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Registration No. 333-64169
PROSPECTUS Rule 424(b)(3)
THE PATHWAYS GROUP, INC.
654,508 Shares of Common Stock
This Prospectus relates to up to 654,508 shares (the "Shares") of the Common
Stock, par value $.01 per share (the "Common Stock"), of The Pathways Group,
Inc. (together with its subsidiaries, unless the context otherwise requires, the
"Company" or "Pathways") to be sold from time to time by the holders thereof
(the "Selling Stockholders") on the NASDAQ over-the-counter Bulletin Board (or
if the Common Stock is accepted for listing on the NASDAQ SmallCap Market, on
the SmallCap Market ("NASDAQ")) or otherwise at prices then attainable, less
ordinary brokers' commissions and dealers' discounts, as applicable. The Shares
were offered and sold to the Selling Stockholders pursuant to private offerings
in which the Shares were not registered with the Securities and Exchange
Commission. The Shares are being offered solely for the account of the Selling
Stockholders and the Company will receive no part of the proceeds of this
Offering. See "The Selling Stockholders", "Use of Proceeds" and "Plan of
Distribution".
The Company's Common Stock is traded in the over-the-counter market under
the symbol PTHW. On October 9, 1998 the last reported bid price per share for
the Common Stock as reported on NASDAQ Bulletin Board was $14.00.
THE COMPANY'S SECURITIES ARE SPECULATIVE IN THAT THEY INVOLVE A HIGH DEGREE
OF RISK AND SHOULD BE PURCHASED ONLY BY PERSONS WHO CAN AFFORD TO LOSE THEIR
ENTIRE INVESTMENT. SEE "RISK FACTORS" FOR A DISCUSSION OF MATTERS WHICH SHOULD
BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THESE SECURITIES.
<TABLE>
<CAPTION>
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Underwriting
discounts and Proceeds to issuer or
Price to Public commissions other persons(3)
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share $ 14.00(1) -0- $ 9,163,112(1)(2)
- -----------------------------------------------------------------------------------------
Total $ 14.00(1) -0- $ 9,163,112(1)(2)
- -----------------------------------------------------------------------------------------
</TABLE>
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(1) Estimated, based upon the last reported sale price of the Company's Common
Stock on October 9, 1998.
(2) The Company will receive no part of the proceeds of this Offering. All
proceeds will go to the Selling Stockholders, and the amount set forth
above assumes that all Shares registered pursuant to this Registration
Statement are sold.
(3) The estimated expenses of the Company in connection with this Registration
Statement, of which this Prospectus constitutes a part, are $65,000.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECRETARY OF STATE
OF ILLINOIS OR THE STATE OF ILLINOIS, NOR HAS THE SECRETARY OF STATE OF ILLINOIS
OR THE STATE OF ILLINOIS PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
--------------------
The date of this Prospectus is October 9, 1998.
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THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFERING OR SOLICITATION WITH RESPECT
TO THESE SECURITIES BY THE COMPANY TO ANY PERSON WHO MAY BE CONSIDERED TO BE AN
UNDERWRITER OR TO ANY PERSON IN ANY STATE IN WHICH SAID OFFERING OR SOLICITATION
IS NOT AUTHORIZED BY THE LAWS THEREOF OR IN WHICH THE PERSON MAKING SAID
OFFERING OR SOLICITATION IS NOT QUALIFIED TO ACT AS DEALER OR BROKER OR
OTHERWISE TO MAKE SUCH OFFERING OR SOLICITATION.
THE COMPANY HAS UNDERTAKEN TO FILE POST-EFFECTIVE AMENDMENTS TO THE
REGISTRATION STATEMENT OF WHICH THIS PROSPECTUS IS A PART AND TO REFLECT THEREIN
ANY FACTS OR EVENTS ARISING AFTER THE DATE HEREOF WHICH REPRESENT A FUNDAMENTAL
OR MATERIAL CHANGE IN THE INFORMATION SET FORTH HEREIN OR IN SAID REGISTRATION
STATEMENT. SEE "UNDERTAKINGS". ANY SUCH AMENDMENTS WHICH RELATE TO THIS
PROSPECTUS WILL BE DISSEMINATED TO SELLING STOCKHOLDERS OF THE COMPANY AFTER THE
REQUIRED FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION HAVE BEEN MADE AND
BECOME EFFECTIVE.
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AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance
therewith, files reports and other information with the Securities and Exchange
Commission (the "Commission"). Reports, proxy statements and other information
filed by the Company may be inspected and copied at the public reference
facilities maintained by the Commission at Room 1024, 450 Fifth Street, N.W.,
Washington, D.C. 20549, and the Commission's regional office at Suite 500 East,
5757 Wilshire Boulevard, Los Angeles, California 90036. Copies of such material
can also be obtained from the Public Reference Section of the Commission at 450
Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. The Commission
maintains a Web site (located at http://www.sec.gov) that contains reports,
proxy and information statements and other information regarding issuers that
file electronically with the Commission. The Company maintains a website at
http://www.pathwaysgroup.com.
The Company will provide without charge to each person who receives this
Prospectus, upon written or oral request of such person, a copy of any of the
information that is incorporated by reference in the Prospectus (not including
exhibits to the information that is incorporated by reference unless the
exhibits are themselves specifically incorporated by reference). Such requests
should be sent to Edward L. Mueller, General Counsel and Secretary to the
Company, at 1221 North Dutton Avenue, Santa Rosa, California 95401.
IN CONNECTION WITH THIS OFFERING, CERTAIN SELLING STOCKHOLDERS MAY ENGAGE IN
PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK OF THE COMPANY ON NASDAQ
IN ACCORDANCE WITH RULE 103 OF REGULATION M. SEE "PLAN OF DISTRIBUTION".
Until January 7, 1999, all dealers effecting transactions in the registered
securities, whether or not participating in this distribution, may be required
to deliver a prospectus. This is in addition to the obligation of dealers to
deliver a prospectus when acting as underwriters and with respect to their
unsold allotments or subscriptions.
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SUMMARY INFORMATION
The following summary is qualified in its entirety by the detailed
information and consolidated financial statements (including the notes thereto)
appearing elsewhere in this Prospectus.
The Company
The Pathways Group, Inc. and its subsidiaries ("Pathways" or the "Company")
designs, markets and services custom smart card applications. The Company
develops unique solutions for creating and processing data and ensuring secure
electronic transactions by utilizing proprietary hardware and application
software systems. Pathways' technology establishes electronic commerce in closed
system environments. A key element of the Company's business plan is the
processing of transactions associated with its current and prospective smart
card installations. The Company also manufactures and markets automated
ticketing kiosks that the Company anticipates will be integrated with its smart
card applications.
The Company was organized in 1993 as a Washington corporation whose
operations are the successor to Pathways International, Ltd., which was
incorporated in Washington in June 1988. In May 1997 the Company reincorporated
in Delaware. The Company's executive offices are located at 14201 NE 200th
Street, Woodinville, Washington 98072 and its telephone number is (425)
483-3411. A primary processing center opened in September 1997, located at 1221
North Dutton Avenue, Santa Rosa, California 95404, and its telephone number is
(707) 546-3010.
The Selling Stockholders
This Prospectus relates to the registration of the resale of 654,508 shares
of the Company's Common Stock, beneficially owned by certain of the Company's
stockholders. These shares were issued in private placement transactions and had
not previously been registered with the Securities and Exchange Commission. See
"The Selling Stockholders" and "Plan of Distribution".
RISK FACTORS
The Shares offered hereby are speculative and involve a high degree of risk.
An investment in the Shares is suitable only for persons who can afford to
sustain the loss of their entire investment. Prospective investors should
carefully consider the following factors in addition to those described
elsewhere in this Prospectus before making an investment decision.
Limited Operating History. The Company was organized under the laws of the
State of Washington in November 1993, reincorporated in Delaware in May 1997,
and has only had a limited operating history. It is the successor to Pathways
International, Ltd., incorporated in June 1988. Since inception, the Company has
been engaged principally in research and development of its products and in
organizational activities, including developing a business plan, hiring
personnel and developing and enhancing its proprietary smart card technology and
software and developing pilot programs for its products. Therefore, the Company
has a limited operating history upon which an evaluation of its prospects can be
made. The Company's prospects must be considered in light of the risks,
uncertainties, expenses, delays and difficulties associated with the
establishment of a new business in the rapidly evolving smart card industry, as
well as those risks encountered in the shift from development to
commercialization of new products based on innovative technologies. See
"Business".
Limited Revenues; Significant and Continuing Losses; Accumulated Deficit.
Through June 30, 1998, Pathways recorded cumulative total revenues of
approximately $353,000 related to its smart card operations, including the
delivery and installation of approximately 57,000 smart and affinity cards
and approximately 120 smart card terminals. The Company has generated limited
revenues to date and any material increase in its revenues is dependent upon
commercial acceptance of its products. The Company
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has incurred significant losses in each period since its inception resulting
in an accumulated deficit at June 30, 1998, of $(15,894,352). Inasmuch as the
Company will continue to have a high level of operating expenses and will be
required to make significant up-front expenditures in connection with both
the development of its business and the commercialization of its smart card
systems (including, without limitation, salaries of executive, technical,
marketing and other personnel), the Company anticipates that it will continue
to incur significant and increasing losses for the foreseeable future until
such time, if ever, as the Company is able to generate sufficient revenues to
finance its operations. There can be no assurance that the Company's smart
card systems will gain market acceptance, or that the Company will be able to
successfully implement its business strategy, generate meaningful revenues or
achieve profitable operations. See "Business" and the Company's financial
statements included herein.
Developing Marketplace; Uncertainty of Market Acceptance. The smart card
industry in the United States is an emerging business. The success of the smart
card industry depends, in large part, on the ability of market participants,
including the Company, to convince governmental authorities, commercial
enterprises and other potential system sponsors to adopt a smart card system in
lieu of existing or alternative systems such as magnetic stripe card and
paper-based systems, thereby changing the way certain transaction and
information processing tasks are accomplished. In addition, due to the large
capital and infrastructure investment made by debit and credit card issuers and
significantly lower costs associated with the use of magnetic stripe cards,
there can be no assurance that the Company's smart card technology will prove to
be economically viable for a sufficient number of sponsors, and many potential
system sponsors may be reluctant to convert to smart card technology in the near
future. Accordingly, there can be no assurance that there will be significant
market opportunities for smart card systems in the United States or that the
acceptance of smart card-based systems in other countries will be sustained. As
such, demand for and market acceptance of the Company's smart card systems are
subject to a high level of uncertainty.
Competition. The smart card industry in the United States is an emerging
business characterized by an increasing and substantial number of new market
entrants that have introduced or are developing an array of new products and
services relating to electronic transactions and information processing. Each of
these entrants is or may be seeking to position its products and services as the
preferred method of effectuating highly individualized, easy-to-use electronic
transaction and information processing. This market is therefore characterized
by intense competition. Specifically, the Company competes with numerous
well-established companies, including Bull, Card Europe, GemPlus, Innovatron,
Philips Electronics, Aladdin Systems, MONDEX, MasterCard, Motorola,
Schlumberger, Siemens, DigiCash, AT&T Card and Visa, which design, manufacture
and/or market smart card systems. While the Company believes that its products
are able to compete on the basis of enhanced security, flexibility, salability,
cost-effectiveness and quality, the Company's smart card systems incorporate new
concepts and may be unsuccessful even if they are superior to those of its
competitors. In addition, certain companies may be developing technologies or
products of which the Company is unaware which may be functionally similar or
superior to those developed by the Company. Most of the Company's competitors
and potential competitors possess substantially greater financial, marketing,
personnel and other resources than the Company and have established reputations
relating to the design, development, manufacture, marketing and service of smart
card systems. As the market for smart card systems grows, new competitors are
likely to emerge. Additional competition could adversely affect the Company's
operations. There can be no assurance that the Company will be able to compete
successfully, that competitors will not develop technologies or products that
render the Company's systems obsolete or less marketable or that the Company
will be able to successfully enhance its products or develop new products when
necessary. See "Business -- Competition".
Uncertainty of Business Plan. The success of the Company's business plan
will be largely dependent upon market acceptance of smart cards generally, as
well as on the Company's ability to successfully market its smart card
systems by persuading potential system sponsors of the perceived benefits of
its products and to develop and commercialize further applications of its
proprietary technology. In addition, the Company's business plan and
prospects will be dependent upon, among other things, the Company's ability
to enter into strategic marketing and licensing or other arrangements on a
timely basis
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and on favorable terms; establish satisfactory arrangements with sales
representatives and marketing consultants; hire and retain skilled management
as well as financial, technical, marketing and other personnel; successfully
manage growth (including monitoring operations, controlling costs and
maintaining effective quality, inventory and service controls); and obtain
adequate financing when and as needed. The Company has limited experience in
developing new products based on innovative technology, and there is limited
information available concerning the performance of the Company's
technologies or market acceptance of the Company's products. There can be no
assurance that the Company will be successful in implementing its business
plan or that unanticipated expenses or problems or technical difficulties
will not occur which would result in material delays in its implementation.
Moreover, there can be no assurance that the Company will have sufficient
capacity to satisfy any increased demand for its smart card products and
technologies resulting from the Company's implementation of its plan of
operation. See "Business".
Limited Marketing Experience. The Company has limited marketing experience
and limited financial, personnel and other resources to undertake extensive
marketing activities. Potential system sponsors of the Company's smart card
systems, as well as the Company's potential strategic partners, must be
persuaded that the costs of adopting and implementing smart card systems, in
general, and, in particular, of adopting and implementing the Company's smart
card systems, are justified by the benefits to be derived therefrom. Achieving
market acceptance for the Company's products and services will require
significant efforts and expenditures by the Company to create awareness, demand
and interest by potential system sponsors, strategic partners and others
regarding the perceived benefits of the Company's technologies. There can be no
assurance that the Company will be able to meet its current objectives, succeed
in positioning its cards and services as a preferred method of delivering
electronic transaction and information processing or achieve significant market
acceptance of its products. See "Business".
Dependence on Third-Party Marketing Arrangements. The Company has limited
marketing capabilities, experience and resources. To date, the Company has
conducted only limited marketing activities and has relied primarily on the
efforts of its executive officers in connection with such activities. Although
the Company expects to continue to market smart card systems directly through
the Company's management and employees, the Company intends to establish
strategic marketing alliances and licensing or other arrangements with systems
integrators, value-added resellers and other smart card vendors and may also
retain the services of sales representatives and marketing and other
consultants. The Company's success will depend in part on its ability to enter
into agreements with such third parties, and on the ability and efforts of such
third parties to successfully market the Company's smart card systems. Moreover,
marketing arrangements with third parties may require financial or other
commitments by the Company. There can be no assurance that the Company will be
able, for financial or other reasons, to enter into third-party marketing
arrangements on commercially acceptable terms, if at all. The failure of the
Company to complete its third-party marketing strategy or the failure of any
such party to develop and sustain a market for the Company's smart cards could
have a material adverse effect on the Company. Although the Company views
third-party marketing arrangements as a major factor in the commercialization of
its smart card systems, there can be no assurance that any strategic partners,
licensees or others would view an arrangement with the Company as significant to
their businesses. See "Business".
Significant Capital Requirements. The Company's capital requirements have
been and will continue to be significant. The Company has been dependent on
the sales of its securities to private investors, as well as on capital
contributions and loans from affiliates and certain financial institutions
guaranteed by certain stockholders of the Company. The Company anticipates,
based on currently proposed business plans and assumptions relating to its
operations (including assumptions regarding the Company's ability to meet its
current marketing objectives and the timing and costs associated therewith),
that the net proceeds of its private placement of Common Stock that was
commenced in July 1998 and completed in August 1998 (the "Private
Placement"), together with projected cash flow from operations, will be
sufficient to fund the Company's operations and capital requirements for at
least twelve months following the Private Placement. In the event that the
Company's plans change, its assumptions change or prove to be inaccurate or
if the proceeds of the Private Placement prove to be insufficient to fund
operations (due
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to unanticipated expenses, technical difficulties or other problems), the
Company will be required to seek additional financing sooner than currently
anticipated. In addition, any implementation of the Company's business plans
subsequent to the twelve-month period following the Private Placement may
require proceeds greater than the proceeds of the Private Placement or
otherwise currently available to the Company. The Company has no current
arrangements with respect to, or sources of, additional financing and there
can be no assurance that any such financing will be available to the Company
on commercially reasonable terms, if at all. It is not anticipated that any
of the officers, directors or stockholders of the Company will provide any
portion of the Company's future financing requirements. Any inability to
obtain additional financing when needed will have a material adverse effect
on the Company, including requiring the Company to curtail its activities and
possibly causing the Company to cease its operations. To the extent that the
Company finances its operations through the issuance of additional equity
securities, any such issuance may involve substantial dilution to the
Company's then-existing stockholders. Additionally, to the extent that the
Company incurs additional indebtedness or issues debt securities, the Company
will be subject to all of the risks associated with incurring substantial
indebtedness, including the risks that interest rates may fluctuate and cash
flow may be insufficient to pay principal and interest on any such
indebtedness. See "Use of Proceeds" and "Business".
Technological Factors. The Company's research and development efforts are
subject to all of the risks inherent in the development of new products and
technology (including unanticipated delays, expenses and difficulties). There
can be no assurance that the Company's products will satisfactorily perform the
functions for which they are designed, that they will meet applicable price or
performance objectives or that unanticipated technical or other problems will
not occur which would result in increased costs or material delays in the
development thereof. Furthermore, software products as complex as those
developed by the Company and incorporated into its smart card products may
contain errors or failures when installed, updated or enhanced. There can be no
assurance that, despite testing by the Company and by current and potential end
users, errors will not be found in new products after the delivery by the
Company, resulting in loss of or delay in market acceptance. See "Business".
Proprietary Rights. The Company's success will depend on its ability to
protect trade secrets and operate without infringing on the proprietary rights
of others. The Company may apply for United States patent, trademark and
copyright protection with respect to its toolkits for smart card programming as
well as its commercial applications. The Company may file similar applications
in selected foreign jurisdictions where such filings would, in the Company's
opinion, provide it with a competitive advantage.
The Company is not aware of any infringement by its technology on the
proprietary rights of others and has not received any notice of claimed
infringement. However, the Company has not conducted any investigation as to
possible infringement and there can be no assurance that third parties will not
assert infringement claims against the Company in connection with its products,
that any such assertion of infringement will not result in litigation or that
the Company would prevail in such litigation.
Moreover, in the event that the Company's technology or proposed products
were deemed to infringe upon the rights of others, the Company would be required
to obtain licenses to utilize such technology. There can be no assurance that
the Company would be able to obtain such licenses in a timely manner on
acceptable terms and conditions, and the failure to do so could have a material
adverse effect on the Company. If the Company were unable to obtain such
licenses, it could encounter significant delays in product market introductions
while it attempted to design around the infringed-upon patents or rights, or
could find the development, manufacture or sale of products requiring such
license to be foreclosed. In addition, patent disputes are common in the smart
card and computer industries and there can be no assurance that the Company will
have the financial resources to enforce or defend a patent infringement or
proprietary rights action. The Company's use of its software, name and trademark
may be subject to challenge by others, which, if successful, could have a
material adverse effect on the Company.
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The Company also relies on trade secrets and proprietary know-how and
employs various methods to protect the concepts, ideas and documentation
relating to its proprietary technology. However, such methods may not afford the
Company complete protection and there can be no assurance that others will not
independently obtain access to the Company's trade secrets and know-how or
independently develop products or technologies similar to those of the Company.
Furthermore, although the Company has and expects to have confidentiality and
non-competition agreements with its employees and appropriate suppliers and
manufacturers, there can be no assurance that such arrangements will adequately
protect the Company's trade secrets. See "Business--Copyrights, Trademarks,
Patents, Proprietary Rights and Licenses".
Year 2000 Risk. During recent years, there has been significant global
awareness raised regarding the potential disruption to business operations
worldwide resulting from the inability of current technology to process properly
the change in the year 1999 to 2000. Based on a review of its data processing,
operating systems, software and other technology already in place, the Company
does not currently believe that it will experience any significant adverse
effects or material unbudgeted costs resulting therefrom. Nevertheless, the
Company cannot provide any assurance in this regard, and any such costs or
effect could materially and adversely affect the operations and financial
condition of the Company.
Lengthy Sales Cycle; Possible Fluctuations in Operating Results. The
Company's sales cycle is expected to commence at the time a prospective customer
demonstrates an interest in purchasing a smart card system from the Company or
issues a request for a proposal or information or takes similar action, and ends
upon the installation and acceptance of a smart card system for the customer.
The sales cycle will vary by customer and industry and could extend for periods
of up to twelve months or more, depending upon, among other things, the time
required by the customer to complete a pilot test of the Company's smart card
system, make a determination regarding an acquisition thereof and negotiate
payment terms with the Company. The Company's operating results could vary from
period to period as a result of this fluctuation in the length of the Company's
sales cycle and as a result of fluctuations in the purchasing patterns of
potential system sponsors, technological factors, variations in marketing
strategies for different target markets and non-recurring smart card system
sales.
Possible Dependence on Government Contracts. As part of its strategy, the
Company intends to market its smart card systems to government agencies in the
United States, Canada and abroad. If successful, the Company will become subject
to the special risks involving government contracts, including delays in
funding, lengthy review processes for awarding contracts, non-renewal, delay,
termination at the convenience of the government, reduction or modification of
contracts in the event of changes in the government's policies or as a result of
budgetary constraints and increased or unexpected costs resulting in losses, any
or all of which could have a material adverse effect on the Company.
The Company will also be required to obtain any potential government
contracts through the competitive bidding process. There can be no assurance
that the Company will be successful in having its bids accepted or, if accepted,
that awarded contracts will generate sufficient revenues to result in profitable
operations. The competitive bidding process is typically lengthy and often
results in the expenditure of financial and other resources in connection with
bids that are not accepted. Additionally, inherent in the competitive bidding
process is the risk that actual performance costs may exceed projected costs
upon which a submitted bid or contract price is based. To the extent that actual
costs exceed projected costs, the Company would incur losses, which would
adversely affect the Company's operating margins and results of operations.
Moreover, in most instances, the Company would be required to post bid and/or
performance bonds in connection with contracts with government agencies. Any
inability by the Company to obtain bonding coverage in sufficient amounts could
have a material adverse effect on the Company. See "Business".
Broad Discretion in Application of Proceeds. The Company intends to use the
net proceeds from the Private Placement for general working capital purposes for
the expansion of its business, including marketing, research and development,
and salaries for new personnel. The Company has not
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developed more specific allocations for the use of such net proceeds, and the
Company's management has broad discretion to use such net proceeds for the
expansion of the Company's business in accordance with its business judgment.
Dependence on Management and Key Personnel. The success of the Company is
highly dependent on the personal efforts of Carey F. Daly, II, its Chief
Executive Officer and its President. The Company has entered into an employment
agreement with Mr. Daly; the loss of his services would have a material adverse
effect on the Company's business and prospects. In order to successfully
implement and manage its proposed expansion, the Company will be dependent upon,
among other things, its ability to attract and retain qualified managerial,
technical and marketing personnel with experience in business activities such as
those contemplated by the Company. Competition for qualified personnel is
intense and there can be no assurance that the Company will be able to hire or
retain such personnel. Any inability to attract and retain qualified personnel
would have a material adverse effect on the Company. The Company has assembled a
core team of financial, marketing and research and technical personnel, who have
been significant contributors to the Company's development to date. The loss of
any of such personnel could have a significant adverse impact on the Company.
The Company currently does not have any "key man" insurance on any of its
personnel. See "Management".
Determination of Offering Prices; Possible Volatility of Market Price of
Common Stock. Since the Company offered its shares of Common Stock in July 1997,
there has only been a limited public trading market for the Common Stock.
Consequently, the offering price of the Common Stock is not necessarily related
to the Company's asset value, net worth or other criteria of value. There can be
no assurance that a regular trading market for the Common Stock will develop
after this offering or that, if developed, it will be sustained. The market
price for the Company's securities following this offering, if a market
develops, may be highly volatile, as has been the case with the securities of
other small capitalization companies. Additionally, in recent years, the stock
market in general, and the market for securities of small capitalization stocks
in particular, have experienced wide price fluctuations which have often been
unrelated to operating performance of such companies.
Limited Liquidity; Shares Eligible for Future Sale. The Company's Common
Stock is currently traded in the NASDAQ over-the-counter market Bulletin Board.
The Company has applied for listing on the NASDAQ SmallCap Market. Although the
Company believes that its application for such listing will be accepted, there
can be no assurance that the Company will meet the criteria necessary for such
application to be granted, or that if granted, the Company will meet the
criteria for continued listing on the NASDAQ SmallCap Market. To the extent that
the Company does not secure or maintain such listing, the Company's stockholders
could find it more difficult to dispose of, or to obtain accurate quotations as
to the market value of, the Common Stock. In addition, failure to list or
maintain a listing for the Common Stock may make the Common Stock ineligible for
use as, or make the Common Stock substantially less attractive as, collateral
for margin and purpose loans, for investment by financial institutions under
their internal policies or state legal investment laws, as consideration in the
financing of future acquisitions of businesses or assets by the Company, and for
issuance by the Company in future capital raising transactions.
As a result of the limited trading market for the Common Stock described
above and the large number (relative to such trading markets) of shares of
Common Stock available for sale in the public market pursuant to Rule 144
under the Securities Act of 1933, as amended (the "Securities Act"), the
sales by stockholders of the Company of Common Stock in the public market
could materially adversely affect the prevailing market price for the Common
Stock and could impair the Company's ability to raise capital through
offerings of its equity securities. In addition to the 654,508 Shares sold in
the Private Placement, approximately 11,000,000 shares of Common Stock held
by the Company's existing stockholders are currently available for sale in
the public market, subject to the provisions of Rule 144 under the Securities
Act. In connection with the Private Placement, the Company entered into
agreements with Allen & Company Incorporated, persons affiliated with Allen &
Company Incorporated, Carey F. Daly, II, Glenn A. Okun and Lawrence Okun (who
collectively hold a total of approximately 7,400,000 shares of Common Stock
purchased at prices significantly lower than the Shares being offered
hereunder), pursuant to which such
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stockholders agreed not to offer for sale any shares of Common Stock until
the Registration Statement, of which this Prospectus constitutes a part, has
become effective. There can be no assurance, however, that such holders will
not offer substantial amounts of Common Stock for sale after this
Registration Statement has become effective or that other stockholders of the
Company will not offer substantial amounts of Common Stock for sale either
before or after such effectiveness. Any such sales could materially adversely
affect the then-prevailing market price for the Common Stock or the ability
of holders of Shares to sell such Shares.
No Dividends. The Company has never paid any cash or other dividends on its
Common Stock. For the foreseeable future, the Board of Directors intends to
retain future earnings, if any, to finance its business operations and does not
anticipate paying any cash dividends with respect to the Common Stock. In
addition, the payment of cash dividends may be limited or prohibited by the
terms of any future loan agreements or any Preferred Stock that may be issued by
the Company.
Limitations on Liability of Directors and Officers. Pursuant to its
Certificate of Incorporation and By-laws, the Company indemnifies its officers
and directors to the maximum extent permitted by law.
Adoption of Certain Charter and By-law Provisions Having Anti-Takeover
Effects. The Company's Certificate of Incorporation permits the Company, without
further stockholder action, to issue up to 1,000,000 shares of preferred stock,
having such rights and preferences as the Company's board may determine. See
"Description of Securities".
The Certificate and By-laws contain various provisions which, under certain
circumstances, could make it more difficult for a third party to gain control of
the Company (e.g., by means of a tender offer), prevent or substantially delay
such a change of control, discourage bids for the Common Stock at a premium, or
otherwise adversely affect the market price of the Common Stock. See
"Description of Securities".
Options Outstanding. As of the date of this Offering Circular, the Company
had outstanding options to purchase an aggregate of 410,833 shares of Common
Stock at a weighted average exercise price of $10.84 per share. Exercise of any
of the foregoing options will have a dilutive effect on the Company's
stockholders. Furthermore, the terms upon which the Company may be able to
obtain additional equity financing may be adversely affected, since holders of
the options can be expected to exercise them, if at all, at a time when the
Company would, in all likelihood, be able to obtain any needed capital on terms
more favorable to the Company than those provided in the options.
USE OF PROCEEDS
The Company will not receive any proceeds from the sale of any of the Shares
by the Selling Stockholders.
7
<PAGE>
CAPITALIZATION
The Company's capitalization, at June 30, 1998, was as follows:
<TABLE>
<CAPTION>
After Giving
Effect to
Private
Actual Placement*
------------- ------------
<S> <C> <C>
Long-term liabilities, net of current portion $ 220, 344 $ 220,344
Common stock, par value $0.01
Stated capital 129,045 135,590
Additional paid-in capital 18,052,730 26,457,678
Preferred stock, par value $0.01 -- --
Accumulated deficit (15,894,352) (15,894,352)
Total stockholders' equity $ 2,287,423 $ 10,698,916
</TABLE>
- ----------
* See "Management's Discussion and Analysis or Plan of Operation" for the
Quarters Ended June 30, 1998 and 1997.
SELECTED CONSOLIDATED FINANCIAL INFORMATION
The following table contains selected financial information derived from the
financial statements set forth elsewhere in this Prospectus, and should be read
in conjunction with such financial statements and notes thereto. The following
tables summarize certain financial data derived from audited consolidated
financial statements of the Company for the fiscal years ended December 31,
1997, 1996, and 1995, respectively, and financial data derived from unaudited
consolidated financial statements of the Company for the six month periods ended
June 30, 1998 and 1997. The unaudited financial statements of the Company as of
June 30, 1998 and 1997 and for the six month periods then ended have been
prepared on the same basis as the audited financial statements of the Company
and, in the opinion of management, include all adjustments necessary (consisting
of only normal recurring adjustments and accruals) to present fairly the
financial position and the results of operations of the Company.
8
<PAGE>
<TABLE>
<CAPTION>
Six Months
Ended
Year Ended December 31, June 30,
(Audited) (Unaudited)
-----------------------------------------------------------------------
1997 1996 1995 1998
-----------------------------------------------------------------------
<S> <C> <C> <C> <C>
Income Statement Data:
Operating revenues.................. $ 61,785 $ 108,418 $ 512,250 $ 13,380
Gross profit........................ 42,293 43,224 443,169 10,379
(Loss) from operations.............. (3,535,487) (2,265,572) (2,318,948) (2,942,809)
Other Income (Expense).............. (51,034) (567,305) (332,599) 5,076
Net (Loss) before taxes............. (3,586,521) (2,832,877) (2,651,547) (2,937,733)
-----------------------------------------------------------------------
Net (Loss).......................... $(3,586,521) $(2,832,877) $(2,651,547) $(2,937,733)
-----------------------------------------------------------------------
-----------------------------------------------------------------------
(Loss) per share basic and
diluted ............................ $ (0.30) $ (0.57) $ (1.49) $ (0.23)
-----------------------------------------------------------------------
-----------------------------------------------------------------------
Balance Sheet Data:
Current assets...................... $ 4,130,369 $ 2,874,727 $ 92,827 $ 741,956
Total assets........................ 6,716,840 5,072,139 2,630,217 3,498,451
Long-term obligations
under capital lease............... 0 0 0 0
Total liabilities................... 1,491,674 2,110,544 5,332,238 1,211,028
Working capital..................... 3,148,595 1,496,074 (2,647,394) (248,728)
Stockholders' equity (deficit)...... 5,225,166 2,961,595 (2,702,021) 2,287,423
</TABLE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
General
Since its inception, the Company has undertaken a program to develop the
hardware and software products and expand the transaction processing services
that it offers. The Company has invested heavily in designing and developing its
proprietary hardware and application software systems and in establishing its
sales and marketing capabilities. The Company plans to continue these efforts in
preparation for and anticipation of the growth in smart card-based electronic
commerce that the Company expects will create a substantial market for its data
and transaction processing services. The Company has also made investments in
computers, networking systems and unattended kiosk equipment.
As a result of operating costs associated with these activities, the
Company has recorded significant operating losses since its inception. The
Company's operating expenses were $2,762,117, $2,308,796, and $3,577,780 for
the years ending December 31, 1995, 1996 and 1997, respectively. The Company
recorded losses of $2,651,547, $2,832,877, and $3,586,521 for the years
ending December 31, 1995, 1996 and 1997, respectively.
9
<PAGE>
The Company's business model is based upon the Company's contracting large
membership based businesses to be a turnkey provider of smart card-based
systems. The Company anticipates licensing its software to its clients and
entering into agreements whereby the company will perform all backroom
processing of the transactions that occur over the system in addition to selling
smart cards and smart card readers programmed by the Company. The Company
expects to receive transaction-processing fees for its backroom processing
services.
Except for historical information, the material contained in this
Management's Discussion and Analysis or Plan of Operation is forward-looking.
This discussion includes, in addition to historical information, forward looking
statements which involve risks and uncertainties. The Company's actual results
could differ materially from the results discussed in the forward looking
statements. Factors that could cause or contribute to such differences are
discussed below and in "Risk Factors" in this Prospectus. These risks and
uncertainties include the rate of market development and acceptance of smart
card technology, the unpredictability of the Company's sales cycle, the limited
revenues and significant operating losses generated to date, and the possibility
of significant ongoing capital requirements. For the purposes of the safe harbor
protection for forward-looking statements provided by the Private Securities
Litigation Reform Act of 1995, readers are urged to review the list of certain
important factors set forth in "Cautionary Statement for Purposes of the 'Safe
Harbor' Provisions of the Private Securities Litigation Reform Act of 1995".
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Results of Operations
Revenues. The Company had revenues of $512,250, $108,418, and $61,785 for
the years ending December 31, 1995, 1996 and 1997, respectively. During 1995,
the Company's revenues consisted principally of credit card transaction
processing fees from its unattended ticketing kiosk software. Throughout late
1995 and early 1996, the Company focused its efforts on developing and
installing its first smart card application system. After the successful
implementation of this system, the Company's resources were increasingly devoted
to the expansion and realization of the smart card application system component
of the Company's business plan. As a result of this refocusing, revenues from
the automated kiosk business have declined throughout 1996 and 1997.
The Company has signed pilot agreements with the Department of Education in
the State of Hawaii for the implementation of an electronic school lunch program
and with First Hawaiian Bank for the use of smart cards in a retail program. The
Company believes it will continue to report minimal revenues until additional
significant contracts are signed or until the existing contracts proceed through
the pilot stage to a full rollout.
Gross Margin. The Company's gross margin as a percentage of revenues was
86.51%, 39.87%, and 68.45% for the years ending 1995, 1996 and 1997
respectively. The Company's overall gross margin percentage varies primarily as
a result of the "mix" of sales between high margin transaction processing fees
and lower margin hardware and smart card sales. Accordingly, the gross margin
declined in 1996 as compared to 1995 due to a higher volume of transaction
processing fees as a percentage of total revenues in 1995 as compared to 1996,
and a higher percentage of credit card chargeback expenses that occurred in 1996
than in 1995. Similarly, gross margins increased in 1997 as compared to 1996 due
to a lower percentage of credit card chargeback expenses in 1997 as compared to
1996 and a greater percentage of lower margin smart card sales that occurred in
1996 than in 1997.
The Company expects future gross margin percentages will be heavily
influenced by potential competition as well as the "mix of sales" between
hardware sales and transaction processing fees. Although this mix is
difficult to predict, generally margins will be lower at the beginning of a
new client system roll out due to the intensity of smart card readers and
smart card sales. Once the initial rollout of a client system is
10
<PAGE>
completed, gross margins are expected to increase due to a sharp increase in
use of the smart card by cardholders and the resulting transaction processing
fees.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased $299,204 or 15.35% in 1996 as compared to
1995. The higher level of selling, general and administrative expenses in 1995
as compared to 1996 is primarily a result of a net receivable write off of
$486,755 as a result of the Company's acquisition of Sprinticket in 1995.
Selling, general and administrative costs increased $1,125,212 or 68.18% in 1997
as compared to 1996 primarily as a result of expanded payroll costs associated
with an increased number of full time and contract employees. The Company had
staff levels of between fifteen and thirty-five employees as of the end of 1997
as compared to eight to fifteen throughout 1996. The Company expects the level
of selling, general and administrative costs to increase substantially as a
result of increased marketing activities and an increase in operating and
technical personnel to support its sales revenues and continued development of
new products and concepts. Additionally, the Company has leased a new 8,700
square foot building in Santa Rosa, California which has been refurbished into a
new state of the art transaction-processing center. Construction of the facility
buildout occurred in the second and third quarters of 1997 and was occupied in
September 1997. Additionally, the Company incorporated a wholly owned subsidiary
and opened a sales and marketing office in Honolulu, Hawaii during the third
quarter 1997.
The Company anticipates substantial investments in its sales and marketing
and product development activities in the foreseeable future as it seeks to
continue to develop products and secure contracts for its smart card systems and
transaction processing fees and resulting sales of smart cards and smart card
terminals and unattended kiosks.
Amortization of Software. Amortization of software costs decreased $200,413
or 27.17% in 1996 as compared to 1995. The higher level of amortization of
software costs in 1995 as compared to 1996 is a result of the write off in 1995
of software costs acquired in the purchase of PT Link in 1994. Amortization of
software costs increased $56,227 or 10.47% in 1997 as compared to 1996 due to an
increase in software costs capitalized in 1997. Software costs capitalized
increased in 1997 compared 1996 due to increases in technical staff and software
costs acquired in connection with the purchase of minority interests in
SPRINTICKET, Inc.
In accordance with generally accepted accounting principles for software
development costs, the Company would, if it were determined that an impairment
of software costs existed, write down the value at which such software
development costs are carried in the Company's financial statements. Any such
write down, if made, would be reflected as a charge to operations in the period
any such impairment was determined and could have a material adverse effect on
the Company's financial position and the results of operations for such period.
The Company believes its capitalized software costs are not impaired.
Depreciation. Depreciation increased $46,296 or 61.75% in 1996 compared to
1995 primarily due to an increase in capital expenditures in 1996 and a full
year of depreciation on the unattended kiosk systems purchased in 1995.
Depreciation increased $87,545 or 72.19% in 1997 as compared to 1996 due to an
increase in capital expenditures of $483,693 which resulted primarily from the
addition of computer equipment to support an increase in technical and marketing
activities and personnel, and the build-out of the Company's Santa Rosa,
California transaction processing center.
Interest. Interest expense increased $39,706, or 12.1%, in 1996 compared
to 1995 due primarily to increases in the total debt outstanding. In the
third and fourth quarters of 1996, the Company received sufficient funds from
sales of its Common Stock to significantly pay down its long-term debt. In
addition, the Company successfully restructured its bank debt and converted
$1,470,331 of interest bearing debt to Common Stock. In 1997, the Company
reduced its long-term debt by $40,250 and received proceeds from its initial
public offering and the exercise of stock warrants and options totaling
$5,875,092. As a result of the decrease in long-term debt in 1997 and
increased interest income earned from investing the proceeds of stock sales,
net interest expense declined $316,271, or 86.1%, in 1997 as compared to
1996. The Company anticipates that its future borrowings and interest expense
will continue to significantly decline.
11
<PAGE>
Liquidity and Capital Resources
The Company's working capital was $3,148,595 and $1,496,074 at December 31,
1997 and 1996, respectively. The increase in working capital was primarily the
result of receipt of proceeds from the sale of 833,333 shares of common stock in
the Company's initial public offering and the exercise of stock warrants and
options in 1997. The net proceeds from the sale of the shares were $4,857,956.
The Company also received $1,017,136 in 1997 from the exercise of stock warrants
and options. In the third quarter 1997, the Company restructured the payment
terms of a $364,000 note payable to a bank previously due in July 1997 to be
payable in equal quarterly installments through May 1999. In addition, the
Company entered into a master lease agreement with a bank, which provides up to
$400,000 of credit to the Company for the lease of certain computer and office
equipment and furniture for a period of three years. The lease provisions
require the company to maintain $200,000 in a certificate of deposit at the bank
provided as collateral for the lease and to deposit additional funds if
available cash and cash equivalents are not maintained above $800,000; of the
$200,000 collateral, $70,500 was classified as restricted cash at December 31,
1997. Also, at December 31, 1997 the Company had drawn down approximately
$141,000 on the lease line of credit and has approximately $259,000 available.
The Company has historically relied upon proceeds from the sale or issuance
of its Common Stock and from the issuance of notes payable to satisfy its
working capital requirements. The Company expects to continue to depend upon
equity financing to fund operations and satisfy its working capital needs until
they are able to generate significant sales or achieve profitability. There can
be no assurance that the Company will achieve sales of the magnitude to generate
sufficient cash flow from operations to continue to execute its business plans.
However, the Company believes that the potential revenue to be realized from the
rollout of its current contracts, its current cash resources and available trade
and other credit facilities are sufficient to meet its present anticipated
working capital needs for 1998. The Company's estimate of its cash requirements
and its ability to meet them are forward looking statements, and there can be no
assurance that the Company's cash requirements will be met without additional
debt or equity financing. There can be no assurance that, if needed, additional
financing will be available on acceptable terms to the Company, if at all.
The Company has evaluated the integrity and reliability of its financial and
operational systems and believes that it has no material Year 2000 issues with
such systems. All products currently provided by the Company are Year 2000
compliant. The costs of achieving Year 2000 compliance are not expected to have
a material impact on the Company's business, financial condition or results of
operations. In addition, the Company is also communicating with its principal
customers, suppliers and service providers to ensure Year 2000 issues will not
have an adverse impact on the Company. Until the Company's assessment of
external Year 2000 issues is completed, the Company will not know whether such
issues may materially adversely affect the Company's business, financial
position or results of operations.
QUARTERS ENDED JUNE 30, 1998 AND 1997
Results of Operations
Revenues. The Company generated limited revenues from operations for these
periods as it has continued to develop and market its smart card systems.
Revenues generated in the three months and six months ended June 30, 1998 and
1997 relate to credit card processing fees from its unattended ticketing kiosks
installed in several ski area and amusement park venues and, in 1997, sales of
smart cards and affinity cards. Revenues decreased $8,493 and $21,212 for the
three months and six months ended June 30, 1998, as compared to the
corresponding periods in 1997 due to a decrease in sales of smart and affinity
cards in 1998, and lower credit card transaction fees in 1998 vs. 1997. Credit
card transaction fees were lower for 1998 as compared to 1997 due to a decrease
in the number of kiosks in operation as a result of the Company's focus on its
smart card systems marketing efforts.
The Company's business model is based upon the Company's contracting with
large membership-based businesses to be a turnkey provider of smart card
based systems. The Company anticipates licensing its software for use by its
clients and entering into agreements whereby the Company
12
<PAGE>
will perform all backroom processing of the transactions that occur over the
system in addition to selling smart cards and smart card readers programmed
by the Company. The Company expects to receive transaction-processing fees
for its backroom processing services. The Company anticipates that revenue
generation from contracts will be dominated initially by the sales of smart
card terminals and readers and smart cards in order to develop an appropriate
concentration of merchants and smart card users in a market area. After this
initial phase, the sales mix for a contract is expected to consist of a
relatively high concentration of transaction processing fees.
The Company has initiated a pilot program pursuant to a signed pilot
agreement with the Department of Education in the State of Hawaii for the
implementation of an electronic payment program for school lunches. The Company
expects completion of the pilot in the fourth quarter. After completion of the
pilot, if deemed successful by the Department of Education, the Company
anticipates it will negotiate a rollout schedule for the remaining schools in
the state of Hawaii. The Company has a signed pilot agreement with First
Hawaiian Bank for the use of smart cards in a retail program and expects to
begin this program in the fourth quarter of 1998 or the first quarter of 1999.
In June of 1998, the Company signed a contract with Scrip Advantage of
Fresno, California to provide its proprietary Smart Script(TM) electronic scrip
and gift certificate product to Scrip Advantage and its members. The system
being installed was originally slated to be used in a pilot program for a
company called "SCRIP Plus", which was owned by the Signature Group, a wholly
owned subsidiary of Montgomery Ward, and one of the largest scrip resellers in
the country. When Montgomery Ward filed for bankruptcy, SCRIP Plus was unable to
support the signed pilot agreement with Pathways. Accordingly, Pathways delayed
installation and has now negotiated a new contract with Scrip Advantage, which
was started by the previous Chief Executive Officer of SCRIP Plus, Inc.
The agreement with Scrip Advantage calls for the Company to sell terminals
to participating merchants and smart cards to non-profit organizations and their
members. In addition, the Company will receive a fee for each smart card, debit
or credit card transaction processed. The agreement is for a term of three years
with annual renewals and includes early termination provisions for both parties
under certain conditions, including the failure of Pathways to provide Scrip
Advantage with competitive pricing. In connection with the agreement with Scrip
Advantage, the Company has advanced $50,000 to Scrip Advantage in exchange for a
demand note receivable. The note receivable is convertible into common stock of
Scrip Advantage at the Company's sole option, and provides the Company, through
Carey F. Daly, II, Chief Executive Officer and President of the Company, to be
represented on the Board of Directors of Scrip Advantage. The Company believes
it will continue to report minimal revenues until additional significant
contracts are signed or until the existing contracts proceed through the pilot
stage to a full rollout.
Gross margin. The Company's overall gross margin as a percentage of revenues
varies primarily as a result of the "mix" of sales between high margin
transaction processing fees and lower margin smart card and terminal sales.
Gross margins decreased to 77% from 80% for the three months ended June 30, 1998
and 1997 respectively as a result of an increase in credit card charge back
expense in 1998. Gross margin increased to 75% from 72% for the six months ended
June 30, 1998 and 1997 respectively as a result of a larger proportion of sales
of hardware and smart cards in 1997, which carry a lower gross margin than
transaction processing fees.
The Company expects future gross margin percentages will be heavily
influenced by potential competition as well as the "mix" of sales between
hardware sales and transaction processing fees. Although this mix is difficult
to predict, margins generally will be lower at the beginning of a new client
system rollout due to the concentration of smart card readers and smart card
sales. Once the initial rollout is completed, gross margins are expected to
increase due to increases in use of the smart card by cardholders and the
resulting transaction processing fees.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $702,238 or 130% and $1,338,953 or 121%
during the three months and six months
13
<PAGE>
ended June 30, 1998, as compared to the corresponding periods in 1997. This
increase is primarily the result of expanded payroll and employee support
costs associated with an increased number of full-time and contract
employees. The Company had approximately forty-eight full-time employees at
June 30, 1998, as compared to twenty-two as of June 30, 1997. In addition,
the Company has incurred increases in administrative costs associated with
becoming a publicly traded company, including professional services and
investor relations' expenditures. The Company expects the level of selling,
general and administrative costs to continue to increase, although more
modestly than the past four quarters, as a result of continued marketing and
customer support activities and an increase in the number of operating and
technical personnel necessary to support its expected sales efforts, product
development and customer support activity. The Company has leased an 8,700
square foot facility in Santa Rosa, California, which has been refurbished
into a new state-of-the-art transaction-processing center. Construction of
the facility build-out occurred in the second and third quarters of 1997, and
the Company occupied this new facility in September 1997. Additionally, the
Company opened a sales and marketing office in Honolulu, Hawaii, during the
third quarter 1997 as a wholly-owned subsidiary. Consequently, the selling,
general, and administrative expenses for the three months and six months
ended June 30, 1998 reflect the costs of operating the Company's three
offices whereas the corresponding periods in 1997 reflect the operating
expenses of only one office. The Company anticipates substantial investments
in its sales, marketing and product development activities in the foreseeable
future as it seeks to expand sales of its smart card systems and transaction
processing fees.
Amortization of Software Costs. Amortization of software costs increased
$17,822 and $37,651 for the three months and six months ended June 30, 1998
compared to the corresponding periods in 1997. This increase is due to continued
capitalization of software costs as a result of the Company's product
development efforts.
In accordance with generally accepted accounting principles for software
development costs, the Company would, if it were determined that an impairment
of software development costs existed, write down the value at which such
software development costs are carried in the Company's financial statements.
Any such write-down, if made, would be reflected as a charge to operations in
the period any such impairment was determined and could have a material adverse
effect on the Company's financial position and results of operations for such
period. The Company believes its capitalized software are not impaired.
Depreciation. Depreciation increased $64,171 and $102,539 for the three
months and six months ended June 30, 1998, as compared to the corresponding
periods in 1997 primarily due to an increase in capital expenditures. Capital
expenditures increased during 1998 as compared to 1997 due to the addition of
computer equipment to support an increase in marketing and technical activities
and personnel, the build-out of the Company's Santa Rosa, California transaction
processing center, and the opening of its Hawaii office.
Interest Expense (Net). For the six months ended June 30, 1998, the Company
had net interest income as compared to interest expense for the six months ended
June 30, 1997. For the three months ended June 30, 1998, the Company had net
interest expense of $10,089 as compared with net interest expense of $18,038 for
the corresponding period in 1997. The decrease in net interest expense was due
to reductions in the total debt outstanding and increased interest income from
the investment of available funds from common stock sales.
Liquidity And Capital Resources
The Company's working capital was $(248,728) and $3,148,595 at June 30,
1998 and December 31, 1997, respectively. The higher working capital at
December 31, 1997, as compared to June 30, 1998, was primarily the result of
the receipt of proceeds from the Company's initial public offering of Common
Stock and the exercise of Common Stock warrants in 1997. Working capital was
used to fund the Company's net losses for the first half of 1998. In July
1997, the Company issued and sold 833,333 shares of Common Stock pursuant to
the filing of Form 1-A (No. 24-3750) with the Securities and Exchange
14
<PAGE>
Commission. The net proceeds from the sale of the shares were $4,857,956. On
July 23, 1998, the Company commenced a private offering of its Common Stock
(the "Private Placement"). With respect to the Company's Private Placement,
which was conducted pursuant to Rule 506 of Regulation D under the Securities
Act, the Company sold 654,508 shares at $13.75 per share to six accredited
investors. The Company engaged Allen & Company Incorporated to act as
placement agent for the offering. Each placement agent who placed shares
received a placement fee of 5% of the purchase price per share. The estimated
net proceeds from the sales and subscriptions are approximately $8,411,493.
Pro forma working capital and cash and cash equivalents at June 30, 1998,
after giving effect to the receipt of the net proceeds from the offering is
$8,162,765 and $8,794,302.
In 1997, the Company entered into a master lease agreement with a bank which
provided up to $400,000 of credit to the Company for the lease of certain
computer and office equipment and furniture for a period of three years and
contains an option to acquire the equipment at the end of the lease term. This
lease has been accounted for as an operating lease. The lease provisions require
the Company to maintain $200,000 in a certificate of deposit at the bank as
collateral for the lease and to deposit additional funds if the Company's
available cash and cash equivalents are not maintained above $850,000. In June
1998, the Company determined that it was in breach of one of the financial
covenants contained in its $400,000 lease financing arrangement. The Company
received a waiver from the bank in August 1998.
The Company incurred increased capital expenditures in 1998 as compared to
1997 primarily due to the purchase of computer equipment required to support
increased marketing and technical activities and personnel and the operation of
three facilities in 1998 as compared to one facility in 1997. Beginning in
September 1997, the Company spent $556,527 through June 30, 1998 in leasehold
improvements, furniture and computer equipment costs to build out its new
transaction processing facility in Santa Rosa, California. To date the Company
has spent $19,065 on equipment for its Hawaii office, and expects to incur
additional cost for computer equipment to complete the facility. The Company
anticipates leasing additional office space for a Research and Development
facility in Santa Rosa, as well as moving to a larger leased facility in Hawaii.
Both of these events will require additional expenditures for leasehold
improvements, furniture and computer equipment, which are expected to be
incurred by the end of 1998.
The Company has historically relied upon proceeds from the sale or issuance
of its Common Stock and from the issuance of notes payable and lease financing
to satisfy its working capital requirements. The Company expects to continue to
depend upon equity financing to fund operations and satisfy its working capital
needs until it is able to generate significant sales and achieve adequate levels
of profitability. There can be no assurance that the Company will achieve sales
of the magnitude to generate sufficient cash flow from operations to continue to
execute its business plans. However, the Company believes that the potential
revenue to be realized from the rollout of its current contracts, its current
cash resources, including proceeds from the Private Placement, and available
trade and other credit facilities are sufficient to meet its present anticipated
working capital needs for the next twelve months. In the event that the Company
is unable to generate significant revenues from the rollout of its current
contracts or any additional contracts that the Company may negotiate, the
Company will be required to seek alternative sources of financing to fund its
operations. The Company's estimate of its cash requirements and its ability to
meet them are forward-looking statements, and there can be no assurance that the
Company's cash requirements will be met without additional debt or equity
financing. There can be no assurance that, if needed, additional financing will
be available on acceptable terms to the Company, if at all.
BUSINESS
The Company was organized in 1993 as a Washington corporation whose
operations are the successor to Pathways International, Ltd., which was
incorporated in Washington in June 1988. In May 1997 the Company
reincorporated in Delaware.
The Company designs, markets and services custom smart card applications.
The Company develops unique solutions for creating and processing data and
ensuring secure electronic
15
<PAGE>
transactions by utilizing proprietary hardware and application software
systems. Pathways' technology establishes electronic commerce in closed
system environments. A key element of the Company's business plan is the
processing of transactions associated with its current and prospective smart
card installations. The Company also manufactures and markets automated
ticketing kiosks that the Company anticipates will be integrated with its
smart card applications.
The Company believes that it is unique in the smart card industry in that it
provides "cradle to grave" solutions as a full service hardware integrator,
software developer and backroom transaction processor. By adopting this market
strategy, the Company believes that it can become a leading developer and
marketer of integrated smart card software systems and that it is positioned to
provide customers sophisticated smart card business solutions across a wide
range of applications. The Company's systems accommodate credit and debit
payment methods in addition to smart cards.
A smart card is a credit card-sized plastic card in which an integrated
circuit, usually containing a microprocessor and reusable memory, has been
embedded. In their simplest form, smart cards provide memory storage
capabilities, such as cash cards, in which the card is discarded after the value
stored on the card is depleted, or "read only" cards, in which stored
information may be entered, accessed and modified by terminals and computers.
Most cards, including the Company's cards, are more sophisticated. Information
and software can be stored on such cards by reading and writing to the card's
microprocessor chip and can be easily, securely and accurately accessed and
manipulated by electronic data processing equipment. The versatile nature of the
smart card technology allows it to be adapted for use over diverse applications
ranging from medical record storage to electronic money.
Smart cards first appeared in the 1970s in France, and at present smart card
technology is established and extensively used in Europe and Asia. The research
firm, Dataquest, estimates that approximately 156 million cards were in
circulation worldwide at the end of 1996, that the 1996 worldwide smart card
market exceeded $1.2 billion in sales and that the market will approach $3
billion in sales by the year 2000. (Source: Don Cunningham, Global Journal of
Advanced Card Technology, Smart Card Industry Association, 1997.)
Smart card installations within Europe dominate the worldwide smart card
industry with a 70% share. It is predicted by the year 2000 that the United
States and the Asia-Pacific region will account for 25% of the global market.
(Source: Don Cunningham, Global Journal of Advanced Card Technology, Smart Card
Industry Association, 1997.) The French were the first to develop practical
smart card technology and applications. Roland Moreno, a Frenchman and the
founder of Innovatron, is considered by many to be the pioneer of smart card
technology. Today, the majority of chip card manufacturers are licensees of
Innovatron. Initially installed only in pay telephones, smart cards are now
being used for transportation, car parking, arcade games and vending machines.
Any coin operated machine can be converted to a smart card format. Other
possible applications include ATM'S, point-of-sale terminals, personal
computers, electronic ticketing and automatic fare collection.
The Company believes that smart card technology represents the next step
in the evolution of credit/debit financial services and related products and
services. Smart card systems differ from other payment mechanisms in their
ability to store securely large quantities of data on a credit-card sized
medium by means of a microprocessor chip. The sophisticated encryption
algorithms and other security mechanisms that the chip employs provide
information protection. The Company's products address the needs of the
healthcare and affinity group markets, among others, with multiple purse and
banking products nearing completion of development.
In addition, a major factor in the rapid growth of smart card usage is
the ability to process small transactions. Smart card technology eliminates
the need to carry cash and coins for most day to day transactions. By
enabling an individual to exchange information and payment through one
portable platform, the Company expects that this technology will open up new
opportunities with regard to the way people
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interact with financial institutions, healthcare providers, retailers and
others. All information-based industries are candidates for smart card
conversion.
The Company anticipates that while it will continue to realize revenue from
transaction processing, significant additional revenue growth opportunities
exist in the area of developing, marketing and, when appropriate, providing
transaction processing services to a variety of markets, many of which the
Company does not at present serve. The Company believes that these opportunities
include the academic campus, retail, banking, travel and traditional healthcare
markets.
Through June 30, 1998, Pathways recorded total revenues of approximately
$353,000 related to its smart card operations, including the delivery and
installation of approximately 57,000 smart and affinity cards and approximately
120 smart card terminals. The Company's core technology involves the development
of smart card application systems and solutions. This core technology has been
customized for prepaid alternative health care, the retail affinity and the
banking and educational institutions markets, but such technology is capable of
being customized for other markets. The Company is encouraged by the results of
these initial programs, and believes that such pilot programs will lead to the
national rollouts of such products.
While the Company's initial programs and other smart card applications were
being designed and developed, the Company's revenues initially were derived
largely from credit and debit card transaction processing fees from its
automated ticketing kiosk software. As the Company's resources are being
increasingly devoted to the realization of the smart card application system
component of the Company's business plan, revenues from the automated kiosk
business declined. The Company considers the automated ticketing kiosk business
integral to its plans for becoming a full-service smart card designer, developer
and provider. It intends to continue to use those devices in the ski and
amusement markets that the Company has already penetrated, as well as to expand
into other markets and integrate its current capabilities to include the
processing of smart card transactions in addition to debit and credit card
processing. It is anticipated that the Company's kiosks will serve as smart card
dispensing, "reloading" and transaction processing points.
The following lists the Company's subsidiaries and their respective
businesses:
- SPRINTICKET ("SPRINTICKET") provides credit card transaction processing
for ski areas and amusement parks utilizing SPRINTICKET's proprietary
hardware and software. SPRINTICKET marketed proprietary ticketing
machines and software manufactured under contract by Pathways
International. In September 1996, the Company acquired 21.29 percent of
the outstanding common stock of SPRINTICKET, which constituted
substantially all of the remaining minority interest in this
subsidiary. Prior to such acquisition, the Company owned 77.53 percent
of Sprinticket. In early 1997 the Company purchased the remaining
approximately 1.18 percent of SPRINTICKET for cash.
- The Pathways Group Inc. (Hawaii) was organized to market the Company's
products in Hawaii and Asia.
- Pathways International, Ltd. retains the copyright for an automated
non-profit organization accounting system which is no longer being
marketed. Since its inception, Pathways International was the
corporation through which the Company first conducted its software
development and hardware manufacturing under contract with companies
which later became part of the Company.
- PT Link Corp. ("PT Link"), is currently not in operation. Historically,
PT Link marketed a medical office management and patient-outcomes
software package that it purchased from Pathways International, which
it developed under contract.
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Smart Card Technology
Owning a smart card is similar to carrying a computer in a handbag or
wallet. Pathways expects that smart cards will eventually replace everything
people carry in their wallets, including drivers' licenses, other important
personal identification, credit cards and cash. Smart cards offer consumers the
ability to transmit payment and information data across a point-of-sale terminal
securely and conveniently.
Over the long term, the Company believes that "multifunctionality" will
become an increasingly important smart card feature. "Multifunctionality" means
that several applications will be combined on one card. A card may contain many
sections that may include personal information, health care data, a prepaid area
and credit line access. The Company is currently developing smart card
applications incorporating multifunctionality technology. As smart cards are
developed to store highly personal information, card security will be required
to be more elaborate in order to achieve consumer acceptance of the technology.
A smart card is a plastic card, approximately the size of a credit card,
which comprises an integrated circuit that usually contains a microprocessor and
reusable memory. Smart cards range from simple single application cards to
sophisticated multi-application cards. A memory card is the most simple type
(also known as a "dumb" smart card). This type of card can only store data and
is discarded after the value stored on the card is depleted. It is difficult to
copy but offers no protection from loss nor does it contain inherent processing
power without the intervention of sophisticated terminal level software. "Read
only" cards store information that may be input, accessed and modified by
terminals and computers. They also do not contain inherent processing power
without the intervention of sophisticated terminal level software. A more
complex card may have one password to restrict its use to one person or machine.
Most cards, including the Company's smart cards, are more sophisticated.
Electronic data processing equipment can accurately and securely store and
manipulate information on such cards by reading and writing to the card's
microprocessor chip. The most sophisticated cards can manipulate several
passwords and can utilize authentication and ciphering techniques to provide
total security. The latest card types are now beginning to support the JAVA
language to allow for greater flexibility and compatibility across card
manufacturers, terminal manufacturers and many processing platforms.
Although many smart cards today incorporate both magnetic stripe
technology and chip technology, the Company believes that chip technology
will increasingly become the preferred medium. Chip technology is more
difficult to counterfeit and can store up to 80 times more data than a
magnetic stripe. The majority of chip cards contain one to four kilobytes of
memory; however, it is the Company's understanding that a 16-kilobyte card
will be introduced this year by the card manufacturers and that a prototype
64-kilobyte card is currently in prototype form. If and when such cards are
introduced, the Company will seek to utilize the latest technology in
developing software for such cards. The primary benefit of this computing
power is that a single card performs numerous functions. For example, the
card can be programmed to effect payment for goods or to provide personal
health information. In addition, transactions conducted with a smart card can
be authorized offline, unlike magnetic stripe cards, which do not have the
capability to interface with remote processing systems. Cards can also be
further defined as either a contact or a contactless card. A contact card
must be directly placed into a reading terminal. Contactless technology
utilizes radio frequencies and requires no direct contact between the card
and the reader. Advantages of a contactless card are convenience and speed.
The user simply passes the contactless card within several inches of the
reader, the transaction data is downloaded to the reader and a return message
is recorded in the card.
To produce each smart card application for a particular client, the Company
must develop customized software and integrate appropriate hardware technology
to adapt the card to the customer's needs. The Company believes that its
engineers have sufficient expertise in hardware technology and computer
programming languages necessary for such development efforts. The manufacturing
cost of a
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card varies from less than $1 to approximately $10 depending on the amount of
information it holds and the complexity of the microprocessor. Similarly, the
cost of a reader terminal can vary from $500 to $2,000, depending on the
complexity and functionality of the terminal.
Current Products and Pilot Programs
Prepaid Medical Benefit Cards. My Choice LLC, a defined benefits medical
provider in the alternative medical care industry, utilizes a natural medicine
benefit card developed by the Company. Use of the Company's card entitles the
holder to a discount on natural medical services.
The Company, pursuant to a development agreement with My Choice, designed a
card holder issuance system, a medical provider acceptance and reimbursement
system and a statistical database that drives an ACH type reimbursement. (ACH,
or automated clearinghouse, is a system of electronic funds transfer to which
most banks subscribe as an economic substitute for a wire transfer using the
Federal Reserve System.) The development agreement contains customary provisions
regarding termination, intellectual property rights, confidentiality, product
warranties, indemnification and the like. Payment to the Company under the
development agreement has been made periodically in connection with the
attainment of defined milestones. In addition, under this agreement My Choice
and its affiliates are entitled to most favored customer treatment and, for a
specified period, to preferential pricing in the purchase of the hardware
equipment related to the implementation and functioning of the product, which
pricing may in no event exceed 118 percent of the actual cost of the equipment.
The non-competition provision of the development agreement prohibits the Company
for a five year period from engaging in business related to smart card systems
that provide for cash payment in connection with naturopathic or homeopathic
medial goods or services. Under the agreement, the Company represents that its
products and services are free from material defect and do not infringe the
intellectual property of third parties; the Company has also provided
indemnification against the breach of such representations.
Affinity Group Programs. The Company has developed applications which
address the current trend in retail environments of rewarding repeat customers.
In addition, the Company has developed an electronic scrip application for use
in fund-raising activities for non-profit organizations. This product allows
members of the non-profit organization to purchase electronic gift certificates
from intermediaries, and upon redemption of such electronic gift certificate at
a merchant, the merchant contributes a predetermined discount to the specific
non-profit organization. The Company believes that individuals utilize the scrip
because it enables them to make donations to charity by spending money on
everyday purchases of products and that member retailers find such programs an
attractive marketing strategy for their products.
The Company signed a contract in June 1998 with Scrip Advantage of
Fresno, California to provide its proprietary Smart Scrip (TM), Electronic
Scrip and Gift Certificate product to Scrip Advantage and its members. The
system being installed was originally intended to be used in a pilot program
for a company called "SCRIP Plus," which was owned by the Signature Group, a
wholly owned subsidiary of Montgomery Ward and one of the largest Scrip
resellers in the country. When Montgomery Ward filed for bankruptcy, SCRIP
Plus was unable to support the signed pilot agreement with Pathways.
Accordingly, Pathways delayed installation and has now negotiated a new
contract with Scrip Advantage, which was started by the previous chief
executive officer of SCRIP Plus.
The agreement with Scrip Advantage calls for the Company to sell terminals
to participating merchants and smart cards to non-profit organizations and their
members. In addition, the Company will receive a fee for each smart, debit or
credit card transaction processed. The term of the agreement is for three years,
with annual renewals, and the agreement includes early termination provisions
for both parties under certain conditions, including the failure of Pathways to
provide Scrip Advantage with competitive pricing.
In connection with the agreement with Scrip Advantage, the Company has
advanced $50,000 to Scrip Advantage in exchange for a demand promissory note.
The note is convertible into equity
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of Scrip Advantage at the Company's sole option. In addition, Scrip Advantage
has agreed to elect a Company designee to its Board of Directors. Initially,
Carey F. Daly II, the President and Chief Executive Officer of the Company,
will be elected to such Board.
SPRINTICKET, a subsidiary of the Company, manufactures and markets automated
ticketing dispensers and provides credit card processing services in connection
with those dispensers. Separate kiosks are provided for indoor and outdoor use.
Indoor models have touch screens, full motion video and stereo sound. Base
prices for kiosks are $15,000 to $20,000 and do not include the supporting
hardware that varies according to client need. The market for this equipment
includes industries that issue some form of ticket that is required for access
into any facility or any service. Markets for the SPRINTICKET products include
travel, entertainment, leisure, government and health care.
Another Company subsidiary, PT Link, applies computer and electronic
technology to service the medical profession. PT Link's software products
include medical practice management, patient documentation and treatment
outcomes analysis as well as patient education and billing.
Department of Education of Hawaii. The Company has entered into agreements
to commence pilot programs in conjunction with the Department of Education of
Hawaii to provide a smart card system for handling both prepaid and
FDA-sponsored school lunch programs. The pilot programs are to be conducted at
six schools in the Mililani School Complex in Honolulu, Hawaii. The Company has
a similar pilot program with the Lanikila School, also in Honolulu. These pilot
programs are expected to begin in September 1998 and to continue to the end of
the school year. Assuming satisfactory completion of the pilot program, the
Company expects that it will be in a position to negotiate a comprehensive
agreement with the Department of Education of Hawaii, which will include
transaction processing and will enable the Company's system to be introduced
throughout the State. The Company's technology can be expanded to include
student identification, bus transportation and prepaid student activities.
First Hawaiian Bank. The Company has entered into a pilot agreement with
First Hawaiian Bank pursuant to which the Company will provide a system to allow
the bank to offer a branded smart card program to its customers for use in
retail purchases through a retail merchant network to be established jointly by
the bank and the Company. The Company also has an agreement to place the
Company's smart card terminals and recharge stations in various branches of the
bank to accommodate card users in both the school lunch programs and First
Hawaiian Bank branded smart card program. The recharge terminals will be
utilized to check card balances and reestablish value on the cards.
Advantages of the Company's Products
The Company's software products encompass a number of technological
breakthroughs, which are discussed below. The most important aspect of the
product is its seamless integration from card fulfillment, through claims
adjudication, through customized transactional reporting, without dependency
on third party commercial software products. Here are other advantages of the
Company's products due to its ownership of its trade secret assets:
- Smart Card Issuance (Fulfillment) with Automated Database Creation.
Unlike other systems under development, the Pathways product utilizes
the latest in database creation technology to facilitate a detailed
tracking mechanism for all smart card transactions from issuance to
payment and includes the facility to replace lost or stolen cards in a
timely fashion. The nearest competitor continues to penalize the user
with a "Lose it you lose it" philosophy.
- Fully Functional Multiple Purse Modules. The Pathways product, in its
first release, possesses the ability to utilize multiple "purses", or
functions, on the same card. This capability, for example, would allow
a medical or insurance application to
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reside on the same card with a merchant loyalty program. There has
been no software on the market to demonstrate such ability.
- Mixed Transaction (credit/debit/ATM card/smart card) Processing at the
Point of Sale with On-line Authorization Where Applicable. The Pathways
product can optionally configure itself for the diverse communications
and security protocols associated with debit, ATM credit, as well as
smart card transactions. A debit card and ATM card transaction both
require the introduction of a personal identification number ("PIN")
number for security purposes and require an on-line (telephone
connection) for purchase authorization. Credit cards normally require
similar communication arrangements, although they rarely require a PIN
number. Smart cards, in a secure application, always require a PIN
number but normally only require a telephone connection to send
end-of-day data for claim processing. Current competing developers are
focused on the smart card requirements and have not addressed the other
needs.
- Product Service Provider Claim Processing. A standard feature of the
Company's product allows the consumer to use his or her smart card for
non-smart card transactions, such as credit or debit card transactions.
The software directs the transaction processing to the appropriate
credit card processor. System sponsors may avail themselves of the full
suite of backroom services offered by Pathways.
- Automated "E-Bank" Card Recharge. A drawback facing smart card
developers, integrators, issuers and processors is the inability of
their smart cards to "recharge." The absence of sufficient funds to
cover a transaction requires that the transaction be terminated and the
card inserted into an ATM (not yet available) or a special location for
recharge. The Company has developed technology that endows smart cards
with recharging capabilities at the point of purchase, as well as
enabling it to connect to electronic banking systems, thus creating an
uninterrupted chain of cashless commercial transactions. The Company
believes that its recharging capability is unique in the smart card
industry.
- Automated Claim Adjudication And Settlement Through ACH. The Pathways
system has the facility to automatically submit a claim to the operator
of the prepaid funds pool (normally the card issuer), adjudicate the
claim and trigger an ACH transfer of funds to the provider/merchant.
- Management Reporting (via Automated Back Room). The Company provides
claims adjudication by means of a System Query Language ("SQL")
compliant database that can service substantially all management
reporting needs. Every element of the database is positioned using
"data pointers," which allows such information to be extracted for
customized client reports.
- ISO Smart Card Development Toolkit. The Company has developed a set of
proprietary software tools that are the building blocks for all of its
current and future applications. These tools are used to develop
applications using the Rapid Application Development ("RAD") technique
within the SQL paradigm. This technique allows the Company to combine
its software modules to create a product satisfying its customer's
needs in a shorter time period than would be possible in the absence of
these toolkits
All of the above modules are integrated seamlessly, to form a "cradle to
grave" process which, to the Company's knowledge, is unlike any other system
available at the current time.
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Strategic Relationships
The Company has entered into a strategic relationship with Schlumberger,
Ltd., a leading developer and producer of smart cards. The relationship with
Schlumberger is designed to enable the Company to establish and maintain
technological leadership, realize advantageous product pricing structures and
expand its marketing and distribution channels. Schlumberger is an $8 billion
worldwide conglomerate whose lines of business include oil field services,
electronics and technology. The Company programs blank stock smart cards that
are developed and manufactured by Schlumberger to meet specific application
needs. Schlumberger has named Pathways its first "Preferred Associate"
worldwide.
The Company has extensive informal relationships with a variety of card and
terminal manufacturers that the Company is currently evaluating for inclusion in
its product line. The Company expects that the formation of strategic alliances,
both formal and informal, with such entities will be an integral element in
expanding its product offerings.
Company Strategy and Product Development
The Company's objective is to become a leading provider of smart card
solutions across a wide range of applications. The Company's marketing strategy
is to focus on product development and innovation in the area of smart card and
debit card technology with the goal of capturing the transaction processing
revenue segment of such business. Transaction processing includes a network of
"backroom" services that includes maintaining and updating appropriate databases
to reflect all information on user cards and transactional changes to such
information, effecting the movement of electronic money to and from a funds pool
holder and periodic reporting to all parties in the transaction.
The Company hopes to realize its strategy to increase transaction fee
revenue by focusing on smart card applications in consumer situations that
necessitate card usage on a weekly or more frequent basis. The Company believes
that it is currently the only full service hardware integrator, software
developer and backroom transaction processor.
The Company anticipates that while it will continue to realize revenue from
transaction processing, significant additional revenue growth opportunities
exist in the area of developing, marketing and, when appropriate, providing
transaction processing services to a variety of markets, many of which the
Company does not at present serve. The Company believes these opportunities
include the academic campus, retail, banking, travel and traditional healthcare
markets. The Company's product development efforts are focused on software and
systems for smart card applications. The Company has identified the following
industries as those best suited to benefit from smart card technology and has
commenced research and development efforts aimed at meeting perceived needs:
- Health Care. The Company believes that the healthcare industry, with
its millions of participants and voluminous and individualized
information and payment requirements, can benefit significantly from
smart card technology. Smart cards can be designed to provide patient
identification and medical record storage and retrieval, as well as
electronic benefit transfers, determination of eligibility and drug
interaction information. In an emergency situation, a quick assessment
of vital information such as allergies, prescriptions and immunizations
is critical for effective healthcare delivery. Additionally, patient
cards can be used to improve and streamline administrative and billing
procedures as well as insurance reimbursement.
- Retailing. All types of retailing can be embraced and enhanced with
smart card technology. The retail sector encompasses everything from
"Mom and Pop" stores to national department stores. Retailers have been
made acutely aware of the
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value of their contact with the consumer. The key to repeat business
is to accurately identify, and then satisfy, customer needs. Smart
cards would enable retailers to track customer behavior and base
marketing decisions gleaned from this valuable information. This
technology can also reduce the risk of fraud, improve inventory
management and offer the customer convenience and better service.
- Travel and Entertainment. The travel and entertainment industry holds
great promise with regard to smart card applications. All categories
that comprise this market, including air travel, car rentals, movie
theaters, sporting events, restaurants, casinos, video stores, sports
arenas, hotels and other venues would benefit from a multifunctional
card. This is an enormous global market with strong growth predicted
for the near future. Business travelers in particular are bogged down
by paper-based expense reimbursement. Paper-based reimbursement systems
are hampered with the potential for fraud in addition to being costly
to administer. Smart cards would enable businesses to more effectively
monitor travel and entertainment expenses.
- Smart cards offer solutions in terms of their ability to collect and
disseminate data and conduct electronic commerce. Several major
airlines have initiated smart card pilot programs that allow ticketless
travel, store frequent flier miles and process payments. In a resort
setting, a multifunction card allows an individual access to
restaurants, shopping, sports and entertainment activities and lodging
while keeping track of loyalty points.
- Government Services. The government is becoming involved in electronic
commerce. The initial focus is centered on a national Electronic
Benefits Transfer (EBT) recently proposed by Vice President Gore. One
proposed and piloted application is to replace paper food stamps with a
smart card. Such a change would eliminate the cumbersome printing,
warehousing, transporting and disposal of this paper medium. Other
applications could include the administration of welfare and Medicaid
benefits and other government payments.
- Transportation. Opportunities exist to apply smart card technology to
public and private transit systems, including bridge, tunnel and
highway toll systems. Smart cards would significantly reduce the time
spent and costs associated with collecting and processing fares and
tolls. A multipurpose card could be used for taxis, trains, tolls and
parking meters in addition to other small expenditures. Commercial
vehicles could utilize this technology to store data about the cargo,
the carrier, maintenance records and the driver.
- Affinity Programs. The trend in retail, fund raising (as discussed
above with respect to Scrip Advantage) and other repeat customer
businesses is the move toward customer rewards. This application
represents a tremendous opportunity and an explosive growth area, which
is virtually untapped.
By incorporating a smart card into a traditional point of sale
application, the retailer will realize complete tracking of all aspects
of the sales process including the ability to reward repeat customers
with premiums or discounts through the use of a smart card without the
traditional computerized infrastructure. Retailers could use the data
accumulated to target market areas not being penetrated and focus
marketing and advertising costs on those areas.
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Marketing and Distribution
The Company intends to market its electronic purse technology to any and all
affinity groups where electronic cash is a viable medium. Although the Company
expects to continue to market smart card systems directly through the Company's
management and employees, the Company intends to establish strategic marketing
alliances and licensing or other arrangements with systems integrators,
value-added resellers and other smart card vendors and may also retain the
services of sales representatives and marketing and other consultants.
Distribution of product will be handled directly by Company sales and marketing
staff.
Service of smart card terminals and related equipment will be performed on a
"Depot Repair/Hot Swap" service basis. "Depot Repair/Hot Swap" service is the
process of replacing faulty equipment with functional equipment via "Express"
transportation methods. Faulty units are repaired if possible at the depot.
Competition
Due to the extensive use of cash, the market for smart card applications is
enormous. Since this is a relatively new technology there is room for many
participants in this market. Some companies currently involved in smart card
development include but are not limited to: Bull, Card Europe, Gemplus,
Innovatron, Philips Electronics, Racom Systems, Aladdin Knowledge Systems,
MONDEX, MasterCard, Motorola, Schlumberger, Siemens, DigiCash, Cylink, AT&T
Universal Card and Visa. All of these vendors are actively involved in producing
smart card terminals. Some, like Schlumberger, also produce the actual smart
card media.
Although the Company is unaware of competitors providing its combination of
products and services to the Company's targeted markets, a few competitors, or
potential competitors (MONDEX, Diebold, VISA and Digicash, etc.) actually
develop software applications to deal with issuance, acceptance and adjudication
of smart card transactions. Pathways is presently the only full service
integrator, software developer and transaction processor of record to date in
the United States.
Smart card applications are the result of creating innovative solutions to
the needs of consumers. This requires significant experience in software
development and knowledge of a variety of business sectors.
Research and Development
The Company has expended substantial resources in the development of its
products. The Company has capitalized software development costs in the
aggregate amount of $3,516,928 from inception to December 31, 1997, and
$439,707 and $236,946 for the years ended December 31, 1997 and 1996,
respectively. In addition, the Company expensed $102,000 as research and
development costs for the year ended December 31, 1997.
Government Regulation
The Company can provide no assurance that a Federal, state or foreign agency
will not attempt to regulate its activities. The principal regulatory issues
presently before the Company are as follows:
Regulation E governs certain electronic funds transfers made by regulated
financial institutions and providers of access devices and electronic fund
transfer systems. Regulation E requires written receipt for transactions,
monthly statements, pretransaction disclosures and error resolution
procedures. Although certain aspects of the Company's services may be subject
to Regulation E, the Company believes that most of its services are not
subject to Regulation E. There can be no assurance that
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the Federal Reserve Board will not require all of the Company's services to
comply with Regulation E, or revise Regulation E, or adopt new rules and
regulations for electronic funds transfers that could lead to increased
operating costs for the Company, and could also reduce the convenience and
functionality of the Company's services, possibly resulting in reduced market
acceptance. In addition, if the Federal Reserve Board challenges the
Company's position, the costs of responding to such a challenge could result
in significant drains on the Company's financial and management resources,
which could result in significant drains on the Company's business, financial
condition or operating results.
The management believes that current state and federal regulations
concerning electronic commerce do not apply to the current product line.
However, there is a move towards taxation of Internet use by several states
including the state of Washington. There are some strategic plans under
consideration to conduct commerce on the Internet using the Company's core
technology. This technology is being developed with a strict eye on these
legislative issues and the company management subscribes to industry watch
publications that address these issues. Planning for such eventualities assures
minimal interruption to the business of the Company should these laws be
enacted.
Copyrights, Trademarks, Patents, Proprietary Rights and Licenses
As of September 15, 1998, the Company held no patents or other registered
intellectual property rights with respect to its smart card products. The
Company presently has filed applications to register the following marks with
the U.S. Patent and Trademark Office: C.H.I.P. SMART CARD, COMPASS DESIGN
(Company logo), C-TELLER, E-TELLER (U.S. and Canada), FUND MASTER, ISLAND ACCESS
CARD, KEIKI CARD, KOKUA CARD, KOKUA KARD, MENEHUNE CARD, QUEST SMART CARD,
RENAISSANCE, SMART GIFT CARD, SMART SCRIP (U.S. and Canada), SMART STUDENT CARD,
THE BUS CARD, THE PATHWAYS GROUP & COMPASS DESIGN (Company logo), THE PATHWAYS
GROUP & COMPASS DESIGN (Company logo), THE PATHWAYS GROUP INC., TIKITBOX,
TSUNAMI CARD, V-TELLER and WIC SMART CARD
The Company seeks to register these marks generally on software, hardware,
terminals, kiosks and other machines used in connection with transaction and
database processing or electronic access cards or integrated chip cards.
The Company may prepare applications for patents, trademarks and copyrights
for intellectual property, to be filed within the statutory time limits that may
apply. Such applications would relate to toolkits for smart card programming
applications as well as certain commercial application of the technology.
However, the Company has historically viewed these items as trade secrets and
relied on protection under those rules. There can be no assurances that such
rights will be granted, or if granted, will have any commercial value.
Although the Company does not believe that its products or services infringe
on the rights of third parties, there can be no assurance that third parties
will not assert infringement claims against the Company in the future or that
any such assertion will not result in any costly litigation or require the
Company to cease using, or obtain a license to use, intellectual property rights
of such parties.
Legal Proceedings
The Company is not party to any legal proceedings.
Employees
As of June 30, 1998, the Company had a total of 47 full-time employees.
Key employees are employed under an employment contract, which includes a
binding non-compete and non-disclosure clause. Each of Carey F. Daly, II, the
Company's President and Chief Executive Officer, Mark T. Schuur, Senior Vice
President and Chief Financial Officer and Joseph Schuler, Senior Vice
President, Business
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Development have employment contracts with the Company. The Company
anticipates that it may substantially increase the number of its employees in
the near term. None of the Company's employees is represented by a labor
union. The Company considers its relations with its employees to be very good.
Property
The Company leases its principal facilities totaling approximately 8000
square feet in Woodinville, Washington. The lease expires in the year 2000. The
Company has also leased additional space for transaction processing, marketing
and research and development operations in Santa Rosa, California, and a
marketing office in Honolulu, Hawaii. The Company has executed a lease agreement
in Honolulu, which allows the Company to accommodate a satellite transaction
processing center. The Company anticipates that additional facility leases will
be required to accommodate its growth plans.
MARKET PRICE OF AND DIVIDENDS ON THE COMPANY'S COMMON EQUITY
The Company's Common Stock is traded in the NASDAQ over-the-counter market
under the symbol PTHW. As quoted in the Monthly Statistical Reports of the
National Association of Securities Dealers, Inc., the approximate high and low
closing prices for each fiscal quarter in the fiscal year ended December 31,
1997, and in 1998 to the date of this registration statement were as follows:
<TABLE>
<CAPTION>
Common Stock Prices
Fiscal Quarter High Low
--------------------- -------- --------
<S> <C> <C>
1st Qtr 97........... -- --
2nd Qtr 97........... -- --
3rd Qtr 97........... $ 20.50 $ 6.00
4th Qtr 97........... $ 26.50 $ 19.00
1st Qtr 98........... $ 25.00 $ 23.50
2nd Qtr 98........... $ 25.00 $ 17.00
3rd Qtr 98........... $ 20.375 $ 14.00
</TABLE>
During the fourth quarter of fiscal 1998 (through October 9, 1998), the
Company's Common Stock had a high price of $15.50 and a low of $14.00.
These quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission and may not represent actual transactions.
As of October 2, 1998, there were approximately 75 holders of record of the
Company's Common Stock. This number of holders of record does not include
beneficial owners of the Company's Common Stock, which shares are held in the
names of various security holders, dealers and clearing agencies. The Company
believes that the number of beneficial owners of its Common Stock held by others
or in nominee names exceeds 400 in number. The Company has not paid any cash
dividends and does not anticipate doing so in the immediate future as it intends
to invest any earnings in the development of the Company's business.
26
<PAGE>
MANAGEMENT
The directors and executive officers of the Company, are as follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Carey F. Daly, II 54 Chairman of the Board of Directors;
President; Chief Executive Officer
Mark T. Schuur 37 Director; Senior Vice President and Chief
Financial Officer
Joseph Schuler 56 Senior Vice President, Business
Development
Robert Haller 44 Senior Vice President, Marketing and
Sales
Glenn Okun 36 Director
Monte P. Strohl 46 Director
Linda Wing 53 Director
</TABLE>
Each director shall hold office until the next annual meeting of the
Company's stockholders and until a successor is selected and qualified.
Carey F. Daly, II, age 54, is the President and Chief Executive Officer of
the Company and the Chairman of the Board of Directors. Mr. Daly founded The
Pathways Group, Inc. in October 1993. Mr. Daly is also President of Pathways
International, Ltd. (1987) and SPRINTICKET, Inc. (1992). Mr. Daly has over 29
years of computer operating system, computer programming and design experience.
From 1968 to 1969, Mr. Daly served as an internal auditor and Director of
Financial Planning for American Standard, Baltimore, Maryland. He also worked
for major computer companies as a systems engineer in Baltimore, Maryland from
1970 through 1973. He received an LLB degree in Business Law from LaSalle
University in 1974 and a BS degree in Accounting as well as an AA in Computer
Science from Baltimore Business College in 1968.
Mr. Daly is the software engineering designer of the SPRINTICKET product
line, the Pathways Medical smart card system, the Pathways E-Teller Transaction
Processing System as well as several other commercial software systems.
Mark T. Schuur, age 37, is Senior Vice President and Chief Financial Officer
and a Director of the Company and has been with the Company since September
1996. From May 1992 through September 1996, Mr. Schuur served as Chief Financial
Officer, Treasurer and a Director of Pizza Blends Inc., Western Blending Inc.
and Flavor Blends Inc., affiliated privately-held food manufacturers based in
Bellevue, Washington. Prior to that, Mr. Schuur was a General Practice Manager
at Coopers & Lybrand in Seattle, Washington. Mr. Schuur received his B.A. degree
in business administration (accounting emphasis) from the University of
Washington in 1983.
Glenn A. Okun, age 36, has been a Director of the Company since the
fourth quarter of 1996. As of April 1998, Mr. Okun is the Chairman and Chief
Executive Officer of Mitchum, Jones & Templeton, Inc., an investment banking
firm. For more than five years prior to April 1998, Mr. Okun was a Director
and Vice President of Allen & Company Incorporated, an investment banking
firm. Allen & Company has acted as a
27
<PAGE>
financial advisor to the Company since May 1995. Mr. Okun received a masters
of business administration and a law degree from Harvard University in 1989.
Linda Wing, age 53, has been a Director of the Company since June 1998.
Since 1993, she has served as President and Chief Executive Officer of Human
Systems Design, an organizational development firm that assists management of
companies in developing their strategic planning. Ms. Wing currently teaches a
course in strategic management at Metro State University in Minneapolis,
Minnesota. She is also an editor of the journal "Empowerment in Organization,"
which is published by MCB University Press. She holds a masters of business
administration from the University of St. Thomas and several undergraduate
degrees from Mankato State University in finance and industrial relations. Ms.
Wing is presently working on obtaining her doctorate in organizational theory
from the Fielding Institute in Santa Barbara, California.
Monte P. Strohl, age 46, has been a Director of the Company since June 1998.
Mr. Strohl is currently the president of MS Digital, which he founded in 1994
and has acted as President and Chief Executive Officer since that time. MS
Digital is a company specializing primarily in corporate communication and cable
broadcasting. MS Digital provides hardware and software solutions to companies
wishing to communicate over cable television (public or internal), or intranets.
MS Digital's clients include universities, municipalities and Fortune 500
companies. Before founding MS Digital, Mr. Strohl worked as Vice President of
sales for OMNI International, which sold video production solutions
internationally. Mr. Strohl is one of the original founders of Pathways
International, Ltd., the predecessor corporation of the Company.
Joseph Schuler, age 56, has been Senior Vice President, Business
Development, of the Company since December 1997. From June 1996 through October
1997, Mr. Schuler was the Director of Sales and Marketing for Schlumberger Smart
Cards and Systems, where he was responsible for the development of a sales and
marketing program for smart cards. Mr. Schuler was the Senior Vice President of
New Business Development and Marketing for Stored Value Systems, a National City
Company, from September 1995 through May 1996. Prior to September 1995, Mr.
Schuler acted as an independent consultant for companies in the smart card
business. Mr. Schuler is a graduate of the Carlson School of Management of the
University of Minnesota.
Bob Haller, age 44, is the Senior Vice President of Marketing and Sales of
the Company. Mr. Haller joined SPRINTICKET, Inc. as the Sales Manager in
November 1992. Previously, he was Sales Manager of QT, Inc. His primary roles of
responsibility have been the direct sales and marketing efforts in the ski and
amusement park industries. Mr. Haller received a BS in Human Biology from the
University of Washington in 1977.
EXECUTIVE COMPENSATION
The following table shows compensation for services rendered to the Company
during the fiscal years ended December 31, 1997, 1996 and 1995, respectively, by
the President and Chief Executive Officer and the Senior Vice President and
Chief Financial Officer. Each executive officer serves under the authority of
the Board of Directors. No other executive officer of the Company received cash
compensation that exceeded $100,000 during the fiscal years ended December 31,
1997, 1996 and 1995. Therefore, pursuant to Item 402 of Regulation S-B, only
compensation for each of the Chief Executive Officer and the Senior Vice
President and Chief Financial Officer is shown.
28
<PAGE>
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
Annual Compensation Long-Term Compensation
------------------------------------------------------------------------------------
Awards Payouts
-----------------------------------------
Securities All Other
Other Annual Restricted Underlying LTIP Compen-
Name and Principal Bonus Compensation Stock Options/SARs Payouts sation
Position Year Salary ($) ($)(c) ($) Award(s)($) (#) ($) ($)
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Carey F. Daly, II, 1997 $200,000 $20,000 $ 8,333(a) 0 0 0 0
President and Chief 1996 200,000 0 12,500(a) 0 200,000/0 0 0
Executive Officer 1995 137,809 0 0 0 0 0
- -----------------------------------------------------------------------------------------------------------------------
Mark T. Schuur, Senior 1997 $112,916 0 0 0 15,000/0 0 0
Vice President and Chief 1996 35,333(b) 0 0 0 20,000/0 0 0
Financial Officer 1995 -- -- -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
- ----------
(a) Represents payment for accrued vacation benefits.
(b) Mr. Schuur's employment with the Company commenced in September 1996.
(c) The Company has no set bonus policy. Bonuses are awarded by the independent
directors of the Board.
Stock Option Plan
The Board of Directors of the Company adopted an Amended and Restated Stock
Incentive Plan (the "Option Plan") on December 16, 1997 in order to attract and
retain qualified personnel. Under the Option Plan, options to purchase up to
2,000,000 shares of Common Stock may be granted to officers and key employees of
the Company and directors who are also officers or key employees of the Company.
Options granted under the Option Plan are intended to qualify as incentive stock
options within the meaning of the Internal Revenue Code of 1986, as amended.
Subject to the terms of the Option Plan, the Board of Directors is
authorized to select optionees and determine the number of shares covered by
each option, its exercise price and certain of its other terms. The exercise
price of incentive stock options granted under the Option Plan may not be
less than the fair market value of the Company's Common Stock on the date of
the grant and may not be less than 110% of such fair market value with
respect to any incentive stock option granted to a participant who owns 10%
or more of the Company's outstanding Common Stock. In general, options become
exercisable in equal annual installments. The period within which any
incentive stock option may be exercised cannot exceed ten years from the date
of grant. Unless otherwise provided in an award agreement with a participant,
all options expire immediately upon the termination of the participant's
employment. If the participant's employment terminates due to retirement or
resignation, the Board of Directors may permit options to continue until the
expiration date set forth in the applicable award agreement. If the
participant's employment terminates due to death or disability, the options
will continue until the expiration date set forth in the applicable award
agreement. To the extent required by law for an option to qualify as an
incentive stock option, no option intended to qualify as an incentive stock
option may be exercised while any options previously granted to that optionee
are outstanding. As of the date of this Prospectus, 410,833 options are
outstanding.
29
<PAGE>
OPTION/SAR GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
Individual Grants
- ----------------------------------------------------------------------------------------------
Percent of
Number of Total
Securities Options/
Underlying SARs(a)
Options/ Granted to
SARs(a) Employees Exercise or
Granted in Fiscal Base Price Expiration
Name (#) Year ($/Sh) Date
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Carey F. Daly, II,
President and Chief
Executive Officer 0 N/A N/A N/A
- ----------------------------------------------------------------------------------------------
Mark T. Schuur, Senior
Vice President and
Chief Executive Officer 15,000 7.01% 23.00 12/23/07
- ----------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------
</TABLE>
- ----------
(a) To date, the Company has issued no SARs.
AGGREGATED OPTIONS/SAR EXERCISES IN LAST FISCAL YEAR
AND FY-END OPTION/SAR VALUES
<TABLE>
<CAPTION>
Number of
Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options/SARs(a) Options/SARs(a)
at Fiscal Year- at Fiscal Year-
End (#) End ($)
Shares Value
Acquired on Realized Exercisable/ Exercisable/
Name Exercise(#) ($) Unexercisable Unexercisable
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Carey F. Daly, II, President N/A N/A 66,667/133,333 $1,400,007/
and Chief Executive Officer $2,799,993
- -------------------------------------------------------------------------------------------------------------------------
Mark T. Schuur, Senior Vice
President and Chief 6,667 $96,204 0/28,333 $0/$305,726
Financial Officer
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
- ----------
(a) To date, the Company has issued no SARs.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of September 21, 1998, by (i) each
person who is known by the Company to own
30
<PAGE>
beneficially more than 5% of the Company's outstanding Common Stock; (ii) each
of the Company's officers and directors; and (iii) all officers and directors
as a group.
As of October 2, 1998, there were 13,565,662 shares of Common Stock
outstanding. Each share of Common Stock is entitled to one vote per share.
<TABLE>
<CAPTION>
Name and Address of Shares of Percent of Common
Beneficial Owners and Common Stock Stock Beneficially
Directors and Officers Beneficially Owned Owned
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
5% Beneficial Owners:
- -----------------------
Allen & Company Incorporated(1) 2,780,932(2) 20.5%
711 Fifth Avenue
New York, New York 10022
- ---------------------------------------------------------------------------------------------------------
Deferred Compensation Trust for Carey F. Daly, II(3) 1,876,978 13.8%
1221 North Dutton Ave.
Santa Rosa, California 95401
- ---------------------------------------------------------------------------------------------------------
Officers and Directors:
- ------------------------
Carey F. Daly, II 619,126(4) 4.6%
1221 North Dutton Ave.
Santa Rosa, California 95401
- ---------------------------------------------------------------------------------------------------------
Mark T. Schuur 13,334(5) *
14201 NE 200th Street
Woodinville, Washington 98072
- ---------------------------------------------------------------------------------------------------------
Glenn A. Okun 511,303(6) 3.8%
1221 North Dutton Ave.
Santa Rosa, California 95401
- ---------------------------------------------------------------------------------------------------------
Monte P. Strohl 67,000 *
13720 68th Avenue West
Edmonds, Washington 98026
- ---------------------------------------------------------------------------------------------------------
Linda Wing None N/A
6117 Wilryan Avenue
Minneapolis, Minnesota 55436
- ---------------------------------------------------------------------------------------------------------
Officers and Directors as a Group (7 persons) 1,274,896 9.4%
- ---------------------------------------------------------------------------------------------------------
</TABLE>
- ----------
* Less than 1%.
(1) Allen & Company Incorporated, a New York corporation, is wholly-owned
by Allen Holding Inc., a Delaware corporation of which members of the
Allen family are beneficial owners of a majority of the shares. The
remaining shares of Allen Holding Inc. are owned by officers of Allen
actively involved in its business.
(2) Excludes approximately 1,578,000 additional shares owed by persons
affiliated with Allen & Company Incorporated.
(3) Mr. Daly has no voting power over or power to dispose of the 1,876,978
shares held in the trust. Mr. Edward L. Mueller, General Counsel to the
Company, is the trustee.
(4) Includes options to acquire 133,334 shares, which options are currently
exercisable. Excludes (a) 203,000 shares owned by Mr. Daly's wife, (b)
options to acquire 66,666 shares, which options are not currently
exercisable and (c) 1,876,978 shares held in the Deferred Compensation
Trust for Carey F. Daly, II, over which Mr. Daly has no power to vote
or dispose.
31
<PAGE>
(5) Excludes options to acquire 21,666 shares, which options are not
currently exercisable.
(6) Includes 75,000 shares owned by Mr. Okun jointly with his wife.
Excludes 145,455 shares held in an account of a client of Mr. Okun,
shares over which Mr. Okun has the power to vote and discretion to
dispose. Mr. Okun disclaims beneficial ownership of the 145,455 shares.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Mr. Carey F. Daly, II, the President and Chief Executive Officer of the
Company, has previously personally guaranteed $1,292,500 principal amount of
indebtedness of the Company. In May 1995, April 1996 and September 1996, the
Company issued an aggregate of 646,250 shares of its Common Stock to Mr. Daly in
consideration for his entering into such guaranty.
In 1996, the Company issued to Allen & Company Incorporated, a financial
advisor to the Company, 300,000 shares of its Common Stock in payment for
$300,000 in fees owed by the Company to Allen & Company for financial consulting
services. Allen & Company purchased shares of Common Stock of the Company
(including the 1996 fee for services issuance) in connection with a series of
transactions at a weighted average price per share of $0.70. Mr. Glenn Okun,
a director of the Company, was, until April 1998, also a Director and Vice
President of Allen & Company.
As part of the Company's private offering of Common Stock pursuant to Rule
506 of Regulation D of the Securities Act, the Company entered into a Placement
Agency Agreement with Allen & Company Incorporated, whereby the Company agreed
to pay Allen & Company Incorporated a placement fee of 5% of the aggregate
amount of Common Stock purchased by a subscriber. The Company paid Allen &
Company Incorporated an aggregate amount of $349,974 as its placement fee. In
addition, Mitchum, Jones & Templeton, Inc. ("Mitchum Jones"), an investment
banking firm for whom Mr. Okun is now a principal, received a 5% placement fee
in connection with a subscription for Common Stock by one of his firm's clients.
Mitchum Jones received $100,000 as its placement fee for that purchase. Allen &
Company Incorporated did not receive a placement fee in connection with the
subscription by Mitchum Jones' client.
In connection with the agreement with Scrip Advantage, Scrip Advantage has
agreed to elect a Company designee to its Board of Directors. Initially, Carey
F. Daly II, the President and Chief Executive Officer of the Company, will be
elected to such Board. The Company has advanced $50,000 to Scrip Advantage in
exchange for a demand promissory note. The note is convertible into equity of
Scrip Advantage at the Company's sole option.
The Company believes that the terms of the transactions with affiliates of
the Company are fair and reasonable in light of prevailing market conditions at
the time when such arrangements were implemented and in light of the
circumstances under which such arrangements were made. The disinterested members
of the Board of Directors will continue to review any ongoing relationships with
such affiliates to assure that such transactions are consistent with the
fiduciary duties of the directors to the stockholders of the Company.
DESCRIPTION OF SECURITIES
The following is a summary of the provisions of the Company's Certificate of
Incorporation and By-Laws, and is qualified in its entirety by reference
thereto.
The Company is authorized to issue up to 50,000,000 shares of Common Stock,
par value $0.01 per share, and 1,000,000 shares of Preferred Stock, par value
$0.01 per share ("Preferred Stock"). There are currently 13,565,662 shares of
Common Stock outstanding and no shares of Preferred Stock outstanding.
32
<PAGE>
The Company's Certificate of Incorporation provides that the Board of
Directors, without stockholder approval, has the authority to issue Preferred
Stock from time to time in series and to fix the stockholder approval, has the
authority to issue Preferred Stock from time to time in series and to fix the
designation, powers (including voting powers, if any), preferences and relative,
participating, optional, conversion and other special rights and the
qualifications, limitations and restrictions of each series.
No holder of Common Stock has any pre-emptive right to subscribe for any
securities of the Company. All outstanding shares of capital of the Company are
fully paid and non-assessable. Holders of Common Stock are not entitled to
cumulative voting and are entitled to one vote per share with respect to all
matters that are required by law to be submitted to the stockholders, including
the election of directors.
The transfer agent for the Company's Common Stock is American Stock Transfer
Company, 40 Wall Street, New York, New York.
THE SELLING STOCKHOLDERS
The persons listed below comprise the Selling Stockholders when shares are
being offered pursuant to the Prospectus. The Company is obligated to update
this Prospectus periodically until the shares offered hereby are sold.
<TABLE>
<CAPTION>
Name of Selling Securityholder Amount Of Amount Of Amount of Common
Common Stock Common Stock Stock To Be Held
Owned To Be After Offering Is
Registered Complete
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
General Electric Pension Trust 290,909 290,909 0*
- ---------------------------------------------------------------------------------------------
Mercantile Equity Partners I, L.P. 72,727 72,727 0*
- ---------------------------------------------------------------------------------------------
Oscar Investment Fund, L.P. 54,545 54,545 0*
- ---------------------------------------------------------------------------------------------
Twinstar International, Ltd. 153,455 145,455 8,000*
- ---------------------------------------------------------------------------------------------
Whittier Opportunity Fund 188,545 54,545 134,000*
- ---------------------------------------------------------------------------------------------
Whittier Ventures LLC 36,327 36,327 0*
- ---------------------------------------------------------------------------------------------
Total 654,508
- ---------------------------------------------------------------------------------------------
</TABLE>
- ----------
* Assumes all shares registered pursuant to this Registration Statement are
sold.
PLAN OF DISTRIBUTION
The Company will not receive any of the proceeds of the sale of the Common
Stock offered hereby. The Common Stock may be sold from time to time to
purchasers directly by the Selling Stockholders. Alternatively, the Selling
Stockholders may from time to time offer the Common Stock through brokers,
dealers or agents who may receive compensation in the form of discounts,
concessions or commissions from the Selling Stockholders and/or the purchasers
of the Common Stock for whom they may act as agent. The Selling Stockholders and
any such brokers, dealers or agents who participate in the distribution of the
Common Stock may be deemed to be "underwriters", and any profits on the sale of
the Common Stock by them and any discounts, commissions or concessions received
by any such brokers, dealers or agents might be deemed to be underwriting
discounts and commissions under the Securities Act. To the extent the Selling
Stockholders may be deemed to be underwriters, the Selling Stockholders may be
subject to certain statutory
33
<PAGE>
liabilities of the Securities Act, including, but not limited to,
Sections 11, 12 and 17 of the Securities Act and Rule 10b-5 under the
Exchange Act.
The Common Stock offered hereby may be sold from time to time in one or more
transactions at fixed prices, at prevailing market prices at the time of sale,
at varying prices determined at the time of sale or at negotiated prices. The
Common Stock may be sold by one or more of the following methods, without
limitation: (a) a block trade in which the broker or dealer so engaged will
attempt to sell the Common Stock as agent but may position and resell a portion
of the block as principal to facilitate the transaction; (b) purchases by a
broker or dealer as principal and resale by such broker or dealer for its
account pursuant to this Prospectus; (c) ordinary brokerage transactions and
transactions in which the broker solicits purchasers; (d) an exchange
distribution in accordance with the rules of such exchange; (e) face-to-face
transactions between sellers and purchasers without a broker-dealer; (f) through
the writing of options; and (g) other. At any time a particular offer of the
Common Stock is made, a revised Prospectus or Prospectus Supplement, if
required, will be distributed which will set forth the aggregate amount and
type of Common Stock being offered and the terms of the offering, including
the name or names of any underwriters, dealers or agents, any discounts,
commissions and other items constituting compensation from the Selling
Stockholders and any discounts, commissions or concessions allowed or
reallowed or paid to dealers. Such Prospectus Supplement and, if necessary,
a post-effective amendment to the Registration Statement of which this
Prospectus is a part, will be filed with the Commission to reflect the
disclosure of additional information with respect to the distribution of the
Common Stock. In addition, the Common Stock covered by this Prospectus may
be sold in private transactions or under Rule 144 rather than pursuant to
this Prospectus.
To the best knowledge of the Company, there are currently no plans,
arrangements or understandings between any Selling Stockholders and any broker,
dealer, agent or underwriter regarding the sale of the Common Stock by the
Selling Stockholders. There is no assurance that any Selling Stockholder will
sell any or all of the Common Stock offered by it hereunder or that any such
Selling Stockholder will not transfer, devise or gift such Common Stock by other
means not described herein.
The Selling Stockholders and any other person participating in such
distribution will be subject to applicable provisions of the Exchange Act and
the rules and regulations thereunder, including, without limitation, Regulation
M, which may limit the timing of purchases and sales of any of the Common Stock
by the Selling Stockholders and any other such person. All of the foregoing may
affect the marketability of the Common Stock and the ability of any person or
entity to engage in market-making activities with respect to the Common Stock.
Pursuant to the registration rights set forth in the various Subscription
Agreements between the Company and the Selling Stockholders, each of the Company
and the Selling Stockholders will be indemnified by the other against certain
liabilities, including certain liabilities under the Securities Act, or will be
entitled to contribution in connection therewith. The Company has agreed to pay
substantially all of the expenses incidental to the registration, offering and
sale of the Common Stock to the public other than commissions, fees and
discounts of underwriters, brokers, dealers and agents, transfer taxes and fees
and expenses of Selling Stockholders' counsels.
INDEMNIFICATION
The Company shall, to the fullest extent permitted by Section 145 of the
General Corporation Law of the State of Delaware, as the same may be amended and
supplemented, indemnify under said section from and against any and all
expenses, liabilities or other matters referred in or covered by said section,
and the indemnification provided for herein shall not be deemed exclusive of any
other rights to which those indemnified may be entitled under any By-Law,
agreement, vote of stockholders or disinterested directors or otherwise, both as
to action in his official capacity and as to action in another capacity while
holding such office, and shall continue as to a person who has ceased to be a
director, officer, employee or agent and shall inure to the benefit of the
heirs, executors and administrators of such a person. The
34
<PAGE>
Company will have the power to purchase and maintain officers' and directors'
liability insurance in order to insure against the liabilities for which such
officers and directors are indemnified pursuant to its By-Laws.
INSOFAR AS INDEMNIFICATION FOR LIABILITIES ARISING UNDER THE SECURITIES ACT
OF 1933 MAY BE PERMITTED TO DIRECTORS, OFFICERS OR PERSONS CONTROLLING THE
COMPANY PURSUANT TO THE FOREGOING PROVISIONS, OR OTHERWISE, THE COMPANY HAS BEEN
INFORMED THAT IN THE OPINION OF THE SECURITIES AND EXCHANGE COMMISSION SUCH
INDEMNIFICATION IS AGAINST PUBLIC POLICY AS EXPRESSED IN THE ACT AND IS
THEREFORE UNENFORCEABLE. IN THE EVENT THAT A CLAIM FOR INDEMNIFICATION AGAINST
SUCH LIABILITIES (OTHER THAN THE PAYMENT BY THE COMPANY OF EXPENSES INCURRED OR
PAID BY A DIRECTOR, OFFICER OR CONTROLLING PERSON OF THE COMPANY IN THE
SUCCESSFUL DEFENSE OF ANY ACTION, SUIT OR PROCEEDING) IS ASSERTED BY SUCH
DIRECTOR, OFFICER OR CONTROLLING PERSON IN CONNECTION WITH THE SECURITIES BEING
REGISTERED, THE COMPANY WILL, UNLESS IN THE OPINION OF ITS COUNSEL THE MATTER
HAS BEEN SETTLED BY CONTROLLING PRECEDENT, SUBMIT TO A COURT OF APPROPRIATE
JURISDICTION THE QUESTION WHETHER SUCH INDEMNIFICATION IS AGAINST PUBLIC
POLICY AS EXPRESSED IN THE ACT AND WILL BE GOVERNED BY THE FINAL ADJUDICATION
OF SUCH ISSUE.
The Company carries directors' and officers' liability insurance covering
losses up to $3,000,000 (subject to certain deductible amounts).
LEGAL OPINIONS
The law firm of Christy & Viener, special counsel to the Company, 620 Fifth
Avenue, New York, New York 10020, has rendered an opinion regarding the validity
of the Shares offered hereby.
EXPERTS
The consolidated balance sheets as of December 31, 1997 and 1996 and the
consolidated statements of operations, stockholders' equity (deficit) and cash
flows for each of the three years in the period ended December 31, 1997,
included in this Prospectus, have been included herein in reliance on the report
of PricewaterhouseCoopers LLP, independent accountants, given on the authority
of that firm as experts in auditing and accounting.
35
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants F-1
Financial Statements:
Year Ended December 31, 1997 (Audited)
Consolidated Balance Sheets at December 31, 1997 and 1996 F-2
Consolidated Statements of Income for the Years
Ended December 31, 1997, 1996 and 1995 F-3
Consolidated Statement of Stockholders' Equity for the
Years Ended December 31, 1997, 1996 and 1995 F-4
Consolidated Statements of Cash Flows for the Years
Ended December 31, 1997, 1996 and 1995 F-5
Notes to Consolidated Financial Statements for the Years
Ended December 31, 1997, 1996 and 1995 F-6
Quarter Ended June 30, 1998 (Unaudited)
Unaudited Consolidated Balance Sheets for the Fiscal Quarter
Ended June 30, 1998 F-20
Unaudited Consolidated Statements of Operations for the Three and Six
Months Ended June 30, 1998 and June 30, 1997 F-21
Unaudited Consolidated Statements of Cash Flows for the Three
and Six Months Ended June 30, 1998 and June 30, 1997 F-22
Unaudited Notes to Consolidated Financial Statements for the
Fiscal Quarter Ended June 30, 1998 F-23
</TABLE>
F-i
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors
The Pathways Group, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of The Pathways
Group, Inc. and Subsidiaries as of December 31, 1997 and 1996 and the related
consolidated statements of operations, stockholders' equity (deficit), and cash
flows for the three years ended December 31, 1997. 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 generally accepted auditing
standards. 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 financial position of The Pathways Group,
Inc. and Subsidiaries as of December 31, 1997 and 1996 and the consolidated
results of their operations and their cash flows for the three years ended
December 31, 1997, in conformity with generally accepted accounting principles.
/s/ COOPERS & LYBRAND
Seattle, Washington
February 24, 1998
F-1
<PAGE>
THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
ASSETS
1997 1996
------------ ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 3,759,720 $ 2,390,127
Accounts receivable 66,493 102,511
Inventory 202,749 382,089
Prepaid expenses and deposits 101,407
------------ ------------
Total current assets 4,130,369 2,874,727
------------ ------------
Restricted cash 70,500
Software, net of accumulated amortization
of $1,911,830 and $1,318,371 1,605,098 1,758,850
Property and equipment, net of
accumulated depreciation 722,678 388,280
Other assets 188,195 50,282
------------ ------------
Total assets $ 6,716,840 $ 5,072,139
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable to banks, current maturities $ 551,991 $ 370,250
Accounts payable 206,986 664,767
Accrued expenses 222,797 343,636
------------ ------------
Total current liabilities 981,774 1,378,653
Notes payable to banks, net of current
maturities 509,900 731,891
------------ ------------
Total liabilities 1,491,674 2,110,544
------------ ------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, .01 par value; 1,000,000
shares authorized; no shares issued
and outstanding
Common stock, .01 par value; 50,000,000
shares authorized; 12,904,487 and
11,756,004 shares issued and
outstanding, respectively 129,045 117,560
Additional paid in capital 18,052,730 12,214,123
Accumulated deficit (12,956,609) (9,370,088)
------------ ------------
Total stockholders' equity 5,225,166 2,961,595
------------ ------------
Total liabilities and stockholders' equity $ 6,716,840 $ 5,072,139
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
F-2
<PAGE>
THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Sales, net $ 61,785 $ 108,418 $ 512,250
Cost of sales 19,492 65,194 69,081
----------- ----------- -----------
Gross margin 42,293 43,224 443,169
----------- ----------- -----------
Selling, general and
administrative expenses 2,775,507 1,650,295 1,949,499
Amortization and write-off of software 593,459 537,232 737,645
Depreciation 208,814 121,269 74,973
----------- ----------- -----------
Total operating expenses 3,577,780 2,308,796 2,762,117
----------- ----------- -----------
Loss from operations (3,535,487) (2,265,572) (2,318,948)
Other expenses:
Interest expense, net 51,034 367,305 327,599
Loan guarantee fees to stockholder 200,000 5,000
----------- ----------- -----------
Net loss $(3,586,521) $(2,832,877) $(2,651,547)
----------- ----------- -----------
----------- ----------- -----------
Basic and fully diluted net
loss per share $(0.30) $(0.57) $(1.49)
Shares used in per share
calculation
12,102,755 4,964,640 1,784,466
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of
the consolidated financial statements.
F-3
<PAGE>
THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
---------------------------
Common Stock Additional
--------------------------- Paid-In Accumulated
Shares Amount Capital Deficit Total
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Stockholders' deficit, January 1, 1995 417,500 $ 15,118 $ 1,974,972 $ (3,760,664) $ (1,770,574)
Issuance of common stock for cash 210,000 2,100 207,900 210,000
Issuance of common stock upon conversion of
note payable to stockholder 100,000 1,000 99,000 100,000
Issuance of common stock upon conversion of
notes payable to individuals 150,000 1,500 148,500 150,000
Issuance of common stock in connection with
the acquisition of Sprinticket, Inc. 819,500 8,195 811,305 819,500
Obligation to issue common stock for loan
guarantees by a stockholder 50 4,950 5,000
Issuance of common stock for loan guarantees
by a stockholder 757,000
Issuance of warrants to purchase common stock 4,356 431,244 435,600
Net loss (2,651,547) (2,651,547)
------------ ------------ ------------ ------------ ------------
Stockholders' deficit, December 31, 1995 2,454,000 32,319 3,677,871 (6,412,211) (2,702,021)
Issuance of common stock for cash 5,162,619 51,626 5,208,374 5,260,000
Issuance of common stock for investment banking
services to stockholder 300,000 3,000 297,000 300,000
Issuance of common stock for loan guarantees to
stockholder 200,000 2,000 198,000 200,000
Issuance of common stock for loan guarantees to
stockholder (earned and accrued prior to 1996) 342,292
Exercise of warrants to purchase common stock
by stockholder 440,000 44 4,356 4,400
Issuance of common stock upon conversion of notes
payable (including 1,303,672 shares to stockholders) 1,470,331 14,703 1,455,628 1,470,331
Issuance of common stock for wages, interest, consulting
and professional fees and conversion of accrued
expenses (including 862,899 shares to stockholders) 1,161,762 11,618 1,150,144 1,161,762
Issuance of common stock for acquisition of minority
interest in SPRINTICKET, Inc. 225,000 2,250 222,750 225,000
Exchange of land for common stock of Pathways
International, Ltd. (125,000) (125,000)
Net loss (2,832,877) (2,832,877)
------------ ------------ ------------ ------------ ------------
Stockholders' equity, December 31, 1996 11,756,004 117,560 12,214,123 (9,370,088) 2,961,595
Redemption of common stock for cash (33,737) (337) (27,663) (28,000)
Issuance of common stock for convertible debenture 3,000 30 2,970 3,000
Issuance of common stock upon exercise of stock
options and warrants 345,887 3,459 1,013,677 1,017,136
Net proceeds from initial public offering of common stock 833,333 8,333 4,849,623 4,857,956
Net loss (3,586,521) (3,586,521)
------------ ------------ ------------ ------------ ------------
Stockholders' equity, December 31, 1997 12,904,487 $ 129,045 $ 18,052,730 $(12,956,609) $ 5,225,166
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
F-4
<PAGE>
THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(3,586,521) $(2,832,877) $(2,651,547)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation 208,354 121,269 74,973
Amortization and write-off of software 593,459 537,232 737,645
Investment banking services 300,000
Loan guarantee fees 200,000
Issuance of common stock for wages, interest,
consulting and professional fees 281,573
Issue of warrants to purchase common stock 435,600
Loan guarantee fees to stockholder 5,000
Write-off of net accounts receivable 486,755
Effects of changes in operating assets and
liabilities, net of effects from acquisition
of businesses:
Trade accounts receivable 36,018 (77,965) (16,870)
Inventory 56,963 (331,857)
Prepaid expenses and deposits (101,407) 29
Other assets (137,913) (38,838) 2,268
Accounts payable (335,404) 107,554 75,938
Accrued expenses (120,839) (206,571) 592,771
----------- ----------- -----------
Net cash used in operating activities (3,387,290) (1,940,480) (257,438)
----------- ----------- -----------
Cash flows from investing activities:
Restricted cash (70,500)
Capital expenditures (542,752) (59,059) (7,528)
Capitalized software development costs (439,707) (236,946) (301,165)
Cash acquired in acquisition of businesses 55,374
----------- ----------- -----------
Net cash used in investing activities (1,052,959) (296,005) (253,319)
----------- ----------- -----------
Cash flows from financing activities:
Principal payments on notes payable to banks (34,750) (517,532) (15,993)
Principal payments on notes payable to stockholders (2,500) (111,634) (2,385)
Principal payments on notes payable to others (517,161) (2,682)
Redemption of common stock (28,000)
Proceeds from notes payable to banks 4,361
Proceeds from notes payable to stockholders 35,670 130,568
Proceeds from notes payable to others 463,500 195,659
Proceeds from issuances of common stock,
net of offering costs of $142,044 5,875,092 5,264,400 210,000
----------- ----------- -----------
Net cash provided by financing activities 5,809,842 4,617,243 519,528
----------- ----------- -----------
Increase in cash and cash equivalents 1,369,593 2,380,758 8,771
Cash and cash equivalents, beginning of year 2,390,127 9,369 598
----------- ----------- -----------
Cash and cash equivalents, end of year $ 3,759,720 $ 2,390,127 $ 9,369
----------- ----------- -----------
----------- ----------- -----------
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
F-5
<PAGE>
THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BASIS OF PRESENTATION:
THE COMPANY
The accompanying consolidated financial statements include the accounts of
The Pathways Group, Inc. ("TPG") and its wholly-owned and majority-owned
subsidiaries as of December 31, 1997 and 1996 and for the three years ended
December 31, 1997. All intercompany balances and transactions have been
eliminated. TPG's subsidiaries include Pathways International, Ltd.
("PIL"), SPRINTICKET, Inc. ("ST"), PT Link, Inc. ("PT Link") and the
Pathways Group, a wholly-owned subsidiary incorporated in the state of
Hawaii in August 1997. TPG and its subsidiaries (the "Company") are
primarily engaged in providing specialized transaction processing services
through the development of proprietary software and hardware systems
including credit card and multiple application smart card technologies.
The Company derives its revenue principally from transaction processing
fees charged to the merchant and the sale of related terminals, hardware
systems and smart cards.
BUSINESS COMBINATIONS
In April 1995, TPG acquired 77.53% of the outstanding stock of ST through
the issuance of 819,500 shares of TPG's common stock. This transaction has
been accounted for as a purchase in accordance with generally accepted
accounting principles.
A summary of the allocation of the purchase price for this acquisition is
as follows:
<TABLE>
<S> <C>
Assets acquired:
Cash $ 55,374
Accounts receivable 8,522
Inventory 50,232
Property and equipment 475,319
Software 1,328,642
Other assets 1,508
-----------
Total assets acquired 1,919,597
Liabilities assumed (1,100,097)
-----------
$ 819,500
-----------
-----------
</TABLE>
In 1996 and 1997, TPG acquired the remaining minority interest in ST. The
Company's acquisition of the remaining minority interest of ST was
accounted for as a purchase with the purchase price of $300,000 being
allocated to software and amortized in accordance with the Company's
amortization policy.
F-6
<PAGE>
THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BASIS OF PRESENTATION, CONTINUED:
REINCORPORATION
In May 1997, TPG reincorporated in the State of Delaware. At such time,
the number of authorized shares of common stock was reduced from
500,000,000 to 50,000,000. The par value was changed to $.01 per share and
1,000,000 shares of preferred stock were authorized. All prior periods
presented have been adjusted to reflect these changes in the capital stock
accounts.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
CASH AND CASH EQUIVALENTS
For purposes of the consolidated statements of cash flows, the Company
considers all highly liquid debt securities purchased with an original
maturity of three months or less to be cash equivalents. As of December
31, 1997 and 1996, cash equivalents consisted of money market accounts and
U.S. Treasury Bills.
INVENTORY
Inventory is stated at the lower of cost (as determined by the first-in,
first-out method) or market.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation expense is
provided by the straight-line method over the estimated useful lives of the
property and equipment which is estimated to be five years, with the
exception of computer equipment as to which the life is three years.
Expenditures for renewals and betterments are capitalized; expenditures for
maintenance and repairs are charged to expense as incurred. The cost and
accumulated depreciation of assets sold or otherwise disposed of are
removed from the accounts, and the related gains and losses are included in
the results of operations.
F-7
<PAGE>
THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
SOFTWARE
Software development costs incurred in conjunction with product development
are charged to expense until technological feasibility is established.
Thereafter, all software development costs are capitalized and reported at
the lower of unamortized cost or net realizable value of each product. In
1997, approximately $102,000 was charged to research and development. In
1996 and 1995, research and development expenses were not material. The
establishment of technological feasibility and the on-going assessment of
the recoverability of costs require considerable judgment by the Company
with respect to certain external factors, including, but not limited to,
anticipated future gross product revenues, estimated economic life and
changes in software and hardware technology. After consideration of the
above factors, the Company amortizes capitalized software costs by the
greater of (a) the ratio that current gross revenues for a product bear to
the total of current and anticipated future gross revenues for that product
or (b) the straight-line method over the remaining estimated economic life
of the product including the period being reported on, generally five
years.
INCOME TAXES
Deferred tax assets and liabilities are recorded for differences between
the financial statement and tax bases of the assets and liabilities that
will result in taxable or deductible amounts in the future based on enacted
tax laws and rates applicable to the periods in which the differences are
expected to affect taxable income. Valuation allowances are established
when necessary to reduce deferred tax assets to the amount expected to be
realized. Income tax expense is recorded for the amount of income tax
payable or refundable for the period increased or decreased by the change
in deferred tax assets and liabilities during the period.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of cash and cash equivalents and accounts receivable
approximate fair value due to their short-term maturities. The carrying
value of debt approximates their estimated fair values because the rates of
interest on the debt approximates current interest rates for similar
obligations with like maturities.
F-8
<PAGE>
THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the company to
concentrations of credit risk consist principally of cash and accounts
receivable. The Company places its cash with high quality financial
institutions. At times, such cash may exceed federally insured limits.
Approximately 55% and 63% of accounts receivable at December 31, 1997 and
1996 are concentrated with one customer.
REVENUE RECOGNITION AND REVENUE SHARING AGREEMENTS
Revenue from hardware and software sales are recognized when a product is
shipped. The Company has revenue sharing and transaction processing
agreements with merchants who process commercial transactions through the
Company's hardware and software systems provided on site to the merchants.
Transaction processing fee revenue is recognized at the time transactions
are processed and the related transaction fee has been collected.
USE OF ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Accordingly, actual results could differ from
those estimates and assumptions.
It is reasonably possible that the estimates of anticipated future gross
revenues and the remaining estimated economic life of the Company's
products used to calculate amortization of software development costs may
be reduced significantly in the near term. As a result, the carrying
amount of the capitalized software costs may be reduced materially in the
near term.
F-9
<PAGE>
THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
3. INVENTORY:
Inventory at December 31, 1997 and 1996 consisted of the following:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Smart cards and related packaging $ 149,204 $ 185,834
Smart card terminals and computer hardware 53,545 145,004
Materials and supplies 51,251
--------- ---------
$ 202,749 $ 382,089
--------- ---------
--------- ---------
</TABLE>
4. PROPERTY AND EQUIPMENT:
Property and equipment at December 31, 1997 and 1996 consisted of the
following:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Ticket dispensing systems $ 465,500 $ 465,500
Computer equipment and software 367,907 87,059
Furniture and fixtures 42,635 34,031
Leasehold improvements 258,239 4,939
---------- ----------
1,134,281 591,529
Less accumulated depreciation (411,603) (203,249)
---------- ----------
$ 722,678 $ 388,280
---------- ----------
---------- ----------
</TABLE>
Computer equipment and software includes $56,384 for software purchased but
not placed in service in 1997.
5. OTHER ASSETS:
In 1992, the Company acquired land for $250,000 in exchange for a $125,000
note payable and the issuance of 10,000 shares of common stock. In August
1996, the Company entered into an agreement whereby the land was returned
to the seller in exchange for the note payable and the shares of common
stock. There was no gain or loss as a result of the settlement.
F-10
<PAGE>
THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
6. NOTES PAYABLE TO BANKS:
Notes payable to banks at December 31, 1997 and 1996 consisted of the
following:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Note payable to bank, interest at bank's
prime rate (8.5% at December 31,1997) plus
2%, principal due in February 1998, interest
due monthly, guaranteed by certain stockholders
and collateralized by substantially all of
the assets of TPG $ 50,000 $ 50,000
Note payable to bank, interest at bank's prime
rate (8.5% at December 31, 1997) plus 1.5%,
principal due in various installments from
February 1988 through November 1998,
interest due monthly, guaranteed by certain
stockholders and collateralized by
substantially all of the assets of PIL 190,000 190,000
Note payable to bank, interest at bank's prime
rate (8.5% at December 31, 1997) plus 1.5%,
principal due in various installments from
May 1998 through February 1999, interest due
monthly, guaranteed by certain stockholders
and collateralized by substantially all of
the assets of PIL 150,000 150,000
Note payable to bank, interest at prime (8.5%
at December 31, 1997) plus 1.5%, principal due
in various installments from February 1998
through May 1, 1999 (however, the note payable
will be due in full upon the sale or transfer
of either a controlling ownership interest
in PT Link or substantially all of PT Link's
assets occurring prior to May 1, 1999),
interest due monthly and collateralized by
substantially all of the assets of PT Link 330,000 364,750
Note payable to bank, interest at prime
(8.5% at December 31, 1997) plus 2.75%,
principal due in various installments from
February 1998 through September 2001,
interest due monthly, guaranteed by certain
stockholders, and collateralized by
substantially all of the assets of PIL 341,891 341,891
Other 5,500
--------- ---------
1,061,891 1,102,141
Less current maturities (551,991) (370,250)
--------- ---------
$ 509,900 $ 731,891
========= =========
</TABLE>
F-11
<PAGE>
THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
6. NOTES PAYABLE TO BANKS, CONTINUED:
The contractual principal maturities of notes payable to banks at December
31, 1997 are as follows:
<TABLE>
<S> <C>
1998 $ 551,991
1999 336,712
2000 107,901
2001 65,287
----------
$1,061,891
----------
----------
</TABLE>
7. ACCRUED EXPENSES:
Accrued expenses at December 31, 1997 and 1996 consisted of the following:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Interest payable $ 20,403 $ 105,273
Accrued payroll and related taxes 4,800 70,433
Insurance premiums payable 48,798
Other accrued expenses 148,796 167,930
--------- ---------
$ 222,797 $ 343,636
--------- ---------
--------- ---------
</TABLE>
F-12
<PAGE>
THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
8. INCOME TAXES:
At December 31, 1997, the Company had accumulated net operating loss
carryforwards for tax purposes of approximately $10,794,000 which expire
through 2012. As a result of acquisitions, the availability of these net
operating losses will be limited to a prescribed amount each year as
specified in the Internal Revenue Code. Net operating losses accumulated
through the dates of acquisition of PT Link and ST will be limited to
their separate taxable income.
The following is a reconciliation of the income tax benefit to the amount
based on the statutory Federal rate of 34%:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Federal income tax benefit at statutory rate $(1,219,417) $ (963,178) $ (901,526)
Losses which provide no current tax benefit 1,215,851 949,604 899,884
Other, net 3,566 13,574 1,642
----------- ----------- -----------
Income tax benefit $ - $ - $ -
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
Deferred income taxes under the liability method reflect the net tax
effects of temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for income tax
purposes.
F-13
<PAGE>
THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
8. INCOME TAXES, CONTINUED:
The significant components of the Company's deferred income tax assets and
liabilities at December 31, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Deferred income tax assets:
Tax loss carryforwards $ 3,670,117 $ 2,455,601
Debt guarantee fees to stockholder 439,466 439,466
Accrued compensation 203,809 202,990
Other 22,242 4,430
----------- -----------
Deferred income tax assets 4,335,634 3,102,487
----------- -----------
Deferred income tax liability:
Depreciation 53,741 36,715
----------- -----------
Deferred income tax liability 53,741 36,715
----------- -----------
Valuation allowance (4,281,893) (3,065,772)
----------- -----------
Net deferred income tax assets $ - $ -
----------- -----------
----------- -----------
</TABLE>
A full valuation allowance has been recorded at December 31, 1997 based on
management's determination that the recognition criteria for realization
has not been met.
9. COMMITMENTS:
LEASE COMMITMENTS
The Company leases its facilities in Woodinville, Washington, Santa Rosa,
California and Honolulu, Hawaii and also leases certain vehicles and office
equipment under operating lease agreements expiring in the years 1998 to
2002. In 1997, the Company entered into a master lease agreement with a
bank which provides up to $400,000 of credit to the Company for the lease
of certain computer and office equipment and furniture. The lease is for a
period of 34 months and contains an option to acquire the equipment at the
end of the lease term for the fair market value of the equipment. The
lease provisions require the Company to maintain up to $200,000 in a
certificate of deposit at the bank as collateral for the lease, and to
deposit additional funds if the Company's cash and cash equivalents are not
maintained above $800,000. Of the $200,000, $70,500 has been classified as
restricted cash at December 31, 1997.
F-14
<PAGE>
THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
9. COMMITMENTS, CONTINUED:
LEASE COMMITMENTS, CONTINUED
This lease has been accounted for as an operating lease. As of December
31, 1997, the Company has drawn approximately $141,000 on the lease line
and has approximately $259,000 available. The approximate future minimum
rental commitments as of December 31, 1997 under these operating leases are
as follows:
<TABLE>
<S> <C>
1998 $ 295,000
1999 262,000
2000 252,000
2001 158,000
2002 96,000
----------
$1,063,000
----------
----------
</TABLE>
Rent expense for the years ended December 31, 1997, 1996 and 1995 was
approximately $147,000, $100,000 and $61,000, respectively.
PURCHASE COMMITMENTS AND DEPOSITS
As of December 31, 1997, the Company has made deposits of $118,087 towards
purchase commitments on furniture and computers totaling $223,112. The
deposits are included in other assets.
10. EMPLOYMENT AGREEMENTS AND STOCK OPTIONS:
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with certain employees
and officers. The agreements provide for future salary, benefits and stock
option grants to the employee/officers during their terms of employment.
The agreements also contain non-compete restrictions on the
employee/officers and provide for certain severance obligations in the
event of termination without cause (as defined). In addition, one of the
officers receives one-half share of TPG common stock for each dollar of
debt personally guaranteed by the officer. In 1996 and 1995, the officer
earned 200,000 and 5,000 shares of TPG common stock under this provision.
F-15
<PAGE>
THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
10. EMPLOYMENT AGREEMENTS AND STOCK OPTIONS, CONTINUED:
STOCK OPTIONS
In December 1997, the Company's Board of Directors adopted The Pathways
Group, Inc. 1996 Stock Incentive Plan (the "Plan"), which provides for the
issuance of incentive stock options ("ISOs") and non-qualified options to
key management and reserved a total of 2,000,000 shares of common stock
pursuant to the Plan.
ISOs may be issued only to employees of the Company and have a maximum term
of 10 years from the date of grant. The exercise price for ISOs may not be
less than 100% of the estimated fair market value of the common stock at
the time of the grant, and the aggregate fair market value (as determined
at the date of the grant) of shares issuable upon the exercise of ISOs for
the first time in any one calendar year may not exceed $100,000. In the
case of options granted to holders of more than 10% of the voting power of
the Company, the exercise price may not be less than 110% of the estimated
fair market value of the common stock at the time of grant, and the term of
the option may not exceed five years. Options become exercisable in whole
or in part from time to time as determined by the Board of Directors, which
will administer the Stock Incentive Plan. Generally, options vest over
periods ranging from one to three years.
The Company has adopted the disclosure only provisions of Statement of
Financial Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for
Stock Based Compensation". The Company has elected to account for
stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees" and related interpretations. Accordingly, compensation cost for
stock options is measured as the excess, if any, of the fair value of the
Company's stock at the date of grant over the exercise price to be paid to
acquire the stock.
F-16
<PAGE>
THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
10. EMPLOYMENT AGREEMENTS AND STOCK OPTIONS, CONTINUED:
STOCK OPTIONS, CONTINUED
Option activity for the years ended December 31, 1997 and 1996 is as
follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
SHARES EXERCISE PRICE
<S> <C> <C>
Balance, January 1, 1996 -
Granted 230,000 $ 2.83
Exercised -
Canceled -
------- --------
Balance, December 31, 1996 230,000 2.83
Granted 214,000 19.79
Exercised (10,001) 1.71
Canceled (6,666) 3.00
------- --------
Balance, December 31, 1997 427,333 $ 11.35
------- --------
------- --------
</TABLE>
No compensation expense has been recorded for options granted in 1997 and
1996 because the exercise price of the options granted was equal to the
fair value of the related shares based upon the price of the Company's
common stock.
The following table summarizes information about options outstanding at
December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ------------------------------------------------ ----------------------------
WEIGHTED AVERAGE
WEIGHTED REMAINING WEIGHTED
AVERAGE NUMBER OF CONTRACTUAL LIFE NUMBER OF AVERAGE
EXERCISE PRICES SHARES (IN YEARS) SHARES EXERCISE PRICE
<S> <C> <C> <C> <C>
$ 2.88 213,333 9 66,667 $3.00
15.00 100,000 10
24.00 114,000 10
</TABLE>
F-17
<PAGE>
THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
10. EMPLOYMENT AGREEMENTS AND STOCK OPTIONS, CONTINUED:
STOCK OPTIONS, CONTINUED
Pro forma information regarding the net loss is required by SFAS No. 123,
and has been determined as if the Company had accounted for its employee
stock options granted after December 31, 1995 under the fair value method
of that statement. The fair value of options granted in 1997 was estimated
at the date of grant using the Black-Scholes option pricing model assuming
no expected dividends and the following weighted-average assumptions:
risk-free interest rates of 5.79% to 5.93%; volatility of 55%; and expected
lives of 3 to 5 years. The weighted average fair value of options granted
in 1997, as calculated using the Black-Scholes option pricing model, was
$9.85 per option.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting periods. The
following table presents pro forma net loss and net loss per share for the
year ended December 31, 1997 as if the Company accounted for compensation
expense related to stock options under the fair value method prescribed by
SFAS 123:
<TABLE>
<CAPTION>
December 31,
1997
<S> <C>
Pro forma net loss $ 3,743,575
------------
------------
Pro forma net loss per share $ 0.31
------------
------------
</TABLE>
The fair value of options granted in 1996 was estimated on the date of
grant using the minimum value method with the following weighted average
assumptions:
<TABLE>
<S> <C>
Risk free interest rate 5.76% to 6.16%
Expected lives 10 years
</TABLE>
There was no difference in 1996 compensation expense between the intrinsic
value method as reported by the Company and the fair value method
prescribed by SFAS 123 because no options vested in 1996.
F-18
<PAGE>
THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
11. CAPITAL STOCK TRANSACTIONS:
COMMON STOCK
In May 1995, the Company entered into an agreement with an investment
banking firm, Allen & Company Incorporated ("Allen"), whereby Allen is to
assist the Company in developing an overall plan for its corporate and
financial development and advise the Company on a variety of transaction
proposals, including financing and acquisition alternatives. The duration
of the agreement is for two years, with a provision for an automatic
extension of one year, unless either party elects to terminate the
agreement. In connection with the agreement, the Company issued Allen
warrants to purchase 440,000 shares of TPG stock at $.01 per share for
services to be provided by Allen. In 1996, the warrants were exercised for
440,000 shares of common stock by Allen for consideration of $4,400.
In 1996, Allen purchased 39% of the outstanding common stock of TPG for
$3,250,000. Also in 1996, the Company incurred a liability of $300,000 for
services provided by Allen. The Company settled the obligation by issuing
300,000 shares of TPG stock to Allen.
In December 1996, the Company sold through a private placement 783,734
shares of common stock for $2,000,000. In connection with the sale, the
Company issued a warrant for the purchase of 335,886 shares of its common
stock at $2.9772 per share, for an aggregate purchase price of $1,000,000.
In December 1997, the warrant was exercised in full.
12. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
<TABLE>
1997 1996 1995
<S> <C> <C> <C>
Cash paid during the year for interest $241,637 $ 283,993 $ 97,774
Non-cash transactions:
Notes payable converted to common stock 3,000 1,470,331 250,000
Accounts payable and accrued expenses
converted to common stock 880,189
Acquisition of minority interest
in subsidiary 225,000
Exchange of land and note payable for
common stock 250,000
</TABLE>
In 1997, the Company changed suppliers of its smart card terminals and
readers. In connection with this supplier change, the Company returned
$122,377 of smart card terminals previously recorded as inventory and
accounts payable to its former supplier.
F-19
<PAGE>
QUARTER ENDED JUNE 30, 1998 (UNAUDITED)
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
ASSETS
June 30, 1998 December 31, 1997
------------- -----------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 382,809 $ 3,759,720
Accounts receivable 81,670 66,493
Inventory 207,570 202,749
Prepaid expenses and deposits 69,907 101,407
------------ ------------
Total current assets 741,956 4,130,369
Restricted cash 200,000 70,500
Software, net 1,424,359 1,605,098
Property and equipment, net 1,027,312 722,678
Other assets 104,824 188,195
------------ ------------
Total assets $ 3,498,451 $ 6,716,840
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable to banks, current maturities $ 571,839 $ 551,991
Accounts payable 258,966 206,986
Accrued expenses 159,879 222,797
------------ ------------
Total current liabilities 990,684 981,774
Notes payable to banks, net of current maturities 220,344 509,900
------------ ------------
Total liabilities $ 1,211,028 $ 1,491,674
------------ ------------
Stockholders' equity:
Preferred stock, $0.01 par value; 1,000,000 shares
authorized; no shares issued and outstanding
Common stock, $0.01 par value; 50,000,000 shares
authorized; 12,904,487 issued and outstanding at
June 30, 1998 and December 31, 1997 $ 129,045 $ 129,045
Additional paid in capital 18,052,730 18,052,730
Accumulated deficit (15,894,352) (12,956,609)
------------ ------------
Total stockholders' equity 2,287,423 5,225,166
------------ ------------
Total liabilities and stockholders' equity $ 3,498,451 $ 6,716,840
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-20
<PAGE>
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
For the
three months ended
June 30, 1998 June 30, 1997
-------------- -------------
<S> <C> <C>
Sales, net $ 12,237 $ 20,730
Cost of sales 2,842 4,074
-------------- -------------
Gross margin 9,395 16,656
-------------- -------------
Selling, general and administrative expenses 1,241,424 539,186
Amortization of software 165,966 148,144
Depreciation 104,120 39,949
-------------- -------------
Total operating expenses 1,511,510 727,279
-------------- -------------
Loss from operations (1,502,115) (710,623)
Net interest income (expense) (10,089) (18,038)
-------------- -------------
Net loss $ (1,512,204) $ (728,661)
-------------- -------------
-------------- -------------
Net loss per share (basic and diluted) $ (0.12) $ (0.06)
Weighted average shares outstanding (basic and diluted) 12,904,487 11,725,267
</TABLE>
<TABLE>
<CAPTION>
For the
six months ended
June 30, 1998 June 30, 1997
-------------- -------------
<S> <C> <C>
Sales, net $ 13,880 $ 35,092
Cost of sales 3,501 9,740
-------------- -------------
Gross margin 10,379 25,352
-------------- -------------
Selling, general and administrative expenses 2,447,403 1,108,450
Amortization of software 327,205 289,554
Depreciation 178,580 76,041
-------------- -------------
Total operating expenses 2,953,188 1,474,045
-------------- -------------
Loss from operations (2,942,809) (1,448,693)
Net interest income (expense) 5,076 (80,525)
-------------- -------------
Net loss $ (2,937,733) $ (1,529,218)
-------------- -------------
-------------- -------------
Net loss per share (basic and diluted) $ (0.23) $ (0.13)
Weighted average shares outstanding (basic and diluted) 12,904,487 11,732,752
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-21
<PAGE>
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
For the
six months ended
June 30, 1998 June 30, 1997
-------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (2,937,733) $ (1,529,218)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation 178,580 76,041
Amortization of software 327,205 289,554
Effects of changes in operating assets and liabilities:
Accounts receivable (15,177) 43,435
Prepaid expenses and deposits 31,500 (166,113)
Inventory (4,821) 68,865
Other assets 15,283 (3,481)
Accounts payable 51,980 (219,903)
Accrued expenses (62,928) (29,479)
-------------- -------------
Net cash used in operating activities (2,416,111) (1,470,299)
-------------- -------------
Cash flows from investing activities:
Capital expenditures (365,126) (209,314)
Capitalized software development costs (146,466) (287,734)
Increase in restricted cash (129,500) --
Advance of funds to Scrip Advantage (50,000) --
-------------- -------------
Net cash used in investing activities (691,092) (497,048)
-------------- -------------
Cash flows from financing activities:
Principal payments on notes payable to banks (269,708) (2,500)
Repurchase of common stock -- (28,000)
-------------- -------------
Net cash used in financing activities (269,708) (30,500)
Decrease in cash and cash equivalents (3,376,911) (1,997,847)
Cash and cash equivalents, beginning of period 3,759,720 2,390,127
-------------- -------------
Cash and cash equivalents, end of period $ 382,809 $ 392,280
-------------- -------------
-------------- -------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-22
<PAGE>
Notes to Consolidated Financial Statements
(Unaudited)
1. Unaudited Interim Financial Information
The accompanying consolidated financial statements are unaudited, but
include all adjustments (consisting only of normal recurring adjustments) which
are, in the opinion of management, necessary for a fair presentation of the
financial position at such dates and the operations and cash flows for the
periods then ended. The financial information is presented in a condensed
format, and it does not include all of the footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles. Operating results for the periods ended June 30, 1998 and
1997 are not necessarily indicative of results that may be expected for the
entire year. The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities and reported
amounts of revenue and expenses during the reporting period. Actual results
could differ materially from such assumptions and estimates. The accompanying
financial statements and related footnotes should be read in conjunction with
the Company's audited financial statements, included in its Form 1-A (No.
24-3750) and Form 10-SB (File No. 000-24119) filed with the Securities and
Exchange Commission.
2. The Company
The accompanying consolidated financial statements include the accounts
of The Pathways Group, Inc. ("TPG") and its wholly-owned subsidiaries. All
intercompany balances and transactions have been eliminated. TPG's subsidiaries
include Pathways International, Ltd. ("PIL"), SPRINTICKET, Inc. ("ST"), PT Link,
Inc. ("PT Link") and The Pathways Group, Inc., a wholly-owned subsidiary
incorporated in the State of Hawaii. TPG and its subsidiaries (the "Company")
are primarily engaged in providing specialized transaction processing services
through the development of proprietary software and hardware systems including
credit card and multiple application smart card technologies. The Company
derives its revenue principally from transaction processing fees charged to the
merchant and the sale of related terminals, hardware systems and smart cards.
The Company has invested heavily in designing and developing its proprietary
hardware and application software systems and in establishing and expanding its
sales and marketing capabilities. The Company plans to continue these efforts in
preparation for, and in anticipation of, the growth in smart card-based
electronic commerce that the Company anticipates will create a substantial
market for its data and transaction processing services.
3. Inventories
Inventories consisted of the following:
<TABLE>
<CAPTION>
June 30, 1998 December 31, 1997
------------- -----------------
<S> <C> <C>
Smart cards and related packaging $153,267 $149,204
Smart card terminals and computer hardware 54,303 53,545
------------- -----------------
$207,570 $202,749
------------- -----------------
------------- -----------------
</TABLE>
4. Capital Stock Transactions/Initial Public Offering
Purchase of Minority Interest
In March, 1997, TPG acquired all of the remaining minority interest in
its majority-owned subsidiary, ST, through a payment of $75,000. This
transaction was accounted for as a purchase in accordance
F-23
<PAGE>
with generally accepted accounting principles. The purchase price of $75,000
was allocated to software and is being amortized in accordance with the
Company's amortization policy.
Reincorporation
In May, 1997, The Pathways Group, Inc. reincorporated in the State of
Delaware. At such time, the number of authorized shares of common stock was
reduced to 50,000,000, the par value of common shares was changed to $0.01, and
1,000,000 shares of preferred stock were authorized. All prior periods presented
have been adjusted to reflect these changes in the capital stock accounts.
Agreements with and loan to Scrip Advantage
In June of 1998, the Company signed a contract with Scrip Advantage of
Fresno, California to provide its proprietary Smart Script-TM- electronic scrip
and gift certificate product to Scrip Advantage and its members. The agreement
with Scrip Advantage calls for the Company to sell terminals to participating
merchants and smart cards to non-profit organizations and their members. In
addition, the Company will receive a fee for each smart card, debit or credit
card transaction processed. The agreement is for a term of three years with
annual renewals and includes early termination provisions for both parties under
certain conditions, including the failure of Pathways to provide Scrip Advantage
with competitive pricing.
In connection with the agreement with Scrip Advantage, the Company has
advanced $50,000 to Scrip Advantage in exchange for a demand promissory note.
The note is convertible into equity of Scrip Advantage at the Company's sole
option. In addition, Scrip Advantage has agreed to elect a Company designee to
its Board of Directors. Initially, Carey F. Daly II, the President and Chief
Executive Officer of the Company, will be elected to such Board.
Initial Public Offering
In July 1997, the Company received net proceeds of $4,857,958 from the
sale of 833,333 shares of common stock. These shares were sold pursuant to
Regulation A under the Securities Exchange Act of 1933. The Company's common
stock is traded in the over-the-counter market (Bulletin Board) under the
trading symbol PTHW.
5. Supplemental Disclosures of Cash Flow Information
<TABLE>
<CAPTION>
For the For the
six months six months
ending ending
June 30, 1998 June 30, 1997
------------- -------------
<S> <C> <C>
Cash paid for interest $48,952 $143,810
Non-cash transactions:
Notes payable converted to common stock -- $3,000
</TABLE>
In April 1997, the Company changed suppliers of its smart card
terminals and readers. In connection with this supplier change, the Company
returned $122,370 of smart card terminals previously recorded as inventory and
accounts payable to its former supplier. In 1998, the Company recorded as other
assets $118,088 for deposits on property and equipment placed in service in
1998.
F-24
<PAGE>
6. Subsequent Events
The Company commenced a private offering of its Common Stock on
July 23, 1998. The offering was completed on August 21, 1998. The Company sold
654,508 shares at $13.75 per share to six accredited investors. The estimated
net proceeds from the above stock sales and subscriptions are approximately
$8,411,493. The Company engaged Allen & Company Incorporated to act as placement
agent for the offering. Each placement agent who placed shares received a
placement fee of 5% of the purchase price per share. Pro forma working capital
and cash and cash equivalents at June 30, 1998, after giving effect to the
receipt of the net proceeds from the offering, is $8,162,765 and $8,794,302.
In 1997, the Company entered into a master lease agreement with a bank
which provided up to $400,000 of credit to the Company for the lease of certain
computer and office equipment and furniture for a period of three years and
contains an option to acquire the equipment at the end of the lease term. This
lease has been accounted for as an operating lease. The lease provisions require
the Company to maintain $200,000 in a certificate of deposit at the bank as
collateral for the lease and to deposit additional funds if the Company's
available cash and cash equivalents are not maintained above $850,000. In June
1998, the Company determined that it was in breach of one of the financial
covenants contained in its $400,000 lease financing arrangements. The Company
received a waiver from the bank in August 1998.
F-25
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
No dealer, salesman or other person has been authorized to give any information
or to make any representations on behalf of the Company not contained in this
Prospectus, and, if given or made, such information or representations must not
be relied upon as having been authorized by the Company. This Prospectus does
not constitute an offer of any securities other than those to which it relates
or an offer to sell, or the solicitation of an offer to buy, any securities in
any jurisdiction where, or to any person to whom, it is unlawful to make such
offer or solicitation. Neither the delivery of this Prospectus nor any sale made
hereunder shall, under any circumstances, create an implication that there has
been no change in the affairs of the Company since the date hereof or that the
information contained herein is correct as of any time subsequent to the date
hereof.
--------------------
TABLE OF CONTENTS
--------------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
AVAILABLE INFORMATION.....................................................iii
SUMMARY INFORMATION .......................................................1
RISK FACTORS...............................................................1
USE OF PROCEEDS............................................................7
CAPITALIZATION.............................................................8
SELECTED CONSOLIDATED FINANCIAL INFORMATION................................8
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF
OPERATION.................................................................9
BUSINESS..................................................................15
MARKET PRICE OF AND DIVIDENDS ON THE COMPANY'S
COMMON EQUITY ...........................................................26
MANAGEMENT................................................................27
EXECUTIVE COMPENSATION....................................................28
SUMMARY COMPENSATION TABLE................................................29
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT...........................................................30
CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS.............................................................32
DESCRIPTION OF SECURITIES.................................................32
THE SELLING STOCKHOLDERS..................................................33
PLAN OF DISTRIBUTION......................................................33
INDEMNIFICATION...........................................................34
LEGAL OPINIONS............................................................35
EXPERTS...................................................................35
INDEX TO FINANCIAL STATEMENTS.............................................F-i
</TABLE>
654,508 Shares
of
Common Stock
The Pathways Group, Inc
Common Stock
-----------------------
Prospectus
-----------------------
October 9, 1998
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
