
buyout. Prior to joining Conair, he was a Managing Director of the buyout
division of Integrated Resources, Inc., a large financial services company where
he was responsible for acquiring a number of companies including Wells Fargo
Mortgage Company, the Linde Welding Division of Union Carbide and Brown-Jordan
Company. Mr. Costantino currently serves as director to several companies
including Clayton Acquisition Corporation, Bemiss-Jason Corp., Vox Radio Group
L.P., Plymouth Acquisition Corp., and Ameriscape Inc. He also serves on the
board of the General Electric Mutual Funds and has served on the boards of a
number of public companies including Conair Corp., Brooklyn Bank Corp. and
Lancit Media Entertainment LTD. He was formerly a member of the Advisory Board
of Republic National Bank.
As compensation for serving on the advisory board, the members have
received options to purchase an aggregate of 210,000 shares of our common stock
at exercise prices ranging from $0.75 to $1.60. All of these options vest
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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.
EXECUTIVE COMPENSATION
Following our business combination with Essential Reality, LLC on
June 20, 2002, the executive officers of Essential Reality, LLC became our
executive officers. See "Management" above. During our fiscal year ended
December 31, 2001, we had two chief executive officers. Frank Drechsler became
our President on June 26, 2001. Prior to Mr. Drechsler's election, Ryan Neely
was our President since March 2000. None of Mr. Drechsler, Mr. Neely, nor any
other executive officer of ours was awarded, earned or paid any compensation for
services they rendered to us.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Business Combination With Essential Reality, LLC
On June 20, 2002, we consummated a business combination with
Essential Reality, LLC, a Delaware limited liability company. Pursuant to the
terms of the transaction, all of the members of Essential Reality, 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 Essential Reality,
LLC, 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.
BusinessDevelopment.com, LLC
BusinessDevelopment.com, LLC (BD) is an entity controlled by an
affiliate of LCG Capital Group, LLC, which is a significant shareholder of ours
and a founding member of Essential Reality, LLC. BD entered into an agreement
with Essential Reality, LLC on December 13, 2000, pursuant to which BD provided
general consulting services to Essential Reality, 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, is currently $15,000 per month and
it can increase from time to time up to a maximum of $20,000 per month, based
upon our mutual consent with BD, depending on the level and geographic scope of
the services. To date, Essential Reality, LLC and we have incurred $178,000 of
consulting fees from BD under the terms of such agreement. In addition to the
monthly retainer, we also are obligated to pay to BD a potential revenue share
of up to four percent (4.0%) on transactions facilitated by BD. Either BD or we
may cancel this agreement with thirty (30) days prior notice.
Up until November 30, 2001, Essential Reality, LLC shared office
space with BD. There was an allocation of general expenses in connection with
such office space, whereby BD paid 70% and Essential Reality, LLC paid 30% of
such expenses. Certain items, such as office supplies and computer leases, were
assumed by Essential Reality and taken to its new offices.
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Other Relationships and Related Transactions
We are allocated the costs of a computer lease assumed by HYMAX
Group, Inc., an affiliate of LCG Capital Group, LLC, a significant shareholder
of ours. We pay an allocated amount of approximately $3,000 per month. Such
payments are due through March 2003. HYMAX has also made certain of its
employees available to provide operational support services to Essential
Reality, LLC and now us and is reimbursed for a portion of such employees'
compensation, based on the percentage of time worked for Essential Reality, LLC
and us. Such reimbursement amount currently aggregates approximately $4,500 per
month. Such services are expected to cease in the near future.
In addition, Essential Reality, LLC received loans totaling $76,617
from LCG Capital Group, LLC, which is payable on demand and interest-free.
Advances totaling approximately $23,000 from BD, HYMAX and a founding member of
Essential Reality, LLC are payable on demand and accrue interest at a rate of
10% per annum.
Abrams Gentile Entertainment Corporation (AGE), a company owned by
certain founding members of Essential Reality, LLC, including Anthony and John
Gentile, directors of ours, have provided various services to us. To date we
have incurred approximately $160,000 in fees from AGE and may incur additional
expenses as services are performed.
We owe an aggregate of $267,000 in accrued salaries to certain
affiliates of Essential Reality, LLC for services they rendered to Essential
Reality, LLC.
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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information concerning ownership of
our common stock as of the date of this prospectus, 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. Unless otherwise indicated, we believe that
each shareholder has sole voting power and sole dispositive power with respect
to the shares beneficially owned by him.
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) 53.5%
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 13.4%
c/o Abrams Gentile Entertainment, Inc.
244 West 54th Street, 9th Floor
New York, NY 10017
Michael B. Schwab 2,113,478 (3) 11.8%
c/o 1219 Lombard Street
San Francisco, CA 94109
Big Sky Partners 2,027,078 (4) 11.3%
c/o 1219 Lombard Street
San Francisco, CA 94109
Anthony Gentile 1,121,760 (5) 6.2%
c/o Abrams Gentile Entertainment, Inc.
244 West 54th Street, 9th Floor
New York, NY 10017
John Gentile 1,121,760 (5) 6.2%
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 6.2%
c/o Jayvee & Co.
P.O. Box 9
Commerce Court West
Securities Level
Toronto, Ontario M5H 4A6
Humbert B. Powell, III 0 (5) 0
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Number of Shares Percentage of Outstanding
Name and Address of Beneficial Owner Beneficially Owned Shares Beneficially Owned (1)
------------------------------------ ------------------ -----------------------------
Marc A. Fries 0 (5) 0
Brian D. Jedwab 0 (5) 0
All executive officers and directors as a group 2,270,320 (6) 12.6%
(7 persons)
----------------
* 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 17,955,718 shares of common stock outstanding.
(2) Includes 4,800,000 shares of common stock held by LCG Capital Group,
LLC 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 Capital Group votes its shares with respect
to certain matters (including but not limited to the election of
directors). LCG Capital Group 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 Capital Group and may be deemed to beneficially own
the shares held by LCG. Winchester Capital Group, LLC, as the
managing member of LCG Capital Group, may be deemed to beneficially
own the shares held by LCG Capital Group. Michael Alpert, as the
managing member of Winchester Capital Group, may be deemed to
beneficially own the shares held by LCG Capital Group. Hamilton
Resources Group, Winchester Capital Group and Michael Alpert each
disclaims beneficial ownership of the shares beneficially owned by
LCG Capital Group, except to the extent of its pecuniary interest
therein.
(3) Includes 86,400 shares of common stock held by Mr. Schwab, 1,920,000
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 1,920,000 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 his pecuniary interest
therein.
(5) Does not include 10,000 shares of common stock issuable upon
exercise of options that are not currently exercisable.
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(6) Includes 26,800 shares of common stock issuable upon exercise of
currently exercisable options held by Reuben Levine, our President
and Chief Operating Officer. Does not include 241,200 shares of
common stock issuable upon exercise of options held by Mr. Levine
that are not currently exercisable.
DESCRIPTION OF CAPITAL STOCK
Authorized Stock
Our authorized capital stock consists of 50,000,000 shares of common
stock, par value $.01 per share, and 5,000,000 shares of preferred stock, par
value $.01 per share. As of the date of this prospectus, there were 17,955,718
shares of common stock and no shares of preferred stock issued and outstanding.
In addition, as of the date of this prospectus, the following shares of common
stock have been reserved for issuance:
o 3,500,000 shares reserved for issuance upon the exercise of
options under our stock option plan (of which 1,032,000 have been
issued);
o 263,158 shares reserved for issuance upon conversion of certain
convertible notes, all of which are being registered in this
prospectus;
o 855,000 shares reserved for issuance upon the exercise of certain
bridge warrants, all of which are being registered in this
prospectus; and
o 331,211 shares reserved for issuance upon the exercise of certain
additional warrants, all of which are being registered in this
prospectus.
Common Stock
Holders of shares of common stock are entitled to one vote per share
on all matters that they are entitled to vote upon at meetings of shareholders.
The holders of common stock do not have cumulative voting rights nor do they
have any preemptive, subscription, redemption or conversion rights.
The holders of shares of common stock are entitled to receive
dividends from our funds legally available therefor when, as and if declared by
our Board of Directors. No dividends have been paid to holders of common stock
since our inception.
Convertible Notes
We have issued convertible promissory notes in the aggregate
principal amount of $500,000. These notes mature on April 30, 2004 and earn
interest at a rate of 8 1/2 % per year. For a six-month period ending December
20, 2002, the outstanding principal amount of these notes and accrued unpaid
interest thereon may, at the option of the holder, be converted into shares of
our common stock at a conversion price of $1.90 per share (subject to standard
adjustments). The accounting effect of this conversion benefit will be to
capitalize deferred interest using the beneficial conversion feature method and
to amortize such amount over the terms of the notes.
Bridge Warrants
We have issued warrants to purchase up to an aggregate of 855,000
shares of our common stock, as partial consideration for loans made to us. These
warrants are immediately exercisable and expire on June 20, 2004. Of such
warrants, 15,000 are exercisable at a purchase price of $1.30 per share and the
remaining 840,000 are exercisable at a purchase price of $1.90 per share. The
value of the bridge warrants will be computed using the Black-Scholes and
relative fair value methods and will be capitalized and amortized over the terms
of the loans.
-39-
In addition, we have the right to call these warrants if (i) the
average closing market price of a share of our common stock is trading at $1.50
or more above the prevailing exercise price for a period of no less than 15
consecutive trading days and (ii) the average daily volume of our common stock
traded during such period was at least 100,000 shares.
Additional Warrants
We have issued warrants to purchase up to an aggregate of 331,211
shares of our common stock, in connection with the consummation of our business
combination with Essential Reality, LLC. These warrants are immediately
exercisable and expire on June 20, 2005. These warrants are exercisable at a
purchase price of $1.30 per share. We may not call these warrants.
-40-
SELLING SHAREHOLDERS
The following table sets forth information, as of the date hereof,
with respect to shares of our common stock beneficially owned by each selling
shareholder. The selling shareholders are not obligated to sell any of the
shares offered by this prospectus. The number of shares sold by each selling
shareholder may depend on a number of factors, such as the market price of our
common stock.
We are registering an aggregate of 8,214,239 shares of our common
stock for resale by the selling shareholders in accordance with registration
rights previously granted to them. We agreed to file a registration statement
under the Securities Act with the SEC, of which this prospectus is a part, with
respect to the resale of:
o an aggregate of 6,764,870 shares that we issued in connection
with our business combination with Essential Reality LLC;
o an aggregate of 855,000 shares underlying certain warrants that
we issued in connection with the business combination to holders
of certain bridge notes;
o an aggregate of 331,211 shares underlying certain additional
warrants that we issued in connection with the business
combination; and
o an aggregate of 263,158 shares underlying our outstanding
convertible promissory notes.
The selling shareholders may sell any or all of their shares listed
below from time to time. Accordingly, we cannot estimate how many shares the
selling shareholders will own upon consummation of any such sales. Also, the
selling shareholders may have sold, transferred or otherwise disposed of all or
a portion of their shares since the date on which the shares were issued, in
transactions exempt from the registration requirements of the Securities Act.
Number of Number of Percentage of
Shares Number of Shares Outstanding
Beneficially Shares Beneficially Common
Owned Prior Being Owned After Stock After
Name to Offering(1) Offered Offering(1)(2) Offering(1)
----- -------------- ------- -------------- -----------
LCG Capital Group, LLC
Hamilton Resources Group, LLC 9,600,000 (3) 1,200,000 8,400,000 46.8%
Winchester Capital Group, LLC
Michael Alpert
Martin Abrams 2,400,480 600,120 1,800,360 10.0%
Michael B. Schwab 2,113,478 (4) 51,840 2,061,538 11.5%
Big Sky Partners 2,027,078 (5) 1,152,000 875,078 4.9%
Anthony Gentile 1,121,760 (6) 280,440 841,320 4.7%
John Gentile 1,121,760 (6) 280,440 841,320 4.7%
Jayvee & Co., for AGF Canadian Growth
Equity 1,113,800 668,280 445,520 2.5%
-41-
Number of Number of Percentage of
Shares Number of Shares Outstanding
Beneficially Shares Beneficially Common
Owned Prior Being Owned After Stock After
Name to Offering(1) Offered Offering(1)(2) Offering(1)
----- -------------- ------- -------------- -----------
Steven R. Berkson 540,000 (7) 348,000 192,000 1.1%
Northumberland Holdings Ltd. 484,421 (8) 446,021 38,400 *
1025 Associates, Inc. 271,526 (9) 233,126 38,400 *
Hirsch Wolf 255,000 (10) 159,000 96,000 *
CitiCapital Group, LLC 244,800 146,880 97,920 *
Casurina Performance Fund 240,000 144,000 96,000 *
Royal Trust Corp. of Canada in Trust for
Account #112438001 240,000 144,000 96,000 *
Jayvee & Co., for IG AGF Canadian
Diversified Growth Fund 219,500 131,700 87,800 *
Coniston Investment Corp. 193,440 (11) 193,440 0 0
MSH Entertainment Corporation 156,000 39,000 117,000 *
Joshua Simms Trust 144,000 86,400 57,600 *
Legend Merchant Group, Inc. 137,771 (12) 137,771 0 0
Royal Trust Corp. of Canada in Trust for
Account #99480072, London Life Growth
Equity 126,200 75,720 50,480 *
62 West 39th LLC 100,000 60,000 40,000 *
135 West 36th LLC 100,000 60,000 40,000 *
Jack Beyda 100,000 60,000 40,000 *
BVH Holdings 96,000 57,600 38,400 *
CGTF, LLC 96,000 57,600 38,400 *
Joseph H. Feldman 96,000 57,600 38,400 *
Tsenvi LLC 96,000 57,600 38,400 *
-42-
Number of Number of Percentage of
Shares Number of Shares Outstanding
Beneficially Shares Beneficially Common
Owned Prior Being Owned After Stock After
Name to Offering(1) Offered Offering(1)(2) Offering(1)
----- -------------- ------- -------------- -----------
Royal Trust Corp. of Canada in Trust for
Account #99480027, GWL Growth Equity 91,900 55,140 36,760 *
Jayvee & Co., for Clarica Alpine Growth
Equity 75,800 45,480 30,320 *
Daniel Mestre 72,000 43,200 28,800 *
David Wohlberg 72,000 43,200 28,800 *
SPH Investments, Inc. 65,158 (13) 55,558 9,600 *
Fenmore Consultants, Ltd. 62,158 (14) 52,558 9,600 *
Jim Smith 60,000 (15) 60,000 0 0
Wolver Limited 58,158 (16) 58,158 0 0
Phillip Vitug 57,600 34,560 23,040 *
Michael Garnick 50,000 (17) 50,000 0 0
Erlinda D. Belen 48,000 28,800 19,200 *
Arthur Fefferman 48,000 28,800 19,200 *
Christe-Marie Fuhrman 48,000 28,800 19,200 *
Eric Lindros 48,000 28,800 19,200 *
Meegan Lowth 48,000 28,800 19,200 *
Howard Perl 38,400 23,040 15,360 *
Tzvi Rosen 38,400 23,040 15,360 *
Steven Spector 38,400 23,040 15,360 *
Bel-Cal Properties 35,000 (18) 35,000 0 0
Rivka Perlstein 35,000 (18) 35,000 0 0
-43-
Number of Number of Percentage of
Shares Number of Shares Outstanding
Beneficially Shares Beneficially Common
Owned Prior Being Owned After Stock After
Name to Offering(1) Offered Offering(1)(2) Offering(1)
----- -------------- ------- -------------- -----------
Winton Capital Holdings, Ltd. 35,000 (18) 35,000 0 0
Lori Matherson 31,200 18,720 12,480 *
Abraham Pearson 31,200 18,720 12,480 *
Myriam Braun 30,000 (19) 30,000 0 0
Glenn Michaelson 30,000 (19) 30,000 0 0
547653 Ontario Ltd. 24,000 14,400 9,600 *
1082824 Ontario Inc. 24,000 14,400 9,600 *
Christine & James Alousis 24,000 14,400 9,600 *
Yvonne Chiu 24,000 14,400 9,600 *
Gordon Currie 24,000 14,400 9,600 *
Patricia Currie 24,000 14,400 9,600 *
Fred Dalley 24,000 14,400 9,600 *
Diana DiTomaso 24,000 14,400 9,600 *
Jack Forgash 24,000 14,400 9,600 *
Gunn Trust dtd 4/20/98 24,000 14,400 9,600 *
Richard Hue 24,000 14,400 9,600 *
Michael Kest 24,000 14,400 9,600 *
George J. Nadel & Mary Anne Keefe-Nadel 24,000 14,400 9,600 *
Angelo Nitsopoulos 24,000 14,400 9,600 *
Edward Penwarden 24,000 14,400 9,600 *
Helen Schwab 24,000 14,400 9,600 *
-44-
Number of Number of Percentage of
Shares Number of Shares Outstanding
Beneficially Shares Beneficially Common
Owned Prior Being Owned After Stock After
Name to Offering(1) Offered Offering(1)(2) Offering(1)
----- -------------- ------- -------------- -----------
Abraham Sieger 24,000 14,400 9,600 *
Mordechai Vogel 24,000 14,400 9,600 *
Shimon Vogel 24,000 14,400 9,600 *
FAC Enterprises, Inc. 15,737 (20) 15,737 0 0
Motty Gurary 15,000 (21) 15,000 0 0
Edward Mercaldo 15,000 (21) 15,000 0 0
SPH Investments, Inc. Profit Sharing 15,000 (21) 15,000 0 0
Sanford J. Hillsberg 14,400 8,640 5,760 *
Richard N. Kipper 14,400 8,640 5,760 *
Philip Shapiro 9,984 5,990 3,994 *
Jordan Toder 9,600 5,760 3,840 *
Capital Growth Trust 6,000 (22) 6,000 0 0
Royal Trust Corp. of Canada in Trust for
Account #117288039, Industrial Alliance Cdn
Equity 4,800 2,880 1,920 *
------------------
* 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 17,955,718 shares of common stock outstanding.
(2) Beneficial ownership of shares held by the selling shareholder after
this offering assumes that each selling shareholder sold all of the
shares it is offering in this prospectus but actually will depend on
the number of securities sold.
-45-
(3) Includes 4,800,000 shares of common stock held by LCG Capital Group,
LLC 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 Capital Group votes its shares with respect
to certain matters (including but not limited to the election of
directors). LCG Capital Group 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 Capital Group and may be deemed to beneficially own
the shares held by LCG. Winchester Capital Group, LLC, as the
managing member of LCG Capital Group, may be deemed to beneficially
own the shares held by LCG Capital Group. Michael Alpert, as the
managing member of Winchester Capital Group, may be deemed to
beneficially own the shares held by LCG Capital Group. Hamilton
Resources Group, Winchester Capital Group and Michael Alpert each
disclaims beneficial ownership of the shares beneficially owned by
LCG Capital Group, except to the extent of its pecuniary interest
therein.
(4) Includes 86,400 shares of common stock held by Mr. Schwab, 1,920,000
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.
(5) Includes 1,920,000 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 his pecuniary interest
therein.
(6) Does not include 10,000 shares of common stock issuable upon
exercise of options that are not currently exercisable.
(7) Includes 60,000 shares of common stock issuable upon exercise of
warrants that are currently exercisable.
(8) Includes 270,000 shares of common stock issuable upon exercise of
warrants that are currently exercisable and 118,421 shares of common
stock issuable upon conversion of convertible promissory notes.
(9) Includes 80,000 shares of common stock issuable upon exercise of
warrants that are currently exercisable and 95,526 shares of common
stock issuable upon conversion of convertible promissory notes.
(10) Includes 15,000 shares of common stock issuable upon exercise of
warrants that are currently exercisable.
(11) Includes 193,440 shares of common stock issuable upon exercise of
warrants that are currently exercisable.
(12) Includes 137,771 shares of common stock issuable upon exercise of
warrants that are currently exercisable.
(13) Includes 28,000 shares of common stock issuable upon exercise of
warrants that are currently exercisable and 13,158 shares of common
stock issuable upon conversion of convertible promissory notes.
(14) Includes 25,000 shares of common stock issuable upon exercise of
warrants that are currently exercisable and 13,158 shares of common
stock issuable upon conversion of convertible promissory notes.
(15) Includes 60,000 shares of common stock issuable upon exercise of
warrants that are currently exercisable.
-46-
(16) Includes 45,000 shares of common stock issuable upon exercise of
warrants that are currently exercisable and 13,158 shares of common
stock issuable upon conversion of convertible promissory notes.
(17) Includes 50,000 shares of common stock issuable upon exercise of
warrants that are currently exercisable.
(18) Includes 35,000 shares of common stock issuable upon exercise of
warrants that are currently exercisable.
(19) Includes 30,000 shares of common stock issuable upon exercise of
warrants that are currently exercisable.
(20) Includes 6,000 shares of common stock issuable upon exercise of
warrants that are currently exercisable and 9,737 shares of common
stock issuable upon conversion of convertible promissory notes.
(21) Includes 15,000 shares of common stock issuable upon exercise of
warrants that are currently exercisable.
(22) Includes 6,000 shares of common stock issuable upon exercise of
warrants that are currently exercisable.
PLAN OF DISTRIBUTION
This prospectus relates to the offer and sale by the selling
shareholders of an aggregate of 6,764,870 shares of our common stock that we
issued in connection with our business combination with Essential Reality, LLC
plus an additional 1,449,369 shares of our common stock that are underlying
certain warrants and convertible promissory notes issued in connection with the
business combination.
The selling shareholders may sell the shares in transactions in the
over-the-counter market, in negotiated transactions, or a combination of such
methods of sale. The selling shareholders may sell the shares through public or
private transactions at prevailing market prices, at prices related to such
prevailing market prices or at privately negotiated prices. The selling
shareholders may also sell shares pursuant to Rule 144 of the Securities Act, if
applicable.
The selling shareholders may use underwriters or broker-dealers to
sell the shares. Such underwriters and broker-dealers may receive compensation
in the form of discounts or commissions from the selling shareholders, or they
may receive commissions from the purchasers of shares for whom they acted as
agents, or both (which compensation as to a particular broker-dealer might be in
excess of customary commissions). The selling shareholders and any underwriter
or broker-dealer who participates in the distribution of the shares may be
deemed to be "underwriters" within the meaning of the Securities Act, and any
commissions received by them and any profit on the resale of the shares
purchased by them may be deemed to be underwriting discounts or commissions
under the Securities Act.
In addition, the broker-dealers' commissions, discounts or
concession may qualify as underwriters' compensation under the Securities Act.
We will disclose in a post-effective amendment to the registration statement any
broker-dealers the selling shareholders contract with in the selling effort who
may appear to be acting as underwriters within the meaning of Section 2(11) of
the Securities Act. If any such broker-dealers are acting as underwriters, we
will revise the disclosures in the registration statement to include the amount
of the shares of our common stock being sold by the broker-dealer and, if the
broker-dealer is entitled to sell additional shares, the broker-dealer's
relationship and obligations to us and the selling shareholders and any
associated expenses which we or the selling shareholders may incur in connection
with such sale of our common stock. We will also file any agreement the selling
shareholders or we may enter into with such broker-dealer as an exhibit to the
registration statement.
-47-
Under applicable rules and regulations under the Securities Exchange
Act of 1934, as amended, any person engaged in a distribution of the shares may
not simultaneously engage in market-making activities with respect to our common
stock for a certain period of time, except under certain limited circumstances.
Also, without limiting the foregoing, each selling shareholder and any other
person participating in such distribution will be subject to applicable
provisions of the Exchange Act and rules and regulations thereunder (including
Regulation M), which provisions may limit the timing of purchases and sales of
shares of our common stock by such selling shareholder.
At the time a selling shareholder makes an offer to sell shares, to
the extent required by the Securities Act, a prospectus will be delivered. If a
supplemental prospectus is required, one will be delivered setting forth the
number of shares being offered and the terms of the offering, including the
names of any underwriters, dealers or agents, the purchase price paid by any
underwriter for the shares, and any discounts or commissions.
In order to comply with the securities laws of certain states, if
applicable, the shares will be sold in such jurisdictions only through
registered or licensed brokers or dealers. In addition, in certain states the
shares may not be sold unless they have been registered or qualified for sale in
the applicable state or an exemption from the registration or qualification
requirement is available and complied with.
We have agreed to pay substantially all of the expenses incident to
the registration, offering and sale of the shares to the public, excluding the
commissions or discounts of underwriters, broker-dealers or agents.
LEGAL MATTERS
The validity of the shares of common stock offered hereby will be
passed upon for us by Olshan Grundman Frome Rosenzweig & Wolosky LLP, New York,
New York.
EXPERTS
The financial statements of JPAL, Inc. as of December 31, 2001 and
2000 and for the period from March 31, 1999 (inception) through December 31,
1999, have been audited by Lesley, Thomas, Schwarz & Postma, Inc., independent
auditors, as stated in their report, which is attached hereto, and have been so
included in reliance upon the report of such firm given on their authority as
experts in accounting and auditing.
Essential Reality, LLC's financial statements as of December 31,
2001 and 2000 and for the period from June 1, 1999 (date of commencement) to
December 31, 2001, included in this prospectus, have been audited by Deloitte &
Touche LLP, independent auditors, as stated in their report, appearing herein
and elsewhere in the registration statement (which report expresses an
unqualified opinion and includes an explanatory paragraph which indicates
substantial doubt about the company's ability to continue as a going concern),
and have been so included in reliance upon the report of such firm given upon
their authority as experts in accounting and auditing.
DISCLOSURE OF COMMISSION POSITION ON
INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to our directors, officers or persons
controlling us, we have been advised that it is the SEC's opinion that such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable.
-48-
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement on Form SB-2 with the SEC for
our common stock offered in this offering. This prospectus does not contain all
of the information set forth in the registration statement. You should refer to
the registration statement and its exhibits for additional information. Whenever
we make references in this prospectus to any of our contracts, agreements or
other documents, the references are not necessarily complete and you should
refer to the exhibits attached to the registration statement for the copies of
the actual contract, agreement or other document.
You should rely only on the information and representations provided
in this prospectus or any related supplement. We have not authorized anyone else
to provide you with different information. The selling shareholders will not
make an offer to sell these shares in any state where the offer is not
permitted. You should not assume that the information in this prospectus or any
supplement is accurate as of any date other than the date on the front of those
documents.
The SEC maintains an Internet site at http://www.sec.gov, which
contains reports, proxy and information statements, and other information
regarding us. You may also read and copy any document we file with the SEC at
its Public Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549.
Please call the SEC at 1-800-SEC-0330 for further information on the operation
of the Public Reference Room.
-49-
INDEX TO FINANCIAL STATEMENTS
ESSENTIAL REALITY, INC. (f/k/a JPAL, INC.)
------------------------------------------
Page
----
AUDITED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED
DECEMBER 31, 2001 AND 2000 AND FOR THE PERIOD FROM MARCH 31, 1999
(INCEPTION) THROUGH DECEMBER 31, 1999
Independent Auditors' Report F-2
Balance Sheets F-3
Statements of Operations F-4
Statements of Stockholders' Equity F-5
Statements of Cash Flows F-6
Notes to Financial Statements F-7
UNAUDITED FINANCIAL STATEMENTS AS OF AND FOR THE THREE MONTHS
ENDED MARCH 31, 2002 AND 2001
Condensed Balance Sheet F-14
Condensed Statements of Operations F-15
Condensed Statements of Cash Flows F-16
Notes to Condensed Financial Statements F-18
UNAUDITED PRO FORMA FINANCIAL STATEMENTS
Balance Sheet as of December 31, 2001 F-21
Balance Sheet as of March 31, 2002 F-23
Statement of Operations for the year ended December 31, 2001 F-25
Statement of Operations for the three months ended March 31, 2002 F-26
Supplementary Schedule of Notes Payable F-27
Notes to Unaudited Pro Forma Statements of Operations F-28
ESSENTIAL REALITY, LLC
----------------------
AUDITED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED
DECEMBER 31, 2001 AND 2000 AND FOR THE CUMULATIVE PERIOD FROM
JUNE 1, 1999 (DATE OF COMMENCEMENT) TO DECEMBER 31, 2001, AND
UNAUDITED FINANCIAL STATEMENTS AS OF MARCH 31, 2002 AND 2001 AND
FOR THE CUMULATIVE PERIOD FROM JUNE 1, 1999 (DATE OF COMMENCEMENT)
TO MARCH 31, 2002
Independent Auditors' Report F-30
Balance Sheets F-31
Statements of Operations F-32
Statements of Members' Equity (Deficit) F-33
Statements of Cash Flows F-34
Notes to Financial Statements F-36
F-1
April 11, 2002
Independent Auditors' Report
To the Board of Directors and Stockholders of JPAL, Inc.:
We have audited the accompanying balance sheets of JPAL, Inc. (the "Company") as
of December 31, 2001 and 2000, and the related statements of operations, changes
in stockholders' equity (deficit), and cash flows for each of the two years
ended December 31, 2001 and 2000 and the period from March 31, 1999 (inception)
through December 31, 1999. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits 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 audits provide 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 JPAL, Inc. as of December 31,
2001 and 2000, and the results of its operations and its cash flows for each of
the two years ended December 31, 2001 and 2000 and the period from March 31,
1999 (inception) through December 31, 1999 in conformity with accounting
principles generally accepted in the United States of America.
/s/ Lesley, Thomas, Schwarz & Postma, Inc.
-----------------------------------------------
Lesley, Thomas, Schwarz & Postma, Inc.
A Professional Accountancy Corporation Newport
Beach, California
F-2
JPAL, INC.
BALANCE SHEETS
December 31,
2001 2000
------------ -----------
ASSETS
Current assets
Cash and cash equivalents $ 1,770 $ 413
Prepaid expenses 121 609
----------- -----------
Total current assets 1,891 1,022
Property and equipment, net 1,477 2,074
Accrued interest on note receivable 19,615 --
Note receivable - Essential Reality, LLC 1,500,000 --
----------- -----------
Total assets $ 1,522,983 $ 3,096
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities
Notes payable $ 650,000 $ --
Accounts payable 4,865 97
Accrued interest payable 25,824 --
----------- -----------
Total current liabilities 680,689 97
Long-term liabilities
Notes payable 911,400 --
----------- -----------
Total liabilities 1,592,089 --
----------- -----------
Commitments and contingencies
Stockholders' equity (deficit)
Preferred stock, $.001 par value
5,000,000 shares authorized
No shares issued or outstanding
Common stock, $.001 par value;
50,000,000 shares authorized,
8,645,260 and 18,987,345 shares issued and outstanding at
December 31, 2001 and 2000, respectively 1,729 3,797
Additional paid-in capital 56,272 34,700
Accumulated deficit (127,107) (35,498)
----------- -----------
Total stockholders' equity (deficit) (69,106) 2,999
----------- -----------
Total liabilities and stockholders' equity (deficit) $ 1,522,983 $ 3,096
=========== ===========
See the accompanying notes to these financial statements
F-3
JPAL, INC.
STATEMENTS OF OPERATIONS
March 31, 1999
(Inception)
Years Ended December 31, Through
------------------------ December 31,
2001 2000 1999
------------ ------------ --------------
REVENUES
Rental commissions $ 1,039 $ 2,462 $ 1,523
Listing fees -- 660 5,270
------------ ------------ ------------
1,039 3,122 6,793
------------ ------------ ------------
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE 85,842 21,599 22,835
OTHER (INCOME) EXPENSE
Interest income (19,615) -- --
Interest expense 25,824 -- --
Depreciation 597 599 380
------------ ------------ ------------
92,648 22,198 23,215
------------ ------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES (91,609) (19,076) (16,422)
PROVISION FOR INCOME TAXES -- -- --
------------ ------------ ------------
NET LOSS $ (91,609) $ (19,076) $ (16,422)
============ ============ ============
BASIC LOSS PER SHARE $ (.01) $ (.00) $ (.00)
============ ============ ============
DILUTIVE LOSS PER SHARE $ (.01) $ (.00) $ (.00)
============ ============ ============
Basic and dilutive weighted average of common shares
outstanding 13,344,135 16,651,693 4,500,000
============ ============ ============
See the accompanying notes to these financial statements
F-4
JPAL, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 2001 AND 2000 AND FOR THE PERIOD
FROM MARCH 31, 1999 (INCEPTION) THROUGH DECEMBER 31, 1999
Common Stock
------------ Additional Accumulated
Shares Amount Paid-In Capital Deficit Total
------ ------ --------------- ------- -----
BALANCE, March 31, 1999 (inception) -- $ -- $ -- $ -- $ --
ISSUANCE OF COMMON STOCK FOR SERVICES 4,500,000 900 -- -- 900
ADDITIONAL PAID-IN CAPITAL, (in exchange for goods and
services and rent) -- -- 18,235 -- 18,235
NET LOSS -- -- -- (16,422) (16,422)
----------- ----------- ----------- ----------- -----------
BALANCE, December 31, 1999 4,500,000 900 18,235 (16,422) 2,713
ISSUANCE OF COMMON STOCK FOR CASH 10,500,000 2,100 920 -- 3,020
ISSUANCE OF COMMON STOCK FOR SERVICES 3,987,345 797 -- -- 797
ADDITIONAL PAID-IN CAPITAL, (paid in cash) -- -- 9,795 -- 9,795
ADDITIONAL PAID-IN CAPITAL (in exchange for rent provided
by a stockholder) -- -- 2,000 -- 2,000
ADDITIONAL PAID-IN CAPITAL (in exchange for computer
services provided by a stockholder) -- -- 3,750 -- 3,750
NET LOSS -- -- -- (19,076) (19,076)
----------- ----------- ----------- ----------- -----------
BALANCE, December 31, 2000 18,987,345 3,797 34,700 (35,498) 2,999
----------- ----------- ----------- ----------- -----------
REDEMPTION OF COMMON STOCK (10,342,085) (2,068) 2,068 -- --
ADDITIONAL PAID IN CAPITAL, (in exchange for rent provided
by a stockholder) -- -- 3,900 -- 3,900
ADDITIONAL PAID IN CAPITAL, (in exchange for computer
services provided by a stockholder) -- -- 4,625 -- 4,625
ADDITIONAL PAID IN CAPITAL, (in exchange for legal,
accounting and other administrative services
provided by a stockholder) -- -- 10,979 -- 10,979
NET LOSS -- -- (91,609) (91,609)
----------- ----------- ----------- ----------- -----------
BALANCE, December 31, 2001 8,645,260 $ 1,729 $ 56,272 $ (127,107) $ (69,106)
=========== =========== =========== =========== ===========
See the accompanying notes to these financial statements
F-5
JPAL, INC.
STATEMENTS OF CASH FLOWS
March 31, 1999
(Inception)
Years Ended December 31, Through
------------------------------ December 31,
2001 2000 1999
--------------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (91,609) $ (19,076) $ (16,422)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities
Depreciation 597 599 380
Services provided in exchange for issuance of common stock -- 797 900
Goods and services and rent provided in exchange for additional
paid-in capital 19,504 5,750 18,235
Changes in operating assets and liabilities
Increase in accrued interest on note receivable (19,615)
(Increase) decrease in prepaid expenses 488 (609) --
Increase (decrease) in accounts payable 4,768 (747) 844
Increase in accrued expenses 25,824 -- --
----------- ---------- -----------
Net cash provided by (used in) operating activities (60,043) (13,286) 3,937
----------- ---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment -- -- (3,053)
Note receivable - related party (1,500,000) -- --
----------- ---------- -----------
Net cash used in investing activities (1,500,000) -- (3,053)
----------- ---------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of notes payable 1,561,400 -- --
Proceeds from issuance of common stock -- 3,020 --
Proceeds from additional paid-in capital 2,068 9,795 --
Redemption of common stock (2,068) -- --
----------- ---------- -----------
Net cash provided by financing activities 1,561,400 12,815 --
----------- ---------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,357 (471) 884
CASH AND CASH EQUIVALENTS, beginning of period 413 884 --
----------- ---------- -----------
CASH AND CASH EQUIVALENTS, end of period $ 1,770 $ 413 $ 884
=========== ========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest $ -- $ -- $ --
Cash paid during the period for income taxes $ -- $ -- $ --
SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS
During the year ended December 31, 2001, the Company recorded rent, computer
services, legal, accounting and other administrative expenses totaling $19,504
and additional paid in capital of $19,504 for rent and services paid for and
provided by a stockholder.
During the year ended December 31, 2000, the Company recorded rent and computer
services expense of $2,000 and $3,750, respectively, and additional paid-in
capital of $5,750 for rent and services provided by a stockholder.
During the years ended December 31, 2000 and 1999, the Company issued stock in
exchange for services provided valued at $797 and $900, respectively. During the
period ended December 31, 1999, the Company recorded additional paid-in capital
of $18,235, for goods and services and rent paid for and provided by
stockholders.
See the accompanying notes to these financial statements
F-6
JPAL, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
NOTE 1 - COMPANY OPERATIONS
JPAL, Inc. (the "Company") was incorporated in the state of Nevada on March 31,
1999 to operate as an Internet based provider of vacation rental properties and
services with an elected December 31st fiscal year end. A majority of the
services were to properties located in Nevada.
During the year ended December 31, 2001 the Company abandoned the development of
their Internet services to provide vacation rental properties and services. The
Company is currently in the process of negotiating a merger with another
company.
The Company has experienced net losses since its inception and had an
accumulated deficit of approximately $127,000 at December 31, 2001. Such losses
are attributable to cash losses resulting from costs incurred in the development
of the Company's services and infrastructure. The Company expects operating
losses to continue for the foreseeable future as it continues to seek
alternative business opportunities.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies are summarized as follows:
Cash and Cash Equivalents - For purposes of the balance sheets and statements of
cash flows, the Company considers all highly liquid debt instruments purchased
with a maturity of three (3) months or less to be cash equivalents.
Accounting 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 and disclosure of contingent assets and
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.
Property and Equipment - Property and equipment are stated at cost. Depreciation
is computed using the straight-line method over the estimated useful lives of
the assets which range from three to seven years. Repairs and maintenance to
property and equipment are expensed as incurred. When property and equipment is
retired or disposed of, the related costs and accumulated depreciation are
eliminated from the accounts and any gain or loss on such disposition is
reflected in income.
Advertising - Advertising costs are charged to operations when incurred.
Income Taxes - The Company accounts for income taxes in accordance with the
provisions of Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes", which requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of events that have been
included in the financial statements or tax returns. Under this method, deferred
tax assets and liabilities are determined based on the difference between the
financial statement and the tax basis of assets and liabilities using enacted
rates in effect for the periods in which the 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. Valuation allowances are established when necessary to reduce
deferred tax assets to the amount expected to be realized.
F-7
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Fair Value of Financial Instruments - SFAS No. 107, "Disclosure about Fair Value
of Financial Instruments", requires entities to disclose the fair value of
financial instruments, both assets and liabilities recognized and not recognized
on the balance sheet, for which it is practicable to estimate fair value. SFAS
No. 107 defines fair value of a financial instrument as the amount at which the
instrument could be exchanged in a current transaction between willing parties.
As of December 31, 1999 and 2000, the carrying value of cash and cash
equivalents, accounts payable and accrued interest payable approximate fair
value due to the short-term nature of such instruments.
Based upon borrowing rates currently available to the Company for loans of
similar terms, the carrying value of its debt obligations approximate fair
value.
Based upon rates of return currently available to the Company for investments of
similar terms the carrying value of its note receivable approximates fair value.
Loss Per Share of Common Stock - Basic and diluted loss per share is computed
using shares of common stock issued to date. Consideration is also given in the
dilutive loss per share calculation for the dilutive effect of common stock
equivalents which might result from the exercise of stock options. However, for
all periods presented, there were no common stock equivalents or the effect of
common stock equivalents would be anti-dilutive.
Common Stock Issued for Services Rendered - The Company periodically issues
common stock for services rendered. Common stock issued is valued at the
estimated fair market value of the services provided, as determined by
management. During the year ended December 31, 2000 and the period ended
December 31, 1999, the Company issued 4,500,000 and 3,987,345 shares of common
stock for services. 4,500,000 shares were issued for advisory services and
3,987,345 shares were issued for legal services.
Recent Accounting Pronouncements - In July 2001, the FASB issued Statement of
Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations,"
which is effective for business combinations initiated after June 30, 2001. SFAS
141 eliminates the pooling of interest method of accounting for business
combinations and requires that all business combinations occurring after July 1,
2001 are accounted for under the purchase method. The Company has not been
affected by SFAS 141.
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
142 ("SFAS 142"), "Goodwill and Other Intangible Assets," which is effective for
fiscal years beginning after December 15, 2001. Early adoption is permitted for
entities with fiscal years beginning after March 15, 2001, provided that the
first interim financial statements have not been previously issued. SFAS 142
addresses how intangible assets that are acquired individually or with a group
of other assets should be accounted for in the financial statements upon their
acquisition and after they have been initially recognized in the financial
statements. SFAS 142 requires that goodwill and intangible assets that have
indefinite useful lives not be amortized but rather be tested at least annually
for impairment, and intangible assets that have finite useful lives be amortized
over their useful lives. SFAS 142 provides specific guidance for testing
goodwill and intangible assets that will not be amortized for impairment. The
Company has not been affected by SFAS 142.
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
143 ("SFAS 143"), "Accounting for Asset Retirement Obligations." SFAS 143
established standards associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. This statement is effective
for financial statements issued for fiscal years beginning after June 15, 2002.
The Company does not expect SFAS 143 to have a material impact on its financial
statements.
In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived
Assets." SFAS 144 addresses financial accounting and reporting for the
impairment of long-lived assets of which to be disposed. The provisions of SFAS
144 are effective for financial statements issued for fiscal years beginning
after December 15, 2001, and interim periods within these fiscal years, with
early adoption encouraged. The Company does not expect SFAS 144 to have a
material impact on its financial statements.
F-8
NOTE 3 - PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
December 31,
------------
2001 2000
---- ----
Computer $ 1,791 $ 1,791
Computer equipment 1,057 1,057
Furniture 205 205
------- -------
3,053 3,053
Less: accumulated depreciation (1,576) (979)
------- -------
$ 1,477 $ 2,074
======= =======
NOTE 4 - NOTES PAYABLE
The Company has several unsecured notes payable with interest rates ranging from
8.00% to 8.50%. Notes totaling $650,000 which have a weighted average interest
rate of 8.5 % will mature on the earliest of (i) March 1, 2002 or (ii) the sale
or exchange of all or substantially all of the outstanding shares of common
stock. As of April 11, 2002, these notes and accrued interest have not been
repaid. The note holders have not called the notes. In the event that a note is
called, other note holders have agreed to fund the Company to satisfy its debt.
Notes totaling $911,400 which have a weighted average interest rate of 8.48%
will mature on the earliest of (i) January 31, 2003 or (ii) the sale or exchange
of all or substantially all of the outstanding shares of common stock. The total
amount of notes payable was $1,561,400 at December 31, 2001. Interest expense on
these notes during the year ended December 31, 2001 was $25,824. The Company
issued warrants to acquire 610,560 shares of JPAL, Inc.'s common stock at a
purchase price of $3.00 per share in connection with the issuance of these notes
payable.
$1,500,000 of the proceeds from these notes has been advanced to Essential
Reality, LLC with which the Company is in the process of negotiating a merger
agreement (Note 8). The note receivable is unsecured and bears an interest rate
of 8.5%, however, interest did not begin to accrue until January 31, 2002.
Imputed interest was $19,615 for the year ended December 31, 2001 which is
included in other income. Principal together with accrued interest is due on the
earliest of (i) January 31, 2004, (ii) the closing of the transactions
contemplated by the agreement dated August 23, 2001 (Note 8) or (iii) the sale
or exchange of all or substantially all of the membership interests of Essential
Reality.
F-9
NOTE 5 - INCOME TAXES
The Company accounts for income taxes under Statement of Financial Accounting
Standards No. 109 ("SFAS 109"). This statement mandates the liability method of
accounting for deferred income taxes and permits the recognition of deferred tax
assets subject to an ongoing assessment of realizability.
The components of the Company's income tax provision consist of:
March 31, 1999
Years Ended December 31, (Inception)
------------------------ December 31,
2001 2000 1999
-------- --------- -----------
Federal taxes (deferred) net operating loss benefit $(13,900) $ (2,800) $ (2,500)
Change in valuation account 13,900 2,800 2,500
-------- -------- --------
$ -- $ -- $ --
======== ======== ========
Deferred income taxes are provided for timing differences in the recognition of
certain income and expense items for tax and financial statement purposes. The
tax effect of the temporary differences giving rise to the Company's deferred
tax assets and liabilities as of December 31, 2001 and 2000 are as follows:
December 31,
----------------------------------
2001 2000
--------------- -------------
Deferred income taxes
Net operating loss benefit $ 19,200 $ 5,300
Valuation allowance (19,200) (5,300)
--------------- -------------
$ -- $ --
=============== =============
The Company has federal net operating loss carryforwards of approximately
$127,000 which if not utilized will expire at various times though 2021. For
income tax purposes, only a portion of the net operating loss can be utilized in
any given year if the company that generated the loss has more than fifty
percent (50%) change in ownership in a three (3) year period. Accordingly, there
may be limitations on the use of the Company's net operating loss carryforwards.
A valuation allowance is provided when it is more likely than not that some
portion or all of the deferred tax assets will not be realized. As a result of
the uncertainties surrounding the realization of the net operating loss
carryforwards, management has determined that the realization of the deferred
tax assets is questionable. Accordingly, the Company has recorded a valuation
allowance equal to the net deferred tax asset amount as of December 31, 2001.
F-10
NOTE 6 - RELATED PARTY TRANSACTIONS
The Company is currently utilizing office space provided by the Company's
president (a stockholder). During the years ended December 31, 2001 and 2000,
the Company has recorded rent expense of $3,900 and $2,000, respectively, which
represents the Company's pro rata share of the office space being provided by
the Company's current and past presidents. The Company has also recorded
computer consulting services of $4,625 and $3,750 which were provided by the
Company's previous president for the years ended December 31, 2001 and 2000,
respectively. The services were valued using hourly rates at estimated fair
market value of similar services. During the year ended December 31, 2001 the
Company has recorded $10,979 for legal, accounting and other administrative
expenses that were paid for by the Company's current and past presidents. The
presidents have waived reimbursement of the allocated rent, computer consulting
services, legal, accounting and other administrative services provided and have
considered them as additional paid-in capital. During the year ended December
31, 2001 the Company's current president received $11,000 as compensation which
is included in selling, general and administrative expense.
During the year ended December 31, 2000 the Company paid fees for web-consulting
services to a stockholder totaling $1,500. Additionally, during the period ended
December 31, 1999, the Company paid fees to a stockholder totaling $2,600 for
the construction of their website.
During the year ended December 31, 2000, the Company entered into a consulting
agreement for legal services in exchange for 3,987,345 shares of common stock
which were valued at $797. The services were valued using hourly rates at
estimated fair market value of similar services. During the period ended
December 31, 1999, the Company entered into consulting agreements for advisory
services relating to the initial start-up of the Company in exchange for
4,500,000 shares of common stock. Total fees were $900 for the period ended
December 31, 1999 with each consultant receiving a percentage of ownership in
the form of common stock. The services were valued using hourly rates at
estimated fair market value of similar services.
In addition, during the period ended December 31, 1999, one of the stockholders
paid for various goods and services relating to the Company's operations
including travel, entertainment, trade shows and transportation costs. These
expenses have been included in the results of operations for the corresponding
period and recorded as additional paid-in-capital.
NOTE 7 - STOCKHOLDERS' EQUITY (DEFICIT)
Preferred stock
---------------
Holders of the preferred stock do not have preemptive rights to purchase
additional shares of preferred stock. The preferred stock carries no conversion
rights and is not subject to redemption or to any sinking fund provisions. The
Company is authorized to issue 5,000,000 shares of preferred stock.
Common stock
------------
Holders of the common stock do not have preemptive rights to purchase additional
shares of common stock. The common stock carries no conversion rights and is not
subject to redemption or to any sinking fund provisions. All shares of common
stock are entitled to share equally in dividends from sources legally available
thereof when and if declared by the Board of Directors and, upon liquidation or
dissolution of the company, whether voluntary or involuntary, to share equally
in the assets of the Company available for distribution to stockholders. The
Company is authorized to issue 50,000,000 shares of common stock.
On June 14, 2001 the Company redeemed 10,342,085 shares of its common stock for
$2,068.
On July 2, 2001, the Company approved a 5 for 1 forward stock split of its
common stock. Accordingly, all share and per share amounts have been
retroactively restated in the financial statements to reflect this split.
F-11
During the year ended December 31, 2000, the Company issued 3,987,345 shares of
common stock for services and 10,500,000 shares for cash.
During the period ended December 31, 1999, the Company issued 4,500,000 shares
of common stock for services.
Warrants
--------
During 2001, the Company issued 610,560 warrants in connection with the short
term promissory notes executed from August 23, 2001 through December 31, 2001.
The warrants were issued for the purchase of common stock at $3.00 per share.
These warrants are exercisable at the option of the warrant holder and expire
three years from the date of issuance.
The following represents a summary of the warrants outstanding as of December
31, 2001, 2000 and 1999.
Weighted Average
Shares Exercise Price
---------- ----------------
Outstanding, March 31, 1999 -- $ --
Granted -- --
Expired/forfeited -- --
---------- ------------
Outstanding, December 31, 1999 -- $ --
========== ============
Outstanding, January 1, 2000 -- $ --
Granted -- --
Expired/forfeited -- --
---------- ------------
Outstanding, December 31, 2000 -- $ --
========== ============
Granted 610,560 $ 3.00
Expired/forfeited -- --
---------- ------------
Outstanding, December 31, 2001 610,560 $ 3.00
========== ============
Weighted average fair value of warrants granted $ 3.00
All of the warrants outstanding at December 31, 2001 had an exercise price and a
weighted average price of $3.00 and a weighted average remaining contractual
life of 2.83 years.
F-12
NOTE 8 - COMMITMENTS AND CONTINGENCIES
The Company has entered into an agreement with Essential Reality, LLC
("Essential Reality") dated August 23, 2001 where as the Company and Essential
Reality have agreed to a business combination. The business combination is
contingent on the consummation of the Company's private placement of up to
1,730,769 shares of common stock and up to an additional 288,462 shares of
common stock at a selling price of $3.00 per share.
Upon the closing of the agreement, the Company shall issue 11,000,000 shares of
common stock in exchange for one hundred percent (100)% interest in Essential
Reality.
The Company currently holds a note receivable due from Essential Reality. This
note bears an interest rate of 8.5% and will mature on the earliest of (i)
January 31, 2004, (ii) the closing of the transactions contemplated by the
agreement dated August 23, 2001 or (iii) the sale or exchange of all or
substantially all of the membership interests of Essential Reality. However,
none of the events have occurred. The Company has not generated any revenues
which could have a significant adverse affect on the Company's ability to repay
its debt. In addition, $650,000 of the notes payable which were due on March 1,
2002 have not been paid. The Company is currently negotiating with these note
holders to extend the due date of these notes. Certain of the long-term note
holders have executed letters to the Company indicating that they could fund the
Company to repay the short term notes if the need arises.
NOTE 9 - SUBSEQUENT EVENTS
The Company executed notes payable agreements during January 2002 through
February 2002. These notes total $882,600 which bear an interest rate of
8.50% with maturity dates from January 15, 2002 through January 31, 2003. The
Company issued warrants to acquire 353,040 shares of JPAL, Inc.'s common stock
at a purchase price of $3.00 per share in connection with the issuance of these
notes payable. A note of $100,000 was due on January 15, 2002 and other notes
totaling $225,000 were due on March 1, 2002. As of April 11, 2002, these notes
and accrued interest have not been repaid. The note holders have not called the
notes. In the event that a note is called, other note holders have agreed to
fund the Company to satisfy its debt.
F-13
JPAL, INC.
CONDENSED BALANCE SHEET
MARCH 31, 2002
(unaudited)
ASSETS
Current assets
Cash and cash equivalents $ 4,885
Prepaid expenses 3,187
-----------
Total current assets 8,072
Property and equipment, net of accumulated depreciation of $1,722 1,331
Accrued interest on notes receivable 59,580
Notes receivable - Essential Reality, LLC 2,525,000
-----------
Total assets $ 2,593,983
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Notes payable, net of deferred interest $ 860,835
Accrued interest payable 71,089
Accounts payable 13,771
-----------
Total current liabilities 945,695
Long-term liabilities
Notes payable 1,634,000
-----------
Total liabilities 2,579,695
-----------
Commitments and contingencies
Stockholders' equity
Preferred stock, $.001 par value
5,000,000 shares authorized
No shares issued or outstanding --
Common stock, $.001 par value;
50,000,000 shares authorized,
8,645,260 shares issued and outstanding at March 31, 2002
and December 31, 2001 1,729
Additional paid-in capital 1,434,635
Accumulated deficit (1,422,076)
-----------
Total stockholders' equity 14,288
-----------
Total liabilities and stockholders' equity $ 2,593,983
===========
See the accompanying notes to these unaudited condensed financial statements
F-14
JPAL, INC.
CONDENSED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended March 31,
----------------------------
2002 2001
----------- --------------
REVENUES
Rental commissions $ -- $ 399
------------ -------------
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE 26,525 14,291
------------ -------------
OTHER (INCOME) EXPENSE
Interest income (39,965) --
Interest expense 747,475 --
Depreciation 146 146
------------ -------------
707,656 146
------------ -------------
LOSS BEFORE PROVISION FOR INCOME TAXES (734,181) (14,038)
PROVISION FOR INCOME TAXES -- --
------------ -------------
NET LOSS $ (734,181) $ (14,038)
============ =============
BASIC LOSS PER SHARE $ (0.08) $ (0.00)
============ =============
DILUTIVE LOSS PER SHARE $ (0.08) $ (0.00)
============ =============
BASIC AND DILUTIVE WEIGHTED AVERAGE OF COMMON
SHARES OUTSTANDING 8,645,260 18,987,345
============ =============
See the accompanying notes to these unaudited condensed financial statements
F-15
JPAL, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(unaudited)
Three Months Ended March 31,
----------------------------
2002 2001
------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (734,181) $ (14,038)
Adjustments to reconcile net loss to net cash used in
operating activities
Depreciation 146 146
Goods and services and rent provided in exchange for additional
paid-in capital 1,200 9,605
Deferred interest 702,210 --
Changes in assets and liabilities
Increase in accrued interest on notes receivable (39,965) --
Increase in prepaid expenses (3,066) (324)
Increase in accounts payable 8,906 4,379
Increase in accrued expenses 45,265 --
----------- -----------
Net cash used in operating activities (19,485) (232)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Issuance of notes receivable (1,025,000) --
----------- -----------
Net cash used in investing activities (1,025,000) --
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of notes payable 1,047,600 --
----------- -----------
Net cash provided by financing activities 1,047,600 --
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 3,115 (232)
CASH AND CASH EQUIVALENTS, beginning of period 1,770 413
----------- -----------
CASH AND CASH EQUIVALENTS, end of period $ 4,885 $ 181
=========== ===========
See the accompanying notes to these unaudited condensed financial statements
F-16
JPAL, INC.
CONDENSED STATEMENTS OF CASH FLOWS (CONTINUED)
(unaudited)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Three Months Ended March 31,
----------------------------
2002 2001
----------- -----------
Cash paid during the period for interest $ -- $ --
Cash paid during the period for income taxes $ -- $ --
SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS
During the period ended March 31, 2002, the Company recorded rent of
$1,200 and additional paid-in capital of $1,200 for rent provided by
a stockholder.
During the period ended March 31, 2002, the Company had $1,047,600 of
proceeds from notes payable, of which $538,887 has been assigned to
the value of the warrants and has been recorded as additional
paid-in capital.
During the period ended March 31, 2001, the Company recorded rent and
computer services of $750 and $3,000, respectively, and additional
paid-in capital of $3,750 for rent and services provided by a
stockholder.
During the period ended March 31, 2001, the Company recorded legal and
accounting expense of $2,705 and $3,150, respectively, and
additional paid-in capital of $5,855 for services paid directly by a
stockholder.
See the accompanying notes to these unaudited condensed financial statements.
F-17
JPAL, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
MARCH 31, 2002 AND 2001
(unaudited)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements reflect the results of
operations for JPAL, Inc. and have been prepared in accordance with accounting
principles generally accepted in the United States of America for interim
financial information and with the instructions to Form 10-QSB and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States of America for complete financial statements. In the opinion of
management, all adjustments consisting of normal recurring accruals and
adjustments considered necessary for a fair presentation have been included.
Operating results for the three month period ended March 31, 2002 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 2002. For further information, refer to the financial statements
and footnotes thereto included in JPAL, Inc.'s Annual Report on Form 10-KSB/A
for the year ended December 31, 2001 filed with the Securities and Exchange
Commission (SEC) on May 8, 2002.
JPAL, Inc. (the "Company") was incorporated in the state of Nevada on March 31,
1999 to operate as an Internet based provider of vacation rental properties and
services with an elected December 31st fiscal year end. A majority of the
services are to properties located in Nevada.
During the year ended December 31, 2001, the Company abandoned the development
of their Internet services to provide vacation rental properties and services.
The Company is currently entered into a contribution agreement with another
company that may result in a merger with that company.
The Company has experienced net losses since its inception and had an
accumulated deficit of approximately $1,422,000 at March 31, 2002. Such losses
are attributable to cash losses resulting from costs incurred in the development
of the Company's services and infrastructure. The Company expects operating
losses to continue for the foreseeable future as it continues to seek
alternative business opportunities.
NOTE 2 - INCOME TAXES
The Company accounts for income taxes under Statement of Financial Accounting
Standards No. 109 ("SFAS 109"). This statement mandates the liability method of
accounting for deferred income taxes and permits the recognition of deferred tax
assets subject to an ongoing assessment of realizability.
The components of the Company's income tax provision consist of:
Three Months Ended March 31,
-----------------------------
2002 2001
------------ -------------
Federal taxes (deferred) net operating loss benefit $ (111,500) $ (2,200)
Change in valuation account 111,500 2,200
-------------- -------------
$ -- $ --
============== =============
F-18
Deferred income taxes are provided for timing differences in the recognition of
certain income and expense items for tax and financial statement purposes. The
tax effect of the temporary differences giving rise to the Company's deferred
tax assets and liabilities as of March 31, 2002 are as follows:
Deferred income taxes
Net operating loss benefit $ 214,600
Valuation allowance (214,600)
--------------
$ --
==============
The Company has federal net operating loss carryforwards of approximately
$688,000 that will expire through 2021.
The Company's tax reporting year end is December 31st. If the Company has a net
operating loss carryforward from operations for the year ended December 31,
2002, it will expire in 2022.
NOTE 3 - RELATED PARTY TRANSACTIONS
The Company is currently utilizing office space provided by the Company's
president (a stockholder). During the period ended March 31, 2002 and 2001, the
Company has recorded rent expense of $1,200 and $750, respectively, which
represents the Company's pro rata share of the office space being provided by
the Company's president. During the period ended March 31, 2001, the Company has
also recorded computer consulting services of $3,000 which were provided by the
Company's president. The services were valued using hourly rates at estimated
fair market value of similar services. During the period ended March 31, 2001,
the Company has recorded legal and accounting fees of $2,705 and $3,150,
respectively. These services were paid for by the Company's president. The
president has waived reimbursement of the allocated rent, computer consulting
services, legal and accounting services provided and has considered them as
additional paid-in capital.
NOTE 4 - NOTES PAYABLE
The Company has several unsecured notes payable with interest rates ranging from
8.00% to 8.50%. Notes totaling $550,000 which have a weighted average interest
rate of 8.50 % will mature on the earliest of (i) January 15, 2002 or (ii) the
sale or exchange of all or substantially all of the outstanding shares of common
stock. Notes totaling $425,000 which have a weighted average interest rate of
8.50 % will mature on the earliest of (i) March 1, 2002 or (ii) the sale or
exchange of all or substantially all of the outstanding shares of common stock.
As of May 15, 2002, these notes and accrued interest have not been repaid. The
note holders have not called the notes. In the event that a note is called,
other note holders have agreed to fund the Company to satisfy its debt. Notes
totaling $1,634,000 which have a weighted average interest rate of 8.49% were
originally scheduled to mature in 2002 but have subsequently been revised to
mature on the earliest of (i) January 31, 2003 or (ii) the sale or exchange of
all or substantially all of the outstanding shares of common stock. The total
amount of notes payable was $2,609,000 at March 31, 2002. Interest expense on
these notes during the three months ended March 31, 2002 was $45,265. For the
three months ended March 31, 2002, the Company issued warrants valued at
$538,887 to acquire 419,040 shares of JPAL, Inc.'s common stock at a purchase
price of $3.00 per share in connection with the issuance of these notes payable.
The value of such warrants has been reflected as a discount to the related notes
payable, and is being amortized to interest expense over the original terms of
the notes. Deferred interest of $702,210 has been amortized as interest expense
during the three months ended March 31, 2002. The remaining balance of deferred
interest of $114,165 has been netted with the outstanding principal balance of
the current notes payable.
F-19
$2,525,000 of the proceeds from these notes has been advanced to Essential
Reality, LLC with which the Company is in the process of negotiating a merger
agreement (Note 5). The note receivable is unsecured and bears an interest rate
of 8.50%, however, interest did not begin to accrue until January 31, 2002.
Imputed interest was $39,965 for the three months ended March 31, 2002 which is
included in other income. The following is a schedule of maturity dates of these
notes receivable:
Principal Maturity Date
--------- -------------
$ 1,950,000 January 1, 2004
200,000 February 12, 2004
225,000 February 28, 2004
150,000 March 20, 2004
$ 2,525,000
Principal together with accrued interest is due on the earliest of (i) the above
schedule of maturity dates, (ii) the closing of the transactions contemplated by
the agreement dated August 23, 2001 (Note 5) or (iii) the sale or exchange of
all or substantially all of the membership interests of Essential Reality.
NOTE 5 - COMMITMENTS AND CONTINGENCIES
The Company has entered into an agreement with Essential Reality, LLC
("Essential Reality") dated August 23, 2001 whereas the Company and Essential
Reality have agreed to a business combination. This agreement was amended on
April 24, 2002.
The following is a summary of the proposed business combination. This summary is
qualified by the more detailed description appearing in the Company's
Preliminary Proxy Statement on Form PRE 14A filed with Securities Exchange
Commission on May 9, 2002. Upon closing of the agreement, (a) the Company
intends to issue up to 17,280,000 shares of our common stock in exchange for all
of the outstanding membership interests of Essential Reality, including
9,600,000 shares to be issued to Essential Reality's current members. As a
result of this transaction, the Company will acquire and assume the business of
Essential Reality. (b) Essential Reality will consummate a private placement of
its membership interests prior to the exchange transaction, which will be
contributed to the Company in exchange for shares of the Company's common stock.
Essential Reality may sell up to 7,680,000 of its membership interests in its
private placement. (c) Upon completion of the exchange transaction, the
Company's business will be the business currently being conducted by Essential
Reality. (d) The Company's shareholders will not receive any cash, stock or
other property in connection with, or as a result of, the exchange transaction.
(e) Shareholder approval of the proposed business combination will require the
affirmative vote of a majority of the Company's outstanding shares of common
stock. The Company's controlling Shareholder has already informed the Company
that he will be voting in favor of the proposal. The number of votes held by the
controlling Shareholder is sufficient to satisfy the Shareholder vote
requirement for the proposed business combination. Therefore, no additional
votes will be needed to approve the proposed business combination.
The Company currently holds several notes receivable due from Essential Reality.
These notes bear an interest rate of 8.50% and will mature on the earliest of
(i) the schedule of maturity dates in Note 4, (ii) the closing of the
transactions contemplated by the agreement dated August 23, 2001 or (iii) the
sale or exchange of all or substantially all of the membership interests of
Essential Reality. However, none of the events have occurred. The Company has
not generated any revenues which could have a significant adverse affect on the
Company's ability to repay its debt. In addition, $550,000 and $425,000 of the
notes payable which were due on January 15, 2002 and March 1, 2002,
respectively, have not been paid. The Company is currently negotiating with
these note holders to extend the due date of these notes. Certain of the
long-term note holders have executed letters to the Company indicating that they
could fund the Company to repay the short term notes if the need arises.
F-20
ESSENTIAL REALITY, INC.
(A Development Stage Company)
Unaudited Pro Forma Financial Statements
March 31, 2002
On June 20, 2002, Essential Reality, Inc., a Nevada corporation formerly known
as JPAL, Inc. (the "Company"), consummated a business combination (the
"Transaction") with Essential Reality, LLC, a Delaware limited liability company
("ER LLC"). Pursuant to the terms of the Transaction, 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 "Common
Stock"). Such shares consisted of 9,600,000 shares of Common Stock issued to the
original members of ER LLC (the "Contribution Shares") and 7,274,784 shares of
Common Stock issued to new investors who purchased membership interests in ER
LLC in a recently completed private placement (the "Private Placement Shares").
Contemporaneous with the Transaction, the Company cancelled 7,564,326 common
shares of the existing JPAL Inc. shareholders leaving the existing JPAL Inc.
shareholders with 1,080,934 shares of Common Stock. As a result of the
Transaction the Company has 17,955,718 issued and outstanding shares of Common
Stock. Following the Transaction, ER LLC, then a wholly-owned subsidiary of the
Company, was merged with and into the Company.
In connection with the Transaction, (i) holders of certain bridge notes issued
by the Company received, as additional consideration for the loans, two-year
warrants to purchase up to 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 Company exchanged them for convertible promissory notes of the
Company, which are 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 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.
Immediately prior to the Transaction, ER LLC completed a private placement of
7,274,784 membership units for gross proceeds of $7,577,900 (the "Offering").
Included in the gross proceeds was $500,000 of bridge notes that were converted
to 480,000 membership units of the Company. Cash fees and expenses of the
Offering were approximately $600,000.
As a result of the Transaction, inter-company balances in the amount of
approximately $2,600,000 consisting of bridge loans and accrued interest thereon
were eliminated.
The Transaction is expected to be accounted for as a reverse acquisition in
which ER LLC is the accounting acquirer and JPAL Inc. is the legal acquirer. The
management of ER LLC is expected to remain the management of the merged entity.
Since the Transaction is expected to be accounted for as a reverse acquisition
and not a business combination, no goodwill is expected to be recorded in
connection with the Transaction and the costs incurred in connection with the
Transaction are expected to be accounted for as a reduction of additional
paid-in capital.
The following unaudited pro forma financial statements give effect to the
Transaction and the Offering. The unaudited pro forma statement of operations
for the year ended December 31, 2001 and the three months ended March 31, 2002,
gives effect to the Transaction and Offering as if these transactions had
occurred on January 1, 2001. The unaudited pro forma balance sheet as of March
31, 2002 gives effect to the Transaction and Offering as if these transactions
had occurred on March 31, 2002.
F-21
The unaudited pro forma financial statements should be read in conjunction with
the historical financial statements and notes thereto incorporated herein by
reference of JPAL, Inc. and ER LLC. The pro forma financial information is
presented for illustrative purposes only and is not necessarily indicative of
the future financial position or future results of operations of the Company
after the Transaction and the Offering.
F-22
JPAL, INC.
(A Development Stage Entity)
UNAUDITED PRO FORMA BALANCE SHEET
MARCH 31, 2002
------------------------------------------------------------------------------------------------------------------------------------
Essential
JPAL, Inc. Reality, LLC Pro Forma Pro Forma After
March 31, 2002 March 31, 2002 Adjustments Completion of Offering
Offering Transaction and Transaction
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,885 $ 277,148 $ 7,077,900 $ -- (1) $ 6,759,933
(600,000) -- (2)
Deferred financing costs -- 262,326 (262,326) -- (2) --
Prepaid expenses and deposits 3,187 10,225 -- -- 13,412
----------- ----------- ----------- ----------- ------------
Total current assets 8,072 549,699 6,215,574 -- 6,773,345
NOTE RECEIVABLE - ESSENTIAL REALITY 2,525,000 -- -- (2,525,000)(5) --
ACCRUED INTEREST ON NOTE RECEIVABLE 59,580 -- -- (59,580)(5) --
DOMAIN NAMES - Net -- 6,750 -- -- 6,750
FIXED ASSETS - Net 1,331 17,986 -- -- 19,317
OTHER ASSETS -- 80,550 -- -- 80,550
DEFERRED INTEREST EXPENSE - BRIDGE LOANS -- 352,162 (38,732) -- (1) 313,430
----------- ----------- ----------- ----------- ------------
TOTAL ASSETS $ 2,593,983 $ 1,007,147 $ 6,176,842 $(2,584,580) $ 7,193,392
=========== =========== =========== =========== ============
See notes to unaudited pro forma financial statements.
F-23
JPAL, INC.
(A Development Stage Entity)
UNAUDITED PRO FORMA BALANCE SHEET
MARCH 31, 2002 (CONTINUED)
------------------------------------------------------------------------------------------------------------------------------------
Essential
JPAL, Inc. Reality, LLC Pro Forma Pro Forma After
March 31, 2002 March 31, 2002 Adjustments Completion of Offering
Offering Transaction and Transaction
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable $ 13,771 $ 687,486 $ -- $ -- $ 701,257
Accounts payable - related parties -- 143,144 -- -- 143,144
Accrued interest - bridge loans -- 411,022 (38,732) -- (1) 372,290
Accrued compensation -- 270,303 -- -- 270,303
Bridge loans - JPAL, Inc. -- 2,525,000 -- (2,525,000)(5) --
Notes payable (see Supplementary Schedule) 2,494,835 500,000 (500,000) (1) 1,568,280
-- 114,165 (6a)
-- (872,520)(6b)
-- (168,200)(7)
Accrued interest payable 71,089 -- -- (59,580)(5) 11,509
Advances from LCG Capital Group, LLC -- 76,617 -- 76,617
Advances from affiliated companies -- 25,915 -- -- 25,915
------------- ----------- ------------ ------------ ------------
Total current liabilities 2,579,695 4,639,487 (538,732) (3,511,135) 3,169,315
------------- ------------ ------------ ------------ ------------
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock 1,729 -- -- 16,875 (4) 17,956
-- (648) (8)
Additional paid-in capital 1,434,635 -- -- (3) 11,982,628
-- 9,198,699 (4)
-- (114,165) (6a)
-- 1,160,179 (6b)
-- 302,632 (7)
-- 648 (8)
Members' capital -- 2,500,000 7,577,900 (1) --
(862,326) (2)
-- (9,215,574) (4)
Accumulated deficit (1,422,076) (6,132,340) -- (287,659) (6b) (7,976,507)
-- -- -- (134,432) (7) --
------------- ------------ ------------ ------------ ----------
Total stockholders' equity (deficit) 14,288 (3,632,340) 6,715,574 926,555 4,024,077
------------- ------------ ------------ ------------ ---------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY (DEFICIT) $ 2,593,983 $ 1,007,147 $ 6,176,842 $ (2,584,580) $7,193,392
============= ============ ============ ============ ==========
See notes to unaudited pro forma financial statements.
F-24
JPAL, INC.
(A Development Stage Entity)
UNAUDITED PRO FORMA STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2001
JPAL, Inc. Essential Reality, LLC Pro Forma Pro Forma After
Year Ended Year Ended Adjustments Completion of Offering
December 31, 2001 December 31, 2001 Transaction and Transaction
OPERATING EXPENSES:
Product development $ -- $ 1,579,129 $ -- $ 1,579,129
Marketing -- 716,674 -- 716,674
General and administrative 85,842 823,791 -- 909,633
Depreciation and amortization 597 11,850 -- 12,447
------------ ------------ ------------ ------------
Total operating expenses 86,439 3,131,444 -- 3,217,883
------------ ------------ ------------ ------------
LOSS FROM OPERATIONS (86,439) (3,131,444) -- (3,217,883)
INTEREST INCOME 19,615 20,465 -- 40,080
INTEREST EXPENSE (586,612) (20,505) (76,169)(6b) (760,377)
(77,091)(7)
OTHER INCOME 1,039 -- -- 1,039
------------ ------------ ------------ ------------
NET LOSS $ (652,397) $ (3,131,484) $ (153,260) $ (3,937,141)
============ ============ ============ ============
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING -
BASIC AND DILUTED 8,645,260 16,874,784 17,955,718
(7,564,326)(8)
NET LOSS PER SHARE $ (0.08) $ (0.22)
============ ============
See notes to unaudited pro forma financial statements.
F-25
JPAL, INC.
(A Development Stage Entity)
UNAUDITED PRO FORMA STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2002
JPAL, Inc. Essential Reality, LLC Pro Forma Pro Forma After
Three Months Ended Three Months Ended Adjustments Completion of Offering
March 31, 2002 March 31, 2002 Transaction and Transaction
OPERATING EXPENSES:
Product development $ -- $ 480,822 $ -- $ 480,822
Marketing -- 287,588 -- 287,588
General and administrative 26,525 539,688 -- 566,213
Depreciation and amortization 146 3,415 -- 3,561
------------ ------------ ------------ ------------
Total operating expenses 26,671 1,311,513 -- 1,338,184
------------ ------------ ------------ ------------
LOSS FROM OPERATIONS (26,671) (1,311,513) -- (1,338,184)
INTEREST INCOME 39,965 -- -- 39,965
INTEREST EXPENSE (747,475) (48,585) (287,659)(6b) (1,218,151)
(134,432)(7)
OTHER INCOME -- -- -- --
------------ ------------ ------------ ------------
NET LOSS $ (734,181) $ (1,360,098) $ (422,091) $ (2,516,370)
============ ============ ============ ============
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING -
BASIC AND DILUTED 8,645,260 16,874,784 17,955,718
(7,564,326)(8)
NET LOSS PER SHARE $ (0.08) $ (0.14)
============ ============
See notes to unaudited pro forma financial statements.
F-26
JPAL, INC.
(A Development Stage Entity)
PRO FORMA SUPPLEMENTARY SCHEDULE OF NOTES PAYABLE
MARCH 31, 2002
Face Value of Notes Deferred Interest Net
Balance per JPAL, Inc. $ 2,609,000 114,165 $ 2,494,835
Balance per ER LLC of third party bridge loans 500,000 - 500,000
Pro forma adjustment #1 (500,000) - (500,000)
Pro forma adjustment #6a - (114,165) 114,165
Pro forma adjustment #6b - 872,520 (872,520)
Pro forma adjustment #7 - 168,200 (168,200)
----------- ------------ -----------
Pro Forma After Completion of Offering
and Exchange $ 2,609,000 $ 1,040,720 $ 1,568,280
============ ============ ===========
See notes to unaudited pro forma financial statements.
F-27
JPAL, INC.
NOTES TO UNAUDITED PRO FORMA FINANCIAL STATEMENTS
MARCH 31, 2002
--------------------------------------------------------------------------------
I. ASSUMPTIONS
a. The pro forma financial statements reflect the Transaction
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.
b. The pro forma financial statements reflect the Offering whereby
7,274,784 membership units of ER LLC were issued for gross
proceeds of $7,577,900.
II. PRO FORMA ADJUSTMENTS
1) Reflects the issuance of 7,274,784 membership units of ER LLC for
gross proceeds of $7,577,900, which includes the conversion of
$500,000 of notes payable and bridge loans for 480,000 membership
units of ER LLC and the reversal of bridge loan related deferred
interest of $38,732.
2) Reflects the payment of $600,000 of estimated closing costs and
recognition of deferred closing costs of $262,326.
3) Reflects the issuance of 331,211 Additional Warrant Shares having an
imputed value of approximately $1,900,000. The value of these
warrants was computed using the Black-Scholes method and has no
net-effect on member's capital.
4) Reflects the exchange of the membership interest in ER LLC of
$9,215,574 for 16,874,784 shares of common stock of JPAL. The
Transaction is expected to be accounted for as a reverse acquisition
in which ER LLC is the accounting acquirer and JPAL Inc. is the
legal acquirer. The management of ER LLC is expected to remain the
management of the merged entity. Since the Transaction is expected
to be accounted for as a reverse acquisition and not a business
combination, no goodwill is expected to be recorded in connection
with the Transaction and the costs incurred in connection with the
Transaction are expected to be accounted for as a reduction of
additional paid-in capital.
5) Reflects the elimination of inter-company debt upon consolidation of
the accounts of JPAL Inc. and ER LLC.
6) a) Reflects the cancellation of 610,560 warrants to purchase common
shares of JPAL, Inc. at $3.00 per share resulting in the reduction
of deferred interest of $114,165 as of March 31, 2002, and
b) the issuance of Bridge Warrants of 760,000 as of March 31, 2002.
The values of the Bridge Warrants of $1,160,179 as of March 31, 2002
was computed using the Black-Scholes and relative fair value
methods, of which, $76,169 and $287,659 for the year ended December
31, 2001 and the three months ended March 31, 2002, respectively,
have been charged to earnings as interest expense and $872,520 as of
March 31, 2002 has been netted against notes payable. The value of
the Bridge Warrants was computed using $3.05 as the market price,
$1.30 to $1.90 as the exercise prices, 2 year expiration, volatility
of 80% and a risk free rate of 5%.
F-28
7) Reflects the beneficial conversion feature of the Convertible Note
at their inception in the amount of $302,632 of which $77,091 and
$134,432 for the year ended December 31, 2001 and the three months
ended March 31, 2002, respectively, have been charged to earnings as
interest expense and $168,200 as of March 31, 2002 has been netted
against notes payable.
8) Reflects the cancellation of 7,564,326 common shares of JPAL Inc.
held by current JPAL Inc. stockholders.
F-29
INDEPENDENT AUDITORS' REPORT
To the Members and Board of Managers of
Essential Reality, LLC:
We have audited the accompanying balance sheets of Essential Reality, LLC (a
development stage entity) (the "Company") as of December 31, 2001 and 2000, and
the related statements of operations, members' deficit, and cash flows for the
years ended December 31, 2001 and 2000 and for the period from June 1, 1999
(date of commencement) to December 31, 2001. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 audits provide a
reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 2001 and
2000, and the results of its operations and its cash flows for the years then
ended and for the period from June 1, 1999 (date of commencement) to December
31, 2001, 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. The Company is a development stage
enterprise engaged in the development, manufacture and marketing of a gloved
shaped device that controls the movement of objects on a computer screen. As
discussed in Note 1 to the financial statements, the Company has experienced
cumulative net losses of $4,772,242 and cumulative negative operating cash flows
of $4,057,437, which 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 these uncertainties.
Deloitte & Touche, LLP
January 21, 2002 (June 20, 2002 as to Note 8)
F-30
ESSENTIAL REALITY, LLC
(A Development Stage Entity)
BALANCE SHEETS
DECEMBER 31, 2001 AND 2000 AND MARCH 31, 2002 (UNAUDITED)
----------------------------------------------------------------------------------------------
December 31, March 31,
2001 2000 2002
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents (Note 2) $ 13,863 $ 231,905 $ 277,148
Interest receivable -- 48,716 --
Deferred financing costs 217,755 -- 262,326
Prepaid expenses and deposits 34,337 6,820 10,225
----------- ----------- -----------
Total current assets 265,955 287,441 549,699
DOMAIN NAMES - Net (Note 3) 9,000 -- 6,750
FIXED ASSETS - Net (Note 3) 10,099 -- 17,986
OTHER ASSETS 80,550 22,500 80,550
DEFERRED INTEREST EXPENSE - BRIDGE LOANS 232,389 -- 352,162
----------- ----------- -----------
TOTAL ASSETS $ 597,993 $ 309,941 $ 1,007,147
=========== =========== ===========
LIABILITIES AND MEMBERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable $ 676,133 $ 75,238 687,486
Accounts payable - related parties 84,000 -- 143,144
Accrued interest expense - bridge loans (Note 4) 250,750 -- 411,022
Accrued compensation - related party (Note 7) 257,103 221,267 270,303
Bridge loans (Note 4) 1,500,000 -- 3,025,000
Advances from LCG Capital Group, LLC 76,617 -- 76,617
Advances from affiliated companies 25,632 19,647 25,915
----------- ----------- -----------
Total current liabilities 2,870,235 316,152 4,639,487
----------- ----------- -----------
COMMITMENTS AND CONTINGENCIES
MEMBERS' DEFICIT:
Members' capital 2,500,000 2,500,000 2,500,000
Note receivable for members' capital -- (865,453) --
Deficit accumulated during development stage (4,772,242) (1,640,758) (6,132,340)
----------- ----------- -----------
Total members' deficit (2,272,242) (6,211) (3,632,340)
----------- ----------- -----------
TOTAL LIABILITIES AND MEMBERS' DEFICIT $ 597,993 $ 309,941 $ 1,007,147
=========== =========== ===========
See notes to financial statements.
F-31
STATEMENTS OF OPERATIONS
CUMULATIVE PERIOD FROM JUNE 1, 1999 (DATE OF COMMENCEMENT) TO MARCH 31, 2002 AND
YEARS ENDED DECEMBER 31, 2001 AND 2000, AND THREE MONTHS ENDED MARCH 31, 2002 AND 2001
--------------------------------------------------------------------------------------------------------------------------
Cumulative Cumulative
Period from Period from
June 1, 1999 (Date June 1, 1999 (Date
of Commencement) of Commencement) Year Ended Three Months Ended
to March 31, to December 31, December 31, March 31,
2002 2001 2001 2000 2002 2001
(Unaudited) (Unaudited) (Unaudited)
OPERATING EXPENSES:
Product development $ 2,961,366 2,480,544 $ 1,579,129 $ 679,891 $ 480,822 $ 133,357
Marketing 1,354,113 1,066,525 716,674 349,851 287,588 83,261
General and administrative 1,855,689 1,316,001 823,791 491,930 539,688 97,506
Depreciation and amortization 15,265 11,850 11,850 -- 3,415 165
----------- ----------- ----------- ----------- ----------- -----------
Total operating expenses 6,186,433 4,874,920 3,131,444 1,521,672 1,311,513 314,289
----------- ----------- ----------- ----------- ----------- -----------
LOSS FROM OPERATIONS (6,186,433) (4,874,920) (3,131,444) (1,521,672) (1,311,513) (314,289)
INTEREST INCOME 125,117 125,117 20,465 104,652 -- 12,878
INTEREST EXPENSE (71,024) (22,439) (20,505) (1,934) (48,585) (513)
----------- ----------- ----------- -----------
NET LOSS $(6,132,340) $(4,772,242) $(3,131,484) $(1,418,954) $(1,360,098) $ (301,924)
=========== =========== =========== =========== =========== ===========
See notes to financial statements.
F-32
ESSENTIAL REALITY, LLC
(A Development Stage Entity)
STATEMENTS OF MEMBERS' EQUITY (DEFICIT) PERIOD FROM JUNE 1, 1999 (DATE OF
COMMENCEMENT) TO DECEMBER 31, 1999, YEARS ENDED DECEMBER 31, 2001 AND 2000 AND
THREE MONTHS ENDED MARCH 31, 2002
------------------------------------------------------------------------------------------------------------------------------------
Note Deficit
Receivable Accumulated
Members' For Members' During
Capital Capital Development Stage Total
BALANCE JUNE 1, 1999 $ -- $ -- $ -- $ --
Issuance of members' capital 2,500,000 (2,000,000) -- 500,000
Net loss -- -- (221,804) (221,804)
---------- ------------- ------------ -------------
BALANCE, DECEMBER 31, 1999 2,500,000 (2,000,000) (221,804) 278,196
Collection of note receivable -- 1,134,547 -- 1,134,547
Net loss -- -- (1,418,954) (1,418,954)
---------- ------------- ------------ -------------
BALANCE, DECEMBER 31, 2000 2,500,000 (865,453) (1,640,758) (6,211)
Collection of note receivable -- 865,453 -- 865,453
Net loss -- -- (3,131,484) (3,131,484)
---------- ------------- ------------ -------------
BALANCE, DECEMBER 31, 2001 2,500,000 -- (4,772,242) (2,272,242)
Net loss (unaudited) -- -- (1,360,098) (1,360,098)
----------- ------------ ------------- -------------
BALANCE, MARCH 31, 2002 (UNAUDITED) $ 2,500,000 $ -- $ (6,132,340) $ (3,632,340)
=========== ============ ============= =============
See notes to financial statements.
F-33
ESSENTIAL REALITY, LLC
(A Development Stage Entity)
STATEMENTS OF CASH FLOWS
CUMULATIVE PERIOD FROM JUNE 1, 1999 (DATE OF COMMENCEMENT) TO MARCH 31, 2002 AND
YEARS ENDED DECEMBER 31, 2001 AND 2000, AND THREE MONTHS ENDED MARCH 31, 2002 AND 2001
-----------------------------------------------------------------------------------------------------------------------------------
Cumulative Cumulative
Period from Period from
June 1, 1999 (Date June 1, 1999 (Date
of Commencement) of Commencement) Year Ended Three Months Ended
to March 31, to December 31, December 31, March 31,
2002 2001 2001 2000 2002 2001
(Unaudited) (Unaudited) (Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(6,132,340) $(4,772,242) $(3,131,484) $(1,418,954) $(1,360,098) $(301,924)
Depreciation and amortization 15,265 11,850 11,850 -- 3,415 165
Amortization of deferred interest 58,860 18,361 18,361 -- 40,499 --
Changes in assets and liabilities: -- --
Deferred financing costs (262,326) (217,755) (217,755) -- (44,571) --
Prepaid expenses, deposits and other assets (90,775) (114,887) (85,567) (29,320) 24,112 (3,000)
Interest receivable -- -- 48,716 (48,716) -- (12,877)
Accounts payable 687,486 676,133 600,895 62,820 11,353 (50,153)
Accounts payable - related parties 143,144 84,000 84,000 -- 59,144 --
Accrued compensation 270,303 257,103 35,836 221,267 13,200 3,100
----------- ----------- ----------- ----------- ----------- -----------
Net cash used in operating activities (5,310,383) (4,057,437) (2,635,148) (1,212,903) (1,252,946) (364,689)
----------- ----------- ----------- ----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for purchase of domain names (18,000) (18,000) (18,000) -- -- --
Payments for purchase of fixed assets (22,001) (12,949) (12,949) -- (9,052) (2,000)
----------- ----------- ----------- ----------- ----------- -----------
Net cash used in investing activities (40,001) (30,949) (30,949) -- (9,052) (2,000)
----------- ----------- ----------- ----------- ----------- -----------
See notes to financial statements.
F-34
ESSENTIAL REALITY, LLC
(A Development Stage Entity)
STATEMENTS OF CASH FLOWS (CONTINUED)
CUMULATIVE PERIOD FROM JUNE 1, 1999 (DATE OF COMMENCEMENT) TO MARCH 31, 2002 AND
YEARS ENDED DECEMBER 31, 2001 AND 2000, AND THREE MONTHS ENDED MARCH 31, 2002 AND 2001
-----------------------------------------------------------------------------------------------------------------------------------
Cumulative Cumulative
Period from Period from
June 1, 1999 (Date June 1, 1999 (Date
of Commencement) of Commencement) Year Ended Three Months Ended
to March 31, to December 31, December 31, March 31,
2002 2001 2001 2000 2002 2001
(Unaudited) (Unaudited) (Unaudited)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of members' capital 500,000 500,000 -- -- -- --
Proceeds from repayment of note
receivable for members' capital 2,000,000 2,000,000 865,453 1,134,547 -- 139,714
Proceeds from bridge loans 3,025,000 1,500,000 1,500,000 -- 1,525,000 --
Proceeds from advances from
LCG Capital Group, LLC 76,617 76,617 76,617 -- -- --
Proceeds from advances from
affiliated companies - net 25,915 25,632 5,985 15,547 283 4,719
----------- ----------- ----------- ----------- ----------- ----------
Net cash provided by financing activities 5,627,532 4,102,249 2,448,055 1,150,094 1,525,283 144,433
----------- ----------- ----------- ----------- ----------- ----------
INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS 277,148 13,863 (218,042) (62,809) 263,285 (222,256)
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD -- -- 231,905 294,714 13,863 231,905
----------- ----------- ----------- ----------- ----------- ----------
CASH AND CASH EQUIVALENTS,
END OF PERIOD $ 277,148 $ 13,863 $ 13,863 $ 231,905 $ 277,148 $ 9,649
=========== =========== =========== =========== =========== ==========
SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS:
Note received for members' capital $ 2,000,000 $ 2,000,000 $ -- $ -- $ -- $ --
Deferred interest expense - bridge loans $ 352,162 $ 232,389 $ 232,389 $ -- $ 119,773 $ --
Accrued interest expense - bridge loans $ 411,022 $ 250,750 $ 250,750 $ -- $ 160,272 $ --
See notes to financial statements.
F-35
ESSENTIAL REALITY, LLC
(A Development Stage Entity)
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001 AND 2002,
CUMULATIVE PERIOD FROM JUNE 1, 1999 (DATE OF COMMENCEMENT) TO DECEMBER 31, 2001,
THREE MONTHS ENDED MARCH 31, 2002 (UNAUDITED) AND MARCH 31, 2001 (UNAUDITED) AND
CUMULATIVE PERIOD FROM JUNE 1, 1999 (DATE OF COMMENCEMENT) TO MARCH 31, 2002
(UNAUDITED)
--------------------------------------------------------------------------------
1. THE COMPANY
Essential Reality, LLC (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 on
December 29, 1999. The Company was formed to develop, manufacture and
market computer peripheral devices, with initial emphasis on a product
called "P5." P5 is a gloved shaped device that controls the movement of
objects on a computer screen. P5 enables three-dimensional movement of the
cursor as well as allowing pitch and yaw, as well as roll. P5 is
controlled by the user moving his/her hand or bending his/her fingers.
The Company is in the development stage. Successful completion of the
Company's development program and ultimately, the attainment of profitable
operations are dependent upon future events, including obtaining adequate
financing to fulfill its development activities, and achieving a level of
revenue adequate to support the Company's cost structure.
Since its commencement, the Company has not generated revenues and has
incurred significant recurring losses from operations, working capital
deficit and deficit in members' capital. As a result, substantial doubt
exists regarding the Company's ability to continue as a going concern. The
Company has recently completed a private placement of membership interests
as described in Note 8. The Company anticipates that, based on currently
proposed plans and assumptions relating to the implementation of its
business plan (including the timetable of costs and expenses associated
with, and success of, its marketing efforts), the net proceeds of the
recently completed private placement together with trade financing and
accounts receivable factoring that needs to be arranged in the second half
of fiscal 2002 and projected revenues from operations, will be sufficient
to satisfy operations until the of end of fiscal 2002 Thereafter, the
Company will require additional funding in order to reach the point of
self sufficiency.
The financial statements have been prepared in conformity with the
Statement of Financial Accounting Standards ("SFAS") No. 7, Accounting and
Reporting by Development Stage Enterprises. As a development stage entity
with no commercial operating history, the Company is subject to all of the
risks and uncertainties inherent in the establishment of a new business
enterprise. To address these risks and uncertainties, the Company must,
among other things, respond to competitive developments; attract, retain,
and motivate qualified personnel; and support the expense of marketing new
products based upon innovative technology. To date, the Company has not
recognized product related revenues. As a result of incurring expenses in
these developmental activities without generating revenues, the Company
has incurred significant losses and negative cash flow from operating
activities. For the cumulative period from June 1, 1999 (Date of
Commencement) to December 31, 2001 the Company had cumulative net losses
of $4,772,242 and cumulative negative cash flow from operating activities
of $4,057,437. For the cumulative period from June 1, 1999 (Date of
Commencement) to March 31, 2002 (unaudited) the Company had cumulative net
losses of $6,132,340 and cumulative negative cash flow from operating
activities of $5,310,383. The Company expects to incur substantial losses
and negative cash flow from operating activities for the near future.
F-36
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The financial statements of the Company have been
prepared on the accrual basis of accounting. A summary of the major
accounting policies followed in the preparation of the accompanying
financial statements, which conform to generally accepted accounting
principles is presented below. The accompanying unaudited financial
statements have been prepared with generally accepted accounting
principles for interim financial information. In the opinion of
management, all adjustments (consisting only of normal recurring accruals)
considered necessary for fair presentation have been included.
Accounting 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 and disclosure
of contingent assets and 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.
Comprehensive Loss - Comprehensive loss is the same as net loss.
Cash and Cash Equivalents - Cash equivalents include time deposits with
maturities of three months or less on the date of purchase.
Domain Name and Fixed Assets - Domain names are recorded at cost, net of
accumulated amortization. Fixed assets are recorded at cost, net of
related accumulated depreciation. Upon sale or retirement, the cost and
related accumulated depreciation and amortization are removed from the
respective accounts, and any gain or loss is included in the statement of
operations. Maintenance and repair costs are expensed as incurred.
Depreciation of fixed assets is computed using the straight-line method
based on the estimated useful lives of the assets, which is three to five
years, beginning when assets are placed in service. Amortization of domain
names is computed using the straight-line method over a period of two
years, taking a full year's depreciation in the year of acquisition.
Product Development - Product development costs include expenses incurred
by the Company to research and develop the P5 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 lesser of the estimated
useful life of the product or three years. All of the costs to date have
been expensed.
Impairment of Assets - In accordance with SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of, the Company reviews long-lived assets for impairment whenever events
or changes in circumstances indicate that the carrying amount of the asset
may not be recoverable. When such events occur, the Company compares the
carrying amount of the assets to undiscounted expected future cash flows.
If this comparison indicates that there is impairment, the amount of the
impairment loss is then based on the fair value of the asset compared with
its carrying value. No impairment of assets existed at December 31, 2001
and March 31, 2002.
Fair Market Value of Financial Instruments - The carrying amount of the
Company's cash and cash equivalents, interest receivable, prepaid expenses
and deposits, accounts payable, accrued liabilities, accrued compensation
and advances from affiliated companies approximates fair market value
because of the short maturity of those instruments.
Income Taxes - The Company is not subject to federal or state income tax.
The taxable income or loss applicable to the operations of the Company is
includable in the federal and state income tax returns of the members. The
Company will become subject to federal and state income taxes after
completion of the transaction described in Note 8.
Effects of Recently Issued Accounting Standards - In June 1998, the
Financial Accounting Standards Board ("FASB") issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", which
establishes accounting and reporting standards for derivative instruments
F-37
and hedging activities. Generally, it requires that an entity recognize
all derivatives as either an asset or liability and measure those
instruments at fair value as well as identify the conditions for which a
derivative may be specifically designed as a hedge. SFAS No. 133 is
effective for fiscal years beginning after June 15, 2000. The adoption of
SFAS No.133, effective January 1, 2001, did not have an impact on the
Company's financial position, results of operations, or cash flows. The
Company currently does not have any derivative instruments and is not
engaged in hedging activities.
On June 29, 2001, the FASB approved for issuance SFAS No. 141, "Business
Combinations", and SFAS No. 142, "Goodwill and Intangibles Assets". Major
provisions of these statements are as follows: all business combinations
initiated after June 30, 2001 must use the purchase method of accounting;
the pooling of interest method of accounting is prohibited except for
transactions initiated before July 1, 2001; intangible assets acquired in
a business combination must be recorded separately from goodwill if they
arise from contractual or other legal rights or are separable from the
acquired entity and can be sold, transferred, licensed, rented or
exchanged, either individually or as part of a related contract, asset or
liability; goodwill and intangible assets with indefinite lives are not
amortized but are tested for impairment annually, except in certain
circumstances, and whenever there is an impairment indicator; adjustments
are made. All acquired goodwill must be assigned to reporting units for
purposes of impairment testing, and effective January 1, 2002, goodwill
will no longer be subject to amortization. The adoption of SFAS No. 142
will not have a material impact on the Company's financial position or
results of operations.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 requires companies to record the
fair value of a liability for asset retirement obligations in the period
in which they are incurred. The statement applies to a company's legal
obligations associated with the retirement of tangible long-lived assets
that result from the acquisition, construction and development or through
the normal operation of a long-lived asset. When a liability is initially
recorded, the company would capitalize the cost, thereby increasing the
capital amount of the related asset. The capitalized asset retirement cost
is depreciated over the life of the respective asset while the liability
in accreted to its present value. Upon settlement of the liability, the
obligation is settled at its recorded amount or the company incurs a gain
or loss. This statement is effective for fiscal years beginning after June
15, 2002. The Company does not expect that adoption of SFAS No. 143 will
have a material impact on the Company's financial position or results of
operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses the
accounting and reporting for the impairment or disposal of long-lived
assets. The statement provides a single accounting model for long-lived
assets to be disposed of. New criteria must be met to classify the asset
as an asset for sale. This statement also focuses on reporting the effects
of a disposal of a segment of a business. This statement is effective for
years beginning after December 15, 2001. The adoption of SFAS No. 144 will
not have a material impact on the Company's financial position or results
of operations.
Reclassification - Certain amounts in the 2000 financial statements have
been reclassified to conform with the basis of presentation used in 2001
and 2002.
F-38
3. FIXED ASSETS AND DOMAIN NAMES
December 31, March 31,
2001 2000 2002
(Unaudited)
Fixed assets
Computer $ 2,000 $-- $ 2,000
Office Furniture and equipment 10,949 -- 20,001
-------- --- --------
At cost 12,949 -- 22,001
Less: accumulated depreciation (2,850) -- (4,015)
-------- --- --------
Net book value $ 10,099 $-- $ 17,986
======== === ========
Domain names
Domain names - at cost $ 18,000 $-- $ 18,000
Less: Accumulated amortization (9,000) -- (11,250)
-------- --- --------
Net book value $ 9,000 $-- $ 6,750
======== === ========
Depreciation and amortization expense for the years ended December 31,
2001 and 2000 amounted to $11,850 and $0, respectively. Depreciation and
amortization expense for the three months ended March 31, 2002 (unaudited)
and 2001 (unaudited) amounted to $3,415 and $165, respectively.
4. BRIDGE LOANS
Through December 31, 2001, the Company received bridge loans from JPAL,
Inc. ("JPAL") of $2,525,000. Through March 31, 2002 (unaudited), the
Company received bridge loans of $3,025,000. $2,525,000 of the bridge
loans are from JPAL, a publicly traded corporation with which the Company
has entered into a merger agreement as described more fully in Note 8c.
The remaining $500,000 bridge loan, received in March 2002, is from an
unrelated third party.
Bridge Loans from JPAL
The bridge loans from JPAL are unsecured and bear interest at the rate of
8 1/2 % per annum, however, the interest did not begin to accrue until
January 31, 2002. The bridge loans, together with accrued interest
thereon, become payable on April 30, 2004, however the bridge loans will
be prepaid as follows:
(i) Up to $250,000 of bridge loans and accrued interest may be converted
to up to 240,000 membership units of the Company pursuant to the
Offering;
(ii) Up to $500,000 of bridge loans and accrued interest may be converted
to up to 263,158 common shares of JPAL;
(iii) Up to $1,000,000 will be repaid upon closing of the Offering and
Merger;
(iv) During fiscal 2003, $100,000 payments per quarter representing
interest and principal;
(v) 50% of the proceeds received as a result of the exercise of bridge
loan warrants as described below;
(vi) During fiscal 2002, 15% of the net proceeds received from the sale
of equity in the Company above $10,000,000, subject to a maximum of
up to $700,000;
F-39
(vii) During fiscal 2003, 20% of the net proceeds received from the sale
of equity in the Company, subject to a maximum of up to $700,000,
provided, that in the event the aggregate principal amount of bridge
loans remaining outstanding at the time such equity is raised shall
exceed $1,000,000, then the maximum amount due and payable shall be
$900,000;
(viii) Beginning October 1, 2002, 35% of any Excess Cash greater than $2
million, up to a maximum of $200,000 (in addition to amounts
received under clause (iv) above) in any quarter, where "Excess
Cash" means any cash on the books of JPAL at the end of a quarter
minus any equity and/or debt raised during such quarter; and
(ix) The remaining balance of interest and principal, if any, on April
30, 2004.
Anything to the contrary in (vi) and (vii) above notwithstanding, if at any time
during either 2002 or 2003 the equity raised from unrelated sales is $1,000,000
or less and the investor(s) in each such unrelated sale objects to the repayment
of the bridge loans, then no such repayment shall be made. For purposes of
calculating the proceeds received and amounts raised set forth in (vi) and (vii)
above, (A) any non-cash investment, or (B) any amounts raised from strategic
investors that are either (1) earmarked for specific use, or (2) received in
connection with actual or anticipated other relationship(s) with such
investor(s) that exist(s) or may exist, shall not be counted in such
calculation.
In no event shall any repayment be made in excess of bridge loans and accrued
interest then outstanding. In addition; (i) all payments to be made pursuant to
(iv) through (ix) above are subordinate to obligations to financing sources, and
may be subject to restrictive covenants imposed by either trade or secured
creditors, and (ii) the holders of the notes representing the bridge loans have
agreed not to take any action on the prepayment obligations until any such
restrictive covenants are eliminated or terminated. To the extent that a cash
payment is not made when due, all unpaid amounts not paid at maturity shall earn
interest at a rate of 12% per annum.
The bridge loans from JPAL include the issuance to certain lenders of JPAL up to
750,000 warrants to purchase common shares of JPAL for an exercise price of
$1.90 per common share. Such warrants expire two years from the date of closing
of the merger agreement. Since these warrants pertain to JPAL and not the
Company, the Company has not recorded any expense related to the warrants.
During 2001, JPAL issued 610,560 warrants in connection with the bridge loans.
Although interest on the bridge loans did not begin to accrue until January 31,
2002, interest on the bridge loans from JPAL in the amount of $250,750 and
$411,022 has been imputed and accrued representing the interest payable on the
bridge loans advanced from inception through December 31, 2001 and March 31,
2002, respectively, and will be amortized over the life of the loans through
April 30, 2004. Deferred interest will be amortized on a daily basis from the
date of the loan to April 30, 2004, which resulted in a charge to earnings in
the amount of $18,361 and $40,499 for year ended December 31, 2001 and for the
three months ended March 31, 2002 (unaudited), respectively.
Bridge Loan from Third Party
The bridge loan from the third party, received in March 2002, is unsecured and
bears interest at the rate of 18% per annum. The bridge loan matures on the
earlier of June 22, 2002 or the consummation by the Company of an equity
financing of at least $1,000,000. The bridge loan together with accrued interest
thereon may be converted, in whole or in part, at the request of the third party
lender, to membership units of the Company at the conversion price of
approximately $1.04. The Company has also granted to the holder of the bridge
loan warrants to purchase 15,000 membership units of the Company for an exercise
price of $1.30 per membership unit.
F-40
5. COMMITMENTS AND CONTINGENCIES
Operating Leases
a. Premises - In November 2001, the Company entered a lease for
premises which provides for the following rental payments:
Year Ending December 31,
2002 $119,000
2003 132,000
2004 135,000
2005 138,000
2006 141,000
Thereafter 14,000
----------
$679,000
==========
Rent expense for the years ended December 31, 2001 and 2000
amounted to approximately $39,000 and $27,000, respectively. Rent
expense for the three months ended March 31, 2002 (unaudited) and
2001 (unaudited) amounted to approximately $29,000 and $5,000,
respectively.
b. Computer Leases - The Company is allocated costs of computer
leases under leases assumed by a company related to a certain
member of LCG Capital Group, LLC ("LCG"), a member of the
Company. The Company is not directly obligated under the leases,
however its portion of the minimum payments under the leases are
as follows:
Year Ending December 31,
2002 $35,000
2003 11,000
-------
$46,000
=======
Computer lease expense for the years ended December 31, 2001 and
2000 amounted to approximately $13,000 and $5,000, respectively.
Computer lease expense for the three months ended March 31, 2002
(unaudited) and 2001 (unaudited) amounted to approximately
$15,500 and $1,500, respectively.
Development and Other Contracts
a. In March 2000, the Company entered into a consulting agreement,
which requires the Company to pay to the consultant, $0.25 for
each of the first 150,000 units of the P5 sold.
b. In July 2000, the Company entered into an agreement for product
development with a company, which is owned by a person who is
related to certain members of the Company (see Note 7). Pursuant
to the agreement, the Company is required to pay royalties of
1.8% on net sales of P5 and 9% of the license fee collected by
the Company with respect to P5, indefinitely.
F-41
c. In August 2000, the Company entered into a memorandum of
understanding, which provides for a renewable, two-year license
for a certain component of P5. Royalties are calculated as the
number of units of P5 sold multiplied by the greater of a) $0.25
and b) the difference between the manufacturing cost of the
licensed component and an alternative component with a minimum
license fee of $125,000 per annum. Should the Company not use the
licensed component no royalties would be due pursuant to the
memorandum of understanding. Included in product development
expense for the years ended December 31, 2001 and 2000 are
development fees of $25,000 and $25,000, respectively. Included
in product development expense for the three months ended March
31, 2002 (unaudited) and 2001 (unaudited) are development fees of
$0 and $0, respectively.
d. In October 2000, the Company entered into an agreement for the
provision of inspection services relating to the manufacture and
packaging of P5. Pursuant to the agreement, the Company is
required to pay an inspection fee, beginning with the start of
production, of the greater of a) $7,000 per month and b) 1% of
the freight-on-board value of P5. This agreement expires in
September 2002 and may be terminated at any time giving
three-months notice.
e. In December 2000, the Company entered into a consulting agreement
with an entity controlled by an affiliate of LCG. Pursuant to
which this entity provides general consulting services to the
Company 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. Through
December 31, 2001, the amount of the retainer was between $6,000
and $12,000 per month and it can increase from time to time up to
a maximum of $20,000 per month, based upon mutual consent with
the entity, depending on the level and geographic scope of the
services. In addition to the monthly retainer, we also are
obligated to pay to the entity a potential revenue share of up to
four percent (4.0%) on transactions facilitated by the entity.
Included in general and administrative expenses are costs
incurred of approximately $96,000, $6,000, $36,000 and $18,000
for the years ended December 31, 2001 and 2000 and for the three
months ended March 31, 2002 (unaudited) and 2001 (unaudited),
respectively relating to this contract.
f. In January 2001, the Company entered into a memorandum of
understanding for the development of certain components of P5.
Pursuant to the memorandum of understanding, the Company is
required to pay royalties of 1% of P5's net sales to the
developer, indefinitely. A nonrefundable royalty advance of
$5,000 and $10,000 is included in product development for the
years ended December 31, 2001 and 2000. A nonrefundable royalty
advance of $0 and $5,000 is included in product development for
the three months ended March 31, 2002 (unaudited) and 2001
(unaudited), respectively. The Company is required to pay a
further royalty advance of $35,000 should the Company incorporate
the component developed pursuant to the memorandum of
understanding into P5. Should the Company not incorporate the
component developed pursuant to the memorandum of understanding
into P5, it will not to be obligated to pay the $35,000 royalty
advance nor the 1% royalty on future sales.
g. In July 2001, the Company entered a development agreement for the
development of certain components of P5. Should the developer
accomplish the goals set forth in the agreement, the Company is
required to pay base royalties of 1% of net sales generated from
P5, indefinitely and an additional 0.5% of net sales generated
from P5, indefinitely, if the developer meets certain milestones
defined in this development agreement.
F-42
6. MEMBERS' CAPITAL AND NOTE RECEIVABLE
In December 1999, LCG acquired a 50% interest in the Company for an
aggregate purchase price of $2,500,000. The consideration received was
comprised of $500,000 in cash and a $2,000,000 note. The note bore
interest at the rate of 6% per annum, had a maturity date of December 13,
2002 and was secured by the membership interest of LCG. The remaining 50%
interest in the Company represents ownership by the founders of the
Company. The note receivable for members' capital was fully repaid in July
2001.
The Company recorded interest income on this note of $20,465 and $103,459
for the years ended December 31, 2001 and 2000, respectively.
As of December 31, 2001 and March 31, 2002 (unaudited), the Company had
9,600,000 membership units issued and outstanding. The Company has
subsequently issued additional membership units as described in Note 8b.
7. RELATED PARTY BALANCES AND TRANSACTIONS
Accrued compensation of $257,103, $221,267 and $270,303 at December 31,
2001 and 2000, and March 31, 2002 (unaudited), respectively, is payable to
certain officers and members of the Company. The amount is due on demand
and is non-interest bearing.
Advances are from entities that are affiliated with LCG. The advances are
payable on demand and bear interest at the rate of 10% per annum.
Advances from LCG are non-interest bearing and payable on demand.
Included in other assets at December 31, 2001 and 2000 and March 31, 2002
(unaudited) is $22,500 which represents the Company's portion of a letter
of credit required to secure computer leases. Included in prepaid expenses
and deposits at December 31, 2000 is $6,000 relating to a security deposit
on premises due from LCG.
Included in product development costs are $0, $105,000, $0 and $0 for the
years ended December 31, 2001 and 2000 and for the three months ended
March 31, 2002 (unaudited) and 2001 (unaudited), respectively, paid to a
company owned by an individual related to certain members of the Company.
Included in product development costs are $91,300, $0, $37,000 and $8,300
for the years ended December 31, 2001 and 2000, and for the three months
ended March 31, 2002 (unaudited) and 2001 (unaudited), respectively, paid
to a company owned by certain members of the Company.
Included in general and administrative expenses are costs incurred of
approximately $242,000, $148,000, $79,000 and $38,000 for the years ended
December 31, 2001 and 2000 and for the three months ended March 31, 2002
(unaudited) and 2001 (unaudited), respectively, by two entities that are
related to certain members of LCG. Such costs include consulting fees,
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.
Included in accounts payable - related parties at December 31, 2001 and
2000 are approximately $26,000 and $0, respectively, payable to a company
owned by a person related to certain members of the Company.
Included in accounts payable - related parties at December 31, 2001 and
2000 are approximately $58,000 and $0, respectively, payable to a company
that is related to certain members of LCG.
F-43
8. SUBSEQUENT EVENTS
a. Bridge loans
(i) From April 1, 2002 to June 20, 2002 the Company received an
additional $300,000 of bridge loans from third party lenders;
(ii) Prior to the completion of the Merger described in Note 8c, the
Company exchanged bridge loans and accrued interest owed to JPAL
of approximately $2,600,000 for notes of approximately $2,767,000
owed to JPAL's lenders.
(iii) On June 20, 2002 the Company repaid bridge loans of $1,100,000,
of which $550,000 was repaid to JPAL and $550,000 was repaid to
third party lenders.
(iv) As part of the private placement described in Note 8b, $500,000
of bridge loans were converted to 480,000 membership units of the
Company, of which JPAL converted $250,000 and a third party
lender converted $250,000.
As a result of the transactions completed subsequent to March 31, 2002, as
of June 20, 2002, the Company had notes payable outstanding of
approximately $1,967,000 owed to JPAL's lenders.
b. Private Placement
On June 20, 2002, the Company completed a private placement ("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.
Cash fees and expenses of the Offering were approximately $600,000. In
addition, in connection with the Offering the Company has issued to its
financial advisors 331,211 warrants to purchase 331,211 membership units.
Such warrants shall have an exercise price per membership unit equal to
$1.30 per membership unit and shall be exercisable for a period of up to
five years (to be determined by the Company prior to issuance). As a
result of the merger discussed in Note 8c, warrants to purchase membership
units in the Company shall become warrants to purchase common shares of
JPAL on the basis of one warrant to purchase a membership unit of the
Company to one warrant to purchase a common share of JPAL.
In May 2002, the Company was advanced $400,000 from the Offering escrow.
No costs or interest was incurred in connection with the advance.
c. Merger with JPAL
On June 20, 2002, the Company completed a merger with JPAL whereby the
members of the Company contributed all of their membership units in the
Company in exchange for 16,874,784 shares of JPAL's common stock.
Contemporaneously, the shareholders of JPAL canceled common shares and
were left with 1,080,934 shares of common stock representing 6.02% of the
surviving entity.
The Merger will be accounted for as a reverse acquisition in which the
Company is the accounting acquirer and JPAL is the legal acquirer. The
management of the Company will remain the management of the merged entity.
Since the Merger will be accounted for as a reverse acquisition and not a
business combination, no goodwill will be recorded in connection with the
Merger and the costs incurred in connection with the Merger will be
accounted for as a reduction of additional paid-in capital.
As a result of the Merger, the warrants issued to the Company's financial
advisors to acquire membership units (see Note 8b), will become warrants
to purchase the same amount of JPAL common shares at the same exercise
price and having the same expiration date.
F-44
The Company expects to use the stock incentive plan established by JPAL
pursuant to which the Company may grant options, stock appreciation
rights, restricted stock and/or other equity-based incentives to its
directors, employees, consultants and advisors for up to an aggregate of
3,500,000 shares of the merged entity's common stock.
d. Contractual Obligations (unaudited)
(i) In May 2002, the Company placed an order for the manufacture of
P5 with a third party manufacturer. Under the terms of the order
the Company was required to pay a deposit of $100,000 upon
placing the order and post letters of credit in the amount of
approximately $2.25 million over a three to four month period
following the order date. As of July 15, 2002 the Company has
posted letters of credit of $575,000.
(ii) In May 2002, the Company entered into a letter of intent with a
game developer. Under the letter of intent the game developer
shall disclose to the Company the source code for two specific
games so that the games can be integrated with P5. In addition,
the game developer will release a software update enabling
current users of the games to use P5. The Company will be
responsible for integration and payment to the game developer of
$100,000.
e. Stock Options (unaudited)
Subsequent to March 31, 2002, the Company issued to its directors and
employees, options to purchase an aggregate of 797,000 shares of its
common stock at a weighted average exercise price of $1.32 per share.
Such options expire ten years following the grant date. The issuance of
the options resulted in deferred compensation expense of approximately
$1,600,000. Such amount will be charged to earnings over the expected
life of the options. Deferred compensation expense was computed using
the Black-Scholes method with a fair market value of $3.05 per share.
Subsequent to March 31, 2002, the Company issued to its advisors and
consultants, options to purchase an aggregate of 235,000 shares of its
common stock at a weighted average exercise price of $0.84 per share.
Such options expire ten years following the grant date. The issuance of
the options resulted in compensation expense in the second quarter of
2002 of approximately $600,000. Compensation expense was computed using
the Black-Scholes method with a fair market value of $3.05 per share.
F-45
Essential Reality, Inc.
8,214,239 Shares
of
Common Stock
------------------
PROSPECTUS
-----------------
__________ ___, 2002
You should rely only on the information contained in this
prospectus. We have not authorized anyone to provide you with information
different from that contained in this prospectus. This prospectus does not
constitute an offer or solicitation by anyone in any state in which such person
is not authorized, or in which the person making such offer or solicitation is
not qualified to do so, or to any person to whom it is unlawful to make such
offer or solicitation. This prospectus does not offer to sell or buy any shares
in any jurisdiction where it is unlawful. The information contained in this
prospectus is accurate only as of the date of this prospectus, regardless of the
time of delivery of this prospectus or of any sale of our common stock.
No action is being taken in any jurisdiction outside the U.S. to
permit a public offering of the common stock or possession or distribution of
this prospectus in that jurisdiction. Persons who come into possession of this
prospectus in jurisdictions outside the U.S. are required to inform themselves
about and to observe any restrictions as to this offering and the distribution
of this prospectus applicable to that jurisdiction.
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 24. Indemnification of Directors and Officers.
The Nevada General Corporation Law (NGCL) provides that a director
or officer of a corporation will not be personally liable for monetary damages
for breach of that individual's fiduciary duties as a director or officer except
for liability for (1) any act or omission constituting a breach of fiduciary
duties as a director or officer and when (2) breach of those duties involved
intentional misconduct, fraud or a knowing violation of law. Under the NGCL, a
corporation may indemnify directors and officers, as well as other employees and
individuals, to any threatened, pending or completed action, suit or proceeding,
except an action by or in the right of the corporation, by reason of the fact
that he is or was a director, officer, employee or agent of the corporation. The
termination of any action, suit or proceeding by judgment, order, settlement,
conviction or upon a plea of nolo contendere or its equivalent, does not, of
itself, create a presumption that the person did not act in good faith and in a
manner which he reasonably believed to be in or not opposed to the best
interests of the corporation, or that, with respect to any criminal action or
proceeding, he had reasonable cause to believe that his conduct was unlawful.
The NGCL further provides that indemnification may not be made for
any claim as to which such a person has been adjudged by a court of competent
jurisdiction, after exhaustion of all appeals therefrom, to be liable to the
corporation or for amounts paid in settlement to the corporation, unless and
only to the extent that the court in which the action or suit was brought or
other court of competent jurisdiction determines upon application that in view
of all the circumstances of the case, the person is fairly and reasonably
entitled to indemnity for such expenses as the court deems proper. To the extent
that a director, officer, employee or agent of a corporation has been successful
on the merits or otherwise in defense of any action, suit or proceeding or in
defense of any claim, issue or matter therein, the corporation shall indemnify
him against expenses, including attorneys' fees, actually and reasonably
incurred by him in connection with the defense. The NGCL provides that this is
not exclusive of other rights to which those seeking indemnification may be
entitled under any bylaw, agreement, vote of stockholders or disinterested
directors or otherwise.
The Registrant's articles of incorporation provide that the
directors and officers will not be personally liable to the Registrant or its
stockholders for monetary damages for breach of their fiduciary duty as a
director or officer, except for liability of a director or officer for acts or
omissions involving intentional misconduct, fraud or a knowing violation of law,
or the payment of dividends in violation of the NGCL. The Registrant's bylaws
provide that the Registrant is required to indemnify its directors and officers
to the maximum extent permitted by law. The Registrant's bylaws also require the
Registrant to advance expenses incurred by a director or officer in connection
with the defense of any proceeding arising out of that party's status or service
as a director or officer of the Registrant or as a director, officer or other
enterprise, if serving as such at the Registrant's request. The Registrant's
bylaws also permit the Registrant to secure insurance on behalf of any director
or officer for any liability arising out of his or her actions in a
representative capacity.
II-1
Item 25. Other Expenses of Issuance and Distribution.
The following table sets forth the costs and expenses payable by the
Registrant in connection with the issuance and distribution of the securities
being registered. The selling shareholders will not pay any of the expenses. All
amounts are estimated except for the SEC registration fee.
Amount to
be Paid
SEC Registration Fee..............................................$ 2,286.03
Accounting Fees and Expenses......................................$ 50,000.00
Legal Fees and Expenses...........................................$ 45,000.00
Miscellaneous.....................................................$ 2,713.97
--------------
Total.................................................$ 100,000.00
=============
Item 26. Recent Sales of Unregistered Securities.
There have been no sales of unregistered securities within the past
three years, which would be required to be disclosed pursuant to Item 701 of
Regulation S-B, except for the following:
On June 20, 2002, the Registrant consummated a business combination
with Essential Reality, LLC, a Delaware limited liability company ("ER LLC").
Pursuant to the terms of the transaction, all of the members of ER LLC
contributed their membership interests in ER LLC to the Registrant in exchange
for an aggregate of 16,874,784 shares of the Registrant's common stock (the
"Common Stock"). In connection with the issuance of these shares of Common
Stock, the Registrant relied on the exemption from registration provided by
Section 4(2) of the Securities Act of 1933, as amended.
In connection with the business combination, (i) holders of certain
bridge notes issued by the Registrant received, as additional consideration for
the loans, two-year warrants to purchase up to 840,000 shares of Common Stock
and 15,000 shares of Common Stock 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 the same principal amount (plus accrued interest)
of convertible promissory notes of the Registrant, which are convertible for a
period of six months at a conversion price of $1.90 into an aggregate of 263,158
shares of Common Stock, and (iii) the Registrant issued three-year warrants to
purchase up to an aggregate of 331,211 shares of Common Stock at a purchase
price of $1.30 per share, as consideration for certain services provided by the
recipients. In connection with the issuance of each of these securities, the
Registrant relied on the exemption from registration provided by Section 4(2) of
the Securities Act of 1933, as amended.
On August 1, 2000, the Registrant issued an aggregate of 797,469
shares of Common Stock to Thomas E. Stepp, Jr., Richard Reincke and Michael
Muellerleile. The shares were issued in exchange for legal services provided to
the Registrant, which were valued at $797. Thomas E. Stepp, Jr., Richard Reincke
and Michael Muellerleile are sophisticated investors and had access to the type
of information that would normally be included in a registration statement. In
connection with the issuance of these shares of Common Stock, the Registrant
relied on the exemption from registration provided by Section 4(2) of the
Securities Act of 1933, as amended.
On or about May 11, 2000, the Registrant issued 2,100,000 shares of
its common stock for $.001 per share. The offer was made to "accredited
investors", as that term is defined under applicable federal and state
securities laws, and no more than 35 non-accredited investors. The value of the
shares was arbitrarily set by the Registrant and had no relationship to its
II-2
assets, book value, revenues or other established criteria of value. There were
no commissions paid on the sale of those shares. The net proceeds to the
Registrant were $2,100. All twenty-one purchasers of the Common Stock were
non-accredited investors and were business associates, personal friends or
family members of Ryan A. Neely, then president, secretary and director of the
Registrant. All non-accredited investors were sophisticated investors and were
provided a private placement memorandum, which contained the type of information
that would normally be included in a registration statement. In connection with
the issuance of these shares of Common Stock, the Registrant relied on the
exemption from registration provided by Section 4(2) of the Securities Act of
1933, as amended.
Item 27. Exhibits.
Number Description
------ -----------
2.1 (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.
2.2 (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.
3.1 (3) Amended and Restated Articles of Incorporation of the
Registrant.
3.2 * Amendment to Articles of Incorporation filed June 20, 2002
with the State of Nevada.
3.3 * Amendment to Articles of Incorporation filed June 21, 2002
with the State of Nevada.
3.4 (4) Bylaws of the Registrant.
4.1 * Form of Additional Warrant of the Registrant.
4.2 * Form of Bridge Warrant of the Registrant.
4.3 * Form of Convertible Promissory Note of the Registrant.
5.1 ** Opinion of Olshan Grundman Frome Rosenzweig & Wolosky LLP.
9.1 (5) Voting Agreement, dated as of June 20, 2002, among LCG
Capital Group, LLC, Martin Abrams, John Gentile, Anthony
Gentile and MSH Entertainment Corporation.
23.1 * Consent of Deloitte & Touche LLP.
23.2 * Consent of Lesley, Thomas, Schwarz & Postma, Inc.
23.3 ** Consent of Olshan Grundman Frome Rosenzweig & Wolosky LLP
(contained in Exhibit 5.1).
24.1 * Power of Attorney (included on signature page).
------------
* Filed herewith.
** To be filed by amendment.
(1) Incorporated herein by reference from Exhibit A to the Registrant's
Proxy Statement on Schedule 14A filed on May 21, 2002.
(2) Incorporated herein by reference from Exhibit 2.2 to the
Registrant's Current Report on Form 8-K filed on July 3, 2002.
(3) Incorporated herein by reference from Exhibit 3.1 to the
Registrant's Registration Statement on Form SB-2 filed on August 18,
2000.
(4) Incorporated herein by reference from Exhibit 3.2 to the
Registrant's Registration Statement on Form SB-2 filed on August 18,
2000.
(5) Incorporated herein by reference from Exhibit 2 to the Schedule 13D
filed on July 2, 2002 by LCG Capital Group, LLC.
II-3
Item 28. Undertakings.
(A) The undersigned Registrant hereby undertakes:
(1) To file, during any period in which if offers or sells
securities, a post-effective amendment to this registration statement to:
(i) include any prospectus required by Section 10(a)(3) of
the Securities Act of 1933;
(ii) reflect in the prospectus any facts or events which,
individually or together, represent a fundamental change in the information in
the registration statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any deviation
from the low or high end of the estimated maximum offering range may be
reflected in the form of prospectus filed with the SEC pursuant to Rule 424(b)
if, in the aggregate, the changes in volume and price represent no more than 20
percent change in the maximum offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement; and
(iii) include any additional or changed material
information on the plan of distribution.
(2) For determining liability under the Securities Act, treat
each post-effective amendment as a new registration statement of the securities
offered, and the offering of the securities at that time to be the initial bona
fide offering.
(3) File a post-effective amendment to remove from
registration any of the securities that remain unsold at the end of the
offering.
(B) Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to directors, officers and controlling
persons of the Registrant pursuant to the foregoing provisions, or otherwise,
the Registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the Registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.
II-4
SIGNATURES
In accordance with the requirements of the Securities Act of 1933,
the Registrant certifies that it has reasonable grounds to believe that it meets
all of the requirements for filing on Form SB-2 and authorized this Registration
Statement to be signed on its behalf by the undersigned, in the City of New
York, State of New York, on the 19th day of July, 2002.
ESSENTIAL REALITY, INC.
By: /s/ Steven Francesco
-------------------------------
Steven Francesco
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below hereby constitutes and appoints Steven Francesco, Chief Executive
Officer and Reuben Levine, President, as his true and lawful attorneys-in-fact
and agents, with full power of substitution and resubstitution, for him in his
name, place and stead, in any and all capacities, in connection with this
Registration Statement, including to sign and file in the name and on behalf of
the undersigned as director or officer of the Registrant (i) any and all
amendments or supplements (including any and all stickers and post-effective
amendments) to this Registration Statement, with all exhibits thereto, and other
documents in connection therewith, and (ii) any and all additional registration
statements, and any and all amendments thereto, relating to the same offering of
securities as those that are covered by this Registration Statement that are
filed pursuant to Rule 462(b) promulgated under the Securities Act of 1933 with
the Securities and Exchange Commission and any applicable securities exchange or
securities self-regulatory body, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite or necessary to be done in and about the premises,
as fully to all intents and purposes as he might or could do in person, hereby
ratifying and confirming all that said attorneys-in-fact and agents, or their
substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
In accordance with the requirements of the Securities Act of 1933,
this Registration Statement has been signed by the following persons in the
capacities and on the dates stated:
Signature Title Date
--------- ----- ----
/s/ Steven Francesco
-------------------------- Chief Executive Officer July 19, 2002
Steven Francesco (Principal Executive Officer)
/s/ Ian Benoliel July 19, 2002
-------------------------- Vice President, Finance (Principal
Ian Benoliel Financial Officer and Principal
Accounting Officer)
/s/ Humbert B. Powell, III Co-Chief Executive Officer July 19, 2002
-------------------------- and Director
Humbert B. Powell, III
II-5
/s/ Marc Fries Director July 19, 2002
--------------------------
Marc Fries
/s/ Anthony Gentile Director July 19, 2002
--------------------------
Anthony Gentile
/s/ John Gentile Director July 19, 2002
--------------------------
John Gentile
/s/ Brian D. Jedwab Director July 19, 2002
--------------------------
Brian D. Jedwab
II-6
Exhibit Index
-------------
Number Description
2.1 (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.
2.2 (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.
3.1 (3) Amended and Restated Articles of Incorporation of the
Registrant.
3.2 * Amendment to Articles of Incorporation filed June 20, 2002
with the State of Nevada.
3.3 * Amendment to Articles of Incorporation filed June 21, 2002
with the State of Nevada.
3.4 (4) Bylaws of the Registrant.
4.1 * Form of Additional Warrant of the Registrant.
4.2 * Form of Bridge Warrant of the Registrant.
4.3 * Form of Convertible Promissory Note of the Registrant.
5.1 ** Opinion of Olshan Grundman Frome Rosenzweig & Wolosky LLP.
9.1 (5) Voting Agreement, dated as of June 20, 2002, among LCG
Capital Group, LLC, Martin Abrams, John Gentile, Anthony
Gentile and MSH Entertainment Corporation.
23.1 * Consent of Deloitte & Touche LLP.
23.2 * Consent of Lesley, Thomas, Schwarz & Postma, Inc.
23.3 ** Consent of Olshan Grundman Frome Rosenzweig & Wolosky LLP
(contained in Exhibit 5.1).
24.1 * Power of Attorney (included on signature page).
------------
* Filed herewith.
** To be filed by amendment.
(1) Incorporated herein by reference from Exhibit A to the Registrant's
Proxy Statement on Schedule 14A filed on May 21, 2002.
(2) Incorporated herein by reference from Exhibit 2.2 to the
Registrant's Current Report on Form 8-K filed on July 3, 2002.
(3) Incorporated herein by reference from Exhibit 3.1 to the
Registrant's Registration Statement on Form SB-2 filed on August 18,
2000.
(4) Incorporated herein by reference from Exhibit 3.2 to the
Registrant's Registration Statement on Form SB-2 filed on August 18,
2000.
(5) Incorporated herein by reference from Exhibit 2 to the Schedule 13D
filed on July 2, 2002 by LCG Capital Group, LLC.
II-7