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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
/X/ Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 2000
/ / Transition report pursuant to Section 13 or 15(d) of the Exchange Act
For the transition period from __________ to __________
Commission file number 000-24119
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THE PATHWAYS GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 91-1617556
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
14201 N.E. 200TH STREET, WOODINVILLE, WASHINGTON 98072
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(Address of principal executive offices)
(425) 483-3411
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(Issuer's telephone number, including area code)
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
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APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Indicated 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 after the distribution of securities under a plan confirmed
by court.
Yes No
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APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: As of November 13, 2000:
18,710,062 shares of Common Stock, par value $0.01 per share.
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FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The financial statements of The Pathways Group, Inc. and its
subsidiaries ("Pathways" or the "Company") for the fiscal quarter ended
September 30, 2000 are attached to this Report, commencing at page F-1.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN 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 Annual Report on Form 10-K for the year
ended December 31, 1999, as 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, the limited revenues and significant operating losses generated to date,
the ability of the Company to achieve adequate levels of revenue to recover its
investment in capitalized software development costs and software licenses, the
possibility of significant ongoing capital requirements, and the ability of the
Company to secure additional financing as and when necessary. 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."
In addition to the risks and uncertainties discussed above, the report
of the Company's independent accountants on the Company's financial statements
for the fiscal years ended December 31, 1999 and 1998 states that there is
substantial doubt as to the ability of the Company to continue as a going
concern.
The Company has required substantial working capital to fund its
operations. To date, the Company has financed its operations principally through
the net proceeds from its initial public offering and other debt and equity
financings. The Company's ability to continue as a going concern is dependent
upon numerous factors, including its ability to obtain additional financing, its
ability to increase its level of future revenues or its ability to reduce
operating expenses.
In an effort to obtain funds to satisfy the Company's cash
requirements, the Company entered into a financing agreement with Jolson
Merchant Partners Group LLC ("Jolson") on June 30, 2000, which provided funds of
$650,000 to the Company and a line of credit of $1,350,000. Through November 14,
2000, Jolson has advanced an aggregate of $1,150,000 to the Company.
The Company also executed a merger agreement on September 8, 2000, with
Upgrade International Corporation ("Upgrade") (OTCBB:UPGD) pursuant to which
Upgrade is
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to acquire 100% of the Company in an all-share transaction. The merger agreement
provides that Upgrade will provide debt financing to the Company for the period
between the date of the merger agreement and the closing of the merger. If the
stockholders of the Company approve the merger with Upgrade and the merger
closes, the funds advanced from Upgrade will increase the conversion ratio by
which the Common Stock of the Company will be converted into common stock of
Upgrade. If the stockholders do not approve the merger or the merger does not
otherwise close, the funds advanced by Upgrade will remain as debt that will
rank PARI PASSU with the funds borrowed from Jolson (discussed above). Through
November 14, 2000, Upgrade has advanced an aggregate of $2,230,000 to the
Company.
There can be no assurance that the Company will be able to obtain
additional financing, reduce expenses or successfully complete other steps to
continue as a going concern. If the Company is unable to obtain sufficient funds
to satisfy its cash requirements, it may be forced to curtail operations,
dispose of assets, or seek extended payment terms from its vendors. Such events
would materially and adversely affect the Company's financial position and
results of operations.
GENERAL
The Company designs, markets and services custom smart card
applications and services. The Company develops unique solutions for creating
and processing data and ensuring secure electronic transactions by utilizing
proprietary hardware and application software systems. 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 has integrated with its
smart card applications.
The Company was organized in 1993 as a Washington corporation whose
operations are the successor to Pathways International, Ltd., which was
incorporated in Washington in June 1988. The Company reincorporated in Delaware
in May 1997. The Company's executive offices are located at 14201 NE 200th
Street, Woodinville, Washington 98072, and its telephone number is (425)
483-3411. The Company also has a sales, marketing and research and development
office located at 1221 North Dutton Avenue, Santa Rosa, California 95401. A
sales and marketing office is located at Grosvenor Center, 2500 Makai Tower, 733
Bishop Street, Honolulu, Hawaii 96813. The Company also formed The Pathways
Group GmbH, a corporation organized under the laws of the Republic of Austria,
which is to have offices located in Vienna. The Company does not currently have
any active operations in Austria.
The Company signed an agreement in April 2000 to acquire SmartCard
Solutions, Inc., a privately held technology services company based in Aspen,
Colorado, in a stock-for-stock transaction. SmartCard Solutions has developed an
information management system that facilitates point-of-sale ticketing and
season passes for resorts, advanced sales, retail and rental purchasing
(including inventory control and back office auditing), financial reporting and
access control. The system is currently in use at several prominent Rocky
Mountain resort areas where approximately 3.5 million transactions per season
are processed. As consideration for the acquisition of Smart Card Solutions, the
Company has agreed to issue up to 1,900,000 shares of
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its Common Stock upon completion of the closing conditions at a price of $1.00
per share. The acquisition closed on August 21, 2000.
The Company also signed an agreement in April 2000 to purchase MS
Digital, Inc., a privately-held corporation based in Washington that specializes
in customized multi-media communications systems. The acquisition is a
stock-for-stock transaction in which the Company issued 2,425,000 shares of
Common Stock to the shareholders of MS Digital. The Company issued 1,200,000
shares at $1.25 per share and the remaining 1,225,000 shares at $1.22 per share.
The majority shareholder of MS Digital is Monte Strohl, who is a director and
Senior Vice President, Marketing and Sales, of the Company; the other two
shareholders are Jay Potts and Gary Baker, both of whom are employees of the
Company. This transaction was approved by the disinterested members of the Board
of Directors of the Company. MS Digital provides corporate communications, call
center information systems integrated with Lucent phone systems, cable
television information systems, point-of-sale information systems, interactive
kiosks, and multi-media presentations. Major cities in western Washington use MS
Digital's call system for their municipal television stations for display of
programming schedules, community events, election results, and emergency and
general information. Pathways will offer MS Digital's core technologies of
multi-media and web presentations to clients interested in high-quality
graphics, motion video, and animation, as part of an e-commerce site or
point-of-sale system. Pathways also plans to incorporate the call center portion
of MS Digital's products into operations of the Company's growing technical and
client support department as a way to increase customer service. Many of the
large communications companies with which MS Digital works currently utilize
card-based products for the marketing and sales of their services. MS Digital's
existing relationship with these companies will provide an opportunity for
marketing of Pathways' smart card technology to MS Digital's client base. The
acquisition closed on August 7, 2000.
The Company executed a merger agreement with Upgrade on September 8,
2000, pursuant to which Upgrade will acquire 100% of the Company in an all-share
transaction. The merger agreement provides that each stockholder of the Company
will receive one share of Upgrade common stock for each 14.3 shares of Company
common stock held by such stockholder, subject to certain adjustments based on
cash advances by Upgrade to the Company while the merger is pending. The
acquisition is subject to the receipt of all regulatory approvals and
stockholder approval.
As reported in the Company's Current Report on Form 8-K that was
filed with the Securities and Exchange Commission on October 27, 2000, the
Company's independent accountants, PricewaterhouseCoopers LLP, resigned on
October 20, 2000. The Company is currently in the process of retaining a new
independent accountant, but has not been able to do so at this time.
Accordingly, the interim financial statements filed herewith have not been
reviewed by an independent accountant.
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. Revenues generated in
the three-month and nine-month periods ended September 30, 2000 primarily relate
to smart card sales, credit card processing fees and maintenance fees and
revenues from equipment leasing. Revenues in 1999 were related primarily to
credit card processing fees. Revenues increased $29,166 or 53% for the three
months ended September 30, 2000, compared to the corresponding period in 1999,
due to the revenue being generated by the Funtastic Traveling Shows. Revenues
increased $69,008, or 61%, for the nine months ended September
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30, 2000 compared to the same period in 1999, due to an increase in smart card
sales of $42,000 and equipment leasing revenues of $18,183.
In late 1997 and during 1998, the Company developed an upgraded version
of its unattended kiosk to accommodate acceptance and vending of smart cards and
also engineered and developed an indoor kiosk to be utilized as a smart card
recharge device. The Company began marketing efforts of its new indoor and
outdoor kiosk products in the first quarter of 1999. The Company has also
changed its marketing strategy for its unattended kiosks. Previously, the
Company leased the kiosks to a customer and collected gross transaction charges
of approximately 5% throughout the lease term. The Company's current marketing
strategy is to sell the kiosk to a customer for cash and collect ongoing gross
transaction fees of approximately 1.75% to 2.00%. The Company believes this
model is more profitable and eliminates negative cash flow required to install
and sell the kiosk products.
The Company has installed its Tikitbox II unattended ticketing systems
at the following locations:
Winter Park Ski Resort in Colorado
Six Flags Great Adventure in New Jersey
Six Flags Magic Mountain Amusement Parks in California.
Blue & Gold Fleet in San Francisco
Deer Valley Ski Area in Utah
Big Mountain Ski Resort in Montana
In May 1999, the Company entered into a License Agreement with Proton
World International, S.A. of Brussels, Belgium. The Company intends to
incorporate this technology into its core product offerings, which will require
substantial investments in the following: up front licensing fees; ongoing
royalty fees; expenditures on training, certification, maintenance and support
services; expansion of computer hardware at its transaction processing centers;
and additional technical and marketing staff to capitalize on the market
opportunity the Company believes has been created as a result of the License
Agreement.
In July 1999, the Company signed agreements with the State of Hawaii
Millennium Commission to design, develop and maintain the official website for
its Hawaii millennium celebration, and to be the official transaction processor
for the transactions over the website. In addition, the Company will issue
commemorative smart cards to be used for discounts, promotions and ticketing to
special events.
In August 1999 the Company signed an agreement with Funtastic
Travelling Shows, one of the largest carnival operators in the United States, to
implement a smart card system that removes all cash from the midway. In October
1999, the Company sold 5,000 smart cards ($20,000) to Funtastic and successfully
installed and operated the system at a carnival in San Bruno, California. Based
upon the success of this pilot, the Company and Funtastic agreed to a limited
rollout to three additional venues in November 1999. In January 2000, the
Company signed an additional contract with Funtastic for the sale of 4,000
additional smart cards, the rental of thirty-eight terminals, and monthly
maintenance fees for the terminals. In June 2000,
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the Company signed another contract with Funtastic for the sale of 14,000
additional smart cards, the rental of nine printers, seventy-five terminals, and
a charge per transaction.
In January 2000, the Company signed a contract with Sun Valley Company
to install three unattended ticketing kiosks for the winter ski season. The
Company waived transaction processing fees and maintenance fees for the first
season of use in exchange for an agreement by Sun Valley to purchase additional
equipment from the Company, and to pay transaction and maintenance fees for
future seasons.
In June 2000, the Company signed a contract with Nietech Corporation to
provide transaction processing for an electronic retail coupon program to be
conducted by Nietech's "CommunityCoupon.com" division. The CommunityCoupon.com
program currently operates a paper-based coupon program that benefits non-profit
organizations in Sonoma County, California, when the coupons are redeemed by
consumers at participating local merchants. There are currently 200 merchants
participating in the CommunityCoupon.com programs, with an anticipated increase
in excess of 4,000 merchants by year end.
In August 2000, the Company signed a contract with Tacoma Public
Schools in Tacoma, Washington, to provide the district with a cPortal integrated
education/cable solution. The solution gives the district the ability to
coordinate dissemination of multi-media content over the cable information
system serving the district's more than 50 schools.
In September 2000, the Company signed a contract to provide cPortal
municipal cable television solution to the city of Burien, Washington. The
system will give the city the ability to create content for a government access
channel over a municipal cable system. The Company also signed a contract with
Metaforia, a Montreal-based company, to provide an enterprise-wide ticketing and
retail sales system for a virtual reality entertainment center under development
by Metaforia in Montreal. The complex is scheduled to open in the fall of 2000.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $224,033, or 15%, during the three months
ended September 30, 2000, and increased $1,433,715, or 32%, during the nine
months ended September 30, 2000, as compared to the corresponding periods in
1999. The increase experienced in the first nine months is primarily the result
of an increase in payroll. The Company had 50 full-time employees at September
30, 2000, as compared to 55 on September 30, 1999, and 63 at the end of 1999.
The increase is due largely to the hiring of certain key senior managers in
November 1999, which the Company believes will improve the Company's strategic
position. The increase is also due to the renewal of employment contracts with
the Company's Chief Executive Officer and Executive Vice President, both of whom
received salary increases that the Company believes compensates these executives
adequately in light of the commitment they have made to the Company.
Rent, office and facility expenses increased $1,685, or 1%, during the
three months ended September 30, 2000, and increased $15,206, or 2%, during the
nine months ended September 30, 2000, as compared to the corresponding period in
1999. Marketing, selling and travel related expenses decreased $25,046, or 13%,
during the three months ended September 30, 2000, and increased $106,521, or
17%, during the nine months ended September 30, 2000.
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Professional and public company related expenses increased $140,810, or 118%,
during the three months ended September 30, 2000, and increased $274,478, or
78%, during the nine months ended September 30, 2000. This increase was due to
an increase in SEC filings and the related services of our auditors and SEC
lawyers in connection with the completion of these filings. Other selling,
general and administrative costs decreased $22,131, or 13%, during the three
months ended September 30, 2000, and increased $123,912, or 26%, during the nine
months ended June 30. This increase was primarily due to increased investor
relations costs.
The level of selling, general and administrative costs is expected to
continue to increase, although at a reduced rate, as a result of ongoing
marketing and customer support activities, and an increase in the number of
operating and technical personnel necessary to support the Company's expected
sales, product development, and customer support activities.
Below is a detail of the changes in selling, general, and
administrative expenses in major categories for the three-month and nine-month
periods ended September 30, 2000 and 1999:
<TABLE>
<CAPTION>
Increase for the three months Increase for the nine months
ended 9/30/00 vs. the three ended 9/30/00 vs. the nine
months ended 9/30/99 months ended 9/30/99
<S> <C> <C>
SG&A Increase attributable to:
Payroll and payroll related expenses $128,715 $913,598
Rent, office, and facility (including equipment) $1,685 $15,206
expenses
Marketing, selling, and travel related expenses $(25,046) $106,521
Professional and public company related expenses $140,810 $274,478
Other SG&A related expenses $(22,131) $123,912
Total Increase in SG&A $224,033 $1,433,715
</TABLE>
AMORTIZATION OF SOFTWARE COSTS. Amortization of software costs
decreased $107,107 in the three months ended September 30, 2000, and decreased
$117,778 in the nine months ended September 30, 2000, as compared to the same
period in 1999. The decrease is due to declining balances in software costs and
a decrease in the amount capitalized.
In accordance with prevailing standards 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.
DEPRECIATION. Depreciation increased $12,663 for the three-month period
ended September 30, 2000, and increased $66,450 for the nine-month period ended
September 30, 2000, as compared to the same periods in 1999, primarily due to
the purchase of assets for
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$209,742, which were leased, and the purchase of terminals for $104,000, which
are to be leased to a customer.
OTHER INCOME (EXPENSE). The Company had a net interest expense of
$366,065 in the nine month period ended September 30, 2000, as compared to a net
interest income of $36,703 in the nine month period ended September 30, 1999.
This decrease is due to the reduction in funds invested during that period, a
fee of $35,000 for funding which never materialized, and an increase in interest
and loan fee expenses. Other expenses also increased due to revaluing the assets
and goodwill of MS Digital and SmartCard Solutions. The amounts of these
expenses at September 30, 2000 are $56,185 for assets and $149,620 for goodwill.
RESEARCH AND DEVELOPMENT. Research and development increased $17,194 in
the three-month period ended September 30, 2000, and increased $130,442 in the
nine-month period ended September 30, 2000, as compared to the same periods in
1999. The increase in 2000 over 1999 reflects increases in programming staff and
their related research and development efforts, and expenditures on equipment
and software used for testing new product technologies and offerings.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital was $(6,544,788) at September 30, 2000,
and $(431,232) at December 31, 1999. The decrease in working capital at
September 30, 2000, compared to December 31, 1999 is due to the Company's net
loss in the first nine months of 2000, the resulting use of cash for operating
expenses, the payment of accrued expenses and the exchange of mandatorily
redeemable preferred stock for Series A Senior Secured Notes due on June 30,
2001.
The Company's capital expenditures for the nine months ended September
30, 2000, increased $216,161 compared to the same period in 1999. The increase
for the nine months ended September 30, 2000, is primarily due to the purchase
of assets for $209,742, which were leased, and the purchase of terminals for
$104,000, which are to be leased to a customer. The Company expects continued
investments in capital expenditures for increased personnel and transaction
processing infrastructure to support more complex operations and high volumes.
The Company closed a secured credit financing agreement with Jolson
Merchant Partners Group LLC on June 30, 2000 that provided the Company with
immediately available funds of $650,000 upon closing and $1,350,000 in funds
through a line of credit; the Company is entitled to draw under the line of
credit upon achieving certain milestones. Through November 14, 2000, the Company
has borrowed an aggregate of $1,150,000 under the Jolson credit facility. The
financing agreement requires that $200,000 under the line of credit be reserved
for interest payments. Hence, the available line of credit is now $650,000. The
Company has issued Series A Senior Secured Notes for the funds advanced under
the facility; the notes bear interest at 10% per annum and are due on June 30,
2001. The Company may prepay the notes without penalty. The Company also issued
warrants in connection with the financing; to date, the Company has issued to
Jolson warrants to acquire an aggregate of 1,501,667 shares of Common Stock; the
warrants are immediately exercisable and expire after three years. The strike
price of the warrants is $0.65 per share.
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As part of the financing agreement with Jolson, the holders of the
outstanding shares of Series A Preferred Stock agreed to exchange their shares
of Series A Preferred Stock for Series A Senior Secured Notes. The Company
issued Series A Senior Secured Notes in the aggregate amount of $3,225,000 in
exchange for the Series A Preferred Stock.
The signed merger agreement with Upgrade provides that the Company and
Upgrade are to agree on terms to provide interim debt financing for the Company
between the time when the merger agreement is executed and the closing of the
transaction. The merger agreement provides that the conversion ratio of the
Company's Common Stock into Upgrade's common stock will be increased based on
the funds advanced. Should the merger fail to close, the funds advanced shall
remains as debt that will rank PARI PASSU with the secured debt payable to
Jolson.
As previously reported, the Company signed an agreement in March 2000
with an investment banking firm pursuant to which the firm would arrange for a
$1.5 million bridge financing and a $15 million equity financing on a best
efforts basis. These transactions were never finalized.
The Company commenced an offshore offering in November 1999 to non-U.S.
investors pursuant to Regulation S of the Securities Act of 1933, as amended,
for up to 4,000,000 shares of Common Stock. The Company engaged advice!
International GmbH of Vienna, Austria, as placement agent in connection with the
offering. As of September 30, 2000, the Company had sold 2,762,700 shares of
Common Stock in connection with the offering, with net proceeds to the Company
of $5,303,202, at prices ranging from $1.00 to $3.25 per share. The Regulation S
offering has been terminated, as no further sales of shares will be made
pursuant thereto.
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 debt or 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 achieve
sales of the magnitude to generate sufficient cash flow from operations to
continue to execute its business plans. In the event the Company is unable to
generate significant revenues from the rollout of its current contracts 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. There
can be no assurance that, if needed, additional financing will be available on
acceptable terms to the Company, if at all.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission released SEC
Staff Accounting Bulletin No. 101 - Revenue Recognition in Financial Statements.
This pronouncement summarizes certain of the SEC Staff's views on applying
generally accepted accounting principles to revenue recognition. SAB 101B, an
amendment to SAB 101, provides
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that the Company must implement SAB 101 for its fiscal year ended December 31,
2000. The Company is in the process of reviewing the impact of adoption of SAB
101 on its financial statements.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
Certain statements contained in this quarterly 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 periodic reports filed pursuant to the Securities Exchange Act of
1934, as amended, including the Company's annual report on Form 10K for the
fiscal year ended December 31, 1999, which has been previously filed with the
Securities and Exchange Commission. These risks and uncertainties include,
without limitation:
o The ability of the Company to continue as a going concern
o Closing the proposed merger with Upgrade
o The rate of market development and acceptance of smart card
technology
o The unpredictability of the Company's sale 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
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 and software licenses
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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.
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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company issued an aggregate of 2,425,000 shares to the shareholders
of MS Digital, Inc. as consideration for the Company's acquisition of the
outstanding shares of capital stock of MS Digital. The three shareholders of MS
Digital were Monte Strohl, who is a director and Senior Vice President of the
Company, and Jay Potts and Gary Baker, both of whom are also employees of the
Company. The Company believes the issuance of the shares of Common Stock to
these individuals is exempt under Section 4(2) of the Securities Act of 1933, as
amended; Mr. Strohl is a director and executive officer of the Company, and
Messrs. Potts and Baker are employees of the Company and had access to
information needed to conduct any due diligence. The acquisition closed on
August 7, 2000.
The Company signed an agreement in April 2000 to acquire SmartCard
Solutions, Inc., a privately held technology services company based in Aspen,
Colorado, in a stock-for-stock transaction. As consideration for the acquisition
of Smart Card Solutions, the Company has agreed to issue up to 1,900,000 shares
of its Common Stock upon completion of the closing conditions. The Company
believes the issuance of the shares of Common Stock as consideration for the
acquisition of Smart Card Solutions is exempt under Section 4(2) of the
Securities Act of 1933, as amended, based on representations made by the Seller
that it is not acquiring the securities with a view to a distribution. The
acquisition closed on August 21, 2000.
The Company entered into a financing agreement with Jolson Merchant
Partners Group LLC ("Jolson"), which closed on June 30, 2000, and provided
immediately available funds of $650,000 on closing date and a $1,350,000 line of
credit, subject to certain conditions. On the date of closing, the Company
issued Series A Senior Secured Notes in the aggregate amount of $650,000 and
warrants to acquire 965,000 shares of the Company's Common Stock at a price of
$0.65 per share. The Company borrowed additional funds under the line of credit
with Jolson on July 14, 2000, and issued additional Series A Senior Secured
Notes in the aggregate amount of $700,000 and warrants to acquire 536,667 shares
of Common Stock. The Company issued Series A Senior Secured Notes for the funds
advanced under the facility; the notes bear interest at 10% per annum and are
due on June 30, 2001. The Company may prepay the notes without penalty. The
Company also issued warrants in connection with the financing; to date, the
Company has issued to Jolson warrants to acquire an aggregate of 1,501,667
shares of Common Stock; the warrants are immediately exercisable and expire
after three years. The strike price of the warrants is $0.65 per share.
As part of the financing agreement with Jolson, the holders of the
outstanding shares of Series A Preferred Stock agreed to exchange their shares
of Series A Preferred Stock for Series A Senior Secured Notes. The Company
issued Series A Senior Secured Notes in the aggregate amount of $3,225,000 in
exchange for the Series A Preferred Stock. Jolson and an
11
<PAGE>
affiliate of Jolson were two of the four holders of the outstanding shares of
Series A Preferred Stock. In addition, the Company agreed to reprice the
exercise price of warrants originally issued in 1999 to the holders of the
Series A Preferred Stock from $2.50 per share to $0.65 per share. Carey F. Daly,
II, the President and Chief Executive Officer of the Company, also agreed, as a
condition of the Jolson financing, to convert funds advanced by him to the
Company into equity at $1.00 per share. The Company issued 260,000 shares of
Common Stock to Mr. Daly in satisfaction of $260,000 of such debt.
Each holder of the Series A Senior Secured Notes are entitled to vote
based on the number of warrants held by such holder. These voting rights are
continued from the voting rights granted to such holders when the Series A
Preferred Stock and warrants were originally issued in 1999.
The Company believes that the issuance of the Series A Senior Secured
Notes to Jolson, the exchange of the Series A Preferred Stock for Series A
Senior Secured Notes and the issuance of warrants is exempt pursuant to Section
4(2) of the Securities Act of 1933, as amended. Jolson is an institutional
investor, the securities issued in exchange for the Series A Preferred Stock
were issued to only four accredited investors, two of which were Jolson and an
affiliate and Jolson, and all of whom had had full access to the Company's
senior management to conduct any due diligence prior to acquiring the
securities. In addition, the Company believes that the issuance of the 260,000
shares to Mr. Daly is exempt under Section 4(2) of the Securities Act of 1933,
as amended, because Mr. Daly is an executive officer of the Company.
The Company commenced an offshore offering in November 1999 to non-U.S.
investors pursuant to Regulation S of the Securities Act of 1933, as amended,
for up to 4,000,000 shares of Common Stock. The Company engaged Advice!
International GmbH of Vienna, Austria, as placement agent in connection with the
offering. As of June 30, 2000, the Company had sold 2,762,700 shares of Common
Stock in connection with the offering, with net proceeds to the Company of
$5,303,202, at prices ranging from $1.00 to $3.25 per share. The Regulation S
offering has been terminated, as no further sales of shares will be made
pursuant thereto. The Company has filed a registration statement with respect to
such shares.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
The Company entered into a merger agreement with Upgrade International
Corporation ("Upgrade") on September 8, 2000, pursuant to which Upgrade will
acquire 100% of the Company in an all-share transaction. The merger agreement
provides that each stockholder of the Company will receive one share of Upgrade
common stock for each 14.3 shares of Company common stock held by such
stockholder, subject to certain adjustments based on cash
12
<PAGE>
advances by Upgrade to the Company while the merger is pending. The acquisition
is subject to the receipt of all regulatory approvals and stockholder approval.
Mr. Robert Fishman resigned from the Company's Board of Directors on
August 23, 2000. Mr. Fishman did not have any disagreement with the Company
relating to the Company's operations, policies or practices.
On October 25, 2000, Nasdaq notified the Company that Nasdaq was
delisting the Company's Common Stock from the SmallCap Market due to the failure
of Pathways to meet the continued listing criteria of the SmallCap Market. The
Company's Common Stock now trades on the Over-The-Counter Bulletin Board.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 10.1 Agreement of Purchase and Sale of Stock entered
into in connection with acquisition of SmartCard
Solutions, Inc. (1)
Exhibit 10.2 Amendment No. 1 to Agreement of Purchase and Sale
of Stock (2)
Exhibit 10.3 Agreement of Purchase and Sale of Stock entered
into in connection with acquisition of MS Digital,
Inc. (1)
Exhibit 10.4 Waiver and Consent to Agreement of Purchase and
Sale of Stock executed by Monte P. Strohl (2)
Exhibit 10.5 Agreement with Hawaiian Millenium Commission (3)
Exhibit 10.6 License Agreement with Proton World International,
S.A. (4)
Exhibit 10.7 Financing Agreement between the Company, Carey F.
Daly, II, Jolson Merchant Partners Group, LLC and
Harvest Opportunity Partners LP (2)
Exhibit 10.8 First Amendment to Financing Agreement (2)
Exhibit 10.9 Security Agreement between the Company, Jolson
Merchant Partners Group LLC and Harvest
Opportunity Partners LP (2)
Exhibit 10.10 Form of Series A Senior Secured Note issued to
Jolson Merchant Partners LLC and the holders of
Series A Preferred Stock (2)
Exhibit 10.11 Form of Amended and Restated Warrant (represents
the warrants issued to Jolson Merchant Partners
Group LLC pursuant to
13
<PAGE>
the Financing Agreement and the warrant issued in
connection with the repricing of the warrants held
by the holders of the Series A Preferred Stock)
(2)
Exhibit 10.12 Pathways Midway-Cash Card System Agreement,
between The Pathways Group, Inc., and Funtastic
Rides Company Inc. (2) (Certain portions of this
Exhibit have been omitted based upon a request for
confidential treatment pursuant to Rule 24B-2
under the Securities Exchange Act of 1934, as
amended. Omitted portions have been filed
separately with the Securities and Exchange
Commission)
Exhibit 10.13 Amendment No. 1, dated February 14, 2000, to
Pathways Midway Cash Card Agreement (2)
Exhibit 10.14 Amendment No. 2, dated June 5, 2000, to Pathways
Midway Cash Card Agreement (2) (Certain portions
of this Exhibit have been omitted based upon a
request for confidential treatment pursuant to
Rule 24B-2 under the Securities Exchange Act of
1934, as amended. Omitted portions have been filed
separately with the Securities and Exchange
Commission)
Exhibit 10.15 Amendment No. 3, Dated July 11, 2000, to Pathways
Midway Cash Card Agreement (2) (Certain portions
of this Exhibit have been omitted based upon a
request for confidential treatment pursuant to
Rule 24B-2 under the Securities Exchange Act of
1934, as amended. Omitted portions have been filed
separately with the Securities and Exchange
Commission)
Exhibit 10.16 Agreement and Plan of Reorganization, dated
September 8, 200, between Upgrade International
Corporation, Upgrade Acquisition, Inc. and the
Company (filed herewith)
Exhibit 27 Financial Data Schedule (filed herewith)
(1) Incorporated herein by reference to the exhibit contained in the
Company's Quarterly Report on Form 10Q for the quarter ended March
31, 2000.
14
<PAGE>
(2) Incorporated herein by reference to the exhibit contained in the
Company's Quarterly Report on Form 10Q for the quarter ended June
30, 2000.
(3) Incorporated herein by reference to the exhibit contained in the
Company's Quarterly Report on Form 10Q for the quarter ended June
30, 1999.
(4) Incorporated herein by reference to the exhibit contained in the
Company's Annual Report on Form 10K for the fiscal year ended
December 31, 1999.
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K on July 13, 2000,
which reported that the Company had signed a letter of intent with Upgrade
International Corporation regarding the proposed merger.
The Company filed a Current Report on Form 8-K on October 20, 2000
that filed audited and pro forma financial statements regarding the Company's
acquisition of MS Digital, Inc. and Smart Card Solutions, Inc.
The Company filed a Current Report on Form 8-K on October 27, 2000
that reported the resignation of the Company's auditors, PricewaterhouseCoopers
LLP.
15
<PAGE>
THE PATHWAYS GROUP, INC.
Index to Condensed Consolidated Financial Statements (Unaudited)
for the Fiscal Quarter Ended June 30, 2000
Condensed Consolidated Balance Sheets F-2
Condensed Consolidated Statements of Operations F-3
Condensed Consolidated Statements of Cash Flows F-4
Notes to Condensed Consolidated Financial Statements F-5
F-1
<PAGE>
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
ASSETS
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------ ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 230,539 $ 645,065
Accounts 81,231 5,523
Inventories 426,396 338,438
Prepaid expenses and deposits 2,137,250 260,664
------------ ------------
Total current assets 2,875,416 1,249,690
Restricted cash 22,000 272,000
Software, net 589,085 666,283
Property and equipment, net 1,054,594 1,003,231
Software license 1,000,000 1,000,000
Deposits and other assets 118,079 85,481
------------ ------------
TOTAL ASSETS $ 5,659,174 $ 4,276,685
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable to banks, current maturities $ 7,266,775 $ 108,908
Accounts payable 1,151,781 319,646
Accrued expenses and deferred revenue 301,648 552,368
Software license fee payable 700,000 700,000
------------ ------------
TOTAL CURRENT LIABILITIES 9,420,204 1,680,922
Notes payable to banks, net of current maturities 234,931 60,781
------------ ------------
TOTAL LIABILITIES 9,655,135 1,741,703
------------ ------------
Commitments and Contingencies
MANDITORILY REDEEMABLE PREFERRED STOCK
Preferred stock, Series A mandatorily redeemable, $.01 par value;
1,000,000 shares authorized; 300,000 shares issued and none outstanding;
0 1,489,527
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; 50,000,000 shares authorized;
18,215,062 issued and outstanding at September 30, 2000 206,401 144,109
Common Stock Warrants from Financing 1,512,651 0
Common Stock Warrants Issued as Dividends 57,728 0
Additional paid in capital 31,854,496 30,639,640
Unearned compensation (298,295) (495,833)
Accumulated deficit (37,328,942) (29,242,461)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY (3,995,961) 1,045,455
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 5,659,174 $ 4,276,685
============ ============
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
F-2
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2000 1999
------------ ------------
<S> <C> <C>
Sales, net $ 84,317 $ 55,151
Direct cost of sales 1,596 13,790
Selling, general and administrative expenses 1,712,465 1,488,432
Research and development 179,656 162,462
Amortization of software 91,252 198,359
Depreciation 131,035 118,372
------------ ------------
Total operating expenses 2,116,004 1,981,415
------------ ------------
Loss from operations (2,031,687) (1,926,264)
Interest income (expense), net (525,960) (2,698)
------------ ------------
NET LOSS $ (2,557,647) $ (1,928,962)
============ ============
Basic and diluted net loss per share $ (0.14) $ (0.15)
Shares used in per share calculations 17,738,432 13,565,662
<CAPTION>
FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2000 1999
------------ ------------
<S> <C> <C>
Sales, net $ 181,809 $ 112,801
Direct cost of sales 69,696 24,275
Selling, general and administrative expenses 5,896,165 4,462,449
Research and development 645,130 514,688
Amortization of software & intangibles 458,135 575,913
Depreciation 419,536 353,086
------------ ------------
Total operating expenses 7,488,662 5,930,411
------------ ------------
Loss from operations (7,306,853) (5,817,610)
Interest income (expense), net (571,869) 36,703
------------ ------------
NET LOSS $ (7,878,722) $ (5,780,907)
============ ============
Basic and diluted net loss per share $ (0.49) $ (0.43)
Shares used in per share calculations 16,238,016 13,565,662
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2000 1999
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(7,878,722) $(5,780,907)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation 419,536 353,086
Amortization of software 452,545 575,913
Amortization of intangibles 61,798 0
Amortization of non-cash prepaid loan interest/fees 269,536 0
Amortization of unearned compensation 110,038
Effects of changes in operating assets and liabilities:
Accounts receivable (75,708) (18,108)
Inventories (187,958) (58,942)
Prepaid expenses and deposits (580,883) 102,119
Accounts payable 818,422 302,442
Accrued expenses (250,721) (630,580)
----------- -----------
Net cash used in operating activities (6,842,117) (5,154,977)
----------- -----------
Cash flows from investing activities:
Capital expenditures (470,899) (282,868)
Capitalized software development costs (375,347) (172,416)
Restricted Cash 250,000 (50,000)
Software license (300,000)
Other assets 11,812 (16,136)
----------- -----------
Net cash used in investing activities (584,434) (821,420)
----------- -----------
Cash flows from financing activities:
Proceeds from issuing common stock 2,647,625 0
Proceeds from issuing preferred stock 0 2,946,863
Proceeds from long term financing 53,455 0
Proceeds from short term financing 314,171 0
Proceeds from stockholder loans 360,000 0
Proceeds from series A senior secured notes 3,730,000 0
Principal payments on notes payable to banks (93,226) (312,640)
----------- -----------
Net cash used in financing activities 7,012,025 2,634,223
----------- -----------
Decrease in cash and cash equivalents (414,526) (3,342,174)
Cash and cash equivalents, beginning of year 645,065 4,628,544
----------- -----------
Cash and cash equivalents, end of period $ 230,539 $ 1,286,370
=========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. UNAUDITED INTERIM FINANCIAL INFORMATION
The accompanying consolidated financial statements are unaudited, but
include all adjustments (consisting only of normal recurring adjustments) which
are, in the opinion of management, necessary for a fair presentation of the
financial position at such dates and of the operations and cash flows for the
periods then ended. The financial information is presented in a condensed
format, and it does not include all of the footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles. Operating results for the periods ended September 30,
2000 and 1999 are not necessarily indicative of results that may be expected for
the entire year. The preparation of financial statements requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities and reported
amounts of revenue and expenses during the reporting period. Actual results
could differ materially from such assumptions and estimates. The accompanying
financial statements and related footnotes should be read in conjunction with
the Company's audited financial statements, included in its annual report on
Form 10-K for the fiscal year ended December 31, 1999, filed with the Securities
and Exchange Commission.
2. THE COMPANY
The accompanying consolidated financial statements include the accounts of
The Pathways Group, Inc. ("TPG") and its wholly owned subsidiaries. All
intercompany balances and transactions have been eliminated. TPG's subsidiaries
include Pathways International, Ltd. ("PIL"), SPRINTICKET, Inc. ("ST"), PT Link,
Inc. ("PT Link") and The Pathways Group, Inc., a wholly owned subsidiary
incorporated in the State of Hawaii. TPG and its subsidiaries (the "Company")
are primarily engaged in providing specialized transaction processing services
through the development of proprietary software and hardware systems including
credit card and multiple application smart card technologies. The Company
derives its revenue principally from transaction processing fees charged to the
merchant and the sale of related terminals, hardware systems and smart cards.
The Company has invested heavily in designing and developing its proprietary
hardware and application software systems and in establishing and expanding its
sales and marketing capabilities. The Company plans to continue these efforts in
preparation for, and in anticipation of, the growth in smart card-based
electronic commerce that the Company anticipates will create a substantial
market for its data and transaction processing services.
The report of the Company's independent accountants on the Company's
financial statements for the fiscal years ended December 31, 1999 and 1998
states that there is substantial doubt as to the ability of the Company to
continue as a going concern.
The Company has required substantial working capital to fund its
operations. To date, the Company has financed its operations principally through
the net proceeds from its initial public offering, and other debt and equity
financings. The Company's ability to continue as a going concern is dependent
upon numerous factors, including its ability to obtain additional
F-5
<PAGE>
financing, its ability to increase its level of future revenues or its ability
to reduce operating expenses.
In an effort to obtain funds to satisfy the Company's cash requirements,
the Company entered into a financing agreement with Jolson Merchant Partners
Group LLC ("Jolson") on June 30, 2000, which provided funds of $650,000 to the
Company and a line of credit of $1,350,000.
The Company also executed a merger agreement on September 8, 2000, with
Upgrade International Corporation ("Upgrade") (Symbol: UPGD) pursuant to which
Upgrade will acquire 100% of the Company in an all-share transaction. This
agreement provides that the Company and Upgrade are to agree on an interim debt
financing plan. The funds advanced from Upgrade will increase the conversion
ratio by which the Common Stock of Pathways will be converted into common stock
of Upgrade. Should the merger fail to close, the funds advanced by Upgrade will
remain as debt that will rank PARI PASSU with the funds borrowed from Jolson.
Through November 10, 2000, Upgrade has advanced an aggregate of $2,230,000 to
the Company.
There can be no assurance that the Company will be able to obtain
additional financing, reduce expenses or successfully complete other steps to
continue as a going concern. If the Company is unable to obtain sufficient funds
to satisfy its cash requirements, it may be forced to curtail operations,
dispose of assets, or seek extended payments terms from its vendors. Such events
would materially and adversely affect the Company's financial position and
results of operations.
3. INVENTORIES
Inventories consisted of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 DECEMBER 31, 1999
------------------ -----------------
<S> <C> <C>
Smart cards and related packaging $ 74,149 $ 74,705
Smart card terminals and computer hardware 72,047 72,840
Assembled unattended kiosks and components 280,200 190,893
-------- --------
$426,396 $338,438
======== ========
</TABLE>
4. 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 as 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
and license may be reduced significantly in the near term. As a result, the
carrying amount of the capitalized software costs ($589,085) may be
F-6
<PAGE>
reduced entirely in the near term. In addition, the carrying amount of
long-lived assets may be reduced materially in the near term.
5. CAPITAL STOCK TRANSACTIONS
COMMON STOCK
In November 1999, the Company sold 845,200 shares of common stock through
a private placement at $2.73 per share. The net proceeds from the offering were
$2,151,675.
In the first two quarters of 2000, the Company sold 1,644,200 shares of
common stock through a private placement at prices ranging from $1.00 per share
to $2.50 per share. The net proceeds from the offering were $2,647,624.
In the second quarter of 2000, the President and Chief Executive Officer
converted a loan of $260,000 to 260,000 shares of common stock at $1.00 per
share.
In August 2000, the Company closed an agreement to purchase MS Digital,
Inc. The acquisition was a stock-for-stock transaction in which the Company
issued 2,425,000 shares of Common Stock to the shareholders of MS Digital. The
Company issued 1,200,000 shares at $1.25 per share and the remaining 1,225,000
shares at $1.22 per share.
F-7
<PAGE>
6. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
FOR THE FOR THE
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2000 1999
----------- -----------
<S> <C> <C>
Cash paid for interest $ 139,864 $ 26,576
Non-cash transactions:
Accretion of mandatorily redeemable preferred stock 292,494 0
Additional accretion of mandatorily redeemable preferred
stock in connection with exchange for series A senior
secured notes 1,292,979 0
Amortization of unearned compensation 110,040 0
Reversal of unearned compensation 87,500 0
Dividends in kind shares on Series A Preferred Stock 150,000 0
Issuance of common stock warrants in connection with
preferred stock dividends 57,758 0
Issuance of common stock warrants in connection with
exchange of mandatorily redeemable preferred stock
for series A senior secured notes 1,512,621 0
Issuance of common stock for purchasing MS Digital 1,673,250 0
Issuance of common stock for purchasing SmartCard
Solutions 1,482,000 0
Exchange of stockholder loan for common stock 260,000 0
Interest on fees payable for common stock subscription
Service 13,712 0
Discounts recorded on preferred stock 0 (1,445,244)
Value of warrants issued for investment banking fee 0 (253,681)
</TABLE>
7. BANK AGREEMENTS
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 34 months, and which
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. In June 1999, the Company amended its lease agreement with the bank.
Under the revised agreement, the bank reduced its minimum cash requirement from
$850,000 to $250,000, and the Company deposited an additional $50,000 in a
certificate of deposit with the bank as additional collateral for the lease
agreement. In March 2000, the Company terminated this lease obligation and
purchased the assets underlying the lease for $209,742. In connection with the
termination of the lease the bank released $40,258 of the Company's deposit.
F-8
<PAGE>
8. NET LOSS PER SHARE
Statement of Financial Accounting Standards No. 128 (SFAS No. 128),
"Earnings Per Share," requires the presentation of basic and diluted earnings
(loss) per share for all periods presented.
In accordance with SFAS No.128, basic net loss per share has been computed
using the weighted average number of shares of common stock outstanding during
the period. Basic and diluted net loss per share are the same for all periods
presented because impact of common stock equivalents is antidilutive.
A reconciliation of net loss used in the calculation of basic and diluted
net loss per share is as follows:
<TABLE>
<CAPTION>
Three months Three months Nine months Nine months
ended ended ended ended
September 30, September 30, September 30, September 30,
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net loss $ (2,557,647) $ (1,928,962) $ (7,878,722) $ (5,780,907)
Accretion of mandatorily redeemable preferred stock 0 (39,711) (292,494) (39,711)
Preferred stock dividends in kind 0 0 (150,000) 0
Preferred Stock dividends - warrants 0 0 (57,758) 0
Preferred Stock Dividend - conversion from 0 0 (1,292,979) 0
preferred stock to debt
Net loss for common stock $ (2,557,647) $ (1,968,673) $ (9,671,953) $ (5,820,618)
Weighted average shares of common stock
outstanding (shares used in computing basic and
diluted net loss per share) 17,738,432 13,565,662 16,238,016 13,565,662
Basic and diluted net loss per share $ (0.14) $ (0.15) $ (0.60) $ (0.43)
</TABLE>
9. SOFTWARE LICENSE AGREEMENT
In May 1999, the Company entered into a License Agreement (the "Proton
Agreement") with Proton World International S.A. As of September 30, 2000
licensing fees of $1,000,000 have been capitalized as Software License in the
balance sheet. This amount include $925,000 of license fees and $75,000 of
implied maintenance fees. Of this $1,000,000, $300,000 was due and paid at the
time of the signing of the agreement. The remaining balance of the licensing
fees are payable upon the initiation of a pilot project and upon the rollout of
the project as defined in the Proton Agreement. The term of the Proton Agreement
is 10 years, and automatically renews for successive periods of five years. The
Pilot Launch of the Licensee System was to occur by May, 2000, but is still in
progress. In the event that Proton is unable to complete the Pilot Launch, the
Company's deposit of $300,000 is refundable, and the Company will not be
obligated for additional payments to Proton. The Roll-Out Launch is to occur 12
months after the occurrence of the Pilot Launch.
The Company's amortization of the $925,000 license fees will be the
greater of the straight-line amortization over 2 years, or $0.37 per smart card
sold. The amortization of the
F-9
<PAGE>
implied maintenance fees will be straight line over a 6-month period. There was
no amortization expense recorded for the nine months ending September 30, 2000,
as the testing and acceptance of the system had not been completed and the
underlying system had not been placed into service.
10. ACQUISITIONS
The Company recently signed an agreement to acquire SmartCard Solutions,
Inc., a privately held technology services company based in Aspen, Colorado, in
a stock-for-stock transaction. The agreement was signed in April 2000 and closed
on August 21, 2000.
In April 2000, the Company signed an agreement to purchase MS Digital,
Inc., a privately held corporation based in Washington that specializes in
customized multi-media communications systems. The agreement was signed in April
2000 and closed on August 7, 2000.
11. SUBSEQUENT EVENT
In September, 2000, Upgrade International Corporation ("Upgrade") signed a
merger agreement with Pathways to acquire 100% of Pathways in an all share
transaction. The merger agreement provides that the stockholders of Pathways
receive one share of Upgrade for each 14.3 shares of Pathways held by such
stockholder, subject to adjustment based on the amount of funds advanced by
Upgrade to the Company while the merger is pending. The acquisition is subject
to regulatory approval and shareholder approval.
F-10
<PAGE>
SIGNATURE
In accordance with the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
THE PATHWAYS GROUP, INC.
By /s/ Carey F. Daly, II
---------------------------------------
Carey F. Daly, II
President, Chief Executive Officer
and Chairman
Date: November 14, 2000
