8-K 1 a2028283z8-k.txt FORM 8-K -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 8-K CURRENT REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED): AUGUST 7, 2000 ------------------------ THE PATHWAYS GROUP, INC. (Exact Name of Registrant as Specified in Its Charter) DELAWARE 000-24119 91-1617556 ------------------------ ------------------------ ------------------------ (State or Other Jurisdiction (Commission (I.R.S. Employer of Incorporation) File Number) Identification No.)

14201 N.E. 200TH STREET, WOODINVILLE, WASHINGTON 98072 -------------------------------------------------------------------------------- (Address of Principal Executive Offices) (Zip Code) 425.483.3411 -------------------------------------------------------------------------------- (Registrant's Telephone Number, Including Area Code) -------------------------------------------------------------------------------- (Former name or former address, if changed since last report) -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS. MS DIGITAL, INC. On August 7, 2000, The Pathways Group, Inc. (the "Company") acquired all of the capital stock of MS Digital, Inc. ("MS Digital") in a stock-for-stock transaction in which the Company has issued a total of 2,425,000 shares of Common Stock. The Company issued the shares at the equivalent of $1.25 per share. The Company has registered 1,225,000 of the 2,425,000 shares issued to the MS Digital Stockholders. At the time of the acquisition, Monte Strohl, a director and the Company's Senior Vice President, Marketing and Sales, was the majority shareholder of MS Digital. Two other employees of the Company, Jay Potts and Gary Baker, were also shareholders of MS Digital. The acquisition was approved by the disinterested members of the Board of Directors of the Company. The assets of MS Digital include, but are not limited to, (i) cash on hand, (ii) accounts and accounts receivable, (iii) furniture and fixtures, equipment, and inventory in all forms, and (iv) contracts and contract rights. These assets are used in connection with MS Digital's business that specializes in customized multi-media communications systems. The company intends to continue such use of the assets of MS Digital. SMART CARD SOLUTIONS, INC. On August 21, 2000, the Company acquired all of the capital stock of Smart Card Solutions, Inc. ("Smart Card Solutions") a privately-held technology services company based in Aspen, Colorado. Smart Card 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 Company issued an aggregate of 1,9000,000 shares of its Common Stock at the equivalent of $1.00 per share. At the time of the acquisition, there was no relationship between Smart Card Solutions and the stockholders of Smart Card Solutions on the one hand and the Company or any of the Company's affiliates or any director or officer of the Company or any associate of any such director or officer on the other hand. The assets of Smart Card Solutions include, but are not limited to, (i) cash on hand, (ii) advances to officers, (iii) furniture and fixtures and equipment, and (iv) contracts and contract rights. These assets are used in connection with Smart Card Solutions' business of information management systems that facilitate point-of-sale ticketing, financial reporting and access control. The Company intends to continue such use of the assets of Smart Card Solutions. ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS. (a) FINANCIAL STATEMENTS OF BUSINESS ACQUIRED. MS DIGITAL.................................................. F-1 Independent Auditor's Report................................ F-1 Balance Sheets as of December 31, 1999 and 1998............. F-2 Statements of Income for the years ended December 31, 1999 and 1998.................................................... F-3 Statements of Changes in Owner's Equity, Partners' Capital and Stockholders' Equity for the years ended December 31, 1998 and 1999............................................... F-4 Statements of cash flow for the years ended December 31, 1999 and 1998............................................... F-5 Notes to the financial statements........................... F-6 SMART CARD SOLUTIONS........................................ F-9 Independent Auditor's Report................................ F-9 Balance Sheets as of December 31, 1999 and 1998............. F-10 Statements of Loss for the year ended December 31, 1999 and for the period from inception (June 16, 1998) to December 31, 1998........................................... F-11 Statements of Stockholders' Equity (deficit) for the year ended December 31, 1999 and the period from inception (June 16, 1998) to December 31, 1998........................ F-12 Statements of cash flow for the year ended December 31, 1999 and for the period from inception (June 16, 1998) to December 31, 1998........................................... F-13 Notes to the financial statements........................... F-14 (b) PRO FORMA FINANCIAL INFORMATION........................ P-1 Unaudited Pro Forma Financial Information................... P-1 Unaudited Pro Forma Condensed Balance Sheets as of June 30, 2000........................................................ P-2 Unaudited Pro Forma Condensed Statements of Operations for the year ended December 31, 1999]........................... P-3 Unaudited Pro Forma Condensed Statements six months ended June 30, 2000............................................... P-4 Notes....................................................... P-5

(c) EXHIBITS. Exhibit 10.1 Agreement of Purchase and Sale of Stock entered into in connection with acquisition of MS Digital, Inc. (Incorporated herein by reference to the exhibit contained in the Company's Quarterly Report on Form 10Q for the quarter ended March 31, 2000.) Exhibit 10.2 Agreement of Purchase and Sale of Stock entered into in connection with acquisition of Smart Card Solutions, Inc. (Incorporated herein by reference to the exhibit contained in the Company's Quarterly Report on Form 10Q for the quarter ended March 31, 2000.)

INDEPENDENT AUDITOR'S REPORT To the Board of Directors and Stockholders of MS Digital, Inc. I have audited the accompanying balance sheets of MS Digital, Inc. as of December 31, 1999 and 1998, and the related statements of income, owner's capital, partners' capital and stockholders' equity and cash flows for the years ended December 31, 1999 and 1998. These statements are the responsibility of the Company's management. My responsibility is to express an opinion on these financial statements based on my audits. Except as discussed in the following paragraph, I conducted my audits in accordance with the generally accepted auditing standards. Those standards require that I plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the management, as well as evaluating the overall financial statement presentation. I believe that my audits provide a reasonable basis for my opinion. I was unable to observe the taking of the physical count of the Company's inventory at December 31, 1999, nor was I able to satisfy myself as to the quantity of physical inventory by alternative means. The valuation and method used for the financial statements are described in Note D. In my opinion, except for the effect of such adjustments, if any, as might have been determined had I been able to observe the count of physical inventory, the financial statements referred to above present fairly, in all material respects, the financial position of MS Digital, Inc. as of December 31, 1999 and 1998 and the results of its operations and cash flows for the years ended December 31, 1999 and 1998 in conformity with the generally accepted accounting principles. MARC LUMER & COMPANY San Francisco, California September 05, 2000 F-1 MS DIGITAL, INC. BALANCE SHEETS DECEMBER 31, 1999 AND 1998

SEE NOTE A See accompanying notes and accountant's report F-2 MS DIGITAL INC. STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998

SEE NOTE A See accompanying notes and accountant's report F-3 MS DIGITAL, INC. STATEMENTS OF CHANGES IN OWNER'S EQUITY, PARTNERS' CAPITAL AND STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1999

SEE NOTE A See accompanying notes and accountant's report F-4 MS DIGITAL INC. STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998

See Note A See accompanying notes and accountant's report F-5 MS DIGITAL, INC. NOTES TO THE FINANCIAL STATEMENTS DECEMBER 31, 1999 AND 1998 NOTE A FORMATION OF THE COMPANY AND OPERATIONS MS Digital was formed in 1994 and operated as a sole proprietorship through December 31, 1998. On January 1,1999, the sole proprietor of MS Digital (the "first general partner") and one other person (the "second general partner") formed MS Digital, GP, a State of Washington general partnership. In connection with the formation of this partnership, the parties agreed that the value of the second general partner's contribution to MS Digital would be an increase in value such that the value of the first general partner's contribution and interest would be 85%, and the value of the second general partner's contribution and interest would be 15%. The assets and liabilities transferred to the partnership follow:

The Partnership's net loss for January 1, 1999 through December 15, 1999 is allocated to the partners' ownership interest percentage in accordance with the Partnership Agreement. On December 16, 1999, MS Digital was incorporated in the State of Washington under the name MS Digital, Inc. (the "Company"). All of the assets and liabilities of the partnership were transferred to MS Digital, Inc. in exchange for common stock in the Company. The Company has been in the business of providing communication solutions to corporations, call centers and government entities. The Company provides complete solutions, including initial project planning, vendor negotiations, project implementation, installation, custom computer hardware, training and support and service contracts. The primary solution is based on InfoChannel multimedia authoring software. InfoChannel has been the main revenue-producing product since the Company's inception. NOTE B SIGNIFICANT ACCOUNTING POLICIES FINANCIAL STATEMENT ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires the management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS The Company considers cash investments with maturity of three months or less at the time of purchase to be cash equivalents. F-6 MS DIGITAL, INC. NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 AND 1998 NOTE B SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation is computed on a straight-line basis over estimated useful lives of five to seven years. INCOME TAXES No provision for income taxes has been made for the years ended December 31, 1999 and 1998 financial statements. Pursuant to applicable regulation, all income or losses of the sole proprietorship and partnership are reportable by the individuals directly to the taxing authorities. No income was allocated or reported for the period from December 16, 1999 through December 31, 1999, therefore no provision for income tax was made for this period. CONCENTRATIONS OF CREDIT RISK Financial instruments, which potentially subject the company to credit risk, consist principally of cash balances greater than $100,000 deposited with a financial institution. The Company periodically reviews its cash policies and believes any potential accounting loss to be minimal. The balances at December 31, 1999 and 1998 in excess of the federal insured limit were $47,138 and $0, respectively. REVENUE RECOGNITION The Company recognizes revenue at the completion of each project. NOTE C ALLOWANCE FOR DOUBTFUL ACCOUNTS No provisions were made for doubtful accounts receivable as the balances at December 31,1999 and December 31, 1998 were considered fully collectible. NOTE D INVENTORY Inventory includes both hardware and software held for resale. The inventory is valued on the specific identification method. The value was reaffirmed in the merger agreement. See Note I. NOTE E PROPERTY AND EQUIPMENT Property and equipment consists of the following:

F-7 MS DIGITAL, INC. NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 AND 1998 NOTE E PROPERTY AND EQUIPMENT (CONTINUED) Depreciation expenses for the years ended December 31, 1999 and 1998 were $2,493 and $1,514, respectively. NOTE F GOODWILL In connection with the formation of the MS Digital partnership, the parties agreed that the value of the second general partner's contribution to MS Digital would be an increase in value such that the value of the first general partner's contribution and interest would be 85%, and the value of the second general partner's contribution and interest would be 15%. (SEE NOTE A). Such increase in the second general partner's capital generated goodwill in the partnership. Goodwill is being amortized on a straight-line basis over a period of 15 years. The amortization expense for the year ended December 31, 1999 was $412. NOTE G COMMITMENTS AND CONTINGENCIES WARRANTY LIABILITIES The Company offers one-year verbal warranties on all completed projects. Based on prior experience no accrual was made for the year ended December 31, 1999. PRODUCT AGREEMENT In 1999, the Company made a verbal agreement with a vendor to pay $8,000 to the vendor each time vendor's product was used by the Company. In 1999 the Company paid $24,000 to the vendor under this agreement. RENT AGREEMENT In 1999, the Company entered into a verbal agreement with the second general partner to make rental payments of $650 per month for production facilities provided by the second general partner. Administrative office was provided by the first general partner at no charge to the Company. NOTE H RELATED PARTY TRANSACTIONS In December 1999, the Company borrowed $144,511 from a Director of the Company. The note had an interest rate of 5.74% and was payable on demand. At December 31, 1999 the amount unpaid on this note was $133,538. Subsequent to the date of the financial statement, the Company repaid the unpaid balance plus accrued interest. NOTE I SUBSEQUENT EVENTS In April, 2000 an agreement of purchase and sale of stock was entered into by The Pathways Group Inc., a Delaware corporation and the shareholders of the Company. Under the terms of the agreement, the Company will sell all of the outstanding stock of the Company in exchange for shares of Pathways Common Stock in a stock-for-stock transaction intended to qualify as a tax-free reorganization under the Internal Revenue Code section 368 (a)(1)(B). F-8 INDEPENDENT AUDITOR'S REPORT To the Board of Directors and Stockholders of Smart Card Solutions, Inc. I have audited the accompanying balance sheets of Smart Card Solutions, Inc., a development stage company, as of December 31, 1999 and 1998, and the related statements of loss, stockholders' equity and cash flows for the year ended December 31, 1999 and for the period from June 16, 1998 (inception) to December 31, 1998. These statements are the responsibility of the Company's management. My responsibility is to express an opinion on these financial statements based on my audits. I conducted my audits in accordance with the generally accepted auditing standards. Those standards require that I plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the management, as well as evaluating the overall financial statement presentation. I believe that my audits provide a reasonable basis for my opinion. In April, 2000, the Company's assets and liabilities, except for certain payroll liabilities, were acquired. The Company ceased to operate after that date. (See Note H) In my opinion, except as above, the financial statements referred to above present fairly, in all material respects, the financial position of Smart Card Solutions, Inc. as of December 31, 1999 and 1998 and the results of its operations and cash flows for the year ended December 31, 1999 and for the period from June 16, 1998 (inception) to December 31, 1998 in conformity with the generally accepted accounting principles. MARC LUMER & COMPANY San Francisco, California September 26, 2000 F-9 SMART CARD SOLUTIONS INC ( A DEVELOPMENT STAGE COMPANY) BALANCE SHEETS DECEMBER 31, 1999 AND 1998

See accompanying notes to financial statements and accountant's report F-10 SMART CARD SOLUTIONS INC. ( A DEVELOPMENT STAGE COMPANY) STATEMENTS OF LOSS FOR THE YEAR ENDED DECEMBER 31, 1999 AND FOR THE PERIOD FROM INCEPTION (JUNE 16,1998) TO DECEMBER 31, 1998

See accompanying notes and accountant's report F-11 SMART CARD SOLUTIONS, INC. (A DEVELOPMENT STAGE COMPANY) STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) FOR THE YEAR ENDED DECEMBER 31, 1999 AND THE PERIOD FROM INCEPTION (JUNE 16, 1998) TO DECEMBER 31, 1998

F-12 SMART CARD SOLUTIONS INC. (A DEVELOPMENT STAGE COMPANY) STATEMENTS OF CASH FLOW FOR THE YEAR ENDED DECEMBER 31, 1999 AND FOR THE PERIOD FROM INCEPTION (JUNE 16, 1998) TO DECEMBER 31, 1998

See accompanying notes and accountant's report F-13 SMART CARD SOLUTIONS, INC. NOTES TO THE FINANCIAL STATEMENTS DECEMBER 31, 1999 AND 1998 NOTE A FORMATION OF THE COMPANY AND OPERATIONS Smart Card Solutions, Inc. (the "Company"), a development stage company, was incorporated on June 16, 1998 in the State of Colorado. The Company is a business-to-business, technology-based solution provider. The Company maintains ownership of its hardware, and integrated smart card and Internet technologies to generate revenue from delivering services to its customers. Remote data server and transaction processing operations are concentrated in the Company's development and operations center in Denver, Colorado and Colorado Springs. The Company also maintained an office in Aspen, Colorado for its operations until March 29, 2000 (see Note H). The Company's market focus is on campus style environments, where the Company can use its technologies and expertise to provide a complete solution, integrating point of sale, access control, rental, retail, food and beverage, reservations, management reporting, accounting, and integrated financial services. These middle market commercial areas include destination winter sports and golf resorts, theater complexes, corporate and college campuses, cruise lines, concerts, performing arts and sporting events. NOTE B SIGNIFICANT ACCOUNTING POLICIES FINANCIAL STATEMENT ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires the management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS The Company considers cash investments with maturity of three months or less at the time of purchase to be cash equivalents. DEPRECIATION AND AMORTIZATION Property and equipment are stated at cost. Software cost is the present value of the contract liabilities under purchase agreement (SEE NOTE D). Depreciation is computed on a straight-line basis over estimated useful lives of five years. Amortization of software cost is computed on straight-line basis over a five-year period. Depreciation for income tax purposes is computed using accelerated methods. INCOME TAXES Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Where a deferred tax F-14 SMART CARD SOLUTIONS, INC. NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 AND 1998 NOTE B SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) asset has been recognized, a valuation allowance is established if, based on available evidence, it is more likely than not that the deferred tax asset will not be realized. The Company had net operating losses of $1,205,022 and $163,615 for the years ended December 31, 1999 and 1998 respectively. No deferred tax assets have been recognized for the year ended December 31, 1999. CONCENTRATIONS OF CREDIT RISK Financial instruments, which potentially subject the company to credit risk, consist principally of cash balances greater than $100,000 deposited with a financial institution. The Company periodically reviews its cash policies and believes any potential accounting loss to be minimal. REVENUE RECOGNITION The Company recognizes revenue at the completion of each project. NOTE C PROPERTY AND EQUIPMENT Property and equipment consists of the following:

Depreciation expense for the year ended December 31, 1999 and 1998 were $2,143 and $11,322, respectively. NOTE D NOTE PAYABLE CONTRACT LIABILITIES On October 15, 1998, the Company entered into a purchase agreement with System Design Group (SDG), a Wisconsin corporation to purchase all rights, title and interests to certain assets of SDG. The Company agreed to pay SDG (4%) of the net revenues up to a total of $500,000 as royalty payments. The Company guaranteed SDG minimum payment of $150,000 as advances against royalty payments and paid SDG $50,000 at the time of closing of the contract and two secured promissory notes for $50,000 each payable on March 31, 1999 and July 31, 1999. The interest rates on the promissory notes were 5% per annum. The Company also agreed to deliver a stock certificate evidencing 400,000 shares of restricted common stock having an estimated fair value of $0.10 per share at the closing of the contract. F-15 SMART CARD SOLUTIONS, INC. NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 AND 1998 NOTE D NOTE PAYABLE (CONTINUED) If the Company has not exercised its right to terminate its obligations under this agreement, the Company has agreed to pay SDG $100,0000 prior to December 31, 2000 to reduce the remaining balance of the royalty payments to $250,000. The remaining balance of $250,000 shall be due in full on demand on June 30,2002. The present value of the payments for the purchase of the assets at the closing of the agreement at an interest rate of 10% per annum compounded monthly are summarized as follows:

The total interest expense paid on the two secured promissory notes was $4,048. The interest expense amortized for the years ended December 31, 1999 and 1998 were $36,692 and $7,647 respectively. NOTE E COMMITMENTS AND CONTINGENCIES In June 1998, the Company entered into a renewable annual lease agreement for office space, which was renewed in June 1999. The Company also entered into an agreement to lease the office space on a month-to-month term from SDG on January 1, 1999 by paying SDG its out-of-pocket costs for the space. This agreement was terminated in 1999. The Company paid $8,125 for the period ended December 31, 1998 and $19,713 for the year ended December 31, 1999 under the annual lease agreement. The Company paid $10,292 under the month-to-month lease agreement for the year ended December 31, 1999. NOTE F RELATED PARTY TRANSACTIONS ADVANCES TO OFFICERS The Company paid $97,500 to stockholders as advances, interest free. During the year ended December 31, 1999, $92,500 was settled by charging to officers' compensation and expenses. EMPLOYMENT AGREEMENTS The Company entered into employment agreements for services with the stockholders of the Company and paid $674,576 to the stockholders as officers' compensation for the year ended December 31, 1999. F-16 SMART CARD SOLUTIONS, INC. NOTES TO THE FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 AND 1998 NOTE F RELATED PARTY TRANSACTIONS (CONTINUED) RENT AGREEMENT The Company subleased, from the wholly-owned LLC of the Chairman of the company, 4,000 square feet for their development office. The lease was terminated in September 1999. The Company paid $68,949 as rent expense to the Chairman's LLC, as landlord. NOTE G STOCK OPTION AGREEMENT In January 1999, the Company adopted the 1999 Stock Plan (the "Plan") under which 500,000 shares of the Company's common stock was reserved for issuance with respect to awards granted to officers and other key employees of the Company. The Plan provides that the stock may be issued at a purchase price not to be less than the fair market value per share of common stock at the time the option was granted. The Plan is administered by the Executive Compensation Committee. NOTE H SUBSEQUENT EVENTS In March 2000, under the Asset Acquisition and Liability Assumption Agreement dated March 29, 2000, SmartCard Solutions Inc. transferred its business and substantially all of its assets and liabilities to Smart Card Solutions Acquisition Inc. for stock in SmartCard Solutions Acquisitions, Inc. In April 2000 an agreement of purchase and sale of stock was entered into by The Pathways Group Inc., a Delaware corporation and the shareholders of the Company. Under the terms of the agreement, the Company will sell all of the outstanding stock of the Company in exchange for shares of Pathways Common Stock in a stock-for-stock transaction intended to qualify as a tax-free reorganization under the Internal Revenue Code section 368 (a)(1)(B). F-17 PRO FORMA FINANCIAL INFORMATION On April 6, 2000 Pathways entered into an agreement to purchase all of the outstanding stock of Smart Card Solutions, Inc. The agreement was modified and the purchase of Smart Card Solutions was completed on August 21, 2000 The acquisition was recorded by Pathways using the purchase method of accounting under APB Opinion No. 16. Pathways issued 1,900,000 shares of stock and assumed liabilities of $527,966 resulting in an aggregated purchase price of $2,009,966 (Note 2). On April 21, 2000 Pathways entered into an agreement to purchase all of the outstanding common stock of MS Digital, Inc. The agreement was modified on August 7, 2000 and the purchase of MS Digital, Inc. was completed on August 7, 2000 The acquisition was recorded by Pathways using the purchase method of accounting under APB Opinion No. 16. Pathways issued 2,425,000 shares of stock and assumed liabilities of $5,839 resulting in an aggregated purchase price of $1,679,089 (Note 2). The unaudited pro forma condensed balance sheet as of June 30, 2000 is based on the indvidual balance sheets of Pathways, Smart Card Solutions, Inc and MS Digital, Inc. after giving effect to the acquisitions of Smatcard Soutions, Inc. and MS Digital as if they had occurred on June 30, 2000. The unaudited pro forma condensed statements of operations are based on individual historical results of operations of Pathways, Inc., SmartCard Solutions, Inc. and MS Digital, Inc. for the year ended December 31, 1999 and for the six months ended June 30, 2000, after giving effect to the acquisitions of SmartCard Solutions, Inc. and MS Digital, Inc. as if they had occurred on January 1, 1999. The unaudited pro forma condensed balance sheet and statements of operations should be read in conjunction with the historical financial statements and notes thereto of Pathways, Inc. included in its 1999 annual report on Form 10-K and its quarterly reports on Form 10-Q and SmartCard Solutions, Inc. and MS Digital, Inc. financial statements included herein. The pro forma adjustments and assumptions described in the accompanying notes to unaudited pro forma condensed balance sheet and statements of operations are based on estimates, evaluations, and other data currently available and are subject to revision. The unaudited pro forma condensed balances sheet and statements of operations are presented for illustrative purposes only and are not necessarily indicative of the financial positions and results of operations that would have actually occurred had the acquisitions of SmartCard Solutions, Inc. and MS Digital, Inc. been effected on the dates assumed. P-1 THE PATHWAYS GROUP, INC., SMART CARD SOLUTIONS, INC. AND MS DIGITAL, INC. UNAUDITED PRO FORMA CONDENSED BALANCE SHEETS AS OF JUNE 30, 2000 (IN THOUSANDS)

P-2 THE PATHWAYS GROUP, INC., SMART CARD SOLUTIONS, INC. AND MS DIGITAL, INC. UNAUDITED PRO FORMA CONDENSED STATEMENTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1999

P-3 THE PATHWAYS GROUP, INC., SMART CARD SOLUTIONS, INC. AND MS DIGITAL, INC. UNAUDITED PRO FORMA CONDENSED STATEMENTS OF OPERATIONS SIX MONTHS ENDED JUNE 30, 2000 (IN THOUSANDS, EXCEPT PER SHARE DATA)

P-4 NOTE 1--BASIS OF PRESENTATION: The unaudited pro forma condensed combined balance sheet has been prepared to reflect the acquisitions of Smart Card Solutions, Inc. and MS Digital, Inc. by The Pathways Group, Inc. as if the acquisitions had occurred on June 30, 2000. The unaudited pro forma condensed combined statements of operations for the year ended December 31, 1999 and for the six months ended June 30, 2000 have been prepared to reflect the acquisitions of Smart Card Solutions, Inc. and MS Digital, Inc. by The Pathways Group, Inc. as if the acquisition had occurred on January 1, 1999. There were no material differences in the accounting policies of Smart Card Solutions, Inc., MS Digital, Inc. and The Pathways Group, Inc. for the periods presented. NOTE 2--PURCHASE ACCOUNTING AND PRO FORMA ADJUSTMENTS PURCHASE PRICE A summary of the purchase consideration is as follows:

ALLOCATION OF PURCHASE PRICE The allocation is preliminary and may be subject to further adjustments. The total purchase price of $3,610,126 was allocated to the fair value of the assets acquired as follows:

The pro forma adjustments of amortization of goodwill and other intangible assets for the six months ended June 30, 2000 and the year ended December 31, 1999 are as follows:

PRO FORMA NET LOSS PER SHARE Basic and diluted pro forma net loss per share is computed using the weighted average number of Pathways common shares outstanding during the period plus shares of Pathways Common Stock issued in connection with acquisitions of Smart Card Solutions, Inc. and MS Digital, Inc., excluding Pathways Common Stock subject to repurchase. Pathways Common Stock issued in connection with the P-5 NOTE 2--PURCHASE ACCOUNTING AND PRO FORMA ADJUSTMENTS (CONTINUED) acquisitions are assumed outstanding at the beginning of each of the periods. The combined Company had a pro forma net loss for all periods presented herein; therefore, none of the options and warrants outstanding during the periods presented or issued in connection with this transaction were included in the computation of pro forma dilutive earnings per share as they were antidilutive. PRO FORMA ADJUSTMENTS (a) To record goodwill and other intangible resulting from the acquisition of MS Digital, Inc. and Smart Card Solutions, Inc. respectively. (b) To record the issuance of common stock of The Pathways Group Inc. for the acquisition of MS Digital, Inc. and Smart Card Solutions, Inc. (c) To eliminate additional paid in capital and retained earnings of MS Digital, Inc. and the additional paid in capital and accumulated deficit of Smart Card Solutions, Inc. (d) To record amortization of goodwill and other intangibles and additional amortization of software for the year ended December 31, 1999. (e) To record amortization of goodwill and other intangibles and additional software amortization for the six months ended June 30, 2000. (f) To adjust weighted average shares outstanding for shares issued in the acquisitions of MS Digital, Inc. and Smart Card Solutions, Inc. P-6 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned, hereunto duly authorized. THE PATHWAYS GROUP, INC. By: /s/ CAREY F. DALY, II ----------------------------------------- Carey F. Daly, II PRESIDENT, CHIEF EXECUTIVE OFFICER AND CHAIRMAN OF THE BOARD

Date: October 20, 2000

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