SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO
Commission File Number: 000-32319
ESSENTIAL REALITY, INC.
(Exact name of small business issuer as specified in its charter)
Nevada 33-0851302
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
49 West 27th Street, Suite 7E
New York, New York 10001
(Address of Principal Executive Offices)
(212) 244-3200
(Issuer's Telephone Number)
JPAL, Inc., 17620 Oak Street, Fountain Valley, California 92708
(Former Name, Former Address and Former Fiscal Year, if Changed Since
Last Report)
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PAGE
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Condensed Balance Sheets as of June 30, 2002 (Unaudited)
and December 31, 2001 3
Condensed Statements of Operations for the three and six
months ended June 30, 2002 and 2001 (Unaudited) 4
Condensed Statements of Cash Flows for the six months ended
June 30, 2002 and 2001 (Unaudited) 5
Notes to Condensed Financial Statements (Unaudited) 6
Item 2 - Management's Discussion and Analysis 10
PART II - OTHER INFORMATION
Item 2 - Changes in Securities and Use of Proceeds 14
Item 4 - Submission of Matters to a Vote of Security Holders 14
Item 6 - Exhibits and Reports on Form 8-K 14
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ESSENTIAL REALITY, INC. (FORMERLY JPAL, INC.)
(A Development Stage Entity)
CONDENSED BALANCE SHEETS
JUNE 30, 2002 (UNAUDITED) AND DECEMBER 31, 2001
--------------------------------------------------------------------------------
June 30, 2002 December 31, 2001
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,135,446 $ 13,863
Restricted cash 575,000 --
Deferred financing costs -- 217,755
Prepaid expenses and deposits 117,917 34,337
------------ ------------
Total current assets 4,828,363 265,955
DOMAIN NAMES - Net 4,500 9,000
FIXED ASSETS - Net 16,821 10,099
OTHER ASSETS 80,550 80,550
DEFERRED INTEREST EXPENSE - BRIDGE LOANS -- 232,389
------------ ------------
TOTAL ASSETS $ 4,930,234 $ 597,993
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 772,389 $ 676,133
Accounts payable - related parties 49,030 84,000
Accrued interest expense - notes payable 4,581 250,750
Accrued compensation 243,737 257,103
Bridge loans -- 1,500,000
Notes payable - current portion 200,000
Advances from LCG Capital Group, LLC 73,617 76,617
Advances from affiliated companies 24,134 25,632
------------ ------------
Total current liabilities 1,367,488 2,870,235
------------ ------------
NOTES PAYABLE --- LONG -TERM PORTION (net of deferred
interest of $1,135,299) 631,771 --
------------ ------------
Total liabilities 1,999,259 2,870,235
------------ ------------
STOCKHOLDERS' EQUITY:
Common stock (par value $.001 per share; 50,000,000 shares
authorized; 17,955,718 and 9,600,000 issued and outstanding
at June 30, 2002 and December 31, 2001, respectively) 17,956 9,600
Additional paid in capital 11,491,307 2,490,400
Deferred compensation expense (1,143,659) --
Deficit accumulated during development stage (7,434,629) (4,772,242)
------------ ------------
Total stockholders' equity 2,930,975 (2,272,242)
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 4,930,234 $ 597,993
============ ============
See notes to condensed financial statements.
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ESSENTIAL REALITY, INC. (FORMERLY JPAL, INC.)
(A Development Stage Entity)
CONDENSED STATEMENTS OF OPERATIONS
THREE AND SIX MONTHS ENDED JUNE 30, 2002 AND 2001 (UNAUDITED)
--------------------------------------------------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
2002 2001 2002 2001
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
OPERATING EXPENSES:
Product development $ 400,288 $ 246,759 $ 881,110 $ 380,116
Marketing 328,935 178,806 616,523 262,067
General and administrative (including non-cash stock
compensation of $118,499 for the three
and six months ended June 30, 2002) 482,201 132,831 1,021,889 230,337
Depreciation and amortization 3,415 1,152 6,830 1,317
------------ ------------ ------------ ------------
Total operating expenses 1,214,839 559,548 2,526,352 873,837
------------ ------------ ------------ ------------
LOSS FROM OPERATIONS (1,214,839) (559,548) (2,526,352) (873,837)
INTEREST INCOME 2,851 7,140 2,851 20,018
INTEREST EXPENSE (90,301) (524) (138,886) (1,037)
------------ ------------ ------------ ------------
NET LOSS $ (1,302,289) $ (552,932) $ (2,662,387) $ (854,856)
============ ============ ============ ============
BASIC AND FULLY DILUTED
LOSS PER SHARE $ (0.07) $ (0.06) $ (0.15) $ (0.09)
============ ============ ============ ============
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING 17,955,718 9,600,000 17,955,718 9,600,000
============ ============ ============ ============
See notes to condensed financial statements.
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ESSENTIAL REALITY, INC. (FORMERLY JPAL, INC.)
(A Development Stage Entity)
CONDENSED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2002 AND 2001 (UNAUDITED)
--------------------------------------------------------------------------------
2002 2001
(Unaudited) (Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(2,662,387) $ (854,856)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 6,830 1,317
Amortization of deferred interest 23,081 --
Stock-based compensation expense 118,499 --
Changes in assets and liabilities:
Restricted cash (575,000) --
Deferred financing costs 217,755 --
Prepaid expenses, deposits and other assets (83,580) (2,000)
Interest receivable -- 23,955
Accounts payable 96,256 20,401
Accounts payable - related parties (34,970) --
Accrued interest 89,651 --
Accrued compensation (13,366) 16,300
----------- -----------
Net cash used in operating activities (2,817,231) (794,883)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for purchase of fixed assets (9,052) (11,874)
----------- -----------
Net cash used in investing activities (9,052) (11,874)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of members' capital 6,227,364 --
Proceeds from bridge loans 1,825,000 --
Repayment of bridge loans (550,000) --
Repayment of notes payable (550,000) --
Proceeds from repayment of note receivable for members' capital -- 662,247
Repayments of advances from LCG Capital Group, LLC (3,000) --
Proceeds from (repayments of) advances from affiliated companies - net (1,498) 5,749
----------- -----------
Net cash provided by financing activities 6,947,866 667,996
----------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 4,121,583 (138,761)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 13,863 231,905
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 4,135,446 $ 93,144
=========== ===========
SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS:
Bridge loans converted to membership units $ 500,000 $ --
Cash paid for interest expense $ 22,500 $ --
Elimination of bridge loans and accrued interest on merger $ 2,378,431 $ --
Assumption of notes payable on merger $ 2,517,070 $ --
Deferred compensation expense $ 1,262,158 $ --
Imputed interest on notes payable $ 1,158,380 $ --
See notes to condensed financial statements.
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ESSENTIAL REALITY, INC. (FORMERLY JPAL, INC.)
NOTES TO CONDENSED FINANCIAL STATEMENTS
JUNE 30, 2002 (UNAUDITED)
1. BASIS OF PRESENTATION, ORGANIZATION AND OTHER MATTERS
The accompanying unaudited condensed financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and pursuant to the rules and
regulations of the Securities and Exchange Commission ("SEC"). Accordingly,
certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been omitted. In the opinion of management,
all material adjustments, consisting of normal recurring adjustments, considered
necessary for a fair presentation have been included in the accompanying
unaudited condensed financial statements.
On June 20, 2002, Essential Reality, LLC, a Delaware Limited Liability Company
("ER LLC"), completed a business combination with JPAL, Inc., a Nevada
corporation and an SEC registrant ("JPAL") pursuant to an Amended Contribution
Agreement between ER LLC and JPAL, whereby all of the members of ER LLC
contributed their membership interests in ER LLC to the Company in exchange for
an aggregate of 16,874,784 shares of the Company's common stock (the
"Transaction"). Concurrent with the Transaction, the shareholders of JPAL
canceled 7,564,326 of their shares of JPAL common stock and were left with
1,080,934 shares of common stock representing 6.02% of the Company. Following
the Transaction, JPAL changed its name to Essential Reality, Inc. (the
"Company") and ER LLC, a wholly owned subsidiary of the Company, was merged into
the Company.
The Transaction was accounted for as a reverse acquisition in which ER LLC is
the accounting acquirer and JPAL is the legal acquirer. The management of ER LLC
remained as the management of the Company. Since the Transaction was accounted
for as a reverse acquisition and not a business combination, no goodwill has
been recorded in connection with the Transaction and the costs incurred in
connection with the Transaction have been accounted for as a reduction of
additional paid-in capital. As a result of the reverse acquisition, (i) the
historical financial statements of the Company for periods prior to the date of
the Transaction are no longer the historical financial statements of JPAL, and,
therefore, JPAL's historical financial statements are no longer presented; (ii)
the historical financial statements of the Company for periods prior to the date
of the Transaction are those of ER LLC; (iii) all references to the financial
statements of the "Company" apply to the historical financial statements of ER
LLC prior to the Transaction and to the financial statements of the Company
subsequent to the Transaction; and (iv) any reference to the Company applies
solely to ER LLC and Essential Reality, Inc.
The Company develops, manufactures and markets computer peripheral devices, with
an initial emphasis on a product called "P5"(TM). P5(TM) is a gloved shaped
device that controls the movement of objects on a computer screen. P5(TM)
enables three-dimensional movement of the cursor as well as allowing pitch and
yaw and roll. The users moving his/her hand and/or bending his/her fingers
control P5(TM).
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 cumulative net losses of $7,434,629. As a
result, substantial doubt exists regarding the Company's ability to continue as
a going concern. The Company anticipates that, based on its proposed plans and
assumptions relating to the implementation of its business plan and cash on hand
as of June 30, 2002 together with projected revenue and anticipated accounts
receivable factoring and trade financing, it will have a cash shortfall of
approximately $1.4 million as of December 2002. Should the Company not raise
additional capital, generate the projected revenue or obtain anticipated
accounts receivable factoring and trade financing, the Company expects to adjust
its cash burn rate such that cash on hand as of June 30, 2002 will be sufficient
to satisfy operations through December 2002. Thereafter, the Company will
require additional funding in order to reach the point of self-sufficiency.
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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. The Company
expects to incur substantial losses and negative cash flow from operating
activities for the near future.
2. PRIVATE PLACEMENT
On June 20, 2002, ER LLC completed a private placement (the "Offering") whereby
it issued 7,274,784 membership units for gross proceeds of $7,577,900. Included
in the gross proceeds was $500,000 of bridge loans that were converted to
480,000 membership units of the Company. $250,000 of the bridge loans converted
was owed to JPAL and $250,000 was due to a third party lender. JPAL exchanged
the membership interest in ER LLC for the reduction of $250,000 in notes payable
it owed to third party lenders.
In connection with the Offering, the Company issued to its financial advisors
warrants to purchase an aggregate of 331,211 membership units (the "Additional
Warrants"). Such warrants shall have an exercise price of $1.30 per membership
unit and shall be exercisable for a period of up to five years. As a result of
the Transaction, warrants to purchase membership units in ER LLC have become
warrants to purchase common shares of the Company. The value of these warrants
of $813,165 was computed using the Black-Scholes pricing model and has no
net-effect on stockholders' equity.
3. NOTES PAYABLE
As a result of the Transaction, bridge loans and accrued interest thereon in the
amount of $2,378,431 owed by ER LLC to JPAL were eliminated. In addition, upon
the Transaction, the Company assumed notes payable in the amount of $2,517,070.
Subsequent to the completion of the Transaction, the Company repaid $550,000 of
notes payable. Such notes bear interest at the rate of 8 1/2% per annum and are
due April 30, 2004, however the notes will be prepaid as follows:
i. During fiscal 2003, $100,000 payments per quarter representing interest
and principal;
ii. 50% of the proceeds received as a result of the exercise of warrants
described below;
iii. 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 $700,000;
iv. During fiscal 2003, 20% of the net proceeds received from the sale of
equity in the Company, subject to a maximum of $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; and
v. 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 the Company at the end of a quarter minus any equity and/or debt
raised during such quarter.
$500,000 of the notes payable may be converted by the holders to 263,158 shares
of common stock of the Company at a conversion price of $1.90 per share. The
conversion right expires on December 20, 2002.
In connection with the notes and the previously outstanding bridge loans,
warrants to purchase an aggregate of 960,000 shares of common stock of JPAL at
$3.00 per share were cancelled and were replaced with warrants to purchase an
aggregate of 840,000 and 15,000 shares of common stock of the Company at the
exercise prices of $1.90 and $1.30, respectively. Such warrants expire on June
20, 2005.
The value of the conversion feature and warrants issued of $1,158,380 has been
computed using the Black-Scholes pricing model and will be accreted into notes
payable as additional interest expense over the remaining life of the
-7-
notes. During the six months ended June 30, 2002, $23,081 has been recorded as
interest expense. At June 30, 2002, $1,135,299 has been netted against notes
payable.
4. STOCK OPTIONS
During the six-month period ended June 30, 2002, the Company issued to its
directors and employees, options to purchase an aggregate of 447,000 shares of
its common stock at a weighted average exercise price of $1.71 per share. Such
options expire ten years following the grant date. The issuance of these options
resulted in deferred stock-based compensation of $681,390 of which $5,259 was
expensed during the six-month period ended June 30, 2002. Deferred compensation
expense will be charged to earnings over the vesting period of the options,
which is between three and five years. Deferred compensation expense was
computed using the intrinsic value method.
During the six-month period ended June 30, 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 deferred stock-based compensation of $580,768 of which $113,240 was
expensed during the six-month period ended June 30, 2002. Deferred compensation
expense will be charged to earnings over the term of the advisors' and/or
consultants' agreements. Deferred compensation expense was computed using the
Black-Scholes pricing model using a fair market value of $3.05 per share, a term
of 10 years, volatility of 80% and a risk-free rate of 5%.
Subsequent to June 30, 2002, the Company granted to employees options to
purchase an aggregate of 335,000 shares of its common stock at exercise prices
between $0.75 and $0.90 per share.
5. RELATED PARTY TRANSACTIONS
a. Accrued compensation of $243,737 and $257,103 at June 30, 2002 and
December 31, 2001, respectively, is payable to certain officers and
shareholders of the Company. The amount is due on demand and is
non-interest bearing.
b. Advances from affiliated companies are from entities that are affiliated
with certain shareholders of the Company. The advances are payable on
demand and bear interest at the rate of 10% per annum.
c. Advances from LCG Capital Group, LLC are non-interest bearing and payable
on demand.
d. Included in other assets at June 30, 2002 and December 31, 2001 is
$22,500, which represents the Company's portion of a letter of credit
required to secure computer leases.
e. Included in product development costs are $5,900, $24,900, $26,700 and
$41,500 for the three and six months ended June 30, 2002 and 2001,
respectively, paid to a company owned by certain shareholders of the
Company.
f. Included in general and administrative expenses are costs incurred of
approximately $49,800, $128,100, $44,700 and $86,700 for the three and six
months ended June 30, 2002 and 2001, respectively, by two entities that
are related to certain shareholders. 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.
g. Included in accounts payable - related parties at June 30, 2002 and
December 31, 2001 are approximately $19,000 and $26,000, respectively,
payable to a company owned by a person related to certain members of the
Company.
h. Included in accounts payable - related parties at June 30, 2002 and
December 31, 2001 are approximately $30,000 and $58,000, respectively,
payable to a company that is related to certain shareholders of the
Company.
-8-
6. CONTRACTUAL OBLIGATIONS
a. 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 paid a
deposit of $100,000 upon placing the order and post letters of credit in
the amount of approximately $2.25 million. As of August 9, 2002, the
Company has posted letters of credit of approximately $1.6 million. The
Company expects to post the remaining letter of credit prior to October
31, 2002.
b. 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. Included in product development expenses for the three and six
months ended June 30, 2002 is $16,667 relating to this letter of intent.
7. RECENT ACCOUNTING PRONOUNCEMENTS
On June 29, 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 142, "Goodwill and Intangible Assets." SFAS No. 142 eliminated the
amortization of goodwill and certain other intangibles and requires an
impairment test of their carrying value. An initial impairment test of goodwill
and certain other intangibles must be completed in the year of adoption with at
least an annual impairment test thereafter. On January 1, 2002, the Company
adopted SFAS No. 142. The Company completed the initial impairment tests in the
first quarter of 2002, which did not result in an impairment of goodwill or
other intangibles.
In June 2001, the FASB issued SFAS No. 143 "Accounting for Asset Retirement
Obligations". SFAS No. 143 addresses financial accounting and reporting for
obligations and costs associated with the retirement of tangible long-lived
assets. The Company is required to implement SFAS No. 143 on January 1, 2003,
and management does not expect its adoption to have a material impact on the
Company's results of operations or financial position.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets", effective for fiscal years beginning after
December 15, 2001. Under SFAS No. 144 assets held for sale will be included in
discontinued operations if the operations and cash flows will be or have been
eliminated from the ongoing operations of the entity and the entity will not
have any significant continuing involvement in the operations of the component.
The Company adopted SFAS No. 144 on January 1, 2002. The adoption of SFAS No.
144 did not have a material impact on the Company's results of operations or
financial position.
In April 2002, the FASB issued SFAS No. 145 "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections".
This statement eliminates the automatic classification of gain or loss on
extinguishment of debt as an extraordinary item of income and requires that such
gain or loss be evaluated for extraordinary classification under the criteria of
Accounting Principles Board No. 30 "Reporting Results of Operations". This
statement also requires sales-leaseback accounting for certain lease
modifications that have economic effects that are similar to sales-leaseback
transactions, and makes various other technical corrections to existing
pronouncements. This statement will be effective for the Company for the year
ending December 31, 2003. The adoption of this statement will not have a
material effect on our results of operations or financial position.
In July 2002, the Financial Accounting Standards Board issued SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146
will supersede Emerging Issues Task Force Issue No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires
that costs associated with an exit or disposal plan be recognized when incurred
rather than at the date of a commitment to an exit or disposal plan. SFAS No.
146 is to be applied prospectively to exit or disposal activities initiated
after December 31, 2002.
-9-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
FORWARD-LOOKING STATEMENTS
The following discussion and analysis should be read in conjunction with the
financial statements included in this report. It is intended to assist the
reader in understanding and evaluating the financial position of the Company.
This report contains, in addition to historical information, forward-looking
statements that involve risks and uncertainties. Words such as "may", "will",
"should", "could", "expects", "plans", "intends", "anticipates", "believes",
"estimates", "potential", or "continue" or the negative of such terms and other
comparable terminology are intended to identify forward-looking statements. The
Company's actual results could differ materially from the results discussed in
the forward-looking statements. Risk factors that could cause or contribute to
such differences include those discussed in Essential Reality, Inc.'s
Registration Statement of Form SB-2 filed on July 19, 2002.
Overview
On June 20, 2002, Essential Reality, LLC, a Delaware Limited Liability Company
("ER LLC"), completed a business combination with JPAL, Inc., a Nevada
corporation and an SEC registrant ("JPAL") pursuant to an Amended Contribution
Agreement between ER LLC and JPAL, whereby all of the members of ER LLC
contributed their membership interests in ER LLC to the Company in exchange for
an aggregate of 16,874,784 shares of the Company's common stock (the
"Transaction"). Concurrent with the Transaction, the shareholders of JPAL
canceled 7,564,326 of their shares of JPAL common stock and were left with
1,080,934 shares of common stock representing 6.02% of the Company. Following
the Transaction, JPAL changed its name to Essential Reality, Inc. (the
"Company") and ER LLC, a wholly owned subsidiary of the Company, was merged into
the Company.
The Transaction was accounted for as a reverse acquisition in which ER LLC is
the accounting acquirer and JPAL is the legal acquirer. The management of the ER
LLC remained as the management of the Company. Since the Transaction was
accounted for as a reverse acquisition and not a business combination, no
goodwill has been recorded in connection with the Transaction and the costs
incurred in connection with the Transaction has been accounted for as a
reduction of additional paid-in capital. As a result of the reverse acquisition,
(i) the historical financial statements of the Company for periods prior to the
date of the Transaction are no longer the historical financial statements of
JPAL, and, therefore, JPAL's historical financial statements are no longer
presented; (ii) the historical financial statements of the Company for periods
prior to the date of the Transaction are those of ER LLC; (iii) all references
to the financial statements of the "Company" apply to the historical financial
statements of ER LLC prior to the Transaction and to the financial statements of
the Company subsequent to the Transaction; and (iv) any reference to the Company
applies solely to ER LLC and Essential Reality, Inc.
Founded in 1999, the Company 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. The user moving his hand and/or bending his fingers controls P5(TM).
On June 20, 2002, the Company completed a private placement (the "Offering")
whereby it issued 7,274,784 membership units for gross proceeds of $7,577,900.
Included in the gross proceeds was $500,000 of bridge loans that were converted
to 480,000 membership units of the Company. $250,000 of the bridge loans
converted was owed to JPAL and $250,000 was due to a third party lender. In
connection with the Offering, the Company issued to its financial advisors
warrants to purchase an aggregate of 331,211 membership units (the "Additional
Warrants"). Such warrants shall have an exercise price of $1.30 per membership
unit and shall be exercisable for a period of up to five years. As a result of
the Transaction, warrants to purchase membership units in the Company have
become warrants to purchase common shares of the Company.
The Company 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, the Company has not generated revenues
and has incurred significant recurring losses from operations.
-10-
Critical Accounting Policy
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 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
June 30, 2002, Essential Reality expensed all product development costs.
For the three and six months ended June 30, 2002 compared to the three and six
months ended June 30, 2001
The unaudited financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America 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 and six months ended June 30, 2002, we 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. Interest income was $2,851 and $2,851 for the three and six
months ended June 30, 2002, respectively, as compared to $7,140 and $20,018 for
the three and six months ended June 30, 2001. During 2002, interest income was
earned from cash and cash equivalents. In 2001, interest was earned primarily
from the note receivable for Essential Reality, LLC's members' capital.
Operating expenses. For the three and six months ended June 30, 2002, operating
expenses totaled $1,214,839 and $2,526,352, respectively, compared to $314,289
and $873,836 for the three and six months ended June 30, 2001, respectively. 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 and six months ended June 30, 2002
was $400,288 and $881,110, respectively, compared with $246,759 and $380,116 for
the three and six months ended June 30, 2001, respectively. 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 expenses are $5,900,
$24,900, $26,700 and $41,500 for the three and six months ended June 30, 2002
and 2001, respectively, paid to a company owned by certain shareholders of the
Company.
Marketing expense. For the three and six months ended June 30, 2002 was $328,935
and $616,523, respectively, compared with $178,806 and $262,067 for the three
and six months ended June 30, 2001, respectively. The increases in marketing
expense reflect increases in marketing related salaries, public relations,
corporate identity programs, trade shows and related travel.
General and administrative expenses for the three and six months ended June 30,
2002 was $482,201 and $1,021,889, respectively, compared to $132,831 and
$230,337 for the three and six months ended June 30, 2001, respectively. The
increase is due to an increase in administrative personnel, the increased
resources required to support our development and marketing activities and a
non-cash charge of $118,499 incurred in the three months ended June 30, 2002
relating to stock options issued to employees, directors, advisors and
consultants. Included in general and administrative expenses are costs incurred
of approximately $49,800, $128,100, $44,700 and $86,700 for the three and six
months ended June 30, 2002 and 2001, respectively, by two entities that are
related to certain shareholders. 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 approximate fair market value.
Interest expense. Interest expense for the three and six months ended June 30,
2002 was $90,301 and $138,886, respectively, compared with $524 and $1,037 for
the three and six months ended June 30, 2001, respectively. In 2002, interest
expense related primarily to bridge loans. Included in interest expense for the
three months ended June 30, 2002 is a non-cash charge of $23,081 relating to
amortization of deferred interest.
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Net loss for the three and six months ended June 30, 2002 and June 30, 2001 were
$1,302,289, $2,662,387, $552,932 and $854,856, respectively.
Liquidity and Capital Resources
For the six months ended June 30, 2002 we used cash in operations of $2,817,231.
The principal difference between net loss and cash flow used in operations was
cash to secure letters of credit in the amount of $575,000.
During the six months ended June 30, 2002, the Company completed a private
placement which generated cash proceeds of $6,227,364 net of costs associated
with the Transaction and Offering of $850,536, of which $217,755 was prepaid as
of December 31, 2001.
During the six months ended June 30, 2002, we received proceeds from bridge
loans of $1,825,000. Bridge loans prior to closing of the Transaction and
Offering amounted to $3,325,000. Upon closing of the Offering, $500,000 of the
bridge loans was converted to 480,000 membership units of ER LLC and we repaid
an additional $550,000 of the bridge loans. Upon closing of the Transaction the
remaining bridge loans and accrued interest in the amount of $2,378,431 were
eliminated and we assumed $2,517,070 of notes payable to third party lenders.
Following the Transaction, we repaid $550,000 of the notes payable.
At June 30, 2002 we had total assets of $4,930,234 of which $4,135,446 was in
cash and cash equivalents and $575,000 was in restricted cash. Restricted cash
is used to secure letters of credit, which are required to place orders for the
manufacture of our products. At June 30, 2002 we had total liabilities of
$1,999,259 of which $772,389 were accounts payable and $831,771 (net of deferred
interest of $1,135,299) were notes payable. Notes payable bear interest at the
rate of 8 1/2% per annum and are due April 30, 2004, except that $200,000 of the
notes payable is due within one year.
The Company anticipates that, based on its proposed plans and assumptions
relating to the implementation of its business plan and cash on hand as of June
30, 2002 together with projected revenue and anticipated accounts receivable
factoring and trade financing, it will have a cash shortfall of approximately
$1.4 million as of December 2002. Should the Company not raise additional
capital, generate the projected revenue or obtain anticipated accounts
receivable factoring and trade financing, the Company expects to adjust its
business plan and cash burn rate such that cash on hand as of June 30, 2002 will
be sufficient to satisfy operations through December 2002. Thereafter, the
Company will require additional funding in order to reach the point of
self-sufficiency. The Company hopes to raise the additional cash from the
exercise of certain warrants and/or through additional offerings of its
securities. The Company is unable project cash requirements through June 30,
2003 until it more fully determines the level of projected revenue from the sale
of its primary product, P5(TM). Such determination is expected to occur in the
second half of 2002.
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Recent Accounting Pronouncements
On June 29, 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 142, "Goodwill and Intangible Assets." SFAS No. 142 eliminated the
amortization of goodwill and certain other intangibles and requires an
impairment test of their carrying value. An initial impairment test of goodwill
and certain other intangibles must be completed in the year of adoption with at
least an annual impairment test thereafter. On January 1, 2002, the Company
adopted SFAS No. 142. The Company completed the initial impairment tests in the
first quarter of 2002, which did not result in an impairment of goodwill or
other intangibles.
In June 2001, the FASB issued SFAS No. 143 "Accounting for Asset Retirement
Obligations". SFAS No. 143 addresses financial accounting and reporting for
obligations and costs associated with the retirement of tangible long-lived
assets. The Company is required to implement SFAS No. 143 on January 1, 2003,
and management does not expect its adoption to have a material impact on the
Company's results of operations or financial position.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets", effective for fiscal years beginning after
December 15, 2001. Under SFAS No. 144 assets held for sale will be included in
discontinued operations if the operations and cash flows will be or have been
eliminated from the ongoing operations of the entity and the entity will not
have any significant continuing involvement in the operations of the component.
The Company adopted SFAS No. 144 on January 1, 2002. The adoption of SFAS No.
144 did not have a material impact on the Company's results of operations or
financial position.
In April 2002, the FASB issued SFAS No. 145 "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections".
This statement eliminates the automatic classification of gain or loss on
extinguishment of debt as an extraordinary item of income and requires that such
gain or loss be evaluated for extraordinary classification under the criteria of
Accounting Principles Board No. 30 "Reporting Results of Operations". This
statement also requires sales-leaseback accounting for certain lease
modifications that have economic effects that are similar to sales-leaseback
transactions, and makes various other technical corrections to existing
pronouncements. This statement will be effective for the Company for the year
ending December 31, 2003. The adoption of this statement will not have a
material effect on our results of operations or financial position.
In July 2002, the Financial Accounting Standards Board issued SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146
will supersede Emerging Issues Task Force Issue No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires
that costs associated with an exit or disposal plan be recognized when incurred
rather than at the date of a commitment to an exit or disposal plan. SFAS No.
146 is to be applied prospectively to exit or disposal activities initiated
after December 31, 2002.
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PART II -- OTHER INFORMATION
Item 2. Changes in Securities.
On June 20, 2002, the Company issued an aggregate of 16,874,784 shares of its
common stock (the "Common Stock") to the members of ER LLC, in exchange for such
members interest in ER LLC, pursuant to the terms of an Amended Contribution
Agreement (the "Contribution Agreement"), dated as of April 24, 2002, between
the Company, ER LLC, Martin Abrams, John Gentile, Anthony Gentile and LCG
Capital Group, LLC, as amended. Following the Transaction, ER LLC, then a wholly
owned subsidiary of the Company, was merged with and into the Company. The
Company financed the Transaction with shares of its common stock having a market
value of approximately $29,000,000.
In connection with the issuance of the shares of Common Stock referenced above,
the Company relied on the exemption from registration provided by Section 4(2)
of the Securities Act of 1933, as amended.
Item 4. Submission of Matters to Vote of Security Holders
(a) A special meeting of the shareholders was held on June 5, 2002.
(b) Not applicable.
(c) The only matter voted on at the meeting was to consider and vote
upon a proposal to approve the Contribution Agreement. The number of
votes cast were as follows:
For: 5,100,260
Against: 0
Withheld: 0
Abstentions: 0
Broker non-votes: 0
Item 6. Exhibits and Reports on Form 8-K
(a) EXHIBITS
2.1 Amended Contribution Agreement, dated as of April 24, 2002, by and
among Essential Reality, LLC, the Company (f/k/a JPAL, Inc.), Martin
Abrams, John Gentile, Anthony Gentile and LCG Capital Group, LLC.
(Incorporated by reference from Exhibit A to the Company's Schedule
14A filed May 21, 2002)
2.2 Amendment to Amended Contribution Agreement, dated as of April 24,
2002, by and among Essential Reality, LLC, the Company (f/k/a JPAL,
Inc.), Martin Abrams, John Gentile, Anthony Gentile and LCG Capital
Group, LLC, dated as of June 14, 2002. (Incorporated herein by
reference from Exhibit 2.2 to the Company's Current Report on Form
8-K filed July 3, 2002)
99.1 Certification of Chief Executive Officer. The Company does not
currently have a Chief Financial Officer.
(b) REPORTS ON FORM 8-K
As reported in a Form 8-K dated June 20, 2002 (filed July 3, 2002) under
Item 2 (Acquisition or Disposition of Assets), the Company entered into an
Amended Contribution Agreement (the "Contribution Agreement"), dated as of
April 24, 2002, with Essential Reality, LLC ("ER LLC"), Martin Abrams,
John Gentile, Anthony Gentile and LCG Capital Group, LLC, as amended,
whereby all the members of ER LLC contributed their membership interest in
ER LLC to the Company in
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exchange for an aggregate of 16,874,784 shares of the Company's common
stock (the "Exchange"). Following the Exchange, ER LLC, then a wholly
owned subsidiary of the Company, was merged with and into the Company. The
Exchange was consummated on June 20, 2002. The Company financed the
transaction with shares of its common stock having a market value of
approximately $29,000,000.
Also reported in the same Form 8-K under Item 7 (Financial Statements, Pro
Forma Financial Information and Exhibits), the Company announced that it
would file the required financial statements as required by Item 7(a) and
7(b) no later than September 3, 2002.
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Essential Reality, Inc.,
a Nevada corporation
(Registrant)
Date: August 19, 2002
By: /s/ Steven Francesco
------------------------------------
Its: Chief Executive Officer
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