As filed with the Securities and Exchange Commission on July 19, 2002 Registration No. 333-_______ ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM SB-2 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------------ ESSENTIAL REALITY, INC. (Exact name of registrant as specified in its charter) Nevada 334119 33-0851302 (State or Other Jurisdiction (North American (I.R.S. Employer of Incorporation or Industry Classification Identification Number) Organization) System Code Number) 49 West 27th Street, Suite 7E New York, New York 10001 (212) 244-3200 (Address and Telephone Number of Principal Executive Offices and Principal Place of Business) ------------------------------ Steven Francesco Chief Executive Officer Essential Reality, Inc. 49 West 27th Street Suite 7E New York, New York 10001 (212) 244-3200 (Name, Address and Telephone Number of Agent for Service) ------------------------------ Copies to: Steven Wolosky, Esq. Olshan Grundman Frome Rosenzweig & Wolosky LLP 505 Park Avenue, New York, New York 10022 (212) 753-7200 ------------------------------ Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement. ------------------------------If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. |X| If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. |_| If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. |_| If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. |_| If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. |_| CALCULATION OF REGISTRATION FEE - --------------------------------------------------------------------------------------------------------------------- Proposed Proposed Amount Maximum Maximum Amount Of Title of Each Class of Securities to To Be Offering Price Aggregate Registration be Registered Registered Per Share Offering Price Fee - --------------------------------------------------------------------------------------------------------------------- Common Stock, par value $.001 per share............................ 6,764,870 $3.025 (1) $20,463,732 (1) $1,882.66 - --------------------------------------------------------------------------------------------------------------------- Shares of Common Stock underlying warrants issued to holders of bridge notes............................ 855,000 $3.025 (2)(3) $2,586,375 (2) $237.95 - --------------------------------------------------------------------------------------------------------------------- Shares of Common Stock underlying warrants issued to agents........ 331,211 $3.025 (2)(3) $1,001,913 (2) $92.18 - --------------------------------------------------------------------------------------------------------------------- Shares of Common Stock underlying outstanding convertible promissory notes............................ 263,158 $3.025 (2)(3) $796,053 (2) $73.24 - --------------------------------------------------------------------------------------------------------------------- TOTAL.................... 8,214,239 $24,848,073 $2,286.03 - --------------------------------------------------------------------------------------------------------------------- (1) Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457(c) under the Securities Act of 1933, as amended, based on the average of the high and low price of $3.05 and $3.00, respectively, of the common stock on July 15, 2002. (2) Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457(g) under the Securities Act of 1933, as amended, based on the price of the common stock determined in accordance with Rule 457(c). -2- (3) Pursuant to Rule 416 promulgated under the Securities Act of 1933, as amended, this Registration Statement includes an indeterminate number of additional shares of common stock as may from time to time become issuable upon the exercise of certain warrants or conversion of certain convertible notes by reason of stock splits, stock dividends and other similar transactions. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. -3- EXPLANATORY NOTES On June 20, 2002, Essential Reality, Inc., a Nevada corporation formerly known as JPAL, Inc. (the "Company"), consummated a business combination (the "Transaction") with Essential Reality, LLC, a Delaware limited liability company ("ER LLC"). Pursuant to the terms of the Transaction, all of the members of ER LLC contributed their membership interests in ER LLC to the Company in exchange for an aggregate of 16,874,784 shares of the Company's common stock (the "Common Stock"). Such shares consisted of 9,600,000 shares of Common Stock issued to the original members of ER LLC (the "Contribution Shares") and 7,274,784 shares of Common Stock issued to new investors who purchased membership interests in ER LLC in a recently completed private placement (the "Private Placement Shares"). Following the Transaction, ER LLC, then a wholly-owned subsidiary of the Company, was merged with and into the Company. In connection with the Transaction, (i) holders of certain bridge notes issued by the Company received, as additional consideration for the loans, two-year warrants to purchase up to 840,000 shares of Common Stock and 15,000 shares of Common Stock (collectively, the "Bridge Warrant Shares") at a purchase price of $1.90 and $1.30 per share, respectively, (ii) holders of certain bridge notes issued by the Company exchanged them for convertible promissory notes of the Company, which are convertible for a period of six months at a conversion price of $1.90 into an aggregate of 263,158 shares of Common Stock (the "Convertible Note Shares"), and (iii) the Company issued warrants to purchase up to an aggregate of 331,211 shares of Common Stock (the "Additional Warrant Shares") at a purchase price of $1.30 per share. In addition, the Company agreed to register (i) 60% of the Private Placement Shares, (ii) 25% of the Contribution Shares, and (iii) all of the Bridge Warrant Shares, Convertible Note Shares and Additional Warrant Shares. The Company has prepared this Registration Statement, in accordance with the requirements of Form SB-2 under the Securities Act of 1933, as amended, to register the shares of Common Stock set forth in the immediately preceding sentence. Notwithstanding the registration of such shares, a number of such Contribution Shares may not be sold currently since they are subject to various lock-up agreements. -4- The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. PRELIMINARY PROSPECTUS--SUBJECT TO COMPLETION, DATED JULY 19, 2002 PROSPECTUS ESSENTIAL REALITY, INC. 8,214,239 shares of Common Stock o All of the shares of common stock offered by this prospectus are being sold by the selling shareholders. o We will not receive any proceeds from the sale of these shares. We will receive proceeds from the exercise of warrants and those proceeds will be used for our general corporate purposes. o Our common stock is traded on the OTC Bulletin Board under the symbol ESSR. o On July 17, 2002, the last reported sale for our common stock was $3.15 per share. Investing in our common stock involves a high degree of risk. You should carefully consider the factors described under the heading "Risk Factors" beginning on page 5 of this prospectus. ---------------------------- Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense. ---------------------------- ________ ___, 2002 TABLE OF CONTENTS Page ---- PROSPECTUS SUMMARY............................................................1 RISK FACTORS..................................................................5 USE OF PROCEEDS..............................................................12 MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.....................12 DESCRIPTION OF BUSINESS......................................................14 MANAGEMENT'S PLAN OF OPERATION...............................................23 MANAGEMENT...................................................................28 EXECUTIVE COMPENSATION.......................................................35 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...............................35 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT..........................................................37 DESCRIPTION OF CAPITAL STOCK.................................................39 SELLING SHAREHOLDERS.........................................................41 PLAN OF DISTRIBUTION.........................................................47 LEGAL MATTERS................................................................48 EXPERTS......................................................................48 DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES..........................................48 WHERE YOU CAN FIND MORE INFORMATION..........................................49 INDEX TO FINANCIAL STATEMENTS...............................................F-1 i PROSPECTUS SUMMARY THIS SUMMARY HIGHLIGHTS SELECTED INFORMATION ABOUT ESSENTIAL REALITY, INC. THIS SUMMARY MAY NOT CONTAIN ALL OF THE INFORMATION THAT YOU SHOULD CONSIDER BEFORE INVESTING IN OUR COMMON STOCK. YOU SHOULD READ THE ENTIRE PROSPECTUS CAREFULLY, INCLUDING THE INFORMATION UNDER "RISK FACTORS" BEGINNING ON PAGE 5, BEFORE MAKING AN INVESTMENT DECISION. Recent Developments On June 20, 2002, we consummated a business combination with Essential Reality, LLC. Pursuant to the terms of the transaction, all of the members of Essential Reality, LLC contributed their membership interests in Essential Reality, LLC to us in exchange for an aggregate of 16,874,784 shares of our common stock. Following such exchange, Essential Reality, LLC, then our wholly-owned subsidiary, was merged with and into us and we began operating Essential Reality, LLC's business exclusively. Therefore, any historical discussion about our business would be meaningless and potentially misleading, so all discussions in this prospectus relating to our business shall mean Essential Reality, LLC's business. The Business General Founded in 1999, Essential Reality, LLC was a developer of real-time tracking and sensory technologies. We will focus on combining these technologies into products that enhance the interaction between human beings and personal computers, game consoles, computer tablets and other related devices, collectively known as computer platforms. We expect to have our first product, the P5(TM), available for sale during the second half of 2002. The P5(TM) is a glove-like peripheral device that could substantially improve the way individuals interact with computer platforms. The P5(TM), which can be offered at a mass market price point, addresses technological limitations of current input devices. We expect the P5(TM) to be suitable for multiple applications including: o Electronic Gaming - games produced for play on personal computers, game consoles and location-based entertainment sites; o Commercial Applications - such as animation, computer aided design (CAD), simulation training, disability and education; and o Other Computer Interactions - Internet browsing and navigation, and general computer interaction. The P5(TM) Product Family Since the advent of the mouse, relatively little has changed in the way of computer input devices, despite the fact that computers and applications have changed dramatically, growing increasingly complex and specialized. Applications, particularly in the electronic gaming and commercial markets, have migrated from flat two-dimensional (2D) interfaces to intuitive, three-dimensional (3D) environments. However, input devices continue to be dominated by 2D products including mouse controllers and gaming-specific peripherals such as joysticks, steering wheels, proprietary console controllers and the like. The P5(TM) is based on our patented and several patent-pending technologies, one of which was incorporated in the "Power Glove." The Power Glove was introduced to the market in the late 1980s as an alternative controller for use only with the 8-bit Nintendo Entertainment System, part of -1- the first generation of game consoles sold to the mass market. The product eventually sold approximately one million units in the United States, Europe and Japan. Subsequent to a decline in consumer demand for first-generation gaming consoles in the early 1990s, such Nintendo system ceased sales. Therefore, the Power Glove technology was not used nor further developed awaiting the return of computer platforms and applications that could benefit from its utility. With the significant increase in sales of computer platforms and applications in the late 1990s, Essential Reality, LLC engaged developers in 1999 to create a peripheral device based on Essential Reality, LLC's belief that the consumer and commercial markets were ripe for a product with the capabilities of the P5(TM). The P5(TM) is a glove-like peripheral that has been engineered to capture five-finger bend sensitivity enabling gesture recognition, combined with an optical tracking technology that will capture the movement of the hand in 3D space with six degrees of freedom (X, Y, Z, yaw, pitch and roll), without the use of the mouse, joystick, keyboard or the like. The P5(TM) is a lightweight and comfortable peripheral, which is a Universal Serial Bus (USB) based product that will allow for direct "plug and play" in personal computers as well as the Sony PlayStation2 game console. We anticipate compatibility with additional computer platforms, such as the Microsoft Xbox, in the future. According to a Dataquest Inc. market study, 100% of personal computer shipments in 2001 were USB-compatible units, with an installed base of over 500 million personal computer units. There are approximately 27 million computer peripherals that are USB-compatible and the growth of these products is anticipated to reach over 400 million by the year 2003. Research & Product Development Currently, product research and development is conducted via an exclusive arrangement between us and a Canadian based entity that currently employs a team of eleven technicians who spend all of their time working on our products. We have planned for future products that will take the initial P5(TM) through several stages of evolution, which may include a wireless product, a two-handed version, the ability to incorporate biometrics, and a product with tactile feedback. We are also seeking to develop other products, of which several are currently in initial phases of development, that will utilize one or more of our technologies. The combination of future generations of the P5(TM) and the creation of new products will increase our commercial opportunities in both existing and new markets. Sales and Marketing We have identified numerous sales and marketing channels to build a brand and capture a mass market for the P5(TM), as well as other planned products. We anticipate that the sales distribution of the P5(TM) will initially utilize an electronic gaming market retail strategy, expanding into an Original Equipment Manufacturer (OEM) and direct sales effort for penetration of commercial and other markets. We plan on selling the P5(TM) into multiple channels, including but not limited to domestic and international retail, e-commerce outlets, direct marketing and OEM/private label partnerships. The P5(TM) was formally introduced at the 2000 Electronic Entertainment Expo (E3, May 2000) to enthusiastic responses from game developers and publishers. As of this date, the P5(TM) has appeared, and in some cases been featured, in over 125 print/online publications and on over 25 television, radio and online segments. In recent months alone, the P5(TM) has been covered by publications including CNN, Wired Magazine, Popular Science, MAC World, MACAddict, Kiplingers, The History Channel, KTLA's Curt The Cyberguy, Discovery Channel (Canada), Newsweek (Japan) and the Regis and Kelly Show. We have signed 20 letters of intent with various software development firms to incorporate the P5(TM) into applications including electronic gaming and commercial markets. These letters of intent, however, only -2- represent expressions of interest and are not binding commitments. There can be no assurance that any definitive agreements with such developers will be finalized or that we will realize any revenues from such relationships. Furthermore, Essential Reality, LLC briefly advertised the availability of a limited number of software development kits (SDKs) to the developer community, and in less than one month received in excess of 450 SDK applications from game developers and from numerous commercial software developers, including in the areas of 3D Animation, CAD, education and research, Internet/multimedia, military and other commercial markets. We have begun to selectively respond to those applications by beginning to offer SDKs to the most promising software developers, including premier electronic game development companies. However, there can be no assurance that any developers will want to integrate or create content that is P5(TM) compatible. Lastly, we have received multiple indications of significant interest from major retailers to begin shipping during the second half of 2002. While there have been no definitive final agreements with any such retailers, we expect to start receiving actual purchase orders, pending the successful completion of vendor integration and the final contractual negotiations with the respective retailers. Such process has already commenced with several key retailers. We continue to solicit other retailers and/or distributors, both domestically and internationally, for P5(TM) volume commitments. Our headquarters are located at 49 West 27th Street, Suite 7E, New York, New York 10001 and our telephone number at that address is (212) 244-3200. We maintain a Web site at www.essentialreality.com. Information contained on our Web site is not a part of this prospectus. The Offering Shares Being Offered This prospectus relates to the offering by the selling shareholders of an aggregate of 8,214,239 shares of our common stock, consisting of o an aggregate of 6,764,870 shares that we issued in connection with our business combination with Essential Reality LLC; o an aggregate of 855,000 shares underlying certain warrants that we issued in connection with the business combination to holders of certain bridge notes; o an aggregate of 331,211 shares underlying certain additional warrants that we issued in connection with the business combination; and o an aggregate of 263,158 shares underlying our outstanding convertible promissory notes. Use of Proceeds We will receive no proceeds from the sale of the shares of common stock by the selling shareholders listed in this prospectus. We will receive proceeds from the exercise of warrants and those proceeds will be used for our general corporate purposes. -3- Capitalization Shares of common stock being offered.............................8,214,239 Shares of common stock outstanding prior to this offering.......17,955,718 Shares of common stock outstanding following this offering......19,405,087 (1) (1) Assumes the exercise of outstanding warrants to purchase 1,186,211 shares of common stock and the conversion of outstanding convertible promissory notes into 263,158 shares of common stock. Does not include the exercise of outstanding options to purchase 1,032,000 shares of common stock. -4- RISK FACTORS An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below before making an investment decision. If any of the following circumstances occur, our business, financial condition or results of operations could be materially adversely affected. In that event, the trading price of our common stock could decline, and you may lose part or all of your investment. Limited Operating History Makes Evaluating Our Business Difficult. Prior to our business combination with Essential Reality, LLC, their operations had consisted primarily of organizational activities and product development. Accordingly, there is very limited operating history upon which an evaluation of our prospects and future performance can be based. There can be no assurance that we will be able to develop our products as we envision, raise additional capital to develop our business, generate revenues or become a viable business. Our prospects must be considered in the light of the risks, uncertainties, expenses and difficulties frequently encountered by companies in their early stages of development, particularly companies in new and rapidly evolving markets, such as electronic gaming. We Require Additional Financing. Essential Reality, LLC had no revenues prior to our business combination. We anticipate, based on currently proposed plans and assumptions relating to the implementation of our business plan (including the timetable of costs and expenses associated with, and success of, our marketing efforts), that the net proceeds of Essential Reality, LLC's recent securities offering together with projected revenues from operations will be sufficient to satisfy our operations and capital requirements until the end of fiscal 2002. There can be no assurance, however, that such funds will not be expended prior thereto due to unanticipated changes in economic conditions or other unforeseen circumstances. In the event our plans change or our assumptions change or prove to be inaccurate (due to unanticipated expenses, difficulties, delays or otherwise) or the net proceeds of the offering and projected revenues otherwise prove to be insufficient to fund the implementation of our business plan or working capital requirements, we could be required to seek additional financing sooner than currently anticipated. We have no current arrangements with respect to any additional financing. Consequently, there can be no assurance that any additional financing will be available to us when needed, on commercially reasonable terms or at all. Any inability to obtain additional financing when needed could have a material adverse effect on us, requiring us to curtail and possibly cease our operations. In addition, any additional equity financing may involve substantial dilution to the interests of our then existing security holders. We Expect to Incur Operating Losses and Negative Cash Flow for the Foreseeable Future. We expect to incur significant net losses and to experience negative cash flow for the foreseeable future. The auditors opinion for the year ended December 31, 2001 indicates substantial doubt about our ability to continue as a going concern. Our success depends on the further development of our products, establishing and strengthening our brand, as well as establishing distribution channels for our products and relationships with retailers. Accordingly, we intend to make significant capital expenditures to market, promote, manufacture and develop our products and to execute our business model. As a result of such expenditures, we will need to generate significant revenues to achieve profitability. There can be no assurance that we will ever achieve revenues or profitable operations. -5- We Need to Manage Our Growth Effectively. We believe that our growth through the development and implementation of our business plan will result in an increase in responsibilities on our management team and will place added pressures on our operating and financial resources. To manage this anticipated growth, we must implement systems and train, manage and integrate our employees as we expand our employee base. We cannot assure you that we have made adequate allowances for the costs and risks associated with this growth, that our procedures or controls will be adequate to support our operations, or that our management will be able to successfully offer and expand our products. If we are unable to manage our growth effectively, our business could be materially adversely affected. If Content Developers Do Not Integrate Our Code and the Console Companies Do Not Accept Us for Licensing or Support, the Full Capabilities of the P5TM May Not Be Realized. The full capabilities of the P5TM cannot initially be realized on its own. However, it is anticipated that PC or Mac users will be able to achieve mouse and joystick default. In order to achieve the full P5TM experience, a content developer must integrate our code into their content. We also must be accepted into a console-licensing program, and we may need to make hardware and/or software modifications based on the consoles specifications, in order for the P5TM to achieve compatibility with such consoles. Certain content developers can receive our code as part of our software developer kit. Once they integrate our code, we will need to be technologically compatible with the various consoles. We have applied for participation in certain licensing programs. There can be no assurance that the content developers will integrate our code, that we will be accepted into the various console licensing/support programs or that the P5TM will be able to achieve compatibility with such consoles. Rapidly Changing Technology Could Hurt Our Operating Results. The electronic gaming market, the computer peripherals market, as well as other commercial markets such as education, design and web browsing, generally are associated with rapidly changing technology and frequent new product introductions, which often leads to obsolescence and significant price erosion over the life of a product. The introduction of new technologies can render existing products obsolete or unmarketable. In addition, a broad range of competing and incompatible emerging technologies may lead consumers to postpone buying decisions until a particular platform gains widespread acceptance. As a result, our products developed for such platforms may not generate sufficient sales to make such products profitable. Obsolescence of software or platforms could leave us with increased inventories of unsold products, which would have a material adverse effect on our operating results. We need to anticipate technological changes and continually adapt our new products to emerging industry standards to remain competitive in terms of price and performance. The development of new, technologically-advanced products and enhancements is a complex and uncertain process requiring high levels of innovation as well as the anticipation of technology and market trends. We may not be able to identify, develop, manufacture, market, sell, or support new products and enhancements successfully, new products or enhancements may not achieve market acceptance, or we may not be able to respond effectively to technology changes, emerging industry standards or product announcements by competitors. In addition, some of our competitors may have patents or intellectual property rights that prevent us from being able to respond effectively to new or emerging technologies and changes in customer requirements. New product announcements by us could cause our customers to defer purchases of existing products or cause distributors to request price protection credits or stock rotations. Any of these events could materially harm our business, financial condition and results of operations. -6- The Electronic Gaming Market is Cyclical, and We May Fail To Anticipate Changing Consumer Preferences. Our business is subject to all of the risks generally associated with the electronic gaming markets, which have been cyclical in nature. Our future operating results will depend on numerous factors beyond our control that change rapidly and cannot be predicted, including: o The popularity and timing of new games and software being released and distributed that are compatible with our products; o International, national and regional economic conditions, particularly economic conditions adversely affecting discretionary consumer spending; o Changes in consumer demographics; o The availability of other forms of entertainment; o Critical reviews and public tastes and preferences; o Acceptance of the P5TM code by global content companies, gaming and other secondary market developers; and o Our inability to expand our product mix beyond the P5(TM) rapidly enough to diversify and insulate our revenue model from a premature downturn in the computer gaming industry. We must anticipate and respond to rapid changes in consumer tastes and preferences. A decline in the popularity of video and computer games requiring 3D-software manipulation could cause sales of our product to decline dramatically. 3D Environments, On Which We Have Based Our First Product Launch and Near-Term Business Focus, May Not Achieve Significant Market Acceptance. Our development efforts with respect to the P5(TM) may not lead to marketable products that generate sufficient revenues to recover their development and marketing costs, especially if games using the 3D environment do not reach a significant level of market acceptance. This risk may increase in the future, as continuing increases in development costs require corresponding increases in net sales in order for us to maintain profitability. We have devoted and will continue to devote significant development and marketing resources on products designed for USB-compatible systems. If such systems do not achieve wide acceptance by consumers or such manufacturers are unable to ship a significant number of such units in a timely fashion, or if the sale of our product fails to meet our expectations, we will experience lower than expected sales. Our Quarterly Operating Results May Vary Significantly, Which Could Cause the Price of Our Securities to Decline. We may experience wide fluctuations in quarterly operating results. The electronic gaming market is highly seasonal, with sales of games and related devices typically higher during the holiday buying season. Our failure or inability to produce products on a timely basis to meet seasonal fluctuations in demand will harm our business and operating results. These fluctuations could also cause the price of our securities to decline. Other factors that cause fluctuations include, but are not limited to: o Volume and timing of orders received during the quarter; o Timing of new product introductions by us and our industry and their acceptance by the market; o Impact of competition on our average selling prices and operating expenses; o Our inventory levels or inventory levels in the distribution channels; o Product returns from customers; and -7- o Changes in technologies and their acceptance by the market. Our expense levels are based, in part, on our expectations regarding future sales and therefore, our operating results would be harmed by a decrease in sales or a failure to meet our sales expectations. The uncertainties associated with peripheral devices design, development and manufacturing make it difficult to predict the quarter in which our products will be shipped and therefore, may cause us to fail to meet financial expectations. In future quarters our operating results may fall below the expectations of securities analysts and investors. In this event, the trading price of our securities could significantly decline. The Peripheral Input Device Market Is Highly Competitive. The market for peripheral input devices, including mouses and joysticks, is very competitive. In addition, Microsoft, Sony and Nintendo, who currently dominate the interactive entertainment hardware and software industry, may determine to develop their own 3D peripheral port device or limit the functionality of input devices utilizing their USB ports, and have the financial resources to withstand significant price competition and to implement extensive advertising campaigns. Many of our competitors have far greater financial, technical, personnel and other resources than we do, and many are able to carry larger inventories and adopt more aggressive pricing policies. Prolonged price competition or reduced operating margins would cause our profits to decrease significantly. Increased Competition for Limited Shelf Space and Promotional Support From Retailers Could Affect the Success of Our Business and Require Us to Incur Greater Expenses to Market Our Products. Retailers typically have limited shelf space and promotional resources, and competition is intense among an increasing number of newly introduced interactive entertainment software products and related items for adequate levels of shelf space and promotional support. Competition for retail shelf space is expected to increase, which may require us to increase our marketing expenditures. Competitors with more extensive lines, popular products and financial resources frequently have greater bargaining power with retailers. Accordingly, we may not be able to achieve the levels of support and shelf space that such competitors receive. Product Returns That Exceed Our Accruals or Products Delivered But Not Sold May Significantly Impact Our Financial Results. As a manufacturer of consumer products, we are exposed to the risk of product returns, either through the exercise by customers of contractual return rights or as a result of our assistance in balancing inventories of retailers and distributors, as well as the risk of products delivered to retailers not being sold to consumers. A portion of our net sales may result in increased inventory at our distributors and resellers, which could lead to reduced orders by these customers in future periods. Overstocking by our distributors and retailers may lead to higher than normal returns or a deduction based on the amount of product not sold. The difficulty in predicting future sales increases the risk that new product introductions, price reductions or other factors affecting the electronic gaming market would result in significant product returns. In addition, we intend to introduce product upgrades, enhancements and improved packaging, and thus may experience higher rates of return on our older products. We expect to recognize revenue upon product shipment, less amounts for estimated returns. We expect that amounts provided for returns will be estimated based upon historical and anticipated experience and our assessment of inventory in the channels. Although we believe that we will provide adequate amounts for projected returns, from time to time we may experience return levels in excess of amounts provided and our amounts provided may not be sufficient for actual returns in future periods. -8- Our Products Are Susceptible to Errors That Can Harm Our Financial Results And Reputation. The technology incorporated into our products may contain defects or errors that do not become apparent until after commercial introduction. Remedying such errors may delay our plans, cause us to incur additional costs and adversely affect our operations. The technological advancements of new platforms also allow more complex software products. As software products become more complex, the risk of undetected errors in our products when first introduced increases. If, despite testing, errors are found in our products after shipments have been made, we could experience a loss of or delay in timely market acceptance, product returns, loss of revenues and damage to our reputation. Our Business is Dependent on Third-Parties Creating Content for Which Our Products Will Be Needed. Our success depends on our ability to identify and support the P5(TM) enabled specific games and other type of content. We have non-binding letters of intent with several companies and we are currently reviewing several potential agreements, but have not yet entered into binding agreements with any third parties to develop games that are specific to our products. Therefore, there can be no assurance that a sufficient number of such games shall be developed. To the extent that such games are not created in a timely fashion, it could have a material adverse affect on our ability to promote our products and/or achieve our planned selling price. We Are Dependent On Third-Party Developers to Complete Our Products. We rely on third-party developers for the development of our products' technology. Quality third-party developers are continually in high demand. Due to the lack of control that we exercise over them, as well as technical difficulties, these developers may not be able to complete the products for us on a timely basis or within acceptable quality standards, if at all. Also, if developers experience financial difficulties, additional costs or unanticipated development delays, we will not be able to sell our products according to our schedule and may incur losses. We Rely On Suppliers of Components Used in Our Products. Certain key components used in the manufacture of our products, as well as certain products, are currently purchased by us from single or limited sources that specialize in these components or products. At present, single-sourced components include certain of our application-specific integrated circuits, sensors (also known as bend sensors) and components. We generally do not have long-term agreements with our single or limited sources of supply. Lead times and prices for materials and components ordered by us or our contract manufacturers can vary significantly and depend on factors such as the specific supplier, contract terms and demand for a component at a given time. From time to time we may experience supply excesses, shortages and fluctuation in component prices. Shortages or interruptions in the supply of components or subcontracted products, or our inability to procure these components or products from alternate sources at acceptable prices in a timely manner, could delay shipment of our products or increase our productions costs, which could decrease our revenue or gross margin. Delays could also adversely affect our business relationships. Our Success Will Depend on the Continued Viability and Financial Stability of Our Distributors and Resellers, As Well As Continued Demand By These Customers for Our Products. We plan on selling our products not only directly, but also through a domestic and/or international network of distributors, sales representatives, retailers and resellers, and our success will depend on the continued viability and financial stability of these customers, as well as continued demand by these customers for our products. The distribution and reseller industries have been historically characterized by rapid change, including periods of widespread financial difficulties and consolidations, and disruptions from the emergence of alternative distribution channels. Our distributor, retailer and reseller -9- customers generally offer products of several different companies, including products competitive with our products. Accordingly, there is a risk that these distributors, retailers and resellers may give higher priority, including greater retail shelf space, to products of other suppliers, which would reduce demand for, and sales of, our products. We Rely on Arrangements with Independent Third Parties for the Delivery and Manufacturing of Our Products. We rely on a number of independent third parties for the manufacture and delivery of our products, ranging from manufacturing, shipping, fulfillment, and customer and technical support. The termination of our arrangements with one or more of these independent companies, or the failure or inability of one or more of these independent companies to timely complete their duties could adversely affect our results of operations. We Are Subject to the Risk That Our Inventory Values May Decline. The electronic gaming market is subject to rapid technological change, new and enhanced generations of products, and evolving industry standards. These changes may cause inventory to decline substantially in value or to become obsolete. We Are Subject to Credit and Collection Risks. Our sales will typically be made on credit and letters of credit, with terms that vary depending upon the country and the customer. As a result, we are subject to credit risks, particularly in the event that any of our receivables represent sales to a limited number of customers or are concentrated in foreign markets. If we are unable to collect on accounts receivable as they become due and such accounts are not covered by insurance, it could adversely affect our financial condition. Our Inability to Secure Purchase Order Financing or Factor Our Receivables Would Have an Adverse Effect on Our Financial Condition. We anticipate obtaining purchase order financing to finance up to 100% of the letters of credit required to order product from the factory. In addition, we expect to factor up to 80% of our accounts receivable. In the event we were unable to obtain such financing or factoring arrangements on reasonable terms, or at all, that would have a material adverse effect on our cash flow from operations and would require us to obtain alternative sources of funds in order to implement our business plan. We May Not Be Able to Protect Our Proprietary Rights or Avoid Claims That We Infringe on the Proprietary Rights of Others. We attempt to protect our technology and production techniques under copyright, trademark and trade secret laws as well as through contractual restrictions on disclosure, copying and distribution. However, unauthorized third parties may be able to copy or to reverse engineer our technology. In addition, our competitors could independently develop technologies substantially equivalent or superior to our technologies. As the type of peripherals to computer and game consoles increases and the functionality of the products overlap, we believe that peripherals will increasingly become the subject of claims that such technology infringes the copyrights or patents of others. Although we believe that our technologies and the technologies of third-party developers with whom we have contractual relations do not and will not infringe or violate proprietary rights of others, it is possible that infringement of proprietary rights of others may occur. Any -10- claims of infringement, with or without merit, could be time-consuming, costly and difficult to defend. We Are Dependent Upon Our Key Executives and Hiring Additional Personnel. Our success is largely dependent on the personal efforts of certain key personnel and the hiring of additional management personnel. We are currently attempting to hire a full-time chief financial officer. The loss of the services of one or more of these key employees, or the inability to hire additional management, could adversely affect our business and prospects. Our success is also dependent upon our ability to hire and retain additional qualified operating, marketing, technical and financial personnel. Competition for qualified personnel in the electronic gaming market is intense, and we may have difficulty hiring or retaining necessary personnel in the future. If we fail to hire and retain necessary personnel as needed, our business will be significantly impaired. We Are Under the Control of Certain Shareholders. Certain of our shareholders who received shares in the business combination with Essential Reality, LLC own a substantial majority of our outstanding common stock. Consequently, they will control the outcome of substantially all matters submitted to a vote of our security holders including but not limited to the adoption of measures that could delay or prevent a change in control or impede a merger, takeover or other business combination we may potentially be involved in. In addition, pursuant to a voting agreement with certain other shareholders, one such shareholder has the ability to choose the members of our Board of Directors. The Price of Our Securities is Likely to Experience Significant Price and Volume Fluctuations. The market price of our securities is likely to be highly volatile and could be subject to wide fluctuations. Disclosures of our operating results, announcements of various events by us or our competitors and the developing and marketing of new products affecting the electronic gaming market may cause the market price of our securities to change significantly over short periods of time. Therefore, investors may be unable to resell their shares of common stock at or above the purchase price. Future Sales of Our Securities May Affect the Market Price of Our Securities. We currently have the following securities outstanding: o 17,955,718 shares of common stock; o warrants to purchase 1,186,211 shares of common stock; o convertible promissory notes convertible into 263,158 shares of common stock; and o 3,500,000 shares of common stock reserved for issuance under our option plan. We cannot predict the effect, if any, that future sales of our securities or the availability of our securities for future sale will have on the market price of our securities prevailing from time to time. Sales of substantial amounts of our securities (including shares issued upon the exercise of stock options and warrants or conversion of promissory notes), or the perception that such sales could occur (based on registration rights or otherwise), may materially and adversely affect prevailing market prices for our securities. -11- If the Price of Our Securities is Volatile, We May Become Subject to Securities Litigation Which is Expensive and Could Result in Diversion of Resources. In the past, following periods of volatility in the market price of a particular company's securities, securities class action litigation has often been brought against that company. We may also become involved in this type of litigation. Litigation is often expensive and diverts management's attention and resources, which could materially and adversely affect our business, financial condition and results of operations. Our Forward-Looking Statements May Prove to be Incorrect. This prospectus includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. In some cases, you can identify forward-looking statements by words such as "may," "will," "should," "could," "expect," "plan," "anticipate," "believe," "estimate," "intend," "project," "seek," "predict," "potential" or "continue" or the negative of these terms or other comparable terminology. These statements are contained principally under the headings "Prospectus Summary," "Risk Factors," "Description of Business" and "Management's Discussion and Analysis or Plan of Operation." These statements are only predictions and actual events or results may differ materially. In evaluating these statements, you should specifically consider various factors, including the risks outlined under "Risk Factors." Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We are under no duty to update any of the forward-looking statements after the date of this prospectus to conform these statements to actual results, except as required by laws and regulations. USE OF PROCEEDS The shares of common stock offered hereby are being registered for the account of the selling shareholders identified in this prospectus. See "Selling Shareholders." We will not receive any proceeds from the sale of such shares. All net proceeds from the sale of the common stock will go to the shareholders that offer and sell such shares. We will, however, receive proceeds from the exercise of warrants and those proceeds will be used for our general corporate purposes. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our common stock has been eligible for trading on the Over-the-Counter Bulletin Board since April 19, 2001. On June 26, 2002, the ticker symbol was changed from JPAL to ESSR. The following table sets out the high and low closing bid prices of our common stock during the periods indicated as quoted on the Bulletin Board. Prices reflect inter-dealer prices, without retail mark-up, mark-down or commissions, and may not represent actual transactions. 2001 High Low ---- ---- --- Second Quarter * $1.00 $0.263 Third Quarter $7.00 $1.00 Fourth Quarter $6.05 $2.97 -12- 2002 ---- First Quarter $4.30 $4.05 Second Quarter $4.05 $2.25 Third Quarter (through July 17, 2002) $3.20 $2.95 * Restated for 5 for 1 stock split effective July 2, 2001. According to information furnished by our transfer agent, as of July 16, 2002 we had 85 holders of record of our common stock. Dividend Policy We have never declared or paid dividends on our common stock and do not anticipate declaring or paying any cash dividends on our common stock in the near future. We plan to retain any future earnings for the development of our business. The payment of future dividends will be at the discretion of our board of directors and will depend upon our, among other things, future earnings, capital requirements, financial condition and general business conditions. -13- DESCRIPTION OF BUSINESS General We were incorporated on March 31, 1999. Our original line of business was to provide vacation rental properties and services for the Year 2000 New Year's Eve celebration in Las Vegas. Afterwards, we continued as an internet-based provider of vacation rental properties and services. In August 2001, we suspended operations and the development of our website in order to focus our attention on the business combination with Essential Reality, LLC. On June 20, 2002, we consummated the business combination and began operating Essential Reality, LLC's business exclusively. Therefore, any historical discussion about our business would be meaningless and potentially misleading, so all discussions in this prospectus relating to our business shall mean Essential Reality, LLC's business. Essential Reality, LLC was organized in 1999 as a developer of real-time tracking and sensory technologies. We will focus on combining these technologies into products that enhance the interaction between human beings and personal computers, game consoles, computer tablets and other related devices, collectively known as computer platforms. We expect to have our first product, the P5(TM), available for sale during the second half of 2002. The P5(TM) is a glove-like peripheral device that could substantially improve the way individuals interact with computer platforms. The P5(TM), which can be offered at a mass market price point, addresses technological limitations of current input devices. We expect the P5(TM) to be suitable for multiple applications including: o Electronic Gaming - games produced for play on personal computers, game consoles and location-based entertainment sites; o Commercial Applications - such as animation, computer aided design (CAD), simulation training, disability and education; and o Other Computer Interactions - Internet browsing and navigation, and general computer interaction. Since the advent of the mouse, relatively little has changed in the way of computer input devices, despite the fact that computers and applications have changed dramatically, growing increasingly complex and specialized. Applications, particularly in the electronic gaming and commercial markets, have migrated from flat two-dimensional (2D) interfaces to intuitive, three-dimensional (3D) environments. However, input devices continue to be dominated by 2D products including mouse controllers and gaming-specific peripherals such as joysticks, steering wheels, proprietary console controllers and the like. The P5(TM) is based on our patented and several patent-pending technologies, one of which was incorporated in the "Power Glove." The Power Glove was introduced to the market in the late 1980s as an alternative controller for use only with the 8-bit Nintendo Entertainment System, part of the first generation of game consoles sold to the mass market. The product eventually sold approximately one million units in the United States, Europe and Japan. Subsequent to a decline in consumer demand for first-generation gaming consoles in the early 1990s, such Nintendo system ceased sales. Therefore, the Power Glove technology was not used nor further developed awaiting the return of computer platforms and applications that could benefit from its utility. With the significant increase in sales of computer platforms and applications in the late 1990s, Essential Reality, LLC engaged developers in 1999 to create a peripheral device based on Essential Reality, LLC's belief that the consumer and commercial markets were ripe for a product with the capabilities of the P5(TM). The P5(TM) is a glove-like peripheral that has been engineered to capture five-finger bend sensitivity enabling gesture recognition, -14- combined with an optical tracking technology that will capture the movement of the hand in 3D space with six degrees of freedom (X, Y, Z, yaw, pitch and roll), without the use of the mouse, joystick, keyboard or the like. The P5(TM) is a lightweight and comfortable peripheral, which is a Universal Serial Bus (USB) based product that will allow for direct "plug and play" in personal computers as well as the Sony PlayStation2 game console. We anticipate compatibility with additional computer platforms, such as the Microsoft Xbox, in the future. According to a Dataquest Inc. market study, 100% of personal computer shipments in 2001 were USB-compatible units, with an installed base of over 500 million personal computer units. There are approximately 27 million computer peripherals that are USB-compatible and the growth of these products is anticipated to reach over 400 million by the year 2003. Business Strategy Our strategy is to establish ourselves as a leading developer of real-time tracking and sensory technologies by establishing and fostering demand for our initial product, the P5(TM), in three distinct markets - electronic gaming, commercial markets and other applications. In order to achieve this, we expect to promote content integration and development across all applicable markets through various initiatives such as providing free SDKs, allocating resources for content integration initiatives, and by bundling product with new content that is P5(TM)-enabled. By leveraging the unique functionality of the P5(TM) at a mass market price point, we expect to differentiate ourselves from our competitors. Furthermore, we are pursuing a product development plan for enhanced versions of the P5(TM) and new products that leverage our core technologies. We expect to have multiple revenue streams based on our current and future product initiatives via retail sales, direct sales and/or royalty streams, depending on the target market. Over time, these multiple revenue streams are expected to diversify our customer base and reduce operating risk. Industry Overview Market Sizing and Key Drivers Electronic Gaming. We operate as part of the global video game console, peripheral, and software industry, which is currently estimated at over $28 billion worldwide and over $9.4 billion in the U.S. based on estimates from Global Information Inc. The global electronic gaming peripheral segment alone generated approximately $4.2 billion in sales in 2001 and is expected to reach $5.8 billion in 2003. Gaming software sales in the U.S., which are expected to drive demand for gaming-related peripherals, grew to $1.42 billion in 2001 from $1.36 billion in 2000 despite the overall decline in a variety of technology segments. Key drivers affecting the growth of this industry have been the broad acceptance of next generation game platforms with faster processing power, advances in technology that make games more realistic and interactive, greater memory, online capabilities and DVD media formats - all of which offer new opportunities to electronic entertainment software companies and peripherals manufacturers. Commercial Markets. Our future sales will also be driven by the growth and changes in the computer-aided design, engineering, and manufacturing (CAD, CAE, and CAM) as well as 3D animation software markets. According to Penton Digital Media Research, the 3D CAD market is expected to grow by over 34% annually to reach $2.3 billion in 2005. In the 3D content creation segment, which includes the tools used in 3D content applications in film, game, Web and design segments, the world-wide market is estimated to be $384 million, growing 25% annually and expected to reach over $1.17 billion by 2005. Key drivers affecting these markets include improvements in data sharing, storage of complex CAD files and increased design collaboration over the Internet throughout a product's lifecycle. -15- Evolving Trends Current trends in the peripheral industry include: o Increased complexity of peripheral devices, including tactile feedback and 3D capabilities; o Wireless communication between peripherals and devices; o Increased precision that is enabling more robust commercial applications in CAD and robotics; o Game production cycles are getting shorter, requiring 3D tool vendors to deliver better, more integrated tools to software developers; o Decreases in component prices and innovations in product design and construction; and o Development of more natural interaction between man and machine. Product Overview The P5(TM) is designed as a low-cost and intuitive man-machine interface for both 2D and 3D software applications. We anticipate that the P5(TM) will serve as a peripheral to personal computers, game consoles and other USB-compatible platforms. Figure 1: The P5(TM) Glove and Optical Tracker [GRAPHIC OMITTED - PICTURE OF GLOVE AND OPTICAL TRACKER] Bend-Sensor Capabilities The P5(TM) consists of a hand-worn glove-like device with embedded electronics. The product utilizes our patented bend sensor technology to accurately determine the bend of the user's five fingers. The sensing of the finger bend is accomplished via conductive inks with variable electrical resistance, detected by position changes of hand digits above a baseline bias voltage and resistance. The P5(TM) is capable of gesture recognition of specific placement of thumb/finger digits and can detect whether or not your digits are in the same position as previously recorded. Motion-Capture Capabilities The P5(TM) also tracks the relative position of the hand in space using a patent-pending optical tracking technology. Utilizing triangulation, the P5(TM) optical tracking receptor tracks the starting position and movement of the glove-like device with electronics and firmware/software supporting X, Y, Z, yaw, pitch and roll positioning. The tracking technology is line-of-sight -16- infrared optical using a sufficient number of high/low glove-mounted LED's to enable a complete six-degrees-of-freedom positioning solution. Two pairs of horizontal and vertical detector clusters will receive the LED transmissions. In addition, these same components will provide 3D positioning information. The P5(TM) will measure yaw, pitch and roll as defined below: Figure 2: Yaw, Pitch and Roll Diagram [GRAPHIC OMITTED - PICTURE Definition of Terms OF HAND WITH ARROWS SHOWING MOVEMENTS] Yaw is defined as movement along a plane parallel to the ground. Yaw motion is achieved by holding the hand palm-downward and parallel to the ground, and pivoting the hand side to side on a horizontal plane. Pitch is defined as movement along an axis that is parallel to the top of the hand and perpendicular to the wrist, such that it would enter the wrist below the thumb and exit below the little finger. Pitch is accomplished by pivoting the hand up and down while holding the forearm parallel to the ground. Roll is defined as rotation of the hand about an axis parallel to the ground, entering the hand at the tip of the middle finger and running through the wrist parallel to the forearm. Roll is accomplished by holding the hand flat with the palm facing the ground and turning the arm such that the thumb rises and the little finger falls or vice versa. Compatibility The first generation P5(TM) is initially designed for compatibility with the following personal computer operating systems: Microsoft Windows 95, 98, ME, XP and 2000, as well as the Apple Mac OS9 and OS10. In addition, we expect the P5(TM) to be compatible with the Linux operating system. The P5(TM) is compatible with the Sony PlayStation2 game console and we anticipate that it will be compatible with the Microsoft Xbox and other Computer Platforms in 2003 and beyond. Integration Our technology allows software developers to easily integrate the P5(TM) into new and existing applications. Although the P5(TM) emulates the mouse and the joystick right out-of-the-box in certain computer platforms, in order to fully penetrate our target markets, it requires that the applications have the appropriate technological capabilities to support the P5(TM), which is primarily a matter of having application drivers (instructions which translate commands into an action or movement with the P5(TM)) written for existing or new applications. We will employ our content development strategy to promote software developers to integrate the code. Pricing Strategy We are targeting an initial manufacturer's suggested retail price (MSRP) of between $129-$149 for the P5(TM), depending upon whether an electronic game bundle is included. We believe that this price point compares favorably with alternative mass-market peripherals. Based upon initial feedback from specialty and mass retailers, we believe that the P5(TM) is within the tolerable price range for products in each of the target markets. We also plan on offering the P5(TM) for sale together with bundled software titles and will increase the MSRP to as much as $149 based on the value of the software titles as they are selling individually at the time. With the cost of electronic games between -17- $20-$60, this price point of $149 with a bundled title represents a significant value to the mass market consumer. In addition, we have received a positive response from the retail community to the planned MSRP. We fully expect to achieve higher price points and profit margins for the P5(TM), enhanced versions, or new products derived from the P5(TM)'s core technology, when sold in conjunction with higher-value commercial applications. Target Markets We will focus on three broad market opportunities: electronic gaming, commercial applications and other computer interactions. We expect to initially focus on the electronic gaming market and expect to begin generating sales of the P5(TM) in the second half of 2002. In the second phase, we will concentrate on the market for commercial applications, where we expect users including engineers, educators, computer animators and others to benefit from using the P5(TM) technology. Lastly, we expect to target broader computer applications, which include Internet navigation and general computer interaction. Electronic Gaming Market According to NPD Group, Inc., U.S. sales of video game hardware, software and accessories, such as hand controllers, jumped 43% to $9.4 billion in 2001 from $6.6 billion in 2000. During the same period, sales of computer-game software rose 4.4% to $1.42 billion from $1.36 billion. Much of this growth is due largely to the successful launch of the Sony PlayStation2, Microsoft Xbox and the Nintendo GameCube; and the growth in the popularity of games produced by such leading developers as Electronic Arts, Activision, TakeTwo Interactive and Infogames. The electronic gaming industry had prompted the need for significant developments in the man-machine interface with computer platforms. The desire for more realistic scenes and interaction has led to the majority of electronic games being developed with 3D environments. Thus, this market presents an opportunity for an improved interface device capable of meeting the interaction and intuitive manipulation needs of today's users. Input devices play an important role in extending the overall video game experience. As users seek more compelling gaming experiences, they often look to peripherals as a way to deepen the feeling of immersion in the game. As games have evolved, peripheral devices have been developed to accommodate the actions of the user. Games are generally categorized by the type of action taking place. Mouse controllers, joysticks and other devices have been developed to meet specific needs: "Simulators" such as flying or driving games have spawned steering wheels and joysticks that emulate the real tools used by pilots or drivers. "First-person shooter" games require `fast-twitch' response: the ability to turn and look rapidly around a room, and the ability to fire rapidly at a target. Mouse controllers with multiple programmable buttons have been developed to replace the many keystrokes required to move through the game. Similarly, roller balls in mouse controllers using different technologies to increase the accuracy of the pointer have been developed to enable quick turns and spins within these gaming environments. "Strategy" and "role-playing" games put the user in the role of a character that walks through an environment to explore areas and pick up objects. Again, mouse controllers with specific buttons and ball designs are targeted at these game users to facilitate their game play. Ultimately, none of the devices designed for these game types provide the optimal functionality that a 3D environment requires, namely, the ability to move in a natural manner and replicate that movement in a character or action within the application itself. Furthermore, traditional game controllers do not offer the control and speed (reaction time) that gamers require. For this reason, 3D gamers have typically settled for game pads and/or a combination of the keyboard and mouse controllers, which remain today's most common computer input devices. -18- Commercial Software Applications Professionals use 3D visualization tools in a wide range of CAD applications. Architects, game designers, product designers, mechanical designers, construction engineers and animators all use PC-based design software to create, manipulate and animate in 3D. This market's needs are distinct from those of the gaming market in that the users seek to create 3D objects, rather than simply manipulate them, which traditionally requires a time-consuming, multi-action process. While the tasks that are enabled by certain devices (i.e., drawing with digitizing tablets) are useful, the software in general has proven consistently frustrating to its user base, primarily because it is so difficult to learn. The primary need in the professional market is to enable the designers to do their jobs without much wasted time in learning and implementing a program. Architects, for example, want to solve architectural problems, not computer problems. It is expected that demonstration of the effectiveness of the P5(TM) to this market through associations with leading software manufacturers and trade groups could lead to rapid adoption of our product. There are opportunities for us to partner with leading software firms in this industry to provide the interface device that will rapidly address this market's needs. Applications for this market can be distilled into four segments based upon the software used and the functionality requirements. These segments are the Architecture, Engineering and Construction (AEC), Mechanical Engineering (ME, or MCAD for Mechanical Computer-Aided Design), the Game Developer and the Film/Video markets. Software vendors operating in these markets include AutoDesk, Dassault Systems and Agile Software. According to Cadence Magazine, the AEC market alone is comprised of roughly 300,000 architects, engineers and construction professionals that utilize CAD systems for 2D drafting and 3D modeling and visualization. It is estimated that 60% of this market works primarily in 2D, though the leading architects have identified a need for software to move beyond today's limited 3D modeling to the development of `live' parametric models that would allow faster and easier establishment of design intent and support all phases of project development. The ME market includes designers of machinery, equipment or any other product that requires computer schematics for production. The ME market utilizes CAD systems and 3D design software for the creation and manipulation of objects. This market is estimated at over 3 million users and is growing at a rate of approximately 10% a year. This recent growth spurt is a result of the move from expensive Unix-based platforms to PCs, making it more affordable for users to purchase and deploy CAD systems. Game developers use 3D animation programs in the creation of both PC and console games. 3D design programs are used in a range of commercial video productions, everything from high-end film creation including movies such as "Toy Story," to much simpler 3D-logo design on the evening news. The software is run primarily on Macintosh and Windows platforms and all use high-end, USB-compatible systems as a matter of necessity. Other markets for 3D design include Web design and education, geographic mapping, imaging, scientific visualization, augmented reality and medicine. Other Computer Interactions The development of 3D Internet and User interface environments are closely tied to the proliferation of graphics-related hardware. Graphics-related hardware includes advanced video cards, video RAM, and 3D accelerator cards, as well as graphics capabilities built into the main processor. Such hardware affects the online experience in that it governs the resolution of Web graphics and the speed at which they render. In addition, some interactive environments outside of the browser, such as a 3D software engine, require high-end hardware acceleration. Currently, very few Web ventures outside of the gaming world use such environments. However, 3D graphics capabilities once limited to high-end systems have become commonplace in consumer PCs. -19- The P5(TM) replicates the existing mouse or joystick commands built into current PC applications. However, with the awareness of the enhanced capabilities of the P5(TM), a developer will be able to create entirely new experiences (commands, gestures, etc.) and user interfaces for existing and future applications. We believe that the expansion of broadband use will drive developers to produce content for the average Internet user. This will enable web developers to incorporate real-looking objects into e-commerce sites, create desktops and browsers, which look like real rooms and require manipulation through a 3D space, and ultimately change the entire Internet experience for the user. The P5(TM) will enable all users to work intuitively within this environment. According to a Broadband Report from eMarketer, there is expected to be approximately 90 million broadband households world-wide by the end of 2004, a 350% increase from the 20 million recorded in 2000. Research & Product Development We have planned for future products that will take the initial P5(TM) through several stages of evolution, which may include a wireless product, a two-handed version, the ability to incorporate biometrics, and a product with tactile feedback. We are also seeking to develop other products, of which several are currently in initial phases of development, that will utilize one or more of our technologies. The combination of future generations of the P5(TM) and the creation of new products will increase the commercial opportunities for us in both existing and new markets. Moreover, our patent pending optical tracker offers a highly functional, low-cost alternative to current tracking technologies, which will enable us to expand our product mix. We intend to develop additional products that would include areas where current products are hindered by sub-optimal remote tracking functionality and costly factors. By combining innovative sensory technologies with these optical tracking advancements, we have the potential to quickly diversify beyond our current offering. Additionally, we have filed a provisional patent on an e-writing product, which is a non-glove-based product. With future products, we hope to diversify beyond the electronic gaming industry into a broader suite of applications. Development Company We have developed our first product, in part by working exclusively via an exclusive arrangement between us and a Canadian based entity that currently employs a team of eleven technicians who spend all of their time working on our products. The development company is headed by an individual who has extensive experience in design and development of consumer electronics and virtual reality hardware and software. Intellectual Property We have been awarded one U.S. patent regarding its bend sensor technology, have two patents pending for (i) our shadow-based optical tracking technology and (ii) a wearable electronic interface device that emits an optical signal for use in tracking six degrees of motion, and have filed a provisional patent regarding proprietary software that converts 8-bit analog data stream to a more precise 12-bit digital data stream for improved motion tracking accuracy and intend on filing a patent in a timely fashion. The integration of these technologies into the P5(TM), combined with proprietary software, firmware and drivers, has resulted in a superior product that can be offered at a mass market price point not previously achieved in the market. We have filed a provisional patent on an e-writing product, which is a non-glove-based product. With future products, we hope to diversify beyond the electronic gaming industry into a broader suite of applications. -20- Sales & Marketing We are executing on a comprehensive sales and marketing plan designed to create brand awareness in advance of the 2002 holiday season with pull through into 2003. We have identified numerous sales and marketing channels to build a brand and capture a mass market for the P5(TM), as well as its other planned products. We anticipate that the sales distribution of the P5(TM) will initially utilize an electronic gaming market retail strategy, expanding into an OEM and direct sales effort for penetration of commercial and other markets. We plan to sell the P5(TM) into multiple channels, including but not limited to domestic and international retail, e-commerce outlets, direct marketing and OEM/private label partnerships. Content-Bundling Strategy In order to achieve product sell through at launch and beyond, we intend to offer specific electronic gaming and/or non-gaming bundles with the P5(TM). We anticipate that these bundles will have enhanced gesture recognition functionality made possible through the use of the P5(TM). We have already identified our first potential bundling opportunity, which is an upcoming software title from a leading game developer. The theme of the game supports a popular movie series scheduled for release in the second half of 2002. Other bundling opportunities have been identified and we are in the process of negotiating with the relevant software developers. There can be no assurance, however, that a definitive agreement will be reached with any of such developers. Retailer Community Strategy In addition to direct discussions with key retailers globally, we have established arrangements with sales representative firms that are responsible for sales into regionally-headquartered retailers throughout the United States. We are also in discussion with geographically-based distributors around the world that would be responsible for sales, distribution and fulfillment in each of their respective markets. We have received multiple indications of significant interest from major retailers to begin shipping during the second half of 2002. While there have been no definitive final agreements with any such retailers, we expect to start receiving actual purchase orders, pending the successful completion of vendor integration and the final contractual negotiations with the respective retailers. Such process has already commenced with several key retailers. We continue to solicit other retailers and/or distributors, both domestically and internationally, for P5(TM) volume commitments. Media Coverage / Consumer Awareness The P5(TM) has gained considerable media acclaim. As of the date of this prospectus, the P5(TM) has appeared, and in some cases been featured, in over 125 print/online publications and on over 25 television, radio and online segments. In recent months alone, the P5(TM) has been covered by publications including CNN, Wired Magazine, Popular Science, MAC World, MACAddict, Kiplingers, The History Channel, KTLA's Curt The Cyberguy, Discovery Channel (Canada), Newsweek (Japan) and the Regis and Kelly Show. Business Development We are executing on a comprehensive business development plan designed to stimulate product demand in electronic gaming, commercial markets and other applications. We have signed 20 letters of intent with various software development firms to incorporate the P5(TM) into applications including electronic gaming and commercial markets. These letters of intent, however, only represent expressions of interest and are not binding commitments. There can be -21- no assurance that any definitive agreements with such developers will be finalized or that we will realize any revenues from such relationships. Furthermore, Essential Reality, LLC briefly advertised the availability of a limited number of software development kits (SDKs) to the developer community, and in less than one month received in excess of 450 SDK applications from game developers and from numerous commercial software developers, including in the areas of 3D Animation, CAD, education and research, Internet/multimedia, military and other commercial markets. We have begun to selectively respond to those applications by beginning to offer SDKs to the most promising software developers, including premier electronic game development companies. However, there can be no assurance that any developers will want to integrate or create content that is P5(TM) compatible. The non-gaming SDK applications have come from an array of commercial software developers in the areas of: 3D animation/CAD, education and research, Internet/Multimedia, Military and other vertical markets. We intend to assist developers in using the SDK to enhance their applications. Although our primary focus for the next nine to twelve months is to establish a significant presence in the PC/MAC and console gaming market, these other non-cyclical vertical markets will provide us with some initial market diversification until other non-P5(TM) products are introduced to the market later in 2003. Manufacturing We have concluded a selection process for our initial manufacturing partner and selected V-Tech Communications Ltd., one of Southeast Asia's leading manufacturers of consumer electronics, toys and other mass market devices under its own name and on a private label basis for some of the world's foremost electronics, telecommunications and retail concerns. V-Tech is currently working with us under a "work-for-hire" agreement on, amongst other things, establishing manufacturing schemes, developing quality control procedures, arranging (and in some cases executing) vendor agreements with our preferred vendors, identifying cost-reduction opportunities, and preparing for the integration of our machine tooling for production. In addition, we are in the final stages of negotiating a long-term manufacturing agreement with V-Tech that will include capacity commitments, ramp-up and production schedules, as well as other key manufacturing terms. We expect to attain volume capacity with V-Tech of approximately 20,000 units per week per set of machine tools we provide. Moreover, we have identified alternative sources of manufacturing to complement or back-up our arrangements with V-Tech. Current estimates indicate an initial unit cost for the P5(TM) of approximately $40, before the anticipated implementation of two ASIC designs that will be introduced over the next twelve months, which should yield further cost reductions. Competition We face competition in the electronic gaming peripheral market from high-end mouse controller and joystick manufacturers such as Logitech and Microsoft. While several peripherals provide high levels of precision, user programmability and in some cases a limited amount of tactile feedback, we are not aware of any peripherals that offer the combination of tracking and gesture recognition that is found in the P5(TM). Companies such as Immersion, Gyration, Fifth Dimension Technologies and Ascension Technologies provide various higher-priced peripherals and motion-capture products for commercial applications. These entities produce systems for relatively complex commercial applications. Prices of these competing products typically run in excess of $1,000 and can exceed $10,000 for advanced models. We believe the P5(TM) possesses unique competitive advantages due in part to (i) the functionality derived from its patented and patent-pending technologies, (ii) its ease of integration and (iii) its mass market price point. We believe these advantages will enable it to penetrate its target markets. -22- Employees As of the date of this prospectus, we have nine full-time salaried employees and two part-time employees. We believe that our relationship with our employees is satisfactory. We plan on adding additional staff in areas of senior management, business development, customer and product support. Property We currently lease approximately 4,300 square feet of office space at 49 West 27th Street, New York, New York 10001, at a price of $10,570 per month. The five-year lease provides for annual increases in the monthly rent to a maximum monthly rental price of $11,575. We believe that the office space will adequately accommodate our expected growth during the upcoming year. Legal Proceedings We are not a party to any pending legal proceeding nor, to the knowledge of our management and board of directors, to any governmental proceeding. MANAGEMENT'S PLAN OF OPERATION Overview We were incorporated on March 31, 1999. Our original line of business was to provide vacation rental properties and services for the Year 2000 New Year's Eve celebration in Las Vegas. Afterwards, we continued as an internet-based provider of vacation rental properties and services. In August 2001, we suspended operations and the development of our website in order to focus our attention on the business combination with Essential Reality, LLC. On June 20, 2002, we consummated the business combination and began operating Essential Reality, LLC's business exclusively. Therefore, any historical discussion about our business would be meaningless and potentially misleading, so all discussions in this prospectus relating to our business shall mean Essential Reality's business. Founded in 1999, Essential Reality, LLC is a developer of real-time tracking and sensory technologies. We are focusing on combining these technologies into products that enhance the interaction between human beings and computer platforms, with initial emphasis on a product called "P5(TM)." P5(TM) is a device shaped in the form of a glove that controls the movement of the cursor on a computer screen. P5(TM) enables three-dimensional movement of the cursor as well as pitch, yaw and roll. P5(TM) is controlled by the user moving his hand or bending his fingers. We are in the development stage. Successful completion of our development program and, ultimately, the attainment of profitable operations are dependent upon future events, including obtaining adequate financing to fulfill our development activities, and achieving a level of revenue adequate to support our cost structure. Since its commencement, Essential Reality, LLC has not generated revenues and has incurred significant recurring losses from operations, working capital deficit and deficit in its members' capital. We believe that we have sufficient resources to operate until the end of fiscal 2002 and thereafter we will require additional funds in order to reach self-sufficiency. Should we be unable to obtain the necessary additional funds, we would not be able to continue as a going concern. Product development costs are expensed until such time as we determine that a product is technologically feasible. Product development costs are capitalized from such date until such time as product development is -23- substantially complete. Capitalized product development costs will be amortized on the straight-line basis over the lesser of the estimated useful life of the product or three years. For the cumulative period from June 1, 1999 (Date of Commencement) to March 31, 2002, Essential Reality expensed all product development costs. For the three months ended March 31, 2002 The unaudited financial statements have been prepared with generally accepted accounting principles for interim financial information. In our opinion, we have included all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation. Revenue. For the three months ended March 31, 2002, Essential Reality did not recognize product-related revenues. We do not anticipate recognizing product-related revenue until the second half of 2002, at the earliest. Interest income, which historically was earned from a note receivable for Essential Reality, LLC's members' capital (as described in "Liquidity and Capital Resources" below), was $0 in the three months ended March 31, 2002 as compared to $12,878 for the three months ended March 31, 2001. During the three months ended March 31, 2002, there was no such note receivable outstanding. Operating expenses. For the three months ended March 31, 2002, operating expenses totaled $1,311,513 compared to $314,289 for the three months ended March 31, 2001. The increase in operating expenses resulted from the increase in product development, marketing and general and administrative expenses as described below. Product development expense for the three months ended March 31, 2002 was $480,822 compared with $133,357 for the three months ended March 31, 2001. The increase in product development reflects increases in salaries and benefits, fees paid to third party developers and materials used in the development and manufacturing our P5(TM) product. Included in product development costs are $37,000 and $8,300 for three months ended March 31, 2002 and 2001, respectively, paid to a company owned by certain of our shareholders. Marketing expense for the three months ended March 31, 2002 was $287,588 compared with $83,261 for the three months ended March 31, 2001. The increase is due to an increase in public relations, corporate identity, trade shows and related travel. General and administrative expenses for the three months ended March 31, 2002 was $539,688 compared to $97,506 for the three months ended March 31, 2001. The increase is due to an increase in administrative personnel and the increased resources required in order to support our development and marketing activities. Included in general and administrative expenses are costs incurred of approximately $79,000 and $38,000 for the three months ended March 31, 2002 and 2001, respectively, by two entities that are related to certain members of LCG Capital Group, LLC, a significant shareholder. Such costs include consulting fees, employee salaries, occupancy, telephone and computer leases. In the case of employee salaries, costs are allocated to us based on the time each employee conducts business specific to us. In the case of the other expenses, costs are allocated based on a percentage of resources used by us. In our opinion, allocated expenses incurred from related parties approximates fair market value. Interest expense. Interest expense for the three months ended March 31, 2002 was $48,585 compared with $513 for the three months ended March 31, 2001. $586 of the interest incurred in 2002 was interest on advances from entities that are affiliated with LCG Capital Group, and $48,000 was incurred in relation to the bridge loans described in "Liquidity and Capital Resources" below. -24- Net loss for the three months ended March 31, 2002 and March 31, 2001 were $1,360,098 and $301,924, respectively. For the year ended December 31, 2001 Revenue. For the year ended December 31, 2001, Essential Reality did not recognize product-related revenues. We do not anticipate recognizing product-related revenue until the second half of 2002, at the earliest. Interest income for the year ended December 31, 2001, which was earned from the note receivable for Essential Reality, LLC's members' capital, was $20,465 compared to $104,652 for the year ended December 31, 2000. The decrease in interest income resulted from the decreases in notes receivable during the year ended December 31, 2001. Operating expenses. For the year ended December 31, 2001, operating expenses totaled $3,131,444 compared to $1,521,672 for the year ended December 31, 2000. The increase in operating expenses resulted from the increase in product development, marketing and general and administrative expenses as described below. Interest expense for the year ended December 31, 2001 was $20,505 compared with $1,934 for the year ended December 31, 2000. $3,819 of the interest incurred in 2001 was interest on advances from entities that are affiliated with LCG Capital Group, LLC, a significant shareholder, and $16,686 was incurred in relation to the bridge loans described in "Liquidity and Capital Resources" below. Product development expense for the year ended December 31, 2001 was $1,579,129 compared with $679,891 for the year ended December 31, 2000. The increase in product development reflects increases in salaries and benefits, fees paid to third party developers and materials used in the development and manufacturing of our P5(TM) product. Included in product development costs are $91,300 and $0 for years ended December 31, 2001 and 2000, respectively, paid to a company owned by certain of our shareholders. In addition, included in product development costs are $0 and $105,000 for the years ended December 31, 2001 and 2000, respectively, paid to a company owned by an individual affiliated with certain of our shareholders. Marketing expense for the year ended December 31, 2001 was $716,674 compared with $349,851 for the year ended December 31, 2000. The increase is due to an increase in public relations, corporate identity, trade shows and related travel. General and administrative expenses for the year ended December 31, 2001 was $823,791 compared to $491,930 for the year ended December 31, 2000. The increase is due to increased resources required to support our development and marketing activities. Included in general and administrative expenses are costs incurred of approximately $242,000 and $148,000 for the years ended December 31, 2001 and 2000, respectively, by two entities that are related to certain members of LCG Capital Group. Such costs include consulting fees, employee salaries, occupancy, telephone and computer leases. In the case of employee salaries, costs are allocated to us based on the time each employee conducts business specific to us. In the case of the other expenses, costs are allocated based on a percentage of resources used by us. Net loss for the years ended December 31, 2001 and 2000 were $3,131,484 and $1,418,954, respectively. Liquidity and Capital Resources Since inception, Essential Reality, LLC has not generated revenues and has incurred significant recurring losses from operations, working capital deficit and deficit in its members' capital. For the period from June 1, 1999 -25- (date of commencement) to March 31, 2002, Essential Reality, LLC incurred losses of $6,132,340 and negative cash flow from operating activities and investing activities of $5,310,383 and $40,001, respectively. Included in the losses for the period from June 1, 1999 to March 31, 2002 were $2,961,366 of product development expenses, $1,354,113 of marketing expenses and $1,855,869 of general and administrative expenses. For the period from June 1, 1999 to March 31, 2002, the difference between losses and cash flows from operating activities was $821,957, principally resulting from an increase in accounts payable of $687,486. In December 1999, LCG Capital Group acquired a 50% interest in Essential Reality, LLC for an aggregate purchase price of $2,500,000. The consideration received was comprised of $500,000 in cash and a $2,000,000 promissory note. The note bore interest at the rate of 6% per annum, had a maturity date of December 13, 2002 and was secured by the membership interests of LCG. The debt due under the note was fully repaid in July 2001. Cash provided by financing activities for the period from June 1, 1999 to March 31, 2002 was $5,627,532, which was derived principally from proceeds from the issuance of members' capital of $500,000, proceeds from the repayments of the note receivable for members' capital in the amount of $2,000,000 and bridge loans in the amount of $3,025,000. Through March 31, 2002, Essential Reality, LLC received total bridge loans of $3,025,000. From April 1, 2002 through June 20, 2002, Essential Reality, LLC received an additional $300,000 in bridge loans. All such loans are unsecured and bear interest at rates of between 8 1/2% and 18% per annum, and mature on April 30, 2004. Interest on the bridge loans from JPAL in the amount of $250,750 and $411,022 has been imputed and accrued representing the interest payable on the bridge loans advanced from inception through December 31, 2001 and March 31, 2002, respectively, and will be amortized over the life of the loans through April 30, 2004. Deferred interest will be amortized on a daily basis from the date of the loan to April 30, 2004, which resulted in a charge to earnings in the amount of $18,361 and $40,499 for year ended December 31, 2001 and for the three months ended March 31, 2002 (unaudited), respectively. Essential Reality, LLC recently raised approximately $7.5 million in gross proceeds through a private placement. We anticipate, based on currently proposed plans and assumptions relating to the implementation of our business plan (including the timetable of costs and expenses associated with, and success of, our marketing efforts), the net proceeds of the recently completed private placement together with purchase order financing, accounts receivable factoring and projected revenues from operations, will be sufficient to satisfy our operations for the nine months ending December 31, 2002. We hope to raise the additional cash required from the exercise of certain warrants and/or through additional offerings of our securities. Plan of Operations We do not anticipate recognizing product-related revenue until the second half of 2002, at the earliest. Product development expenses for the period from April 1, 2002 to March 31, 2003 are expected to be approximately $3.2 million. The increase in product development is related to expenses incurred for tooling, ASIC design and new game development. Marketing expense is expected to be approximately $3.5 million for the period from April 1, 2002 to March 31, 2003. The significant increase in marketing expense is due to anticipated increases in the number of marketing and sales employees, as well as increases in advertising and promotion, trade shows and commission expenses. -26- General and administrative expenses are expected to be approximately $2.8 million for the period from April 1, 2002 to March 31, 2003. The increase in general and administrative is due to anticipated increases in the number of administrative employees required to support our product development and marketing activities. We expect interest expense to be approximately $560,000 for the period from April 1, 2002 to March 31, 2003. In addition to interest on the bridge loans, we will incur interest on purchase order financing and accounts receivable factoring. We expect that approximately $11.5 million will be required to order and/or purchase inventory and product related costs. We expect that bridge loan principal and interest in the net amount of approximately $2.3 million will be repaid or converted to equity in the period from April 1, 2002 to March 31, 2003. To date, bridge loans have been reduced by a net amount of approximately $1.1 million. Essential Reality, LLC recently raised approximately $7.5 million in gross proceeds through a private placement. In addition, during the period from April 1, 2002 to March 31, 2003, we anticipate arranging purchase order financing, accounts receivable factoring and other trade financing which will provide cash resources of approximately $8 million. We expect to arrange such financing prior to the end of fiscal 2002. For the period from April 1, 2002 to March 31, 2003, it is expected that we will require a total of approximately $24 million in cash or cash equivalents, before taking into account projected revenues, in order to repay the bridge loans, complete our development plan and to begin to produce, market and sell our primary product. We anticipate, based on currently proposed plans and assumptions relating to the implementation of our business plan (including the timetable of costs and expenses associated with, and success of, our marketing efforts), the net proceeds of the recently completed private placement together with purchase order financing, accounts receivable factoring and projected revenues from operations, will be sufficient to satisfy our operations for the nine months ending December 31, 2002. We hope to raise the additional cash required from the exercise of certain warrants and/or through additional offerings of our securities. -27- MANAGEMENT Pursuant to the terms of our business combination with Essential Reality, LLC, upon consummation of the transaction in June 2002, each of the officers and directors of Essential Reality, LLC became our officers and directors. Executive Officers and Other Significant Employees Set forth below for each of our executive officers and other significant employees and consultants is his name, age, positions and offices held with us, and his principal occupations during the past five years. We plan on hiring additional management personnel in the future including but not limited to a full-time Chief Financial Officer. Name Age Title ---- --- ----- Steven Francesco 46 Chief Executive Officer Humbert B. Powell, III 63 Co-Chief Executive Officer Reuben Levine 36 President and Chief Operating Officer Stanley Friedman 59 Vice President, Manufacturing Richard Rubin 44 Vice President, Product Development Aaron Gavios 43 Vice President, Sales and Distribution David Devor 39 Vice President, Marketing Ian Benoliel 38 Vice President, Finance (Acting) Martin Currie 36 Vice President, Business Development Steven Francesco, Chief Executive Officer Mr. Francesco has been our Chief Executive Officer since July 1, 2002. He brings over 20 years of experience in the financial services, information technologies and telecommunications sectors. From January 2001 to February 2002, Mr. Francesco served as an investment advisor to the venture capital firms of E-Goo and HFS VC. From April 1999 through November 2000 he served as Chief Executive Officer of Netrix Corporation (NASD: NXWX), where he refocused the company toward providing end-to-end packetized voice/data telecommunications solutions, as well as facilitated the strategic merger with OpenRoute Corporation and acquisition of Aetherworks Inc. The resulting company, re-named Nx Networks, offered a comprehensive suite of secure voice communications over Internet Protocol and partnered with industry leaders, such as Motorola, Siemens, and Alcatel. Mr. Francesco provided overall strategic direction and helped position Nx Networks as an industry leader in the Internet-based voice communications market. During his tenure, the company's market capitalization rose from $18 million to its peak of $1.32 billion. Prior to joining Nx Networks, Mr. Francesco launched SmartServ Online, Inc. (NASD:SSOL), serving as its President and Chief Operating Officer from January 1993 to February 1997, where he was -28- responsible for business and product development, as well as its marketing strategy of the firm's products and services. After launching SmartServ, Mr. Francesco founded and was President of Darien Development Corporation, a technology consulting firm specializing in the financial sector, from February 1997 to April 1999. While at Darien Development, his clients included GTE Advanced Network Services, KeyTrade, e-Tel, AT&T, GTE, Citibank, Chemical Bank, Chase Manhattan Bank, J.J. Kenny, ADP, Telerate, and the Chicago Mercantile Exchange. From January 1998 to August 2001, Mr. Francesco has served as a consultant to a number of firms, including DSLI, a privately held company offering nationwide DSL services, and Sideware Systems, a publicly traded Electronic Customer Relationship Management (eCRM) firm. From 1989 to 1991, Mr. Francesco held the position of Senior Vice President of Strategic Planning and Operations for a division of Cantor-Fitzgerald Securities. This unit offered processing services to major brokerage and lending institutions, including clearance and settlement for mortgage-backed securities and derivative products. In February 1986, Mr. Francesco launched Market Technology Group, a computer and technology services firm providing financial systems and market data retrieval technologies to the financial services industry and worked there until March 1989. Mr. Francesco began his career with IBM as a systems engineer. He is also a veteran of the United States Navy, maintaining ship board Terrier missile systems. Mr. Francesco served as a member of Net2000's (NASD:NTKK) Board of Directors from May 2000 to September 2001. He was also a member of their compensation and nomination committees. In addition, he was Chairman of the Advisory Board of iBrite, a privately held firm specializing in enabling technology for handheld devices, as well as a member of its Board of Directors. Humbert B. Powell, III, Co-Chief Executive Officer Mr. Powell had been Essential Reality, LLC's acting Chief Executive Officer and has worked for us in the same capacity since the consummation of the business combination with Essential Reality, LLC. As of July 1, 2002, he now serves as our Co-Chief Executive Officer. Mr. Powell also has been a Managing Director at Sanders Morris Harris, a regional investment-banking firm headquartered in Houston, Texas, with a branch in New York City, where he resides, since November 1996. Mr. Powell served as Chairman of Marleau, Lemire USA and Vice Chairman of Marleau, Lemire Securities, Inc. between 1994 and 1996. Prior to his employment with Marleau, Lemire he served as a Senior Managing Director in the Corporate Finance Department of Bear Stearns & Co., from 1984 to 1994, with responsibilities for the Investment Banking effort both domestically and internationally. Prior to his employment with Bear Stearns, Mr. Powell served as a Senior Vice President and Director of E.F. Hutton & Co., where he was employed in various capacities for 18 years. He is also a Director of Lawman Armour Corp., Bikers Dream Inc., World Water Corp., and a trustee of Salem-Teikyo University. Reuben Levine, President and Chief Operating Officer Mr. Levine had been with Essential Reality, LLC since November 2001, and has served as our President and Chief Operating Officer since January 1, 2002, responsible for our day-to-day operations. Prior to joining Essential Reality, LLC, Mr. Levine was Executive Vice President of ClosingGuard.com Incorporated, an application service provider for advanced residential real estate closing technology, from March 2000 to December 2001. Prior to that, he spent six years at Chase Manhattan Bank, leading some of the company's mission critical business and technology transformation initiatives in their retail and wholesale operations. Most recently, he served as the Director of Business Development for the bank's Internet Division, Chase.com. While at Chase.com, Mr. Levine managed ongoing business development activities relating to numerous lines of business, which included initiating, screening and coordinating all aspects of over a dozen transactions. Additionally, Mr. Levine managed teams of over 30 internal staff members and external consultants for numerous high-priority process reengineering initiatives. Throughout Chase's (and formerly Chemical Bank's) mergers, Mr. Levine managed organization-wide milestones throughout the bank's retail division that contained high-risk implications in the event of failure. He began his career in investment banking, with four years in Fortune 500 structured finance and trade finance while at Bankers Trust Company and Bank Leumi Trust Company of New York. Prior to joining Essential Reality, he served as an advisor to over a dozen technology start-ups in a broad range of industries. Mr. Levine holds professional certifications in the areas of -29- strategic design and operational modeling/simulation, developed and facilitated by MIT and Stanford University graduate level programs. Mr. Levine earned his Bachelor of Arts degree in Economics in 1989 from Yeshiva University in New York. Stanley Friedman, Vice President, Manufacturing Mr. Friedman had been Essential Reality, LLC's, and now is our, our Vice President of Manufacturing since February 2000 and manages manufacturing and production control for us. Previously, Mr. Friedman served as Head of Purchasing and Production at Gund, Inc. from July 1998 to September 1999 and Eden, LLC from February 1991 to May 1998, where he managed overseas vendors while directing daily purchasing, production, inventory control, quality assurance and logistics operations. He was also involved in such company's product forecasting and source selection, negotiation of purchase orders as well as recruiting, training and supervising managerial staff. Prior to those positions, Mr. Friedman was at Megastar Inc. as its Production Controller from August 1970 to December 1990. He graduated with a Bachelor of Science degree in Accounting from Duquesne University in Pennsylvania and has completed graduate courses in Industrial Management and Cost Estimating. Mr. Friedman holds advanced licenses from the FAA and FCC, as well as USAF training in electronics. Richard Rubin, Vice President, Product Development Mr. Rubin has twenty years of experience in engineering management positions. He had been Essential Reality, LLC's, and now is our, Vice President of Product Development since April 2001. Prior to joining Essential Reality, LLC, he was Vice President of Product Development for Akrion, a semiconductor equipment manufacturer since November 1999 and Vice President of Engineering & Manufacturing for ActiMed Laboratories, a producer of medical devices from June 1998 to June 1999. Before that he was the Senior Engineering Program Manager/ Operations Manager for Materials Research Corporation/Veeco Industries, Inc., a manufacturer of state-of-the-art sputtering cluster systems for the thin film industry, from November 1995 to February 1998. Mr. Rubin also served as Director of Engineering for Eden Toys, a global manufacturer and distributor of interactive toys, from August 1992 to November 1995 and as engineering manager for Machine Technology, Inc., a developer of wafer processing equipment, from June 1980 to February 1992. He has a Bachelor of Industrial Design degree from Rhode Island School of Design and has done advanced study in design in the United Kingdom at the City of London Polytechnic. Aaron Gavios, Vice President, Sales and Distribution Mr. Gavios had been Essential Reality, LLC's, and now is our, Vice President of Sales and Distribution since November 2001. Mr. Gavios has nearly twenty years of experience managing marketing and sales for large companies. Most recently, he was Vice President of Business Development at K2 Digital, a leading Internet business strategy firm, from September 2000 to November 2001. In that position, Mr. Gavios headed up K2's marketing and business development efforts, including the areas of public relations and strategic alliances. Prior to joining K2, Mr. Gavios served as Vice President of Global Sales for MondoSoft, a Danish developer and marketer of Web site search engine technology (ASP solution), from March 1999 to September 2000. Prior to MondoSoft, he was the Executive Vice President of DSTV Holdings from September 1996 to March 1999, where he developed and executed a successful marketing strategy for the sale of digital satellite television in a joint marketing effort with electric utility companies. Prior to DSTV, Mr. Gavios was National Sales Manager at Rolodex from February 1994 to September 1996, where he oversaw the sales growth of the Electronic Organizer Division. Prior to Rolodex, Mr. Gavios was the Regional Sales Manager of the Eastern Region at Casio from February 1993 to February 1994, where he helped successfully introduce several products including "My Magic Diary" and the "Z-7000 PDA." Prior to working at Casio, Mr. Gavios worked at Nintendo as an Area Sales Manager for the Eastern Region from July 1988 to February 1993, and helped manage some of the firm's largest accounts, including Toys R Us, Kmart, and KB Toys. While at Nintendo, he played an important role in rolling out the "World of Nintendo" store within a store concept. Mr. Gavios received his B.A. in Sociology from Brandeis University and his M.B.A. in Marketing/International Business from New York University (Stern) Graduate School of Business Administration. -30- David Devor, Vice President, Marketing Mr. Devor had been with Essential Reality, LLC since November 1999, and he is now our Vice President of Marketing since November 2001 and is responsible for marketing and branding of our products. Prior to joining Essential Reality, LLC, Mr. Devor managed private equity investments from February 1991 to October 1999 through his principal position with Devor Capital Investments LLC, which is an investment firm specializing in high-tech companies with a primary focus on interactive entertainment, electronic gaming and internet-related opportunities. Prior to that, from October 1983 to January 1991, Mr. Devor founded and managed a large chain of home entertainment furnishings centers. Mr. Devor also has over eight years' experience managing private equity investments through his principal position with Devor Capital Investments LLC, which investment firm specializes in high-tech companies with a primary focus on interactive entertainment, electronic gaming and internet-related opportunities. On February 27, 1996, Mr. Devor pleaded guilty to the crime of offering a false instrument for filing. He received a three-year conditional discharge, paid $10,000, and was obligated to perform 40 hours of community service. Ian Benoliel, Acting Vice President, Finance Mr. Benoliel had been Essential Reality, LLC's, and now is our, Acting Vice President of Finance since February 2000. Mr. Benoliel has over 15 years of business, finance and accounting experience. Mr. Benoliel has been a Principal of NumberCruncher.com, Inc., a company that develops business decision software for small businesses and provides outsourced CFO services to small and mid-size companies, since November 1999. In this capacity, Mr. Benoliel has provided financial consulting services to us since February 2000. From May 1999 to February 2000, Mr. Benoliel served as the CFO of Cortex Telecom International, Inc., a VOIP technology company. From May 1996 to April 1999, Mr. Benoliel was the CFO and Treasurer of BrandEra, Inc. (NASDAQ-BRND), formerly Warp 10 Technologies, Inc. BrandEra's web site serves as the business-to-business destination for the marketing communications industry. Mr. Benoliel was responsible for all of BrandEra's SEC filings, accounting and taxation as well as administration and investor relations. During a one-year period while at BrandEra he also acted as the company's COO. From October 1990 to April 1996 Mr. Benoliel was a partner at Benoliel, Kay - Chartered Accountants. Mr. Benoliel is a Certified Public Accountant and a Chartered Accountant and NumberCruncher.com, Inc. is a member of the Intuit Developer Network. Martin Currie, Vice President, Business Development Mr. Currie had been Essential Reality, LLC's, and now is our, Vice President of Business Development since June 2001. Mr. Currie is a seasoned marketing executive who has been immersed in the video game industry for over seven years. In his last position, Mr. Currie was Director of Marketing for Infogames, Inc. (formally GT Interactive) from January 1998 to February 2001, where he oversaw the launch of titles such as Driver 2, Duke Nukem Time To Kill and Duke Nukem Zero Hour. Driver 2 won the prestigious award of "Favorite Video Game of the Year" at the annual Blockbuster Awards and Duke Nukem Time to Kill was awarded the title of "Best Shooter of the Year" by Sony PlayStation. Prior to this, Mr. Currie was Marketing Director for RDA International, advertising agency for Acclaim Entertainment and GT Interactive, from February 1995 to January 1998, where he took a lead role in the development of major marketing campaigns such as Unreal, Total Annihilation, Turok Dinosaur Hunter and the Acclaim Sports franchise. Mr. Currie has also helped such companies as Mad Katz, Titus, Kesmai and Microsoft Games with their marketing efforts. Before entering the video game industry, Mr. Currie honed his marketing skills at a number of prestigious advertising and design agencies in New York City, including the Arnell Group where he worked on the Donna Karan and DKNY accounts, and Frankfurt Balkind Partners, where he worked on many high-profile projects. There are no family relationships among our directors and executive officers. -31- Board of Directors Set forth below for each of the members of our Board of Directors is his name, age, the term during which he has served as one of our directors, his principal occupations during the past five years and any additional directorships he has held in publicly-held companies. For Humbert B. Powell, III's information, please see "Executive Officers and Other Significant Employees". Marc A. Fries, age 34 Mr. Fries has been the President of The Raynor Group, an established national sales and marketing firm in the office furniture industry, since February 1998. Mr. Fries is responsible for the development and implementation of sales strategies for each of the distribution channels Raynor services. These channels include big box retail, mail order, internet sales, national buying groups, regional distributors and independent dealers. Mr. Fries has headed the licensed product division at Raynor since its inception two years ago. Currently this division is launching its Technomesh(TM) seating and accessories product line under license agreements with National Football League Properties and the National Hockey League. Raynor is in the process of signing agreements with the National Basketball Association and the NCAA Collegiate Licensing Committee. Mr Fries has been responsible for all product development including design, global sourcing and manufacturing. He has been instrumental in developing the marketing plan and coordinating sales and distribution with key retail partners across the country. Prior to being appointed President of Raynor, Mr. Fries was the National Sales Manager responsible for Raynor's outside sales force. Mr. Fries began his career in sales with Raynor in October 1990. Mr. Fries received his Bachelor of Arts in Economics from Yeshiva University in New York. Brian D. Jedwab, Esq., age 31 Mr. Jedwab has served as General Counsel to The Hymax Group, a private equity investment company with investments in numerous public and private companies, primarily Internet and technology related, for more than five years. In such capacity, he has been responsible for the direction and management of all legal and administrative affairs for The Hymax Group. Mr. Jedwab has practiced law in the areas of commercial litigation and real estate, is a member of the Bar of the States of New York and New Jersey and is a member of the New York State Bar Association. Mr. Jedwab received his B.A. in History cum laude from Queens College and received a J.D. from the Benjamin N. Cardozo School of Law. John Gentile, age 45 Mr. Gentile has served as President of Abrams Gentile Group (ACG), a New York-based entertainment technology and marketing firm since its inception in 1986. He also is a principal and Board member of T-INK Technologies, Inc.(TM), a company founded in December 2000 that develops and markets high tech conductive inks for both interactive consumer and industrial applications. Mr. Gentile, along with his brother Anthony, holds many patents and trademarks for technology and toy applications as well as technical and process technologies they have created for joint ventures with Hasbro, Kenner, and Mattel, which collectively generated over a billion dollars of retail sales. Prior to AGG, he was a founder and Chief Executive Officer of The Instar Group from 1973 to 1986, an entertainment design firm where he created many successful campaigns and film design for Paramount Pictures, Universal Studios and Columbia Pictures. Anthony Gentile, age 45 Mr. Gentile has served as Vice-President of Abrams Gentile Group (ACG), a New York-based entertainment technology and marketing firm since its inception in 1986. He also is a principal and Board member of T-INK Technologies, Inc.(TM), a company founded in December 2000 that develops and markets high tech conductive inks for both interactive consumer and industrial applications. Mr. Gentile, along with his brother John, holds many patents and trademarks for technology and toy applications as well as technical and process technologies they have created for joint ventures with Hasbro, Kenner, and Mattel, which collectively have generated over a billion dollars of retail sales. Prior to AGG, he was a -32- founder and Vice-President of The Instar Group from 1973 to 1986, an entertainment design firm where he created many successful campaigns and film design for Paramount Pictures, Universal Studios and Columbia Pictures. Committees In June 2002, the Board of Directors established an audit committee and a compensation committee. The Board has assigned certain responsibilities to the committees and the committees approve actions and make recommendations to the Board. The audit committee works with the chief financial officer and outside auditors, in connection with various auditing and accounting matters, including the recommendation of auditors, the scope and accuracy of the annual audits, fees to be paid to the auditors, the independence of the auditors, and our internal controls and accounting practices. The members of the audit committee currently are Marc Fries (Chairman), Humbert B. Powell, III and John Gentile. The compensation committee reviews the budget and recommends, reviews and oversees the salaries, benefits and stock option plans for our employees, consultants, directors and other individuals compensated by us. The members of the compensation committee currently are Humbert B. Powell, III (Chairman), Brian D. Jedwab and Anthony Gentile. The Board of Directors may from time to time establish other committees to facilitate our management. Director Compensation As compensation for their services as members of the Board of Directors, each of the Board members receives annual compensation of $10,000 plus options to purchase 10,000 shares of our common stock at an exercise price equal to the closing price of the common stock on the date of the grant. The options vest over a one-year period in equal quarterly amounts, so long as the director completes service for such quarter. Non-employee directors are reimbursed for reasonable expenses in connection with serving as a director and member of a committee. Advisory Board In January 2001, Essential Reality, LLC established an advisory board for the purpose of providing it with strategic advice. The members of the advisory board meet periodically with and advise our employees, customers and third-party consultants. Set forth below for each member is his or her name, age and principal occupations during the past five years Paul Eibeler, age 45 Mr. Eibeler is the President of Take-Two Interactive, an integrated global developer, marketer, distributor, and publisher of interactive entertainment software games and accessories for the Sony PlayStation2, Nintendo 64, and Microsoft Xbox. He has been with Take-Two interactive, since July 2000. Previously, Mr. Eibeler held various consulting positions for Microsoft's Xbox launch team, W-Trade Inc. and Essential Reality, LLC from January 1999 to June 2000. Mr. Eibeler also served as Acclaim Entertainment's executive vice president and General Manager from June 1996 to January 1999. Joshua I. Smith, age 61 Mr. Smith is an internationally distinguished entrepreneur and lecturer. Since 1998, Mr. Smith has been Chairman and Managing Partner of The Coaching Group. In that capacity he is the "coach," senior advisor/consultant, to the CEO's of the portfolio companies and assumes active roles with these companies which includes serving as Chairman or Vice Chairman of the Board, Board member, or Advisory Board member. Previously he was Founder, Chairman and CEO of the MAXIMA Corporation, a 20 year-old firm that achieved a national reputation as one of -33- the top African American owned firms in the United States. In addition, Mr. Smith presently serves on the Boards of Directors for Caterpillar, Inc. (CAT-NYSE), FedEx Corp (FDX-NYSE) and Allstate Corporation (ALL-NYSE). Glenn Wong, age 45 Mr. Wong has been the principal of Catalyst Solutions Ltd., a consulting company, since February 2001. Mr. Wong currently provides strategic consulting services to Mike's Hard Lemonade(TM), the number one hard lemonade in the US and Canada. Previously, Mr. Wong served as President & General Manager for Electronic Arts (Canada), Inc., the world's largest video game studio, from January 1998 to January 2001. In this capacity, he oversaw development of the full line of interactive computer and video game entertainment software for Electronic Arts studios in Burnaby, BC and Bellevue, WA. Prior to joining Electronic Arts, he was President of Rogers Cable TV for British Columbia from November 1995 to January 1998, where he concentrated his efforts on the quickly changing environment of the cable and telecommunications industry. From 1993 to 1995, Mr. Wong served as President and Chief Executive Officer of B.C. Hothouse, Ltd., a Canadian produce company. Mr. Wong also served as Vice President of Marketing at Nabob Foods from January 1984 to January 1993, where he oversaw several successful campaigns and received his first AMA "Marketer of the Year" Award and "Top Marketer" from Strategy Magazine. He began his professional career in 1980 as a Brand Manager at Procter and Gamble Inc. Mr. Wong has served on a number of boards including the Insurance Corporation of B.C., Canadian Cable Labs, Mohawk Oil Ltd., and the Dragon Boat Festival Society. David H. Starr, age 51 Mr. Starr is currently the Managing Director of NRW Holdings, a voice over implementations company. Prior to NRW, Mr. Starr served as Chief Information Officer for 3COM Corporation for two years, where he was responsible for over 800 information technology professionals in 43 countries and was involved in managing the Palm and U.S. Robotics spin-offs. From May 1993 to August 1999, he served as Chief Information Officer at Knight Ridder, Reader's Digest Association and the ITT Corporation, and also has held senior officer titles at Mastercard International, Citicorp and Price Waterhouse. His published works have appeared in CIO Magazine and he has been a guest lecturer at various universities and professional networks, including MIT. Mr. Starr has and/or currently sits on the Boards of Directors of Best Buy Corporation, BoysHope GirlsHope, ePurpose, GenerationPix, AdvisorTeam and NRW Corporation. Mr. Starr holds an MBA from Harvard University and received his Bachelor of Arts in Physics in 1972 from Florida State University. In addition, John R. Costantino, who has not yet signed an advisory agreement with us, has been providing advice to us and is expected to execute an advisory agreement in the near future. Mr. Costantino has been a principal in Walden Partners Ltd., a merchant bank, since 1992, and a founder of Walden Capital Partners since 1996. From 1987 through 1992, Mr. Costantino was a partner in Costantino, Melamede & Greenberg, an investment partnership that acquired and managed a number of companies in manufacturing, distribution and service industries. From 1985 through 1987, he served as the chief operating officer of Conair Corporation where he was involved in the company's leverage buyout. Prior to joining Conair, he was a Managing Director of the buyout division of Integrated Resources, Inc., a large financial services company where he was responsible for acquiring a number of companies including Wells Fargo Mortgage Company, the Linde Welding Division of Union Carbide and Brown-Jordan Company. Mr. Costantino currently serves as director to several companies including Clayton Acquisition Corporation, Bemiss-Jason Corp., Vox Radio Group L.P., Plymouth Acquisition Corp., and Ameriscape Inc. He also serves on the board of the General Electric Mutual Funds and has served on the boards of a number of public companies including Conair Corp., Brooklyn Bank Corp. and Lancit Media Entertainment LTD. He was formerly a member of the Advisory Board of Republic National Bank. As compensation for serving on the advisory board, the members have received options to purchase an aggregate of 210,000 shares of our common stock at exercise prices ranging from $0.75 to $1.60. All of these options vest -34- equally on the first, second and third anniversaries of the date of grant, so long as the advisory board member completes service for such period. EXECUTIVE COMPENSATION Following our business combination with Essential Reality, LLC on June 20, 2002, the executive officers of Essential Reality, LLC became our executive officers. See "Management" above. During our fiscal year ended December 31, 2001, we had two chief executive officers. Frank Drechsler became our President on June 26, 2001. Prior to Mr. Drechsler's election, Ryan Neely was our President since March 2000. None of Mr. Drechsler, Mr. Neely, nor any other executive officer of ours was awarded, earned or paid any compensation for services they rendered to us. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Business Combination With Essential Reality, LLC On June 20, 2002, we consummated a business combination with Essential Reality, LLC, a Delaware limited liability company. Pursuant to the terms of the transaction, all of the members of Essential Reality, LLC contributed their membership interests to us in exchange for an aggregate of 16,874,784 shares of our common stock. LCG Capital Group, LLC, Martin Abrams, John Gentile and Anthony Gentile, all of whom were members of Essential Reality, LLC, are now significant shareholders of ours. See "Security Ownership of Certain Beneficial Owners and Management". Following the Transaction, ER LLC, then our wholly-owned subsidiary, was merged with and into us. BusinessDevelopment.com, LLC BusinessDevelopment.com, LLC (BD) is an entity controlled by an affiliate of LCG Capital Group, LLC, which is a significant shareholder of ours and a founding member of Essential Reality, LLC. BD entered into an agreement with Essential Reality, LLC on December 13, 2000, pursuant to which BD provided general consulting services to Essential Reality, LLC, and now to us, in return for a monthly cash retainer. Such services consist of forming revenue-generating opportunities, including without limitation distribution agreements, licensing agreements, joint ventures, strategic alliances and partnerships. The amount of the retainer originally was $6,000 per month, is currently $15,000 per month and it can increase from time to time up to a maximum of $20,000 per month, based upon our mutual consent with BD, depending on the level and geographic scope of the services. To date, Essential Reality, LLC and we have incurred $178,000 of consulting fees from BD under the terms of such agreement. In addition to the monthly retainer, we also are obligated to pay to BD a potential revenue share of up to four percent (4.0%) on transactions facilitated by BD. Either BD or we may cancel this agreement with thirty (30) days prior notice. Up until November 30, 2001, Essential Reality, LLC shared office space with BD. There was an allocation of general expenses in connection with such office space, whereby BD paid 70% and Essential Reality, LLC paid 30% of such expenses. Certain items, such as office supplies and computer leases, were assumed by Essential Reality and taken to its new offices. -35- Other Relationships and Related Transactions We are allocated the costs of a computer lease assumed by HYMAX Group, Inc., an affiliate of LCG Capital Group, LLC, a significant shareholder of ours. We pay an allocated amount of approximately $3,000 per month. Such payments are due through March 2003. HYMAX has also made certain of its employees available to provide operational support services to Essential Reality, LLC and now us and is reimbursed for a portion of such employees' compensation, based on the percentage of time worked for Essential Reality, LLC and us. Such reimbursement amount currently aggregates approximately $4,500 per month. Such services are expected to cease in the near future. In addition, Essential Reality, LLC received loans totaling $76,617 from LCG Capital Group, LLC, which is payable on demand and interest-free. Advances totaling approximately $23,000 from BD, HYMAX and a founding member of Essential Reality, LLC are payable on demand and accrue interest at a rate of 10% per annum. Abrams Gentile Entertainment Corporation (AGE), a company owned by certain founding members of Essential Reality, LLC, including Anthony and John Gentile, directors of ours, have provided various services to us. To date we have incurred approximately $160,000 in fees from AGE and may incur additional expenses as services are performed. We owe an aggregate of $267,000 in accrued salaries to certain affiliates of Essential Reality, LLC for services they rendered to Essential Reality, LLC. -36- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information concerning ownership of our common stock as of the date of this prospectus, by (i) each person known by us to be the beneficial owner of more than five percent of the outstanding shares of our common stock, (ii) each director, and (iii) all of our directors and executive officers as a group. Unless otherwise indicated, we believe that each shareholder has sole voting power and sole dispositive power with respect to the shares beneficially owned by him. Number of Shares Percentage of Outstanding Name and Address of Beneficial Owner Beneficially Owned Shares Beneficially Owned (1) - ------------------------------------ ------------------ ----------------------------- LCG Capital Group, LLC 9,600,000 (2) 53.5% Hamilton Resources Group, LLC Winchester Capital Group, LLC Michael Alpert c/o 335 Central Avenue, 2nd Floor Lawrence, NY 11559 Martin Abrams 2,400,480 13.4% c/o Abrams Gentile Entertainment, Inc. 244 West 54th Street, 9th Floor New York, NY 10017 Michael B. Schwab 2,113,478 (3) 11.8% c/o 1219 Lombard Street San Francisco, CA 94109 Big Sky Partners 2,027,078 (4) 11.3% c/o 1219 Lombard Street San Francisco, CA 94109 Anthony Gentile 1,121,760 (5) 6.2% c/o Abrams Gentile Entertainment, Inc. 244 West 54th Street, 9th Floor New York, NY 10017 John Gentile 1,121,760 (5) 6.2% c/o Abrams Gentile Entertainment, Inc. 244 West 54th Street, 9th Floor New York, NY 10017 Jayvee & Co., for AGF Canadian Growth Equity 1,113,800 6.2% c/o Jayvee & Co. P.O. Box 9 Commerce Court West Securities Level Toronto, Ontario M5H 4A6 Humbert B. Powell, III 0 (5) 0 -37- Number of Shares Percentage of Outstanding Name and Address of Beneficial Owner Beneficially Owned Shares Beneficially Owned (1) - ------------------------------------ ------------------ ----------------------------- Marc A. Fries 0 (5) 0 Brian D. Jedwab 0 (5) 0 All executive officers and directors as a group 2,270,320 (6) 12.6% (7 persons) - ---------------- * Less than 1% (1) Unless otherwise indicated, we believe that all persons named in the above table have sole voting and investment power with respect to all shares of voting stock beneficially owned by them. A person is deemed to be the beneficial owner of securities that can be acquired by such person within 60 days from the date hereof upon the exercise of options, warrants or convertible securities. Each beneficial owner's percentage ownership is determined by assuming that options, warrants and convertible securities held by such person (but not those held by any other person) and which are exercisable or convertible within 60 days have been exercised and converted. Assumes a base of 17,955,718 shares of common stock outstanding. (2) Includes 4,800,000 shares of common stock held by LCG Capital Group, LLC and an additional 4,800,000 shares of common stock held collectively by Martin Abrams, John Gentile, Anthony Gentile and MSH Entertainment Corporation, who have agreed to vote their shares in the same manner as LCG Capital Group votes its shares with respect to certain matters (including but not limited to the election of directors). LCG Capital Group may be deemed to beneficially own such shares whose vote it controls but it disclaims beneficial ownership of such shares except to the extent of its pecuniary interest. Hamilton Resources Group, LLC currently owns a majority of the equity in LCG Capital Group and may be deemed to beneficially own the shares held by LCG. Winchester Capital Group, LLC, as the managing member of LCG Capital Group, may be deemed to beneficially own the shares held by LCG Capital Group. Michael Alpert, as the managing member of Winchester Capital Group, may be deemed to beneficially own the shares held by LCG Capital Group. Hamilton Resources Group, Winchester Capital Group and Michael Alpert each disclaims beneficial ownership of the shares beneficially owned by LCG Capital Group, except to the extent of its pecuniary interest therein. (3) Includes 86,400 shares of common stock held by Mr. Schwab, 1,920,000 shares of common stock held directly by Big Sky Partners, and 107,078 shares of common stock held indirectly by Big Sky Partners through its ownership in LCG Capital Group. Mr. Schwab, as managing partner of Big Sky Partners, may be deemed to beneficially own the shares held by Big Sky Partners, but he disclaims beneficial ownership of such shares, except to the extent of his pecuniary interest therein. (4) Includes 1,920,000 shares of common stock held directly by Big Sky Partners, and 107,078 shares of common stock held indirectly by Big Sky Partners through its ownership in LCG Capital Group. Big Sky Partners disclaims beneficial ownership of the shares held by LCG Capital Group, except to the extent of his pecuniary interest therein. (5) Does not include 10,000 shares of common stock issuable upon exercise of options that are not currently exercisable. -38- (6) Includes 26,800 shares of common stock issuable upon exercise of currently exercisable options held by Reuben Levine, our President and Chief Operating Officer. Does not include 241,200 shares of common stock issuable upon exercise of options held by Mr. Levine that are not currently exercisable. DESCRIPTION OF CAPITAL STOCK Authorized Stock Our authorized capital stock consists of 50,000,000 shares of common stock, par value $.01 per share, and 5,000,000 shares of preferred stock, par value $.01 per share. As of the date of this prospectus, there were 17,955,718 shares of common stock and no shares of preferred stock issued and outstanding. In addition, as of the date of this prospectus, the following shares of common stock have been reserved for issuance: o 3,500,000 shares reserved for issuance upon the exercise of options under our stock option plan (of which 1,032,000 have been issued); o 263,158 shares reserved for issuance upon conversion of certain convertible notes, all of which are being registered in this prospectus; o 855,000 shares reserved for issuance upon the exercise of certain bridge warrants, all of which are being registered in this prospectus; and o 331,211 shares reserved for issuance upon the exercise of certain additional warrants, all of which are being registered in this prospectus. Common Stock Holders of shares of common stock are entitled to one vote per share on all matters that they are entitled to vote upon at meetings of shareholders. The holders of common stock do not have cumulative voting rights nor do they have any preemptive, subscription, redemption or conversion rights. The holders of shares of common stock are entitled to receive dividends from our funds legally available therefor when, as and if declared by our Board of Directors. No dividends have been paid to holders of common stock since our inception. Convertible Notes We have issued convertible promissory notes in the aggregate principal amount of $500,000. These notes mature on April 30, 2004 and earn interest at a rate of 8 1/2 % per year. For a six-month period ending December 20, 2002, the outstanding principal amount of these notes and accrued unpaid interest thereon may, at the option of the holder, be converted into shares of our common stock at a conversion price of $1.90 per share (subject to standard adjustments). The accounting effect of this conversion benefit will be to capitalize deferred interest using the beneficial conversion feature method and to amortize such amount over the terms of the notes. Bridge Warrants We have issued warrants to purchase up to an aggregate of 855,000 shares of our common stock, as partial consideration for loans made to us. These warrants are immediately exercisable and expire on June 20, 2004. Of such warrants, 15,000 are exercisable at a purchase price of $1.30 per share and the remaining 840,000 are exercisable at a purchase price of $1.90 per share. The value of the bridge warrants will be computed using the Black-Scholes and relative fair value methods and will be capitalized and amortized over the terms of the loans. -39- In addition, we have the right to call these warrants if (i) the average closing market price of a share of our common stock is trading at $1.50 or more above the prevailing exercise price for a period of no less than 15 consecutive trading days and (ii) the average daily volume of our common stock traded during such period was at least 100,000 shares. Additional Warrants We have issued warrants to purchase up to an aggregate of 331,211 shares of our common stock, in connection with the consummation of our business combination with Essential Reality, LLC. These warrants are immediately exercisable and expire on June 20, 2005. These warrants are exercisable at a purchase price of $1.30 per share. We may not call these warrants. -40- SELLING SHAREHOLDERS The following table sets forth information, as of the date hereof, with respect to shares of our common stock beneficially owned by each selling shareholder. The selling shareholders are not obligated to sell any of the shares offered by this prospectus. The number of shares sold by each selling shareholder may depend on a number of factors, such as the market price of our common stock. We are registering an aggregate of 8,214,239 shares of our common stock for resale by the selling shareholders in accordance with registration rights previously granted to them. We agreed to file a registration statement under the Securities Act with the SEC, of which this prospectus is a part, with respect to the resale of: o an aggregate of 6,764,870 shares that we issued in connection with our business combination with Essential Reality LLC; o an aggregate of 855,000 shares underlying certain warrants that we issued in connection with the business combination to holders of certain bridge notes; o an aggregate of 331,211 shares underlying certain additional warrants that we issued in connection with the business combination; and o an aggregate of 263,158 shares underlying our outstanding convertible promissory notes. The selling shareholders may sell any or all of their shares listed below from time to time. Accordingly, we cannot estimate how many shares the selling shareholders will own upon consummation of any such sales. Also, the selling shareholders may have sold, transferred or otherwise disposed of all or a portion of their shares since the date on which the shares were issued, in transactions exempt from the registration requirements of the Securities Act. Number of Number of Percentage of Shares Number of Shares Outstanding Beneficially Shares Beneficially Common Owned Prior Being Owned After Stock After Name to Offering(1) Offered Offering(1)(2) Offering(1) - ----- -------------- ------- -------------- ----------- LCG Capital Group, LLC Hamilton Resources Group, LLC 9,600,000 (3) 1,200,000 8,400,000 46.8% Winchester Capital Group, LLC Michael Alpert Martin Abrams 2,400,480 600,120 1,800,360 10.0% Michael B. Schwab 2,113,478 (4) 51,840 2,061,538 11.5% Big Sky Partners 2,027,078 (5) 1,152,000 875,078 4.9% Anthony Gentile 1,121,760 (6) 280,440 841,320 4.7% John Gentile 1,121,760 (6) 280,440 841,320 4.7% Jayvee & Co., for AGF Canadian Growth Equity 1,113,800 668,280 445,520 2.5% -41- Number of Number of Percentage of Shares Number of Shares Outstanding Beneficially Shares Beneficially Common Owned Prior Being Owned After Stock After Name to Offering(1) Offered Offering(1)(2) Offering(1) - ----- -------------- ------- -------------- ----------- Steven R. Berkson 540,000 (7) 348,000 192,000 1.1% Northumberland Holdings Ltd. 484,421 (8) 446,021 38,400 * 1025 Associates, Inc. 271,526 (9) 233,126 38,400 * Hirsch Wolf 255,000 (10) 159,000 96,000 * CitiCapital Group, LLC 244,800 146,880 97,920 * Casurina Performance Fund 240,000 144,000 96,000 * Royal Trust Corp. of Canada in Trust for Account #112438001 240,000 144,000 96,000 * Jayvee & Co., for IG AGF Canadian Diversified Growth Fund 219,500 131,700 87,800 * Coniston Investment Corp. 193,440 (11) 193,440 0 0 MSH Entertainment Corporation 156,000 39,000 117,000 * Joshua Simms Trust 144,000 86,400 57,600 * Legend Merchant Group, Inc. 137,771 (12) 137,771 0 0 Royal Trust Corp. of Canada in Trust for Account #99480072, London Life Growth Equity 126,200 75,720 50,480 * 62 West 39th LLC 100,000 60,000 40,000 * 135 West 36th LLC 100,000 60,000 40,000 * Jack Beyda 100,000 60,000 40,000 * BVH Holdings 96,000 57,600 38,400 * CGTF, LLC 96,000 57,600 38,400 * Joseph H. Feldman 96,000 57,600 38,400 * Tsenvi LLC 96,000 57,600 38,400 * -42- Number of Number of Percentage of Shares Number of Shares Outstanding Beneficially Shares Beneficially Common Owned Prior Being Owned After Stock After Name to Offering(1) Offered Offering(1)(2) Offering(1) - ----- -------------- ------- -------------- ----------- Royal Trust Corp. of Canada in Trust for Account #99480027, GWL Growth Equity 91,900 55,140 36,760 * Jayvee & Co., for Clarica Alpine Growth Equity 75,800 45,480 30,320 * Daniel Mestre 72,000 43,200 28,800 * David Wohlberg 72,000 43,200 28,800 * SPH Investments, Inc. 65,158 (13) 55,558 9,600 * Fenmore Consultants, Ltd. 62,158 (14) 52,558 9,600 * Jim Smith 60,000 (15) 60,000 0 0 Wolver Limited 58,158 (16) 58,158 0 0 Phillip Vitug 57,600 34,560 23,040 * Michael Garnick 50,000 (17) 50,000 0 0 Erlinda D. Belen 48,000 28,800 19,200 * Arthur Fefferman 48,000 28,800 19,200 * Christe-Marie Fuhrman 48,000 28,800 19,200 * Eric Lindros 48,000 28,800 19,200 * Meegan Lowth 48,000 28,800 19,200 * Howard Perl 38,400 23,040 15,360 * Tzvi Rosen 38,400 23,040 15,360 * Steven Spector 38,400 23,040 15,360 * Bel-Cal Properties 35,000 (18) 35,000 0 0 Rivka Perlstein 35,000 (18) 35,000 0 0 -43- Number of Number of Percentage of Shares Number of Shares Outstanding Beneficially Shares Beneficially Common Owned Prior Being Owned After Stock After Name to Offering(1) Offered Offering(1)(2) Offering(1) - ----- -------------- ------- -------------- ----------- Winton Capital Holdings, Ltd. 35,000 (18) 35,000 0 0 Lori Matherson 31,200 18,720 12,480 * Abraham Pearson 31,200 18,720 12,480 * Myriam Braun 30,000 (19) 30,000 0 0 Glenn Michaelson 30,000 (19) 30,000 0 0 547653 Ontario Ltd. 24,000 14,400 9,600 * 1082824 Ontario Inc. 24,000 14,400 9,600 * Christine & James Alousis 24,000 14,400 9,600 * Yvonne Chiu 24,000 14,400 9,600 * Gordon Currie 24,000 14,400 9,600 * Patricia Currie 24,000 14,400 9,600 * Fred Dalley 24,000 14,400 9,600 * Diana DiTomaso 24,000 14,400 9,600 * Jack Forgash 24,000 14,400 9,600 * Gunn Trust dtd 4/20/98 24,000 14,400 9,600 * Richard Hue 24,000 14,400 9,600 * Michael Kest 24,000 14,400 9,600 * George J. Nadel & Mary Anne Keefe-Nadel 24,000 14,400 9,600 * Angelo Nitsopoulos 24,000 14,400 9,600 * Edward Penwarden 24,000 14,400 9,600 * Helen Schwab 24,000 14,400 9,600 * -44- Number of Number of Percentage of Shares Number of Shares Outstanding Beneficially Shares Beneficially Common Owned Prior Being Owned After Stock After Name to Offering(1) Offered Offering(1)(2) Offering(1) - ----- -------------- ------- -------------- ----------- Abraham Sieger 24,000 14,400 9,600 * Mordechai Vogel 24,000 14,400 9,600 * Shimon Vogel 24,000 14,400 9,600 * FAC Enterprises, Inc. 15,737 (20) 15,737 0 0 Motty Gurary 15,000 (21) 15,000 0 0 Edward Mercaldo 15,000 (21) 15,000 0 0 SPH Investments, Inc. Profit Sharing 15,000 (21) 15,000 0 0 Sanford J. Hillsberg 14,400 8,640 5,760 * Richard N. Kipper 14,400 8,640 5,760 * Philip Shapiro 9,984 5,990 3,994 * Jordan Toder 9,600 5,760 3,840 * Capital Growth Trust 6,000 (22) 6,000 0 0 Royal Trust Corp. of Canada in Trust for Account #117288039, Industrial Alliance Cdn Equity 4,800 2,880 1,920 * - ------------------ * less than 1% (1) Unless otherwise indicated, we believe that all persons named in the above table have sole voting and investment power with respect to all shares of voting stock beneficially owned by them. A person is deemed to be the beneficial owner of securities that can be acquired by such person within 60 days from the date hereof upon the exercise of options, warrants or convertible securities. Each beneficial owner's percentage ownership is determined by assuming that options, warrants and convertible securities held by such person (but not those held by any other person) and which are exercisable or convertible within 60 days have been exercised and converted. Assumes a base of 17,955,718 shares of common stock outstanding. (2) Beneficial ownership of shares held by the selling shareholder after this offering assumes that each selling shareholder sold all of the shares it is offering in this prospectus but actually will depend on the number of securities sold. -45- (3) Includes 4,800,000 shares of common stock held by LCG Capital Group, LLC and an additional 4,800,000 shares of common stock held collectively by Martin Abrams, John Gentile, Anthony Gentile and MSH Entertainment Corporation, who have agreed to vote their shares in the same manner as LCG Capital Group votes its shares with respect to certain matters (including but not limited to the election of directors). LCG Capital Group may be deemed to beneficially own such shares whose vote it controls but it disclaims beneficial ownership of such shares except to the extent of its pecuniary interest. Hamilton Resources Group, LLC currently owns a majority of the equity in LCG Capital Group and may be deemed to beneficially own the shares held by LCG. Winchester Capital Group, LLC, as the managing member of LCG Capital Group, may be deemed to beneficially own the shares held by LCG Capital Group. Michael Alpert, as the managing member of Winchester Capital Group, may be deemed to beneficially own the shares held by LCG Capital Group. Hamilton Resources Group, Winchester Capital Group and Michael Alpert each disclaims beneficial ownership of the shares beneficially owned by LCG Capital Group, except to the extent of its pecuniary interest therein. (4) Includes 86,400 shares of common stock held by Mr. Schwab, 1,920,000 shares of common stock held directly by Big Sky Partners, and 107,078 shares of common stock held indirectly by Big Sky Partners through its ownership in LCG Capital Group. Mr. Schwab, as managing partner of Big Sky Partners, may be deemed to beneficially own the shares held by Big Sky Partners, but he disclaims beneficial ownership of such shares, except to the extent of his pecuniary interest therein. (5) Includes 1,920,000 shares of common stock held directly by Big Sky Partners, and 107,078 shares of common stock held indirectly by Big Sky Partners through its ownership in LCG Capital Group. Big Sky Partners disclaims beneficial ownership of the shares held by LCG Capital Group, except to the extent of his pecuniary interest therein. (6) Does not include 10,000 shares of common stock issuable upon exercise of options that are not currently exercisable. (7) Includes 60,000 shares of common stock issuable upon exercise of warrants that are currently exercisable. (8) Includes 270,000 shares of common stock issuable upon exercise of warrants that are currently exercisable and 118,421 shares of common stock issuable upon conversion of convertible promissory notes. (9) Includes 80,000 shares of common stock issuable upon exercise of warrants that are currently exercisable and 95,526 shares of common stock issuable upon conversion of convertible promissory notes. (10) Includes 15,000 shares of common stock issuable upon exercise of warrants that are currently exercisable. (11) Includes 193,440 shares of common stock issuable upon exercise of warrants that are currently exercisable. (12) Includes 137,771 shares of common stock issuable upon exercise of warrants that are currently exercisable. (13) Includes 28,000 shares of common stock issuable upon exercise of warrants that are currently exercisable and 13,158 shares of common stock issuable upon conversion of convertible promissory notes. (14) Includes 25,000 shares of common stock issuable upon exercise of warrants that are currently exercisable and 13,158 shares of common stock issuable upon conversion of convertible promissory notes. (15) Includes 60,000 shares of common stock issuable upon exercise of warrants that are currently exercisable. -46- (16) Includes 45,000 shares of common stock issuable upon exercise of warrants that are currently exercisable and 13,158 shares of common stock issuable upon conversion of convertible promissory notes. (17) Includes 50,000 shares of common stock issuable upon exercise of warrants that are currently exercisable. (18) Includes 35,000 shares of common stock issuable upon exercise of warrants that are currently exercisable. (19) Includes 30,000 shares of common stock issuable upon exercise of warrants that are currently exercisable. (20) Includes 6,000 shares of common stock issuable upon exercise of warrants that are currently exercisable and 9,737 shares of common stock issuable upon conversion of convertible promissory notes. (21) Includes 15,000 shares of common stock issuable upon exercise of warrants that are currently exercisable. (22) Includes 6,000 shares of common stock issuable upon exercise of warrants that are currently exercisable. PLAN OF DISTRIBUTION This prospectus relates to the offer and sale by the selling shareholders of an aggregate of 6,764,870 shares of our common stock that we issued in connection with our business combination with Essential Reality, LLC plus an additional 1,449,369 shares of our common stock that are underlying certain warrants and convertible promissory notes issued in connection with the business combination. The selling shareholders may sell the shares in transactions in the over-the-counter market, in negotiated transactions, or a combination of such methods of sale. The selling shareholders may sell the shares through public or private transactions at prevailing market prices, at prices related to such prevailing market prices or at privately negotiated prices. The selling shareholders may also sell shares pursuant to Rule 144 of the Securities Act, if applicable. The selling shareholders may use underwriters or broker-dealers to sell the shares. Such underwriters and broker-dealers may receive compensation in the form of discounts or commissions from the selling shareholders, or they may receive commissions from the purchasers of shares for whom they acted as agents, or both (which compensation as to a particular broker-dealer might be in excess of customary commissions). The selling shareholders and any underwriter or broker-dealer who participates in the distribution of the shares may be deemed to be "underwriters" within the meaning of the Securities Act, and any commissions received by them and any profit on the resale of the shares purchased by them may be deemed to be underwriting discounts or commissions under the Securities Act. In addition, the broker-dealers' commissions, discounts or concession may qualify as underwriters' compensation under the Securities Act. We will disclose in a post-effective amendment to the registration statement any broker-dealers the selling shareholders contract with in the selling effort who may appear to be acting as underwriters within the meaning of Section 2(11) of the Securities Act. If any such broker-dealers are acting as underwriters, we will revise the disclosures in the registration statement to include the amount of the shares of our common stock being sold by the broker-dealer and, if the broker-dealer is entitled to sell additional shares, the broker-dealer's relationship and obligations to us and the selling shareholders and any associated expenses which we or the selling shareholders may incur in connection with such sale of our common stock. We will also file any agreement the selling shareholders or we may enter into with such broker-dealer as an exhibit to the registration statement. -47- Under applicable rules and regulations under the Securities Exchange Act of 1934, as amended, any person engaged in a distribution of the shares may not simultaneously engage in market-making activities with respect to our common stock for a certain period of time, except under certain limited circumstances. Also, without limiting the foregoing, each selling shareholder and any other person participating in such distribution will be subject to applicable provisions of the Exchange Act and rules and regulations thereunder (including Regulation M), which provisions may limit the timing of purchases and sales of shares of our common stock by such selling shareholder. At the time a selling shareholder makes an offer to sell shares, to the extent required by the Securities Act, a prospectus will be delivered. If a supplemental prospectus is required, one will be delivered setting forth the number of shares being offered and the terms of the offering, including the names of any underwriters, dealers or agents, the purchase price paid by any underwriter for the shares, and any discounts or commissions. In order to comply with the securities laws of certain states, if applicable, the shares will be sold in such jurisdictions only through registered or licensed brokers or dealers. In addition, in certain states the shares may not be sold unless they have been registered or qualified for sale in the applicable state or an exemption from the registration or qualification requirement is available and complied with. We have agreed to pay substantially all of the expenses incident to the registration, offering and sale of the shares to the public, excluding the commissions or discounts of underwriters, broker-dealers or agents. LEGAL MATTERS The validity of the shares of common stock offered hereby will be passed upon for us by Olshan Grundman Frome Rosenzweig & Wolosky LLP, New York, New York. EXPERTS The financial statements of JPAL, Inc. as of December 31, 2001 and 2000 and for the period from March 31, 1999 (inception) through December 31, 1999, have been audited by Lesley, Thomas, Schwarz & Postma, Inc., independent auditors, as stated in their report, which is attached hereto, and have been so included in reliance upon the report of such firm given on their authority as experts in accounting and auditing. Essential Reality, LLC's financial statements as of December 31, 2001 and 2000 and for the period from June 1, 1999 (date of commencement) to December 31, 2001, included in this prospectus, have been audited by Deloitte & Touche LLP, independent auditors, as stated in their report, appearing herein and elsewhere in the registration statement (which report expresses an unqualified opinion and includes an explanatory paragraph which indicates substantial doubt about the company's ability to continue as a going concern), and have been so included in reliance upon the report of such firm given upon their authority as experts in accounting and auditing. DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES Insofar as indemnification for liabilities arising under the Securities Act may be permitted to our directors, officers or persons controlling us, we have been advised that it is the SEC's opinion that such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. -48- WHERE YOU CAN FIND MORE INFORMATION We have filed a registration statement on Form SB-2 with the SEC for our common stock offered in this offering. This prospectus does not contain all of the information set forth in the registration statement. You should refer to the registration statement and its exhibits for additional information. Whenever we make references in this prospectus to any of our contracts, agreements or other documents, the references are not necessarily complete and you should refer to the exhibits attached to the registration statement for the copies of the actual contract, agreement or other document. You should rely only on the information and representations provided in this prospectus or any related supplement. We have not authorized anyone else to provide you with different information. The selling shareholders will not make an offer to sell these shares in any state where the offer is not permitted. You should not assume that the information in this prospectus or any supplement is accurate as of any date other than the date on the front of those documents. The SEC maintains an Internet site at http://www.sec.gov, which contains reports, proxy and information statements, and other information regarding us. You may also read and copy any document we file with the SEC at its Public Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the Public Reference Room. -49- INDEX TO FINANCIAL STATEMENTS ESSENTIAL REALITY, INC. (f/k/a JPAL, INC.) - ------------------------------------------ Page ---- AUDITED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000 AND FOR THE PERIOD FROM MARCH 31, 1999 (INCEPTION) THROUGH DECEMBER 31, 1999 Independent Auditors' Report F-2 Balance Sheets F-3 Statements of Operations F-4 Statements of Stockholders' Equity F-5 Statements of Cash Flows F-6 Notes to Financial Statements F-7 UNAUDITED FINANCIAL STATEMENTS AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND 2001 Condensed Balance Sheet F-14 Condensed Statements of Operations F-15 Condensed Statements of Cash Flows F-16 Notes to Condensed Financial Statements F-18 UNAUDITED PRO FORMA FINANCIAL STATEMENTS Balance Sheet as of December 31, 2001 F-21 Balance Sheet as of March 31, 2002 F-23 Statement of Operations for the year ended December 31, 2001 F-25 Statement of Operations for the three months ended March 31, 2002 F-26 Supplementary Schedule of Notes Payable F-27 Notes to Unaudited Pro Forma Statements of Operations F-28 ESSENTIAL REALITY, LLC - ---------------------- AUDITED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000 AND FOR THE CUMULATIVE PERIOD FROM JUNE 1, 1999 (DATE OF COMMENCEMENT) TO DECEMBER 31, 2001, AND UNAUDITED FINANCIAL STATEMENTS AS OF MARCH 31, 2002 AND 2001 AND FOR THE CUMULATIVE PERIOD FROM JUNE 1, 1999 (DATE OF COMMENCEMENT) TO MARCH 31, 2002 Independent Auditors' Report F-30 Balance Sheets F-31 Statements of Operations F-32 Statements of Members' Equity (Deficit) F-33 Statements of Cash Flows F-34 Notes to Financial Statements F-36 F-1 April 11, 2002 Independent Auditors' Report To the Board of Directors and Stockholders of JPAL, Inc.: We have audited the accompanying balance sheets of JPAL, Inc. (the "Company") as of December 31, 2001 and 2000, and the related statements of operations, changes in stockholders' equity (deficit), and cash flows for each of the two years ended December 31, 2001 and 2000 and the period from March 31, 1999 (inception) through December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of JPAL, Inc. as of December 31, 2001 and 2000, and the results of its operations and its cash flows for each of the two years ended December 31, 2001 and 2000 and the period from March 31, 1999 (inception) through December 31, 1999 in conformity with accounting principles generally accepted in the United States of America. /s/ Lesley, Thomas, Schwarz & Postma, Inc. ----------------------------------------------- Lesley, Thomas, Schwarz & Postma, Inc. A Professional Accountancy Corporation Newport Beach, California F-2 JPAL, INC. BALANCE SHEETS December 31, 2001 2000 ------------ ----------- ASSETS Current assets Cash and cash equivalents $ 1,770 $ 413 Prepaid expenses 121 609 ----------- ----------- Total current assets 1,891 1,022 Property and equipment, net 1,477 2,074 Accrued interest on note receivable 19,615 -- Note receivable - Essential Reality, LLC 1,500,000 -- ----------- ----------- Total assets $ 1,522,983 $ 3,096 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities Notes payable $ 650,000 $ -- Accounts payable 4,865 97 Accrued interest payable 25,824 -- ----------- ----------- Total current liabilities 680,689 97 Long-term liabilities Notes payable 911,400 -- ----------- ----------- Total liabilities 1,592,089 -- ----------- ----------- Commitments and contingencies Stockholders' equity (deficit) Preferred stock, $.001 par value 5,000,000 shares authorized No shares issued or outstanding Common stock, $.001 par value; 50,000,000 shares authorized, 8,645,260 and 18,987,345 shares issued and outstanding at December 31, 2001 and 2000, respectively 1,729 3,797 Additional paid-in capital 56,272 34,700 Accumulated deficit (127,107) (35,498) ----------- ----------- Total stockholders' equity (deficit) (69,106) 2,999 ----------- ----------- Total liabilities and stockholders' equity (deficit) $ 1,522,983 $ 3,096 =========== =========== See the accompanying notes to these financial statements F-3 JPAL, INC. STATEMENTS OF OPERATIONS March 31, 1999 (Inception) Years Ended December 31, Through ------------------------ December 31, 2001 2000 1999 ------------ ------------ -------------- REVENUES Rental commissions $ 1,039 $ 2,462 $ 1,523 Listing fees -- 660 5,270 ------------ ------------ ------------ 1,039 3,122 6,793 ------------ ------------ ------------ SELLING, GENERAL AND ADMINISTRATIVE EXPENSE 85,842 21,599 22,835 OTHER (INCOME) EXPENSE Interest income (19,615) -- -- Interest expense 25,824 -- -- Depreciation 597 599 380 ------------ ------------ ------------ 92,648 22,198 23,215 ------------ ------------ ------------ LOSS BEFORE PROVISION FOR INCOME TAXES (91,609) (19,076) (16,422) PROVISION FOR INCOME TAXES -- -- -- ------------ ------------ ------------ NET LOSS $ (91,609) $ (19,076) $ (16,422) ============ ============ ============ BASIC LOSS PER SHARE $ (.01) $ (.00) $ (.00) ============ ============ ============ DILUTIVE LOSS PER SHARE $ (.01) $ (.00) $ (.00) ============ ============ ============ Basic and dilutive weighted average of common shares outstanding 13,344,135 16,651,693 4,500,000 ============ ============ ============ See the accompanying notes to these financial statements F-4 JPAL, INC. STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT) YEARS ENDED DECEMBER 31, 2001 AND 2000 AND FOR THE PERIOD FROM MARCH 31, 1999 (INCEPTION) THROUGH DECEMBER 31, 1999 Common Stock ------------ Additional Accumulated Shares Amount Paid-In Capital Deficit Total ------ ------ --------------- ------- ----- BALANCE, March 31, 1999 (inception) -- $ -- $ -- $ -- $ -- ISSUANCE OF COMMON STOCK FOR SERVICES 4,500,000 900 -- -- 900 ADDITIONAL PAID-IN CAPITAL, (in exchange for goods and services and rent) -- -- 18,235 -- 18,235 NET LOSS -- -- -- (16,422) (16,422) ----------- ----------- ----------- ----------- ----------- BALANCE, December 31, 1999 4,500,000 900 18,235 (16,422) 2,713 ISSUANCE OF COMMON STOCK FOR CASH 10,500,000 2,100 920 -- 3,020 ISSUANCE OF COMMON STOCK FOR SERVICES 3,987,345 797 -- -- 797 ADDITIONAL PAID-IN CAPITAL, (paid in cash) -- -- 9,795 -- 9,795 ADDITIONAL PAID-IN CAPITAL (in exchange for rent provided by a stockholder) -- -- 2,000 -- 2,000 ADDITIONAL PAID-IN CAPITAL (in exchange for computer services provided by a stockholder) -- -- 3,750 -- 3,750 NET LOSS -- -- -- (19,076) (19,076) ----------- ----------- ----------- ----------- ----------- BALANCE, December 31, 2000 18,987,345 3,797 34,700 (35,498) 2,999 ----------- ----------- ----------- ----------- ----------- REDEMPTION OF COMMON STOCK (10,342,085) (2,068) 2,068 -- -- ADDITIONAL PAID IN CAPITAL, (in exchange for rent provided by a stockholder) -- -- 3,900 -- 3,900 ADDITIONAL PAID IN CAPITAL, (in exchange for computer services provided by a stockholder) -- -- 4,625 -- 4,625 ADDITIONAL PAID IN CAPITAL, (in exchange for legal, accounting and other administrative services provided by a stockholder) -- -- 10,979 -- 10,979 NET LOSS -- -- (91,609) (91,609) ----------- ----------- ----------- ----------- ----------- BALANCE, December 31, 2001 8,645,260 $ 1,729 $ 56,272 $ (127,107) $ (69,106) =========== =========== =========== =========== =========== See the accompanying notes to these financial statements F-5 JPAL, INC. STATEMENTS OF CASH FLOWS March 31, 1999 (Inception) Years Ended December 31, Through ------------------------------ December 31, 2001 2000 1999 --------------- ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (91,609) $ (19,076) $ (16,422) Adjustments to reconcile net loss to net cash provided by (used in) operating activities Depreciation 597 599 380 Services provided in exchange for issuance of common stock -- 797 900 Goods and services and rent provided in exchange for additional paid-in capital 19,504 5,750 18,235 Changes in operating assets and liabilities Increase in accrued interest on note receivable (19,615) (Increase) decrease in prepaid expenses 488 (609) -- Increase (decrease) in accounts payable 4,768 (747) 844 Increase in accrued expenses 25,824 -- -- ----------- ---------- ----------- Net cash provided by (used in) operating activities (60,043) (13,286) 3,937 ----------- ---------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property and equipment -- -- (3,053) Note receivable - related party (1,500,000) -- -- ----------- ---------- ----------- Net cash used in investing activities (1,500,000) -- (3,053) ----------- ---------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of notes payable 1,561,400 -- -- Proceeds from issuance of common stock -- 3,020 -- Proceeds from additional paid-in capital 2,068 9,795 -- Redemption of common stock (2,068) -- -- ----------- ---------- ----------- Net cash provided by financing activities 1,561,400 12,815 -- ----------- ---------- ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,357 (471) 884 CASH AND CASH EQUIVALENTS, beginning of period 413 884 -- ----------- ---------- ----------- CASH AND CASH EQUIVALENTS, end of period $ 1,770 $ 413 $ 884 =========== ========== =========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the period for interest $ -- $ -- $ -- Cash paid during the period for income taxes $ -- $ -- $ -- SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS During the year ended December 31, 2001, the Company recorded rent, computer services, legal, accounting and other administrative expenses totaling $19,504 and additional paid in capital of $19,504 for rent and services paid for and provided by a stockholder. During the year ended December 31, 2000, the Company recorded rent and computer services expense of $2,000 and $3,750, respectively, and additional paid-in capital of $5,750 for rent and services provided by a stockholder. During the years ended December 31, 2000 and 1999, the Company issued stock in exchange for services provided valued at $797 and $900, respectively. During the period ended December 31, 1999, the Company recorded additional paid-in capital of $18,235, for goods and services and rent paid for and provided by stockholders. See the accompanying notes to these financial statements F-6 JPAL, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2001 AND 2000 NOTE 1 - COMPANY OPERATIONS JPAL, Inc. (the "Company") was incorporated in the state of Nevada on March 31, 1999 to operate as an Internet based provider of vacation rental properties and services with an elected December 31st fiscal year end. A majority of the services were to properties located in Nevada. During the year ended December 31, 2001 the Company abandoned the development of their Internet services to provide vacation rental properties and services. The Company is currently in the process of negotiating a merger with another company. The Company has experienced net losses since its inception and had an accumulated deficit of approximately $127,000 at December 31, 2001. Such losses are attributable to cash losses resulting from costs incurred in the development of the Company's services and infrastructure. The Company expects operating losses to continue for the foreseeable future as it continues to seek alternative business opportunities. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The significant accounting policies are summarized as follows: Cash and Cash Equivalents - For purposes of the balance sheets and statements of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three (3) months or less to be cash equivalents. Accounting Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Property and Equipment - Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets which range from three to seven years. Repairs and maintenance to property and equipment are expensed as incurred. When property and equipment is retired or disposed of, the related costs and accumulated depreciation are eliminated from the accounts and any gain or loss on such disposition is reflected in income. Advertising - Advertising costs are charged to operations when incurred. Income Taxes - The Company accounts for income taxes in accordance with the provisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes", which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and the tax basis of assets and liabilities using enacted rates in effect for the periods in which the differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. F-7 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Fair Value of Financial Instruments - SFAS No. 107, "Disclosure about Fair Value of Financial Instruments", requires entities to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized on the balance sheet, for which it is practicable to estimate fair value. SFAS No. 107 defines fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. As of December 31, 1999 and 2000, the carrying value of cash and cash equivalents, accounts payable and accrued interest payable approximate fair value due to the short-term nature of such instruments. Based upon borrowing rates currently available to the Company for loans of similar terms, the carrying value of its debt obligations approximate fair value. Based upon rates of return currently available to the Company for investments of similar terms the carrying value of its note receivable approximates fair value. Loss Per Share of Common Stock - Basic and diluted loss per share is computed using shares of common stock issued to date. Consideration is also given in the dilutive loss per share calculation for the dilutive effect of common stock equivalents which might result from the exercise of stock options. However, for all periods presented, there were no common stock equivalents or the effect of common stock equivalents would be anti-dilutive. Common Stock Issued for Services Rendered - The Company periodically issues common stock for services rendered. Common stock issued is valued at the estimated fair market value of the services provided, as determined by management. During the year ended December 31, 2000 and the period ended December 31, 1999, the Company issued 4,500,000 and 3,987,345 shares of common stock for services. 4,500,000 shares were issued for advisory services and 3,987,345 shares were issued for legal services. Recent Accounting Pronouncements - In July 2001, the FASB issued Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations," which is effective for business combinations initiated after June 30, 2001. SFAS 141 eliminates the pooling of interest method of accounting for business combinations and requires that all business combinations occurring after July 1, 2001 are accounted for under the purchase method. The Company has not been affected by SFAS 141. In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets," which is effective for fiscal years beginning after December 15, 2001. Early adoption is permitted for entities with fiscal years beginning after March 15, 2001, provided that the first interim financial statements have not been previously issued. SFAS 142 addresses how intangible assets that are acquired individually or with a group of other assets should be accounted for in the financial statements upon their acquisition and after they have been initially recognized in the financial statements. SFAS 142 requires that goodwill and intangible assets that have indefinite useful lives not be amortized but rather be tested at least annually for impairment, and intangible assets that have finite useful lives be amortized over their useful lives. SFAS 142 provides specific guidance for testing goodwill and intangible assets that will not be amortized for impairment. The Company has not been affected by SFAS 142. In July 2001, the FASB issued Statement of Financial Accounting Standards No. 143 ("SFAS 143"), "Accounting for Asset Retirement Obligations." SFAS 143 established standards associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. The Company does not expect SFAS 143 to have a material impact on its financial statements. In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS 144 addresses financial accounting and reporting for the impairment of long-lived assets of which to be disposed. The provisions of SFAS 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within these fiscal years, with early adoption encouraged. The Company does not expect SFAS 144 to have a material impact on its financial statements. F-8 NOTE 3 - PROPERTY AND EQUIPMENT Property and equipment consist of the following: December 31, ------------ 2001 2000 ---- ---- Computer $ 1,791 $ 1,791 Computer equipment 1,057 1,057 Furniture 205 205 ------- ------- 3,053 3,053 Less: accumulated depreciation (1,576) (979) ------- ------- $ 1,477 $ 2,074 ======= ======= NOTE 4 - NOTES PAYABLE The Company has several unsecured notes payable with interest rates ranging from 8.00% to 8.50%. Notes totaling $650,000 which have a weighted average interest rate of 8.5 % will mature on the earliest of (i) March 1, 2002 or (ii) the sale or exchange of all or substantially all of the outstanding shares of common stock. As of April 11, 2002, these notes and accrued interest have not been repaid. The note holders have not called the notes. In the event that a note is called, other note holders have agreed to fund the Company to satisfy its debt. Notes totaling $911,400 which have a weighted average interest rate of 8.48% will mature on the earliest of (i) January 31, 2003 or (ii) the sale or exchange of all or substantially all of the outstanding shares of common stock. The total amount of notes payable was $1,561,400 at December 31, 2001. Interest expense on these notes during the year ended December 31, 2001 was $25,824. The Company issued warrants to acquire 610,560 shares of JPAL, Inc.'s common stock at a purchase price of $3.00 per share in connection with the issuance of these notes payable. $1,500,000 of the proceeds from these notes has been advanced to Essential Reality, LLC with which the Company is in the process of negotiating a merger agreement (Note 8). The note receivable is unsecured and bears an interest rate of 8.5%, however, interest did not begin to accrue until January 31, 2002. Imputed interest was $19,615 for the year ended December 31, 2001 which is included in other income. Principal together with accrued interest is due on the earliest of (i) January 31, 2004, (ii) the closing of the transactions contemplated by the agreement dated August 23, 2001 (Note 8) or (iii) the sale or exchange of all or substantially all of the membership interests of Essential Reality. F-9 NOTE 5 - INCOME TAXES The Company accounts for income taxes under Statement of Financial Accounting Standards No. 109 ("SFAS 109"). This statement mandates the liability method of accounting for deferred income taxes and permits the recognition of deferred tax assets subject to an ongoing assessment of realizability. The components of the Company's income tax provision consist of: March 31, 1999 Years Ended December 31, (Inception) ------------------------ December 31, 2001 2000 1999 -------- --------- ----------- Federal taxes (deferred) net operating loss benefit $(13,900) $ (2,800) $ (2,500) Change in valuation account 13,900 2,800 2,500 -------- -------- -------- $ -- $ -- $ -- ======== ======== ======== Deferred income taxes are provided for timing differences in the recognition of certain income and expense items for tax and financial statement purposes. The tax effect of the temporary differences giving rise to the Company's deferred tax assets and liabilities as of December 31, 2001 and 2000 are as follows: December 31, ---------------------------------- 2001 2000 --------------- ------------- Deferred income taxes Net operating loss benefit $ 19,200 $ 5,300 Valuation allowance (19,200) (5,300) --------------- ------------- $ -- $ -- =============== ============= The Company has federal net operating loss carryforwards of approximately $127,000 which if not utilized will expire at various times though 2021. For income tax purposes, only a portion of the net operating loss can be utilized in any given year if the company that generated the loss has more than fifty percent (50%) change in ownership in a three (3) year period. Accordingly, there may be limitations on the use of the Company's net operating loss carryforwards. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. As a result of the uncertainties surrounding the realization of the net operating loss carryforwards, management has determined that the realization of the deferred tax assets is questionable. Accordingly, the Company has recorded a valuation allowance equal to the net deferred tax asset amount as of December 31, 2001. F-10 NOTE 6 - RELATED PARTY TRANSACTIONS The Company is currently utilizing office space provided by the Company's president (a stockholder). During the years ended December 31, 2001 and 2000, the Company has recorded rent expense of $3,900 and $2,000, respectively, which represents the Company's pro rata share of the office space being provided by the Company's current and past presidents. The Company has also recorded computer consulting services of $4,625 and $3,750 which were provided by the Company's previous president for the years ended December 31, 2001 and 2000, respectively. The services were valued using hourly rates at estimated fair market value of similar services. During the year ended December 31, 2001 the Company has recorded $10,979 for legal, accounting and other administrative expenses that were paid for by the Company's current and past presidents. The presidents have waived reimbursement of the allocated rent, computer consulting services, legal, accounting and other administrative services provided and have considered them as additional paid-in capital. During the year ended December 31, 2001 the Company's current president received $11,000 as compensation which is included in selling, general and administrative expense. During the year ended December 31, 2000 the Company paid fees for web-consulting services to a stockholder totaling $1,500. Additionally, during the period ended December 31, 1999, the Company paid fees to a stockholder totaling $2,600 for the construction of their website. During the year ended December 31, 2000, the Company entered into a consulting agreement for legal services in exchange for 3,987,345 shares of common stock which were valued at $797. The services were valued using hourly rates at estimated fair market value of similar services. During the period ended December 31, 1999, the Company entered into consulting agreements for advisory services relating to the initial start-up of the Company in exchange for 4,500,000 shares of common stock. Total fees were $900 for the period ended December 31, 1999 with each consultant receiving a percentage of ownership in the form of common stock. The services were valued using hourly rates at estimated fair market value of similar services. In addition, during the period ended December 31, 1999, one of the stockholders paid for various goods and services relating to the Company's operations including travel, entertainment, trade shows and transportation costs. These expenses have been included in the results of operations for the corresponding period and recorded as additional paid-in-capital. NOTE 7 - STOCKHOLDERS' EQUITY (DEFICIT) Preferred stock - --------------- Holders of the preferred stock do not have preemptive rights to purchase additional shares of preferred stock. The preferred stock carries no conversion rights and is not subject to redemption or to any sinking fund provisions. The Company is authorized to issue 5,000,000 shares of preferred stock. Common stock - ------------ Holders of the common stock do not have preemptive rights to purchase additional shares of common stock. The common stock carries no conversion rights and is not subject to redemption or to any sinking fund provisions. All shares of common stock are entitled to share equally in dividends from sources legally available thereof when and if declared by the Board of Directors and, upon liquidation or dissolution of the company, whether voluntary or involuntary, to share equally in the assets of the Company available for distribution to stockholders. The Company is authorized to issue 50,000,000 shares of common stock. On June 14, 2001 the Company redeemed 10,342,085 shares of its common stock for $2,068. On July 2, 2001, the Company approved a 5 for 1 forward stock split of its common stock. Accordingly, all share and per share amounts have been retroactively restated in the financial statements to reflect this split. F-11 During the year ended December 31, 2000, the Company issued 3,987,345 shares of common stock for services and 10,500,000 shares for cash. During the period ended December 31, 1999, the Company issued 4,500,000 shares of common stock for services. Warrants - -------- During 2001, the Company issued 610,560 warrants in connection with the short term promissory notes executed from August 23, 2001 through December 31, 2001. The warrants were issued for the purchase of common stock at $3.00 per share. These warrants are exercisable at the option of the warrant holder and expire three years from the date of issuance. The following represents a summary of the warrants outstanding as of December 31, 2001, 2000 and 1999. Weighted Average Shares Exercise Price ---------- ---------------- Outstanding, March 31, 1999 -- $ -- Granted -- -- Expired/forfeited -- -- ---------- ------------ Outstanding, December 31, 1999 -- $ -- ========== ============ Outstanding, January 1, 2000 -- $ -- Granted -- -- Expired/forfeited -- -- ---------- ------------ Outstanding, December 31, 2000 -- $ -- ========== ============ Granted 610,560 $ 3.00 Expired/forfeited -- -- ---------- ------------ Outstanding, December 31, 2001 610,560 $ 3.00 ========== ============ Weighted average fair value of warrants granted $ 3.00 All of the warrants outstanding at December 31, 2001 had an exercise price and a weighted average price of $3.00 and a weighted average remaining contractual life of 2.83 years. F-12 NOTE 8 - COMMITMENTS AND CONTINGENCIES The Company has entered into an agreement with Essential Reality, LLC ("Essential Reality") dated August 23, 2001 where as the Company and Essential Reality have agreed to a business combination. The business combination is contingent on the consummation of the Company's private placement of up to 1,730,769 shares of common stock and up to an additional 288,462 shares of common stock at a selling price of $3.00 per share. Upon the closing of the agreement, the Company shall issue 11,000,000 shares of common stock in exchange for one hundred percent (100)% interest in Essential Reality. The Company currently holds a note receivable due from Essential Reality. This note bears an interest rate of 8.5% and will mature on the earliest of (i) January 31, 2004, (ii) the closing of the transactions contemplated by the agreement dated August 23, 2001 or (iii) the sale or exchange of all or substantially all of the membership interests of Essential Reality. However, none of the events have occurred. The Company has not generated any revenues which could have a significant adverse affect on the Company's ability to repay its debt. In addition, $650,000 of the notes payable which were due on March 1, 2002 have not been paid. The Company is currently negotiating with these note holders to extend the due date of these notes. Certain of the long-term note holders have executed letters to the Company indicating that they could fund the Company to repay the short term notes if the need arises. NOTE 9 - SUBSEQUENT EVENTS The Company executed notes payable agreements during January 2002 through February 2002. These notes total $882,600 which bear an interest rate of 8.50% with maturity dates from January 15, 2002 through January 31, 2003. The Company issued warrants to acquire 353,040 shares of JPAL, Inc.'s common stock at a purchase price of $3.00 per share in connection with the issuance of these notes payable. A note of $100,000 was due on January 15, 2002 and other notes totaling $225,000 were due on March 1, 2002. As of April 11, 2002, these notes and accrued interest have not been repaid. The note holders have not called the notes. In the event that a note is called, other note holders have agreed to fund the Company to satisfy its debt. F-13 JPAL, INC. CONDENSED BALANCE SHEET MARCH 31, 2002 (unaudited) ASSETS Current assets Cash and cash equivalents $ 4,885 Prepaid expenses 3,187 ----------- Total current assets 8,072 Property and equipment, net of accumulated depreciation of $1,722 1,331 Accrued interest on notes receivable 59,580 Notes receivable - Essential Reality, LLC 2,525,000 ----------- Total assets $ 2,593,983 =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Notes payable, net of deferred interest $ 860,835 Accrued interest payable 71,089 Accounts payable 13,771 ----------- Total current liabilities 945,695 Long-term liabilities Notes payable 1,634,000 ----------- Total liabilities 2,579,695 ----------- Commitments and contingencies Stockholders' equity Preferred stock, $.001 par value 5,000,000 shares authorized No shares issued or outstanding -- Common stock, $.001 par value; 50,000,000 shares authorized, 8,645,260 shares issued and outstanding at March 31, 2002 and December 31, 2001 1,729 Additional paid-in capital 1,434,635 Accumulated deficit (1,422,076) ----------- Total stockholders' equity 14,288 ----------- Total liabilities and stockholders' equity $ 2,593,983 =========== See the accompanying notes to these unaudited condensed financial statements F-14 JPAL, INC. CONDENSED STATEMENTS OF OPERATIONS (unaudited) Three Months Ended March 31, ---------------------------- 2002 2001 ----------- -------------- REVENUES Rental commissions $ -- $ 399 ------------ ------------- SELLING, GENERAL AND ADMINISTRATIVE EXPENSE 26,525 14,291 ------------ ------------- OTHER (INCOME) EXPENSE Interest income (39,965) -- Interest expense 747,475 -- Depreciation 146 146 ------------ ------------- 707,656 146 ------------ ------------- LOSS BEFORE PROVISION FOR INCOME TAXES (734,181) (14,038) PROVISION FOR INCOME TAXES -- -- ------------ ------------- NET LOSS $ (734,181) $ (14,038) ============ ============= BASIC LOSS PER SHARE $ (0.08) $ (0.00) ============ ============= DILUTIVE LOSS PER SHARE $ (0.08) $ (0.00) ============ ============= BASIC AND DILUTIVE WEIGHTED AVERAGE OF COMMON SHARES OUTSTANDING 8,645,260 18,987,345 ============ ============= See the accompanying notes to these unaudited condensed financial statements F-15 JPAL, INC. CONDENSED STATEMENTS OF CASH FLOWS (unaudited) Three Months Ended March 31, ---------------------------- 2002 2001 ------------- ------------ CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (734,181) $ (14,038) Adjustments to reconcile net loss to net cash used in operating activities Depreciation 146 146 Goods and services and rent provided in exchange for additional paid-in capital 1,200 9,605 Deferred interest 702,210 -- Changes in assets and liabilities Increase in accrued interest on notes receivable (39,965) -- Increase in prepaid expenses (3,066) (324) Increase in accounts payable 8,906 4,379 Increase in accrued expenses 45,265 -- ----------- ----------- Net cash used in operating activities (19,485) (232) ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Issuance of notes receivable (1,025,000) -- ----------- ----------- Net cash used in investing activities (1,025,000) -- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of notes payable 1,047,600 -- ----------- ----------- Net cash provided by financing activities 1,047,600 -- ----------- ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 3,115 (232) CASH AND CASH EQUIVALENTS, beginning of period 1,770 413 ----------- ----------- CASH AND CASH EQUIVALENTS, end of period $ 4,885 $ 181 =========== =========== See the accompanying notes to these unaudited condensed financial statements F-16 JPAL, INC. CONDENSED STATEMENTS OF CASH FLOWS (CONTINUED) (unaudited) SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Three Months Ended March 31, ---------------------------- 2002 2001 ----------- ----------- Cash paid during the period for interest $ -- $ -- Cash paid during the period for income taxes $ -- $ -- SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS During the period ended March 31, 2002, the Company recorded rent of $1,200 and additional paid-in capital of $1,200 for rent provided by a stockholder. During the period ended March 31, 2002, the Company had $1,047,600 of proceeds from notes payable, of which $538,887 has been assigned to the value of the warrants and has been recorded as additional paid-in capital. During the period ended March 31, 2001, the Company recorded rent and computer services of $750 and $3,000, respectively, and additional paid-in capital of $3,750 for rent and services provided by a stockholder. During the period ended March 31, 2001, the Company recorded legal and accounting expense of $2,705 and $3,150, respectively, and additional paid-in capital of $5,855 for services paid directly by a stockholder. See the accompanying notes to these unaudited condensed financial statements. F-17 JPAL, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS MARCH 31, 2002 AND 2001 (unaudited) NOTE 1 - BASIS OF PRESENTATION The accompanying unaudited condensed financial statements reflect the results of operations for JPAL, Inc. and have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-QSB and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments consisting of normal recurring accruals and adjustments considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2002 are not necessarily indicative of the results that may be expected for the year ended December 31, 2002. For further information, refer to the financial statements and footnotes thereto included in JPAL, Inc.'s Annual Report on Form 10-KSB/A for the year ended December 31, 2001 filed with the Securities and Exchange Commission (SEC) on May 8, 2002. JPAL, Inc. (the "Company") was incorporated in the state of Nevada on March 31, 1999 to operate as an Internet based provider of vacation rental properties and services with an elected December 31st fiscal year end. A majority of the services are to properties located in Nevada. During the year ended December 31, 2001, the Company abandoned the development of their Internet services to provide vacation rental properties and services. The Company is currently entered into a contribution agreement with another company that may result in a merger with that company. The Company has experienced net losses since its inception and had an accumulated deficit of approximately $1,422,000 at March 31, 2002. Such losses are attributable to cash losses resulting from costs incurred in the development of the Company's services and infrastructure. The Company expects operating losses to continue for the foreseeable future as it continues to seek alternative business opportunities. NOTE 2 - INCOME TAXES The Company accounts for income taxes under Statement of Financial Accounting Standards No. 109 ("SFAS 109"). This statement mandates the liability method of accounting for deferred income taxes and permits the recognition of deferred tax assets subject to an ongoing assessment of realizability. The components of the Company's income tax provision consist of: Three Months Ended March 31, ----------------------------- 2002 2001 ------------ ------------- Federal taxes (deferred) net operating loss benefit $ (111,500) $ (2,200) Change in valuation account 111,500 2,200 -------------- ------------- $ -- $ -- ============== ============= F-18 Deferred income taxes are provided for timing differences in the recognition of certain income and expense items for tax and financial statement purposes. The tax effect of the temporary differences giving rise to the Company's deferred tax assets and liabilities as of March 31, 2002 are as follows: Deferred income taxes Net operating loss benefit $ 214,600 Valuation allowance (214,600) -------------- $ -- ============== The Company has federal net operating loss carryforwards of approximately $688,000 that will expire through 2021. The Company's tax reporting year end is December 31st. If the Company has a net operating loss carryforward from operations for the year ended December 31, 2002, it will expire in 2022. NOTE 3 - RELATED PARTY TRANSACTIONS The Company is currently utilizing office space provided by the Company's president (a stockholder). During the period ended March 31, 2002 and 2001, the Company has recorded rent expense of $1,200 and $750, respectively, which represents the Company's pro rata share of the office space being provided by the Company's president. During the period ended March 31, 2001, the Company has also recorded computer consulting services of $3,000 which were provided by the Company's president. The services were valued using hourly rates at estimated fair market value of similar services. During the period ended March 31, 2001, the Company has recorded legal and accounting fees of $2,705 and $3,150, respectively. These services were paid for by the Company's president. The president has waived reimbursement of the allocated rent, computer consulting services, legal and accounting services provided and has considered them as additional paid-in capital. NOTE 4 - NOTES PAYABLE The Company has several unsecured notes payable with interest rates ranging from 8.00% to 8.50%. Notes totaling $550,000 which have a weighted average interest rate of 8.50 % will mature on the earliest of (i) January 15, 2002 or (ii) the sale or exchange of all or substantially all of the outstanding shares of common stock. Notes totaling $425,000 which have a weighted average interest rate of 8.50 % will mature on the earliest of (i) March 1, 2002 or (ii) the sale or exchange of all or substantially all of the outstanding shares of common stock. As of May 15, 2002, these notes and accrued interest have not been repaid. The note holders have not called the notes. In the event that a note is called, other note holders have agreed to fund the Company to satisfy its debt. Notes totaling $1,634,000 which have a weighted average interest rate of 8.49% were originally scheduled to mature in 2002 but have subsequently been revised to mature on the earliest of (i) January 31, 2003 or (ii) the sale or exchange of all or substantially all of the outstanding shares of common stock. The total amount of notes payable was $2,609,000 at March 31, 2002. Interest expense on these notes during the three months ended March 31, 2002 was $45,265. For the three months ended March 31, 2002, the Company issued warrants valued at $538,887 to acquire 419,040 shares of JPAL, Inc.'s common stock at a purchase price of $3.00 per share in connection with the issuance of these notes payable. The value of such warrants has been reflected as a discount to the related notes payable, and is being amortized to interest expense over the original terms of the notes. Deferred interest of $702,210 has been amortized as interest expense during the three months ended March 31, 2002. The remaining balance of deferred interest of $114,165 has been netted with the outstanding principal balance of the current notes payable. F-19 $2,525,000 of the proceeds from these notes has been advanced to Essential Reality, LLC with which the Company is in the process of negotiating a merger agreement (Note 5). The note receivable is unsecured and bears an interest rate of 8.50%, however, interest did not begin to accrue until January 31, 2002. Imputed interest was $39,965 for the three months ended March 31, 2002 which is included in other income. The following is a schedule of maturity dates of these notes receivable: Principal Maturity Date --------- ------------- $ 1,950,000 January 1, 2004 200,000 February 12, 2004 225,000 February 28, 2004 150,000 March 20, 2004 $ 2,525,000 Principal together with accrued interest is due on the earliest of (i) the above schedule of maturity dates, (ii) the closing of the transactions contemplated by the agreement dated August 23, 2001 (Note 5) or (iii) the sale or exchange of all or substantially all of the membership interests of Essential Reality. NOTE 5 - COMMITMENTS AND CONTINGENCIES The Company has entered into an agreement with Essential Reality, LLC ("Essential Reality") dated August 23, 2001 whereas the Company and Essential Reality have agreed to a business combination. This agreement was amended on April 24, 2002. The following is a summary of the proposed business combination. This summary is qualified by the more detailed description appearing in the Company's Preliminary Proxy Statement on Form PRE 14A filed with Securities Exchange Commission on May 9, 2002. Upon closing of the agreement, (a) the Company intends to issue up to 17,280,000 shares of our common stock in exchange for all of the outstanding membership interests of Essential Reality, including 9,600,000 shares to be issued to Essential Reality's current members. As a result of this transaction, the Company will acquire and assume the business of Essential Reality. (b) Essential Reality will consummate a private placement of its membership interests prior to the exchange transaction, which will be contributed to the Company in exchange for shares of the Company's common stock. Essential Reality may sell up to 7,680,000 of its membership interests in its private placement. (c) Upon completion of the exchange transaction, the Company's business will be the business currently being conducted by Essential Reality. (d) The Company's shareholders will not receive any cash, stock or other property in connection with, or as a result of, the exchange transaction. (e) Shareholder approval of the proposed business combination will require the affirmative vote of a majority of the Company's outstanding shares of common stock. The Company's controlling Shareholder has already informed the Company that he will be voting in favor of the proposal. The number of votes held by the controlling Shareholder is sufficient to satisfy the Shareholder vote requirement for the proposed business combination. Therefore, no additional votes will be needed to approve the proposed business combination. The Company currently holds several notes receivable due from Essential Reality. These notes bear an interest rate of 8.50% and will mature on the earliest of (i) the schedule of maturity dates in Note 4, (ii) the closing of the transactions contemplated by the agreement dated August 23, 2001 or (iii) the sale or exchange of all or substantially all of the membership interests of Essential Reality. However, none of the events have occurred. The Company has not generated any revenues which could have a significant adverse affect on the Company's ability to repay its debt. In addition, $550,000 and $425,000 of the notes payable which were due on January 15, 2002 and March 1, 2002, respectively, have not been paid. The Company is currently negotiating with these note holders to extend the due date of these notes. Certain of the long-term note holders have executed letters to the Company indicating that they could fund the Company to repay the short term notes if the need arises. F-20 ESSENTIAL REALITY, INC. (A Development Stage Company) Unaudited Pro Forma Financial Statements March 31, 2002 On June 20, 2002, Essential Reality, Inc., a Nevada corporation formerly known as JPAL, Inc. (the "Company"), consummated a business combination (the "Transaction") with Essential Reality, LLC, a Delaware limited liability company ("ER LLC"). Pursuant to the terms of the Transaction, all of the members of ER LLC contributed their membership interests in ER LLC to the Company in exchange for an aggregate of 16,874,784 shares of the Company's common stock (the "Common Stock"). Such shares consisted of 9,600,000 shares of Common Stock issued to the original members of ER LLC (the "Contribution Shares") and 7,274,784 shares of Common Stock issued to new investors who purchased membership interests in ER LLC in a recently completed private placement (the "Private Placement Shares"). Contemporaneous with the Transaction, the Company cancelled 7,564,326 common shares of the existing JPAL Inc. shareholders leaving the existing JPAL Inc. shareholders with 1,080,934 shares of Common Stock. As a result of the Transaction the Company has 17,955,718 issued and outstanding shares of Common Stock. Following the Transaction, ER LLC, then a wholly-owned subsidiary of the Company, was merged with and into the Company. In connection with the Transaction, (i) holders of certain bridge notes issued by the Company received, as additional consideration for the loans, two-year warrants to purchase up to 840,000 shares of Common Stock and 15,000 shares of Common Stock (collectively, the "Bridge Warrant Shares") at a purchase price of $1.90 and $1.30 per share, respectively, (ii) holders of certain bridge notes issued by the Company exchanged them for convertible promissory notes of the Company, which are convertible for a period of six months at a conversion price of $1.90 into an aggregate of 263,158 shares of Common Stock (the "Convertible Note Shares"), and (iii) the Company issued warrants to purchase up to an aggregate of 331,211 shares of Common Stock (the "Additional Warrant Shares") at a purchase price of $1.30 per share. Immediately prior to the Transaction, ER LLC completed a private placement of 7,274,784 membership units for gross proceeds of $7,577,900 (the "Offering"). Included in the gross proceeds was $500,000 of bridge notes that were converted to 480,000 membership units of the Company. Cash fees and expenses of the Offering were approximately $600,000. As a result of the Transaction, inter-company balances in the amount of approximately $2,600,000 consisting of bridge loans and accrued interest thereon were eliminated. The Transaction is expected to be accounted for as a reverse acquisition in which ER LLC is the accounting acquirer and JPAL Inc. is the legal acquirer. The management of ER LLC is expected to remain the management of the merged entity. Since the Transaction is expected to be accounted for as a reverse acquisition and not a business combination, no goodwill is expected to be recorded in connection with the Transaction and the costs incurred in connection with the Transaction are expected to be accounted for as a reduction of additional paid-in capital. The following unaudited pro forma financial statements give effect to the Transaction and the Offering. The unaudited pro forma statement of operations for the year ended December 31, 2001 and the three months ended March 31, 2002, gives effect to the Transaction and Offering as if these transactions had occurred on January 1, 2001. The unaudited pro forma balance sheet as of March 31, 2002 gives effect to the Transaction and Offering as if these transactions had occurred on March 31, 2002. F-21 The unaudited pro forma financial statements should be read in conjunction with the historical financial statements and notes thereto incorporated herein by reference of JPAL, Inc. and ER LLC. The pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of the future financial position or future results of operations of the Company after the Transaction and the Offering. F-22 JPAL, INC. (A Development Stage Entity) UNAUDITED PRO FORMA BALANCE SHEET MARCH 31, 2002 - ------------------------------------------------------------------------------------------------------------------------------------ Essential JPAL, Inc. Reality, LLC Pro Forma Pro Forma After March 31, 2002 March 31, 2002 Adjustments Completion of Offering Offering Transaction and Transaction ASSETS CURRENT ASSETS: Cash and cash equivalents $ 4,885 $ 277,148 $ 7,077,900 $ -- (1) $ 6,759,933 (600,000) -- (2) Deferred financing costs -- 262,326 (262,326) -- (2) -- Prepaid expenses and deposits 3,187 10,225 -- -- 13,412 ----------- ----------- ----------- ----------- ------------ Total current assets 8,072 549,699 6,215,574 -- 6,773,345 NOTE RECEIVABLE - ESSENTIAL REALITY 2,525,000 -- -- (2,525,000)(5) -- ACCRUED INTEREST ON NOTE RECEIVABLE 59,580 -- -- (59,580)(5) -- DOMAIN NAMES - Net -- 6,750 -- -- 6,750 FIXED ASSETS - Net 1,331 17,986 -- -- 19,317 OTHER ASSETS -- 80,550 -- -- 80,550 DEFERRED INTEREST EXPENSE - BRIDGE LOANS -- 352,162 (38,732) -- (1) 313,430 ----------- ----------- ----------- ----------- ------------ TOTAL ASSETS $ 2,593,983 $ 1,007,147 $ 6,176,842 $(2,584,580) $ 7,193,392 =========== =========== =========== =========== ============ See notes to unaudited pro forma financial statements. F-23 JPAL, INC. (A Development Stage Entity) UNAUDITED PRO FORMA BALANCE SHEET MARCH 31, 2002 (CONTINUED) - ------------------------------------------------------------------------------------------------------------------------------------ Essential JPAL, Inc. Reality, LLC Pro Forma Pro Forma After March 31, 2002 March 31, 2002 Adjustments Completion of Offering Offering Transaction and Transaction LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Accounts payable $ 13,771 $ 687,486 $ -- $ -- $ 701,257 Accounts payable - related parties -- 143,144 -- -- 143,144 Accrued interest - bridge loans -- 411,022 (38,732) -- (1) 372,290 Accrued compensation -- 270,303 -- -- 270,303 Bridge loans - JPAL, Inc. -- 2,525,000 -- (2,525,000)(5) -- Notes payable (see Supplementary Schedule) 2,494,835 500,000 (500,000) (1) 1,568,280 -- 114,165 (6a) -- (872,520)(6b) -- (168,200)(7) Accrued interest payable 71,089 -- -- (59,580)(5) 11,509 Advances from LCG Capital Group, LLC -- 76,617 -- 76,617 Advances from affiliated companies -- 25,915 -- -- 25,915 ------------- ----------- ------------ ------------ ------------ Total current liabilities 2,579,695 4,639,487 (538,732) (3,511,135) 3,169,315 ------------- ------------ ------------ ------------ ------------ STOCKHOLDERS' EQUITY (DEFICIT): Common stock 1,729 -- -- 16,875 (4) 17,956 -- (648) (8) Additional paid-in capital 1,434,635 -- -- (3) 11,982,628 -- 9,198,699 (4) -- (114,165) (6a) -- 1,160,179 (6b) -- 302,632 (7) -- 648 (8) Members' capital -- 2,500,000 7,577,900 (1) -- (862,326) (2) -- (9,215,574) (4) Accumulated deficit (1,422,076) (6,132,340) -- (287,659) (6b) (7,976,507) -- -- -- (134,432) (7) -- ------------- ------------ ------------ ------------ ---------- Total stockholders' equity (deficit) 14,288 (3,632,340) 6,715,574 926,555 4,024,077 ------------- ------------ ------------ ------------ --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 2,593,983 $ 1,007,147 $ 6,176,842 $ (2,584,580) $7,193,392 ============= ============ ============ ============ ========== See notes to unaudited pro forma financial statements. F-24 JPAL, INC. (A Development Stage Entity) UNAUDITED PRO FORMA STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2001 JPAL, Inc. Essential Reality, LLC Pro Forma Pro Forma After Year Ended Year Ended Adjustments Completion of Offering December 31, 2001 December 31, 2001 Transaction and Transaction OPERATING EXPENSES: Product development $ -- $ 1,579,129 $ -- $ 1,579,129 Marketing -- 716,674 -- 716,674 General and administrative 85,842 823,791 -- 909,633 Depreciation and amortization 597 11,850 -- 12,447 ------------ ------------ ------------ ------------ Total operating expenses 86,439 3,131,444 -- 3,217,883 ------------ ------------ ------------ ------------ LOSS FROM OPERATIONS (86,439) (3,131,444) -- (3,217,883) INTEREST INCOME 19,615 20,465 -- 40,080 INTEREST EXPENSE (586,612) (20,505) (76,169)(6b) (760,377) (77,091)(7) OTHER INCOME 1,039 -- -- 1,039 ------------ ------------ ------------ ------------ NET LOSS $ (652,397) $ (3,131,484) $ (153,260) $ (3,937,141) ============ ============ ============ ============ WEIGHTED AVERAGE COMMON SHARES OUTSTANDING - BASIC AND DILUTED 8,645,260 16,874,784 17,955,718 (7,564,326)(8) NET LOSS PER SHARE $ (0.08) $ (0.22) ============ ============ See notes to unaudited pro forma financial statements. F-25 JPAL, INC. (A Development Stage Entity) UNAUDITED PRO FORMA STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2002 JPAL, Inc. Essential Reality, LLC Pro Forma Pro Forma After Three Months Ended Three Months Ended Adjustments Completion of Offering March 31, 2002 March 31, 2002 Transaction and Transaction OPERATING EXPENSES: Product development $ -- $ 480,822 $ -- $ 480,822 Marketing -- 287,588 -- 287,588 General and administrative 26,525 539,688 -- 566,213 Depreciation and amortization 146 3,415 -- 3,561 ------------ ------------ ------------ ------------ Total operating expenses 26,671 1,311,513 -- 1,338,184 ------------ ------------ ------------ ------------ LOSS FROM OPERATIONS (26,671) (1,311,513) -- (1,338,184) INTEREST INCOME 39,965 -- -- 39,965 INTEREST EXPENSE (747,475) (48,585) (287,659)(6b) (1,218,151) (134,432)(7) OTHER INCOME -- -- -- -- ------------ ------------ ------------ ------------ NET LOSS $ (734,181) $ (1,360,098) $ (422,091) $ (2,516,370) ============ ============ ============ ============ WEIGHTED AVERAGE COMMON SHARES OUTSTANDING - BASIC AND DILUTED 8,645,260 16,874,784 17,955,718 (7,564,326)(8) NET LOSS PER SHARE $ (0.08) $ (0.14) ============ ============ See notes to unaudited pro forma financial statements. F-26 JPAL, INC. (A Development Stage Entity) PRO FORMA SUPPLEMENTARY SCHEDULE OF NOTES PAYABLE MARCH 31, 2002 Face Value of Notes Deferred Interest Net Balance per JPAL, Inc. $ 2,609,000 114,165 $ 2,494,835 Balance per ER LLC of third party bridge loans 500,000 - 500,000 Pro forma adjustment #1 (500,000) - (500,000) Pro forma adjustment #6a - (114,165) 114,165 Pro forma adjustment #6b - 872,520 (872,520) Pro forma adjustment #7 - 168,200 (168,200) ----------- ------------ ----------- Pro Forma After Completion of Offering and Exchange $ 2,609,000 $ 1,040,720 $ 1,568,280 ============ ============ =========== See notes to unaudited pro forma financial statements. F-27 JPAL, INC. NOTES TO UNAUDITED PRO FORMA FINANCIAL STATEMENTS MARCH 31, 2002 - -------------------------------------------------------------------------------- I. ASSUMPTIONS a. The pro forma financial statements reflect the Transaction whereby all of the members of ER LLC contributed their membership interests in ER LLC to the Company in exchange for an aggregate of 16,874,784 shares of the Company's common stock. b. The pro forma financial statements reflect the Offering whereby 7,274,784 membership units of ER LLC were issued for gross proceeds of $7,577,900. II. PRO FORMA ADJUSTMENTS 1) Reflects the issuance of 7,274,784 membership units of ER LLC for gross proceeds of $7,577,900, which includes the conversion of $500,000 of notes payable and bridge loans for 480,000 membership units of ER LLC and the reversal of bridge loan related deferred interest of $38,732. 2) Reflects the payment of $600,000 of estimated closing costs and recognition of deferred closing costs of $262,326. 3) Reflects the issuance of 331,211 Additional Warrant Shares having an imputed value of approximately $1,900,000. The value of these warrants was computed using the Black-Scholes method and has no net-effect on member's capital. 4) Reflects the exchange of the membership interest in ER LLC of $9,215,574 for 16,874,784 shares of common stock of JPAL. The Transaction is expected to be accounted for as a reverse acquisition in which ER LLC is the accounting acquirer and JPAL Inc. is the legal acquirer. The management of ER LLC is expected to remain the management of the merged entity. Since the Transaction is expected to be accounted for as a reverse acquisition and not a business combination, no goodwill is expected to be recorded in connection with the Transaction and the costs incurred in connection with the Transaction are expected to be accounted for as a reduction of additional paid-in capital. 5) Reflects the elimination of inter-company debt upon consolidation of the accounts of JPAL Inc. and ER LLC. 6) a) Reflects the cancellation of 610,560 warrants to purchase common shares of JPAL, Inc. at $3.00 per share resulting in the reduction of deferred interest of $114,165 as of March 31, 2002, and b) the issuance of Bridge Warrants of 760,000 as of March 31, 2002. The values of the Bridge Warrants of $1,160,179 as of March 31, 2002 was computed using the Black-Scholes and relative fair value methods, of which, $76,169 and $287,659 for the year ended December 31, 2001 and the three months ended March 31, 2002, respectively, have been charged to earnings as interest expense and $872,520 as of March 31, 2002 has been netted against notes payable. The value of the Bridge Warrants was computed using $3.05 as the market price, $1.30 to $1.90 as the exercise prices, 2 year expiration, volatility of 80% and a risk free rate of 5%. F-28 7) Reflects the beneficial conversion feature of the Convertible Note at their inception in the amount of $302,632 of which $77,091 and $134,432 for the year ended December 31, 2001 and the three months ended March 31, 2002, respectively, have been charged to earnings as interest expense and $168,200 as of March 31, 2002 has been netted against notes payable. 8) Reflects the cancellation of 7,564,326 common shares of JPAL Inc. held by current JPAL Inc. stockholders. F-29 INDEPENDENT AUDITORS' REPORT To the Members and Board of Managers of Essential Reality, LLC: We have audited the accompanying balance sheets of Essential Reality, LLC (a development stage entity) (the "Company") as of December 31, 2001 and 2000, and the related statements of operations, members' deficit, and cash flows for the years ended December 31, 2001 and 2000 and for the period from June 1, 1999 (date of commencement) to December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2001 and 2000, and the results of its operations and its cash flows for the years then ended and for the period from June 1, 1999 (date of commencement) to December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. The Company is a development stage enterprise engaged in the development, manufacture and marketing of a gloved shaped device that controls the movement of objects on a computer screen. As discussed in Note 1 to the financial statements, the Company has experienced cumulative net losses of $4,772,242 and cumulative negative operating cash flows of $4,057,437, which raise substantial doubt about its ability to continue as a going concern. Management's plans concerning these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of these uncertainties. Deloitte & Touche, LLP January 21, 2002 (June 20, 2002 as to Note 8) F-30 ESSENTIAL REALITY, LLC (A Development Stage Entity) BALANCE SHEETS DECEMBER 31, 2001 AND 2000 AND MARCH 31, 2002 (UNAUDITED) - ---------------------------------------------------------------------------------------------- December 31, March 31, 2001 2000 2002 (Unaudited) ASSETS CURRENT ASSETS: Cash and cash equivalents (Note 2) $ 13,863 $ 231,905 $ 277,148 Interest receivable -- 48,716 -- Deferred financing costs 217,755 -- 262,326 Prepaid expenses and deposits 34,337 6,820 10,225 ----------- ----------- ----------- Total current assets 265,955 287,441 549,699 DOMAIN NAMES - Net (Note 3) 9,000 -- 6,750 FIXED ASSETS - Net (Note 3) 10,099 -- 17,986 OTHER ASSETS 80,550 22,500 80,550 DEFERRED INTEREST EXPENSE - BRIDGE LOANS 232,389 -- 352,162 ----------- ----------- ----------- TOTAL ASSETS $ 597,993 $ 309,941 $ 1,007,147 =========== =========== =========== LIABILITIES AND MEMBERS' DEFICIT CURRENT LIABILITIES: Accounts payable $ 676,133 $ 75,238 687,486 Accounts payable - related parties 84,000 -- 143,144 Accrued interest expense - bridge loans (Note 4) 250,750 -- 411,022 Accrued compensation - related party (Note 7) 257,103 221,267 270,303 Bridge loans (Note 4) 1,500,000 -- 3,025,000 Advances from LCG Capital Group, LLC 76,617 -- 76,617 Advances from affiliated companies 25,632 19,647 25,915 ----------- ----------- ----------- Total current liabilities 2,870,235 316,152 4,639,487 ----------- ----------- ----------- COMMITMENTS AND CONTINGENCIES MEMBERS' DEFICIT: Members' capital 2,500,000 2,500,000 2,500,000 Note receivable for members' capital -- (865,453) -- Deficit accumulated during development stage (4,772,242) (1,640,758) (6,132,340) ----------- ----------- ----------- Total members' deficit (2,272,242) (6,211) (3,632,340) ----------- ----------- ----------- TOTAL LIABILITIES AND MEMBERS' DEFICIT $ 597,993 $ 309,941 $ 1,007,147 =========== =========== =========== See notes to financial statements. F-31 STATEMENTS OF OPERATIONS CUMULATIVE PERIOD FROM JUNE 1, 1999 (DATE OF COMMENCEMENT) TO MARCH 31, 2002 AND YEARS ENDED DECEMBER 31, 2001 AND 2000, AND THREE MONTHS ENDED MARCH 31, 2002 AND 2001 - -------------------------------------------------------------------------------------------------------------------------- Cumulative Cumulative Period from Period from June 1, 1999 (Date June 1, 1999 (Date of Commencement) of Commencement) Year Ended Three Months Ended to March 31, to December 31, December 31, March 31, 2002 2001 2001 2000 2002 2001 (Unaudited) (Unaudited) (Unaudited) OPERATING EXPENSES: Product development $ 2,961,366 2,480,544 $ 1,579,129 $ 679,891 $ 480,822 $ 133,357 Marketing 1,354,113 1,066,525 716,674 349,851 287,588 83,261 General and administrative 1,855,689 1,316,001 823,791 491,930 539,688 97,506 Depreciation and amortization 15,265 11,850 11,850 -- 3,415 165 ----------- ----------- ----------- ----------- ----------- ----------- Total operating expenses 6,186,433 4,874,920 3,131,444 1,521,672 1,311,513 314,289 ----------- ----------- ----------- ----------- ----------- ----------- LOSS FROM OPERATIONS (6,186,433) (4,874,920) (3,131,444) (1,521,672) (1,311,513) (314,289) INTEREST INCOME 125,117 125,117 20,465 104,652 -- 12,878 INTEREST EXPENSE (71,024) (22,439) (20,505) (1,934) (48,585) (513) ----------- ----------- ----------- ----------- NET LOSS $(6,132,340) $(4,772,242) $(3,131,484) $(1,418,954) $(1,360,098) $ (301,924) =========== =========== =========== =========== =========== =========== See notes to financial statements. F-32 ESSENTIAL REALITY, LLC (A Development Stage Entity) STATEMENTS OF MEMBERS' EQUITY (DEFICIT) PERIOD FROM JUNE 1, 1999 (DATE OF COMMENCEMENT) TO DECEMBER 31, 1999, YEARS ENDED DECEMBER 31, 2001 AND 2000 AND THREE MONTHS ENDED MARCH 31, 2002 - ------------------------------------------------------------------------------------------------------------------------------------ Note Deficit Receivable Accumulated Members' For Members' During Capital Capital Development Stage Total BALANCE JUNE 1, 1999 $ -- $ -- $ -- $ -- Issuance of members' capital 2,500,000 (2,000,000) -- 500,000 Net loss -- -- (221,804) (221,804) ---------- ------------- ------------ ------------- BALANCE, DECEMBER 31, 1999 2,500,000 (2,000,000) (221,804) 278,196 Collection of note receivable -- 1,134,547 -- 1,134,547 Net loss -- -- (1,418,954) (1,418,954) ---------- ------------- ------------ ------------- BALANCE, DECEMBER 31, 2000 2,500,000 (865,453) (1,640,758) (6,211) Collection of note receivable -- 865,453 -- 865,453 Net loss -- -- (3,131,484) (3,131,484) ---------- ------------- ------------ ------------- BALANCE, DECEMBER 31, 2001 2,500,000 -- (4,772,242) (2,272,242) Net loss (unaudited) -- -- (1,360,098) (1,360,098) ----------- ------------ ------------- ------------- BALANCE, MARCH 31, 2002 (UNAUDITED) $ 2,500,000 $ -- $ (6,132,340) $ (3,632,340) =========== ============ ============= ============= See notes to financial statements. F-33 ESSENTIAL REALITY, LLC (A Development Stage Entity) STATEMENTS OF CASH FLOWS CUMULATIVE PERIOD FROM JUNE 1, 1999 (DATE OF COMMENCEMENT) TO MARCH 31, 2002 AND YEARS ENDED DECEMBER 31, 2001 AND 2000, AND THREE MONTHS ENDED MARCH 31, 2002 AND 2001 - ----------------------------------------------------------------------------------------------------------------------------------- Cumulative Cumulative Period from Period from June 1, 1999 (Date June 1, 1999 (Date of Commencement) of Commencement) Year Ended Three Months Ended to March 31, to December 31, December 31, March 31, 2002 2001 2001 2000 2002 2001 (Unaudited) (Unaudited) (Unaudited) CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(6,132,340) $(4,772,242) $(3,131,484) $(1,418,954) $(1,360,098) $(301,924) Depreciation and amortization 15,265 11,850 11,850 -- 3,415 165 Amortization of deferred interest 58,860 18,361 18,361 -- 40,499 -- Changes in assets and liabilities: -- -- Deferred financing costs (262,326) (217,755) (217,755) -- (44,571) -- Prepaid expenses, deposits and other assets (90,775) (114,887) (85,567) (29,320) 24,112 (3,000) Interest receivable -- -- 48,716 (48,716) -- (12,877) Accounts payable 687,486 676,133 600,895 62,820 11,353 (50,153) Accounts payable - related parties 143,144 84,000 84,000 -- 59,144 -- Accrued compensation 270,303 257,103 35,836 221,267 13,200 3,100 ----------- ----------- ----------- ----------- ----------- ----------- Net cash used in operating activities (5,310,383) (4,057,437) (2,635,148) (1,212,903) (1,252,946) (364,689) ----------- ----------- ----------- ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Payments for purchase of domain names (18,000) (18,000) (18,000) -- -- -- Payments for purchase of fixed assets (22,001) (12,949) (12,949) -- (9,052) (2,000) ----------- ----------- ----------- ----------- ----------- ----------- Net cash used in investing activities (40,001) (30,949) (30,949) -- (9,052) (2,000) ----------- ----------- ----------- ----------- ----------- ----------- See notes to financial statements. F-34 ESSENTIAL REALITY, LLC (A Development Stage Entity) STATEMENTS OF CASH FLOWS (CONTINUED) CUMULATIVE PERIOD FROM JUNE 1, 1999 (DATE OF COMMENCEMENT) TO MARCH 31, 2002 AND YEARS ENDED DECEMBER 31, 2001 AND 2000, AND THREE MONTHS ENDED MARCH 31, 2002 AND 2001 - ----------------------------------------------------------------------------------------------------------------------------------- Cumulative Cumulative Period from Period from June 1, 1999 (Date June 1, 1999 (Date of Commencement) of Commencement) Year Ended Three Months Ended to March 31, to December 31, December 31, March 31, 2002 2001 2001 2000 2002 2001 (Unaudited) (Unaudited) (Unaudited) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of members' capital 500,000 500,000 -- -- -- -- Proceeds from repayment of note receivable for members' capital 2,000,000 2,000,000 865,453 1,134,547 -- 139,714 Proceeds from bridge loans 3,025,000 1,500,000 1,500,000 -- 1,525,000 -- Proceeds from advances from LCG Capital Group, LLC 76,617 76,617 76,617 -- -- -- Proceeds from advances from affiliated companies - net 25,915 25,632 5,985 15,547 283 4,719 ----------- ----------- ----------- ----------- ----------- ---------- Net cash provided by financing activities 5,627,532 4,102,249 2,448,055 1,150,094 1,525,283 144,433 ----------- ----------- ----------- ----------- ----------- ---------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 277,148 13,863 (218,042) (62,809) 263,285 (222,256) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD -- -- 231,905 294,714 13,863 231,905 ----------- ----------- ----------- ----------- ----------- ---------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 277,148 $ 13,863 $ 13,863 $ 231,905 $ 277,148 $ 9,649 =========== =========== =========== =========== =========== ========== SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS: Note received for members' capital $ 2,000,000 $ 2,000,000 $ -- $ -- $ -- $ -- Deferred interest expense - bridge loans $ 352,162 $ 232,389 $ 232,389 $ -- $ 119,773 $ -- Accrued interest expense - bridge loans $ 411,022 $ 250,750 $ 250,750 $ -- $ 160,272 $ -- See notes to financial statements. F-35 ESSENTIAL REALITY, LLC (A Development Stage Entity) NOTES TO FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2001 AND 2002, CUMULATIVE PERIOD FROM JUNE 1, 1999 (DATE OF COMMENCEMENT) TO DECEMBER 31, 2001, THREE MONTHS ENDED MARCH 31, 2002 (UNAUDITED) AND MARCH 31, 2001 (UNAUDITED) AND CUMULATIVE PERIOD FROM JUNE 1, 1999 (DATE OF COMMENCEMENT) TO MARCH 31, 2002 (UNAUDITED) - -------------------------------------------------------------------------------- 1. THE COMPANY Essential Reality, LLC (the "Company") was formed as Freedom Multimedia, LLC in the State of Delaware on July 9, 1998 and began active operations on June 1, 1999. The Company changed its name to Essential Reality, LLC on December 29, 1999. The Company was formed to develop, manufacture and market computer peripheral devices, with initial emphasis on a product called "P5." P5 is a gloved shaped device that controls the movement of objects on a computer screen. P5 enables three-dimensional movement of the cursor as well as allowing pitch and yaw, as well as roll. P5 is controlled by the user moving his/her hand or bending his/her fingers. The Company is in the development stage. Successful completion of the Company's development program and ultimately, the attainment of profitable operations are dependent upon future events, including obtaining adequate financing to fulfill its development activities, and achieving a level of revenue adequate to support the Company's cost structure. Since its commencement, the Company has not generated revenues and has incurred significant recurring losses from operations, working capital deficit and deficit in members' capital. As a result, substantial doubt exists regarding the Company's ability to continue as a going concern. The Company has recently completed a private placement of membership interests as described in Note 8. The Company anticipates that, based on currently proposed plans and assumptions relating to the implementation of its business plan (including the timetable of costs and expenses associated with, and success of, its marketing efforts), the net proceeds of the recently completed private placement together with trade financing and accounts receivable factoring that needs to be arranged in the second half of fiscal 2002 and projected revenues from operations, will be sufficient to satisfy operations until the of end of fiscal 2002 Thereafter, the Company will require additional funding in order to reach the point of self sufficiency. The financial statements have been prepared in conformity with the Statement of Financial Accounting Standards ("SFAS") No. 7, Accounting and Reporting by Development Stage Enterprises. As a development stage entity with no commercial operating history, the Company is subject to all of the risks and uncertainties inherent in the establishment of a new business enterprise. To address these risks and uncertainties, the Company must, among other things, respond to competitive developments; attract, retain, and motivate qualified personnel; and support the expense of marketing new products based upon innovative technology. To date, the Company has not recognized product related revenues. As a result of incurring expenses in these developmental activities without generating revenues, the Company has incurred significant losses and negative cash flow from operating activities. For the cumulative period from June 1, 1999 (Date of Commencement) to December 31, 2001 the Company had cumulative net losses of $4,772,242 and cumulative negative cash flow from operating activities of $4,057,437. For the cumulative period from June 1, 1999 (Date of Commencement) to March 31, 2002 (unaudited) the Company had cumulative net losses of $6,132,340 and cumulative negative cash flow from operating activities of $5,310,383. The Company expects to incur substantial losses and negative cash flow from operating activities for the near future. F-36 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation - The financial statements of the Company have been prepared on the accrual basis of accounting. A summary of the major accounting policies followed in the preparation of the accompanying financial statements, which conform to generally accepted accounting principles is presented below. The accompanying unaudited financial statements have been prepared with generally accepted accounting principles for interim financial information. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for fair presentation have been included. Accounting Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Comprehensive Loss - Comprehensive loss is the same as net loss. Cash and Cash Equivalents - Cash equivalents include time deposits with maturities of three months or less on the date of purchase. Domain Name and Fixed Assets - Domain names are recorded at cost, net of accumulated amortization. Fixed assets are recorded at cost, net of related accumulated depreciation. Upon sale or retirement, the cost and related accumulated depreciation and amortization are removed from the respective accounts, and any gain or loss is included in the statement of operations. Maintenance and repair costs are expensed as incurred. Depreciation of fixed assets is computed using the straight-line method based on the estimated useful lives of the assets, which is three to five years, beginning when assets are placed in service. Amortization of domain names is computed using the straight-line method over a period of two years, taking a full year's depreciation in the year of acquisition. Product Development - Product development costs include expenses incurred by the Company to research and develop the P5 product. Product development costs are expensed until such time as the Company determines that a product is technologically feasible. Product development costs are capitalized from such date until such time as product development is substantially complete. Product development costs capitalized will be amortized on the straight-line basis over the lesser of the estimated useful life of the product or three years. All of the costs to date have been expensed. Impairment of Assets - In accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, the Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. When such events occur, the Company compares the carrying amount of the assets to undiscounted expected future cash flows. If this comparison indicates that there is impairment, the amount of the impairment loss is then based on the fair value of the asset compared with its carrying value. No impairment of assets existed at December 31, 2001 and March 31, 2002. Fair Market Value of Financial Instruments - The carrying amount of the Company's cash and cash equivalents, interest receivable, prepaid expenses and deposits, accounts payable, accrued liabilities, accrued compensation and advances from affiliated companies approximates fair market value because of the short maturity of those instruments. Income Taxes - The Company is not subject to federal or state income tax. The taxable income or loss applicable to the operations of the Company is includable in the federal and state income tax returns of the members. The Company will become subject to federal and state income taxes after completion of the transaction described in Note 8. Effects of Recently Issued Accounting Standards - In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments F-37 and hedging activities. Generally, it requires that an entity recognize all derivatives as either an asset or liability and measure those instruments at fair value as well as identify the conditions for which a derivative may be specifically designed as a hedge. SFAS No. 133 is effective for fiscal years beginning after June 15, 2000. The adoption of SFAS No.133, effective January 1, 2001, did not have an impact on the Company's financial position, results of operations, or cash flows. The Company currently does not have any derivative instruments and is not engaged in hedging activities. On June 29, 2001, the FASB approved for issuance SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Intangibles Assets". Major provisions of these statements are as follows: all business combinations initiated after June 30, 2001 must use the purchase method of accounting; the pooling of interest method of accounting is prohibited except for transactions initiated before July 1, 2001; intangible assets acquired in a business combination must be recorded separately from goodwill if they arise from contractual or other legal rights or are separable from the acquired entity and can be sold, transferred, licensed, rented or exchanged, either individually or as part of a related contract, asset or liability; goodwill and intangible assets with indefinite lives are not amortized but are tested for impairment annually, except in certain circumstances, and whenever there is an impairment indicator; adjustments are made. All acquired goodwill must be assigned to reporting units for purposes of impairment testing, and effective January 1, 2002, goodwill will no longer be subject to amortization. The adoption of SFAS No. 142 will not have a material impact on the Company's financial position or results of operations. In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 requires companies to record the fair value of a liability for asset retirement obligations in the period in which they are incurred. The statement applies to a company's legal obligations associated with the retirement of tangible long-lived assets that result from the acquisition, construction and development or through the normal operation of a long-lived asset. When a liability is initially recorded, the company would capitalize the cost, thereby increasing the capital amount of the related asset. The capitalized asset retirement cost is depreciated over the life of the respective asset while the liability in accreted to its present value. Upon settlement of the liability, the obligation is settled at its recorded amount or the company incurs a gain or loss. This statement is effective for fiscal years beginning after June 15, 2002. The Company does not expect that adoption of SFAS No. 143 will have a material impact on the Company's financial position or results of operations. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses the accounting and reporting for the impairment or disposal of long-lived assets. The statement provides a single accounting model for long-lived assets to be disposed of. New criteria must be met to classify the asset as an asset for sale. This statement also focuses on reporting the effects of a disposal of a segment of a business. This statement is effective for years beginning after December 15, 2001. The adoption of SFAS No. 144 will not have a material impact on the Company's financial position or results of operations. Reclassification - Certain amounts in the 2000 financial statements have been reclassified to conform with the basis of presentation used in 2001 and 2002. F-38 3. FIXED ASSETS AND DOMAIN NAMES December 31, March 31, 2001 2000 2002 (Unaudited) Fixed assets Computer $ 2,000 $-- $ 2,000 Office Furniture and equipment 10,949 -- 20,001 -------- --- -------- At cost 12,949 -- 22,001 Less: accumulated depreciation (2,850) -- (4,015) -------- --- -------- Net book value $ 10,099 $-- $ 17,986 ======== === ======== Domain names Domain names - at cost $ 18,000 $-- $ 18,000 Less: Accumulated amortization (9,000) -- (11,250) -------- --- -------- Net book value $ 9,000 $-- $ 6,750 ======== === ======== Depreciation and amortization expense for the years ended December 31, 2001 and 2000 amounted to $11,850 and $0, respectively. Depreciation and amortization expense for the three months ended March 31, 2002 (unaudited) and 2001 (unaudited) amounted to $3,415 and $165, respectively. 4. BRIDGE LOANS Through December 31, 2001, the Company received bridge loans from JPAL, Inc. ("JPAL") of $2,525,000. Through March 31, 2002 (unaudited), the Company received bridge loans of $3,025,000. $2,525,000 of the bridge loans are from JPAL, a publicly traded corporation with which the Company has entered into a merger agreement as described more fully in Note 8c. The remaining $500,000 bridge loan, received in March 2002, is from an unrelated third party. Bridge Loans from JPAL The bridge loans from JPAL are unsecured and bear interest at the rate of 8 1/2 % per annum, however, the interest did not begin to accrue until January 31, 2002. The bridge loans, together with accrued interest thereon, become payable on April 30, 2004, however the bridge loans will be prepaid as follows: (i) Up to $250,000 of bridge loans and accrued interest may be converted to up to 240,000 membership units of the Company pursuant to the Offering; (ii) Up to $500,000 of bridge loans and accrued interest may be converted to up to 263,158 common shares of JPAL; (iii) Up to $1,000,000 will be repaid upon closing of the Offering and Merger; (iv) During fiscal 2003, $100,000 payments per quarter representing interest and principal; (v) 50% of the proceeds received as a result of the exercise of bridge loan warrants as described below; (vi) During fiscal 2002, 15% of the net proceeds received from the sale of equity in the Company above $10,000,000, subject to a maximum of up to $700,000; F-39 (vii) During fiscal 2003, 20% of the net proceeds received from the sale of equity in the Company, subject to a maximum of up to $700,000, provided, that in the event the aggregate principal amount of bridge loans remaining outstanding at the time such equity is raised shall exceed $1,000,000, then the maximum amount due and payable shall be $900,000; (viii) Beginning October 1, 2002, 35% of any Excess Cash greater than $2 million, up to a maximum of $200,000 (in addition to amounts received under clause (iv) above) in any quarter, where "Excess Cash" means any cash on the books of JPAL at the end of a quarter minus any equity and/or debt raised during such quarter; and (ix) The remaining balance of interest and principal, if any, on April 30, 2004. Anything to the contrary in (vi) and (vii) above notwithstanding, if at any time during either 2002 or 2003 the equity raised from unrelated sales is $1,000,000 or less and the investor(s) in each such unrelated sale objects to the repayment of the bridge loans, then no such repayment shall be made. For purposes of calculating the proceeds received and amounts raised set forth in (vi) and (vii) above, (A) any non-cash investment, or (B) any amounts raised from strategic investors that are either (1) earmarked for specific use, or (2) received in connection with actual or anticipated other relationship(s) with such investor(s) that exist(s) or may exist, shall not be counted in such calculation. In no event shall any repayment be made in excess of bridge loans and accrued interest then outstanding. In addition; (i) all payments to be made pursuant to (iv) through (ix) above are subordinate to obligations to financing sources, and may be subject to restrictive covenants imposed by either trade or secured creditors, and (ii) the holders of the notes representing the bridge loans have agreed not to take any action on the prepayment obligations until any such restrictive covenants are eliminated or terminated. To the extent that a cash payment is not made when due, all unpaid amounts not paid at maturity shall earn interest at a rate of 12% per annum. The bridge loans from JPAL include the issuance to certain lenders of JPAL up to 750,000 warrants to purchase common shares of JPAL for an exercise price of $1.90 per common share. Such warrants expire two years from the date of closing of the merger agreement. Since these warrants pertain to JPAL and not the Company, the Company has not recorded any expense related to the warrants. During 2001, JPAL issued 610,560 warrants in connection with the bridge loans. Although interest on the bridge loans did not begin to accrue until January 31, 2002, interest on the bridge loans from JPAL in the amount of $250,750 and $411,022 has been imputed and accrued representing the interest payable on the bridge loans advanced from inception through December 31, 2001 and March 31, 2002, respectively, and will be amortized over the life of the loans through April 30, 2004. Deferred interest will be amortized on a daily basis from the date of the loan to April 30, 2004, which resulted in a charge to earnings in the amount of $18,361 and $40,499 for year ended December 31, 2001 and for the three months ended March 31, 2002 (unaudited), respectively. Bridge Loan from Third Party The bridge loan from the third party, received in March 2002, is unsecured and bears interest at the rate of 18% per annum. The bridge loan matures on the earlier of June 22, 2002 or the consummation by the Company of an equity financing of at least $1,000,000. The bridge loan together with accrued interest thereon may be converted, in whole or in part, at the request of the third party lender, to membership units of the Company at the conversion price of approximately $1.04. The Company has also granted to the holder of the bridge loan warrants to purchase 15,000 membership units of the Company for an exercise price of $1.30 per membership unit. F-40 5. COMMITMENTS AND CONTINGENCIES Operating Leases a. Premises - In November 2001, the Company entered a lease for premises which provides for the following rental payments: Year Ending December 31, 2002 $119,000 2003 132,000 2004 135,000 2005 138,000 2006 141,000 Thereafter 14,000 ---------- $679,000 ========== Rent expense for the years ended December 31, 2001 and 2000 amounted to approximately $39,000 and $27,000, respectively. Rent expense for the three months ended March 31, 2002 (unaudited) and 2001 (unaudited) amounted to approximately $29,000 and $5,000, respectively. b. Computer Leases - The Company is allocated costs of computer leases under leases assumed by a company related to a certain member of LCG Capital Group, LLC ("LCG"), a member of the Company. The Company is not directly obligated under the leases, however its portion of the minimum payments under the leases are as follows: Year Ending December 31, 2002 $35,000 2003 11,000 ------- $46,000 ======= Computer lease expense for the years ended December 31, 2001 and 2000 amounted to approximately $13,000 and $5,000, respectively. Computer lease expense for the three months ended March 31, 2002 (unaudited) and 2001 (unaudited) amounted to approximately $15,500 and $1,500, respectively. Development and Other Contracts a. In March 2000, the Company entered into a consulting agreement, which requires the Company to pay to the consultant, $0.25 for each of the first 150,000 units of the P5 sold. b. In July 2000, the Company entered into an agreement for product development with a company, which is owned by a person who is related to certain members of the Company (see Note 7). Pursuant to the agreement, the Company is required to pay royalties of 1.8% on net sales of P5 and 9% of the license fee collected by the Company with respect to P5, indefinitely. F-41 c. In August 2000, the Company entered into a memorandum of understanding, which provides for a renewable, two-year license for a certain component of P5. Royalties are calculated as the number of units of P5 sold multiplied by the greater of a) $0.25 and b) the difference between the manufacturing cost of the licensed component and an alternative component with a minimum license fee of $125,000 per annum. Should the Company not use the licensed component no royalties would be due pursuant to the memorandum of understanding. Included in product development expense for the years ended December 31, 2001 and 2000 are development fees of $25,000 and $25,000, respectively. Included in product development expense for the three months ended March 31, 2002 (unaudited) and 2001 (unaudited) are development fees of $0 and $0, respectively. d. In October 2000, the Company entered into an agreement for the provision of inspection services relating to the manufacture and packaging of P5. Pursuant to the agreement, the Company is required to pay an inspection fee, beginning with the start of production, of the greater of a) $7,000 per month and b) 1% of the freight-on-board value of P5. This agreement expires in September 2002 and may be terminated at any time giving three-months notice. e. In December 2000, the Company entered into a consulting agreement with an entity controlled by an affiliate of LCG. Pursuant to which this entity provides general consulting services to the Company in return for a monthly cash retainer. Such services consist of forming revenue-generating opportunities, including without limitation distribution agreements, licensing agreements, joint ventures, strategic alliances and partnerships. Through December 31, 2001, the amount of the retainer was between $6,000 and $12,000 per month and it can increase from time to time up to a maximum of $20,000 per month, based upon mutual consent with the entity, depending on the level and geographic scope of the services. In addition to the monthly retainer, we also are obligated to pay to the entity a potential revenue share of up to four percent (4.0%) on transactions facilitated by the entity. Included in general and administrative expenses are costs incurred of approximately $96,000, $6,000, $36,000 and $18,000 for the years ended December 31, 2001 and 2000 and for the three months ended March 31, 2002 (unaudited) and 2001 (unaudited), respectively relating to this contract. f. In January 2001, the Company entered into a memorandum of understanding for the development of certain components of P5. Pursuant to the memorandum of understanding, the Company is required to pay royalties of 1% of P5's net sales to the developer, indefinitely. A nonrefundable royalty advance of $5,000 and $10,000 is included in product development for the years ended December 31, 2001 and 2000. A nonrefundable royalty advance of $0 and $5,000 is included in product development for the three months ended March 31, 2002 (unaudited) and 2001 (unaudited), respectively. The Company is required to pay a further royalty advance of $35,000 should the Company incorporate the component developed pursuant to the memorandum of understanding into P5. Should the Company not incorporate the component developed pursuant to the memorandum of understanding into P5, it will not to be obligated to pay the $35,000 royalty advance nor the 1% royalty on future sales. g. In July 2001, the Company entered a development agreement for the development of certain components of P5. Should the developer accomplish the goals set forth in the agreement, the Company is required to pay base royalties of 1% of net sales generated from P5, indefinitely and an additional 0.5% of net sales generated from P5, indefinitely, if the developer meets certain milestones defined in this development agreement. F-42 6. MEMBERS' CAPITAL AND NOTE RECEIVABLE In December 1999, LCG acquired a 50% interest in the Company for an aggregate purchase price of $2,500,000. The consideration received was comprised of $500,000 in cash and a $2,000,000 note. The note bore interest at the rate of 6% per annum, had a maturity date of December 13, 2002 and was secured by the membership interest of LCG. The remaining 50% interest in the Company represents ownership by the founders of the Company. The note receivable for members' capital was fully repaid in July 2001. The Company recorded interest income on this note of $20,465 and $103,459 for the years ended December 31, 2001 and 2000, respectively. As of December 31, 2001 and March 31, 2002 (unaudited), the Company had 9,600,000 membership units issued and outstanding. The Company has subsequently issued additional membership units as described in Note 8b. 7. RELATED PARTY BALANCES AND TRANSACTIONS Accrued compensation of $257,103, $221,267 and $270,303 at December 31, 2001 and 2000, and March 31, 2002 (unaudited), respectively, is payable to certain officers and members of the Company. The amount is due on demand and is non-interest bearing. Advances are from entities that are affiliated with LCG. The advances are payable on demand and bear interest at the rate of 10% per annum. Advances from LCG are non-interest bearing and payable on demand. Included in other assets at December 31, 2001 and 2000 and March 31, 2002 (unaudited) is $22,500 which represents the Company's portion of a letter of credit required to secure computer leases. Included in prepaid expenses and deposits at December 31, 2000 is $6,000 relating to a security deposit on premises due from LCG. Included in product development costs are $0, $105,000, $0 and $0 for the years ended December 31, 2001 and 2000 and for the three months ended March 31, 2002 (unaudited) and 2001 (unaudited), respectively, paid to a company owned by an individual related to certain members of the Company. Included in product development costs are $91,300, $0, $37,000 and $8,300 for the years ended December 31, 2001 and 2000, and for the three months ended March 31, 2002 (unaudited) and 2001 (unaudited), respectively, paid to a company owned by certain members of the Company. Included in general and administrative expenses are costs incurred of approximately $242,000, $148,000, $79,000 and $38,000 for the years ended December 31, 2001 and 2000 and for the three months ended March 31, 2002 (unaudited) and 2001 (unaudited), respectively, by two entities that are related to certain members of LCG. Such costs include consulting fees, employee salaries, occupancy, telephone and computer leases. In the case of employee salaries, costs are allocated to the Company based on the time each employee conducts business specific to the Company. In the case of the other expenses, costs are allocated based on a percentage of resources used by the Company. Included in accounts payable - related parties at December 31, 2001 and 2000 are approximately $26,000 and $0, respectively, payable to a company owned by a person related to certain members of the Company. Included in accounts payable - related parties at December 31, 2001 and 2000 are approximately $58,000 and $0, respectively, payable to a company that is related to certain members of LCG. F-43 8. SUBSEQUENT EVENTS a. Bridge loans (i) From April 1, 2002 to June 20, 2002 the Company received an additional $300,000 of bridge loans from third party lenders; (ii) Prior to the completion of the Merger described in Note 8c, the Company exchanged bridge loans and accrued interest owed to JPAL of approximately $2,600,000 for notes of approximately $2,767,000 owed to JPAL's lenders. (iii) On June 20, 2002 the Company repaid bridge loans of $1,100,000, of which $550,000 was repaid to JPAL and $550,000 was repaid to third party lenders. (iv) As part of the private placement described in Note 8b, $500,000 of bridge loans were converted to 480,000 membership units of the Company, of which JPAL converted $250,000 and a third party lender converted $250,000. As a result of the transactions completed subsequent to March 31, 2002, as of June 20, 2002, the Company had notes payable outstanding of approximately $1,967,000 owed to JPAL's lenders. b. Private Placement On June 20, 2002, the Company completed a private placement ("Offering") whereby it issued 7,274,784 membership units for gross proceeds of $7,577,900. Included in the gross proceeds was $500,000 of bridge loans that were converted to 480,000 membership units of the Company. Cash fees and expenses of the Offering were approximately $600,000. In addition, in connection with the Offering the Company has issued to its financial advisors 331,211 warrants to purchase 331,211 membership units. Such warrants shall have an exercise price per membership unit equal to $1.30 per membership unit and shall be exercisable for a period of up to five years (to be determined by the Company prior to issuance). As a result of the merger discussed in Note 8c, warrants to purchase membership units in the Company shall become warrants to purchase common shares of JPAL on the basis of one warrant to purchase a membership unit of the Company to one warrant to purchase a common share of JPAL. In May 2002, the Company was advanced $400,000 from the Offering escrow. No costs or interest was incurred in connection with the advance. c. Merger with JPAL On June 20, 2002, the Company completed a merger with JPAL whereby the members of the Company contributed all of their membership units in the Company in exchange for 16,874,784 shares of JPAL's common stock. Contemporaneously, the shareholders of JPAL canceled common shares and were left with 1,080,934 shares of common stock representing 6.02% of the surviving entity. The Merger will be accounted for as a reverse acquisition in which the Company is the accounting acquirer and JPAL is the legal acquirer. The management of the Company will remain the management of the merged entity. Since the Merger will be accounted for as a reverse acquisition and not a business combination, no goodwill will be recorded in connection with the Merger and the costs incurred in connection with the Merger will be accounted for as a reduction of additional paid-in capital. As a result of the Merger, the warrants issued to the Company's financial advisors to acquire membership units (see Note 8b), will become warrants to purchase the same amount of JPAL common shares at the same exercise price and having the same expiration date. F-44 The Company expects to use the stock incentive plan established by JPAL pursuant to which the Company may grant options, stock appreciation rights, restricted stock and/or other equity-based incentives to its directors, employees, consultants and advisors for up to an aggregate of 3,500,000 shares of the merged entity's common stock. d. Contractual Obligations (unaudited) (i) In May 2002, the Company placed an order for the manufacture of P5 with a third party manufacturer. Under the terms of the order the Company was required to pay a deposit of $100,000 upon placing the order and post letters of credit in the amount of approximately $2.25 million over a three to four month period following the order date. As of July 15, 2002 the Company has posted letters of credit of $575,000. (ii) In May 2002, the Company entered into a letter of intent with a game developer. Under the letter of intent the game developer shall disclose to the Company the source code for two specific games so that the games can be integrated with P5. In addition, the game developer will release a software update enabling current users of the games to use P5. The Company will be responsible for integration and payment to the game developer of $100,000. e. Stock Options (unaudited) Subsequent to March 31, 2002, the Company issued to its directors and employees, options to purchase an aggregate of 797,000 shares of its common stock at a weighted average exercise price of $1.32 per share. Such options expire ten years following the grant date. The issuance of the options resulted in deferred compensation expense of approximately $1,600,000. Such amount will be charged to earnings over the expected life of the options. Deferred compensation expense was computed using the Black-Scholes method with a fair market value of $3.05 per share. Subsequent to March 31, 2002, the Company issued to its advisors and consultants, options to purchase an aggregate of 235,000 shares of its common stock at a weighted average exercise price of $0.84 per share. Such options expire ten years following the grant date. The issuance of the options resulted in compensation expense in the second quarter of 2002 of approximately $600,000. Compensation expense was computed using the Black-Scholes method with a fair market value of $3.05 per share. F-45 Essential Reality, Inc. 8,214,239 Shares of Common Stock ------------------ PROSPECTUS ----------------- __________ ___, 2002 You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. This prospectus does not constitute an offer or solicitation by anyone in any state in which such person is not authorized, or in which the person making such offer or solicitation is not qualified to do so, or to any person to whom it is unlawful to make such offer or solicitation. This prospectus does not offer to sell or buy any shares in any jurisdiction where it is unlawful. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock. No action is being taken in any jurisdiction outside the U.S. to permit a public offering of the common stock or possession or distribution of this prospectus in that jurisdiction. Persons who come into possession of this prospectus in jurisdictions outside the U.S. are required to inform themselves about and to observe any restrictions as to this offering and the distribution of this prospectus applicable to that jurisdiction. PART II INFORMATION NOT REQUIRED IN PROSPECTUS Item 24. Indemnification of Directors and Officers. The Nevada General Corporation Law (NGCL) provides that a director or officer of a corporation will not be personally liable for monetary damages for breach of that individual's fiduciary duties as a director or officer except for liability for (1) any act or omission constituting a breach of fiduciary duties as a director or officer and when (2) breach of those duties involved intentional misconduct, fraud or a knowing violation of law. Under the NGCL, a corporation may indemnify directors and officers, as well as other employees and individuals, to any threatened, pending or completed action, suit or proceeding, except an action by or in the right of the corporation, by reason of the fact that he is or was a director, officer, employee or agent of the corporation. The termination of any action, suit or proceeding by judgment, order, settlement, conviction or upon a plea of nolo contendere or its equivalent, does not, of itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the corporation, or that, with respect to any criminal action or proceeding, he had reasonable cause to believe that his conduct was unlawful. The NGCL further provides that indemnification may not be made for any claim as to which such a person has been adjudged by a court of competent jurisdiction, after exhaustion of all appeals therefrom, to be liable to the corporation or for amounts paid in settlement to the corporation, unless and only to the extent that the court in which the action or suit was brought or other court of competent jurisdiction determines upon application that in view of all the circumstances of the case, the person is fairly and reasonably entitled to indemnity for such expenses as the court deems proper. To the extent that a director, officer, employee or agent of a corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding or in defense of any claim, issue or matter therein, the corporation shall indemnify him against expenses, including attorneys' fees, actually and reasonably incurred by him in connection with the defense. The NGCL provides that this is not exclusive of other rights to which those seeking indemnification may be entitled under any bylaw, agreement, vote of stockholders or disinterested directors or otherwise. The Registrant's articles of incorporation provide that the directors and officers will not be personally liable to the Registrant or its stockholders for monetary damages for breach of their fiduciary duty as a director or officer, except for liability of a director or officer for acts or omissions involving intentional misconduct, fraud or a knowing violation of law, or the payment of dividends in violation of the NGCL. The Registrant's bylaws provide that the Registrant is required to indemnify its directors and officers to the maximum extent permitted by law. The Registrant's bylaws also require the Registrant to advance expenses incurred by a director or officer in connection with the defense of any proceeding arising out of that party's status or service as a director or officer of the Registrant or as a director, officer or other enterprise, if serving as such at the Registrant's request. The Registrant's bylaws also permit the Registrant to secure insurance on behalf of any director or officer for any liability arising out of his or her actions in a representative capacity. II-1 Item 25. Other Expenses of Issuance and Distribution. The following table sets forth the costs and expenses payable by the Registrant in connection with the issuance and distribution of the securities being registered. The selling shareholders will not pay any of the expenses. All amounts are estimated except for the SEC registration fee. Amount to be Paid SEC Registration Fee..............................................$ 2,286.03 Accounting Fees and Expenses......................................$ 50,000.00 Legal Fees and Expenses...........................................$ 45,000.00 Miscellaneous.....................................................$ 2,713.97 -------------- Total.................................................$ 100,000.00 ============= Item 26. Recent Sales of Unregistered Securities. There have been no sales of unregistered securities within the past three years, which would be required to be disclosed pursuant to Item 701 of Regulation S-B, except for the following: On June 20, 2002, the Registrant consummated a business combination with Essential Reality, LLC, a Delaware limited liability company ("ER LLC"). Pursuant to the terms of the transaction, all of the members of ER LLC contributed their membership interests in ER LLC to the Registrant in exchange for an aggregate of 16,874,784 shares of the Registrant's common stock (the "Common Stock"). In connection with the issuance of these shares of Common Stock, the Registrant relied on the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended. In connection with the business combination, (i) holders of certain bridge notes issued by the Registrant received, as additional consideration for the loans, two-year warrants to purchase up to 840,000 shares of Common Stock and 15,000 shares of Common Stock at a purchase price of $1.90 and $1.30 per share, respectively, (ii) holders of certain bridge notes issued by the Registrant exchanged them for the same principal amount (plus accrued interest) of convertible promissory notes of the Registrant, which are convertible for a period of six months at a conversion price of $1.90 into an aggregate of 263,158 shares of Common Stock, and (iii) the Registrant issued three-year warrants to purchase up to an aggregate of 331,211 shares of Common Stock at a purchase price of $1.30 per share, as consideration for certain services provided by the recipients. In connection with the issuance of each of these securities, the Registrant relied on the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended. On August 1, 2000, the Registrant issued an aggregate of 797,469 shares of Common Stock to Thomas E. Stepp, Jr., Richard Reincke and Michael Muellerleile. The shares were issued in exchange for legal services provided to the Registrant, which were valued at $797. Thomas E. Stepp, Jr., Richard Reincke and Michael Muellerleile are sophisticated investors and had access to the type of information that would normally be included in a registration statement. In connection with the issuance of these shares of Common Stock, the Registrant relied on the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended. On or about May 11, 2000, the Registrant issued 2,100,000 shares of its common stock for $.001 per share. The offer was made to "accredited investors", as that term is defined under applicable federal and state securities laws, and no more than 35 non-accredited investors. The value of the shares was arbitrarily set by the Registrant and had no relationship to its II-2 assets, book value, revenues or other established criteria of value. There were no commissions paid on the sale of those shares. The net proceeds to the Registrant were $2,100. All twenty-one purchasers of the Common Stock were non-accredited investors and were business associates, personal friends or family members of Ryan A. Neely, then president, secretary and director of the Registrant. All non-accredited investors were sophisticated investors and were provided a private placement memorandum, which contained the type of information that would normally be included in a registration statement. In connection with the issuance of these shares of Common Stock, the Registrant relied on the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended. Item 27. Exhibits. Number Description - ------ ----------- 2.1 (1) Amended Contribution Agreement, dated as of April 24, 2002, by and among Essential Reality, LLC, the Registrant (f/k/a JPAL, Inc.), Martin Abrams, John Gentile, Anthony Gentile and LCG Capital Group, LLC. 2.2 (2) Amendment to Amended Contribution Agreement, dated as of June 14, 2002, by and among Essential Reality, LLC, the Registrant (f/k/a JPAL, Inc.), Martin Abrams, John Gentile, Anthony Gentile and LCG Capital Group, LLC. 3.1 (3) Amended and Restated Articles of Incorporation of the Registrant. 3.2 * Amendment to Articles of Incorporation filed June 20, 2002 with the State of Nevada. 3.3 * Amendment to Articles of Incorporation filed June 21, 2002 with the State of Nevada. 3.4 (4) Bylaws of the Registrant. 4.1 * Form of Additional Warrant of the Registrant. 4.2 * Form of Bridge Warrant of the Registrant. 4.3 * Form of Convertible Promissory Note of the Registrant. 5.1 ** Opinion of Olshan Grundman Frome Rosenzweig & Wolosky LLP. 9.1 (5) Voting Agreement, dated as of June 20, 2002, among LCG Capital Group, LLC, Martin Abrams, John Gentile, Anthony Gentile and MSH Entertainment Corporation. 23.1 * Consent of Deloitte & Touche LLP. 23.2 * Consent of Lesley, Thomas, Schwarz & Postma, Inc. 23.3 ** Consent of Olshan Grundman Frome Rosenzweig & Wolosky LLP (contained in Exhibit 5.1). 24.1 * Power of Attorney (included on signature page). - ------------ * Filed herewith. ** To be filed by amendment. (1) Incorporated herein by reference from Exhibit A to the Registrant's Proxy Statement on Schedule 14A filed on May 21, 2002. (2) Incorporated herein by reference from Exhibit 2.2 to the Registrant's Current Report on Form 8-K filed on July 3, 2002. (3) Incorporated herein by reference from Exhibit 3.1 to the Registrant's Registration Statement on Form SB-2 filed on August 18, 2000. (4) Incorporated herein by reference from Exhibit 3.2 to the Registrant's Registration Statement on Form SB-2 filed on August 18, 2000. (5) Incorporated herein by reference from Exhibit 2 to the Schedule 13D filed on July 2, 2002 by LCG Capital Group, LLC. II-3 Item 28. Undertakings. (A) The undersigned Registrant hereby undertakes: (1) To file, during any period in which if offers or sells securities, a post-effective amendment to this registration statement to: (i) include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; (ii) reflect in the prospectus any facts or events which, individually or together, represent a fundamental change in the information in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the SEC pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than 20 percent change in the maximum offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement; and (iii) include any additional or changed material information on the plan of distribution. (2) For determining liability under the Securities Act, treat each post-effective amendment as a new registration statement of the securities offered, and the offering of the securities at that time to be the initial bona fide offering. (3) File a post-effective amendment to remove from registration any of the securities that remain unsold at the end of the offering. (B) Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. II-4 SIGNATURES In accordance with the requirements of the Securities Act of 1933, the Registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form SB-2 and authorized this Registration Statement to be signed on its behalf by the undersigned, in the City of New York, State of New York, on the 19th day of July, 2002. ESSENTIAL REALITY, INC. By: /s/ Steven Francesco ------------------------------- Steven Francesco Chief Executive Officer POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints Steven Francesco, Chief Executive Officer and Reuben Levine, President, as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him in his name, place and stead, in any and all capacities, in connection with this Registration Statement, including to sign and file in the name and on behalf of the undersigned as director or officer of the Registrant (i) any and all amendments or supplements (including any and all stickers and post-effective amendments) to this Registration Statement, with all exhibits thereto, and other documents in connection therewith, and (ii) any and all additional registration statements, and any and all amendments thereto, relating to the same offering of securities as those that are covered by this Registration Statement that are filed pursuant to Rule 462(b) promulgated under the Securities Act of 1933 with the Securities and Exchange Commission and any applicable securities exchange or securities self-regulatory body, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof. In accordance with the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities and on the dates stated: Signature Title Date --------- ----- ---- /s/ Steven Francesco - -------------------------- Chief Executive Officer July 19, 2002 Steven Francesco (Principal Executive Officer) /s/ Ian Benoliel July 19, 2002 - -------------------------- Vice President, Finance (Principal Ian Benoliel Financial Officer and Principal Accounting Officer) /s/ Humbert B. Powell, III Co-Chief Executive Officer July 19, 2002 - -------------------------- and Director Humbert B. Powell, III II-5 /s/ Marc Fries Director July 19, 2002 - -------------------------- Marc Fries /s/ Anthony Gentile Director July 19, 2002 - -------------------------- Anthony Gentile /s/ John Gentile Director July 19, 2002 - -------------------------- John Gentile /s/ Brian D. Jedwab Director July 19, 2002 - -------------------------- Brian D. Jedwab II-6 Exhibit Index ------------- Number Description 2.1 (1) Amended Contribution Agreement, dated as of April 24, 2002, by and among Essential Reality, LLC, the Registrant (f/k/a JPAL, Inc.), Martin Abrams, John Gentile, Anthony Gentile and LCG Capital Group, LLC. 2.2 (2) Amendment to Amended Contribution Agreement, dated as of June 14, 2002, by and among Essential Reality, LLC, the Registrant (f/k/a JPAL, Inc.), Martin Abrams, John Gentile, Anthony Gentile and LCG Capital Group, LLC. 3.1 (3) Amended and Restated Articles of Incorporation of the Registrant. 3.2 * Amendment to Articles of Incorporation filed June 20, 2002 with the State of Nevada. 3.3 * Amendment to Articles of Incorporation filed June 21, 2002 with the State of Nevada. 3.4 (4) Bylaws of the Registrant. 4.1 * Form of Additional Warrant of the Registrant. 4.2 * Form of Bridge Warrant of the Registrant. 4.3 * Form of Convertible Promissory Note of the Registrant. 5.1 ** Opinion of Olshan Grundman Frome Rosenzweig & Wolosky LLP. 9.1 (5) Voting Agreement, dated as of June 20, 2002, among LCG Capital Group, LLC, Martin Abrams, John Gentile, Anthony Gentile and MSH Entertainment Corporation. 23.1 * Consent of Deloitte & Touche LLP. 23.2 * Consent of Lesley, Thomas, Schwarz & Postma, Inc. 23.3 ** Consent of Olshan Grundman Frome Rosenzweig & Wolosky LLP (contained in Exhibit 5.1). 24.1 * Power of Attorney (included on signature page). - ------------ * Filed herewith. ** To be filed by amendment. (1) Incorporated herein by reference from Exhibit A to the Registrant's Proxy Statement on Schedule 14A filed on May 21, 2002. (2) Incorporated herein by reference from Exhibit 2.2 to the Registrant's Current Report on Form 8-K filed on July 3, 2002. (3) Incorporated herein by reference from Exhibit 3.1 to the Registrant's Registration Statement on Form SB-2 filed on August 18, 2000. (4) Incorporated herein by reference from Exhibit 3.2 to the Registrant's Registration Statement on Form SB-2 filed on August 18, 2000. (5) Incorporated herein by reference from Exhibit 2 to the Schedule 13D filed on July 2, 2002 by LCG Capital Group, LLC. II-7
- ADTR Dashboard
- Filings
-
SB-2 Filing
Alliance Distributors Holding (ADTR) Inactive SB-2Registration of securities for small business issuer
Filed: 19 Jul 02, 12:00am