UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
OR
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from ________ to ________
Commission file number 0-24119
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THE PATHWAYS GROUP, INC.
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(Exact name of registrant as specified in its charter)
Delaware 91-1617556
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
14201 NE 200th Street, Woodinville, Washington 98072
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(Address of principal executive offices) (Zip Code)
(425) 483-3411
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(Registrant's telephone number, including area code)
Securities registered under Section 12(b) of the Exchange Act: None.
Securities registered under Section 12(g) of the Exchange Act:
Name of Each Exchange
Title of Each Class on Which Registered
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Common Stock, par value $.01 per share NASDAQ
Indicate by check mark whether the registrant: (1) filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for past 90 days.
Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (ss. 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.
|_|
State the aggregate market value of the voting and non-voting common
equity held by non-affiliates of the registrant. The aggregate market value
shall be computed by reference to the price at which the common equity was sold,
or the average bid and asked price of such common equity, as of a specified date
within the past 60 days prior to the date of filing: $100,964,630 as of March
24, 1999. The aggregate market value was based upon the closing price for the
Common Stock, par value $.01 per share, of the registrant as quoted by the
NASDAQ for such date.
(APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PAST FIVE YEARS)
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes |_| No |_|
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(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Indicate the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: As of March 31, 1999,
13,565,662 shares of Common Stock, par value $.01 per share.
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents if incorporated by reference and
the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document
is incorporated: (1) Any annual report to security holders; (2) Any proxy or
information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or
(c) of the Securities Act of 1933. The listed documents should be clearly
descried for identification purposes (e.g., annual report to security holder for
fiscal year ended December 24, 1980). NONE.
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PART I
Item 1. BUSINESS
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- based business solutions.
The Company was organized in 1993 as a Washington corporation whose
operations are the successor to Pathways International, Ltd., which was
incorporated in the state of 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. A sales and marketing office is located at Grosvenor Center,
2500 Makai Tower, 733 Bishop Street, Honolulu, Hawaii 96813.
The Company's shares are currently traded on the NASDAQ SmallCap
market under the symbol "PTHW".
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 smart cards, including the Company's smart 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
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transportation, car parking, arcade games and vending machines. Any coin
operated machine can be converted to a smart card format. Other possible
applications include ATMs, 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 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.
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 principal subsidiaries and their
respective businesses:
o SPRINTICKET, Inc. ("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, Ltd. 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.
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o The Pathways Group Inc., a Hawaii corporation, was organized
to market the Company's products in Hawaii and Asia.
o 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.
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 driver's 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 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
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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 card varies from less than $1 to approximately $10 depending on the
amount of information the smart card 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
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 SmartScrip (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 paper scrip
fundraising 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. The Company has
not yet recognized any revenues from the Scrip Advantage contract.
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. See "Certain
Relationships and Related Transactions".
INTERNET COMMERCE MARKET. In December 1998, the Company signed a
letter of intent with LinkOpp Marketing, Inc, a start-up internet company. The
letter of intent anticipates a contract between The Pathways Group and LinkOpp
to provide a set of "turn-key" smart card solutions for LinkOpp's national
membership, currently transacting business on the Internet. These solutions
include the adaptation of the Company's existing smart card technology and
processing and related backroom support services. Under the terms outlined in
the letter of intent, LinkOpp anticipates purchasing up to 1.5 million smart
cards from the Company, which will be issued to the LinkOpp membership as a part
of the initial rollout of LinkOpp projects. The Company and LinkOpp are
presently negotiating a contract based
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upon the signed letter of intent, but there can be no assurance that such
contract will be completed, or if completed, will be profitable.
Hawaii Student Card. The Company is in progress with a pilot program
in the State of Hawaii for the implementation of an electronic school lunch
program, with later expansion to include student identification, bus
transportation and student prepaid activities. 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 also signed a letter of intent with Coca-Cola Bottling
of Hawaii, which provides for Coca-Cola's and Pathways' participation in
offering incentive-based product purchase options to the school lunch program.
The Coca-Cola program anticipates the award of loyalty points for cafeteria
visits and the purchase of Coke products which will be redeemed at local
participating merchants. The agreement anticipates co-marketing of the program
to schools in Hawaii by the Company and Coca-Cola to include student
identification, bus transportation and prepaid student activities.
Consolidated Theatres. In February 1999, the Company entered into a
letter of intent with Consolidated Amusement Company, Inc., in Honolulu, Hawaii.
The letter of intent anticipates a contract between the Company and Consolidated
Amusement Company, Inc. to provide an integrated loyalty- based smart card
system which emphasized concession and box office purchases and also includes
unattended electronic ticketing to a new "Eighteen-Plex" Consolidated Amusement
Company theater located at the Pearlridge Shopping Center in Honolulu. The
Company and Consolidated Amusement are currently negotiating a contract based on
the signed letter of intent, but there can be no assurance that such contract
will be completed, or if completed, will be profitable.
Tikitbox II. SPRINTICKET, a subsidiary of the Company, manufactures
and markets automated ticketing dispensers under the name Tikitbox(R) 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. Customers for this equipment includes companies 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.
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
medical 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.
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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
Company's smart card system is its seamless integration from card fulfillment,
through claims adjudication, through customized transactional reporting, without
dependency on third party commercial software products. Other advantages of the
Company's products include:
o SMART CARD ISSUANCE (FULLFILLMENT) 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 ability
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.
o 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 reside on the same card with a merchant loyalty
program.
o MIXED TRANSACTION (CREDIT/DEBIT/ATM CARD/SMART CARD)
PROCESSING AT THE POINT OF SALE WITH ON-LINE AUTHORIZATION
WHERE APPLICABLE. The Pathways product can be configured for
the diverse communications and security protocols associated
with debit, ATM and credit, as well as smart, card
transactions. A debit card transaction or an ATM card
transaction requires the introduction of a personal
identification number ("PIN") for security purposes and
require an 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.
o PRODUCT SERVICES 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 for
authorization and settlement. System sponsors may also avail
themselves of the full suite of backroom services offered by
Pathways.
o 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.
o AUTOMATED CLAIM ADJUDICATION AND SETTLEMENT THROUGH ACH. The
Pathways system has the ability to submit a claim
automatically 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.
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o MANAGEMENT REPORTING (VIA AUTOMATED BANK ROOM). The Company
provides claims adjudication by means of a Structured 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.
o 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.
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 focuses its
marketing strategy 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 include 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 which
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 currently 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:
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o 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.
o RETAILING. All types of retailing can be embraced and enhanced
with smart card technology. The Company believes that
providing a cardholder a large number of retail or point of
sale venues in which to use a smart card will significantly
increase the adoption of smart card technology. The retail
sector encompasses everything from "Mom and Pop" stores to
national department stores. Retailers are acutely aware of the
value of their contact with the consumer. The key to repeat
business is to accurately identify and 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.
o 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 multi functional
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.
o 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.
o 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.
8
<PAGE>
o 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.
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
Because smart cards are potential substitutes for the use of cash in
the economy, the market for smart card applications is enormous. As smart cards
constitute 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 one of a limited
number of companies offering full service integration, software development and
transaction processing of record to date in the United States. The Company
believes its range of services and products are broader and more encompassing
than any existing competitor.
RESEARCH AND DEVELOPMENT
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. The Company
has expended substantial resources in the development of its products. The
Company has capitalized software development costs in the aggregate amount of
$3,784,580 from inception through December 31, 1998, and $272,564 and $439,707
and $236,946 for the years ended December 31, 1998, 1997 and 1996, respectively.
In addition, the Company expensed $474,120 and $102,000 as research and
development costs for the years ended December 31, 1998 and 1997, respectively.
9
<PAGE>
GOVERNMENT REGULATION
The Company can provide no assurance that a Federal, state or
foreign agency will not attempt to regulate its activities.
Regulation E of the Federal Reserve Board 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, pre-transaction 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 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 December 31, 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 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 patent protection of
toolkits for smart card programming applications as well as certain commercial
applications 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.
EMPLOYEES
As of December 31, 1998, the Company had a total of 58 full-time
employees. Key employees are employed under employment contracts, which includes
a binding non-compete and non-
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<PAGE>
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 Development has an
employment contract 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.
Item 2. PROPERTIES
The Company leases its principal facilities totaling approximately
8,000 square feet in Woodinville, Washington. The lease expires in the year
2000. The Company expects that it will be able to renew such lease, or find
replacement space, if necessary, on terms reasonably acceptable to it. 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.
Item 3. LEGAL PROCEEDINGS
Not applicable.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
11
<PAGE>
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company offered its common stock to the public in July 1997
pursuant to Regulation A of the Securities Act of 1993 ("Securities Act"). The
Company offered 833,333 shares of Common Stock, par value $.01 per share
("Common Stock"), for a purchase price of $6.00 per share. The offering
commenced on July 15, 1997, and terminated on July 21, 1997. All shares offered
were sold, providing $5,000,000 in gross proceeds to the Company.
The Company offered shares of its Common Stock in a private offering
in July and August 1998 pursuant to Rule 506 of Regulation D under the
Securities Act. The Company sold 654,508 shares at $13.75 per share to
accredited investors, resulting in gross proceeds to the Company of $8,999,485.
The Company engaged Allen & Company Incorporated and Mitchum Jones & Templeton
to act as placement agents for the offering, each of which received a placement
fee of 5% of the purchase price per share for shares placed by them.
The Company's Common Stock has traded in the NASDAQ SmallCap Market
under the symbol PTHW since October 1998. Previously, the Company's Common Stock
was traded on the electronic bulletin board of the National Association of
Securities Dealers.
The approximate high and low closing prices for each fiscal quarter
in the fiscal year ended December 31, 1997 (commencing in July 1997 when the
Company first became a public company), and in 1998 to the date of this annual
report were as follows:
Common Stock Prices
Fiscal Quarter High Low
------------------------------------------
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
4th Qtr 98.......... $ 19.125 $ 13.00
During the first quarter of fiscal 1999 (through March 26, 1999),
the Company's Common Stock had a high price of $19.00 and a low of $13.00. These
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not represent actual transactions.
As of March 26, 1999, there were approximately 73 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 350. 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.
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<PAGE>
Item 6. SELECTED FINANCIAL DATA
The following table contains selected financial information derived
from the audited consolidated financial statements set forth elsewhere in this
Form 10-K, and in the Company's filings on Form 10-SB, as amended, and Form
SB-2, as filed with the Securities and Exchange Commission, and should be read
in conjunction with such audited consolidated 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, 1998, 1997, 1996, 1995 and 1994, respectively.
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Income Statement Data:
Operating revenues .................. $ 76,565 $ 61,785 $ 108,418 $ 512,250 $ 664,801
Gross profit ........................ 41,702 42,293 43,224 443,169 459,697
(Loss) from operations .............. (7,336,717) (3,535,487) (2,265,572) (2,318,948) (1,391,456)
Other Income (Expense) .............. 84,256 (51,034) (567,305) (332,599) (521,585)
Net (Loss) before taxes ............. (7,252,461) (3,586,521) (2,832,877) (2,651,547) (1,913,041)
----------- ----------- ----------- ----------- -----------
Net (Loss) .......................... (7,252,461) $(3,586,521) $(2,832,877) $(2,651,547) (1,913,041)
=========== =========== =========== =========== ===========
(Loss) per share basic and
diluted ............................. $ (0.55) $ (0.30) $ (0.57) $ (1.49) $ --
=========== =========== =========== =========== ===========
Balance Sheet Data:
Current assets ...................... $5,261,583 $4,130,369 $2,874,727 $92,827 $821,248
Total assets ........................ 7,978,688 6,716,840 5,072,139 2,630,217 2,059,362
Long-term obligations
under capital lease ............... 0 0 0 0 0
Total liabilities ................... 1,613,020 1,491,674 2,110,544 5,332,238 3,829,936
Working capital ..................... 3,819,466 3,148,595 1,496,074 (2,647,394) (388,930)
Stockholders' equity
(deficit) ........................... 6,365,668 5,225,166 2,961,595 (2,702,021) (1,770,574)
</TABLE>
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
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 the Company's Registration Statements on Form 10-SB, as
amended, and Form SB-2 each as previously filed with the Securities
and Exchange Commission. These risks and uncertainties include the rate of
market development and acceptance of smart card technology, the unpredictability
of the Company's sales cycle,
13
<PAGE>
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".
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.
RESULTS OF OPERATIONS
REVENUES. The Company has generated limited revenues from operations
to date as it has continued to develop and market its smart card systems. The
Company believes it will continue to report minimal revenues until additional
significant contracts are signed or until the existing contracts, discussed
below, proceed through the pilot stage to a full rollout. The Company's revenues
have consisted of credit card transaction processing fees from installation of
its unattended ticketing kiosks in amusement and ski areas and the sales of
unattended ticketing kiosks and the sale of smart cards and terminals from its
initial smart card system developed and installed in 1996.
Details of the Company's revenues for the last three fiscal years
are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------------ ------------------- -------------------
$ % $ % $ %
<S> <C> <C> <C> <C> <C> <C>
Transaction processing fees, net 27,459 35.86% 39,009 63.14% 45,197 41.69%
Sale of kiosks, smart and affinity cards
and smart card terminals 49,104 64.14% 22,774 36.86% 63,221 58.31%
------- ----- ------- ----- -------- -----
Total 76,565 100.0% 61,785 100.0% 108,418 100.0%
======= ===== ======= ===== ======== =====
</TABLE>
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 for use by 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. The Company anticipates that revenue generation from contracts will be
dominated initially by the sales of smart card terminals, 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.
In 1996, the Company began focusing its product development and
marketing efforts towards its smart card systems. In 1997 and 1998, the Company
developed an upgraded version of its unattended kiosk to, among other things,
accommodate acceptance and vending of smart cards and also engineered and
developed an indoor kiosk that the Company plans to be utilized as a smart card
recharge device. As a result of these efforts, the Company's base of existing
installed outdoor kiosks declined throughout 1997 and 1998, resulting in lower
transaction fees.
The Company has now completed its new kiosk model and expects to
market this product aggressively in 1999. The Company has also changed its
marketing strategy for its unattended kiosks.
14
<PAGE>
Previously, the Company leased the kiosk to a customer and collected gross
transaction charges of approximately 5% throughout the lease term. The Company's
new marketing strategy is to sell the kiosk to a customer for cash and to
collect ongoing gross transaction fees of approximately 1.75% to 2%. The Company
believes this model is more profitable and eliminates negative cash flow
required to install and sell the kiosk products. In the fourth quarter of 1998,
the Company installed at Winter Park Ski Resort in Colorado its Tikitbox II
unattended ticketing system and upgraded its existing systems at Six Flags Great
Adventure and Magic Mountain Amusement Parks. These contracts are accompanied by
transaction processing arrangements at fees generally ranging from 2% to 5%.
Because these installations occurred in the fourth quarter, 1998 revenues from
these operations were minimal. In addition, the Company has a number of units
installed on a pilot basis and is involved in negotiations with those customers
for the purchase of multiple units. Although there can be no assurance of the
successful outcome of these negotiations, the Company expects to increase its
kiosk sales in 1999 compared to previous years.
With the exception of the installation of its initial smart card
system and resulting sales of cards and terminals in 1996, the Company has not
realized meaningful revenues from its smart card system products. The Company's
marketing efforts have resulted in a number of letters of intent and pilot
agreements, including the installation of a pilot program in Honolulu, Hawaii.
Although these efforts have not resulted in significant revenues to date, the
Company believes that its agreements and activities demonstrate the substantial
market for smart card systems in the United States. See "Description of Business
- -- Current Products and Pilot Programs".
GROSS MARGIN. The Company's gross margin as a percentage of revenues
was 39.87%, 68.45%, and 54.46% for the years ended 1996, 1997, and 1998
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 terminal and smart card sales. 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. Gross margins in 1998 declined as
compared to 1997 due to a higher percentage of lower margin kiosk sales that
occurred in 1998.
The Company expects future gross margin percentages will be largely
influenced by potential competition as well as the sales mix 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 on the sales of smart card readers and smart
cards, which sales generally carry lower profit margins. Once the initial
rollout of a program is completed, gross margins are expected to increase due to
increases in use of the smart cards by cardholders and the resulting transaction
processing fees.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by $3,245,006, or 121%, in 1998 as compared to
1997, and by $1,023,212, or 62%, in 1997 as compared to 1996. These increases
are primarily the result of expanded payroll and employee support costs
associated with an increased number of full-time employees in 1998 and 1997 and
additional bonus compensation to senior executives in 1998. In 1998, the Company
had staff levels beginning at 35 and increasing to 58 for the year 1998 as
compared to 15 increasing to 35 for 1997. In addition, the Company has incurred
increases in sales and marketing related expenditures commensurate with the
increase in marketing personnel and 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 in 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 1997 and the Company occupied this new facility in September 1997.
Additionally, the Company, through its wholly-owned subsidiary, opened a sales
and marketing office in Honolulu,
15
<PAGE>
Hawaii, during the third quarter 1997 and expanded the office in September 1998.
Consequently the selling, general, and administrative expenses for 1998 reflect
the costs of operating the Company's three offices whereas the corresponding
periods in 1997 reflect the operating expense 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. In October 1998, the
Company also leased and occupied a 6,390 square foot research and development
facility primarily for the continued advancement of the many product components
integral to the Pathways smart card systems. This space is also utilized in the
assembly and testing of Tikitbox II unattended ticketing and other Pathways
smart card systems.
Set forth below is a detail of the increase in selling, general, and
administrative expenses in major categories for the 1998 fiscal year as compared
to the 1997 fiscal year, and the 1997 fiscal year as compared to the 1996 fiscal
year.
<TABLE>
<CAPTION>
Increase/(decrease) in
Increase in the year the year ended
ended December 31, 1998 December 31, 1997 vs.
vs. the year ended the year ended
SG&A Increase attributable to: December 31, 1997 December 31, 1996
<S> <C> <C>
Payroll and payroll related expenses $2,282,204 $626,585
Rent, office, and facility (including 358,001 165,150
equipment) expenses
Marketing, selling, and travel related 359,697 213,109
expenses
Professional and public company related 180,248 (272,279)
expenses
Other SG&A related expenses 64,856 290,647
------------- -------------
Total Increase in SG&A $3,245,006 $1,023,212
</TABLE>
AMORTIZATION OF SOFTWARE COSTS. Amortization of software costs
increased $28,183 in 1998 compared to 1997, and increased $56,227 in 1997 as
compared to 1996 due to increases in costs capitalized.
In accordance with generally accepted accounting principles for the
accounting 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 is
not impaired, and is stated at net realizable value.
DEPRECIATION. Depreciation increased by $155,330 for 1998 as
compared to 1997, and by $87,545 for the year ended 1997 as compared to 1996,
primarily due to an increase in capital expenditures. Capital expenditures
increased during 1998 as compared to 1997 because of the Company's acquisition
of additional 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 research and development facility,
and the opening and expansion of the Company's Hawaii office.
INTEREST EXPENSE (NET). The Company had net interest income of
$84,256 in 1998 compared to interest expense of $51,034 and $567,305 in 1997 and
1996, respectively. The decline in interest expense in 1997 as compared to 1996
and the net interest income realized in 1998 reflects the
16
<PAGE>
reduction of total long term debt from $3,346,629 at the beginning of 1996 to
$507,850 at December 31, 1998 and higher net cash equivalent balances throughout
1998 as compared to 1997.
RESEARCH AND DEVELOPMENT. Research and development increased
$372,120 in 1998 as compared to 1997, and $102,000 in 1997 as compared to 1996.
The increase in 1998 over 1997 reflects the increase in programming staff and
their related research and development efforts, and expenditure of $49,145 on
equipment and software used for testing. The increase in 1997 over 1996 reflects
the increase in programming staff and their related research and development
efforts. In 1996 the Company capitalized the majority of its product development
costs resulting in immaterial research and development expenditures.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital was $3,819,466 and $3,148,595 at December
31, 1998 and December 31, 1997, respectively. The higher working capital at
December 31, 1998 as compared to December 31, 1997 was primarily the result of
the receipt of proceeds from the Company's private offering completed in August
1998, offset in part by a larger net loss incurred in 1998 as compared with
1997. In July and August, 1998, the Company sold 654,508 shares at $13.75 per
share to accredited investors pursuant to Rule 506 of Regulation D under the
Securities Act. The Company engaged Allen & Company Incorporated and Mitchum,
Jones & Templeton to act as placement agents for the offering, each of which
received a placement fee of 5% of the purchase price per share for shares placed
by them. These shares were subsequently registered for resale via the Company's
Form SB-2 filed with the Securities and Exchange Commission on September 24,
1998. The registration statement became effective on October 9, 1998. In March
1999, the Company received a firm commitment for additional funding of
$3,000,000. The Company believes that its existing cash reserves, planned
expenditure reductions (if necessary), revenues and proceeds from the equity
funding (if required) will be adequate to fund the Company's operations through
1999.
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.
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. At December 31, 1998, the Company had fully drawn on the lease
line of credit.
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. The
Company incurred capital expenditures of $379,837 and $304,621 in 1998 and 1997,
respectively, for the Santa Rosa facility, and $57,538 and $17,736 in 1998 and
1997, respectively, for the Hawaii facility. In August 1998, the Company leased
additional office space for a research and development facility in Santa Rosa,
as well as moved to a larger leased facility in Hawaii. The Company expects to
continue to make investments in expanding its research, transaction processing
and backroom capabilities to satisfy current and anticipated market demand.
The Company has historically relied upon proceeds from the sale or
issuance of its common shares 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 or achieve
profitability. There can be no assurance that the Company will, in the
foreseeable future, achieve sales of the magnitude necessary 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 products, its current cash resources, including proceeds
from the pending private placement, reduction in expenditures (if necessary) 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
the Company is unable to
17
<PAGE>
generate significant revenues from the rollout of its products or additional
contracts 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. Furthermore, there can
be no assurance that, if needed, additional financing will be available on
acceptable terms to the Company, if at all.
YEAR 2000
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 from the year 1999 to 2000. The Company is aware of the potential Year
2000 problem, and has undertaken a Year 2000 project to address the Company's
readiness and exposure to Year 2000 issues. The Year 2000 project addresses the
Company's products; internally used operating systems, software, and other
technology; and third party vendors and suppliers. Each of these areas is
discussed below.
The Company believes that it has substantially identified and
resolved all potential Year 2000 problems with any of the products that it
develops and markets. In order to confirm its belief, the Company has
implemented an ongoing program to test its products for Year 2000 issues. The
Company believes that if any Year 2000 issues are identified, the Company will
be able to correct the problem with a minimal cost or time investment. However,
management also believes that it is not possible to determine with complete
certainty that all Year 2000 problems affecting the Company's products have been
identified or corrected due to the fact that these products interact with other
third party vendor systems not under the Company's control (see below). In
addition, the Company's evaluation is based on a limited number of actual
customer installations.
The Company has conducted a process to identify all internally used
operating systems, software, and other technology that may be impacted by the
Year 2000 problem. This process is now substantially complete. For the
internally used operating systems, software, and technology the Company has
identified as material, the Company is assessing the Year 2000 exposure through
testing and vendor inquiry. Material operating systems, software, and other
technology deemed to be adversely affected by the Year 2000 problem will be
upgraded or replaced. The Company currently estimates the range of costs to
upgrade or replace systems it believes may be impacted by Y2K issues to be from
$50,000 to $150,000. In addition to operating systems, software, and other
technology, the operation of office and facilities equipment, such as fax
machines, photocopiers, telephone systems, security systems, elevators, and
other common devices may be affected by the Year 2000 problem.
The Company has identified major suppliers and other third party
vendors integral to the operations of the Company's business. The Company will
initiate communications with those suppliers and third party vendors to assess
their readiness to deal with Year 2000 problems. As part of the Year 2000
project, the Company will identify alternative providers of products and
services deemed material to the Company's operations. However, the Company has
no control over and cannot predict the corrective actions of these third party
vendors and suppliers. The Company intends to arrange, to the extent available,
alternate supplier arrangements in the event a third party vender is materially
impacted by Y2K issues. While the Company expects that it will be able to
resolve any significant Year 2000 problems related to third party products and
services, there can be no assurance that it will be successful in resolving any
such problems. Any failure of these third party vendors and suppliers to resolve
Year 2000 problems with their systems in a timely manner could have a material
adverse effect on the Company's business, financial condition, and results of
operations.
The discussions of the Company's efforts relating to Year 2000
compliance are forward-looking statements. The Company's ability to achieve Year
2000 compliance and the associated level of incremental costs could be adversely
impacted by, among other things, the availability and cost of programming and
testing resources, vendors' ability to modify proprietary software, and other
unanticipated problems. The failure to correct a material Year 2000 problem
could result in an interruption
18
<PAGE>
of certain normal business activities or operations. Such failures could
materially affect the Company's results of operations, liquidity and financial
condition. Due to the general uncertainty inherent in the Year 2000 problem, the
Company is unable at this time to determine those consequences. The Company
believes that, with the completion of the Year 2000 project as scheduled, the
possibility of significant interruptions of normal operations should be reduced
or eliminated.
CAUTIONARY STATEMENT FOR PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995.
Certain statements contained in this Annual Report contain
"forward-looking statements" within the meaning of the private Securities
Litigation Reform Act of 1995. These are statements that do not relate strictly
to historical or current facts. Such forward-looking statements involve known
and unknown 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
the Company's Registration Statements on Form 10SB, as amended and on Form SB-2,
which Registration Statements have been previously filed with the Securities and
Exchange Commission. These risks and uncertainties include, without limitation:
o the rate of market development and acceptance of smart card
technology;
o the unpredictability of the Company's sales cycle;
o the limited revenues and significant operating losses generated to
date;
o the possibility of significant ongoing capital requirements
o the loss of any significant customer;
o the ability of the Company to compete successfully with the other
providers of smart cards and smart card services. See "Description
of Business -- Competition" above;
o the ability of the Company to secure additional financing as and
when necessary;
o the ability of the Company to retain the services of its key
management, and to attract new members of the management team;
o the ability of the Company to effect and retain appropriate patent,
copyright and trademark protection of its products;
o the ability of the Company to achieve adequate levels of revenue to
recover its investment in capitalized software development costs.
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".
The Company undertakes no obligation to release publicly any
revisions to the forward-looking statements or to reflect events or
circumstances after the date of this Report.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable
19
<PAGE>
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial information required by this item appears in the pages
marked F-1 through F-20 at the end of this Report and are incorporated herein
by reference as if fully set forth herein.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Accountant's Report F-2
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statements of Stockholders' Equity (Deficit) F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-7
20
<PAGE>
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The directors and executive officers of the Company are as follows:
Name Age Position
- ---- --- --------
Carey F. Daly, II 55 Chairman of the Board of Directors;
President; Chief Executive Officer; Director
Mark T. Schuur 38 Senior Vice President and Chief Financial
Officer; Director
Joseph Schuler 57 Senior Vice President, Marketing and Sales
Robert W. Haller 44 Executive Vice President
Glenn Okun 37 Director
Monte P. Strohl 47 Director
Linda Wing 54 Director
Each director shall hold office until the next annual meeting of the
Company's stockholders, which is anticipated to occur in the spring or summer of
1999. The Company's By-laws provide for the creation of classes of directors
comprising the Board of Directors. The Company anticipates that it will
implement the classified Board structure at the next annual meeting. Under such
structure, each class will serve separately expiring terms of office such that
all of the directors will not be up for election at any one time.
Carey F. Daly, II is the President and Chief Executive Officer of
the Company, the Chairman of the Board of Directors and a Director of the
Company. Mr. Daly founded The Pathways Group, Inc. in October 1993. Mr. Daly is
also President of Pathways International, Ltd. and SPRINTICKET, Inc. 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 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.,
21
<PAGE>
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.
Joseph Schuler has been Senior Vice President, Marketing and Sales,
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.
Robert W. Haller is the Executive Vice President. Mr. Haller joined
SPRINTICKET, Inc. as the Sales Manager in November 1991. Previously, he was
Sales Manager of QT, Inc. Mr. Haller served as Senior Vice President, Marketing
and Sales of the company since 1996, and became Executive Vice President in
December 1997. Mr. Haller has played a significant role in the development of
the Company's marketing plans and products. Mr. Haller received a BS in human
biology from the University of Washington in 1977.
Glenn A. Okun has been a Director of the Company since the fourth
quarter of 1996. In April 1998, Mr. Okun became 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 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 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 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.
Item 11. EXECUTIVE COMPENSATION
The following table shows compensation for services rendered to the
Company during the fiscal years ended December 31, 1998, 1997 and 1996,
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 $100,000 during the fiscal years ended
December 31, 1998, 1997 and 1996.
22
<PAGE>
Therefore, pursuant to Item 402 of Regulation S-K, only compensation for the
Chief Executive Officer, the Senior Vice President and Chief Financial Officer,
the Executive Vice President and the Senior Vice President, Sales and Marketing
is shown.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Annual Compensation Long-Term Compensation
------------------------------------------------------------------------------------
Award Payouts
--------------------------------------------
Securities All Other
Other Annual Restricted Underlying LTIP Compen-
Name and Principal Bonus Compensation Stock Options/SARs Payouts sation
Position Year Salary ($) ($)(c) ($) Award(s) ($) (#) ($) ($)
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Carey F. Daly, II, 1998 $200,000 $363,526 $ 0 $0 0/0 0 0
President, Chief 1997 200,000 220,000 8,333(a) 0 0/0 0 0
Executive Officer and 1996 200,000 0 12,500(a) 0 200,000/0 0 0
Chairman of the Board
- ----------------------------------------------------------------------------------------------------------------------------------
Mark T. Schuur, Senior 1998 $124,005 $97,663 $0 $0 15,000/0(e) 0 0
Vice President and Chief 1997 112,916 0 0 0 15,000/0 0 0
Financial Officer 1996 35,333(b) 0 0 0 20,000/0 0 0
- ----------------------------------------------------------------------------------------------------------------------------------
Robert W. Haller, 1998 $ 89,943 $ 79,945 $0 $0 15,000/0(e) 0 0
Executive Vice President 1997 69,376 23,717 0 0 15,000/0 0 0
1996 45,099 52,383 0 0 0/0 0 0
- ----------------------------------------------------------------------------------------------------------------------------------
Joseph F. Schuler, 1998 $107,000 $46,450 $0 $0 0/0 0 0
Senior Vice President, 1997 10,000(d) 0 0 0 100,000/0 0 0
Sales and Marketing 1996 -- -- -- -- -- 0 0
- ----------------------------------------------------------------------------------------------------------------------------------
</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
Compensation Committee of the Board, which is currently comprised of
Mr. Okun, an independent director of the Board.
(d) Mr. Schuler's employment with the Company commenced in December
1997.
(e) The Company repriced Mr. Schuur's and Mr. Haller's stock options on
December 4, 1998.
STOCK INCENTIVE PLAN
The Board of Directors of the Company adopted an Amended and
Restated Stock Incentive Plan (the "Incentive Plan") on December 16, 1997 in
order to attract and retain qualified personnel. Under the Incentive 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 Incentive 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 Incentive 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 Incentive 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
23
<PAGE>
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 Form 10-K,
447,666 options are outstanding.
DIRECTORS STOCK OPTION PLAN
The Board of Directors of the Company adopted a Directors Stock
Option Plan (the "Directors Plan") on December 14, 1998 in order to attract and
retain directors. Under the Directors Plan, options to purchase up to 100,000
shares of Common Stock may be granted to eligible non-employee directors of the
Company.
The following persons ("Eligible Directors") are eligible to receive
grants of stock options pursuant to the Directors Plan: directors of the Company
who are not officers or employees of the Company or any subsidiary thereof (a
"Non-employee Director") and who (i) have not been designated by the Company's
Board of Directors within 30 days after becoming a director of the Company as
being eligible to receive awards under a the Amended and Restated Stock
Incentive Plan or (ii) having been eligible to participate in the Amended and
Restated Stock Incentive Plan, have ceased to be so eligible as a result of a
determination by the Board of Directors. The eligibility of any such director to
participate in the Directors Plan shall cease if such director is subsequently
designated as being eligible to receive awards under the Amended and Restated
Stock Incentive Plan for as long as he or she remains so eligible.
Shares related to options (or portions thereof) that are forfeited,
canceled or terminated, expire unexercised, are surrendered in exchange for
other options or are otherwise settled in such manner that all or some of the
shares covered by an option are not and will not be issued will be restored to
the total number of shares available for issuance pursuant to options granted
under the Directors Plan. In the event of any change in the number of shares of
outstanding Common Stock of the Company by reason of a stock split, stock
dividend, combination or reclassification of shares, recapitalization, merger,
consolidation or similar event, proportional adjustments will be made in the
number of shares of the Company's Common Stock (a) reserved for issuance
pursuant to the Directors Plan, (b) for which stock options shall be granted,
and (c) covered by outstanding stock options, as well as in the exercise price
of such outstanding options. In addition, equitable adjustments will be made in
the event of any other change affecting the Company's Common Stock or any
distribution (other than normal cash dividends) to stockholders of the Company.
Under the Directors Plan, non-qualified stock options to purchase
shares of the Company's Common Stock are granted automatically to Eligible
Directors at the times specified in the Directors Plan. In general, unless an
Eligible Director has received a previous grant of a stock option (under the
Directors Plan, the Amended and Restated Stock Incentive Plan or otherwise), he
or she will receive an initial option to purchase 10,000 shares of the Company's
Common Stock on the date on which he or she first becomes eligible to
participate in the Directors Plan. Thereafter, as long as the Eligible Director
(including any Eligible Director who received a previous grant) remains eligible
to participate in the Directors Plan, he or she will receive annually, on the
date of the Annual Meeting of Stockholders, an option to purchase 5,000 shares
of the Company's Common Stock, beginning on the date specified in the Directors
Plan. Notwithstanding the foregoing, no stock option shall be granted to any
person whose service as a director of the Company ends on the date on which the
option would otherwise be granted.
24
<PAGE>
The Directors Plan is administered by the Company's Board of
Directors or a committee composed of not less than two members thereof as may be
designated from time to time by all such members. The Board or such committee
administers the Directors Plan, but has no discretion regarding the grant,
amount, timing, terms and conditions of stock options granted under the
Directors Plan.
The exercise price of any stock option granted pursuant to the
Directors Plan is the fair market value of the Company's Common Stock on date of
grant. Each stock option is exercisable, cumulatively, as to one-third of the
shares after the first anniversary of the date of grant and as an additional
one-third after each of the second and third anniversaries of the date of grant.
Each option is exercisable for a period of ten years from the date of grant.
The price at which shares of the Company's Common Stock may be
purchased upon exercise of an option must be paid in full in cash at the time of
exercise or by (i) tendering shares of the Company's Common Stock or
surrendering another stock option, (ii) delivering a promissory note issued by
the participant to the Company or otherwise as determined by the Board or the
committee, or (iii) any other means acceptable to the Board or the committee.
In order to enable the Company to satisfy any tax payment
obligations resulting from any exercise of a stock option under the Directors
Plan, the Company has the right, among other things, to withhold from the shares
of the Company's Common Stock receivable by a participant an appropriate number
of shares for payment thereof. In addition, participants may elect to have the
Company deduct applicable taxes by withholding an appropriate number of shares
of the Company's Common Stock or to elect to tender to the Company other shares
of the Company's Common Stock held by the participant for the purpose of
satisfying tax payment obligations.
Except as described below, if a participant's association with the
Company terminates, any unexercised stock option (or portion thereof) shall, to
the extent it is exercisable pursuant to the terms of such option on the date of
such termination, remain exercisable for a period of three months following the
date of termination or until the stated expiration of the stock option, if
earlier. If a participant dies, or ceases to be associated with the Company
because he (i) is disabled, (ii) retires at age 62 or thereafter or (iii)
assumes a position with a governmental, charitable or educational agency or
institution, any stock option granted under the Directors Plan then held by such
participant shall become fully exercisable as of the date on which such
participant dies or ceases to be associated with the Company, and shall be
exercisable through the expiration date specified in the applicable option
agreement.
Stock options granted under the Directors Plan are subject to
acceleration of exercisability in the event of a change in control of the
Company, as set forth in agreements between the Company and certain of its
directors which provide for certain protections and benefits in the event of a
change of control (as defined in such agreements), or as provided in applicable
option agreements. In general, awards granted under the Directors Plan are not
assignable or transferable by a participant, except under the limited
circumstances contemplated by the Directors Plan.
The Board or the committee may amend, suspend or terminate the
Directors Plan for the purpose of meeting or addressing any changes in any
applicable tax, securities or other law. In addition, the Directors Plan may
not, without the approval of the stockholders, as set forth therein, be amended
to (i) increase materially the aggregate number of shares of the Company's
Common Stock that may be issued under the Directors Plan (except for adjustments
pursuant to Section 8 of the Directors Plan), (ii) materially increase the
benefits accruing to participants, or (iii) modify materially the eligibility
requirements of the Directors Plan. Nor may the Directors Plan be changed in
such a way as to alter, impair, amend, modify, suspend or terminate any rights
of a participant or any obligations of the Company under any stock options
theretofore granted in any manner adverse to such participant, without the
consent of such participant. The Directors Plan terminates ten years after the
date of approval by the stockholders of the Company, subject to earlier
termination by the Board as set forth above, by the affirmative vote of a
majority of the votes cast at a stockholders' meeting at which the approval of
the Directors Plan is con sidered, provided that the total vote cast represents
over 50% of all shares entitled to vote on the
25
<PAGE>
proposal. The Directors Plan is scheduled to be voted upon by the stockholders
at the Annual Meeting of Stockholders in 1999.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
Individual Grants
-------------------------------------------------------
Percent of
Total Potential Realizable Value at
Options/ Options/ Assumed Annual Rates of Stock
SARS SARS Price Appreciation for
Granted in Granted to Exercise Option Term
Fiscal Employees in or Base Expiration -----------
Name Year(#) Fiscal Year Price ($/sh) Date 5%($) 10%($)
---- ------- ----------- ------------ ------ ----- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Carey F. Daly, II 0 -- -- -- -- --
Mark T. Schuur 15,000(a) 17.6% $14.375 12/22/07 $135,605 $343,651
Robert W. Haller 15,000(a) 17.6% $14.375 12/22/07 $135,605 $343,651
Joseph F. Schuler 0 -- -- -- -- --
</TABLE>
(a) The Board of Directors approved the repricing of Mr. Schuur's and
Mr. Haller's options on December 4, 1998. The options to both Mr.
Schuur and Mr. Haller became exercisable on December 23, 1998.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
AND FY-END OPTION/SAR VALUES
<TABLE>
<CAPTION>
Number of
Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options/SARs(a) Options/SARs(a)
at Fiscal Year- at Fiscal Year-
End (#) End ($)
Shares Acquired Value Exercisable/ Exercisable/
Name on Exercise(#) Realized ($) Unexercisable Unexercisable
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Carey F. Daly, II N/A N/A 133,334/66,666 $1,875,076/
$937,524
- ---------------------------------------------------------------------------------------------------------------------------
Mark T. Schuur 6,667 $86,204 15,000/6,666 $40,320/
$106,609
- ---------------------------------------------------------------------------------------------------------------------------
Robert W. Haller N/A N/A 15,000/0 $40,320/0
- ---------------------------------------------------------------------------------------------------------------------------
Joseph F. Schuler N/A N/A 33,334/66,666 $68,768/
$137,532
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) To date, the Company has issued no SARs.
Item 12. 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 March 31, 1999, by (i)
each person who is known by the Company to own
26
<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 March 31, 1999, 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 Common Percent of Common
Beneficial Owners and Stock Beneficially Stock Beneficially
Directors and Officers 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 619,306(4) 4.6%
1221 North Dutton Ave
Santa Rosa, California 95401
- ------------------------------------------------------------------------------------------------------------
Mark T. Schuur 28,334(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(7) *
13720 68th Avenue West
Edmonds, Washington 98026
- ------------------------------------------------------------------------------------------------------------
Linda Wing None(8) N/A
6117 Wilryan Avenue
Minneapolis, Minnesota 55436
- ------------------------------------------------------------------------------------------------------------
Robert W. Haller 63,633(9) *
14201 NE 200th St
Woodinville, Washington 98072
- ------------------------------------------------------------------------------------------------------------
Joseph F. Schuler 33,334(10) *
14201 NE 200th St
Woodinville, Washington 98072
- ------------------------------------------------------------------------------------------------------------
Officers and Directors as a Group (7 persons) 1,322,910 9.8%
- ------------------------------------------------------------------------------------------------------------
</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.
27
<PAGE>
(4) Includes options to acquire 133,334 shares, which options are
currently exercisable. Excludes (a) 119,000 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.
(5) Excludes options to acquire 6,666 shares, which options are not
currently exercisable.
(6) Includes 75,000 shares owned by Mr. Okun jointly with his wife.
Excludes 149,955 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 149,955
shares. Also excludes options to acquire 10,000 shares, which
options are not currently exercisable, granted pursuant to the
Directors Stock Option Plan.
(7) Excludes options to acquire 10,000 shares, which options are not
currently exercisable, granted pursuant to the Directors Stock
Option Plan.
(8) Excludes options to acquire 10,000 shares, which options are not
currently exercisable, granted pursuant to the Directors Stock
Option Plan.
(9) Includes options to acquire 15,000 shares, which options are
currently exercisable.
(10) Includes options to acquire 33,334 options, which options are
currently exercisable. Excludes options to acquire 66,666 options,
which options are not currently exercisable.
Item 13. 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
former 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 also a Director and Vice President of
Allen & Company until April 1998.
In connection with the Company's private offering of Common Stock
pursuant to Rule 506 of Regulation D of the Securities Act, commenced in July
1998 and completed in August 1998, 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 of the Company by one of that 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.
28
<PAGE>
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.
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following Exhibits are filed as part of this Report:
<TABLE>
<S> <C>
3.1 Certificate of Incorporation of the Company(1)
3.2 Amended and Restated By-Laws of the Company(1)
4.1 Form of Subscription Agreement for the shares of Common Stock being registered
by the Registration Statement(2)
10.1 Joint Marketing and Servicing Agreement, dated as of February 19, 1998, between
First Hawaiiin Bank and The Pathways Group, Inc.(1)
10.2 Development Agreement, dated as of June 5, 1995, between Stephen A. Gregg
and The Pathways Group, Inc.(1)
10.3 Authorization and Loan Agreement (Guaranty Loans), dated February 13, 1992,
among Towne Bank of Woodinville, U.S. Small Business Administration and
Pathways International Ltd.(1)
10.4 Restructure and Extension Agreement, dated as of July 1, 1996, between SeaFirst
Bank and The Pathways Group, Inc. and Pathways International Ltd.(1)
10.5 Restructure and Extension Agreement, dated as of July 1, 1997, between SeaFirst
Bank and PT Link Corporation and The Pathways Group, Inc.(1)
10.6 Schlumberger Associate Program Agreement, dated June 16, 1997, between
Schlumberger Technologies, Inc. and The Pathways Group, Inc., together with
Addendum No. 1 thereto(3)
10.7 Corporate Officer Employment Agreement, dated as of November 1, 1996, between
The Pathways Group, Inc. and Carey F. Daly, II(3)
10.8 Corporate Officer Employment Agreement, dated as of November 1, 1996, between
The Pathways Group, Inc. and Mark Schuur(3)
10.9 Executive Employment Agreement, dated as of November 16, 1997, between The
Pathways Group, Inc. and Joseph Schuler(3)
10.10 Letter of Intent, dated December 12, 1997, from The Pathways Group, Inc. and The
Department of Education, State of Hawaii(3)
10.11 Equipment Lease Agreement, dated August 25, 1997, between Union Bank of
California, N.A., and The Pathways Group, Inc., together with Addendums A and B
dated September 16, 1997, Conditional Sales Lease dated September 8, 1997 and
Covenant Agreement, dated February 25, 1998(3)
10.12 Master Project Agreement, dated June 19, 1998, between Scrip Advantage, Inc.
and The Pathways Group, Inc., together with a Promissory Note, dated June 19,
1998, given by Scrip Advantage, Inc. to The Pathways Group, Inc.(3)
</TABLE>
29
<PAGE>
<TABLE>
<S> <C>
10.13 Covenant Agreement, dated August 13, 1998, between Union Bank of California
and The Pathways Group, Inc.(2)
10.14 Placement Agency Agreement, dated July 22, 1998 between The Pathways Group,
Inc. and Allen & Company Incorporated(2)
10.15 Amended and Restated Stock Incentive Plan(2)
10.16 Directors Stock Option Plan (filed herewith)
10.17 Letter of Intent, dated November 4, 1998, between The Pathways Group, Inc. and
LinkOpp Marketing, Inc. (filed herewith)
10.18 Letter of Intent, dated February 1, 1999, between The Pathways Group, Inc. and
Consolidated Amusement Company, Inc. (filed herewith)
21 Subsidiaries of Registrant(2)
27 Financial Data Schedule
</TABLE>
- --------------------------------
1 Incorporated herein by reference to the exhibit contained in the Company's
Registration Statement on Form 10SB under the Securities Exchange Act of
1934, as amended, filed with the Securities and Exchange Commission on
April 29, 1998.
2 Incorporated by reference to the exhibit contained in the Company's
Registration Statement on Form SB-2 under the Securities Act of 1933, as
amended, filed with the Securities and Exchange Commission on September
24, 1998.
3 Incorporated herein by reference to the exhibit contained in the Company's
Registration Statement on Form 10SB/A-1 under the Securities Exchange Act
of 1934, as amended, filed with the Securities and Exchange Commission on
August 7, 1998.
(b) Reports on Form 8-K
None.
30
<PAGE>
The Pathways Group,
Inc. and Subsidiaries
Consolidated Financial Statements
With Report of Independent
Accountants for the Years Ended
December 31, 1998, 1997 and 1996
F-1
<PAGE>
Report of Independent Accountants
To Board of Directors
The Pathways Group, Inc. and Subsidiaries
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of stockholders' equity (deficit) and of
cash flows present fairly, in all material respects, the financial position of
The Pathways Group, Inc. and Subsidiaries at December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ PRICEWATERHOUSECOOPERS LLP
PRICEWATERHOUSECOOPERS LLP
Seattle, Washington
February 23, 1999, except as to the information presented in Note
14, for which the date is March 26, 1999
F-2
<PAGE>
The Pathways Group, Inc. and Subsidiaries
Consolidated Balance Sheets
December 31, 1998 and 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents
Cash and cash equivalents $ 4,628,544 $ 3,759,720
Accounts receivable 102,793 66,493
Inventories 361,467 202,749
Prepaid expense and deposits 168,779 101,407
------------ ------------
Total current assets 5,261,583 4,130,369
------------ ------------
Restricted cash 222,000 70,500
Software, net of accumulated amortization of
$2,528,560 and $1,911,830 1,256,020 1,605,098
Property and equipment, net 1,100,061 722,678
Deposits and other assets 139,024 188,195
------------ ------------
Total assets $ 7,978,688 $ 6,716,840
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable to banks, current maturities $ 336,947 $ 551,991
Accounts payable 251,140 206,986
Accrued expenses and unearned revenue 854,030 222,797
------------ ------------
Total current liabilities 1,442,117 981,774
Notes payable to banks, net of current maturities 170,903 509,900
------------ ------------
Total liabilities 1,613,020 1,491,674
------------ ------------
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;
13,565,662 and 12,904,487 shares issued and outstanding,
respectively 135,657 129,045
Additional paid in capital 26,439,081 18,052,730
Accumulated deficit (20,209,070) (12,956,609)
------------ ------------
Total stockholders' equity 6,365,668 5,225,166
------------ ------------
Total liabilities and stockholders' equity $ 7,978,688 $ 6,716,840
============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
<PAGE>
The Pathways Group, Inc. and Subsidiaries
Consolidated Statements of Operations
For the years ended December 31, 1998, 1997, and 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Sales, net $ 76,565 $ 61,785 $ 108,418
Cost of sales 34,863 19,492 65,194
------------ ------------ ------------
Gross profit 41,702 42,293 43,224
------------ ------------ ------------
Selling, general and administrative expenses 5,918,513 2,673,507 1,650,295
Research and development 474,120 102,000
Amortization of software 621,642 593,459 537,232
Depreciation 364,144 208,814 121,269
------------ ------------ ------------
Total operating expenses 7,378,419 3,577,780 2,308,796
------------ ------------ ------------
Loss from operations (7,336,717) (3,535,487) (2,265,572)
Other expenses:
Interest income/(expense), net 84,256 (51,034) (367,305)
Loan guarantee fees to stockholder (200,000)
------------ ------------ ------------
Net loss $ (7,252,461) $ (3,586,521) $ (2,832,877)
============ ============ ============
Basic and diluted net loss per share $(0.55) $(0.30) $(0.57)
Shares used in per share calculation 13,148,939 12,102,755 4,964,640
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
<PAGE>
The Pathways Group, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity (Deficit)
For the years ending December 31, 1998,1997, and 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Common Stock Additional Accumulated
Shares Amount Paid in Capital Deficit Total
<S> <C> <C> <C> <C> <C>
Total, January 1, 1996 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 for 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 professiona 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)
---------- ------------ ------------ ------------ ------------
Total, 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)
---------- ------------ ------------ ------------ ------------
Total, December 31, 1997 12,904,487 129,045 18,052,730 (12,956,609) 5,225,166
Net proceeds from private placement of
common stock 654,508 6,545 8,379,284 8,385,829
Issuance of common stock upon exercise
of stock options 6,667 67 7,067 7,134
Net loss (7,252,461) (7,252,461)
---------- ------------ ------------ ------------ ------------
Total, December 31, 1998 13,565,662 $ 135,657 $ 26,439,081 $(20,209,070) $ 6,365,668
========== ============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
<PAGE>
The Pathways Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
For the years ending December 31, 1998, 1997, and 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(7,252,461) $(3,586,521) $(2,832,877)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation 364,144 208,354 121,269
Amortization and write-off of software 621,642 593,459 537,232
Investment banking services 300,000
Loan guarantee fees 200,000
Issuance of common stock for wages, interest,
consulting and professional fees 281,573
Effects of changes in operating assets and
liabilities, net of effects from acquisition of
businesses
Accounts receivable (36,300) 36,018 (77,965)
Prepaid expense and deposits (67,372) (101,407)
Inventories (158,718) 56,963 (331,857)
Other assets (18,917) (137,913) (38,838)
Accounts payable 44,154 (335,404) 107,554
Accrued expenses 631,233 (120,839) (206,571)
----------- ----------- -----------
Net cash used in operating activities (5,872,595) (3,387,290) (1,940,480)
----------- ----------- -----------
Cash flows from investing activities:
Capital expenditures (623,439) (542,752) (59,059)
Capitalized software development costs (272,564) (439,707) (236,946)
Restricted cash (151,500) (70,500)
Advance to Scrip Advantage (50,000)
----------- ----------- -----------
Net cash used in investing activities (1,097,503) (1,052,959) (296,005)
----------- ----------- -----------
Cash flows from financing activities:
Principal payments on notes payable to banks (554,041) (34,750) (517,532)
Principal payments on notes payable to shareholders (2,500) (111,634)
Principal payments on notes payable to others (517,161)
Redemption of common stock (28,000)
Proceeds from notes payable to stockholders 35,670
Proceeds from notes payable to others 463,500
Proceeds from issuance of common stock, net of
offering costs of $597,980, $142,040 and $0 for 1998,
1997 and 1996, respectively 8,392,963 5,875,092 5,264,400
----------- ----------- -----------
Net cash provided by financing activities 7,838,922 5,809,842 4,617,243
----------- ----------- -----------
Increase of cash and cash equivalents 868,824 1,369,593 2,380,758
Cash and cash equivalents, beginning of year 3,759,720 2,390,127 9,369
----------- ----------- -----------
Cash and cash equivalents, end of year $ 4,628,544 $ 3,759,720 $ 2,390,127
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<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, 1998 and 1997 and for the three years
ended December 31, 1998. 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 of 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.
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, 1998 and 1997, cash equivalents consisted of money market accounts
principally invested in U.S. government obligations.
Restricted Cash
The Company entered into a certain operating lease agreement whereby the
Company is required to maintain up to $200,000 in a certificate of deposit
at the bank as collateral for the lease. As of December 31, 1998 and 1997
$200,000 and $70,500, respectively, has been classified as restricted
cash. During 1998, the Company was also required to maintain a deposit
with a state agency for the payment of fees and taxes in the amount of
$22,000 and is classified as restricted cash on the balance sheet.
Inventories
Inventories are stated at the lower of cost (as determined by the
first-in, first-out method) or market.
F-7
<PAGE>
The Pathways Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. Summary of Significant Accounting Policies, Continued:
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.
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. The establishment of technological feasibility and the
on-going assessment of the recoverability of costs require considerable
judgement 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.
Research and Development
Research and development costs are expensed as incurred in accordance with
Statement of Financial Standards (SFAS) No. 2, Accounting for Research and
Development Costs.
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 changes 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
- --------------------------------------------------------------------------------
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 50% and 55% of accounts receivable at December 31, 1998 and
1997 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
processing services are performed and earned. Revenues collected for
warranty services to be performed in the future are deferred and
recognized ratably over the related contract period.
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 lives used to calculate
depreciation and amortization of the Company's long lived assets and
software may be reduced significantly in the near term. As a result, the
carrying amount of the capitalized software costs ($1,256,020) may be
reduced entirely in the near term. In addition, the carrying amount of
long lived assets may be reduced materially in the near term.
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130,
"Comprehensive Income". This statement establishes standards for reporting
and display of comprehensive income and its components in a full set of
financial statements. Comprehensive income includes items such as foreign
currency translation adjustments. Management believes this standard is not
applicable as the Company does not have any items in its financial
statements meeting the criteria for comprehensive income.
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of
an Enterprise and Related Information," which changes the way public
companies report information about operating segments. This statement,
which is based on the management approach to segment reporting,
establishes requirements to report selected segment information quarterly
and to report entitiy-wide disclosures about products and services, major
customers and the major countries in which the Company holds assets and
reports revenues. Management believes this standard is not applicable as
the Company currently operates as one segment.
F-9
<PAGE>
The Pathways Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. Inventories:
Inventories at December 31,1998 and 1997 consisted of the following:
1998 1997
Smart cards and related packaging $ 158,917 $ 149,204
Smart card terminals 61,846 53,545
Assembled unattended kiosks and components 140,704
--------- ---------
$ 361,467 $ 202,749
========= =========
4. Property and Equipment:
Property and equipment at December 31, 1998 and 1997 consisted of the
following:
1998 1997
Ticket dispensing systems $ 476,318 $ 465,500
Computer equipment and software 853,670 367,907
Furniture and fixtures 211,360 42,635
Leasehold improvements 334,461 258,239
---------- ----------
1,875,809 1,134,281
Less accumulated depreciation and amortization (775,748) (411,603)
---------- ----------
$1,100,061 $ 722,678
========== ==========
5. Note Receivable
In 1998 the Company advanced $50,000 to Scrip Advantage, Inc. in exchange
for a demand note receivable with interest bearing at 10%, which is
included in deposits and other assets in the accompanying consolidated
balance sheet. The note receivable is convertible into common stock of
Scrip Advantage at the Company's option.
F-10
<PAGE>
The Pathways Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
6. Notes Payable to Banks:
Notes payable to banks at December 31, 1998 and 1997 consisted of the
following:
<TABLE>
<CAPTION>
1998 1997
<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
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 1998 through November 1998, interest
due monthly, guaranteed by certain stockholders and
collateralized by substantially all of the assets of PIL 190,000
Note payable to bank, interest at bank's prime rate (7.75% at
December 31, 1998) plus 1.5%, principal due in various
installments from May 1998 through May 1999, interest due
monthly, guaranteed by certain stockholders and
collateralized by substantially all of the assets of PIL $ 130,000 150,000
Note payable to bank, interest at prime (7.75% at December 31,
1998) 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 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 110,000 330,000
Note payable to bank, interest at prime (7.75% at December 31,
1998) 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 267,850 341,891
----------- -----------
507,850 1,061,891
Less current maturities (336,947) (551,991)
----------- -----------
$ 170,903 $ 509,900
=========== ===========
</TABLE>
F-11
<PAGE>
The Pathways Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
6. Notes Payable to Banks, Continued:
The contractual principal maturities of notes payable to banks at December
31, 1998 are as follows:
1999 $ 336,947
2000 108,166
2001 62,737
-----------
$ 507,850
===========
7. Accrued Expenses:
Accrued expenses at December 31, 1998 and 1997 consisted of the following:
1998 1997
Interest payable $ 1,912 $ 20,403
Accrued payroll, bonus, and related taxes 599,339 4,800
Insurance premiums payable 90,262 48,798
Other accrued expenses 159,122 148,796
Unearned revenue 3,395
-------- --------
$854,030 $222,797
======== ========
8. Income Taxes:
At December 31, 1998, the Company had accumulated net operating loss
carryforwards for tax purposes of approximately $17,439,836 which expire
through 2018. As a result of acquisitions, the availability of these net
operating losses to offset future taxable income 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 may 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>
December 31,
1998 1997 1996
<S> <C> <C> <C>
Federal income tax benefit at statutory rate $(2,421,389) $(1,219,417) $ (963,178)
Losses which provide no current tax benefit 2,414,470 1,215,851 949,604
Other, net 6,919 3,566 13,574
----------- ----------- -----------
Income tax benefit $ -- $ -- $ --
=========== =========== ===========
</TABLE>
F-12
<PAGE>
The Pathways Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
8. Income Taxes, Continued:
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.
The significant components of the Company's deferred income tax assets and
liabilities at December 31, 1998 and 1997 are as follows:
1998 1997
Deferred income tax assets:
Tax loss carryforwards $ 5,929,544 $ 3,670,117
Debt guarantee fees to stockholder 439,466 439,466
Accrued compensation 204,150 203,809
Depreciation 50,615 --
Other -- 22,242
----------- -----------
Deferred income tax assets 6,623,775 4,335,634
----------- -----------
Deferred income tax liability:
Depreciation 53,741
Other 1,222
----------- -----------
Deferred income tax liability 1,222 53,741
----------- -----------
Valuation allowance (6,622,553) (4,281,893)
----------- -----------
Net deferred income tax assets $ -- $ --
=========== ===========
A full valuation allowance has been recorded at December 31, 1998 and 1997
based on management's determination that the recognition criteria for
realization have not been met.
F-13
<PAGE>
The Pathways Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
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
1999 to 2003. 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 $850,000. As of December 31, 1998 and 1997 $200,000
and $70,500 respectively has been classified as restricted cash.
This lease has been accounted for as an operating lease. As of December
31, 1998 the Company has drawn all $400,000 of the lease line. The
approximate future minimum rental commitments as of December 31, 1998
under all operating leases are as follows:
1999 $ 472,000
2000 438,000
2001 323,000
2002 227,000
2003 42,000
----------
$1,502,000
==========
Rent expense for the years ended December 31, 1998, 1997 and 1996 was
approximately $463,000, $147,000 and $100,000 respectively.
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 with 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 the officer earned
200,000 shares of TPG common stock under this provision.
F-14
<PAGE>
The Pathways Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
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 to employees of the Company and have a maximum term of
10 years from the date of the grant. The exercise price for ISOs may not
be less than 100% of the estimated fair market value of 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 by an employee 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.
In December 1998, the Company adopted the Pathways Group, Inc. Directors
stock option plan to assist the Company in attracting and retaining
outside directors. The terms of the plan reserves a total 100,000 shares
of common stock for issuance to outside non-employee directors. Initial
grants of options to acquire 10,000 shares were granted to three
non-employee directors in December 1998.
F-15
<PAGE>
The Pathways Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
10. Employment Agreements and Stock Options, Continued:
Stock Options, Continued:
Option activity for the three years ended December 31, 1998 is as follows:
Weighted
Average
Shares Exercise Price
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
Granted 84,000 14.88
Exercised (6,667) 1.07
Canceled (57,000) 24.00
------- ---------
Balance, December 31, 1998 447,666 $ 10.55
======= =========
No compensation expense has been recorded for options granted in 1998,
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.
F-16
<PAGE>
The Pathways Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
10. Employment Agreements and Stock Options, Continued:
Stock Options, Continued:
The following table summarizes information about options outstanding at
December 31, 1998:
Options Outstanding Options Exercisable
------------------------------- -------------------------
Weighted
Average
Weighted Remaining Weighted
Average Number Contractual Number Average
Exercise of Life of Exercise
Prices Shares (in years) Shares Prices
$ 2.94 206,666 8 133,334 $ 3.00
15.00 100,000 9 33,334 15.00
24.00 61,500 10 55,500 24.00
14.36 79,500 10 31,500 14.375
--------- ------- ------- ----------
$ 10.55 447,666 253,668 $ 10.58
========= ======= ======= ==========
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.
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 ending December 31,1998 and 1997 as if the Company accounted for
compensation expense related to stock options under the fair value method
prescribed by SFAS 123:
December 31, December 31,
1998 1997
Pro forma net loss $ (8,514,217) $ (3,743,575)
Pro forma net loss per share (0.65) (0.31)
F-17
<PAGE>
The Pathways Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
10. Employment Agreements and Stock Options, Continued:
Stock Options, Continued:
The fair value of options granted was estimated on the date of grant using
the Black-Scholes. For value method for 1998 and 1997 and the
Black-Scholes minimum value method for 1996 assuming no dividends and the
following weighted average assumptions:
1998 1997 1996
Risk free interest rate 4.13% to 5.61% 5.79% to 5.93% 5.76% to 6.16%
Expected lives 3 to 5 years 3 to 5 years 10 years
Volatility 83% 55%
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. The weighted
average fair value of options granted in 1998 and 1997, as calculated
using the Black-Scholes option pricing model, was $9.28 and $9.85 per
option respectively.
11. Capital Stock Transactions:
Common Stock
In connection with a financial advisory agreement with Allen and Company,
Inc. ("Allen"), 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, the Company issued 542,292 shares of common stock to the
Company's President and Chief Executive Officer in consideration for
personally guaranteeing 1,292,500 principal amount of indebtedness of the
Company. The Company also issued 1,470,331 shares of common stock for
conversion of notes payable to stockholders, officers and individuals and
1,161,762 shares for conversion of wages, interest consulting and
professional fees. These transactions were recorded at the fair value of
$1.00 per share of common stock at the date of issuance or conversion.
In 1996 and 1997, the Company acquired the remaining minority interest in
its subsidiary, SPRINTICKET, Inc. by issuing 225,000 shares of common
stock (1996) and payment of $75,000 cash (1997). This transaction was
accounted for as a purchase with the purchase price of $300,000 allocated
to software and amortized in accordance with the Company's amortization
policy.
In 1992, the Company acquired land for $250,000 in exchange for $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-18
<PAGE>
The Pathways Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
11. Capital Stock Transactions:
Common Stock, Continued:
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.
In July 1997, the Company sold 833,333 shares of common stock in an
initial public offering at $6.00 per share. The net proceeds from the
offering was $4,857,956.
In July and August of 1998, the Company sold 654,508 shares of common
stock through a private placement at 13.75 per share. The net proceeds
from the sale shares was $8,385,829.
12. Supplemental Disclosure of Cash Flow Information:
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Cash paid during the year for interest $ 98,227 $ 241,637 $ 283,993
Non-cash transactions:
Notes payable converted to common stock 3,000 1,470,331
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. On December 31, 1997, the Company
recorded as other assets $118,088 for deposits on property and equipment.
During 1998 these items were placed in service.
13. Related Party Transactions:
In 1998, the Company paid a total of $505,602 to Allen and Company
Incorporated, a shareholder, and Mitchum, Jones and Templeton, whose Chief
Executive Officer is a Director and shareholder of the Company for
investment banking services and direct expenses in connection with the
Company's private placement.
F-19
<PAGE>
The Pathways Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
14. Subsequent Event - Funding of Operations
In March of 1999, the Company received a firm commitment for additional
funding of $3,000,000. The Company believes that its existing cash
reserves, planned expenditure reductions (if necessary) and revenues will
be adequate to fund the Company's operations through 1999.
F-20
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 19834, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
THE PATHWAYS GROUP, INC.
March 31, 1999 By: /s/ CAREY F. DALY, II
--------------------------------------
Carey F. Daly, II
President, Chief Executive Officer and
Chairman of the Board (principal executive
officer)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
<S> <C> <C>
/s/Carey F. Daly, II President, Chief Executive March 31, 1999
- ------------------------------- Officer, Chairman of the Board
Carey F. Daly, II and Director
/s/ Mark T. Schuur Chief Financial Officer and March 31, 1999
- ------------------------------- Director
Mark T. Schuur
/s/ Glenn A. Okun Director March 31, 1999
- -------------------------------
Glenn A. Okun
/s/ Monte P. Strohl Director March 31, 1999
- -------------------------------
Monte P. Strohl
/s/ Linda Wing Director March 31, 1999
- -------------------------------
Linda Wing
</TABLE>
Exhibit 10.16
THE PATHWAYS GROUP, INC.
DIRECTORS STOCK OPTION PLAN
1. Purpose. The purpose of the Directors Stock Option Plan (the
"Plan") is to aid the Company in attracting, retaining and motivating directors
by providing them with incentives for making significant contributions to the
growth and profitability of the Company. The Plan is designed to accomplish this
goal by the granting of stock options, thereby providing Participants with a
proprietary interest in the growth, profitability and success of the Company.
2. Definitions.
(a) Board. The Board of Directors of the Company.
(b) Code. The Internal Revenue Code of 1986, as amended from time to
time.
(c) Committee. The members of the Board who are not eligible to
participate in the Plan, or a committee composed of such members (consisting of
not less than two persons) as may be designated from time to time by all such
members, who shall administer the Plan.
(d) Company. The Pathways Group, Inc.
(e) Fair Market Value. If the Stock is listed on the New York Stock
Exchange (or other national exchange), the average of the high and low sale
prices as reported on the New York Stock Exchange (or such other exchange) or,
if the Stock is not listed on a national exchange, the average of the high and
low sale prices of the Stock in the over-the-counter market, as reported by the
National Association of Securities Dealers through its Automated Quotation
System or otherwise, in either case for the date in question, provided that if
no transactions in the Stock are reported for that date, the average of the high
and low sale prices as so reported for the preceding day on which transactions
in the Stock were effected.
(f) Non-Employee Directors. Directors of the Company who are not
officers or employees of the Company or any direct or indirect subsidiary of the
Company.
(g) Option. A non-qualified stock option to purchase shares of Stock
granted pursuant to the terms and conditions of the Plan.
(h) Option Agreement. An agreement between the Company and a
Participant setting forth the terms, conditions and limitations applicable to an
Option.
(i) Participant. A director of the Company to whom an Option has
been granted.
(j) Stock. Authorized and issued or unissued shares of Common Stock
of the Company or any security issued in exchange or substitution therefor.
3. Eligibility. Only the following persons are eligible to
participate in the Plan: Non- Employee Directors who (i) have not been
designated by the Board within 30 days after becoming a director as being
eligible to receive Awards under the Amended and Restated Stock Incentive Plan,
or (ii) having been eligible to participate in the Amended and Restated Stock
Incentive Plan, have ceased to be so eligible as a result of a determination by
the Board. The eligibility of any such director to partici pate in the Plan
shall cease if such director is subsequently designated as being eligible to
receive
<PAGE>
Awards (as defined in the Amended and Restated Stock Incentive Plan) under the
Amended and Restated Stock Incentive Plan.
4. Stock Available for Options. Subject to Section 8 hereof, a total
of 100,000 shares of Stock shall be available for issuance pursuant to options
granted under the Plan. From time to time, the Board and appropriate officers of
the Company shall file such documents with governmental authorities and, if the
Stock is listed on the New York Stock Exchange (or other national exchange),
with such stock exchange, as are required to make shares of Stock available for
issuance pursuant to Options and publicly tradeable. Shares of Stock related to
Options, or portions of Options, that are forfeited, canceled or terminated,
expire unexercised, are surrendered in exchange for other Options, or in such
manner that all or some of the shares covered by an Option are not and will not
be issued to a Participant, shall be restored to the total number of shares of
Stock available for issuance pursuant to Options.
5. Administration. The Plan shall be administered by the Committee,
which shall have full and exclusive power to (a) construe and interpret the Plan
and all Option Agreements, (b) adopt and amend such rules, procedures,
regulations and guidelines for carrying out the Plan as it may deem necessary or
desirable and (c) take any other action necessary for the proper operation and
administration of the Plan, all of which powers shall be exercised in a manner
consistent with the objectives, and in accordance with the terms and conditions,
of the Plan; provided, however, that no discretion regarding the grant, amount,
timing, terms and conditions of Options granted under the Plan (which are
established by the Plan), shall be afforded to the Committee. All actions of the
Committee with respect to the Plan shall require the vote of a majority of its
members or, if there are only two members, by the vote of both. Any action of
the Committee may be taken by a written instrument signed by a majority (or
both) of such members and any action so taken shall be as effective as if it had
been taken by a vote of such members at a meeting. All determinations and acts
of the Committee as to any matters concerning the Plan, including
interpretations or constructions of the Plan and any Award Agreement, shall be
conclusive and binding on all Participants and on any parties validly claiming
through any Participants.
6. Granting of Options.
(a) On the date the Plan becomes effective, each director who at
such date is eligible to participate in the Plan shall automatically be granted
an Option to purchase 10,000 shares of Stock.
(b) On the date that any Non-Employee Director (other than a
director who received a grant pursuant to subparagraph (a) of this Section 6)
first becomes eligible to participate in the Plan, such Non-Employee Director
shall automatically be granted an Option to purchase 10,000 shares of Stock.
(c) Commencing on the date of the Annual Meeting of Stockholders of
the Company (i) on or next preceding the second anniversary of the date on which
a Participant becomes eligible to participate in the Plan, in the case of a
Participant who is granted an Option pursuant to subparagraph (b) of this
Section 6, or (ii) on or next preceding the first anniversary of the date on
which a Non-Employee Director becomes eligible to participate in the Plan, in
the case of a Non-Employee Director who is not granted an Option pursuant to
subparagraph (b) of this Section 6, and, in each case, on the date of each
succeeding Annual Meeting of Stockholders, any such Participant, if remaining a
director and eligible to participate in the Plan, shall automatically be granted
an Option to purchase 5,000 shares of Stock.
(d) Notwithstanding the foregoing, no Option shall be granted to any
person whose service as a director ends at the Annual Meeting of Stockholders on
the date of which the Option would otherwise be granted.
-2-
<PAGE>
(e) The number of shares of Stock for which Options shall be granted
under this Section 6 is subject to adjustment as set forth in Section 7(l)
hereof.
7. Options. Each Option granted pursuant to, or otherwise to be
governed by the terms and conditions of, the Plan shall have the following terms
and conditions:
(a) Each Option shall have an exercise price equal to the Fair
Market Value of a share of Stock on the date of grant.
(b) The price at which shares of Stock may be purchased upon
exercise of an Option shall be paid in full at the time of exercise, in
cash or by (i) tendering Stock or surrendering another stock option,
valued at, or on the basis of, the Fair Market Value of the Stock on the
date of exercise, (ii) delivery of a promissory note issued by a
Participant to the Company in a form determined by the Committee, or (iii)
other means acceptable to the Committee. The Committee shall determine
acceptable methods for tendering Stock or surren dering other stock
options. Participants may also exercise Options and simultaneously sell
some or all of the shares of Stock so acquired pursuant to a brokerage or
similar arrangement which provides for the payment of the Option exercise
price substantially concurrently with the delivery of such shares.
(c) Each Option shall be exercisable for a period of ten years from
the date of grant.
(d) Each Option shall be exercisable as to one-third of the shares
of Stock subject to such Option on and after the first anniversary of the
date of grant of such Option, as to an additional one-third, on and after
the second anniversary thereof, and as to the remaining one-third, on and
after the third anniversary thereof.
(e) The Company shall have the right to deduct applicable taxes
resulting from any exercise of or other payment on an Option and to
withhold an appropriate number of shares of Stock for payment of tax
withholding obligations, if any, or to take such other action as may be
necessary in the opinion of the Company to satisfy any tax withholding
obligations. In addition, Participants may elect to (i) have the Company
deduct applicable taxes by withholding an appropriate number of shares of
Stock for payment of taxes required by law or (ii) tender to the Company
for the purpose of satisfying tax payment obligations other Stock held by
the Par ticipant. If the Company withholds shares of Stock to satisfy tax
payment obligations, the value of such Stock shall be its Fair Market
Value on the date the Option is exercised. If a Participant tenders shares
of Stock pursuant to clause (ii) above to satisfy tax payment obligations,
the value of such Stock shall be the Fair Market Value on the date the
Participant tenders such Stock to the Company.
(f) Except as otherwise set forth in the applicable Option Agreement
or as other wise provided in paragraphs (g), (h), (i) and (j) of this
Section 7, if a Participant's association with the Company terminates, any
unexercised Option (or portion thereof) shall, to the extent it is ex
ercisable pursuant to the terms of such Option on the date of such
termination, remain exercis able for a period of three months following
the date of termination or until the stated expiration date of the Option,
if earlier.
(g) If a Participant dies, any outstanding Option then held by the
Participant shall become fully exercisable as of the date of the
Participant's death. Any such Option shall be exercisable by the
Participant's estate or beneficiaries following the Participant's death
through the expiration date specified in the applicable Option Agreement
and in such manner as if the Participant were living. Rights with respect
to any such Option shall pass in the following order: (i) to beneficiaries
so designated in writing by the Participant; or if none, then (ii) to the
-3-
<PAGE>
Participant's legal representatives; or if none, then (iii) to the persons
entitled thereto as determined by a court of competent jurisdiction.
(h) If a Participant ceases to be associated with the Company
because the Participant is deemed by the Company to be disabled, any
Option held by the Participant may be exercised by the Participant, if
legally competent, or by a committee or other legally designated guardian
or representative if the Participant is legally incompetent, through the
expiration date specified in the applicable Option Agreement. Any such
Option shall become fully exercisable as of the date of the Participant's
termination of his or her association with the Company by virtue of such
disability.
(i) If a Participant's association with the Company terminates in
order that such Participant may assume a position with a governmental,
charitable or educational agency or institution, such Participant's
Options, to the extent permitted by law, shall continue in effect and be
exercisable beyond the date of termination, up until the expiration date
specified in the applicable Option Agreement. Any such Option shall become
fully exercisable as of the date of the Participant's termination. To the
extent permitted by law, the Participant may authorize a third party
(including, without limitation, the trustee of a "blind" trust),
acceptable to the appli cable authorities, the Participant and the
Committee, to act on behalf of the Participant with respect to such
Options.
(j) If a Participant's association with the Company terminates by
reason of the Participant's retirement at 62 years of age or thereafter,
any outstanding Option then held by the Participant shall become fully
exercisable as of the date of the Participant's retirement. Any such
Option shall be exercisable through the expiration date specified in the
applicable Option Agreement.
(k) An Option shall not be assignable or transferable to, or
exercisable by, anyone other than the Participant to whom it is granted,
except as provided in subparagraphs (g), (h), (i) and (j) of this Section
7.
(l) In the event of any change in the number of shares of
outstanding Stock by reason of a stock split, stock dividend, combination
or reclassification of shares, recapitalization, merger, consolidation or
similar event, the Committee shall adjust proportionally the number of
shares of Stock covered by each outstanding Option and the exercise price
thereof. In the event of any other change affecting the Stock or any
distribution (other than normal cash dividends) to holders of Stock, such
adjustments as may be deemed equitable by the Committee, including
adjustments to avoid fractional shares, shall be made to give proper
effect to such event.
(m) Notwithstanding the provisions of paragraph (d) of this Section
7, Options shall be subject to acceleration of exercisability in the event
of a Change in Control of the Company, as provided in agreements between
the Company and certain of its officers and directors which provide for
certain protections and benefits in the event of a Change in Control (as
defined in such agreements), or as shall be provided in applicable Option
Agreements. "Change in Control" for purposes of the Plan and any Options
shall mean a change in control of the Company under such circumstances as
shall be specified (i) where applicable to any Options by any such
agreement between the Company and a Participant as (A) may have been
entered into prior to the effective date of the Plan or (B) shall be
entered into after the effective date of the Plan upon such terms and
conditions, to the extent applicable to any Options, as are substantially
the same as those contained in earlier prior agreements with certain
officers and directors, or (ii) in the applicable Option Agreement. For
the purposes of the Plan or any Option, a "Change in Control" may, without
limitation, be deemed to have occurred if (U) a change in control of the
Company of a nature that would be required to be reported in response to
Item 6(e) of Schedule 14A of Regulation 14A under the Exchange Act occurs;
(V) any "person" or
-4-
<PAGE>
"group" of persons (as the terms "person" and "group" are used in Section
13(d) and 14(d) of the Exchange Act and the rules thereunder) is or
becomes the beneficial owner, directly or indirectly, of securities of the
Company representing 30% or more of the combined voting power of the then
outstanding securities of the Company; (W) the Company consummates a
merger, consolidation, share exchange, division or other reorganization of
the Company with any other corporation or entity, unless the stockholders
of the Company immediately prior to such transaction beneficially own,
directly or indirectly, (1) if the Company is the surviving corporation in
such transaction, 60% or more of the combined voting power of the
Company's outstanding voting securities as well as 60% or more of the
total market value of the Company's outstanding equity securities, (2) if
the Company is not the surviving corporation, 80% or more of the combined
voting power of the surviving entity's outstanding voting securities as
well as 80% or more of the total market value of such entity's outstanding
equity securities, or (3) in the case of a division, 80% or more of the
combined voting power of the outstanding voting securities of each entity
resulting from the division as well as 80% or more of the total market
value of each such entity's outstanding equity securities, in each case in
substantially the same proportion as such stockholders owned shares of the
Company prior to such transaction; (X) the Company adopts a plan of
complete liquidation or winding-up of the Company; (Y) the stockholders of
the Company approve an agreement for the sale or disposition (in one
transaction or a series of transactions) of all or substantially all of
the Company's assets; or (Z) a change of more than 25% in the composition
of the Board occurs within a two-year period unless such change was
approved in advance by at least two-thirds of the previous directors.
8. Adjustments. In the event of any change in the outstanding Stock
by reason of a stock split, stock dividend, combination or reclassification of
shares, recapitalization, merger, consolidation or similar event, the Committee
shall adjust proportionally the number of shares of Stock (a) reserved for
issuance pursuant to the Plan and (b) available for Options.
9. Amendment or Termination. The Committee may amend, modify,
suspend or terminate the Plan for the purpose of (a) meeting or addressing any
changes in any applicable tax, securities or other laws, rules or regulations or
(b) for any other purpose permitted by law. Subject to changes in law or other
legal requirements which would permit otherwise, the Plan may not be amended
without stockholder approval to (i) materially increase the aggregate number of
shares of Stock that may be issued under the Plan (except for any increase
resulting from adjustments pursuant to Section 7(l) or 8 hereof) or (ii)
materially increase the benefits accruing to Participants or (iii) materially
modify the requirements as to eligibility for participation in the Plan.
Further, the Plan may not be amended in a manner that would alter, impair,
amend, modify, suspend or terminate any rights of a Participant or obligation of
the Company under any Options theretofore granted, in any manner adverse to such
affected Participant, without the consent of such affected Participant.
10. Notice. Any written notice to the Company required by any of the
provisions of the Plan shall be addressed to the Committee, c/o the Secretary of
the Company, and shall become effective when received by the Secretary.
11. Governing Law. The Plan and all determinations made and actions
taken pursuant hereto, to the extent not otherwise governed by the Code or the
securities laws of the United States, shall be governed by and construed under
the laws of the State of Delaware.
12. Effective and Termination Dates. The Plan, and any amendment
hereof requiring stockholder approval, shall become effective as of the date of
its approval by the stockholders of the Company by the affirmative vote of a
majority of the votes cast at a stockholders' meeting at which the approval of
the Plan (or any such amendment) is considered, provided that the total vote
cast represents over 50% of all shares entitled to vote on the proposal. The
Plan shall terminate ten years after its initial effective date, subject to
earlier termination by the Board pursuant to Section 9 hereof, except as to
Options then outstanding.
-5-
EXHIBIT 10.17
November 4, 1998
Steve Cody
LinkOpp Marketing, Inc.
2615 Pacific Coast Hwy., Suite 300
Hermosa Beach, CA 90254
Re: Application of Pathways Smart Card Technology
to LinkOpp Marketing Programs.
Dear Mr. Cady:
In an effort to summarize the current status of negotiations between
LinkOpp Marketing, Inc. (LinkOpp) and the Pathways Group, Inc. (Pathways), we
are submitting this letter of Intent (LOI). This LOI is consistent with recent
discussions between our two companies. It is understood that although either
party may disclose the existence and provisions of this LOI, all other
information disclosed by the parties either in the course of negotiating this
LOI or in any course of dealings subsequent to this LOI is subject to the
existing Non-Disclosure Agreement between LinkOpp and Pathways.
This letter is only a statement of intent to conduct negotiations
toward a mutually acceptable agreement.
A binding agreement between the parties concerning the subject of
this LOI will arise only when all material terms have been stated in a written
agreement approved by legal counsel of each party and signed by the CEO of
Pathways and the President of LinkOpp.
All documents concerning the proposed provisions of a binding
agreement which are exchanged in the course of negotiations, even if signed by a
CEO or President, shall be considered only a part of the negotiations and shall
have no legal effect unless subsequently incorporated in the fully executed
agreement. Each party agreass that it will not contend to the contrary.
1. Designation of Negotiators. The parties agree that the persons
named below shall represent them in the negotiations:
For LinkOpp:
Name and Title: Steve Cady
President
Business Address: LinkOpp International Inc.
2615 Pacific Coast Hwy; Suite 300
Hermosa Beach, CA 90254
Business Phone: 310 379 0099
Business Fax: 310 379 1466
For Pathways:
Name and Title: Carey F. Daly II
<PAGE>
President & CEO
Business Address: The Pathways Group, Inc.
1221 N Dutton Avenue
Santa Rosa, CA 95401
Business Phone: (707) 543-3010
Business Fax: (707) 546-4041
2. Conduct of Negotiations. All negotiations, including exchanges of
drafts, proposals and other information, shall be conducted only through the
negotiators named above.
3. Points of Tentative Agreement and Further Negotiation.
(a) Both parties are working towards an agreement under which
Pathways will provide certain hardware and software system solutions for use
with or to integrate with LinkOpp's system, which is an internet-based
membership business network that provides services and discounts to its members.
(b) The parties are presently in agreement an the following general
business points and responsibilities which, although subject to further
modification, will serve as a guideline for negotiation a definitive agreement:
(i) Pathways will develop certain software and hardware
solutions for use by LinkOpp and its members. Pathways' system solution
will integrate the use of smart cards, ATM Kiosks, and reader/writer
terminals into a transaction and database system maintained by both
Pathways and LinkOpp. Such a system will provide, as necessary, database
management, reports, interfaces, security, card stock management,
personalization and fulfillment of cards, deployment of terminals and
kiosks, clearance and facilitation of bank settlement, and credit and
debit card authorization and settlement. The system will include all
software necessary to perform these functions and facilitate operation of
an integrated system.
(ii) The parties will agree on specifications and functionality
before Pathways begins the development process.
(iii) After development, Pathways will be the exclusive provider
of smart cards, terminals and kiosks/recharge stations as well as credit
and debit card processing. As an inducement for Pathways to begin
development, LinkOpp will provide a purchase order for ________ smart
cards and _________ terminals for delivery before January 31, 1999.
(iv) It is understood that all information in the database as
well as all business concepts related to LinkOpp and its membership
business are to remain the property of LinkOpp. It is also understood that
all software developed by Pathways, including but not limited to source
code and toolkits, is to remain the property of Pathways.
4. Target Data for Execution of a Binding Agreement. The target date
for execution of a binding agreement between the parties is December 15, 1998.
However, if a binding agreement has not been fully executed by that date, the
parties nevertheless expect to continue working toward execution of a binding
agreement as soon as possible thereafter.
5. Termination of Negotiations. The parties also recognize that
either party, at any time, and without stating any reason, may terminate the
negotiations for which this Letter of Intent provides.
-2-
<PAGE>
6. Applicable Law. This Letter of Intent shall be construed and
interpreted pursuant to the laws of the state of California, including its
choice of law rules.
7. Entire Letter of Intent. This LOI supercedes all prior
discussions and agreements, if any, between the parties concerning a possible
business relationship. The provisions of this LOI shall not he amended or
modified except by a written amendment to this LOI signed by the CEO of Pathways
arid the President of LinkOpp.
This LOI is expressed in two identical originals to be signed by
both parties.
I have signed both of the enclosed originals. If this LOI states our
mutually acknowledged current intent respecting the procedures, purpose and
scope of our negotiations, please indicate by signing below and returning one of
the signed originals to Pathways' Corporate Offices in Woodinville, Washington.
THE PATHWAYS GROUP, INC. LINKOPP MARKETING, INC.
By: /s/ Carey F. Daly II By: /s/ Steve Cady
----------------------- ------------------------
Carey F. Daly II Steve Cady
President & CEO President
Date: Date:
------------------------- --------------------------
-3-
THE PATHWAYS GROUP, INC. EXHIBIT 10.18
Hawaii Region
Grosvenor Center, 2500 Makai Tower
733 Bishop Street
Honolulu, Hawaii 96813
FEBRUARY 1, 1999
Consolidated Amusement Company, Inc.
290 Sand Island Road
Honolulu, Hawaii 96819
Attn: Mr. Glenn Yim
Re: Application of Smart Card Technology for use in a loyalty program,
electronic ticketing, concession purchase purse, and a frequent
premier card for the Consolidated Theaters located at the Pearlridge
Shopping Center.
Dear Mr. Yim,
In an effort to summarize the current understanding of discussions between
Consolidated Amusement Company, Ltd. (Client) and the Pathways Group, Inc.
(Pathways), we are submitting this Letter of Intent (LOI). This LOI is
consistent with recent discussions between Mr. David A. Mayeda, Vice President
and General Manager of The Pathways Group, Inc. and Mr. Glenn Yim, Director of
Operations of Consolidated Amusement Co. Ltd. It is understood that this LOI and
any ensuing negotiations resulting between Pathways and Client are covered by
the attached Non-Disclosure Agreement (NDA).
This letter is a statement of intent for both parties to work together in good
faith to (1) define the requirements to implement a program, broadly defined in
the reference above (The Project) and (2) if the results are mutually acceptable
to negotiate a binding Implementation Agreement.
A binding Implementation Agreement between the parties for The Project will
arise only after all material terms have been agreed to by both parties and a
written agreement is signed by an officer of Pathways and Consolidated Amusement
Co., Ltd.
All documents concerning the proposed provisions of a binding agreement which
are exchanged in the course of negotiations, even if signed, shall be considered
only a part of negotiations and shall have no legal effect unless subsequently
incorporated in the fully executed implementation Agreement. Each party agrees
that it will not contend to the contrary.
<PAGE>
1. Designation of Negotiators
The parties agree that the persons named below shall represent them in the
negotiations:
For Consolidated Amusement Co.,Ltd.:
Name and Title: Mr. Glenn Yim
Director of Operations
Business Address: 290 Sand Island Road
Consolidated Amusement Co.,Ltd.
Honolulu, Hawaii 96819
Business Phone: (808) 847-1985
Business Fax: (808) 847-9285
For The Pathways Group, Inc:
Name and Title: David A. Mayeda
Vice President & General Manager
Business Address: The Pathways Group, Inc.
Grosvenor Center
733 Bishop Street, Suite 2500
Honolulu, HI 96813
Business Phone (808) 599-6190
Business Fax: (808) 537-3541
2. Conduct of Negotiations
All negotiations, including exchanges of drafts, proposals and other
information, shall be conducted only through the negotiators named above.
3. Points of Tentative Agreement and Further Negotiation
A. Both parties are working towards an agreement to implement The
Project.
B. In forming an Implementation Agreement, the parties agree to the
following general allocation of responsibilities which may be
modified on a case-by-case basis if circumstances warrant:
(1) Pathways will provide an integrated system solution (the System) to
perform specifically identified functions, in which Pathways will
integrate the use of Smart Cards, related reader/writer devices and
terminals. Such a system will provide, as necessary, for database
management, reports, interfaces, security, card stock management,
personalization, fulfillment, clearance and the facilitation of account
settlement. The system will include all software necessary to perform
these functions and facilitate operation of the Integrated system for each
identified function.
<PAGE>
(2) Consolidated Amusement Co., Ltd. is responsible for the redemption
agreement(s) with participating merchant(s).
(3) Both organizations will market the concept to selected merchants jointly.
C. Consolidated Amusement Co., Ltd. and Pathways will provide to each
other the information necessary to fulfill their responsibilities
under this LOI and any subsequent Implementation.
D. The parties anticipate working together on the following projects:
(1) Electronic Ticketing & Kioske
(2) Frequent Movie Passes & Loyalty Program
(3) Concession purchases on the Smart Card
4, Entire Letter of Intent;
This Letter of Intent is intended for discussion purposes only and will not
create a binding obligation on the part of either Consolidated Amusement Co.,
Ltd. or The Pathways Group, Inc., and is subject to the parties entering into a
comprehensive and binding agreement.
THE PATHWAYS GROUP, INC. CONSOLIDATED AMUSEMENT CO., LTD.
By: /s/ David A. Mayeda By: /s/ Glenn Yim
------------------------------ -----------------------------
David A. Mayeda Mr. Glenn Yim
Date: February 1, 1999 Date: February 1, 1999
<PAGE>
MUTUAL CONFIDENTIALITY AND NONDISCLOSURE AGREEMENT
WHEREAS, Consolidated Amusement Co., Ltd., located at 290 Sand Island Road,
Honolulu, Hawaii 96819, including its affiliates, (hereinafter referred to as
Client) and THE PATHWAYS GROUP, INC. located at 733 Bishop Street, Suite 2500,
Honolulu, HI 96813, including its affiliates, (hereinafter referred to am
PATHWAYS) each wish to be able to disclose to the other party and receive from
the other party certain information deemed proprietary and/or confidential by
whichever party is making the disclosure, while protecting the proprietary
and/or confidential nature of the disclosed information; and
WHEREAS, each PARTY wishes to receive this information from the other for the
purpose of evaluating a possible business relationship with the other PARTY
regarding the application of Smart Card Technology for use the movie theater for
the purpose a loyalty program, electronic ticketing through a kioske, concession
purchase with a general purse, provide demographics and other features.
NOW, THEREFORE, the parties agree as follows:
4. DEFINITIONS:
A. The term "DISCLOSING PARTY" refers to the party who discloses
proprietary and/or confidential information to the other.
B. The term "RECEIVING PARTY" refers to the party who receives
proprietary and/or confidential information to the other.
C. The term "proprietary and/or confidential information" shall
include all information obtained from and/or about the
business products, services, procedures, procedures, internal
organization and/or operations(s) of a DISCLOSING PARTY, and
marketing information or data compiled or generated by a
DISCLOSING PARTY about its own marketing processes,
procedures, efforts, or customer base, and any other
information that supplements such information, EXCEPT to the
extent that parts or all of such information is excluded by
PARAGRAPH 6 below.
5. Nothing in this Agreement shall be construed to require the
DISCLOSING PARTY to disclose any information. The extent of any
disclosure and the details thereof are deteminable at the sole
discretion of the DISCLOSING PARTY. ANY PROPRIETARY AND/OR
CONFIDENTIAL INFORMATION DISCLOSED BY THE DISCLOSING PARTY SHALL BE
SUBJECT TO THIS AGREEMENT,
6. For a period of five (5) years from the date of receipt of any
information to which this Agreement applies the RECEIVING PARTY
agrees that it shall not disclose any proprietary and/or
confidential information it receives from the DISCLOSING PARTY,
relating to the above described subject matter, to any person, firm
or corporation, or use the information for its own benefit, except
for the purpose described above. RECEIVING PARTY shall use at least
the same degree of care to avoid disclosure of the information as
RECEIVING PARTY employs with respect to its own proprietary and/or
confidential information.
7. RECEIVING PARTY agrees that to the extent it discloses any
information subject to this Agreement to any of its officers,
directors, employees, agents, subcontractors, or other
representatives or consultants hired to advise it, that the
RECEIVING PARTY shall advise such officers, directors, employees,
agents or other representatives or consultants of this Agreement,
and provide a copy of this Agreement to each such person, and ask
that each such person sign the attached Addendum A by which it
agrees to be bound by this Agreement, and keep the signed Addendum A
as part of the RECEIVING PARTY's copy of this Agreement, The
DISCLOSING PARTY shall be entitled to receive a signed copy of
Addendum A from RECEIVING PARTY whenever requested, and to receive
further copies when requested.
8. RECEIVING PARTY agrees to be responsible for the actions of any of
its officers, directors, employees, agents, subcontractors, or other
representatives or consultants which violate the provisions of this
Agreement, as if the acts had been done by that RECEIVING PARTY.
9. Information shall not be deemed proprietary and/or confidential and
RECEIVING PARTY shall have no obligation to protect the
confidentiality of any information which is not otherwise protected
by patent, copyright, or trademark law, and:
(1) is already known to the Receiving party; or
(2) is or becomes publicly known through no wrongful act of the
RECEIVING PARTY; or
(3) is rightfully received by the RECEIVING PARTY from a third party
without similar restriction and without breach of this Agreement; or
(4) is independently developed by the RECEIVIN13 PARTY without
reference to this information disclosed under this Agreement; or
(5) is approved for release by written authorization of the
DISCLOSING PARTY.
10. RECEIVING PARTY shall not be deemed to have breached this Agreement
if the RECEIVING PARTY is compelled to disclose the information
pursuant to the requirement of a governmental
<PAGE>
agency, or disclosure is required by operation of law such as
subpoena or other discovery procedure in any legal, regulatory or
arbitration or mediation proceeding, PROVIDED THAT this exception
shall apply only if DISCLOSING PARTY has been advised by RECEIVING
PARTY of the pending disclosure and has been sent a copy of the
disclosure request at least twenty-one (21) days in advance of any
such disclosure or within such other reasonable time as the existing
circumstances permit so that DISCLOSING PARTY may seek protection by
Court Order from such disclosure or its potential adverse effects.
11. RECEIVING PARTY shall not be liable for (1) inadvertent disclosure
or use of proprietary and/or confidential information provided that
(a) it uses at least the same degree of care in safeguarding the
proprietary and/or confidential information as it uses for its own
proprietary and/or confidential information of like importance, and
(b) upon discovery of the inadvertent disclosure or use of the
proprietary and/or confidential information, it shall endeavor to
prevent any further inadvertent disclosure or use; and (2)
unauthorized disclosure or use of proprietary and/or confidential
information by persons who are or who have been in its employ,
unless it fails to safeguard the proprietary and/or confidential
information which with at least the same degree of care as it uses
for its own proprietary and/or confidential information of like
importance.
12. All proprietary and/or confidential information delivered by the
DISCLOSING PARTY to RECEIVING PARTY pursuant to this Agreement shall
be, and shall remain, the property of the DISCLOSING PARTY and all
proprietary and/or confidential information, whether in written,
electronic, or digital form, and any copies thereof, shall be
promptly returned to the DISCLOSING PARTY upon written request, or
destroyed at the DISCLOSING PARTY'S option.
13. Nothing contained in this Agreement shall be construed either
directly or by implication as granting or conferring any rights by
license to use, expressly, impliedly, or by operation of law any
invention, discovery or improvements made, conceived, or acquired
prior to or after the date of this Agreement, whether protected by
patent or copyright or not. Nothing contained in this Agreement
shall be construed as an agreement either directly or by implication
to make any other agreement between the DISCLOSING PARTY and
RECEIVING PARTY.
14. Neither party shall publicly announce or disclose the existence of
this Agreement or its terms and conditions, or advertise or release
any publicity regarding this Agreement, without the prior written
consent of the other party. This provision shall survive the
expiration, termination or cancellation of this Agreement.
15. Each signer warrants his authority to bind the corporation for which
he signs, and further agrees to be personally bound as a RECEIVING
PARTY pursuant to the provisions of this Agreement.
16. This Agreement shall be construed in accordance with the laws of the
State of Hawaii.
17. This Agreement is the entire agreement between the parties, and
supercedes any prior or contemporaneous oral or written agreements
which concern the same subjects covered by this agreement, This
Agreement may not be modified or amended except in writing signed by
both parties.
IN WITNESS WHEREOF, the parties agree that the effective date of this Agreement
shall be the 1st day of February, 1999.
THE PATHWAYS GROUP, INC. CONSOLIDATED AMUSEMENT CO., LTD.
By: /s/ David A. Mayeda By: /s/ Glenn Yim
-------------------------------- -----------------------------
David A. Mayeda Mr. Glenn Yim
Vice President & General Manager Director of Operations
<PAGE>
ADDENDUM A
TO MUTUAL CONFIDENTIALITY AND NONDISCLOSURE AGREEMENT
dated _____________, between __________________ and THE PATHWAYS GROUP, INC,
and other signers.
Each person or entity undersigned agrees that he/she/it has read the MUTUAL
CONFIDENTIALITY AND NONDISCLOSURE AGREEMENT to which this ADDENDUM A is attached
and HEREBY AGREES TO BE BOUND BY ITS TERMS AND PROVISIONS AS IF HE/SHE WERE AN
ORIGINAL RECEIVING PARTY.
A. RELATED COMPANY/CONSULTANT/INDEPENDENT CONTRACTOR
OF RECEIVING PARTY
Name:_________________________ __________________________
Relationship to Receiving Party
By: __________________________
(if a business entity)
BUSINESS ADDRESS:
B. OFFICERS, DIRECTORS, EMPLOYEES, AGENTS and OTHER
REPRESENTATIVES OF RECEIVING PARTY
Signature:________________________ Print Name:_______________________
Signature:________________________ Print Name:_______________________
Signature:________________________ Print Name:_______________________
Signature:________________________ Print Name:_______________________
Signature:________________________ Print Name:_______________________
Signature:________________________ Print Name:_______________________
(If you need more space for signatures, plum add pages to Addendum A)
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 4,628,544
<SECURITIES> 0
<RECEIVABLES> 102,793
<ALLOWANCES> 0
<INVENTORY> 361,467
<CURRENT-ASSETS> 5,261,583
<PP&E> 1,875,808
<DEPRECIATION> 775,748
<TOTAL-ASSETS> 7,978,688
<CURRENT-LIABILITIES> 1,442,117
<BONDS> 170,903
0
0
<COMMON> 135,657
<OTHER-SE> 6,230,011
<TOTAL-LIABILITY-AND-EQUITY> 7,978,688
<SALES> 76,565
<TOTAL-REVENUES> 76,565
<CGS> 34,863
<TOTAL-COSTS> 34,863
<OTHER-EXPENSES> 7,378,419
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (84,256)
<INCOME-PRETAX> (7,252,461)
<INCOME-TAX> 0
<INCOME-CONTINUING> (7,252,461)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,252,461)
<EPS-PRIMARY> (0.55)
<EPS-DILUTED> (0.55)
</TABLE>
