UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 8-K/A
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of Earliest Event Reported): June 20, 2002
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Essential Reality, Inc.
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(Exact name of registrant as specified in its charter)
Nevada 000-32319 33-0851302
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(State or other (Commission File Number) (IRS Employer
of incorporation) Identification No.)
49 West 27th Street, Suite 7E, New York, New York 10001
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (212) 244-3200
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(Former name or former address, if changed since last report)
1
PORTIONS AMENDED:
The Registrant hereby amends Item 7 contained in the Registrant's Current
Report on Form 8-K filed July 3, 2002 to provide the requisite financial
information required by Item 7 including pro forma financial information. Except
as set forth in Item 7 below, no other changes are made to the Registrant's
Current Report on Form 8-K filed July 3, 2002.
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS.
a. Audited Financial Statements of Essential Reality LLC for the years ended
December 31, 2001 and 2000.
b. Unaudited financial statements of Essential Reality, Inc. (Formerly JPAL,
Inc.) for the six months ended June 30, 2002 and 2001
c. Unaudited Pro Forma Financial Information of Essential Reality, Inc.
(Formerly JPAL, Inc.) for the year ended December 31, 2001 and for the six
months ended June 30, 2002.
d. Exhibits:
None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
Date: September 27, 2002 Essential Reality, Inc.
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(Registrant)
/s/ STEVEN FRANCESCO
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Steven Francesco
Chief Executive Officer
2
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.
New York, New York
January 21, 2002 (July 9, 2002 as to Note 8)
3
ESSENTIAL REALITY, LLC
(A Development Stage Entity)
BALANCE SHEETS
DECEMBER 31, 2001 AND 2000
--------------------------------------------------------------------------------
December 31,
2001 2000
ASSETS
CURRENT ASSETS:
Cash and cash equivalents (Note 2) $ 13,863 $ 231,905
Interest receivable - 48,716
Deferred financing costs 217,755 -
Prepaid expenses and deposits 34,337 6,820
----------- -----------
Total current assets 265,955 287,441
DOMAIN NAMES - Net (Note 2) 9,000 -
FIXED ASSETS - Net (Note 3) 10,099 -
OTHER ASSETS 80,550 22,500
DEFERRED INTEREST EXPENSE - BRIDGE LOANS 232,389 -
----------- -----------
TOTAL ASSETS $ 597,993 $ 309,941
=========== ===========
LIABILITIES AND MEMBERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable $ 676,133 $ 75,238
Accounts payable - related parties 84,000 -
Accrued interest expense - bridge loans (Note 4) 250,750 -
Accrued compensation (Note 7) 257,103 221,267
Bridge loans (Note 4) 1,500,000 -
Advances from LCG Capital Group, LLC 76,617 -
Advances from affiliated companies 25,632 19,647
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Total current liabilities 2,870,235 316,152
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COMMITMENTS AND CONTINGENCIES
MEMBERS' EQUITY (DEFICIT):
Members' capital 2,500,000 2,500,000
Note receivable for members' capital - (865,453)
Deficit accumulated during development stage (4,772,242) (1,640,758)
----------- -----------
Total members' equity (deficit) (2,272,242) (6,211)
----------- -----------
TOTAL LIABILITIES AND MEMBERS' EQUITY (DEFICIT) $ 597,993 $ 309,941
=========== ===========
See notes to financial statements.
4
ESSENTIAL REALITY, LLC
(A Development Stage Entity)
STATEMENTS OF OPERATIONS
CUMULATIVE PERIOD FROM JUNE 1, 1999 (DATE OF COMMENCEMENT) TO DECEMBER 31, 2001,
YEARS ENDED DECEMBER 31, 2001 AND 2000
--------------------------------------------------------------------------------
Cumulative
Period from
June 1, 1999 (Date
of Commencement) Year Ended Year Ended
to December 31, December 31, December 31,
2001 2001 2000
OPERATING EXPENSES:
Product development $ 2,480,544 $ 1,579,129 $ 679,891
Marketing 1,066,525 716,674 349,851
General and administrative 1,316,001 823,791 491,930
Depreciation and amortization 11,850 11,850 -
----------- ----------- -----------
Total operating expenses 4,874,920 3,131,444 1,521,672
LOSS FROM OPERATIONS (4,874,920) (3,131,444) (1,521,672)
----------- ----------- -----------
INTEREST INCOME 125,117 20,465 104,652
INTEREST EXPENSE (22,439) (20,505) (1,934)
----------- ----------- -----------
NET LOSS $(4,772,242) $(3,131,484) $(1,418,954)
=========== =========== ===========
See notes to financial statements.
5
ESSENTIAL REALITY, LLC
(A Development Stage Entity)
STATEMENTS OF MEMBERS' EQUITY (DEFICIT)
PERIOD FROM JUNE 1, 1999 (DATE OF COMMENCEMENT) TO
DECEMBER 31, 1999 AND YEARS ENDED DECEMBER 31, 2001 AND 2000
---------------------------------------------------------------------------------------
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)
========== =========== ============ ============
See notes to financial statements.
6
ESSENTIAL REALITY, LLC
(A Development Stage Entity)
STATEMENTS OF CASH FLOWS
CUMULATIVE PERIOD FROM JUNE 1, 1999 (DATE OF COMMENCEMENT) TO DECEMBER 31, 2001,
YEARS ENDED DECEMBER 31, 2001 AND 2000
-----------------------------------------------------------------------------------------------
Cumulative
Period from
June 1, 1999 (Date
of Commencement) Year Ended Year Ended
to December 31, December 31, December 31,
2001 2001 2000
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(4,772,242) $(3,131,484) $(1,418,954)
Depreciation and amortization 11,850 11,850 -
Amortization of deferred interest 18,361 18,361 -
Changes in assets and liabilities:
Deferred financing costs (217,755) (217,755) -
Prepaid expenses, deposits and other assets (114,887) (85,567) (29,320)
Interest receivable - 48,716 (48,716)
Accounts payable 676,133 600,895 62,820
Accounts payable - related parties 84,000 84,000 -
Accrued compensation 257,103 35,836 221,267
----------- ----------- -----------
Net cash used in operating activities (4,057,437) (2,635,148) (1,212,903)
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for purchase of domain names (18,000) (18,000) -
Payments for purchase of fixed assets (12,949) (12,949) -
----------- ----------- -----------
Net cash used in investing activities (30,949) (30,949) -
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of members' capital 500,000 - -
Proceeds from repayment of note -
receivable for members' capital 2,000,000 865,453 1,134,547
Proceeds from bridge loans 1,500,000 1,500,000 -
Proceeds from advances from
LCG Capital Group, LLC 76,617 76,617 -
Proceeds of advances from
affiliated companies - net 25,632 5,985 15,547
----------- ----------- -----------
Net cash provided by financing activities 4,102,249 2,448,055 1,150,094
----------- ----------- -----------
INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS 13,863 (218,042) (62,809)
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD - 231,905 294,714
----------- ----------- -----------
CASH AND CASH EQUIVALENTS,
END OF PERIOD $ 13,863 $ 13,863 $ 231,905
=========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS:
Note received for members' capital 2,000,000 $ - $ -
Deferred interest expense - bridge loans $ 232,389 $ 232,389 $ -
Accrued interest expense - bridge loans $ 250,750 $ 250,750 $ -
See notes to financial statements.
7
ESSENTIAL REALITY, LLC
(A Development Stage Entity)
NOTES TO FINANCIAL STATEMENTS
CUMULATIVE PERIOD FROM JUNE 1, 1999 (DATE OF COMMENCEMNET) TO DECEMBER 31, 2001
AND YEARS ENDED DECEMBER 31, 2001 AND 2000
1. THE COMPANY
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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, which should be completed in the near future. P5 is
controlled by the user moving their hand or bending their 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 period the cumulative
period from June 1, 1999 (Date of Commencement) to December 31, 2001. During
this period, the Company had cumulative net losses of $4,772,242 and cumulative
negative cash flow from operating activities of $4,057,437. The Company expects
to incur substantial losses and negative cash flow from operating activities for
the near future.
8
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.
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.
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.
Revenue Recognition - Revenue from sales of the P5 will be recognized when
the product has been shipped, the sales price is fixed and determinable,
collection of the resulting receivable is probable and there are no
significant rights of return. Given that the Company does not have a
history of sales of its P5 product, revenue recognition will be deferred
until the right of return period expires.
The Company may bundle product offerings from third party vendors along
with the P5 product. The Company maintains the relationship with the
customer and, as such, is the primary obligor. The Company has assumed the
responsibility for customer acceptance of all features of the product, as
well as returns. As such, the Company will record the gross amount of the
purchase price of the P5 as revenue and will reflect the related royalty to
be paid to the third party vendor as a component of cost of sales.
9
Inventory - Inventory will be valued at the lower or cost or market value,
with cost being determined on the first-in-first-out basis.
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.
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
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 Company does not expect that
adoption of SFAS No. 142 will have a material impact on the Company's
financial position or results of operations.
10
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 Company does not expect that
adoption of SFAS No. 144 will 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.
3. FIXED ASSETS AND DOMAIN NAMES
At December 31, 2001, the fixed assets were comprised of $10,949 of office
furniture and equipment and $2,000 for computer equipment. Depreciation
expense and accumulated amortization for the years ended December 31, 2001
and 2000 and for the period from June 1, 1999 (Date of Commencement) to
December 31, 1999 amounted to $2,850, 0 and 0, respectively.
At December 31, 2001, the Company incurred $18,000 for Domain names.
Amortization and accumulated amortization of domain names for the years
ended December 31, 2001 and 2000 and for the period from June 1, 1999 (Date
of Commencement) to December 31, 1999 amounted to $9,000, 0 and 0,
respectively.
4. BRIDGE LOANS
The bridge loans are from JPAL, Inc. ("JPAL") a publicly traded corporation
with which the Company has completed a merger transaction (the
"Transaction") as described more fully in Note 8c. The bridge loans are
unsecured and bear interest at the rate of 8.5 % per annum, however
interest does not begin to accrue until January 31, 2002. The bridge loans,
together with accrued interest thereon become payable on the earlier of i)
January 31, 2004 and (ii) the sale or exchange of all or substantially all
of the membership interests of the Company which results in the Company
having an infusion of $4.5 million in capital.
Although interest on the bridge loans does not begin to accrue until
January 31, 2002, interest on the bridge loans in the amount of $250,750
has been imputed and accrued representing the interest payable on the
bridge loans advanced from
11
inception through December 31, 2001 to January 31, 2004 with a
corresponding debit to deferred interest. Deferred interest has been
amortized on a daily basis from the date of the loan to December 31, 2001
resulting in a charge to earnings in the amount of $18,361 for year ended
December 31, 2001.
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.
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.
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.
12
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.
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 and $6,000 for the years ended
December 31, 2001 and 2000, 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, 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.
13
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 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 and $221,267 at December 31, 2001 and
2000, 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 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 and $105,000 for the
years ended December 31, 2001 and 2000, respectively, paid to a
company owned by an individual related to certain members of the
Company, which have expertise in the area of product design.
Included in product development costs are $91,300 and $0 for the years
ended December 31, 2001 and 2000, respectively, paid to a company
owned by certain members of the Company, which have expertise in the
area of product strategy, design and development.
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. Such costs include consulting fees related to
business development, employee salaries, occupancy, telephone and
computer leases. In the case of employee salaries, costs are allocated
to the Company based on the time each employee conducts business
specific to the Company. In the case of the other expenses, costs are
allocated based on a percentage of resources used by the Company.
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.
14
RELATED PARTY TRANSACTIONS BY EXPENSE CATEGORY
Year Ended December 31,
2001 2000
Product development $ 91,300 $ 105,000
General and administrative 242,000 148,000
------------------------
$ 333,300 $ 253,000
========================
8. SUBSEQUENT EVENTS
a. Bridge loans
(i) From January 1, 2002 to June 20, 2002 the Company received an
additional $1,825,000 of bridge loans, of which $1,025,000 were
from JPAL and $800,000 were received third party lenders on the
following terms:
a. Bridge loan from a third party in the amount of $500,000,
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. Contingent on the
closing of the Merger discussed in 8c below, the Company has
also granted to the holder of the bridge loan warrants to
purchase 15,000 common shares of the JPAL for an exercise
price of $1.30 per common share.
b. Bridge loans from third parties in the amount of $300,000,
received in May 2002, are unsecured and bears interest at
the rate of 8% 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. Contingent on
the closing of the Merger discussed in 8c below, the Company
has also granted to the holder of the bridge loan warrants
to purchase 90,000 common shares of the JPAL for an exercise
price of $1.90 per common share.
(ii) In April 2002 the maturity of the bridge loans were changed to
April 30, 2004 with the following prepayment:
a. 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 private placement described in Note 8b;
b. During fiscal 2003, $100,000 payments per quarter
representing interest and principal;
c. 50% of the proceeds received as a result of the exercise of
warrants described below;
d. 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;
e. 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
15
f. 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.
(iii) As part of the private placement described in Note 8b, $500,000
of bridge loans and accrued interest thereon were converted to
480,000 membership units of the Company, of which JPAL converted
$250,000 and a third party lender converted $250,000.
(iv) Upon completion of the Merger described in Note 8c, bridge loans
and accrued interest thereon in the amount of $2,378,431 owed by
the Company to JPAL were eliminated and the Company assumed notes
payable in the amount of $2,517,070. As a result of the
additional borrowings by JPAL, $138,639 has been charged to
additional paid-in capital in the Company's June 30, 2002
financial statements.
The notes payable and bridge loans have substantially the same
terms, except that:
a. $500,000 of the notes payable may be converted by the
holders to 263,158 shares of common stock of JPAL at a
conversion price of $1.90 per share. The conversion right
expires on December 20, 2002.
b. The holders of notes payable agreed to cancel previously
issued warrants to acquire an aggregate of 1,029,600 common
shares for $3.00 per share and were issued warrants having
an expiration of June 20, 2004, to purchase an aggregate of
750,000 common shares of JPAL for $1.90 per share.
(v) Upon completion of the merger described in Note 8c, bridge loans
in the amount of $550,000 to third party lenders were repaid.
(vi) Upon completion of the merger described in Note 8c, notes payable
in the amount of $550,000 were repaid.
The value resulting from the beneficial conversion feature in the
amount of $297,780 and warrants in the amount of $860,600 has been
recorded as additional paid-in capital in the June 30, 2002 financials
statement of the Company and has been computed using the Black-Scholes
pricing model using a stock price of $3.05, expiration dates of
December 20, 2002 for the beneficial conversion feature and June 20,
2004 for the warrants, volatility of 80% and a risk free rate of 5%.
Such amount will be accreted into notes payable as additional interest
expense over the remaining life of the notes.
As a result of the transactions completed subsequent to December 31,
2001 as of June 20, 2002, the Company had no bridge loans outstanding
and had notes payable outstanding of approximately $1,967,000.
b. 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. The Company incurred cash costs associated
with the Transaction and Offering of $850,536, of which $217,755 was
prepaid as of December 31, 2001.
16
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 Additional 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, which was both a credit and debit to adjusted paid-in
capital and thus had no net effect on members' capital, was computed
using the Black-Scholes pricing model and using $3.05 as the market
price, $1.30 as the exercise prices, 5 year expiration, volatility of
80% and a risk free rate of 5%.
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.
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
(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 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 July 9, 2002, the Company has posted letters of
credit of approximately $575,000. The Company expects to post the
remaining letter of credit prior to October 31, 2002.
17
(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
(i) 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 theses 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.
(ii) 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%.
(iii)From July 1, 2002 to July 9, 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.
18
ESSENTIAL REALITY, INC. (FORMERLY JPAL, INC.)
(A Development Stage Entity)
CONDENSED BALANCE SHEETS
JUNE 30, 2002 AND 2001 (UNAUDITED)
June 30, 2002 June 30, 2001
(Unaudited) (Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,135,446 $ 93,145
Restricted cash 575,000 -
Interest receivable - 24,761
Prepaid expenses and deposits 117,917 8,820
----------- -----------
Total current assets 4,828,363 126,726
DOMAIN NAMES 4,500 -
FIXED ASSETS 16,821 10,557
OTHER ASSETS 80,550 22,500
DEFERRED INTEREST EXPENSE - BRIDGE LOANS - -
----------- -----------
TOTAL ASSETS $ 4,930,234 $ 159,783
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 772,389 95,640
Accounts payable - related parties 49,030 -
Accrued interest expense - notes payable 4,581 -
Accrued compensation 243,737 237,567
Notes payable - current portion 200,000 -
Advances from LCG Capital Group, LLC 73,617 -
Advances from affiliated companies 24,134 25,396
----------- -----------
Total current liabilities 1,367,488 358,603
----------- -----------
NOTES PAYABLE --- LONG -TERM PORTION (net of deferred
interest of $1,135,299) 631,771 -
----------- -----------
Total liabilities 1,999,259 358,603
----------- -----------
STOCKHOLDERS' EQUITY (DEFICIT):
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 June 30, 2001, respectively) 17,956 9,600
Additional paid in capital 11,491,307 2,490,400
Deferred compensation expense (1,143,659) -
Note receivable for stockholders' capital - (203,206)
Deficit accumulated during development stage (7,434,629) (2,495,614)
----------- -----------
Total stockholders' equity (deficit) 2,930,975 (198,820)
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 4,930,234 $ 159,783
=========== ===========
See notes to condensed financial statements.
19
ESSENTIAL REALITY, INC. (FORMERLY JPAL, INC.)
(A Development Stage Entity)
CONDENSED STATEMENTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2002 AND 2001 (UNAUDITED)
-----------------------------------------------------------------------------------
Six Months Ended June 30,
2002 2001
(Unaudited) (Unaudited)
-----------------------------------------------------------------------------------
OPERATING EXPENSES:
Product development $ 881,110 $ 380,116
Marketing 616,523 262,067
General and administrative (including non-cash stock
compensation of $118,499 for the
six months ended June 30, 2002) 1,021,889 230,337
Depreciation and amortization 6,830 1,317
----------- ----------
Total operating expenses 2,526,352 873,837
----------- ----------
LOSS FROM OPERATIONS (2,526,352) (873,837)
INTEREST INCOME 2,851 20,018
INTEREST EXPENSE (138,886) (1,037)
----------- ----------
NET LOSS $(2,662,387) $ (854,856)
=========== ==========
BASIC AND FULLY DILUTED
LOSS PER SHARE $ (0.15) $ (0.09)
=========== ==========
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING 17,955,718 9,600,000
=========== ==========
See notes to condensed financial statements.
20
ESSENTIAL REALITY, INC. (FORMERLY JPAL, INC.)
(A Development Stage Entity)
CONDENSED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2002 AND 2001 (UNAUDITED)
Six months ended June 30,
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 20,402
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) (794,882)
---------- ---------
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 (138,760)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 13,863 231,905
---------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 4,135,446 $ 93,145
========== =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest expense $ 22,500 $ -
SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS:
Bridge loans converted to membership units $ 500,000 $ -
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.
21
ESSENTIAL REALITY, INC. (FORMERLY JPAL, INC.)
NOTES TO CONDENSED FINANCIAL STATEMENTS
JUNE 30, 2002 AND 2001 (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" . 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 .
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, 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
22
to satisfy operations through December 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. 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 Additional 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 8.5% 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.
23
The value of the beneficial 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
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 theses
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. The issuance of the options resulted in
deferred stock-based compensation of $783,750 which will be recorded in the
Company's September 30, 2002 financial statements.
5. RELATED PARTY TRANSACTIONS
a. Accrued compensation of $243,737 and $237,567 at June 30, 2002 and
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 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 $24,900 and $41,500 for the
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 $128,100 and $86,700 for the 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
2001 are approximately $19,000 and $0, respectively, payable to a
company owned by a person related to certain members of the Company.
24
h. Included in accounts payable - related parties at June 30, 2002 and
2001 are approximately $30,000 and $0, respectively, payable to a
company that is related to certain shareholders of the Company.
Six Months Ended June 30,
2002 2001
(Unaudited) (Unaudited)
RELATED PARTY TRANSACTIONS BY EXPENSE CATEGORY
Product development $ 24,900 $ 41,500
General and administrative 128,100 86,700
----------------------
$ 153,000 $ 128,200
======================
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 six months ended June 30, 2002 is $16,667 relating to
this letter of intent.
25
ESSENTIAL REALITY, INC. (FORMERLY JPAL, INC)
(A Development Stage Company)
Unaudited Pro Forma Financial Statements
Year ended December 31, 2001 and six months ended June 30, 2002
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 JPAL'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 JPAL. 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.
Immediately prior to the Transaction, 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.
Upon completion of the Transaction, bridge loans and accrued interest thereon in
the amount of $2,378,431 owed by ER LLC to JPAL were eliminated and the Company
assumed notes payable in the amount of $2,517,070. (i) As a result
additional borrowings by JPAL, $138,639 has been charged to additional paid-in
capital in the Company's June 30, 2002 financial statements. The notes payable
and bridge loans have substantially the same terms, except that:
26
(i) $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.
(ii) The holders of notes payable agreed to cancel previously issued
warrants to acquire an aggregate of 1,029,600 common shares for $3.00
per share and were issued warrants having an expiration of June 20,
2004, to purchase an aggregate of 750,000 common shares of the Company
for $1.90 per share.
Additionally, the Company issued to its third party bridge loan lenders warrants
to purchase an aggregate of 90,000 and 15,000 shares of its common shares for
$1.90 and $1.30, respectively. Such warrants expire on June 20, 2004.
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 Additional 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 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 six months ended June 30, 2002,
gives effect to the Transaction and Offering as if these transactions had
occurred on January 1, 2001 respectively. An unaudited pro forma balance sheet
as of June 30, 2002 and JPAL's statement of operations dated for the six months
ended June 30, 2002 have not been included herein since the Transaction and the
Offering were completed prior to the date of the June 30, 2002 financial
statements.
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.
27
ESSENTIAL REALITY, INC. (FORMERLY 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 for Completion of Offering
December 31, 2001 December 31, 2001 the Offering and and Transaction
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) (219,353) (4) (940,175)
- (28,087) (5)
(85,618) (6)
OTHER INCOME 1,039 - - 1,039
------------ ----------- ---------- ------------
NET LOSS $ (652,397) $(3,131,484) $ (333,058) $(4,116,939)
============ =========== ========== ============
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING -
BASIC AND DILUTED 8,645,260 7,274,784 (1) 17,955,718
9,600,000 (2)
(7,564,326) (3)
NET LOSS PER SHARE $ (0.08) $ (0.23)
============= ============
See notes to unaudited pro forma financial statements.
28
ESSENTIAL REALITY, INC. (FORMERLY JPAL, INC.)
(A Development Stage Entity)
UNAUDITED PRO FORMA STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2002
Essential Reality, Inc. Pro Forma Pro Forma After
Six Months Ended Adjustments for Completion of Offering
June 30, 2002 the Offering and and Transaction
Transaction
OPERATING EXPENSES:
Product development $ 881,110 $ - $ 881,110
Marketing 616,523 - 616,523
General and administrative 1,021,889 - 1,021,889
Depreciation and amortization 6,830 - 6,830
----------- ----------- -----------
Total operating expenses 2,526,352 - 2,526,352
----------- ----------- -----------
LOSS FROM OPERATIONS (2,526,352) - (2,526,352)
INTEREST INCOME - - -
INTEREST EXPENSE (48,585) (328,427) (4) (547,256)
- (42,053) (5)
OTHER INCOME - (128,191) (6) -
----------- ----------- -----------
NET LOSS $(2,574,937) $ (422,091) $(3,073,608)
=========== =========== ===========
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING -
BASIC AND DILUTED 17,955,718 17,955,718
NET LOSS PER SHARE $ (0.14) $ (0.17)
=========== ===========
See notes to unaudited pro forma financial statements.
29
ESSENTIAL REALITY, INC. (FORMERLY JPAL, INC.)
NOTES TO UNAUDITED PRO FORMA FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 2001 AND SIX MONTHS ENDED JUNE 30, 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.
2) Reflects the exchange of the membership interest in ER LLC for
16,874,784 shares of common stock of JPAL. Prior to the Offering
reflected in adjustment #1, there were 9,600,000 membership units
issued and outstanding in ER LLC. Since the shares issued as a result
of the offering are reflected in adjustment #1, only the 9,600,000
shares issued are reflected in this adjustment.
3) Reflects the cancellation of 7,564,326 common shares of JPAL Inc. held
by current JPAL Inc. stockholders.
4) Reflects amortization of deferred interest in the amount of $219,352
and $328,427 for the year ended December 31, 2001 and six months ended
June 30, 2002, respectively. Deferred interest resulted from the value
of the issuance of warrants to purchase an aggregate of 750,000 common
shares for $1.90 per share in connection with the notes payable. The
values of the warrants of $762,914 was computed using the
Black-Scholes pricing model using $3.05 as the market price, $1.90 as
the exercise price, 2 year expected life, volatility of 80% and a risk
free rate of 5%. Such amount will be accreted into notes payable as
additional interest expense over the life of the notes.
30
5) Reflects amortization of deferred interest in the amount of $28,087
and $42,053 for the year ended December 31, 2001 and six months ended
June 30, 2002, respectively. Deferred interest resulted from the value
of the issuance of warrants to purchase an aggregate of 90,000 and
15,000 common shares for $1.90 and $1.30 per share, respectively,
issued to the Company's bridge loan lenders. The values of the
warrants of $97,686 was computed using the Black-Scholes pricing model
using $3.05 as the market price, $1.90 and $1.30 as the exercise
prices, 2 year expected life, volatility of 80% and a risk free rate
of 5%. Such amount will be accreted into notes payable as additional
interest expense over the life of the notes.
6) Reflects amortization of deferred interest in the amount of $85,618
and $59,490 for the year ended December 31, 2001 and six months ended
June 30, 2002, respectively. Deferred interest resulted from the
beneficial conversion feature of the $500,000 notes payable which 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 values of the
beneficial conversion feature of $297,780 was computed using the
Black-Scholes pricing model using $3.05 as the market price, $1.90 as
the exercise price, 6 months expected life, volatility of 80% and a
risk free rate of 5%. Such amount will be accreted into notes payable
as additional interest expense over the life of the notes.
31