10KSB40 1 d10ksb40.txt FORM 10-KSB ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ANNUAL REPORT ON FORM 10-KSB [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 Commission File Number 0-6106 UNITED LEISURE CORPORATION (Exact name of registrant as specified in its charter) Delaware 13-2652243 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 1990 Westwood Boulevard, Penthouse Los Angeles, California 90025-4650 (Address, including zip code, of principal executive offices) (310) 441-0900 (Registrant's telephone number, including area code) Securities registered under Section 12(b) of the Act: None Securities registered under Section 12(g) of the Act: Common Stock, par value $.01 per share (Title of Class) Check whether the Issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [X] The Issuer's revenues for the most recent fiscal year were $22,779_ The aggregate market value of the Common Stock of the Registrant held by non-affiliates of the Registrant on March _21__, 2002, based on the closing price of the Common Stock as quoted on the OTC Bulletin Board on such date, was approximately $_4_ million. The number of shares of the Registrant's Common Stock outstanding as of March 21, 2002 was __20,511,375_________ shares. DOCUMENTS INCORPORATED BY REFERENCE Transitional Small Business Disclosure Format (Check one): Yes [_] No [X] ================================================================================ UNITED LEISURE CORPORATION ANNUAL REPORT ON FORM 10-KSB INDEX
Page ---- PART I. ------- ITEM 1. Business............................................................................ 3 ITEM 2. Description of Property............................................................. 10 ITEM 3. Legal Proceedings................................................................... 10 ITEM 4. Submission of Matters to a Vote of Security Holders................................. 11 PART II. -------- ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters............... 11 ITEM 6. Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................... 11 ITEM 7. Financial Statements................................................................ 18 ITEM 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............................................................ 18 PART III. --------- ITEM 9. Directors, Executive Officers, Promoters and Control Persons of the Registrant; Compliance with Section 16(a) of the Exchange Act................................... 18 ITEM 10. Executive Compensation.............................................................. 21 ITEM 11. Security Ownership of Certain Beneficial Owners and Management...................... 22 ITEM 12. Certain Relationships and Related Transactions...................................... 23 ITEM 13. Exhibits and Reports on Form 8-K.................................................... 24 Signatures................................................................................................. 26
ii PART I This Annual Report on Form 10-KSB includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Exchange Act of 1934, as amended. These include, among others, the statements about United Leisure's plans and strategies under the headings "Business" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." When used in this document and the documents incorporated herein by reference, the words "believes," "expects," "anticipates," "intends," "plans," "estimates," or similar expressions are intended to identify, in certain circumstances, forward looking statements. Forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties, and other factors, some of which are beyond the Company's control, are difficult to predict and could cause actual results to differ materially from those expressed in forward-looking statements. Although it is not possible to itemize all of the factors and specific events that could affect the outlook of a technology company like ours operating in a competitive environment, factors that could significantly impact expected results include: the acceptance of our technology; the effect of national and local economic conditions; the Company's outstanding indebtedness; the loss of key employees; competition from technologies developed by other companies; the ability to attract and retain employees; and the ability to identify and consummate relationships with strategic partners, as well as risks set forth in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Factors That Could Impact Future Results." Although United Leisure believes that its plans, intentions and expectations reflected in or suggested by such forward looking statements are reasonable, it cannot assure that such plans, intentions or expectations will be achieved. Actual results may differ materially from the forward-looking statements made in this Annual Report on Form 10-KSB. ITEM 1. BUSINESS Overview Through our subsidiary, United Internet Technologies, Inc. ("UIT"), we are engaged in the business of developing technologies that allow a wide range of electronic devices, such as smart toys, medical devices, household and business appliances, and consumer electronics, to communicate and be controlled locally, when connected to a computer, or over the Internet and over other digital systems, such as cable, television and wireless networks. We have developed several proprietary technologies: (1) Intelligent Control Interactive Technology (TM) ("I-C-IT(TM)") ("software"), (2) Digitally Integrated Video Overlay (TM) ("Divo(TM)") ("software"), and (3) Fiber Optic based bar code scanning technology. We also have acquired technology from Andy Rifkin's company, JED Development / Gorilla that enables our smart toys to be completely wireless from the computer. Our technologies enable businesses to transition their traditional product lines into the interactive world. Our objective is to create solutions for specific business sectors by customizing our I-C-IT platform, allowing our technologies to be embedded in a wide range of electronic devices. Our strategy is to form relationships with top tier companies to speed the delivery of our technologies to the market. Through our technologies, we offer the opportunity to create best-of-breed "smart" products on a proven technology platform. We have branded our I-C-IT platform under the slogan "We Put the Smart in Smart Devices. "(TM) Our Solutions I-C-IT I-C-IT is a proprietary platform of hardware and software for networking devices through various digital delivery systems such as the Internet, cable, television and wireless networks. Devices empowered with I-C-IT technology become "networkable." This means that these devices can communicate with the user and/or other I-C-IT enabled devices and be accessed and controlled by the user or other devices from a remote location. I-C-IT enabled products are built to function in low bandwidth environments suitable for consumer markets 3 I-C-IT enabled devices can communicate with the user and/or other I-C-IT enabled devices and become accessible and controllable from any place in the world through the Internet, wireless and broadcast networks. I-C-IT enabled devices can receive commands, transmit data or even become a transmitter of human communication. The following examples illustrate how I-C-IT technology may be applied to enable devices: . Transmission of data: For example, a user can measure his or her blood pressure with an I-C-IT enabled medical monitoring device at home and transmit the results in real-time to a healthcare professional anywhere in the world. A healthcare professional can monitor and record a patient's blood pressure while the patient is at home and the doctor is at the office. . Transmission of human communication: I-C-IT enabled toys take on traits of Artificial Intelligence. Toys can communicate with other toys all over the world. Users can control I-C-IT enabled toys at home and also instruct other I-C-IT enabled toys to move and speak in real-time. The toys become transmitters of human communication and behavior. . Broadcast communication and control: Users can instruct and control home and office appliances remotely from anywhere in the world through the Internet, the personal digital assistant (PDA) or cell phone. For example, while watching your favorite cooking show on television, I-C-IT technology will send instructions, cooking time, and temperature to the oven. Simple Interface for Complex Functionality UIT creates user-friendly interfaces for devices as they become more complex. The I-C-IT platform can be used in conjunction with a wide range of existing products. By embedding the I-C-IT technology into existing devices a new, more intelligent product generation is created. I-C-IT enabled products are designed to function in both low and high bandwidth environments and are targeted at the mass consumer market. Interactive Entertainment Applications of I-C-IT We have targeted the interactive entertainment market for the first application of our I-C-IT platform. We have developed prototypes of interactive smart devices which are able to connect, communicate and be controlled through the Internet, game consoles, wireless devices, DVDs and CDs, cable, broadcast signals and set top boxes. These devices can also be equipped with a web cam, enabling the user to see the reaction of his or her friend, enhancing the interactive experience. It is the Company's strategy to form relationships with media companies to obtain the rights to characters to develop I-C-IT enabled devices for the interactive entertainment space. We are pursuing strategic relationships with companies in the media and Internet sectors to exploit opportunities to create I-C-IT enabled devices based on well- known characters, such as those from movies, cartoons, comic books and television shows. By creating Internet enabled devices that can be controlled and communicate through chat rooms, we believe we are offering a very strong value proposition to companies looking to build communities on the Internet and reduce overall churn rates, which is the rate at which people drop off from visiting a particular site or stop subscribing to a particular online service. We have chosen to apply our I-C-IT technology for the creation of smart toys and corresponding interactive software because of the strong demand this market exhibits for smart toys with a higher degree of Internet enabled functionality and the demand by portals to attract and retain a younger demographic. The company has the license for the Terminator 2 Endoskeleton. We unveiled the device at the International Toy Fair in New York City in February 2001. The product generated substantial interest from retailers; however, the product price range was not commercially viable in mass quantities. During the balance of 2001 we addressed that problem and have created products with substantially the same features and additional features for significantly less cost. In April of 2001 we entered into a license agreement with Warner Bros to create a line of these smart toy products and prepare them for sale and distribution for 2002. We are currently meeting with retailers and manufacturers in an effort to bring these newer, less expensive products that are far less expensive than the original technologies to the market. Healthcare Applications of I-C-IT We have also developed prototypes of I-C-IT enabled medical monitoring devices that are able to record, monitor and transmit vital sign data online through a healthcare portal. We are actively seeking strategic partners within the medical device industry to bring to the market a line of I-C-IT enabled medical devices for use in the home setting, such as blood pressure monitors and blood glucose analyzers. Divo(TM) 4 Digitally Integrated Video Overlay(TM) (Divo(TM)) is a technology that allows high-quality video to be delivered over the Internet while connected with a standard dial-up telephone line. Divo(TM) files are activated by a server that can instruct any computer's CD-ROM or DVD-ROM drive and have it activate video files that have been stored locally on a CD-ROM or DVD-ROM. This process integrates video material into a website. Once the Divo(TM) software has been downloaded to the personal computer, the video content can be updated by passive download or through the distribution of additional CD-ROMs/DVDs. Divo(TM) technology enhances the web presentation experience and we believe that it is suitable for the entertainment, travel, shopping, corporate and educational markets. This Divo(TM) technology enhances our Parallel Addressing Video (see below) technology by allowing video that is distributed and controlled through Parallel Addressing Video technology to be integrated within a Web page. This integration allows for special effects and an active video to be played and controlled within a live web page using a combination of video and fixed Web design tools and technologies. We believe combining these innovations with full motion 30 frame-per-second broadcast quality video results in a more multimedia enhanced Web page than those using traditional static elements and streaming video. For example, using Digitally Integrated Video Overlay technology, a host can appear in full motion video on the Web page to educate or entertain the user. This technology allows the host in the video to appear as an actual part of the web site although two different sources are involved. Digitally Integrated Video Overlay technology also provides functions that allow video to be combined seamlessly within the user's own Web browser software. Like Parallel Addressing Video, Digitally Integrated Video Overlay technology is designed to work with popular browsers from both Netscape Communication Corporation and Microsoft Corporation. In the past, we have generally licensed the Divo(TM) technology to large customers as part of turnkey projects custom-designed for each individual customer. For instance, we licensed an application of the Divo(TM) technology for television to NBC, an application of the technology for wrestling and related activities to World Championship Wrestling, Inc. and travel-related applications of the technology to Netcruise.com, Inc. (formerly known as Genisys Reservation Systems, Inc.). We believe our solutions allow businesses to provide superior video functionality in combination with the Internet, provide a unique experience to consumers, help drive greater volumes of traffic to their Web sites and ultimately create greater value. Travel. We developed an application of our Parallel Addressing Video technology called NetCruise (TM) that allows anyone to book travel, including cruises, hotels, car rental and airline tickets from a one-stop shopping Web site at netcruise.com. In July 1998, we licensed NetCruise, together with all other travel-related applications of our Parallel Addressing Video technology, to a wholly owned subsidiary of NetCruise, formerly Genisys Travel Reservations, Inc. In June 1998, our wholly owned subsidiary, United Internet Technologies, Inc., granted to NetCruise Interactive, Inc., a wholly owned subsidiary of NetCruise, an exclusive, worldwide and perpetual license for travel related applications of certain interactive technology. In addition, we sold to NetCruise certain intellectual property and computer equipment for certain consideration consisting of stock and warrants of NetCruise. On April 24, 2000, the Company and NetCruise restructured the agreements they originally entered into in 1998 and which were subsequently amended in 1998 and 1999. In the restructuring, completed on April 24, 2000, UIT provided a revised and updated PAV software and technology license to NetCruise. UIT sold 1,500,000 shares of NetCruise's common stock in a private transaction for a cash purchase price of $600,000 to Mr. Joseph Perri, NetCruise's principal shareholder, and agreed to the NetCruise's cancellation of warrants to purchase an aggregate of 1,600,000 shares. In this connection, NetCruise issued to UIT new privately placed warrants to purchase up to 400,000 shares of common stock for a period of five years at an initial purchase price of $1.00 per share. NetCruise has since ceased operations. In July 2000 we formed a subsidiary in Germany, Interactive Internet Technologies GmbH (IIT). We have invested $192,859 in, and contributed a non- exclusive license to market our technologies in Europe to IIT and we retained a 66.67% ownership interest. IIT raised total capital of $964,496 in July 2000. IIT is primarily engaged in the marketing of our Divo technology in Europe. Parallel Addressing Video This technology, which is not a broadcast, downloaded or streaming technology, uses pre-recorded audio and video that is distributed to the user on a CD-ROM or DVD-ROM. The technology equips Websites with software that allows the Web site to interact with a user's Internet browser and activate the CD-ROM or DVD-ROM. The result is a 30 frame-per-second broadcast quality, full-motion, full-screen video and audio on the user's computer, while the user is connected to the Internet. 5 Unlike traditional CD-ROM or DVD-ROM multimedia products, such as interactive encyclopedias or magazines, which are completely controlled by the user from their computer, with our technology the display of the content is completely controlled from the Web site. Various security techniques allow the creator of the pre-recorded material to control when and how much of the material is available to the user. For example, a Web site administrator could pre-record more video than would be available on the Web site at any one time, distribute it on a CD-ROM or DVD-ROM and make it accessible by the user either in a time- released fashion or with proprietary security codes. The user's video player communicates with the Web server that creates a secure encryption key to unlock the video. Security and time-control functions exist on both the Web site and the distributed medium that allow the video to be delivered to the user in the manner that the content provider desires. Encryption keys also allow the owners of the Web sites to protect against unauthorized use or distribution of their video content. In addition, Parallel Addressing Video technology permits all information other than the actual pre-recorded material to be changed on the Web site. This results in a more diverse interactive experience that can change as frequently as the Web site administrator desires. As a result, the Web site content remains current and the context in which the material is viewed can be updated to maintain the user's interest. This product has been married into the DIVO product and now both products will be marketed as one. Shopping Pal Shopping Pal is a device that is about the same size as a woman's lipstick container. It connects to almost any cell phone on the market. The consumer doesn't need a special phone, not even a WAP phone. The only requirement for the Shopping Pal is that the cell phone has a headset jack. The Shopping Pal does the rest. It does not change the software in the phone. With the Shopping Pal you can buy products advertised in magazines, newspapers, catalogs or on billboards. The advertiser would only have to place their bar code anywhere in the advertisement. The consumer can then aim the Shopping Pal at a bar code in the magazine, and you get wirelessly connected to purchase the product. In-Store shopping - Purchase products and Compare prices. Walk into any retail store, for example, Wal Mart, or Best Buy, and find a product you are interested in purchasing. Aim Shopping Pal at the bar code, and your cell phone will autodial into a shopping portal and immediately tell you on your cell phone how much the product would cost if you purchased the product on-line... if the price is better than the retail price in the store, you may purchase the product directly from your cell phone. Pay your bills - Most bills contain bar coding. You can scan your bills using Shopping Pal and your cell phone, connect to almost any banking system and directly pay your bills simply and quickly by phone. Walk into any record store and listen to music before purchasing. Choose a music CD, grab your cell phone, aim Shopping Pal at the CD barcode, and listen to audio samples from the CD on your cell phone. Our proprietary technology converts bar codes into audio tones...enabling any cell phone to work with Shopping Pal The product will be marketed to cell phone manufacturers, cell phone service providers and internet shopping portals. Industry Background Networked Home and Device Sector The networked home will move from today's first generation products, such as basic PC adapter cards and simple gateways, to tomorrow's, where connectivity technology is embedded in recognizable devices with which non-technical users are familiar and comfortable. New connectivity-based services, enabled through home networking technology, will help drive growth in this market. Additional voice lines, home management and monitoring, as well as new value added entertainment services, are predicted to create a $3 billion connectivity services market by 2004. Interactive Gaming and Smart Toy Sector Smart toys are physical toys that use-computing power to create an enhanced play experience and include toys that: . connect to the Internet, Personal Computer, and Television - Networked Toys . contain electronics that enhance their play value - Interactive Toys We believe that smart toys will be the significant growth engines of the toy industry in the future. Manufacturers credit the decreasing cost of technology and the increasingly sophisticated tastes of kids as major success drivers. 6 We believe our smart toys will be the most interactive toys created to date and have the potential to be positioned as the market leader in the smart toy industry segment. Toys currently introduced to the market with a significantly reduced degree of interactive functionality have already generated impressive sales, such as Furby, with over 40 million units sold worldwide to date, and Poo-Chi, with over 25 million units sold worldwide. We believe this is a strong indicator of how successful our toys will be. We believe our toys that are Hollywood characters and have enhanced functionality, connectivity and wireless communication capability have significant market advantages over these non-connective interactive smart toys. Additionally, our online, networked functionallity provides us with additional online revenue streams such as downloads. We intend to aggressively target the 30 million people age 18 and under in the U.S. who are currently online and the 60 million people in the U.S. who use instant messaging and chat. Our goal is to be a leader in the rapidly growing smart toy segment of the toy industry. Smart toys are the growth engine of the $22 billion toy industry. While total toy sales decreased 1.4% in 2000, smart toy sales rose 98% in 2000 and are rapidly approaching the $1 billion mark according to the NPD group, a leading market intelligence provider. In its last report on the smart toy industry Forrester Research reports the total market for networked smart toys is forecast to grow rapidly, reaching $1.9 billion in sales by 2002. It is estimated that 16.5 million units will be shipped by 2002. This implies that almost every second child in the US will have a networked toy by 2002. In the top selling toys of 2000, in the $20.00 and over the category, ranked by units sold, the top seller was the Poo-Chi Robotic Dog, manufactured by Tiger Electronics. The fourth best seller was the Tekno Robot Dog, manufactured by Manley Toy Quest. Both of these "interactive pets" had a limited degree of interactive functionality compared to our smart toys. A substantial part of the value proposition of networked toys is the promise of renewable media content through web downloads and an online virtual environment. This ensures that play activities are continually unique and valuable, adding to the appeal of the toy. This also allows the toy to "develop" in conjunction with the cognitive abilities of the child. Therefore, a PC, Internet, or TV-based environment that captivates the imagination of a child is likely a key success factor to a networked toy. During the year we developed and added a line of smart toys that can be retailed for approximately $19.99. These new smart toys include Licensed Characters from Looney Tunes and three other products that we developed internally. One is "Bradford the Bear", the second is "Rusty the Robot" and the third is a "Skater Dude" These toys have multiple functions; 1. When you are connected to an Instant Messaging environment (CHAT), the friend that you are chatting with on-line can control your toy, make it speak and make it move...(all in real time) so if I type...."how are you?" The toy in your house moves and says, "How are you"...these can work anywhere in the world. 2. These smart toys play on-line and off-line games and can be upgraded to do many different functions. They can educate, read stories and sing songs. 3. There are no wires, no cables that need to plug to the computer. 4. The toys can also be remote controlled with cell phones. We can manufacture these toys for about $6 in China. The technology is proprietary and it is based on our proprietary technology as well as technology we acquired from Andy Rifkin and JED Development / Gorilla. Internet Video Delivery Currently there are several technologies and methods to communicate and retrieve various types of information from Internet resources. The format for retrieving much of this information is satisfactory, but the length of time that it takes to transfer some audio and video content is inconvenient or unacceptable to many users. Despite these improvements, there are significant limitations with streaming technology, especially with respect to the quality of the video images. Streaming technology is limited by available bandwidth. For example, a video streaming at 28.8 kbps will produce a jumpy or choppy video that the viewer perceives as less than full motion. In addition, streaming video is displayed in a small window on the viewer's computer screen and enlarging the image further reduces its quality. Internet congestion or losses in Internet connection may also interrupt audio and video streams. These factors can result in an unsatisfactory experience for users of streaming technology. Increased transmission speeds will enhance the quality of the technology, but industry analysts disagree as to the time frame in which transmission speeds sufficient to overcome the current limitations will be in use. 7 Marketing In November 1999, we entered into an agreement with Teen People Magazine to design and produce a 12-page "magalog" of Nordstrom fashions, accessories and beauty products and an interactive CD-ROM. The mini-catalog served as a self-mailer for the CD-ROM. In addition, we included Internet Service Provider software as part of the package. Approximately 600,000 CD-ROMs were distributed in March 2000. We received revenues of approximately $700,000 in the first quarter of 2000 in connection with this agreement. This was the only source of revenue for our Internet technology business in 2000. In February 2000, we entered into an agreement with Liquid Audio, Inc. under which Liquid Audio granted us a limited, non-exclusive, worldwide, royalty-free license to reproduce, market and distribute Liquid Audio products along with the distribution of our proprietary software. The agreement continues until terminated upon 30 days written notice by either party. We have not received any revenues from this agreement. In March 2001, we entered into a joint marketing agreement with Kodak under which both Kodak and us will jointly create a Divo / Programmable - CD Rom demonstration CD and will dedicate creative marketing and management personnel to the project. The demonstration CD and marketing material was completed in 2001 and Kodak is currently marketing the DIVO technology with it's technology throughout the US. Research and Development During the first several years we devoted most of our internal research and development resources to making advances in our interactive technology platform. We were continuously involved in the refinement, enhancement, and expansion of our operating and application capabilities. We have developed prototypes of all our new proprietary devices for many different industry sectors. Research and Development expenses were approximately $782,000 and $1,091,500 in the fiscal years ended December 31, 1999 and December 31, 2000. In 2001 we spent approximately $1,410,000 to complete the technology development stage and prepare to shift from an R&D based company to a technology marketing and licensing company. Patents and Trademarks Since inception the company has filed for patent protection on all of its technologies. Particularly noteworthy are what we believe to be the three most important technologies for the company which have been issued or approved for issuance are: 1. The DIVO technology (issued) 2. The Medical Monitoring Technology (issued) 3. The I-C-IT Technology (approved and Intellectual Property rights, and the fact that such efforts have been highly successful. With respect to the six applications remaining, we are still waiting for Office Actions for all but one of these cases. However, given that they, for the most part, depend upon the core technology of the company, we believe that most, if not all, of the presently pending applications will support claims, which will be allowed to proceed to issuance. Below is a comprehensive list of the company's patent filings.
--------------------------------------------------------------------------------------------------------------------------------- Matter Title Status Filed Issued Remarks --------------------------------------------------------------------------------------------------------------------------------- P002 METHOD AND APPARATUS FOR MERGING MULTIMEDIA DATA WITH Issued 7/23/97 11/30/99 TEXT INFORMATION --------------------------------------------------------------------------------------------------------------------------------- P003 METHOD AND APPARATUS FOR COMBINING VIDEO DATA WITH Pending 5/14/99 8/14/2001:Watch for STATIC WEB PAGE DATA first office action --------------------------------------------------------------------------------------------------------------------------------- P005 METHOD AND APPARATUS FOR CONTROLLING ANIMATRONIC Pending 8/12/99 8/22/2002:Watch for DEVICES OVER THE INTERNET next office action --------------------------------------------------------------------------------------------------------------------------------- P005x1 METHOD AND APPARATUS FOR CONTROLLING AN ANIMATRONIC Pending 12/2/2000 6/2/2002:Watch for DEVICE IN AN INTERACTIVE GAME ENVIRONMENT first office action --------------------------------------------------------------------------------------------------------------------------------- P005x2 METHOD AND APPARATUS FOR CONTROLLING AN ANIMATRONIC Pending 12/2/2000 6/2/2002:Watch for DEVICE USING A WEB ENABLED CELLULAR PHONE first office action --------------------------------------------------------------------------------------------------------------------------------- P005x3 METHOD AND APPARATUS FOR CONTROLLING AN ANIMATRONIC Pending 12/2/2000 6/2/2002:Watch for DEVICE USING A WEB ENABLED PERSONAL DIGITAL ASSISTANT first office action --------------------------------------------------------------------------------------------------------------------------------- P005x4 METHOD AND APPARATUS FOR CONTROLLING AN ANIMATRONIC Pending 12/2/2000 6/2/2002:Watch for DEVICE FROM A WEB PAGE first office action --------------------------------------------------------------------------------------------------------------------------------- P006 METHOD AND APPARATUS FOR CONTROLLING MEDICAL Issued 8/12/99 10/16/01 MONITORING DEVICES OVER THE INTERNET --------------------------------------------------------------------------------------------------------------------------------- P011 METHOD AND APPARATUS FOR REMOTE DATA Pending 1/16/2001 7/9/2003 watch for first ---------------------------------------------------------------------------------------------------------------------------------
8 --------------------------------------------------------------------------------------------------------------------------------- COLLECTION OF PRODUCT INFORMATION USING A COMMUNICATIONS office action DEVICE --------------------------------------------------------------------------------------------------------------------------------- P012z METHOD AND APPARATUS FOR CONTROLLING ANIMATRONIC Pending 6/12/2001 6/12/2002:Deadline to DEVICES file utility application based on provisional ---------------------------------------------------------------------------------------------------------------------------------
Competition There is significant competition in the development of technologies designed to connect external devices. Sun Microsystems has developed Jini, which provides simple mechanisms that enable devices to plug together to form an impromptu community. Jini was launched in January 1999, when Sun demonstrated how a laptop, printer and digital camera were able to communicate with one another. Microsoft has developed UPnP Universal Plug and Play (UPnP), the next phase of Microsoft's seven-year Plug and Play initiative. UPnP makes it easier for consumers to install and configure their intelligent consumer appliances and devices on a home or small-business network. UPnP also makes it easier for those products to work together on a network and to share resources from any device in the home or business. For example, a homeowner with two PCs and one high-speed Internet connection can share Internet access across both PCs. Major companies pledging to produce UPnP-compatible products include Intel, Hewlett-Packard Co., Compaq and AT&T Corp. There is significant competition in the interactive gaming and smart toy area from established toy companies, video game developers, video game console developers and interactive software developers. There is significant competition in the online healthcare monitoring market from established healthcare companies, including Bayer and Johnson & Johnson as well as from newer companies such as Stayhealthy.com, DiabetesWell and Life Chart. There is significant competition in the evolving market for delivery of video content on the Internet. We have approached the delivery of video content using different technology than that of our competitors. Our competitors, however, have substantially greater financial, marketing, personnel and other resources than we do. There is also significant competition for content development and broadcasting on the Internet. Our largest competitors in this area are broadcast.com and RealNetworks, Inc. These and other competitors in the content development and broadcast area, also have greater resources than we do. We expect competition in this area to remain strong and to increase further. Government Regulation It is likely that new laws and regulations will be enacted in the United States and elsewhere covering a wide range of Internet-related issues. These could include broadcast license fees, music licensing, copyrights, privacy, pricing, sales tax and characteristics and quality of Internet services. It is also possible that laws could be passed that would apply to us in the areas of content, network security, encryption, privacy protection, electronic authentication or digital signatures, illegal or harmful content, access charges and re-transmission activities. If certain laws or regulations apply to the type of service we provide, we could be exposed to significant liabilities in connection with the content on our Web sites. We could also have liability for the content on the Web sites of our licensees. If restrictive laws or regulations are adopted, it could also slow Internet growth and increase our cost of doing business. There are also uncertainties about how existing laws in other areas apply to the Internet. Some of these laws deal with issues like property ownership, libel, taxation, defamation and personal privacy. The majority of these laws were adopted before the widespread use of the Internet and do not address the unique nature of the Internet and related technologies. In 1996, Congress enacted the Communications Decency Act of 1996. Although the Supreme Court ruled that sections of this legislation that would have imposed criminal penalties for the distribution of indecent material to minors over the Internet were unconstitutional, it is possible that similar legislation could be adopted and upheld in the future. Even though we do not distribute content that the Communications Decency Act would consider illegal, it is not possible to predict how any future laws or regulations regarding indecency would be interpreted. If Internet growth is slowed as a result of restrictive legislation, the demand for our technology could be adversely impacted. We do not require our licensees to indemnify us against these potential liabilities, nor do we have insurance to cover such liabilities. If we are considered to be a distributor of Internet content, we could face potential liability for negligence, copyright, patent, trademark, defamation, indecency and other claims. These types of lawsuits have been brought against Internet content distributors. In addition, we could be liable for the broadcast content or unauthorized duplication of broadcast 9 content. We do not require our licensees to indemnify us against these potential liabilities, nor do we have insurance to cover such liabilities. Employees As of February 28, 2002, we had eight full-time employees and two employees working on a consulting basis. None of our employees are covered by a collective bargaining agreement. Discontinued Operations In October 2000, we determined to divest all of our remaining non-technology businesses. We concluded that these operations were not strategically compatible with our core internet-technology business. We believe that the opportunity in our core business requires singular focus of management time and resources. As a result, our board of directors decided to divest our non-core businesses. These non-core businesses consist of the Planet Kids business and our investments in Grand Havana, HEP II Limited Partnership and certain other investments. We have closed all three children's recreational facilities two of them have been leased and the company has no further lease obligations on those two. The company expects to lease the remaining facility within the next 90 days. The company is liable for the payments of that lease untill 2005. Before February 1997, our primary business was to act as a developer and manager of facilities for recreational and corporate activities. As part of our decision to reorient our business to developing and licensing our technology, we closed some of these facilities. In August 1999, we sold real property located in El Cajon, California, which was previously used for some of our recreational and corporate activities. In October 1999, we sold our 50% interest in real estate holdings in Las Vegas, Nevada. See Part II, Item 6, "Management's Discussion and Analysis of Financial Condition and Results of Operation" and "Financial Statements - Note 2 to Notes to Consolidated Financial Statements." ITEM 2. DESCRIPTION OF PROPERTY. We maintain our principal executive offices in approximately 6,000 square feet of leased office space in Los Angeles under a lease that expires in February 2005. The lease was entered into with 1990 Westwood Boulevard, Inc., which is owned partially by Harry Shuster, the former Chairman of the Board, President, Chief Executive Officer, Chief Financial Officer and a principal stockholder of United Leisure. Harry Shuster is also the father of Brian Shuster, our Chairman of the Board, President and Chief Executive Officer. United Leisure believes that the rent and other terms of the lease are no more favorable to the lessor than could have been obtained in a similar building in the same area from an unrelated lessor. See Item 12, "Certain Relationships and Related Transactions." We believe our existing leased properties are adequate for our current needs. We also believe that all of the properties are adequately covered by insurance. ITEM 3. LEGAL PROCEEDINGS. On January 17, 2001 we announced that all litigation with Broadbridge Media, LLC and Hyperlock Technologies, Inc. had been settled, with all claims and counterclaims voluntarily dismissed. The settlement specifically covered the patent litigation between the parties under the jurisdiction of the United States District Court for the Northern District of Illinois, Eastern Division. Specifically, the cases voluntarily dismissed were Case No. 99C 3778, Hyperlock Technologies, Inc. v. United Internet Technologies, Inc., and Case No. 00 C 2311, United Leisure and United Internet Technologies v. Broadbridge Media, LLC and Hyperlock Technologies, Inc. On or about February 16, 2001, we terminated the employment contracts of Sonja Mikic and Chris Riley. It is the Company's position that no further compensation or benefits are due under those contracts. On or about February 28, 2001, Sonja Mikic and Christopher Riley (Plaintiffs) filed a lawsuit against us, UIT, and Brian Shuster (collectively, Defendants) in the Superior Court of the State of California for the County of Los Angeles, West District. Plaintiffs asserted causes of action for breach of written employment, tortuous breach of contract, and tortuous interference with contract. Plaintiffs seek compensatory damages in an unspecified amount against Defendants, punitive damages, attorneys' fees, costs of suit, and pre- and post- judgment interest as allowed by law. Plaintiffs essentially allege that their contracts were terminated without cause and that UIT and United Leisure are in breach of the employment agreements by not providing the benefits that would accrue to each Plaintiff in the event his or her employment was terminated without cause. Separately, Plaintiff's purported rights with respect to their ownership of stock options in UIT also may be at issue. We believe this lawsuit is without merit in that the employment agreements were 10 terminated for cause, thereby eliminating Plaintiff's rights to additional benefits under the agreements. The company is currently engaged in settlement negotiations. In the normal course of business, we are subject to various claims and legal actions. We believe that we will not be adversely materially affected by the ultimate outcome of any of these matters, either individually or in the aggregate. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Our common stock is traded on the Over the Counter Bulletin Board (the "OTC Bulletin Board") under the symbol "UTDL." The following table sets forth the high and low closing prices of the common stock for the quarters indicated as quoted on the OTC Bulletin Board.
2000 2001 High Low High Low First Quarter $13.50 $2.8438 $3.5937 $1.1875 Second Quarter $9.9375 $5.4375 $1.6875 $0.86 Third Quarter $10.00 $3.7812 $0.87 $0.27 Fourth Quarter $5.75 $2.125 $0.59 $0.25
The above quotations represent prices between dealers without adjustments for retail markups, markdowns or commissions and may not represent actual transactions. As of March 21st, 2002, there were approximately 2,303 active shareholders of record of United Leisure common stock. We have never declared or paid any cash dividends on our capital stock and do not anticipate paying cash dividends on our common stock in the foreseeable future. We currently intend to retain future earnings to finance our operations and fund the growth of our business. Any payment of future dividends will be at the discretion of the Board of Directors of United Leisure and will depend upon, among other things, our earnings, financial condition, capital requirements, level of indebtedness, contractual restrictions in respect to the payment of dividends and other factors that our Board of Directors deems relevant. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction Through our subsidiary, United Internet Technologies, Inc. ("UIT"), we are engaged in the business of developing technologies that allow a wide range of electronic devices, such as smart toys, medical devices, household and business appliances, and consumer electronics, to communicate and be controlled locally, when connected to a computer, or over the Internet and over other digital systems, such as cable, television and wireless networks. We have developed several proprietary technologies: (1) Intelligent Control Interactive Technology TM ("I-C-IT/TM/") ("software"), (2) Digitally Integrated Video Overlay /TM/ ("Divo/TM/") ("software"), and (3) Fiber Optic based bar code scanning technology. We also have acquired technology from Andy Rifkin's company, JED Development / Gorilla that enables our smart toys to be completely wireless from the computer. During the period ended December 31, 2001, we spent most of our time and resources in developing and creating working, price competitive prototypes of products utilizing our newer technologies. Toward the end of 2001 we concluded building prototypes of its products and prepared supporting material to market the technology to potential strategic partners. It is the hopes that we will be able to generate revenues from the sale or licensing of its products and proprietary technologies. We focused our resources primarily integrating our technologies to the smart toy business sector. Critical Accounting Policies and Estimates 11 Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to the useful life of the assets, reserve for discontinued operations and reserve for litigation settlement. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in preparation of our consolidated financial statements. Revenue Recognition Revenue is recognized upon delivery of the Technology. For arrangements to deliver the Technology requiring significant modification or customization, revenue is recognized on the percentage-of-completion method. Earnings Per Share Basic Earning Per Share (EPS) is calculated by dividing income available to common stockholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. The computation of diluted EPS is similar to the computation of basic EPS except the denominator is increased to include the number of additional common shares outstanding if the dilutive potential common shares (securities such as options, warrants, convertible securities, or contingent stock agreements) had been issued. In addition, in computing the dilutive effect of convertible securities, the numerator is adjusted to add back (a) any convertible preferred dividends and (b) the after-tax amount of interest recognized in the period associated with any convertible debt. The computation of diluted EPS shall not assume conversion, exercise, or contingent issuance of securities would have an antidilutive effect on EPS. Results of Operations Fiscal Year Ended December 31, 2001 Compared to Fiscal Year Ended December 31, 2000 Net Revenues. For the fiscal year ended December 31, 2001, we had revenues of $22,779 compared to revenues of $712,942 for the fiscal year ended December 31, 2000, a decrease of $690,163 or approximately 97%. The revenues were greater in fiscal 2000 primarily from revenues generated by licensing agreements in connection with interactive CD-ROMs created for Teen People Magazine and Nordstrom stores. In 2001 the company shifted it's focus to developing it's I-C- IT toy technology and did not market the CD-ROM technology as aggressively as it had in the prior year. Operating Expenses. Total costs and expenses decreased to $5,428,139 for the fiscal year ended December 31, 2001 from $ 14,438,430 for the fiscal year ended December 31, 2000, a decrease of $ 9,010,291 or approximately 62%. The decrease is composed of several components including a decrease in personnel, consultant fees, legal, non-cash compensation associated with the issuance of options and overhead. Selling, general and administrative expenses were $1,522,873 for the year ended December 31, 2001 compared to $1,616,832 for the year ended December 31, 2000, a decrease of $ 93,959 or approximately 6%. Non-cash compensation from option grants decreased by $6,147,921 from $6,102,943 to $(44,978) or approximately 101%. Depreciation and amortization for the year ended December 31, 2001 was $202,646 compared to $122,316 for the year ended December 31, 2000, an increase of $80,330 or approximately 66%. For the year ended December 31, 2001, we had a net loss of $5,461,800, including loss from discontinued operations of $465,000 or $(0.27) per share, compared with a net loss of $13,414,554 or $(0. 68) per share for the year ended December 31, 2000. The net loss for the year ended December 31, 2001 is primarily attributable to a decrease in direct operating expenses and stock compensation. Discontinued Operations Fiscal Year Ended December 31, 2001 Compared to Fiscal Year Ended December 31, 2000. Net Revenues associated with discontinued operations. For the fiscal year ended December 31, 2001, we had revenues from discontinued operations of $465,848 compared to revenues of $957,617 for the fiscal year ended December 31, 2000, a decrease of $491,799 or approximately _51_%. The decrease in revenues for fiscal 2001 compared to fiscal 2000 is primarily due to the closing of the Planet Kids facilities. 12 Operating Expenses associated with discontinued operations. Total costs and expenses associated with discontinued operations decreased to $1,167,390 for the fiscal year ended December 31, 2001 from $1,343,825 for the fiscal year ended December 31, 2000, a decrease of $176,435or approximately 13%. The decrease is mainly due to decreased headcount and salaries due to the closing of our Planet Kids facilities. Selling, general and administrative expenses were $37,924 for the year ended December 31, 2001 compared to $53,202 for the year ended December 31, 2000, a decrease of $15,278or approximately 29%. Depreciation and amortization for the year ended December 31, 2001 was $2,505compared to $4,505 for the year ended December 31, 2000, a decrease of $2,000 or approximately 44%. Fiscal Year Ended December 31, 2000 Compared to Fiscal Year Ended December 31, 1999 Net Revenues. For the fiscal year ended December 31, 2000, we had revenues of $712,942 compared to revenues of $240,000 for the fiscal year ended December 31, 1999, an increase of $472,942 or approximately 197%. The increase in revenues for fiscal 2000 compared to fiscal 1999 increase resulted primarily from revenues generated by licensing agreements in connection with interactive CD- ROMs created for Teen People Magazine and Nordstrom stores. Operating Expenses. Total costs and expenses increased to $14,438,430 for the fiscal year ended December 31, 2000 from $3,009,529 for the fiscal year ended December 31, 1999, an increase of $11,428,901 or approximately 380%. The increase is composed of several components including increases in personnel, consultant fees, legal, non-cash compensation associated with the issuance of options and additional overhead . These increases in operating expenses were primarily related to the development of UIT's technologies and prototypes of devices embedded with UIT's technologies, as well as business activities to promote our technologies. Selling, general and administrative expenses were $1,616,832 for the year ended December 31, 2000 compared to $1,127,255 for the year ended December 31, 1999, an increase of $489,577 or approximately 43%. Non-cash compensation from option grants increased by $5,796,443 from $306,500 to $6,102,943 or approximately 1891%. Depreciation and amortization for the year ended December 31, 2000 was $122,316 compared to $28,035 for the year ended December 31, 1999, an increase of $94,281 or approximately 336%. For the year ended December 31, 2000, we had a net loss of $13,414,554 including loss from discontinued operations of $743,915, or $(0. 68) per share, compared with a net loss of $4,118,914 or $(0.27) per share for the year ended December 31, 1999. The net loss for the year ended December 31, 2000 is primarily attributable to an increase in expenses in connection with our Internet technology business. Discontinued Operations Fiscal Year Ended December 31, 2000 Compared to Fiscal Year Ended December 31, 1999 Net Revenues associated with discontinued operations. For the fiscal year ended December 31, 2000, we had revenues from discontinued operations of $957,617 compared to revenues of $1,145,679 for the fiscal year ended December 31, 1999, a decrease of $188,062 or approximately 16%. The decrease in revenues for fiscal 2000 compared to fiscal 1999 is primarily due to the closing of one of the Planet Kids facilities and restructuring the operations of the remaining facilities. Operating Expenses associated with discontinued operations. Total costs and expenses associated with discontinued operations decreased to $ 1,343,825 for the fiscal year ended December 31, 2000 from $ 1,539,997 for the fiscal year ended December 31, 1999, a decrease of $ 196,172 or approximately 13%. The decrease is mainly due to decreased headcount and salaries due to the scaling back of operations at our Planet Kids facilities. Selling, general and administrative expenses were $53,202 for the year ended December 31, 2000 compared to $ 64,400 for the year ended December 31, 1999, a decrease of $ 11,198 or approximately 17%. Depreciation and amortization for the year ended December 31, 2000 was $4,505 compared to $99,984 for the year ended December 31, 1999, a decrease of $95,479 or approximately 95%. Liquidity and Capital Resources We have experienced operating losses in recent years. For the year ended December 31, 2001 we had cash and cash equivalents of $1,645,450 and an accumulated deficit of $43,496,746. Our future capital requirements will depend on various factors including: 1. The length of time that it takes us to restructure and dispose of our remaining children's recreational facilities and the manner of disposition. 2. The length of time it takes us to get products to the market that generate revenues. 3. The need to hire additional marketing staff and technical support staff. 13 We have significantly curtailed all activities that are not directly related to the development and promotion of our core technology business. The result of this management refocus is a substantially reduced expenditure levels budgeted for the year 2002. We have budgeted minimum amounts for the purchase of needed assets and reduced capital expenditures. If we are unable to raise additional funds, when needed, through the private placement of our securities, we may seek financing from affiliated or unaffiliated third parties. Such financing, however, may not be available when and if it is needed, or if available, it may not be available on acceptable terms. If we are unable to sell our securities or obtain sufficient financing to meet our working capital needs and to repay indebtedness as it becomes due, we may have to consider such alternatives as selling or pledging portions of our assets, among other possibilities, in order to meet such obligations. We intend to stop further development of our technologies. The company is transitioning from an R&D model with expensive technology staffing to a technology marketing company. Our primary objective over the next year will be to market the technologies that we developed and refined during the previous years. This may require additional financing from either public or private sources. To accomplish this, we may raise additional capital by borrowing money or through a public or private sale of debt or equity securities. We may not be able to acquire additional financing on favorable terms, or at all. At December 31, 2001, minimum annual rentals under non-cancelable leases are as follows: Year Ending December 31 Leases --------------------------------------------- 2002 $ 180,659 2003 73,374 2004 58,238 2005 9,784 --------------------------------------------- Total $ 322,055 Factors That Could Impact Future Results We Have a History of Losses and May Not Be Profitable In the Future. We have sustained operating losses for the last several years from our traditional business of children's recreational activities. For the year ended December 31, 2001, we had a net loss of $5,461,800 and an accumulated deficit of $43,496,746. In addition, we have significant working capital and research and development requirements and these needs are expected to continue to be significant. Our Business May Lack Sufficient Diversification and May Affect Our Ability to Spread the Risk of Any Downturn in the Technology Sector. Our primary business in 2001 was Research and Development of our hardware and software. These activities are conducted through our wholly owned subsidiary, United Internet Technologies, Inc. (UIT). Our interactive technology business has been our primary business focus since 1998 and our operations from that business are limited in scope and duration. In October 2000, our Board of Directors decided to discontinue our other businesses of (i) children's recreational activities and (ii) making investments in affiliated companies. We intend to dispose of our remaining children's recreational facilities. Therefore, our business is not sufficiently diversified to spread the risk of any downturn in the growth of the Internet or in the development and licensing of our interactive Internet technology. Our Prospects in the Technology Sector Are Difficult to Forecast Because of Limited Operating History in our Technology Business. Our technology subsidiary, UIT, was formed to develop and market our proprietary interactive Internet technology and related products. So far, UIT's operations have been limited to developing, marketing and licensing a small number of applications of our technology. Our success in 2002 depends upon licensing, or selling the technologies developed. If our technologies are not successfully licensed or sold, it would seriously harm our business, results of operations and financial condition. Future Revenues Are Uncertain. 14 We cannot forecast revenues from our technology business accurately. This is because of the limited operating history of our technology business and the rapidly developing nature of the Technology market. The market for our technology is uncertain. We Will Need Additional Financing Through UIT, we intend to enter into additional license agreements for our technology. We expect that these license agreements will generate revenue for UIT. However, it is not known whether we will be successful in entering into additional license agreements. If license agreements and other arrangements do not generate enough revenue, we will need to raise money. Selling our stock, stock of UIT, or other securities in public or private offerings would probably do this. It is not known whether we would be successful in raising additional money in the future. Depending upon how much money we raise, UIT may have more or less ability to expand the sale or licensing of our technology business rapidly. If we are unable to generate revenue from our business operations or raise additional funds when needed or on favorable terms, UIT may not be able to continue developing our technology business. That would seriously harm our business, results of operations and financial condition. Future Strategic Alliances Involve Risk for Us. To be successful, we will need to enter into strategic alliances and license agreements with companies in the media, entertainment and Technology sectors. However, we do not know if we will be able to enter into any such agreements or if any agreements entered into will be favorable to us. If additional agreements are not entered into, the cost of introducing new applications of our technology in the marketplace may be prohibitive under our current business plan and capitalization. Unanticipated Technological Problems May Affect Our Ability to Meet Our Release and Delivery Schedules and Adversely Affect our Overall Financial Condition. All of our products undergo thorough quality assurance testing prior to release. But, we cannot anticipate all of the technological and other issues that may arise in connection with our future product development. We may be unable to meet delivery commitments if technological or other development issues arise in connection with our continued product development and enhancement. Our reputation may suffer if we fail to meet our release and delivery schedules or if our products upon release do not perform as expected. We cannot assure you that we will be able to fix any new problems that arise in a timely or cost effective manner, or at all. If unexpected problems continue to arise, and we are unable to resolve them timely or at all, we may be unable meet our release and delivery schedules, our reputation may suffer, it may become more difficult forming strategic alliances with distribution and other partners, and our results of operations and financial condition could be materially and adversely affected. Our Technology May Not Be Commercially Accepted, Which Will Adversely Affect Our Revenues and Profitability. Our ability to enter into the online entertainment and smart toy sectors, as well as the healthcare and medical monitoring device sectors, establish brand recognition, and compete effectively depend upon many factors, including broad commercial acceptance of products embedded with our technology. The commercial success of products embedded with our technology depends upon the quality and acceptance of other competing products and technologies, capabilities of our competitors to provide more widely accepted products and technologies, our ability to secure licensing agreements with third parties, general economic conditions and other tangible and intangible factors, all of which can change and cannot be predicted with certainty. We cannot assure that new products embedded with our technology will achieve significant market acceptance or will generate significant revenue. If we are unable to license our technology to third parties or the marketplace does not broadly accept our products embedded with our technology, our results of operations and financial condition could be materially and adversely affected. Our Growth and Operating Results Will Be Impaired if the Internet and Online Commerce Industries Do Not Continue to Grow. Our ability to earn revenue from our Internet products depends in part upon increased acceptance of the Internet as a medium for "e-commerce" by consumers. The Internet may not develop into a viable commercial marketplace as quickly as some industry estimates suggest. E-commerce on the Internet may not develop to the extent anticipated. Rapid growth and interest in the Internet and other online services is a recent development. We do not know if the use of the Internet for e-commerce will continue to develop or that a large enough number of consumers will use the Internet and other online services for e-commerce. Because global commerce on the Internet is still new and evolving, we cannot predict the extent to which the Internet will be a viable commercial marketplace. In addition, there are several factors that could have an impact on the growth of e-commerce. These include: 15 . security . reliability of service . cost of Internet access . how easy it is to use the Internet or e-commerce features on the Internet . how easy it is to gain access to the Internet . quality of service . delays in developing new standards and protocols to handle increased Internet traffic . increased governmental regulation Slow growth of e-commerce on the Internet for these or any other reasons could have a material adverse effect on our business, results of operations and financial condition. We depend upon Web browsers, Internet Service Providers and Online Service Providers to allow Internet users to access UIT's own Web sites and Web sites of UIT's licensees. From time to time, users may experience difficulties accessing or using Web sites due to system failures or delays, which are not related to UIT's systems. These difficulties may negatively affect audio and video quality or result in interruption of video delivery. Any significant delays or failure of service could reduce the attractiveness of our technology and applications to our licensees, users, advertisers and content providers. Any of these events could seriously harm our business, results of operations and financial condition. Our Technology Business Faces Security Risks. Even though we employ security measures, UIT's Web sites and the Web sites of UIT's licensees may be vulnerable to unauthorized access, computer viruses, Trojan horses, worms and other disruptions. A party who is able to circumvent security measures could misappropriate proprietary information or cause interruptions in UIT's or its licensees' Internet operations. Internet Service Providers and Online Service Providers have experienced, and may in the future experience, interruptions in service as a result of the accidental or intentional actions of Internet users, their own current and former employees or others. We may be required to spend significant capital or other resources to protect against the threat of security breaches or to solve problems caused by these sorts of security breaches. Although UIT intends to continue to implement industry-standard security measures, we do not know if the measures implemented by UIT will be circumvented in the future. Eliminating computer viruses, Trojan horses and worms and solving other security problems may require interruptions or delays in service to users who access UIT's or its licensees' Web sites. Any of these things could seriously harm our business, results of operations and financial condition. We Are Subject to Intense Competition. There is significant competition in the evolving market for video delivery on the Internet. Our primary competitors and we have each approached Internet video delivery using different technologies. Many of our competitors have substantially greater financial, marketing, personnel and other resources than we have. Our management believes that the barriers to enter this market are relatively high and there is significant lead-time required to market a competitive Internet video delivery technology. There is significant competition for content development and broadcasting on the Internet. The largest competitors in the content development and broadcast area are Broadcast.com, Inc. and RealNetworks, Inc. These, and many other competitors in the content development and broadcast area, have substantially greater assets then we do. We expect competition in this area to remain strong and to increase further. Failure to Adapt to Technological Change Could Adversely Affect Our Earnings. The Internet, computer hardware and software markets, and the field of e- commerce, all are undergoing rapid technological changes. Newer technologies, techniques or products could be developed which might perform functions similar to our technology and which operate as efficiently and easily, or which solve the problem of long download times for multimedia files in other ways. For example, a new technological advance that allows faster downloading of information from computer networks, or the development of entirely new methods of data transmission, could seriously harm our business, results of operations and financial condition. It is probable that existing broadband technology will eventually develop to allow streaming video to provide television-quality video in direct competition with our technology, as well as with other alternative video delivery systems. While some industry estimates project that such developments may not occur for the next six to eight years, we do not know if these technological developments will occur sooner. In any event, over time we will need to respond to technological innovation in a rapidly changing industry. 16 Burdensome Government Regulation and Legal Uncertainties Could Impair Our Results of Operations. It is likely that new laws and regulations will be adopted in the United States and elsewhere covering a wide range of Internet-related issues. This could include broadcast license fees, music licensing, copyrights, privacy, pricing, sales taxes, and characteristics and quality of Internet services. It is also possible that laws could be passed that may apply to us in the areas of content, network security, encryption, privacy protection, electronic authentication or "digital" signatures, illegal and harmful content, access charges and re- transmission activities. If restrictive laws or regulations are adopted, it could slow Internet growth. If certain laws or regulations apply to us and the type of technology business or service we provide, it could expose us to significant liabilities associated with the content on UIT's Web sites, and possibly for the content on the Web sites of UIT's licensees. We do not know if laws will be adopted that apply to our business on the Internet. If such laws and regulations are adopted, we do not know if they will affect our business. Any new legislation or regulation or enforcement of existing laws and regulations could limit the growth of the Internet, increase our cost of doing business or increase our legal exposure. There are also uncertainties about how existing laws in other areas apply to the Internet. Some of these laws deal with such issues as property ownership, libel, taxation, defamation and personal privacy. The majority of these laws were adopted before the widespread use of the Internet. Therefore, they do not address the unique issues of the Internet and related technologies. There are very few cases about the interpretation of these types of law on Internet use. If such laws apply to the Internet, it could limit growth of the Internet and could seriously harm our business, results of operations and financial condition. Congress enacted the Communications Decency Act in 1996. The U.S. Supreme Court ruled that certain sections of that Act which would have imposed criminal penalties on anyone distributing "indecent" material to minors over the Internet were unconstitutional. We do not know if similar laws will be adopted and upheld. Even though we do not currently distribute the types of materials on the Internet that the Act may have considered illegal, we do not know how any future laws or regulations regarding decency might be interpreted. In addition to the potential for liability, these types of laws could also damage the growth of the Internet generally, which would have the effect of decreasing the demand for our technology and its applications. Any of these developments could seriously harm our business, results of operations and financial condition. So far, we have not required our licensees to indemnify us for this type of liability and we do not have insurance for this type of liability. If we are considered to be a distributor of Internet content, we face potential liability for negligence, copyright, patent, trademark, defamation, indecency and other claims. These types of lawsuits have been brought against Internet content distributors. In addition, we could be liable for the broadcast content, or unauthorized duplication of broadcast content. So far, we have not required our licensees to indemnify us for this type of liability. Any liability that is not covered by insurance or an indemnification by a licensee could seriously harm our business, results of operations and financial condition. At present, we do not have insurance for this type of liability. Patent Protection Our Technology Business Relies on the Enforcement of Our Intellectual Property Rights. We have been issued or approved for issuance on the following patents. 1. The DIVO technology (issued) 2. The Medical Monitoring Technology (issued) 3. The I-C-IT Technology (approved and issue fee paid) The Company believes that this is a very positive indication of the efforts, which the Company has made to protect its Intellectual Property rights, and the fact that such efforts have been highly successful. With respect to the six applications remaining, we are still waiting for Office Actions for all but one of these cases. However, given that they, for the most part, depend upon the core technology of the company, the Company believes that most, if not all, of the presently pending applications will support claims, which will be allowed to proceed to issuance. Our copyrights, trademarks, trade secrets and other intellectual property rights are critical to our success. We rely on copyright and trademark laws, trade secret protection, and confidentiality and non-disclosure agreements with our employees and third parties to protect our proprietary rights. We do not know if these steps will be adequate. We do not know if we will be able to obtain trademark registrations for our marks in the United States or other countries. We do not know if third parties will infringe upon or misappropriate our copyrights, trademarks, service marks and other intellectual proprietary rights. None of our marks or rights are registered at present. In addition, meaningful copyright and trademark 17 protection may be unenforceable or limited in certain countries. In the future, it is possible that we would have to sue to protect our copyrights, trademarks, trade secrets and other intellectual property rights. We cannot give any assurance as to our ability to enforce our rights or the outcome of any suits to protect those rights. UIT generally enters into nondisclosure agreements with its employees and consultants. UIT also limits access to and distribution of its software, sensitive documents and other proprietary information. We do not know if the steps taken by UIT to prevent misappropriation of its proprietary information will be successful. If these agreements are breached we do not know if we will have adequate remedies available, or if the agreements themselves would be enforceable. Even with the precautions taken by UIT, it might be possible for a third party to copy, obtain and use, our proprietary information without authorization. It is also possible that our trade secrets will be independently developed by competitors. We Depend on Certain Personnel An important part of our performance depends upon the services of our senior management, certain other key personnel, and technical and business consultants. The loss of their services could have a material adverse effect on our business, results of operations and financial condition. Sales of Additional Shares of Our Common Stock Into the Public Market May Cause Our Stock Price to Fall and Dilute Our Stockholders' Interests. If we raise additional funds by selling common stock or other equity securities, the interests of current stockholders would be diluted. We may also issue common stock, options or warrants to purchase our common stock to provide incentives to officers, employees, consultants, advisors and other people who perform services for us. Stock, which is issued when options and warrants are exercised, will dilute our present stockholders' ownership percentage in our Company. Control of Our Company by Certain Stockholders Brian Shuster - Chairman of the Board, President, and Chief Executive Officer of our Company - and certain of his relatives are principal stockholders of our Company. Harry Shuster, the father of Brian Shuster, owns 25.28% of our common stock, including options exercisable within 60 days, and Brian Shuster owns 4.99%of our common stock, including options exercisable within 60 days. Therefore, Brian Shuster and members of his family have the ability to control the outcome of Company actions requiring the approval of our stockholders. These matters include: . election of directors . mergers, sales of all or most of our assets; or . other change of control of our Company. We Have Never Paid Dividends on our Common Stock. We have not paid dividends on our common stock in the past and we do not expect to declare dividends on our common stock in the foreseeable future. We intend to continue to retain earnings for use in the operation and expansion of our business. Dividend policy in the future is at the discretion of our Board of Directors and will depend upon our financial condition, results of operations, capital requirements and other factors that the Board of Directors considers relevant. We are not a party to any agreement restricting the payment of dividends. ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and supplemental data required by this Item 7 appear in a separate section of this Form 10-KSB following Part III. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT. Directors and Executive Officers 18 Set forth in the table below is the names, ages and positions of the current directors and executive officers of United Leisure. Ages are shown as of December 31, 2001. Directors hold office until the next annual meeting of stockholders and until their successors are elected and qualified. Executive officers are elected by and serve at the discretion of the United Leisure Board. None of the executive officers has any family relationship to any director or any other executive officer of United Leisure, except that Brian Shuster is both an executive officer and director. 19
Positions Currently Held Name Age With United Leisure Director Since ----- --- ------------------------ -------------- Brian Shuster 43 Chief Executive Officer, President, 1996 Chairman of the Board and Director J. Brooke Johnston, Jr. 61 Director 1996 Victor A. Hollander 69 Director 2001 Gerald M. Chizever 58 Director 2001
Set forth below is a brief description of the business experience for the previous five years of all current directors and executive officers of United Leisure. Brian Shuster has served as a director of United Leisure since May 1996 and as Chief Executive Officer and President of United Leisure since May 1999. Brian Shuster is also chairman, chief executive officer and president of UIT. From March 1997 to May 1999, he also served as Executive Vice President of United Leisure. From 1993 through 1995, Mr. Shuster served as President of Beverly Hills Producers Group, an independent motion picture production company. J. Brooke Johnston, Jr. has served as a director of United Leisure since May 1996. Since 1998, Mr. Johnston has been a partner of the law firm of Baker, Johnston & Wilson, LLP, in Birmingham, Alabama. He was Senior Vice President and General Counsel for Med Partners, Birmingham, Alabama from April 1996 until July 1998. Prior to that, Mr. Johnston was a senior principal of the law firm of Haskell, Slaughter, Young & Johnston, a professional association, in Birmingham, Alabama, where he practiced securities law for over 19 years. Mr. Johnston is also a director of Grand Havana Enterprises, Inc., a publicly held company that owns and operates cigar clubs in Beverly Hills and New York City. Victor A. Hollander has served as a director of United Leisure since February 2001. He was licensed to practice public accounting in California as a certified public accountant in 1958. In 1965 he established and was partner in charge of the Los Angeles office of a large New York certified public accounting firm where he specialized in audit and securities matters. In 1978 he formed the accounting firm of Hollander, Gilbert & Co., the predecessor to Hollander, Lumer & Co. LLP and in February 2001 he merged his firm with the Los Angeles accounting firm Good Swartz Brown & Berns, LLP where he manages the firms Securities Group. Gerald M. Chizever has served as a director of the Company since February 2001. Mr. Chizever presently is, and has been since 1990, a partner of the law firm of Richman, Mann, Chizever, Phillips & Duboff in Beverly Hills, California. Mr. Chizever's primary area of practice is corporate and business law. Significant Employees The following individual is a significant employee of our subsidiary, United Internet Technologies: Andy Rifkin has served as Chief Technology Officer of UIT since December 2000. Andy Rifkin oversees the development and commercialization of UIT's interactive technologies. The development of the companies technologies have been completed and January of 2002 Mr. Rifkin began his severance package, the company will now focus on marketing these technologies. Mr. Rifkin will continue to earn royalties based on certain technologies acquired by the company that were developed by Mr. Rifkin and one of his companies. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934 requires our officers and directors, and persons who beneficially own more than 10% of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Officers, directors and beneficial owners of more than 10% of our Common Stock are required by SEC regulations to furnish us with copies of all Section 16(a) forms that they file. Based solely on review of the copies of such forms furnished to us, or written representations that no reports on Form 5 were required, we believe that for the period through December 31, 2000, all officers, directors and greater-than-10% beneficial owners complied with all Section 16(a) filing requirements applicable to them. 20 ITEM 10. EXECUTIVE COMPENSATION The following table sets forth all compensation received for services rendered to United Leisure in all capacities for the three fiscal years ended December 31, 2001 by our Chief Executive Officer during fiscal 2001 and the most highly compensated executive officers at the end of fiscal 2001. SUMMARY COMPENSATION TABLE
Annual Compensation Long Term Compensation ------------ ---------------------- Name and Principal Positions Year Salary Securities and Underlying Options ---------------------------- ---- ------ --------------------------------- Brian Shuster (1) Chairman of the Board 2001 $290,400 President, Chief Executive Officer 2000 $263,660 1,750,000 (2) 1999 $240,000 300,000 Rifkin 2001 $311,400 (3) 300,000 (4) Chief Technology Officer, UIT
(1) Effective May 24, 1999, Brian Shuster was appointed to serve as Chairman of the Board, Chief Executive Officer, President and Chief Financial Officer. (2) Consists of UIT Options. (3) We acquire certain technology from Andy Rifkin and his associated companies Jed Development/Gorilla in the amount of $115,000 and relocation expenses of $65,720. (4) Consists of UIT options. Commencing January 2002, the Directors will receive $1,000 per month cash compensation for their services to the Company as directors, and are reimbursed for expenses actually incurred in connection with attending meetings of the Board of Directors. Directors receive periodic stock option grants. Stock Option Grants No stock options were granted to Executive Officers during the fiscal year ended December 31, 2001. This table shows information regarding unexercised options held by our Named Executive Officers. No options were exercised by Executive Officers during the fiscal year ended December 31, 2001. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES
Number of Unexercised Options at Value of Unexercised In The Money Options at December 31, 2001 December 31, 2001 (1) Name Exercisable Unexercisable Exercisable Unexercisable ----------- ------------- ----------- ------------- Brian Shuster 2,400,000 (2) --- $3,000 (4) --- Andy Rifkin 300,000 (3) --- $0.00 ---
21 (1) Represents the difference between the market price of our common stock and the respective exercise prices of the options at December 31, 2000. Actual values which may be realized, if any, upon any exercise of these options will be based on the market price of our common stock at the time of any exercise and are therefore dependent upon future performance of our common stock. (2) Includes 1,750,000 UIT options. (3) Consists of 300,000 UIT options. (4) Based on the assumption that UIT options can be converted on a one to one basis to United Leisure options. Consulting and Employment Agreements United Internet Technologies and Brian Shuster are parties to five-year employment agreement dated as of January 1, 1999, which was amended in Feb 2001. Under this employment agreement, Mr. Shuster is employed as the President of United Internet Technologies at an initial base salary of $240,000 per year The Executive shall be entitled to an increase in Base Salary of 10% per annum, effective on January 1 of each year of the term of this Agreement Mr. Shuster was paid $263,660 in 2000 and $290,400 in 2001 pursuant to this agreement. The employment agreement also provides that any inventions developed by Mr. Shuster during his employment by United Internet Technologies that relate to the business of United Internet Technologies, will remain United Internet Technologies' property. The employment agreement also contains a confidentiality provision. Mr. Shuster is permitted to engage in outside business activities to the extent that these obligations do not interfere with his duties to United Internet Technologies. Prior to becoming President and Chief Executive Officer of our Company in May 1999, Brian Shuster provided certain consulting services to us and received $6,000 per month in consulting fees. During 2001 Mr. Shuster's consulting fees were increased by 10% and he received $6,600 per month. Stock Options On December 31, 2001, there were outstanding presently exercisable non-qualified stock options to purchase a total of 2,800,000 shares of UIT and United Leisure common stock held by our officers and director. Of this amount, 2,400,000 were held by Brian Shuster, our Chairman of the Board, President and Chief Executive Officer, 1,750,000 of which are options to purchase shares in UIT. The balance was held by the current director and officer of our Company, at option prices ranging from $.23 to $3.00 per share. See "Security Ownership of Certain Beneficial Owners and Management." All non-qualified stock options that we have issued to our directors and executive officers are in substantially the same form. All options have a term ranging from five years to ten years from the date of grant and are immediately exercisable as to all of the shares of our common stock covered by the option. The option price is the fair market value of our common stock as of the date of grant. In addition to the non-qualified stock options held by our directors and executive officers on December 31, 2001, there were outstanding non-qualified options to purchase a total of 4,657,450 shares of United Leisure and UIT common stock held by third parties. All of these non-qualified options are in substantially the same form as those issued to our directors and executive officers, except that generally they are not terminable until they expire. These options have exercise prices ranging from $.23 to $6.71 and expire from December 31, 2002 through September 29, 2003. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The following table sets forth certain information regarding beneficial ownership of United Leisure common stock as of December 31, 2001: (a) by each person who is known by United Leisure to own beneficially more than 5% of its common stock; (b) by each of United Leisure's directors; (c) by each of the named executive officers; and (d) by all officers and directors of United Leisure as a group. 22
Name and Address Number of ULC Percentage Number of UIT Percentage Shares Ownership Shares Ownership Of Beneficial Owner (1) Beneficially Of Class (3) Beneficially Of Class Owned (2) (3) Owned (2) (3) (3) ------------------------------- ------------------ ------------- ----------------- ------------ Brian Shuster 1,050,000 (4) 4.99% 1,750,000 5.11% J. Brooke Johnston 151,400 (5) * 0 0 Victor A. Hollander 0 0 0 0 Gerald M. Chizever 25,000 * 0 0 Harry Shuster 5,879,993 (6) 25.28% 0 0 All officers and directors 1,242,600 5.87% 4,250,000 12.40% as a group ( 5 people)
*1ess than 1% (1) Each person's address is c/o United Leisure, 1990 Westwood Boulevard, Los Angeles, California 90025, unless otherwise noted. (2) Unless otherwise indicated, United Leisure believes that all persons named in the table have sole voting and investment power with respect to the shares of common stock beneficially owned by them. (3) A person is deemed to be the beneficial owner of Common stock that can be acquired by such person within 60 days of the date hereof upon the exercise of warrants or stock options. Except as otherwise specified, each beneficial owner's percentage ownership is determined by assuming that warrants and stock options that are held by such person (but not those held by any other person) and that are exercisable within 60 days from the date hereof, have been exercised. Figures include options in UIT and United Leisure. (4) Includes options to purchase 650,000 shares of United Leisure common stock. Includes 80,000 shares held by Brian Shuster as trustee of each of Bennett Shuster Trust, Bentley Shuster Trust and Blake Shuster Trust and 300 shares held by Nita Shuster and Brian Shuster. (5) Includes options to purchase 100,000 shares. (6) Includes 111,000 shares of common stock held by Koorn N.V., all of whose capital stock is owned by Harry Shuster. Also includes 125,000 shares of common stock held by the Harry and Nita Shuster Charitable Foundation and 300 shares owned by Nita Shuster, the spouse of Harry Shuster. Does not include 10,000 shares owned by Bardene Shuster, 300 shares owned by Nita Shuster and Bardene Anne Shuster, 300 shares owned by Nita Shuster and Brian Shuster, and 300 shares owned by Nita Shuster and Stanley Shuster, of which Mr. Shuster disclaims beneficial ownership. Also includes options to purchase 2,606,950 shares of our common stock and 3,037,583 shares of our common stock owned directly by Harry Shuster. Does not include an aggregate of 480,000 shares of our common stock owned by trusts of which Harry Shuster's adult children are the beneficial owners. Until May 24, 1999, Harry Shuster served as Chairman of the Board, President, Chief Executive Officer and a director of United Leisure. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Transactions with Harry Shuster. In January 2001 we entered into a termination of the consulting services agreement with Mr. Harry Shuster The termination agreement effective November 2000, allowed us to buy out the consulting agreement of Mr. Shuster, which had a remaining duration of five years at an annual consulting fee of approximately $270,000. The terms of the agreement consisted of a one-time payment of $250,000 and the transfer of assets with a book value of $740,246 from United Leisure to Harry Shuster. The assets consisted of a loan receivable of $686,790 and accounts receivable of $53,456 owed to United Leisure by Grand Havana, an affiliated company. 23 Lease of Office Premises. On January 1, 1999, we entered into a five-year lease with 1990 Westwood Boulevard, Inc. This agreement was amended on May 1, 1999 and covers approximately 6,000 square feet of office space for our principal executive offices. The lease provides for rent of $10,500 per month. 1990 Westwood Boulevard, Inc. is presently owned more than 50 % by Harry Shuster, our former Chairman of the Board, President, Chief Executive Officer, Chief Financial Officer, and a principal stockholder of United Leisure. We believe that the rent and other terms of the lease are no more favorable to the lessor than could have been obtained in a similar building in the same area from an unrelated lessor. Grand Havana's Common Stock. As of December 31, 2001, we held 966,666 shares of Grand Havana's common stock. The Chief Executive Officer of Grand Havana is Stanley Shuster, the brother of Brian Shuster. Advanced transaction with Andy Rifkin. We acquired technology rights of certain products from Andy Rifkin, our Chief Technology Officer. In accordance with the agreement, we are obligated to pay the employee an advance royalty of $230,000 and 125,000 shares of United Leisure's common stock, payable when certain licensing criteria have been meet, and then a continuing royalty based upon the sale of any products using this technology. As of December 31, 2001, $115,000 of this advance royalty has been paid and is reflected in other assets in the accompanying balance sheet. ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits.
EXHIBIT NUMBER DESCRIPTION ------ ----------- 3.1 Restated Certificate of Incorporation of United Leisure (incorporated by reference to Exhibit 3.1 of United Leisure's Form SB-2 (File No. 33-81074 (the "SB-2")). 3.2 Bylaws of United Leisure (incorporated by reference to Exhibit 3.2 of the SB-2). 4.1 Warrant Agreement, dated November 18, 1994 between United Leisure and OTR, Inc. (incorporated by reference to Exhibit 4.1 of the SB-2). 4.2 Form of Warrant to Purchase Common Stock in connection with 12% Promissory Note unit private placement and Bankruptcy Court deposit (incorporated by reference to Exhibit 4.3 of the SB-2). 10.2 Stock Option Agreement dated October 7, 1988, between United Leisure and Harry Shuster as extended by Extension of Option Agreement, dated April 20, 1993 between United Leisure and Harry Shuster (incorporated by reference to Exhibit 10.12 of the SB-2). 10.3 Stock Option Agreement dated November 17, 1988, between United Leisure and Harry Shuster as extended by Extension of Option Agreement, dated April 20, 1993 between United Leisure and Harry Shuster (incorporated by reference to Exhibit 10.13 of the SB-2). 10.4 Stock Option Agreement dated December 5, 1988, between United Leisure and Harry Shuster as extended by Extension of Option Agreement, dated April 20, 1993 between United Leisure and Harry Shuster (incorporated by reference to Exhibit 10.14 of the SB-2). 10.5 Stock Option Agreement dated July 24, 1987, between United Leisure and Harry Shuster as extended by Extension of Option Agreement, dated April 20, 1993 between United Leisure and Harry Shuster (incorporated by reference to Exhibit 10.16 of the SB-2). 10.7 Form of Indemnity Agreement entered into by United Leisure with each of its directors (incorporated by reference to Exhibit 10.35 of the SB-2). 10.10 Lease dated June 29, 1995, between Magnolia Square and Planet Kids, Inc. and Addendum thereto (incorporated by reference to Exhibit 10.34 of the 1995 10-KSB).
24 10.12 Option Agreement dated as of September 22, 1998, between United Leisure and Brian Shuster (incorporated by reference to Exhibit 10.45 of the United Leisure's Quarterly Report on Form 10-QSB for the quarter ended September 30, 1998 (the "September 30, 1998 10-QSB")). 10.13 Option Agreement dated as of September 30, 1998, by and between United Leisure Brian Shuster (incorporated by reference to Exhibit 10.46 of the September 30, 1998 10-QSB). 10.14 Option Agreement dated as of January 4, 1999 between United Leisure and Brian Shuster (incorporated by reference to Exhibit 10.49 of United Leisure's Quarterly Report on Form 10-QSB for the period ended June 30, 1999 (the "June 30, 1999 10-QSB")). 10.15 Option Agreement dated as of January 4, 1999 between United Leisure and J. Brooke Johnston, Jr. (incorporated by reference to Exhibit 10.51 of the June 30, 1999 10-QSB). 10.16 Option Agreement dated as of February 1, 1999, between United Leisure and Brian Shuster (incorporated by reference to Exhibit 10.52 of the June 30, 1999 10-QSB). 10.17 Employment Agreement dated as of January 1, 1999 between United Leisure and Brian Shuster, as amended February 2001, United Internet Technologies, Inc. and Brian Shuster (incorporated by reference to Exhibit 10.53 of the June 30, 1999 10-QSB). 10.18 Agreement dated as of July 21, 1999 between United Leisure and Media Group, Inc. (incorporated by reference to Exhibit 10.55 of the June 30, 1999 10-QSB). 10.19 Purchase Agreement and Escrow Instructions dated as of June 10, 1999, between United Leisure and Shih Ching Chiang, as amended on August 7, 1999 (incorporated by reference to Exhibit 10.1 of United Leisure's Current Report on Form 8-K dated August 23, 1999). 10.22 Letter Agreement dated November 19, 1999 between United Internet Technologies and Teen People Magazine (incorporated by reference to Exhibit 10.33 of the 1999 10-KSB). 10.23 Distribution Agreement dated February 2, 2000 between United Internet Technologies and Liquid Audio, Inc. (incorporated by reference to Exhibit 10.34 of the 1999 10-KSB). 10.24* Termination Agreement and General Release dated January 31, 2001 between United Leisure Corporation and Harry Shuster 10.25* Option Agreement dated as of February 27, 2002 between United Leisure and Brian Shuster 10.26* Option Agreement dated February 27, 2002 between United Leisure and J.Brooke Johnston 10.27* Option Agreement dated February 27, 2002 between United Leisure and Victor A. Hollander 10.28* Option Agreement dated February 27, 2002 between United Leisure and Gerald M. Chizever 21.1 Subsidiaries of United Leisure (incorporated by reference to Exhibit 21.1 of the 1999 10-KSB) 23.1* Consent of Ernst and Young, LLP * Filed herewith. + Management contract or compensatory plan required to be filed as an exhibit pursuant to applicable rules of the Securities and Exchange Commission.
(b) Reports on Form 8-K. ------------------------ No reports on Form 8-K were filed by us during the quarter ended December 31, 2001. 25 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. UNITED LEISURE CORPORATION By:/s/BRIAN SHUSTER ------------------- Brian Shuster President, Chief Executive Officer and Director Date: March 29, 2002 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated.
SIGNATURE TITLE --------- ----- /s/ BRIAN SHUSTER Chairman of the Board, President, Chief Executive Officer ------------------- Brian Shuster and Chief Financial Officer (Chief Executive Officer; Principal Financial and Accounting Officer) /s/ J. BROOKE JOHNSTON, JR. ----------------------------- J. Brooke Johnston, Jr. Director /s/ VICTOR A. HOLLANDER ------------------------- Victor A. Hollander Director /s/ GERALD M.CHIZEVER ----------------------- Gerald M. Chizever Director
26 Consolidated Financial Statements United Leisure Corporation and Subsidiaries Years ended December 31, 2001 and 2000 with Report of Independent Auditors 27 United Leisure Corporation and Subsidiaries Consolidated Financial Statements Years ended December 31, 2001 and 2000 Contents Report of Independent Auditors.............................................. 29 Audited Consolidated Financial Statements Consolidated Balance Sheets................................................. 30 Consolidated Statements of Operations and Comprehensive Income (Loss)....... 31 Consolidated Statements of Stockholders' Equity............................. 32 Consolidated Statements of Cash Flows....................................... 33 Notes to Consolidated Financial Statements.................................. 35
28 Report of Independent Auditors The Board of Directors and Stockholders United Leisure Corporation We have audited the accompanying consolidated balance sheets of United Leisure Corporation and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations and comprehensive income (loss), stockholders' equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of United Leisure Corporation and subsidiaries at December 31, 2001 and 2000, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with auditing standards generally accepted in the United States. As discussed in Note 1 to the financial statements, the Company's recurring losses from operations raise substantial doubt about its ability to continue as a going concern. Management's plans as to these matters are also described in Note 1. The 2001 financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ ERNST & YOUNG LLP February 15, 2002 Los Angeles, California 29 UNITED LEISURE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
Year ended December 31, -------------------------------- 2001 2000 ------------ ------------ Assets Current assets: Cash and cash equivalents $ 1,645,450 $ 7,416,966 Receivables 19,769 27,925 Due from related parties 5,995 -- Prepaid expense and other current assets 117,829 144,562 ------------ ------------ Total current assets 1,789,043 7,589,453 Property and equipment - net 731,611 987,521 Net assets of discontinued operations 38,540 98,880 Investment in Grand Havana at fair value - related party 5,800 105,753 Other assets: Capitalized cost 128,184 -- Deposits and other assets 68,960 45,493 ------------ ------------ Total $ 2,762,138 $ 8,827,100 ============ ============ Liabilities and stockholders' equity Current liabilities: Accounts payable and accrued expenses $ 495,793 $ 366,811 Reserve for discontinued operations 84,885 300,000 Reserve for litigation 45,000 -- Due to related parties -- 285,059 ------------ ------------ Total current liabilities 625,678 951,870 Minority interest 4,413 114,546 Stockholders' equity Preferred stock, $100 par value; authorized - 100,000 shares; issued and outstanding - none -- -- Common stock, $0.01 par value; authorized - 30,000,000 shares; issued and outstanding, 20,511,375 shares in 2001 and 20,363,222 shares in 2000 204,304 202,822 Additional paid-in capital 45,514,075 45,525,722 Accumulated deficit (43,496,746) (38,034,946) Accumulated other comprehensive income (loss) (89,586) 67,086 ------------ ------------ Total stockholders' equity 2,132,047 7,760,684 ------------ ------------ Total $ 2,762,138 $ 8,827,100 ============ ============
See accompanying notes. 30 UNITED LEISURE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31, 2001 2000 ---- ---- Revenue - licensing fees $ 22,779 $ 712,942 Cost and expenses: Direct operating expense 3,747,598 6,596,339 Selling, general and administrative 1,522,873 1,616,832 Stock compensation (44,978) 6,102,943 Depreciation and amortization 202,646 122,316 ------------ ------------ 5,428,139 14,438,430 ------------ ------------ Other income (loss): Interest income 172,020 501,751 Interest expense (3,721) (71,930) Gain on sale of Genisys -- 600,000 Realized loss from write-down of investment in HEP II -- (100,000) Other, net 129,881 17,189 Minority interest in loss 110,380 107,839 ------------ ------------ Total other income (loss) 408,560 1,054,849 ------------ ------------ Loss from continuing operations (4,996,800) (12,670,639) Loss from discontinued operations (465,000) (743,915) ------------ ------------ Net loss (5,461,800) (13,414,554) ------------ ------------ Other comprehensive loss: Unrealized holding gain (loss) on securities available for sale (99,953) 4,253 Foreign currency translation loss (56,719) -- ------------ ------------ Comprehensive loss $ (5,618,472) $(13,410,301) ------------ ------------ Weighted average number of common shares outstanding 20,437,156 19,583,516 Basic loss per share: Loss per share from continuing operations $ (0.24) $ (0.65) Loss per share from discontinuing operations (0.02) (0.04) Total loss per share $ (0.27) $ (0.68)
See accompanying notes. 31 UNITED LEISURE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated Common Stock Additional Other Number of Paid-in Accumulated Comprehensive Shares Amount Capital Deficit Income (Loss) Total ------ ------ ------- ------- ------------- ----- ------------------------------------------------------------------------------------------- Balance at December 31, 1999 16,230,868 $161,468 $26,892,688 $(24,620,392) $ 62,833 $ 2,496,597 Sale of common stock 2,240,000 22,400 5,577,600 5,600,000 Exercise of stock options 195,000 1,950 76,250 78,200 Exercise of warrants 1,697,354 17,004 6,622,412 6,639,416 Fair value of options issued to non-employees 6,102,943 6,102,943 Change in capital of subsidiary 253,829 253,829 Unrealized gain on investment 4,253 4,253 Net loss (13,414,554) (13,414,554) ------------------------------------------------------------------------------------------- Balance at December 31, 2000 20,363,322 202,822 45,525,722 (38,034,946) 67,086 7,760,684 Exercise of stock options 148,153 1,482 33,331 34,813 Fair value of options issued to non-employees (44,978) (44,978) Unrealized loss on investment (99,953) (99,953) Foreign currency translation loss (56,719) (56,719) Net loss (5,461,800) (5,461,800) ------------------------------------------------------------------------------------------- Balance at December 31, 2001 20,511,375 $204,304 $45,514,075 $(43,496,746) $ (89,586) $ 2,132,047 -------------------------------------------------------------------------------------------
See accompanying notes. 32 UNITED LEISURE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, ---------------------------------- 2001 2000 ------------ ------------ Operating activities Net loss $ (5,461,800) $(13,414,554) Adjustments to reconcile net loss to net cash used in operating activities: Loss from discontinued operations 465,000 743,915 Depreciation and amortization 202,646 122,316 Loss on disposal of assets 110,538 -- Gain on sale of investment in Genisys -- (600,000) Minority share of loss (110,380) (107,839) Settlement of consulting agreement -- 845,403 Fair value of options granted to non-employees (44,978) 6,102,943 Write-down of investment in HEP II -- 100,000 Other -- 20,000 Changes in operating assets and liabilities: Receivables 8,156 59,772 Receivables - related party (5,995) Deferred productions costs -- 115,027 Prepaid expenses and other current assets 26,733 (154,791) Deposits and other assets -- 14,920 Accounts payable and accrued expenses 128,982 (336,176) Reserve for litigation 45,000 -- Due to related parties -- 189,672 Deposits and other liabilities -- -- Deferred revenues -- (210,133) ------------ ------------ Net cash used in continuing operations (4,636,098) (6,509,525) Net cash used in discontinued operations (619,775) (465,721) ------------ ------------ Net cash used in operating activities (5,255,873) (6,975,246) Investing activities Purchases of property and equipment (57,274) (949,471) Increase in deposits and other assets (23,467) -- Investment in capitalized costs (128,184) -- Proceeds from sale of investment in Genisys -- 600,000 Loans receivable from Grand Havana -- (65,723) Advances to related party (285,059) 61,027 ------------ ------------ Net cash used in investing activities (493,984) (354,167)
33 UNITED LEISURE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Financing activities Sale of common stock $ -- $ 5,600,000 Proceeds from minority shareholders -- 476,639 Common stock issued for warrants and options exercised 34,813 6,717,616 ----------- ----------- Net cash provided by financing activities 34,813 12,794,255 ----------- ----------- Effect of currency rate changes (56,472) -- Net increase in cash and cash equivalents (5,771,516) 5,464,842 Cash and cash equivalents at beginning of year 7,416,966 1,952,124 ----------- ----------- Cash and cash equivalents at end of year $ 1,645,450 $ 7,416,966 =========== =========== Cash paid for: Interest $ 3,721 $ 71,930 ----------- ----------- Supplemental disclosures of non-cash investing and financing activities Fair value of options and warrants to non-employees $ (44,978) $ 6,102,943 ----------- -----------
See accompanying notes. 34 United Leisure Corporation and Subsidiaries Notes to Consolidated Financial Statements December 31, 2001 1. Summary of Significant Accounting Policies Description of Business Through its subsidiary, United Internet Technologies, Inc. (UIT"), the Company is engaged in the business of developing technologies that allow a wide range of electronic devices, such as smart toys, medical devices, household and business appliances and consumer electronics, to communicate and be controlled over the Internet and over other digital systems, such as cable, television and wireless networks. The Company has developed two proprietary technologies: (1) Intelligent Control Interactive Technology ("I-C-It") ("software") and (2) Digitally Integrated Video Overlay ("Divo") ("software"). These technologies enable businesses to transition their traditional product liens into the interactive world. The Company's objective is to create solutions for specific business sectors by customizing our I-C-IT platform, allowing these technologies to be embedded in a wide range of electronic devices. Principles of Consolidation The consolidated financial statements include the accounts of United Leisure Corporation and its majority-owned subsidiaries. During 2000 the Company created a subsidiary in Germany to license its technology in Europe. At December 31, 2001 the German subsidiary is 67% owned and has total assets of $50,369. Intercompany transactions and balances have been eliminated. Current Developments The Company has experienced operating losses. For the year ended December 31, 2001 the Company had cash and cash equivalents of $1,645,450 and an accumulated deficit of $43,496,746. To conserve its resources, the Company has significantly curtailed all activities are not directly related to its core technology business, reduced its staff to a minimum, and reduced capital expenditure. The Company intends to stop further development of its technologies. The primary objective over the next year will be to market the technologies that were developed and refined during the previous years. This may require additional financing. To accomplish this, the Company may raise additional funding by borrowing money or through a public or private sale of debt or equity securities. Such financing, however, may not be available when and if it is needed, or if available, it may not be available on acceptable terms. If the Company is unable to sell its securities or obtain sufficient financing to meet its working capital needs and to repay indebtedness as it becomes due, the Company may have to consider such alternatives as selling or pledging portions of the assets, among other possibilities, in order to meet such obligations. If the company doesn't continue as an ongoing concern the amounts shown in the financial statements may not be realized at their stated value. The financial statements have no adjustments recorded for such an event. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates. 35 Investments The Company accounts for ownership investments in affiliates using the equity method of accounting when the Company's voting control in the affiliate is between 20% and 50%. Investments in companies owned less than 20%, are accounted for at cost subject to annual impairment reviews, unless the ownership allows for significant influence in which case the investments are accounted for by the equity method. Investments in available for sale securities are carried at fair value, with the unrealized gains and losses reported as a separate component of stockholders' equity. Sale of Stock by Subsidiary At the time a subsidiary or affiliate issues its stock to unrelated parties at a price more than or less than its book value, the Company's net investment in the subsidiary or affiliate increases or decreases, respectively. The increase or decrease is reflected in "Changes in capital of investee" (a component of additional paid-in capital) in the Company's consolidated statement of stockholders' equity. In 2000, the Company's German subsidiary sold shares where the Company recorded its share of this change in capital of subsidiary in its Stockholder's equity accounts. Cash and Cash Equivalents The Company considers highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. The cash balance as of December 31, 2001 and 2000 includes $8,271 and $305,388, respectively, of cash held in the German subsidiary and is expected to be restricted to only offshore uses. Fair Value of Financial Instruments The Company's financial instruments consist of cash equivalents, receivables and accounts payable, accrued expenses, notes payable and due to related parties. The fair values of the Company's financial instruments approximate the carrying value of the instruments. Concentration of Risk The Company invests its excess cash in certificates of deposit and money market funds, which, at times, may exceed federally insured limits. The Company maintains its accounts with financial institutions with high credit ratings. Property and Equipment Property and equipment is recorded at cost and depreciation is computed on the straight-line method based upon the estimated useful life of the related asset as follows: Buildings and improvements 3 - 27 years Machinery, equipment and vehicles 4 - 10 years Furniture, fixtures and office equipment 5 - 10 years Computers 6 years Long-Lived Assets Long-lived assets are reviewed for impairment whenever events or circumstances indicate that the asset's undiscounted expected cash flows are not sufficient to recover its carrying amount. The Company measures an impairment loss by comparing the fair value of the asset to its carrying amount. Fair value of an asset is calculated as the present value of expected future cash flows. 36 Revenue Recognition The Company is engaged as a provider of consultancy services and as a licensor of its technology. Generally, revenue is recognized upon delivery of the technology. For arrangements to deliver the technology requiring significant modification or customization, revenue is recognized on the percentage-of- completion method. Licensing revenue arises from the preparation of programs using the Company's interactive technology for marketing purposes to principally two unrelated parties. Stock-Based Compensation The Company and its subsidiaries account for employee and director's stock option grants using the intrinsic method. Generally, the exercise price of the Company's employee stock options equals or exceeds the market price of the underlying stock on the date of grant and no compensation expense is recognized. If the option price is less than fair value, the Company records compensation expense over the vesting period of the option. The Company accounts for equity instruments issued to non-employees in exchange for goods or services using the fair value method and records expense based on the values determined using an option pricing model. The Company discloses the pro forma effects of using the fair value method for all option plans in its consolidated financial statements, if material. Income Taxes The Company utilizes the asset and liability method for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period including the enactment date. Earnings Per Share Basic Earning Per Share (EPS) is calculated by dividing income available to common stockholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. The computation of diluted EPS is similar to the computation of basic EPS except the denominator is increased to include the number of additional common shares outstanding if the dilutive potential common shares (securities such as options, warrants, convertible securities, or contingent stock agreements) had been issued. In addition, in computing the dilutive effect of convertible securities, the numerator is adjusted to add back (a) any convertible preferred dividends and (b) the after-tax amount of interest recognized in the period associated with any convertible debt. The computation of diluted EPS shall not assume conversion, exercise, or contingent issuance of securities would have an antidilutive effect on EPS. 37 Reclassifications Certain 2000 accounts have been reclassified to conform to 2001 presentation. 2. Discontinued Operations In prior years, the Company's engaged in a business related to children's recreational activities. On October 30, 2000, the Company determined to divest its remaining non-technology businesses. The Company concluded that these operations were not strategically compatible with its core Internet technology businesses. These non-core businesses consist of its Planet Kids activity. Management anticipates the complete disposal of the Planet Kids business to occur during 2001 by the assumption of leased facilities by outside parties. The assets and liabilities of Planet Kids as of December 31, 2001 and 2000 are as follows:
2001 2000 ---------------------------------- Net assets of discontinued operations Assets Cash and cash equivalents $ 946 $ 31,136 Prepaid expenses and other assets 22,110 78,876 Property, plant and equipment, net 15,484 16,894 ---------------------------------- Total assets 38,540 126,906 Liabilities: Accounts payable and accrued expenses - 18,599 Deferred revenues - 4,595 Deposits and other - 4,832 ---------------------------------- Total liabilities - 28,026 ---------------------------------- Net assets of discontinued operations $ 38,540 $ 98,880 ==================================
The Planet Kids business incurred an operating loss of $68,417 for the period from November 1, 2000 through December 31, 2000 and $728,717 for the year 2001. The operating results of discontinued operations for the years ended December 31, 2001 and 2000 are as follows:
December 31 2001 2000 -------------------------------------- Revenue $ 465,818 $ 957,617 Direct operating expenses (1,167,390) (1,343,825) Provision for operating losses during phase-out period - (300,000) Selling, general and administrative expenses (37,924) (53,202) Depreciation and amortization (2,505) (4,505) Gain (loss) on sale of assets 13,284 - -------------------------------------- Loss from discontinued operations $ (728,717) $ (743,915) ======================================
38 The Company estimated a reserve amount for the shut down cost of the discontinued operations of $300,000 at December 31, 2000. During the year ended December 31, 2001, the Company increased the reserve by $465,000 to account for additional operating costs and costs to terminate existing leases. As of December 31, 2001, the Company closed down all remaining operations, and assigned all but one of the outstanding leases. The remaining reserve of $84,885 reflects the estimated cost of terminating the remaining lease, however the amount may be subject to adjustment in the future. 3. Properties and Equipment Property and equipment consisted of the following at December 31, 2001 and 2000:
2001 2000 -------------------------------- Buildings and improvements $ 107,506 $ 130,386 Machinery, equipment and vehicles 320,886 301,529 Furniture, fixtures and office equipment 147,847 229,984 Computers 497,293 479,100 Signs and other 297 34,464 -------------------------------- 1,073,829 1,175,463 Less accumulated depreciation and amortization (342,218) (187,942) -------------------------------- $ 731,611 $ 987,521 ================================
4. Stockholders' Equity The following table summarizes the activity of common shares under stock options for the years ended December 31, 2000 and 2001:
Weighted Number of Price per Average Shares Share Exercised Price ---------------------------------------------- Shares outstanding under options at December 31, 1999 4,297,950 $ .23 - $1.75 $ 1.13 Granted 6,924,500 $1.50 - $6.71 $ 2.67 Exercised (195,000) $ .23 - $1.00 $ .42 Cancelled - - Shares outstanding under options at December 31, 2000 11,027,450 $ .23 - $6.71 $ 2.08 Granted 158,000 $1.04 - $6.70 $ 1.69 Exercised (100,000) $ .23 - $1.00 $ .35 Cancelled (3,628,000) $ .23 - $6.71 $ 1.98 Shares outstanding under options at December 31, 2001 7,457,450 $ .23 - $6.71 $ 1.85
39 The following tables summarize information concerning outstanding and exercisable options at December 31, 2001.
Options Outstanding Options Exercisable ---------------------------------------------------- ---------------------------------- Weighted Average Weighted Weighted Remaining Average Average Range of Contractual Exercise Exercise Price Exercise Number Life (in Years) Price per Number per Share Prices Outstanding Share Exercisable ------------------------------------------------------------------------ ---------------------------------- $0.01-$1.00 3,402,950 2.0 $0.59 3,402,950 $ 0.59 $1.01-$3.00 3,098,000 3.4 1.95 3,080,000 1.95 $3.01-$6.71 956,500 4.0 6.02 946,500 5.95 ---------------------------------------------------- ---------------------------------- Total 7,457,450 2.8 1.77 7,429,450 $ 1.75 ============== ==============
Stock options granted to non-employees during 2001 and 2000 were valued using the fair value at the grant date adjusted for changes in market prices until vesting. Compensation expense (income) recognized amounted to ($44,978) and $6,102,943 in 2001 and 2000, respectively. The fair value of the options granted during 2001 and 2000 is estimated on the date of the grant using the Black- Scholes pricing model with the following assumptions.
2001 2000 ---------------------------- Risk-free interest rate 5.03% 6.00% Dividend yield 0% 0% Volatility factor 126% 144% Expected life 5 years 5 years
The Company applied the intrinsic value method to account for its stock options to employees. There were a minimal stock options granted to employees during 2001 and most of the options granted in 2000 were cancelled. Had compensation cost for the Company's stock options issued to employees been determined based upon the fair value at the grant date, using the Black-Scholes pricing, there would be an immaterial impact in the Company's net loss and loss per share in 2001. Option valuation models require the input of highly subjective assumptions. Because the Company's stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate in management's opinion, the existing model does not necessarily provide a reliable single measure of the fair value of its stock options. At December 31, 2001 and 2000, the following warrants were outstanding:
2001 2000 ----------------------------- Balance at beginning of year 3,297,646 4,995,000 Granted - - Exercised - (1,697,354) Cancelled - - ---------------------------- Balance at end of year 3,297,646 3,297,646 ============================
At December 31, 2001 the 3,297,646 warrants outstanding had an exercise price of $4.00 per share and expire May 9, 2002. Outstanding options and warrants to purchase shares at December 31, 2001 and 2000 were not included in the computation of diluted loss per common share because the effect would be antidilutive. 40 5. Commitments and Contingencies On or about February 16, 2001, UIT terminated the employment contracts of its Chief Executive Officer and Chief Financial Officer, Sonja Mikic and Chris Riley. It is the Company position that no further compensation or benefits are due under those contracts. On or about February 28, 2001, Sonja Mikic and Chris Riley (Plaintiffs) filed a lawsuit against the Company, UIT, and Brian Shuster (collectively, Defendants) in the Superior Court of the State of California for the County of Los Angeles, West District. Plaintiffs asserted causes of action for breach of written employment, tortuous breach of contracts, and tortuous interference with contract. On or about April 26, 2001, Plaintiffs filed a first amended complaint wherein they withdrew their causes of action for tortuous breach of contract, but asserted new claims of fraud against both corporate entities. Plaintiffs seek compensatory damages in an unspecified amount against Defendants, punitive damages, attorneys' fees, costs of suit, and judgment interest as allowed by law. Plaintiffs essentially allege that their contracts were terminated without cause and that UIT and the Company are in breach of the employment agreements by not providing the benefits that would accrue to each Plaintiff in the event his or her employment was terminated without cause. Separately, Plaintiffs' purported rights with respect to their ownership of stock options in UIT also may be at issue. The Company believes this lawsuit is without merit in that the employment agreements were terminated by UIT for cause, thereby eliminating Plaintiffs' rights to additional benefits under the agreements. The Company has answered the complaint, denying the allegations and asserting various affirmative defenses. The Company also has interposed a cross-complaint against the Plaintiffs asserting claims for breach of contract and related causes of action. The directors' and officers' liability insurance policy is covering the defense of the claims against Mr. Shuster in excess of the self-insured retention. In the normal course of business, the Company is subject to various claims and legal actions. The Company believes that the ultimate outcomes of any of these matters, either individually or in the aggregate, will not materially adverse affect the Company. The Company acquired technology rights of certain products from its employees. In accordance with the agreement, the Company is obligated to pay the employee and advance royalty of $230,000 and 125,000 shares of its common stock, payable when certain licensing criteria have been meet, and then a continuing royalty based upon the sale of any products using this technology. As of December 31, 2001, $115,000 of this advance royalty has been paid and is reflected in other assets in the accompanying balance sheet. In April 2001, the Company entered into a licensing agreement with Warner Bros. to embed its I-C-IT technology into toys embodying certain of the Warner Bros. characters, creating Looney Tunes Chat Pals. The Company also obtained a license to utilize the specific sound/voice tracks relating to the licensed characters. The license period extends until December 31, 2003, and requires a payment to Warner Bros. a royalty based upon the net sales of the licensed products. The Company also granted Warner Bros. a first priority lien and security interest in the inventory, contract rights, and accounts receivable, if any, with respect to the licensed products. There are no amounts due under these licensing agreements as of December 31, 2001. Warner Bros. may terminate these agreements for various reasons, including but not limited to, any material breaches of the Company's obligation under the agreements. 41 Lease Arrangements At December 31, 2001, minimum annual rentals under non-cancelable leases and minimum sub-lease income are as follows:
Year Ending December 31 Leases ---------------------------------------------------------------- 2002 $ 180,659 2003 73,374 2004 58,238 2005 9,784 Total $ 322,055
Rent expense was $370,983 in 2001 and $870,685 in 2000. 6. Income Taxes No provision for income taxes will be recorded for the year 2001. The Company has deferred tax assets of approximately $12.3 million and deferred tax liabilities of approximately $.2 million for the year 2001. The deferred tax assets are comprised in major part of net operating loss carryforwards. Due to the uncertainty surrounding the timing of realizing the benefits of favorable tax attributes in future tax returns, the Company has placed a full valuation allowance against its otherwise recognizable net deferred tax asset.
2001 2000 ---------------------------------- Deferred Tax Assets Net Operating Losses 10,477,264 7,851,193 Impairment Losses 73,954 160,000 Deferred Compensation 1,496,279 1,514,270 Other 249,849 471,589 ---------------------------------- Deferred Tax Assets 12,297,346 9,997,052 Valuation Allowance (12,067,503) (9,882,131) Deferred Tax Liabilities Depreciation (229,842) (114,921) ---------------------------------- Deferred Tax Liabilities (229,842) (114,921) ---------------------------------- Net Deferred Tax Assets (Liabilities) (0) (0)
The Company has cumulative net operating losses of $26.2 million for federal tax purposes. Pursuant to Internal Revenue Code Section 382, the utilization of the net operating loss carryforwards may be limited based upon changes in the percentage of ownership of the Company. 42 7. Related Party Transactions Due to (from) related parties at December 31, 2001 and 2000 consisted of the following:
2001 2000 -------------------------- $ - $ 250,000 Due to Harry Shuster Due to Grand Havana - 35,059 -------------------------- - 285,059 Less: Due from Grand Havana 5,995 - -------------------------- $ (5,995) $ 285,059 ==========================
The Company leases certain of its office space from a corporation of which Harry Shuster, is an officer and a principal stockholder. The Company incurred rent expense under this lease of $ 297,800 in 2001 and $441,574 in 2000. In January 2001, the Company agreed to terminate a consulting services agreement with Harry Shuster. The termination agreement effective December 31, 2000, allowed the Company to terminate the consulting agreement for Mr. Shuster, which had a remaining duration of five years. The terms of the agreement required a one-time payment of $250,000 and the transfer of certain amounts owed to the Company by Grand Havana (an affiliated company). The amounts included a loan receivable from Grand Havana, including accrued interest, of $682,156 and other balances due from Grand Havana aggregating, which after deducting amounts owed to Grand Havana, amounted to $58,090. These amounts were expensed in 2000 and are included in selling, general and administrative expense. As of December 31, 2001 the Company held 966,666 shares of Grand Havana's common stock. The Chief Executive Officer of Grand Havana is Stanley Shuster, the brother of Brian Shuster. As of December 31, 2001, the Company has paid $115,000 advance royalty to an employee in connection with the acquisition of technology rights of certain products. (See Note 5). 43