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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 June 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
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(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 ________
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 August 17, 2000:
17,485,062 shares of Common Stock, par value $0.01 per share.
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FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The financial statements for the Company's fiscal quarter
ended June 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.
The Company also executed a letter of intent with Upgrade
International Corporation ("Upgrade") (OTCBB:UPGD) pursuant to which Upgrade
will acquire 100% of the Company in an all-share transaction. The letter of
intent provides that the Company and Upgrade are to agree on an interim
financing plan. The funds advanced from Upgrade would
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increase the conversion ratio of Pathway's Common Stock into Upgrade's common
stock. Should the merger fail to close, the funds advanced by Upgrade would be
converted into debt that will rank PARI PASSU with the funds borrowed from
Jolson. Through August 15, 2000, Upgrade has advanced an aggregate of $735,000
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.
GENERAL
The Pathways Group, Inc. and its subsidiaries ("Pathways" or
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
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
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Company has agreed to issue 2,425,000 shares of Common Stock. The Company has
already issued 1,200,000 shares at $1.25 per share; the remaining 1,225,000
shares, which will be issued at $1.22 per share, still have not been issued, but
the Company expects that it will do so shortly. 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 letter of intent with Upgrade on July
11, 2000, pursuant to which Upgrade will acquire 100% of the Company in an
all-share transaction. Upgrade proposes that each stockholder of the Company
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 during the pendency of the merger. The
acquisition is subject to the negotiation of a definitive merger agreement, the
receipt of all regulatory approvals and stockholder approval.
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 six-month periods ended June 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 $11,212 or 22% for the three
months ended June 30, 2000, compared to the corresponding period in 1999, due to
the revenue being generated by the Funtastic Traveling Shows. Revenues increased
$39,842, or 69%, for the six months ended June 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, among other things, accommodate
acceptance and vending of smart cards and also engineered and developed an
indoor kiosk to be utilized as a smart card recharge device.
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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%. 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, 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
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agreement by Sun Valley to purchase additional equipment from the Company, and
to pay transaction and maintenance fees for future seasons.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general
and administrative expenses increased $605,704 or 40% during the three months
ended June 30, 2000, and increased $1,209,682 or 41% during the six months ended
June 30, 2000, as compared to the corresponding periods in 1999. The increase
experienced in the first six months is primarily the result of an increase in
payroll. The Company had 53 full-time employees at June 30, 2000, as compared to
54 on June 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 $13,838, or 7%,
during the three months ended June 30, 2000, and increased $13,521,or 3%, during
the six months ended June 30, 2000, as compared to the corresponding period in
1999. Marketing, selling and travel related expenses increased $24,802, or 9%,
during the three months ended June 30, 2000, and increased $131,567, or 30%,
during the six months ended June 30. This increase was primarily due to the
Company's marketing activities in Europe. Professional and public company
related expenses increased $110,462, or 79%, during the three months ended June
30, 2000, and increased $133,668, or 58%, during the six months ended June 30.
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 increased $87,680, or 53%,
during the three months ended June 30, 2000, and increased $146,043, or 47%,
during the six 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 six-month
periods ended June 30, 2000 and 1999:
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<TABLE>
<CAPTION>
Increase for the three Increase for the six
months ended June 30, months ended June 30,
2000 vs. the three 2000 vs. the six months
SG&A Increase attributable to: months ended June 30, ended June 30, 1999
1999
<S> <C> <C>
Payroll and payroll related expenses $368,960 $784,211
Rent, office, and facility (including equipment) expenses $13,838 $13,521
Marketing, selling, and travel related expenses $24,802 $131,567
Professional and public company related expenses $110,462 $133,668
Other SG&A related expenses $87,642 $146,715
Total Increase in SG&A $605,704 $1,209,682
</TABLE>
AMORTIZATION OF SOFTWARE COSTS. Amortization of software
costs increased $57,637 in the three months ended June 30, 2000 and decreased
$10,671 in the six months ended June 30, 2000, as compared to the same period
in 1999. The increase for the three month period is described in the next
paragraph. The decrease for the six month period 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. The Company believes its capitalized software is
impaired, and has written down its capitalized software to what it perceives
as its realizable value. The amount of this additional write-down made on
June 30, 2000 is $127,422. This amount is included with the amortization of
the software costs, netting in an overall decrease of $10,671 compared to the
same six month period ended June 30, 1999.
DEPRECIATION. Depreciation increased $24,861 for the
three-month period ended June 30, 2000, and increased $53,787 for the six-month
period ended June 30, 2000, as compared to the same periods in 1999, primarily
due to the purchase of assets for $209,743, which were leased, and the purchase
of terminals for $104,000, which are to be leased to a customer.
INTEREST INCOME (NET). The Company had a net interest expense
of $45,909 in the six month period ended June 30, 2000, as compared to a net
interest income of $39,043 in the six month period ended June 30, 1999. This
decrease is due to the reduction in funds invested during that period and a fee
of $35,000 for funding which never materialized.
RESEARCH AND DEVELOPMENT. Research and development increased
$19,727 in the three-month period ended June 30, 2000, and increased $113,248 in
the six-month period ended June 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.
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LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital was $(5,146,272) at June 30,
2000 and $(431,232) at December 31, 1999. The decrease in working capital at
June 30, 2000 compared to December 31, 1999 is due to the Company's
net loss in the first six 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 six months ended
June 30, 2000 increased $323,005 compared to the same period in 1999. The
increase for the six months ended June 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 August
15, 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.
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 letter of intent with Upgrade provides that the Company
and Upgrade are to agree on terms to provide interim financing for the Company
between the time when the merger agreement is executed and the closing of the
transaction. The letter of intent 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 be
converted to debt, which 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 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.
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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 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:
- The ability of the Company to continue as a going
concern
- Negotiating and closing the proposed merger with
Upgrade
- The rate of market development and acceptance of
smart card technology
- The unpredictability of the Company's sale cycle
- The limited revenues and significant operating losses
generated to date
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- The possibility of significant ongoing capital
requirements
- The loss of any significant customer
- The ability of the Company to compete successfully
with the other providers of smart cards and smart
card services
- The ability of the Company to secure additional
financing as and when necessary
- The ability of the Company to retain the services of
its key management, and to attract new members of the
management team
- The ability of the Company to effect and retain
appropriate patent, copyright and trademark
protection of its products
- The ability of the Company to achieve adequate levels
of revenue to recover its investment in capitalized
software development costs and software licenses
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 1,200,000 shares to the
shareholders of MS Digital, Inc. on August 7, 2000, as partial 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 has agreed to issue
an additional 1,225,000 shares as payment of the balance of the consideration
for the acquisition. 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 affiliate of Jolson were two of the four holders
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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 to 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 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 executed a letter of intent with Upgrade
International Corporation ("Upgrade") on July 11, 2000, pursuant to which
Upgrade will acquire 100% of the Company in an all-share transaction. Upgrade
proposes that each stockholder of the Company receive one share of Upgrade
common stock for each 14.3 shares of Company common stock held by such
stockholder. The acquisition is subject to the negotiation of a definitive
merger agreement, the receipt of all regulatory approvals and stockholder
approval.
11
<PAGE>
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
its Common Stock upon completion of the closing conditions.
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 has agreed to issue 2,425,000
shares of Common Stock. 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 Company executed a letter of intent with Upgrade
International Corporation ("Upgrade") on July 11, 2000, pursuant to which
Upgrade will acquire 100% of the Company in an all-share transaction. Upgrade
proposes that each stockholder of the Company receive one share of Upgrade
common stock for each 14.3 shares of Company common stock held by such
stockholder. The acquisition is subject to the negotiation of a definitive
merger agreement, the receipt of all regulatory approvals and stockholder
approval.
ITEM 6.EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 3.1 Certificate of Designations for
Series A Preferred Stock (1)
Exhibit 10.1 Agreement of Purchase and Sale of
Stock entered into in connection
with acquisition of SmartCard
Solutions, Inc. (2)
12
<PAGE>
Exhibit 10.2 [Amendment No. 1 to Agreement of
Purchase and Sale of Stock (filed
herewith)]
Exhibit 10.3 Agreement of Purchase and Sale of
Stock entered into in connection
with acquisition of MS Digital,
Inc. (2)
Exhibit 10.4 Waiver and Consent to Agreement
of Purchase and Sale of Stock
executed by Monte P. Strohl
(filed herewith)
Exhibit 10.5 Agreement with Hawaiian Millenium
Commission (1)
Exhibit 10.6 License Agreement with Proton
World International, S.A. (3)
Exhibit 10.7 Financing Agreement between the
Company, Carey F. Daly, II,
Jolson Merchant Partners Group,
LLC and Harvest Opportunity
Partners LP (filed herewith)
Exhibit 10.8 First Amendment to Financing
Agreement
Exhibit 10.9 Security Agreement between the
Company, Jolson Merchant Partners
Group LLC and Harvest Opportunity
Partners LP (filed herewith)
Exhibit 10.10 Form of Series A Senior Secured
Note issued to Jolson Merchant
Partners LLC and the holders of
Series A Preferred Stock(filed
herewith)
Exhibit 10.11 Form of Amended and Restated
Warrant (represents the warrants
issued to Jolson Merchant
Partners Group LLC pursuant to
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)
Exhibit 10.12 Pathways Midway-Cash Card System
Agreement, between The Pathways
Group, Inc., and Funtastic Rides
Company Inc. (filed herewith)
(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 # 1, dated
February 14, 2000, to Pathways
Midway Cash Card Agreement
(filed herewith)
Exhibit 10.14 Amendment #2, dated June 5, 2000
to Pathways Midway Cash Card
Agreement (filed herewith)
(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 #3, Dated July 11, 2000
to Pathways Midway Cash Card
Agreement (filed herewith)
(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 Letter of intent with Upgrade
International Corporation (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 June 30, 1999.
(2) Incorporated herein by reference to the exhibit contained in
the Company's Quarterly Report on Form 10Q for the quarter
ended March 31, 2000.
(3) 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.
13
<PAGE>
(b) Reports on Form 8-K
The Company filed a report on Form 8-K on July 13, 2000 that
reported the proposed merger with Upgrade International Corporation.
14
<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)
ASSETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
---- ----
<S> <C> <C>
Current assets:
Cash and cash equivalents $239,560 $645,065
Accounts receivable 66,638 5,523
Inventories 391,288 338,438
Prepaid expenses and deposits 814,234 260,664
------- -------
Total current assets 1,511,720 1,249,690
Restricted cash 22,000 272,000
Software, net 359,654 666,283
Property and equipment, net 1,140,282 1,003,231
Software license 1,000,000 1,000,000
Deposits and other assets 163,929 85,481
------- ------
TOTAL ASSETS $4,197,585 $4,276,685
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable to banks, current maturities $4,096,066 $108,908
Accounts payable 1,572,800 319,646
Accrued expenses and deferred revenue 289,126 552,368
Software license fee payable 700,000 700,000
------- -------
TOTAL CURRENT LIABILITIES 6,657,992 1,680,922
Notes payable to banks, net of current maturities 19,397 60,781
------ ------
TOTAL LIABILITIES 6,677,389 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;
16,315,062 issued and outstanding at June 30, 2000. 163,151 144,109
Common Stock Warrants from Financing 563,135 0
Common Stock Warrants Issued as Dividends 57,758 0
Additional paid in capital 31,841,538 30,639,640
Unearned compensation (334,091) (495,833)
Accumulated deficit (34,771,295) (29,242,461)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY (2,479,804) 1,045,455
----------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $4,197,585 $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
JUNE 30, 2000 JUNE 30, 1999
------------- -------------
<S> <C> <C>
Sales, net $ 62,610 $ 51,397
Direct cost of sales 51,847 10,181
Selling, general and administrative expenses 2,121,354 1,515,650
Research and development 228,768 209,041
Amortization of software 248,833 191,196
Depreciation 142,668 117,807
------- -------
Total operating expenses 2,793,470 2,043,875
--------- ---------
Loss from operations (2,730,860) (1,992,478)
Interest income (expense), net (39,050) 7,341
-------- -----
NET LOSS $ (2,769,910) $ (1,985,137)
============= =============
Basic and diluted net loss per share $ (0.27) $ (0.15)
Shares used in per share calculations 15,994,185 13,565,662
FOR THE SIX MONTHS ENDED
JUNE 30, 2000 JUNE 30, 1999
------------- -------------
Sales, net $ 97,492 $ 57,649
Direct cost of sales 68,100 10,485
Selling, general and administrative expenses 4,183,700 2,974,018
Research and development 465,474 352,226
Amortization of software and intangibles 366,883 377,554
Depreciation 288,501 234,714
------- -------
Total operating expenses 5,372,658 3,948,997
--------- ---------
Loss from operations (5,275,166) (3,891,348)
Interest income (expense), net (45,909) 39,403
-------- ------
NET LOSS $ (5,321,075) $ (3,851,945)
============= =============
Basic and diluted net loss per share $ (0.46) $ (0.28)
Shares used in per share calculations 15,479,565 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 SIX MONTHS ENDED
JUNE 30, 2000 JUNE 30, 1999
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(5,321,075) $(3,851,945)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation 288,501 234,714
Amortization of software 366,883 377,554
Amortization of unearned compensation 74,243
Effects of changes in operating assets and liabilities:
Accounts receivable (61,115) (40,516)
Inventories (52,850) (5,430)
Prepaid expenses and deposits 9,565 74,279
Accounts payable 1,239,441 172,738
Accrued expenses (263,243) (644,840)
--------- ---------
Net cash used in operating activities (3,719,650) (3,683,446)
----------- -----------
Cash flows from investing activities:
Capital expenditures (425,552) (102,547)
Capitalized software development costs (58,107) (135,111)
Restricted Cash 250,000 (50,000)
Software license (30,000)
Other assets (80,595) (12,646)
- --------
Net cash used in investing activities (314,254) (330,304)
--------- ---------
Cash flows from financing activities:
Proceeds from issuing common stock 2,647,624 0
Proceeds from stockholder loans 360,000 0
Proceeds from series A senior secured notes 650,000 0
Principal payments on notes payable to banks (29,225) (287,957)
------- ---------
Net cash used in financing activities 3,628,399 (287,957)
--------- ---------
Decrease in cash and cash equivalents (405,505) (4,301,707)
Cash and cash equivalents, beginning of year 645,065 4,628,544
------- ---------
Cash and cash equivalents, end of period $239,560 $326,837
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
</TABLE>
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 June 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 letter of intent with Upgrade
International Corporation ("Upgrade") (OTCBB:UPGD) pursuant to which Upgrade
will acquire 100% of the Company in an all-share transaction. The letter of
intent provides that the Company and Upgrade are to agree on an interim
financing plan. The funds advanced from Upgrade would increase the conversion
ratio of Pathway's Common Stock into Upgrade's common stock. Should the merger
fail to close, the funds advanced by Upgrade would be converted into debt that
will rank PARI PASSU with the funds borrowed from Jolson. As of August 15, 2000,
Upgrade has advanced an aggregate of $735,000 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
<TABLE>
<CAPTION>
Inventories consisted of the following:
JUNE 30, 2000 DECEMBER 31, 1999
------------- -----------------
<S> <C> <C>
Smart cards and related packaging $74,705 $74,705
Smart card terminals and computer hardware 94,211 72,840
Assembled unattended kiosks and components 222,372 190,893
------- -------
$391,288 $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 ($487,075) 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.
6. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
FOR THE FOR THE
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2000 JUNE 30, 1999
------------- -------------
<S> <C> <C>
Cash paid for interest $ 58,378 $ 17,509
Non-cash transactions:
Accretion of mandatorily redeemable preferred stock 292,494 0
Additional accretion of manditorily redeemable
preferred stock in connection with exchange for
series A senior secured notes 1,292,979 0
Amortization of unearned compensation 74,243 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 manditorily redeemable preferred
stock for series A senior secured notes 563,135 0
Exchange of Stockholder loan for common stock 260,000 0
</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-7
<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 Six months Six months
ended June 30, ended June 30, ended June 30, ended June 30,
2000 1999 2000 1999
-------------- -------------- ------------- -------------
<S> <C> <C> <C> <C>
Net loss $ (2,769,910) $ (1,985,137) $ (5,321,075) $ (1,985,137)
Accretion of mandatorily redeemable preferred stock (153,114) 0 (292,494) 0
Preferred stock dividends in kind (75,000) 0 (150,000) 0
Preferred Stock dividends - warrants (6,105) 0 (57,758) 0
Preferred Stock Dividend - conversion from preferred stock to debt (1,292,979) 0 (1,292,979) 0
Net loss for common stock $ (4,297,108) $ (1,985,137) $ (7,114,306) $ (1,985,137)
Weighted average shares of common stock outstanding (shares used in 15,994,185 13,565,662 15,479,565 13,565,662
computing basic and diluted net loss per share)
Basic and diluted net loss per share $ (0.27) $ (0.15) $ (0.46) $ (0.15)
</TABLE>
9. SOFTWARE LICENSE AGREEMENT
In May 1999, the Company entered into a License Agreement (the
"Agreement") with Proton World International S.A. As of June 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 Agreement. The term of the 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 implied maintenance fees will be
straight line over a 6-month period. This amortization will begin on April 1,
2000.
F-8
<PAGE>
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.
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.
11. SUBSEQUENT EVENT
In July, 2000, Upgrade International Corporation signed a
letter of intent to acquire 100% of The Pathways Group, Inc. in an all share
transaction. Upgrade proposes that the shareholders of The Pathways Group, Inc.
receive one Upgrade International Corp share for each 14.3 shares of The
Pathways Group, Inc. The acquisition is subject to further negotiation of a
definitive agreement and then shareholder approval.
F-9
<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: August 21, 2000
