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                                  UNITED STATES
                       SECURITIES AND EXCHANGE k
                              Washington, DC 20549

                                    FORM 10-K
(Mark One)
/X/      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1999

                                       OR

/ /      TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
         ACT OF 1934

         For the transition period from ________ to ________

                        Commission file number  000-24119

                            THE PATHWAYS GROUP, INC.
             (Exact name of registrant as specified in its charter)

                   Delaware                                      91-1617556
        (State or other jurisdiction of                       (I.R.S. Employer
        incorporation or organization)                       Identification No.)

14201 NE 200th Street, Woodinville, Washington                      98072
   (Address of principal executive offices)                      (Zip Code)

                                 (425) 483-3411
              (Registrant's telephone number, including area code)

      Securities registered under Section 12(b) of the Exchange Act: NONE.

         Securities registered under Section 12(g) of the Exchange Act:

                                                      Name of Each Exchange
         Title of Each Class                           on Which Registered
         -------------------                           -------------------

Common Stock, par value $.01 per share                         NASDAQ

         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    / /

         Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (ss. 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K.   / /

         State the aggregate market value of the voting and non-voting common
equity held by non-affiliates of the registrant. The aggregate market value
shall be computed by reference to the price at which the common equity was sold,
or the average bid and asked prices of such common equity, as of a specified
date within the past 60 days prior to the date of filing: $23,195,692 as

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of March 24, 2000. The aggregate market value was based upon the closing price
for the Common Stock, par value $.01 per share, of the registrant as quoted by
the NASDAQ for such date.

              APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
                     PROCEEDINGS DURING THE PAST FIVE YEARS:

         Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes      / /      No       / /

                   (APPLICABLE ONLY TO CORPORATE REGISTRANTS)

         Indicate the number of shares outstanding of each of the issuer's
classes of common equity, as of the latest practicable date: As of April 12,
2000, 14,613,162 shares of Common Stock, par value $.01 per share.

                       DOCUMENTS INCORPORATED BY REFERENCE

         List hereunder the following documents if incorporated by reference and
the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document
is incorporated: (1) Any annual report to security holders; (2) Any proxy or
information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or
(c) of the Securities Act of 1933. The listed documents should be clearly
descried for identification purposes (e.g., annual report to security holder for
fiscal year ended December 24, 1980). NONE.




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                                     PART I

ITEM 1.  BUSINESS

         The Pathways Group, Inc. and its subsidiaries ("Pathways" or the
"Company") designs, markets and services custom smart card applications 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. Pathways' technology establishes electronic
commerce in both open and closed system environments. A key element of the
Company's business plan is the processing of transactions associated with its
current and prospective smart card installations. The Company also manufactures
and markets automated ticketing kiosks that the Company 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's shares are currently traded on the NASDAQ SmallCap market
under the symbol "PTHW".

         The Company believes that it is unique in the smart card industry in
that it provides "cradle to grave" solutions as a full service hardware
integrator, software developer and backroom transaction processor. By adopting
this market strategy, the Company believes that it can become a leading
developer and marketer of integrated smart card software systems and that it is
positioned to provide customers sophisticated smart card business solutions
across a wide range of applications. The Company's systems accommodate credit
and debit payment methods, electronic benefit transfer, electronic funds
transfer and smart card systems utilizing its threestate infrastructure (backup
redundancies in California, Washington and Hawaii) of processing centers on a
"24x7" basis.

         A smart card is a credit card-sized plastic card in which an integrated
circuit, usually containing a microprocessor and reusable memory, has been
embedded. In their simplest form, smart cards provide memory storage
capabilities, such as cash cards, in which the card is discarded after the value
stored on the card is depleted, or "read only" cards, in which stored
information may be accessed by terminals and computers. Most smart cards,
including the Company's smart cards, are more sophisticated. Information and
software can be stored on such cards by reading and writing to the card's
microprocessor chip and can be easily, securely and accurately accessed and
manipulated by electronic data processing equipment.


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         Smart cards first appeared in the 1970s in France, and at present
smart card technology is established and extensively used in Europe and Asia.
The research firm Dataquest estimates that approximately 156 million cards
were in circulation worldwide at the end of 1996, that the 1996 worldwide
smart card market exceeded $1.2 billion in sales and that the market will
approach $3 billion in sales by the year 2000. (Source: Don Cunningham,
Global Journal of Advanced Card Technology, Smart Card Industry Association,
1997.) Current statistics provided (Smart Cards 2010--"The Revolution in the
Cards Market", Lafferty Publications) reveal that there are currently in
excess of three billion chip cards in use worldwide.

         Smart card installations within Europe dominate the worldwide smart
card industry with a 70% share. It is predicted that by the end of the year 2000
the United States and the Asia-Pacific region will account for 25% of the global
market. (Source: Don Cunningham, Global Journal of Advanced Card Technology,
Smart Card Industry Association, 1997.) The same resource as (Smart Cards 2010)
reveals that the United States is poised to adopt the technology more readily
than first believed.

         The French were the first to develop practical smart card technology
and applications. Roland Moreno, a Frenchman and the founder of Innovatron, is
considered by many to be the pioneer of smart card technology. Today, the
majority of chip card manufacturers are licensees of Innovatron. Initially
installed only in pay telephones, smart cards are now being used for
transportation, car parking, arcade games and vending machines. Any coin
operated machine can be converted to a smart card format. Other possible
applications include ATMs, point-of-sale terminals, personal computers,
electronic ticketing and automatic fare collection.

         The Company believes that smart card technology represents the next
step in the evolution of credit/debit financial services and related products
and services. Smart card systems differ from other payment mechanisms in their
ability to securely store large quantities of data on a credit-card sized medium
by means of a microprocessor chip. The sophisticated encryption algorithms and
other security mechanisms that the chip employs provide information protection.
The Company's products address the needs of the healthcare and affinity group
markets, among others, with multiple purse and banking products being marketed
in the first quarter of 2000.

         In addition, a major factor in the rapid growth of smart card usage is
the ability to process small transactions. Smart card technology eliminates the
need to carry cash and coins for most day to day transactions. By enabling an
individual to exchange information and payment through one portable platform,
the Company expects that this technology will open up new opportunities with
regard to the way people interact with financial institutions, healthcare
providers, retailers and others. All information-based industries are candidates
for smart card conversion.

         The Company anticipates that while it will continue to realize revenue
from transaction processing, significant additional revenue growth opportunities
exist in the area of developing, marketing and, when appropriate, providing
transaction processing services to a variety of markets, many of


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which the Company does not presently serve. The Company believes that these
opportunities include the academic campus, retail, banking, travel and
traditional healthcare markets, to name a few.

         The Company's core technology involves the development of smart card
application systems and solutions. This core technology has been customized for
prepaid alternative health care, retail affinity and the banking and educational
institutions markets, but such technology is capable of being customized for
other markets. The Company is encouraged by the results of these initial
programs, and believes that such pilot programs will lead to the national
rollouts of such products.

         While the Company's initial programs and other smart card applications
were being designed and developed, the Company's revenues initially were derived
largely from credit and debit card transaction processing fees from its
automated ticketing kiosk software. As the Company's resources are being
increasingly devoted to the realization of the smart card application system
component of the Company's business plan, revenues from the automated kiosk
business have begun to grow back to previous levels.

         The Company considers the automated ticketing kiosk business integral
to its plans for becoming a full-service smart card designer, developer and
provider. It intends to continue to use those devices in the ski and amusement
markets that the Company has already penetrated, as well as to expand into other
markets and integrate its current capabilities to include the processing of
smart card transactions in addition to debit and credit card processing. It is
anticipated that the Company's kiosks will serve as smart card dispensing,
"reloading" and transaction processing points, as well as e-commerce fulfillment
devices.

         The Company has three principal subsidiaries:

         o        SPRINTICKET, INC. ("Sprinticket") provides credit card
                  transaction processing for ski areas and amusement parks
                  utilizing Sprinticket's proprietary hardware and software.
                  Sprinticket marketed proprietary ticketing machines and
                  software manufactured under contract by Pathways
                  International, Ltd.

         o        THE PATHWAYS GROUP INC., a Hawaii corporation, was organized
                  to market the Company's products in Hawaii and Asia.

         o        PATHWAYS INTERNATIONAL, LTD. retains the copyright for an
                  automated non-profit organization accounting system that no
                  longer is being marketed. Since its inception, Pathways
                  International was the corporation through which the Company
                  first conducted its software development and hardware
                  manufacturing under contract with companies which later became
                  part of the Company.

         o        THE PATHWAYS GROUP, Gmbh, an Austrian corporation, was
                  organized to market the Company's products in Europe.


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SMART CARD TECHNOLOGY

         Owning a smart card is similar to carrying a computer in a handbag or
wallet. The Company expects that smart cards will eventually replace everything
people carry in their wallets, including driver's licenses, other important
personal identification, credit cards and cash. Smart cards offer consumers the
ability to transmit payment and information data securely and conveniently
across a point-of-sale terminal.

         Over the long term, the Company believes that "multifunctionality" will
become an increasingly important smart card feature. "Multifunctionality" means
that several applications will be combined on one card. A card may contain many
sections that may include personal information, health care data, a prepaid area
and credit line access. The Company is currently developing smart card
applications incorporating multifunctionality technology. As smart cards are
developed to store highly personal information, card security will need to be
more elaborate in order to achieve consumer acceptance of the technology.

         A smart card is a plastic card, approximately the size of a credit
card, which comprises an integrated circuit that usually contains a
microprocessor and reusable memory. Smart cards range from simple single
application cards to sophisticated multi-application cards. A memory card (also
known as a "dumb" smart card) is the most simple type. This type of card can
only store data and is discarded after the value stored on the card is depleted.
These "read only" cards store information that may be accessed by terminals and
computers. It is difficult to copy these cards, but they offer no protection
from loss nor do they contain inherent processing power without the intervention
of sophisticated terminal level software.

         A more complex card may have one password to restrict its use to one
person or machine. Most cards, including the Company's smart cards, are more
sophisticated. Electronic data processing equipment can accurately and securely
store and manipulate information on such cards by reading and writing to the
card's microprocessor chip. The most sophisticated cards can manipulate several
passwords and can utilize authentication and ciphering techniques to provide
total security. The latest card types are now beginning to support the JAVA
application language to allow for greater flexibility and compatibility across
card manufacturers, terminal manufacturers and processing platforms.

         Although many smart cards today incorporate both magnetic stripe
technology and chip technology, the Company believes that chip technology will
increasingly become the preferred medium. Chip technology is more difficult to
counterfeit and can store up to 80 times more data than a magnetic stripe. The
majority of chip cards contain one to eight kilobytes of memory; however, it is
the Company's understanding that a 16-kilobyte card will be introduced this year
by the card manufacturers and that a 64-kilobyte card is currently in prototype
form. If and when such cards are introduced, the Company will seek to utilize
the latest technology in developing software for such cards. The primary benefit
of this computing power is that a single card performs numerous functions. For
example, the card can be programmed to effect payment for goods or to provide
personal health information. In addition, transactions conducted with a smart
card can be authorized offline, unlike


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magnetic stripe cards, which do not have the capability to interface with remote
processing systems. Cards can also be further defined as either a contact or a
contactless card. A contact card must be directly placed into a reading
terminal. Contactless technology utilizes radio frequencies and requires no
direct contact between the card and the reader. Advantages of a contactless card
are convenience and speed. The user simply passes the contactless card within
several inches of the reader, the transaction data is downloaded to the reader
and a return message is recorded in the card.

         To produce each smart card application for a particular client, the
Company must develop customized software and integrate appropriate hardware
technology to adapt the card to the customer's needs. The Company believes that
its engineers have sufficient expertise in hardware technology and computer
programming languages necessary for such development efforts. The manufacturing
cost of a card varies from less than $1 to approximately $10, depending on the
amount of information the smart card holds and the complexity of the
microprocessor. Similarly, the cost of a reader terminal can vary from $500 to
$2,000, depending on the complexity and functionality of the terminal.

CURRENT PRODUCTS AND PILOT PROGRAMS

         AFFINITY GROUP PROGRAMS. The Company has developed applications that
address the current trend in retail environments of rewarding repeat customers.
These applications, in conjunction with the PROTON purse, are the platform for a
product being marketed in the state of Hawaii for the current Millennium project
contract awarded to the Company. In addition to this product being directed to
the Hawaii project, it provides the proof-of-concept for a planned marketing
push in the United States later this year.

         INTERNET COMMERCE MARKET. The Company has contracted to provide an
e-commerce site for the state of Hawaii. This site(hi2k.net) is currently
operational and is processing transactions. As is the case with the above smart
card initiative, the e-commerce initiative provides yet another platform for
proof-of-concept. The Company has been approached by several prospective
clients, as well as existing clients, to provide a similar solution for their
use. This very important product allows a non-invasive penetration of existing
markets.

         HAWAII STUDENT CARD. The Company has operated a pilot program in the
State of Hawaii for the implementation of an electronic school lunch program,
with later expansion to include student identification, bus transportation and
student prepaid activities. Due to the present economic situation in the state
of Hawaii, there has been very little activity beyond the pilot. However, the
pilot did provide proof-of-concept. Accordingly, the Company is searching for
the appropriate sales representatives to market this product across the United
States.

         TIKITBOX II. Sprinticket, a subsidiary of the Company, manufactures and
markets automated ticketing dispensers under the name Tikitbox(R) and provides
credit card processing services in connection with those dispensers. Separate
kiosks are provided for indoor and outdoor use. Indoor models have touch
screens, full motion video and stereo sound, and are equipped to dispense both


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fixed and variable value Smart Cards. Base prices for kiosks are $15,000 to
$20,000 and do not include the supporting hardware (which varies according to
client need). Customers for this equipment include companies that issue some
form of ticket that is required for access into any facility or any service.
Markets for the Sprinticket products include travel, entertainment, leisure,
government and health care. Recently, in response to a client request, an
initiative has been launched by the Company to utilize these devices as
e-commerce fulfillment devices for orders placed on the Internet.

         The Company's contracts for Sprinticket installations to date include:

         o        Deer Valley, Utah

         o        Winter Park Resort, Colorado

         o        Six Flags Magic Mountain, California and

         o        Six Flags Great Adventure, New Jersey.

         o        Blue and Gold Fleet, California

         o        Big Mountain Ski and Summer Resort, Montana

         PREPAID MEDICAL BENEFIT CARDS. My Choice LLC, a defined benefits
medical provider in the alternative medical care industry, utilizes a natural
medicine benefit card developed by the Company. Use of the Company's card
entitles the holder to a discount on natural medical services. The Company,
pursuant to a development agreement with My Choice, designed a card holder
issuance system, a medical provider acceptance and reimbursement system and a
statistical database that drives an ACH type reimbursement. (ACH, or automated
clearinghouse, is a system of electronic funds transfer to which most banks
subscribe as an economic substitute for wire transfers using the Federal Reserve
System.)

         CASH-FREE MIDWAY CARD. The Company recently completed a pilot project
with a client to provide a proof of concept for the use of chip cards in the
carnival and state fair settings. This project was completed successfully in the
fourth quarter of 1999 and the Company has signed a new contract with the client
for the year 2000. This product currently is being marketed across the United
States to amusement parks, tour operators and state fairs. Further, as a
by-product of this project, the Company has developed a new hardware device for
use in high-speed encryption of smart cards with the variable information
required. The Company intends to apply for both copyright and patent protection
of this intellectual property, as it may be use in other smart card applications
the Company sells.


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ADVANTAGES OF THE COMPANY'S PRODUCTS

         The Company's software products encompass a number of technological
breakthroughs, which are discussed below. The most important aspect of the
Company's smart card system is its seamless integration from card fulfillment
through claims adjudication and customized transnational reporting without
depending on third party commercial software products. Other advantages of the
Company's products include:

         o        SMART CARD ISSUANCE (FULFILLMENT) WITH AUTOMATED DATABASE
                  CREATION. Unlike other systems under development, the Pathways
                  product utilizes the latest in database creation technology to
                  facilitate a detailed tracking mechanism for all smart card
                  transactions from issuance to payment and includes the ability
                  to replace lost or stolen cards in a timely fashion. The
                  nearest competitor continues to penalize the user with a "Lose
                  it, you lose it" philosophy. The aforementioned high-speed
                  card-loading device recently created by the Company also puts
                  it in a unique position of offering large card issuers a more
                  cost-effective solution for card personalization and
                  encryption.

         o        FULLY FUNCTIONAL MULTIPLE PURSE MODULES. The Pathways product,
                  in its first release, possesses the ability to utilize
                  multiple "purses," or functions, on the same card. This
                  capability, for example, would allow a medical or insurance
                  application to reside on the same card with a merchant loyalty
                  program. The current "HMC" product being distributed has the
                  full multi-function, multi-purse features built in.

         o        MIXED TRANSACTION (CREDIT/DEBIT/ATM CARD/SMART CARD)
                  PROCESSING AT THE POINT OF SALE WITH ON-LINE AUTHORIZATION
                  WHERE APPLICABLE. The Pathways product can be configured for
                  the diverse communications and security protocols associated
                  with debit, ATM and credit, as well as smart, card
                  transactions. A debit card transaction or an ATM card
                  transaction requires the introduction of a personal
                  identification number ("PIN") for security purposes and
                  requires a telephone connection for purchase authorization.
                  Credit cards normally require similar communication
                  arrangements, although they rarely require a PIN number. Smart
                  cards, in a secure application, always require a PIN number
                  but normally only require a telephone connection to send
                  end-of-day data for claim processing. Current competing
                  developers are focused on the smart card requirements and have
                  not addressed the other needs.

         o        PRODUCT SERVICE PROVIDER CLAIM PROCESSING. A standard feature
                  of the Company's product allows the consumer to use his or her
                  smart card for non-smart card transactions, such as credit or
                  debit card transactions. The software directs the transaction
                  processing to the appropriate credit card processor


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                  for authorization and settlement. System sponsors may also
                  avail themselves of the full suite of backroom services
                  offered by Pathways.

         o        AUTOMATED "E-BANK" CARD RECHARGE. A drawback facing smart card
                  developers, integrators, issuers and processors is the
                  inability of their smart cards to "recharge." The absence of
                  sufficient funds to cover a transaction requires that the
                  transaction be terminated and the card inserted into an ATM
                  (not yet available) or a special location for recharge. The
                  Company has developed technology that endows smart cards with
                  recharging capabilities at the point of purchase, as well as
                  enabling them to connect to electronic banking systems, thus
                  creating an uninterrupted chain of cashless commercial
                  transactions. The Company believes that its recharging
                  capability is unique in the smart card industry.

         o        AUTOMATED CLAIM ADJUDICATION AND SETTLEMENT THROUGH ACH. The
                  Pathways system has the ability to submit a claim
                  automatically to the operator of the prepaid funds pool
                  (normally the card issuer), adjudicate the claim and trigger
                  an ACH transfer of funds to the provider/merchant.

         o        MANAGEMENT REPORTING (VIA AUTOMATED BACK ROOM). The Company
                  provides claims adjudication by means of a Structured Query
                  Language ("SQL") compliant database that can service
                  substantially all management reporting needs. Every element of
                  the database is positioned using "data pointers," which allow
                  such information to be extracted for customized client
                  reports.

         o        ISO SMART CARD DEVELOPMENT TOOLKIT. The Company has developed
                  a set of proprietary software tools that are the building
                  blocks for all of its current and future applications. These
                  tools are used to develop applications using the Rapid
                  Application Development ("RAD") technique within the SQL
                  paradigm. This technique allows the Company to combine its
                  software modules to create a product satisfying its customer's
                  needs in a shorter time period than would be possible in the
                  absence of these toolkits.

         o        E-COMMERCE FUNCTIONALITY. The Company's product offering also
                  allows the cardholder to utilize its smart card in both a
                  traditional "bricks and mortar" environment as well as an
                  Internet environment. This offering, scheduled for release in
                  the third quarter 2000, is, to the Company's knowledge, well
                  in advance of any other smart card developer/processor.

         All of the above modules are integrated seamlessly, to form a "cradle
to grave" process which, to the Company's knowledge, is unlike any other system
available at the current time.


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STRATEGIC RELATIONSHIPS

         The Company entered into a license agreement in May 1999 with Proton
World, an international open smart card solutions provider based in Brussels,
Belgium. Proton World was created by major smart card industry participants
American Express, ERG, InterPay Nederland and Visa International, and is
currently the largest electronic purse platform with 30 million cards issued and
accepted at 230,000 terminals in 15 countries. The Company is the second company
licensed by Proton World in the United States. The license terms provide for
up-front license fees and ongoing fees for each Proton-compliant smart card
issued.

         The Company has entered into a strategic relationship with BankSys,
Inc., a manufacturer and developer of smart card terminal and processing
equipment. The relationship with BankSys is designed to allow Pathways and
BankSys to do joint development of certain smart card applications involving the
PROTON purse and secure access applications.

         The Company has entered into an agreement with Bull Systems to engineer
applications across the entire Bull product line of smart cards.

         The Company has extensive informal relationships with a variety of card
and terminal manufacturers that the Company is currently evaluating for
inclusion in its product line. The Company expects that the formation of
strategic alliances, both formal and informal, with such entities will be an
integral element in expanding its product offerings.

COMPANY STRATEGY AND PRODUCT DEVELOPMENT

         The Company's objective is to become a leading provider of smart card
solutions across a wide range of applications. The Company focuses its marketing
strategy on product development and innovation in the area of smart card and
debit card technology with the goal of capturing the transaction processing
revenue segment of such business. Transaction processing includes a network of
"backroom" services that include maintaining and updating appropriate databases
to reflect all information on user cards and transnational changes to such
information, effecting the movement of electronic money to and from a funds pool
holder, and periodic reporting to all parties in the transaction.

         The Company hopes to realize its strategy to increase transaction fee
revenue by focusing on smart card applications in consumer situations that
necessitate card usage on a weekly or more frequent basis. The Company believes
that currently it is one of a limited number of companies serving as a hardware
integrator, software developer and backroom transaction processor, under one
roof.

         The Company anticipates that while it will continue to realize revenue
from transaction processing, significant additional revenue growth opportunities
exist in the area of developing, marketing and, when appropriate, providing
transaction processing services to a variety of markets, many of


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which the Company does not currently serve. The Company believes these
opportunities include the academic campus, retail, banking, travel and
traditional healthcare markets. The Company's product development efforts are
focused on software and systems for smart card applications. The Company has
identified the following industries as those best suited to benefit from smart
card technology and has commenced research and development efforts aimed at
meeting perceived needs:

         o        AFFINITY PROGRAMS. The trend in retail, fund raising (as
                  discussed above with respect to Scrip Advantage) and other
                  repeat customer businesses is the move toward customer
                  rewards. This application represents a tremendous opportunity
                  and an explosive growth area that is virtually untapped. By
                  incorporating a smart card into a traditional point of sale
                  application, the retailer will realize complete tracking of
                  all aspects of the sales process including the ability to
                  reward repeat customers with premiums or discounts through the
                  use of a smart card without the traditional computerized
                  infrastructure. Retailers could use the data accumulated to
                  target market areas not being penetrated and focus marketing
                  and advertising expenditures on those areas.

         o        RETAILING. All types of retailing can be embraced and enhanced
                  with smart card technology. The Company believes that
                  providing a cardholder a large number of retail or point of
                  sale venues in which to use a smart card will significantly
                  increase the adoption of smart card technology. The retail
                  sector encompasses everything from "Mom and Pop" stores to
                  national department stores. Retailers are acutely aware of the
                  value of their contact with the consumer. The key to repeat
                  business is to accurately identify and satisfy customer needs.
                  Smart cards enable retailers to track customer behavior and
                  base marketing decisions gleaned from this valuable
                  information. This technology can also reduce the risk of
                  fraud, improve inventory management and offer the customer
                  convenience and better service.

         o        TRAVEL AND ENTERTAINMENT. The travel and entertainment
                  industry holds great promise with regard to smart card
                  applications. All categories that comprise this market,
                  including air travel, car rentals, movie theaters, sporting
                  events, restaurants, casinos, video stores, sports arenas,
                  hotels and other venues would benefit from a multifunctional
                  card. This is an enormous global market with strong growth
                  predicted for the near future. Business travelers in
                  particular are bogged down by paper-based expense
                  reimbursement. Paper-based reimbursement systems are hampered
                  with the potential for fraud in addition to being costly to
                  administer. Smart cards can enable businesses to more
                  effectively monitor travel and entertainment expenses.

                  Smart cards offer solutions in terms of their ability to
                  collect and disseminate data and conduct electronic commerce.
                  Several major airlines have initiated smart card pilot
                  programs that allow ticketless travel, store frequent flier
                  miles


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                  and process payments. In a resort setting, a multifunction
                  card allows an individual access to restaurants, shopping,
                  sports and entertainment activities and lodging while keeping
                  track of loyalty points.

         o        GOVERNMENT SERVICES. The government is becoming involved in
                  electronic commerce. The initial focus is centered on a
                  national Electronic Benefits Transfer (EBT) proposed by Vice
                  President Gore. One proposed and piloted application is to
                  replace paper food stamps with a smart card. Such a change
                  would eliminate the cumbersome printing, warehousing,
                  transporting and disposal of this paper medium. Other
                  applications could include the administration of welfare and
                  Medicaid benefits and other government payments.

         o        TRANSPORTATION. Opportunities exist to apply smart card
                  technology to public and private transit systems, including
                  bridge, tunnel and highway toll systems. Smart cards would
                  significantly reduce the time spent and costs associated with
                  collecting and processing fares and tolls. A multipurpose card
                  could be used for taxis, trains, tolls and parking meters in
                  addition to other small expenditures. Commercial vehicles
                  could utilize this technology to store data about the cargo,
                  the carrier, maintenance records and the driver.

         o        HEALTH CARE. The Company believes that the healthcare
                  industry, with its millions of participants and voluminous and
                  individualized information and payment requirements, can
                  benefit significantly from smart card technology. Smart cards
                  can be designed to provide patient identification and medical
                  record storage and retrieval, as well as electronic benefit
                  transfers, determination of eligibility and drug interaction
                  information. In an emergency situation, a quick assessment of
                  vital information such as allergies, prescriptions and
                  immunizations is critical for effective healthcare delivery.
                  Additionally, patient cards can be used to improve and
                  streamline administrative and billing procedures as well as
                  insurance reimbursement.

         o        INTERNET COMMERCE AND SECURE ACCESS. The Company believes that
                  the Internet Commerce and secure access arenas are the next
                  emerging marketplace for smart cards. This belief is validated
                  by recent statements in the press by Microsoft spokesmen. The
                  Company is in final stage development of products to meet this
                  anticipated demand.

MARKETING AND DISTRIBUTION

         The Company intends to market its electronic purse technology to any
and all affinity groups where electronic cash is a viable medium. Although the
Company expects to continue to market smart card systems directly through the
Company's management and employees, the Company


                                       11
<PAGE>

intends to establish strategic marketing alliances and licensing or other
arrangements with systems integrators, value-added resellers and other smart
card vendors and may also retain the services of sales representatives and
marketing and other consultants. Distribution of products will be handled
directly by the Company's sales and marketing staff.

         Service of smart card terminals and related equipment will be performed
on a "Depot Repair/Hot Swap" service basis. "Depot Repair/Hot Swap" service is
the process of replacing faulty equipment with functional equipment via express
transportation methods. Faulty units are repaired if possible at the depot.

COMPETITION

         Because smart cards are potential substitutes for the use of cash in
the economy, the market for smart card applications is enormous. As smart cards
constitute a relatively new technology, there is room for many participants in
this market. Some companies currently involved in smart card development include
but are not limited to: Bull, Card Europe, Gemplus, Innovatron, Philips
Electronics, Racom Systems, Aladdin Knowledge Systems, MONDEX, MasterCard,
Motorola, Schlumberger, Siemens, DigiCash, Cylink, AT&T Universal Card and Visa.
All of these vendors are actively involved in producing smart card terminals.
Some, like Schlumberger, also produce the actual smart card media.

         Although the Company is unaware of competitors providing its
combination of products and services to the Company's targeted markets, a few
competitors, or potential competitors (e.g., MONDEX, Diebold, Visa and Digicash)
actually develop software applications to deal with issuance, acceptance and
adjudication of smart card transactions. Of record to date in the United States,
Pathways presently is one of a limited number of companies offering full service
integration, software development and transaction processing. The Company
believes its range of services and products are broader and more encompassing
than any existing competitor.

RESEARCH AND DEVELOPMENT

         Smart card applications are the result of creating innovative solutions
to the needs of consumers. This requires significant experience in software
development and knowledge of a variety of business sectors. The Company has
expended substantial resources in the development of its products. The Company
has capitalized software development costs in the aggregate amount of $3,958,504
from inception through December 31, 1999, and $173,924, $272,564 and $439,707
for the years ended December 31, 1999, 1998 and 1997, respectively. In addition,
the Company expensed $599,746, $474,120 and $102,000 as research and development
costs for the years ended December 31, 1999, 1998 and 1997, respectively.


                                       12
<PAGE>

GOVERNMENT REGULATION

         The Company can provide no assurance that a Federal, state or foreign
agency will not attempt to regulate its activities.

         Regulation E of the Federal Reserve Board governs certain electronic
funds transfers made by regulated financial institutions and providers of access
devices and electronic funds transfer systems. Regulation E requires written
receipts for transactions, monthly statements, pre-transaction disclosures and
error resolution procedures. Although certain aspects of the Company's services
may be subject to Regulation E, the Company believes that most of its services
are not subject to Regulation E. There can be no assurance that the Federal
Reserve Board will not require all of the Company's services to comply with
Regulation E, revise Regulation E, or adopt new rules and regulations for
electronic funds transfers that could lead to increased operating costs for the
Company, and could also reduce the convenience and functionality of the
Company's services, possibly resulting in reduced market acceptance. In
addition, if the Federal Reserve Board challenges the Company's position, the
costs of responding to such a challenge could result in significant drains on
the Company's financial and management resources, which could adversely affect
the Company's business, financial condition or operating results.

         Management believes that current state and federal regulations
concerning electronic commerce do not apply to the Company's current product
line. However, there is a move towards taxation of Internet use by several
states, including the state of Washington. There are some strategic plans under
consideration to conduct commerce on the Internet using the Company's core
technology. This technology is being developed with a strict eye on these
legislative issues and the Company's management subscribes to industry watch
publications that address these issues. Planning for such eventualities assures
minimal interruption to the business of the Company should these laws be
enacted.

COPYRIGHTS, TRADEMARKS, PATENTS, PROPRIETARY RIGHTS AND LICENSES

         As of December 31, 1999, the Company held no patents or other
registered intellectual property rights with respect to its smart card products.
The Company presently has registered the Compass Design, The Pathways Group,
Inc. mark and Sprinticket. The Pathways Group, Inc. (U.S.) has been registered
but the Company is awaiting confirmation as of this date. The following marks
have been allowed and are awaiting filing of Statement of Use: C-Teller (Japan),
Island Access Card (U.S.), Keiki Card (U.S.), Kokua Card (U.S.), Kokua Kard
(U.S.), Renaissance (U.S.), Smart Scrip (U.S.), Tikitbox (U.S.), The Pathways
Group and Compass Design (U.S.), V-Teller (Japan), V-Teller (U.S.). Applications
which are currently pending: C-Teller (Canada),C-Teller (EU), C-Teller (U.S.),
E-Teller (Canada), E-Teller (U.S.), Fund Master (Canada), Fund Master (U.S.),
Smart Scrip (Canada), Sprinticket (Canada), Sprinticket (EU), Stylized E (U.S.),
Stylized TPG (U.S.), Tikitbox (Canada), Tikitbox (Japan), The Pathways Group and
Compass Design (U.S.), The Pathways Group and Compass Design (U.S.), Compass
Design (EU), V-Teller (Canada), V-Teller (EU), V-Teller (Japan), Kama'aina Card
(U.S.), hi2k.net (U.S.), and Akamai Card (U.S.).


                                       13
<PAGE>

         The Company filed applications to register the following marks with the
U.S. Patent and Trademark Office: C.H.I.P. SMART CARD, COMPASS DESIGN (Company
logo), C-TELLER, E-TELLER (U.S. and Canada), FUND MASTER, ISLAND ACCESS CARD,
KEIKI CARD, KOKUA CARD, KOKUA KARD, MENEHUNE CARD, QUEST SMART CARD,
RENAISSANCE, SMART GIFT CARD, SMART SCRIP (U.S. and Canada), SMART STUDENT CARD,
THE BUS CARD, THE PATHWAYS GROUP & COMPASS DESIGN (Company logo), THE PATHWAYS
GROUP INC., TIKITBOX, TSUNAMI CARD, V-TELLER and WIC SMART CARD.

         The Company seeks to register these marks generally on software,
hardware, terminals, kiosks and other machines used in connection with
transaction and database processing or electronic access cards or integrated
chip cards.

         The Company may prepare applications for patent protection of toolkits
for smart card programming applications as well as certain commercial
applications of that technology. However, historically the Company has viewed
these items as trade secrets and relied on protection under those rules. There
can be no assurances that any such patent protection will be granted, or if
granted, will have any commercial value. As stated above, the Company recently
has developed a device that should prove to have a commercial value and be
instrumental in the encryption of smart cards in general. See "Advantages of the
Company's Products".

         Although the Company does not believe that its products or services
infringe on the intellectual property rights of third parties, there can be no
assurance that third parties will not assert infringement claims against the
Company in the future or that any such assertion will not result in any costly
litigation or require the Company to cease using, or obtain a license to use,
such products or services in violation of the intellectual property rights of
such parties.

EMPLOYEES

         As of December 31, 1999, the Company had a total of 63 full-time
employees. Key employees are employed under employment contracts, which includes
a binding non-compete and non-disclosure clause. Each of Carey F. Daly, II, the
Company's President and Chief Executive Officer, Robert W. Haller, Executive
Vice President, Monte P. Strohl, Senior Vice President, Sales and Marketing, and
Christopher R. Miller, Senior Vice President, Business Development, has an
employment contract with the Company. The Company anticipates that it may
substantially increase the number of its employees in the near term. None of the
Company's employees is represented by a labor union. The Company considers its
relations with its employees to be very good.


ITEM 2.           PROPERTIES

         The Company leases its principal facilities totaling approximately
8,000 square feet in Woodinville, Washington. The lease expires in the year
2000. The Company expects that it will be


                                       14
<PAGE>

able to renew such lease, or find replacement space if necessary, on terms
reasonably acceptable to it. The Company has leased additional space for
transaction processing, marketing and research and development operations in
Santa Rosa, California, and a marketing office in Honolulu, Hawaii. The Company
has executed a lease agreement in Honolulu which allows the Company to
accommodate a satellite transaction processing center. The Company anticipates
that additional facility leases will be required to accommodate its growth
plans.

ITEM 3.  LEGAL PROCEEDINGS

         From time to time the Company is involved in legal proceedings arising
in the ordinary course of its business, none of which is material.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         None.










                                       15
<PAGE>

                                                      PART II

ITEM 5.   MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         The Company offered its common stock to the public in July 1997
pursuant to Regulation A of the Securities Act of 1993 ("Securities Act"). The
Company offered 833,333 shares of Common Stock, par value $.01 per share
("Common Stock"), for a purchase price of $6.00 per share. The offering
commenced on July 15, 1997, and terminated on July 21, 1997. All shares offered
were sold, providing $5,000,000 in gross proceeds to the Company.

         The Company offered shares of its Common Stock in a private offering in
July and August 1998 pursuant to Rule 506 of Regulation D under the Securities
Act. The Company sold 654,508 shares at $13.75 per share to accredited
investors, resulting in gross proceeds to the Company of $8,999,485. The Company
engaged Allen & Company Incorporated and Mitchum Jones & Templeton, Inc. ("MJT")
to act as placement agents for the offering, each of which received a placement
fee of 5 percent of the purchase price per share for shares placed by them.

         The Company sold 300,000 shares of Series A Preferred Stock, par value
$0.01 per share (the "Series A Preferred Stock"), and 1,200,000 warrants to
acquire shares of the Company's Common Stock in August and September 1999. The
securities were sold in units of 1 share of Series A Preferred Stock and 4
warrants, each warrant entitling the holder to acquire one share of Common Stock
at an exercise price of $2.50 per share, and the price per unit was $10.00,
which resulted in $3,000,000 in gross proceeds to the Company. The warrants are
immediately exercisable and expire 3 years after the date of issue. The Company
engaged Mitchum Jones and Templeton, Inc. to act as placement agent, which
received 150,000 warrants as its placement fee; each warrant entitles MJT to
acquire 1 share of Common Stock at an exercise price of $2.50 per share.

         In November 1999, the Company commenced an offshore offering to
non-U.S. investors pursuant to Regulation S of the Securities Act 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 such offering. As of
December 31, 1999, the Company sold 845,200 shares of Common Stock pursuant to
such Regulation S offering, at prices ranging from $2.00 per share to $3.25 per
share, which resulted in $2,301,675 in gross proceeds to the Company. Since
January 1, 2000, the Company has sold an additional 1,208,900 shares in the
Regulation S offering, at prices ranging from $1.75 to $2.06 per share.

         The Company's Common Stock has traded in the NASDAQ SmallCap Market
under the symbol PTHW since October 1998. Previously, the Company's Common Stock
was traded on the electronic bulletin board of the National Association of
Securities Dealers.

         The approximate high and low closing prices for each fiscal quarter in
the fiscal years ended December 31, 1998, and 1999 are as follows:


                                       16
<PAGE>

                               Common Stock Prices

               Fiscal Quarter               High            Low
         ---------------------------       -------        -------

         1st Qtr 98.................       $    25        $23 1/2

         2nd Qtr 98.................       $    25        $    17

         3rd Qtr 98.................       $20 3/8        $    14

         4th Qtr 98.................       $19 1/8        $    13

         1st Qtr. 99................       $    19        $    13

         2nd Qtr. 99................       $12 5/8        $ 6 5/8

         3rd Qtr. 99................       $ 7 1/4        $2 3/16

         4th Qtr. 99................       $ 6 3/8        $  1.72

         During the first quarter of fiscal 2000 (through March 24, 2000), the
Company's Common Stock had a high price of $4.31 and a low of $2.16. These
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not represent actual transactions.

         As of March 24, 2000, there were approximately 65 holders of record
of the Company's Common Stock. This number of holders of record does not include
beneficial owners of the Company's Common Stock, which shares are held in the
names of various security holders, dealers and clearing agencies. The Company
believes that the number of beneficial owners of its Common Stock held by others
or in nominee names exceeds 350. The Company has not paid any cash dividends and
does not anticipate doing so in the immediate future as it intends to invest any
earnings in the development of the Company's business.

ITEM 6.  SELECTED FINANCIAL DATA

         The following table contains selected financial information derived
from the audited consolidated financial statements set forth elsewhere in
this Form 10-K or in Forms 10-K previously filed, and should be read in
conjunction with such audited consolidated financial statements and notes
thereto. The following tables summarize certain financial data derived from
audited consolidated financial statements of the Company for the fiscal years
ended December 31, 1999, 1998, 1997, 1996 and 1995, respectively.


                                       17
<PAGE>

<TABLE>
<CAPTION>
                                                              YEAR ENDED DECEMBER 31,
                                   -------------------------------------------------------------------------------
                                      1999             1998              1997            1996             1995
                                   -----------      -----------      -----------      -----------      -----------
<S>                                <C>              <C>              <C>              <C>              <C>
INCOME STATEMENT DATA:
Operating revenues ...........     $   186,309      $    76,565      $    61,785      $   108,418      $   512,250
Gross profit .................         122,840           41,702           42,293           43,224          443,169
(Loss) from operations .......      (9,002,694)      (7,336,717)      (3,535,487)      (2,265,572)      (2,318,948)
Other Income (Expense) .......          44,303           84,256          (51,034)        (567,305)        (332,599)
Net (Loss) before taxes ......      (8,958,391)      (7,252,461)      (3,586,521)      (2,832,877)      (2,651,547)
                                                    -----------      -----------      -----------      -----------
Net (Loss) ...................     $(8,958,391)     $(7,252,461)     $(3,586,521)     $(2,832,877)     $(2,651,547)
                                   ===========      ===========      ===========      ===========      ===========
(Loss) per share basic and
diluted ......................     $     (0.68)     $     (0.55)     $     (0.30)     $     (0.57)     $     (1.49)
                                   ===========      ===========      ===========      ===========      ===========

BALANCE SHEET DATA:
Current assets ...............     $ 1,249,690      $ 5,261,583      $ 4,130,369      $ 2,874,727      $    92,827
Total assets .................       4,276,685        7,978,688        6,716,840        5,072,139        2,630,217
Long-term obligations
  under capital lease ........               0                0                0                0                0
Total liabilities ............       1,741,703        1,613,020        1,491,674        2,110,544        5,332,238
Working capital ..............        (431,232)       3,819,466        3,148,595        1,496,074       (2,647,394)
Redeemable preferred stock ...       1,489,527               --               --               --               --
Stockholders' equity (deficit)     $ 1,045,455      $ 6,365,668      $ 5,225,166      $ 2,961,595      $(2,702,021)
</TABLE>


ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
         AND RESULTS OF OPERATION

         Except for historical information, the material contained in this
Management's Discussion and Analysis or Plan of Operation is forward-looking.
This discussion includes, in addition to historical information, forward looking
statements that 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, 1998, 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


                                       18
<PAGE>

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 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.

         Management has made the following arrangements to obtain sufficient
funds to satisfy the Company's cash requirements:

o        As previously announced, the Company has engaged an investment banking
         firm to conduct a best efforts basis offering of shares of the
         Company's common stock for gross proceeds of up to $15,000,000. The
         offering requires the filing of a registration statement and
         registration of a sufficient number of shares of the Company's common
         stock to cover the shares to be issued under the offering. The purchase
         price of the shares to be sold under the offering will be 90% of
         average daily prices as defined in the agreement.

o        In addition, the investment bank has offered a $1,500,000 bridge loan
         to be funded on a best efforts basis.

o        The President and Chief Executive Officer of the Company has committed
         to provide the Company with his personal guarantee of up to $3,000,000
         to support bank loans to the Company. The President will be provided
         common stock warrant coverage equal to 25% of the value committed under
         the guarantee. Presently, bank loans have been applied for but are not
         yet completed.

         In the event that the above financings are not completed or are not
sufficient in amount or timeliness, the Company has identified reductions in
staffing, rent and other expenses to be made if necessary.

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.

         The Company designs markets and services custom smart card
applications. The Company develops unique solutions for creating and processing
data and ensuring secure electronic transactions by utilizing proprietary
hardware and application software systems. Pathways' technology establishes
electronic commerce in closed system environments. A key element of the
Company's business plan is the processing of transactions associated with its
current and prospective smart card installations. The Company also manufactures
and markets automated ticketing kiosks that the Company anticipates will be
integrated with its smart card applications.

RESULTS OF OPERATIONS

         REVENUES. The Company has generated limited revenues from operations to
date as it has continued to develop and market its smart card systems. The
Company believes it will continue to report minimal revenues until additional
significant contracts are signed or until the existing contracts, discussed
below, proceed through the pilot stage to a full rollout. Transaction revenues
generated in 1999 and 1998 primarily relate to credit card processing fees from
the unattended ticketing kiosks installed in several ski area and amusement park
venues. Transaction revenues increased $39,054 or 142% for 1999, compared to the
corresponding period in 1998, due to an increase in the number of kiosks
installed and operating, which resulted in higher volumes of transactions being
processed. Revenues from the sale of unattended kiosks, smart cards and
terminals increased $70,692, or 144%, for 1999 compared to1998, due to the
following:

         o        The sale and installation of 5 kiosks and 3 manager
                  workstations in 1999 compared to 3 kiosks and 1 manager
                  workstation in 1998.

         o        The sale of 5,000 smart cards to Funtastic Traveling Shows in
                  1999.

         o        Recognition of $12,375 in software maintenance and upgrade
                  fees in 1999.

The details of the Company's revenues for the last three fiscal years are as
follows:

<TABLE>

                                      ($) 1999        %      ($) 1998      %      ($) 1997      %
                                      ---------    ------     -------   ------     -------   ------
<S>                                   <C>           <C>       <C>        <C>       <C>        <C>
Transaction processing fees, net      $  66,513     35.70%    $27,459    35.86%    $39,009    63.14%

Sale of kiosks, smart and
affinity cards and smart
card terminals                          119,796     64.30%     49,105    64.14%     22,775    36.86%
                                      ---------    ------     -------   ------     -------   ------

Total                                 $ 186,309    100.00%    $76,564   100.00%    $61,784   100.00%
                                      =========    ======     =======   ======     =======   ======
</TABLE>


                                       19
<PAGE>

         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 late 1997 and during 1998, the Company developed an upgraded version
of its unattended kiosk to accommodate acceptance and vending of smart cards,
among other things, and also engineered and developed an indoor kiosk to be
utilized as a smart card recharge device. The Company began marketing efforts of
its new indoor and outdoor kiosk products in the first quarter of 1999. The
Company has also changed its marketing strategy for its unattended kiosks.
Previously, the Company leased the kiosks to a customer and collected gross
transaction charges of approximately 5% throughout the lease term. The Company's
current marketing strategy is to sell the kiosk to a customer for cash and
collect ongoing gross transaction fees of approximately 1.75% to 2%. The Company
believes this model is more profitable and eliminates negative cash flow
required to install and sell the kiosk products.

         The Company signed contracts for sale of one additional kiosk in Deer
Valley ($12,995), and one kiosk at Big Mountain Ski & Summer Resort in Montana
($17,566), both of which were installed in November 1999.

         In July 1999, the Company signed agreements with the State of Hawaii
Millennium Commission to design, develop and maintain the official WEB site for
its Hawaii millennium celebration, and to be the official transaction processor
for the transactions over the WEB site. 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.


                                       20
<PAGE>

         In October 1999, the Company announced that it had signed agreements to
provide smart card transaction processing as well as software and hardware
maintenance and support services to MyChoice Health Services, Inc. MyChoice is a
Portland, Oregon-based company offering technological strategies for the access
of alternative medicine network services in Oregon. The agreements provide for
Pathways to provide smart card transaction processing and reporting in addition
to software and hardware maintenance services, including help desk and technical
phone support for MyChoice and its membership and provider network. The
agreements are for three years.

         In January 2000, the Company signed a contract with Sun Valley Company
to install three unattended ticketing kiosks for the winter ski season.
Transaction processing fees and maintenance fees have been waived for this first
season of use in exchange for an agreement by Sun Valley to purchase additional
equipment from the Company, and to pay transaction and maintenance fees for
future seasons.

         SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $1,223,499 or 21% in 1999 when compared to
1998, and $3,245,006 or 121% in 1998 when compared to 1997.

         The increases from 1998 to 1999 primarily result from payroll related
costs. These include the increase in staff during 1999, from 58 at the beginning
of the year to 63 at the end of the year, and additions to executive management,
including renewal of contracts and sign up bonuses for two executives. Rent,
Office & Facility expenses increased due to the inclusion of a full twelve
months of rent for the R&D facility in Santa Rosa and an increased rental rate
for the expanded Hawaii office. In addition, two lease schedules were added
under the Union Bank of California lease agreement in August 1998, that resulted
in twelve months' expense in 1999 compared to four months' expense in 1998.
Marketing, Selling and travel related expenses were higher due to the Company's
marketing activities in Europe. Other selling, general and administrative costs
increased in 1999 due to increased investor relations costs resulting from the
expense of private placement of preferred stock in August 1999 and a private
placement of common stock in November and December 1999. In addition, a loan for
$50,000 to Scrip Advantage was determined not to be not collectible, and was
written off as a bad debt expense.

         The increases from 1997 to 1998 are primarily the result of expanded
payroll and employee support costs associated with an increased number of
full-time employees in 1998 and 1997 and additional bonus compensation to senior
executives in 1998. In 1998, the Company had staff levels beginning at 35 and
increasing to 58 for the year 1998 as compared to 15 increasing to 35 for 1997.
In addition, the Company has incurred increases in sales and marketing related
expenditures commensurate with the increase in marketing personnel and in
administrative costs associated with becoming a publicly traded company,
including professional services and investor relations' expenditures.

         The Company expects the level of selling, general and administrative
costs to continue to increase as a result of continued marketing and customer
support activities and an increase in the


                                       21
<PAGE>

number of operating and technical personnel necessary to support its expected
sales efforts, product development, and customer support activity.

         Below is a detail of the increase in selling, general, and
administrative expenses in major categories for the years ending 1999 as
compared to 1998, and 1998 as compared to 1997.

--------------------------------------------------------------------------------
                                   INCREASE IN THE              INCREASE IN THE
                                        YEAR ENDED                   YEAR ENDED
                                 DECEMBER 31, 1999            DECEMBER 31, 1998
SG&A INCREASE                   VS. THE YEAR ENDED           VS. THE YEAR ENDED
ATTRIBUTABLE TO:                 DECEMBER 31, 1998            DECEMBER 31, 1997
--------------------------------------------------------------------------------
Payroll and payroll related
expenses                                $  715,036                   $2,282,204
--------------------------------------------------------------------------------
Rent, office, and facility
(including equipment) expenses          $  161,648                   $  358,001
--------------------------------------------------------------------------------
Marketing, selling, and
travel related expenses                 $  132,937                   $  359,697
--------------------------------------------------------------------------------
Professional and public
company related expenses                $   25,281                   $   80,248
--------------------------------------------------------------------------------
Other SG&A related expenses             $  188,597                   $   64,856
                                      ------------              ---------------
--------------------------------------------------------------------------------
Total Increase in SG&A                  $1,223,499                   $3,245,006
--------------------------------------------------------------------------------

         AMORTIZATION OF SOFTWARE COSTS. Amortization of software costs
increased $145,235 in 1999 compared to 1998 and increased $28,183 in 1998 as
compared to 1997. The large increase seen in 1999 compared to 1998 results from
a reevaluation and shortening of the amortization periods being used for various
projects, resulting in a higher amortization amount for 1999 compared to 1998,
as discussed in the notes to the financial statements.

         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 not impaired, and is
stated at net realizable value.

         DEPRECIATION. Depreciation increased $120,755 for the year ending 1999
as compared to 1998 and increased $155,330 for the year ending 1998 as compared
to 1997 primarily


                                       22
<PAGE>

due to an increase in capital expenditures. Capital expenditures continued
during 1999, but at a more modest level than in 1998, due to the continued
addition of computer equipment to support an increase in marketing and technical
activities and personnel.

         INTEREST INCOME (NET). The Company had net interest income of $44,303
in 1999 compared to $84,256 in 1998 and net interest expense of $51,034 in 1997.
The decline in net interest income in 1999 as compared to 1998 reflects the pay
down of total long term debt from $507,850 to $169,688 during 1999 (resulting in
less interest expense), and lower net cash equivalent balances throughout 1999
as compared to 1998 (resulting in less interest being earned).

         RESEARCH AND DEVELOPMENT. Research and development increased $125,626
in 1999 as compared to 1998, and $372,120 in 1998 as compared to 1997. The
increase in 1999 over 1998 reflects increases in programming staff and their
related research and development efforts. The increase in 1998 over 1997
reflects the increase in programming staff and their related research and
development efforts, and the expenditure of $49,145 on equipment and software
used for testing.

         PROTON WORLD LICENSING AGREEMENT. In May 1999, the Company entered into
a License Agreement with Proton World International S.A. Under the terms of the
Agreement, the Company, acquired a non-exclusive, non-transferable license to
use the Proton technology in the United States including its territories. In
exchange for its licensing rights under the Agreement and for the issuance of up
to 2,500,000 smart cards, the Company has agreed to pay licensing fees. The
Agreement provides for additional license fees to be paid for additional card
issuance levels over 2,500,000 cards. In addition, a royalty fee will be paid on
each smart card and smart card capable reader or terminal sold or issued.
Through September 30, 1999, the Company has incurred a licensing fee of
$1,000,000, which has been recorded as Software Licenses in the consolidated
balance sheet. Of this $1,000,000, $300,000 was due and payable at the time of
the signing of the license agreement. The remaining balance of the license fees
are payable upon the initiation of a pilot project and upon the rollout of the
project as defined in the Agreement. The Agreement also requires the Company to
pay ongoing certification, maintenance and support service fees and expenses as
those services are provided by Proton World. The license agreement has a term of
ten years and is automatically renewable for successive five year periods
subject to the achievement by the Company of certain performance goals.

         Proton World is the world's largest electronic purse platform with over
thirty million cards issued in 15 countries. The licensed technology from Proton
World smart card provides a secure open-platform system which enables issues and
sponsors of smart card programs to have their cards be accepted at other
issuers/sponsors terminals and readers as long as they are issued under Proton
technology. The system also encompasses back room transaction processing and
clearing functions.


                                       23
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

         The Company's working capital was ($431,232) at December 31, 1999 and
$3,819,466 at December 31, 1998. The decrease in working capital at December 31,
1999 compared to December 31, 1998 is primarily due to the Company's net loss
during the year, and the resulting use of cash for operating expenses and the
payment of accrued expenses. In addition, the current liabilities at December
31, 1999 reflect an accrued license fee of $700,000 due to Proton World.

         The Company signed a placement agency agreement in March 2000 with
an investment banking firm, pursuant to which the firm has agreed to raise an
aggregate of up to $15 million on a best efforts basis through the sale of
the Company's equity securities.

         In March 1999, the Company received a firm commitment for additional
funding of $3,000,000 through the sale of common stock. Due to a significant
decline in the price of the Company's common stock, the Company subsequently
determined that closing this transaction was not its most advantageous financing
alternative. Consequently, in August 1999, the Company entered into an agreement
with Mitchum Jones and Templeton, an investment bank in San Francisco, CA, whose
chief executive officer is a director of the Company, for a firm commitment
financing for $3,000,000 of units, with each unit comprised of one share of
redeemable preferred stock financing and four common stock purchase warrants.
Each unit has a subscription price of $10.00, and each warrant has an exercise
price of $2.50 per share and a term of three years. In the aggregate, the firm
commitment offering required the Company to issue 300,000 shares of preferred
stock and warrants to purchase 1,200,000 shares. In addition, Mitchum Jones and
Templeton has agreed to a best efforts offering of units for an additional
$3,000,000 on the same terms and conditions as the committed financing. The
preferred stock is redeemable at any time, but no later than December 31, 2001;
requires quarterly dividends payable at six percent per annum or an in kind
dividend at a rate of ten percent per annum; contains provisions relating to
preferential liquidation rights, voting rights for the warrants issuable under
the preferred stock and registration provisions. In addition, in the event the
Company does not redeem the preferred shares before December 31, 1999, the
Company will be required to issue during each quarter the shares remain
unredeemed an additional warrant for each six shares of preferred stock held (or
a total of 50,000 warrants for each 300,000 shares of preferred stock
outstanding). The terms of the preferred stock also prohibit the Company from
issuing further debt, or increasing its bank obligations without approval of
preferred stockholders. In connection with the sale of the units, the Company
paid a placement fee to Mitchum Jones and Templeton of warrants to purchase
150,000 shares of common stock at $2.50 per share. If the best efforts offering
is concluded, Mitchum Jones and Templeton will receive an additional placement
fee on the same terms. On August 13, 1999, the Company closed the sale of
$1,000,000 of units (100,000 shares of preferred stock and 400,000 warrants) and
closed the additional $2,000,000 (200,000 shares of preferred stock and 800,000
warrants) on September 3, 1999. The Company has agreed to register the shares of
Common Stock underlying the warrants.

         The Company has also entered into a letter of intent with Advice!
Investment Services GmbH of Vienna, Austria, with respect to an offering of
shares of the Company's Common Stock pursuant to Regulation S under the
Securities Act of 1933. Pursuant to the Regulation S offering, the Company
intends to offer and sell up to a maximum of 4,000,000 shares at prices based on
the market price of the Common Stock prior to closing. As of December 31, 1999,
the Company sold 845,200 shares pursuant to the Regulation S offering, with net
proceeds to the Company of $2,151,675. Since


                                       24
<PAGE>

January 1, 2000, the Company has sold an additional 1,208,900 shares in the
Regulation S offering, at prices ranging from $1.75 to $2.06 per share.

         On July 23, 1998, the Company commenced a private offering of its
Common Stock and completed the offering on August 21, 1998. The offering was
conducted pursuant to Rule 506 of Regulation D under the Securities Act. The
Company sold 654,508 shares at $13.75 per share to accredited investors
including GE Capital, a wholly owned investment management subsidiary of General
Electric Company, and Whittier Trust. The Company engaged Allen & Company
Incorporated and Mitchum, Jones & Templeton to act as placement agents for the
offering, each of which received a placement fee of 5% of the purchase price per
share for shares placed by them. These shares were subsequently registered for
resale via the Company's Form SB-2 filed with the Securities and Exchange
Commission on September 24, 1998. The registration statement became effective on
October 9, 1998. In 1997, the Company sold 833,333 shares of common stock in an
initial public offering. The net proceeds of the offering was $4,857,956.

         In 1997, the Company entered into a master lease agreement with a Bank
which provided up to $400,000 of credit to the Company for the lease of certain
computer and office equipment and furniture for a period of three years, and
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.

         The Company's capital expenditures for the year ended December 31, 1999
were $388,069 compared to $623,439 in 1998. The decrease in 1999 compared to
1998 is primarily due to significant costs incurred in 1998 for computer
equipment and leasehold improvements for its transaction processing center in
Santa Rosa, California. The Company expects continued investments in capital
expenditures for increased personnel, and transaction processing infrastructure
to support more complex operations and higher volumes.

         The Company has historically relied upon proceeds from the sale or
issuance of its common shares and from the issuance of notes payable and lease
financing to satisfy its working capital requirements. The Company expects to
continue to depend upon equity financing to fund operations and satisfy its
working capital needs until it is able to generate significant sales or achieve
profitability. There can be no assurance that the Company will 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


                                       25
<PAGE>

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.

YEAR 2000

         During recent years, there was significant global awareness raised
regarding the potential disruption to business operations worldwide resulting
from the inability of current technology to process properly the change from the
year 1999 to 2000. The Company was aware of the potential year 2000 problem, and
undertook a Year 2000 project to address the Company's readiness and exposure to
Year 2000 issues. The Year 2000 project addressed the Company's products;
internally used operating systems, software, and other technology; and third
party vendors and suppliers. Each of these areas is discussed below.

         The Company believes that it substantially identified and resolved all
potential Year 2000 problems with any of the products that it develops and
markets. In order to confirm its belief, the Company implemented an ongoing
program to test its products for Year 2000 issues. The Company believes that if
any Year 2000 issues are identified, the Company will be able to correct the
problem with a minimal cost or time investment. However, management also
believes that it is not possible to determine with complete certainty that all
Year 2000 problems affecting the Company's products have been identified or
corrected due to the fact that these products interact with other third party
vendor systems not under the Company's control (see below). In addition, the
Company's evaluation is based on a limited number of actual customer
installations.

         The Company conducted a process to identify all internally used
operating systems, software, and other technology that may be impacted by the
Year 2000 problem. This process was completed prior to the end of 1999. For the
internally used operating systems, software, and technology the Company has
identified as material, the Company assessed the Year 2000 exposure through
testing and vendor inquiry. This process was completed by the end of second
quarter, 1999. Material operating systems, software, and other technology deemed
to be adversely affected by the Year 2000 problem were upgraded or replaced. In
addition to operating systems, software, and other technology, the operation of
office and facilities equipment, such as fax machines, photocopiers, telephone
systems, security systems, elevators, and other common devices that could be
affected by the Year 2000 problem were tested after January 1, with no problems
found.

         The Company identified major suppliers and other third party vendors
integral to the operations of the Company's business. The Company initiated
communications with those suppliers and third party vendors to assess their
readiness to deal with Year 2000 problems. As part of the Year 2000 project, the
Company identified alternative providers of products and services deemed
material to the Company's operations. This process was completed by the end of
the second quarter 1999.


                                       26
<PAGE>

However, the Company had no control over and could not predict the corrective
actions of these third party vendors and suppliers. Thus, while the Company
expected that it would be able to resolve any significant Year 2000 problems
related to third party products and services, there was no assurance that it
would be successful in resolving any such problems. Any failure of these third
party vendors and suppliers to resolve Year 2000 problems with their systems in
a timely manner could have had a material adverse effect on the Company's
business, financial condition, and results of operations, but no such problems
have arisen.

         The Company believes that with the completion of the Year 2000 project,
significant interruptions of normal operations were reduced or eliminated. As a
result of the preparations made, the Company experienced no disruptions in its
systems or products as a result of the calendar turning to the Year 2000.

CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995

         Certain statements contained in this Annual Report contain
"forward-looking statements" within the meaning of the private Securities
Litigation Reform Act of 1995. These are statements that do not relate strictly
to historical or current facts. Such forward-looking statements involve known
and unknown risks and uncertainties. The Company's actual results could differ
materially from the results discussed in the forward looking statements. Factors
that could cause or contribute to such differences are discussed below. These
risks and uncertainties include, without limitation:

         o        the ability of the Company to continue as a going concern
                  (see "Report of Independent Accountants" on page F-1);

         o        the rate of market development and acceptance of smart card
                  technology;

         o        the unpredictability of the Company's sales cycle;

         o        the limited revenues and significant operating losses
                  generated to date;

         o        the possibility of significant ongoing capital requirements

         o        the loss of any significant customer;

         o        the ability of the Company to compete successfully with the
                  other providers of smart cards and smart card services (see
                  "Description of Business -- Competition" above);

         o        the ability of the Company to secure additional financing as
                  and when necessary;

         o        the ability of the Company to retain the services of its key
                  management, and to attract new members of the management team;


                                       27
<PAGE>

         o        the ability of the Company to effect and retain appropriate
                  patent, copyright and trademark protection of its products;

         o        the ability of the Company to achieve adequate levels of
                  revenue to recover its investment in capitalized software
                  development costs;

For the purposes of the safe harbor protection for forward-looking statements
provided by the Private Securities Litigation Reform Act of 1995, readers are
urged to review the list of certain important factors set forth in "Cautionary
Statement for Purposes of the 'Safe Harbor' Provisions of the Private Securities
Litigation Reform Act of 1995".

         The Company undertakes no obligation to release publicly any revisions
to the forward-looking statements or to reflect events or circumstances after
the date of this Report.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         Not Applicable

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         Financial information required by this item appears in the pages marked
F-1 through F-20 at the end of this Report and are incorporated herein by
reference as if fully set forth herein.

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

                                                                            PAGE


Accountant's Report                                                          F-1

Consolidated Balance Sheets                                                  F-2

Consolidated Statements of Operations                                        F-3

Consolidated Statements of Stockholders' Equity (Deficit)                    F-4

Consolidated Statements of Cash Flows                                        F-5

Notes to Consolidated Financial Statements                                   F-6


                                       28
<PAGE>

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
         AND FINANCIAL DISCLOSURE

         None.


                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT


         The directors and executive officers of the Company are as follows:

<TABLE>
<CAPTION>

Name                        Age              Position
----                        ---              --------
<S>                         <C>              <C>
Carey F. Daly, II           56               Chairman of the Board of Directors;  President; Chief
                                             Executive Officer; Director

Robert E. Boeck             53               Senior Vice President, Finance; Director

Charles W. Dunn             63               Senior Vice President, Treasurer; Director

Robert J. Fishman           53               Director

Robert W. Haller            45               Executive Vice President; Director

Christopher R. Miller       55               Senior Vice President, Business Development

Glenn A. Okun               37               Director

Mark T. Schuur              39               Director

Monte P. Strohl             48               Senior Vice President, Sales and Marketing; Director

Linda Wing                  55               Director
</TABLE>

         Each director shall hold office until the next annual meeting of the
Company's stockholders, which is anticipated to occur in the spring or summer of
2000. The Company's Bylaws provide for the creation of classes of directors
comprising the Board of Directors. The Company anticipates that it will
implement the classified Board structure at the next annual meeting. Under such
structure, each class will serve separately expiring terms of office such that
all of the directors will not be up for election at any one time.


                                       29
<PAGE>

         CAREY F. DALY, II is the President and Chief Executive Officer of the
Company, the Chairman of the Board of Directors and a Director of the Company.
Mr. Daly founded The Pathways Group, Inc. in October 1993. Mr. Daly is also
President of Pathways International, Ltd. and SPRINTICKET, Inc. Mr. Daly has
over 30 years of computer operating system, computer programming and design
experience. From 1968 to 1969, Mr. Daly served as an internal auditor and
Director of Financial Planning for American Standard, Baltimore, Maryland. He
also worked for major computer companies as a systems engineer in Baltimore,
Maryland from 1970 through 1973. He received an LLB degree in business law from
LaSalle University in 1974 and a BS degree in accounting as well as an AA in
computer science from Baltimore Business College in 1968.

         Mr. Daly is the software engineering designer of the SPRINTICKET
product line, the Pathways Medical smart card system, the Pathways E-Teller
Transaction Processing System as well as several other commercial software
systems.

         ROBERT E. BOECK is the Senior Vice President, Finance, and a
director of the Company. Mr. Boeck joined the Company in February 2000. Mr.
Boeck was financial actuary for Canada Life Assurance Company from December
1998 to February 2000. From February 1996 to December 1998, he was a
consulting actuary for KPMG. Mr. Boeck had his own actuarial consulting
practice from January 1995 to February 1996. Mr. Boeck is the brother-in-law
of Mr. Daly.  Mr. Boeck earned a B.S. in Mathematics from University of
Nebraska and is also a Fellow of the Society of Actuaries.

         CHARLES W. DUNN is the Senior Vice President and Treasurer, and a
Director, of the Company. Mr. Dunn joined the Company in February 2000.
Previously, Mr. Dunn was associated with Merchants Group International, a
merchant banking group located in San Francisco, from October 1998. During this
time he served as interim CFO of several clients companies, including Parthenon,
LP a broker/dealer firm, Pericles, LP, a hedge fund, and FurnitureONline.com.
Earlier, Mr. Dunn was President and CEO of IntegriSoft, Inc. and Advanced
Softeware Automation, Inc., its predecessor, two companies developing software
testing tools for embedded systems, and President and CEO of their investment
company parent, having started in 1992. Mr. Dunn received a MBA from University
of California at Berkeley, and a PhD in economics from the University of Paris
(Sorbonne).

         ROBERT J. FISHMAN was elected as a Director of the Company in February
2000. Mr. Fishman has been President/CEO of Fishman Enterprises since April
1999. From May 1998 through March 1999, he was Vice President of Airport
Services, Hawaiian Airlines, Inc. Mr. Fishman was Managing Director for the City
and County of Honolulu from October 1994 through June 1998.

         ROBERT W. HALLER is the Executive Vice President of the Company, and
since February 2000, has also served as a Director of the Company. Mr. Haller
joined SPRINTICKET, Inc. as the Sales Manager in November 1991. Previously, he
was Sales Manager of QT, Inc. Mr. Haller served as Senior Vice President,
Marketing and Sales of the company since 1996, and became Executive Vice
President in December 1997. Mr. Haller has played a significant role in the
development of the Company's marketing plans and products. Mr. Haller received a
BS in human biology from the University of Washington in 1977.


                                       30
<PAGE>

         CHRISTOPHER R. MILLER is Senior Vice President of Business Development,
and a Director. Mr. Miller joined the Company in November 1999. He was managing
partner at Miller Culver & Maillard, a law firm, from 1987 to 1999, and served
as of-counsel at Lanahan & Reilly, also a law firm, from February 1999 to
October 1999. During this time, Mr. Miller's legal practice focused on general
corporate and business law, business litigation, intellectual property licensing
and international contract negotiation and drafting. Mr. Miller received his
B.A. in Philosophy/Psychology from Sonoma State University in 1971 and a J.D.
from the University of San Francisco, School of Law in 1975.

         GLENN A. OKUN has been a Director of the Company since the fourth
quarter of 1996. Mr. Okun became the Chairman and Chief Executive Officer of
Mitchum Jones & Templeton, Inc., an investment banking firm, in April 1998, and
became a managing director of Jolson Merchant Partners LLC, an investment
management firm, in 1999. Mr. Okun also serves as a director for Farlake Plc,
also an investment management firm, since April 1998. For more than five years
prior to April 1998, Mr. Okun was a Director and Vice President of Allen &
Company Incorporated, an investment banking firm. Allen & Company acted as a
financial advisor to the Company from May 1995 to May 1999. Mr. Okun received a
MBA and a LLB from Harvard University in 1989.

         MARK T. SCHUUR is a Director of the Company, and served as Senior Vice
President and Chief Financial Officer of the Company from September 1996 through
March 2000. From May 1992 through September 1996, Mr. Schuur served as Chief
Financial Officer, Treasurer and a Director of Pizza Blends Inc., Western
Blending Inc. and Flavor Blends Inc., affiliated privately-held food
manufacturers based in Bellevue, Washington; Mr. Schuur presently serves as a
director for those companies. Prior to that, Mr. Schuur was a General Practice
Manager at Coopers & Lybrand in Seattle, Washington. Mr. Schuur received his BA
degree in business administration (accounting emphasis) from the University of
Washington in 1983.

         MONTE P. STROHL has been a Director of the Company since June 1998 and
has been serving as Senior Vice President of Sales and Marketing since November
1999. Mr. Strohl is currently the president of MS Digital, which he founded in
1994 and has acted as President and Chief Executive Officer since that time. MS
Digital is a company specializing primarily in corporate communication and cable
broadcasting. MS Digital provides hardware and software solutions to companies
wishing to communicate over cable television (public or internal), or intranets.
MS Digital's clients include universities, municipalities and Fortune 500
companies. Before founding MS Digital, Mr. Strohl worked as Vice President of
sales for OMNI International, which sold video production solutions
internationally. Mr. Strohl is one of the original founders of Pathways
International, Ltd., the predecessor corporation of the Company.

         LINDA WING has been a Director of the Company since June 1998. Since
1993, she has served as President and Chief Executive Officer of Human Systems
Design, an organizational development firm that assists management of companies
in developing their strategic planning. Ms. Wing currently teaches a course in
strategic management at Metro State University in Minneapolis, Minnesota. She is
also an editor of the journal "Empowerment in Organization," which is published
by MCB University Press. She holds a masters of business administration from the
University of St. Thomas and several undergraduate degrees from Mankato State
University in finance and industrial


                                       31
<PAGE>

relations. Ms. Wing is presently working on obtaining her doctorate in
organizational theory from the Fielding Institute in Santa Barbara, California.

ITEM 11. EXECUTIVE COMPENSATION

         The following table shows compensation for services rendered to the
Company during the fiscal years ended December 31, 1999, 1998 and 1997,
respectively, by the Carey F. Daly, II, President and Chief Executive Officer,
Mark T. Schuur, former Senior Vice President and Chief Financial Officer of the
Company, Robert W. Haller, Executive Vice President, Christopher R. Miller,
Senior Vice President of Business Development and Joseph F. Schuler, former
Senior Vice President of Sales and Marketing. Each executive officer serves
under the authority of the Board of Directors. No other executive officer of the
Company received cash compensation that exceeded $100,000 during the fiscal
years ended December 31, 1999, 1998 and 1997.

                           SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
                                             Annual Compensation                   Long-Term Compensation
                                    ------------------------------------    -------------------------------------
                                                                                     Award               Payouts
                                                                            -------------------------- ----------
                                                                                          Securities                All Other
                                                            Other Annual    Restricted    Underlying      LTIP       Compen-
                                                            Compensation      Stock      Options/SARs    Payouts     sation
Name and Principal Position   Year  Salary ($) Bonus ($)(c)      ($)        Award(s)($)      (#)           ($)         ($)
-----------------------------------------------------------------------------------------------------------------------------
<S>                           <C>   <C>         <C>             <C>            <C>         <C>     <C>      <C>         <C>
Carey F. Daly, II, President  1999  $247,693    $531,971        $    0         $0          223,000/0        0           0
Chief Executive Officer and   1998   200,000     220,000             0          0                0/0        0           0
Chairman of the Board         1997   200,000           0         8,333(a)       0                0/0        0           0
-----------------------------------------------------------------------------------------------------------------------------
Mark T. Schuur(b), Senior     1999  $129,381    $      0        $    0         $0           12,880/0        0           0
Vice President and Chief      1998   124,005      97,663             0          0           15,000/0(e)     0           0
Financial Officer             1997   112,916           0             0          0           15,000/0        0           0
-----------------------------------------------------------------------------------------------------------------------------
Robert W. Haller, Executive   1999  $115,909    $      0        $    0         $0          110,380/0        0            0
Vice President                1998    89,943      79,945             0          0           15,000/0(e)     0            0
                              1997    69,376      23,717             0          0           15,000/0        0            0
-----------------------------------------------------------------------------------------------------------------------------
Joseph F. Schuler(d),         1999  $103,672    $      0        $    0         $0              0(f)/0       0            0
Senior Vice President,        1998   107,000      46,450             0          0                0/0        0            0
Sales and Marketing           1997    10,000(e)        0             0          0          100,000/0        0            0
-----------------------------------------------------------------------------------------------------------------------------
Christopher R. Miller(g),     1999   $26,841    $100,000        $    0         $0          100,000/0        0            0
Senior Vice President,        1998         -           -             -          -                -          -            -
Business Development          1997         -           -             -          -                -          -            -
-----------------------------------------------------------------------------------------------------------------------------
</TABLE>

(a)      Represents payment for accrued vacation benefits.

(b)      Mr. Schuur's employment with the Company terminated in March 2000.


                                       32
<PAGE>

(c)      The Company has no set bonus policy. Bonuses are awarded by the
         Compensation Committee of the Board, which is currently comprised of
         Ms. Wing and Mr. Fishman, independent directors of the Board. During
         1999, the Compensation Committee consisted of Ms. Wing and Mr. Strohl
         (prior to his becoming an executive officer of the Company).

(d)      Mr. Schuler's employment with the Company terminated in October 1999.

(e)      The Company repriced Mr. Schuur's and Mr. Haller's stock options on
         December 4, 1998.

(f)      Mr. Schuler received options to acquire 10,940 shares of the Company's
         Common Stock on June 1, 1999. Those options terminated after Mr.
         Schuler terminated his employment with the Company.

(g)      Mr. Miller joined the Company in November 1999. Mr. Miller received
         $26,841 as salary and $100,000 as a bonus for the Company's fiscal year
         ended December 31, 1999, $50,000 of which was paid in 1999 and the
         remaining $50,000 of which was paid in January 2000. Lanahan & Reilley,
         the firm for which Mr. Miller served from February to November 1999 as
         of-counsel, billed the Company for $65,000 of legal fees and expenses.


STOCK INCENTIVE PLAN

         The Board of Directors of the Company adopted an Amended and Restated
Stock Incentive Plan (the "Incentive Plan") on December 16, 1997 in order to
attract and retain qualified personnel. Under the Incentive Plan, options to
purchase up to 2,000,000 shares of Common Stock may be granted to officers and
key employees of the Company and directors who are also officers or key
employees of the Company. Options granted under the Incentive Plan are intended
to qualify as incentive stock options within the meaning of the Internal Revenue
Code of 1986, as amended.

         Subject to the terms of the Incentive Plan, the Board of Directors is
authorized to select optionees and determine the number of shares covered by
each option, its exercise price and certain of its other terms. The exercise
price of incentive stock options granted under the Incentive Plan may not be
less than the fair market value of the Company's Common Stock on the date of the
grant and may not be less than 110% of such fair market value with respect to
any incentive stock option granted to a participant who owns 10% or more of the
Company's outstanding Common Stock. In general, options become exercisable in
equal annual installments. The period within which any incentive stock option
may be exercised cannot exceed ten years from the date of grant. Unless
otherwise provided in an award agreement with a participant, all options expire
immediately upon the termination of the participant's employment. If the
participant's employment terminates due to retirement or resignation, the Board
of Directors may permit options to continue until the expiration date set forth
in the applicable award agreement. If the participant's employment terminates
due to death or disability, the options will continue until the expiration date
set forth in the applicable award agreement. To the extent required by law for
an option to qualify as an incentive stock option, no option intended to qualify
as an incentive stock option may be exercised while any options previously
granted to that optionee are outstanding. As of the date of this Form 10-K,
1,251,283 options are outstanding.


                                       33
<PAGE>

DIRECTORS STOCK OPTION PLAN

         The Board of Directors of the Company adopted a Directors Stock Option
Plan (the "Directors Plan") on December 14, 1998 in order to attract and retain
directors. Under the Directors Plan, options to purchase up to 100,000 shares of
Common Stock may be granted to eligible non-employee directors of the Company.

         The following persons ("Eligible Directors") are eligible to receive
grants of stock options pursuant to the Directors Plan: directors of the Company
who are not officers or employees of the Company or any subsidiary thereof (a
"Non-employee Director") and who (i) have not been designated by the Company's
Board of Directors within 30 days after becoming a director of the Company as
being eligible to receive awards under a the Amended and Restated Stock
Incentive Plan or (ii) having been eligible to participate in the Amended and
Restated Stock Incentive Plan, have ceased to be so eligible as a result of a
determination by the Board of Directors. The eligibility of any such director to
participate in the Directors Plan shall cease if such director is subsequently
designated as being eligible to receive awards under the Amended and Restated
Stock Incentive Plan for as long as he or she remains so eligible.

         Shares related to options (or portions thereof) that are forfeited,
canceled or terminated, expire unexercised, are surrendered in exchange for
other options or are otherwise settled in such manner that all or some of the
shares covered by an option are not and will not be issued will be restored to
the total number of shares available for issuance pursuant to options granted
under the Directors Plan. In the event of any change in the number of shares of
outstanding Common Stock of the Company by reason of a stock split, stock
dividend, combination or reclassification of shares, recapitalization, merger,
consolidation or similar event, proportional adjustments will be made in the
number of shares of the Company's Common Stock (a) reserved for issuance
pursuant to the Directors Plan, (b) for which stock options shall be granted,
and (c) covered by outstanding stock options, as well as in the exercise price
of such outstanding options. In addition, equitable adjustments will be made in
the event of any other change affecting the Company's Common Stock or any
distribution (other than normal cash dividends) to stockholders of the Company.

         Under the Directors Plan, non-qualified stock options to purchase
shares of the Company's Common Stock are granted automatically to Eligible
Directors at the times specified in the Directors Plan. In general, unless an
Eligible Director has received a previous grant of a stock option (under the
Directors Plan, the Amended and Restated Stock Incentive Plan or otherwise), he
or she will receive an initial option to purchase 10,000 shares of the Company's
Common Stock on the date on which he or she first becomes eligible to
participate in the Directors Plan. Thereafter, as long as the Eligible Director
(including any Eligible Director who received a previous grant) remains eligible
to participate in the Directors Plan, he or she will receive annually, on the
date of the Annual Meeting of Stockholders, an option to purchase 5,000 shares
of the Company's Common Stock, beginning on the date specified in the Directors
Plan. Notwithstanding the foregoing, no stock option shall be granted to any
person whose service as a director of the Company ends on the date on which the
option would otherwise be granted.


                                       34
<PAGE>

         The Directors Plan is administered by the Company's Board of Directors
or a committee composed of not less than two members thereof as may be
designated from time to time by all such members. The Board or such committee
administers the Directors Plan, but has no discretion regarding the grant,
amount, timing, terms and conditions of stock options granted under the
Directors Plan.

         The exercise price of any stock option granted pursuant to the
Directors Plan is the fair market value of the Company's Common Stock on date of
grant. Each stock option is exercisable, cumulatively, as to one-third of the
shares after the first anniversary of the date of grant and as an additional
one-third after each of the second and third anniversaries of the date of grant.
Each option is exercisable for a period of ten years from the date of grant.

         The price at which shares of the Company's Common Stock may be
purchased upon exercise of an option must be paid in full in cash at the time of
exercise or by (i) tendering shares of the Company's Common Stock or
surrendering another stock option, (ii) delivering a promissory note issued by
the participant to the Company or otherwise as determined by the Board or the
committee, or (iii) any other means acceptable to the Board or the committee.

         In order to enable the Company to satisfy any tax payment obligations
resulting from any exercise of a stock option under the Directors Plan, the
Company has the right, among other things, to withhold from the shares of the
Company's Common Stock receivable by a participant an appropriate number of
shares for payment thereof. In addition, participants may elect to have the
Company deduct applicable taxes by withholding an appropriate number of shares
of the Company's Common Stock or to elect to tender to the Company other shares
of the Company's Common Stock held by the participant for the purpose of
satisfying tax payment obligations.

         Except as described below, if a participant's association with the
Company terminates, any unexercised stock option (or portion thereof) shall, to
the extent it is exercisable pursuant to the terms of such option on the date of
such termination, remain exercisable for a period of three months following the
date of termination or until the stated expiration of the stock option, if
earlier. If a participant dies, or ceases to be associated with the Company
because he (i) is disabled, (ii) retires at age 62 or thereafter or (iii)
assumes a position with a governmental, charitable or educational agency or
institution, any stock option granted under the Directors Plan then held by such
participant shall become fully exercisable as of the date on which such
participant dies or ceases to be associated with the Company, and shall be
exercisable through the expiration date specified in the applicable option
agreement.

         Stock options granted under the Directors Plan are subject to
acceleration of exercisability in the event of a change in control of the
Company, as set forth in agreements between the Company and certain of its
directors which provide for certain protections and benefits in the event of a
change of control (as defined in such agreements), or as provided in applicable
option agreements. In general, awards granted under the Directors Plan are not
assignable or transferable by a participant, except under the limited
circumstances contemplated by the Directors Plan.


                                       35
<PAGE>

         The Board or the committee may amend, suspend or terminate the
Directors Plan for the purpose of meeting or addressing any changes in any
applicable tax, securities or other law. In addition, the Directors Plan may
not, without the approval of the stockholders, as set forth therein, be amended
to (i) increase materially the aggregate number of shares of the Company's
Common Stock that may be issued under the Directors Plan (except for adjustments
pursuant to Section 8 of the Directors Plan), (ii) materially increase the
benefits accruing to participants, or (iii) modify materially the eligibility
requirements of the Directors Plan. Nor may the Directors Plan be changed in
such a way as to alter, impair, amend, modify, suspend or terminate any rights
of a participant or any obligations of the Company under any stock options
theretofore granted in any manner adverse to such participant, without the
consent of such participant. The Directors Plan terminates ten years after the
date of approval by the stock holders of the Company, subject to earlier
termination by the Board as set forth above, by the affirmative vote of a
majority of the votes cast at a stockholders' meeting at which the approval of
the Directors Plan is considered, PROVIDED that the total vote cast represents
over 50% of all shares entitled to vote on the proposal. The Directors Plan was
approved by the stockholders at the Annual Meeting of Stockholders in 1999.

                                       OPTION/SAR GRANTS IN LAST FISCAL YEAR

<TABLE>
<CAPTION>
                                             Individual Grants
                         -------------------------------------------------------
                                       Percent of Total                            Potential Realizable Value at
                                          Options/                                 Assumed Annual Rates of Stock
                           Options/         SARS                                      Price Appreciation for
                             SARS        Granted to      Exercise                           Option Term
                          Granted in    Employees in   or Base Price  Expiration   -----------------------------
       Name              Fiscal Year(#)  Fiscal Year       ($/sh)        Date          5%($)            10%($)
       ----              --------------  -----------       ------        ----          -----            ------
<S>                         <C>             <C>           <C>          <C>           <C>              <C>
Carey F. Daly, II           23,000(a)       1.8%          $9 1/16       5/30/09      $131,085         $332,195
                           200,000(b)      15.9%          $     3      10/31/09      $377,337         $956,245
Mark T. Schuur              12,880(c)      1.09%          $9 1/16       5/30/09      $ 73,407         $186,030
Robert W. Haller            10,380(d)       0.8%          $9 1/16       5/30/09      $ 59,159         $149,921
                           100,000(e)       7.9%          $     3      10/31/09      $188,668         $478,123
Joseph F. Schuler(f)                0         -                 -          -                -                -
Christopher R. Miller      100,000(g)       7.9%          $     3      10/31/09      $188,668         $478,123
</TABLE>

(a)      The options vest in three annual installments as follows: 7,667 options
         on June 1, 2000; 7,667 options on June 1, 2001; and 7,666 options on
         June 1, 2002.

(b)      The options vest in three annual installments as follows: 66,667
         options on November 1, 2000; 66,667 options on November 1, 2001; and
         66,666 options on November 1, 2002.

(c)      The options vest in three annual installments as follows: 4,293 options
         on June 1, 2000; 4,293 options on June 1, 2001; and 4,294 options on
         June 1, 2002.


                                       36
<PAGE>

(d)      The options vest in three annual installments as follows: 3,460 options
         on June 1, 2000; 3,460 options on June 1, 2001; and 3,460 options on
         June 1, 2002.

(e)      The options vest in three annual installments as follows: 33,333
         options on November 1, 2000; 33, 333 options on November 1, 2001;
         33,334 options on November 1, 2002.

(f)      Mr. Schuler received a grant of options to acquire 10,940 on June 1,
         1999; these options have now terminated due to Mr. Schuler's
         termination of his employment with the Company.

(g)      The options vest in three annual installments as follows: 33,333
         options on November 1, 2000; 33,333 options on November 1, 2001; and
         33,334 options on November 1, 2002.

               AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
                          AND FY-END OPTION/SAR VALUES

<TABLE>
<CAPTION>
                                                                                  Number of                 Value of
                                                                                 Securities                Unexercised
                                                                                 Underlying               In-the-Money
                                                                         Unexercised Options/SARs(a)      Options/SARsa
                                                                               at Fiscal Year-           at Fiscal Year-
                                                                                   End (#)                   End ($)
                                    Shares Acquired on   Value Realized         Exercisable/              Exercisable/
               Name                     Exercise(#)           ($)               Unexercisable             Unexercisable
----------------------------------- ------------------- ---------------- ---------------------------  ---------------------
<S>                                         <C>               <C>              <C>                            <C>
Carey F. Daly, II                           N/A               N/A              200,000/223,000                $0/$0
Mark T. Schuur                              N/A               N/A               21,666/12,880                 $0/$0
Robert W. Haller                            N/A               N/A              15,000/110,834                 $0/0
Joseph F. Schuler                           N/A               N/A                    0/0                      $0/$0
Christopher R. Miller                       N/A               N/A                 0/100,000                   $0/$0
----------------------------------- ------------------- ---------------- ---------------------------  ---------------------
</TABLE>

(a)               To date, the Company has issued no SARs.


ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The following table sets forth certain information regarding the
beneficial ownership of the Company's Common Stock as of March 24, 2000, by (i)
each person who is known by the Company to own beneficially more than 5 percent
of the Company's outstanding Common Stock; (ii) each of the Company's officers
and directors; and (iii) all officers and directors as a group.

         As of March 24, 2000, there were 14,613,162 shares of Common Stock
outstanding. Each share of Common Stock is entitled to one vote per share.


                                       37
<PAGE>

<TABLE>
<CAPTION>

NAME AND ADDRESS OF                                                                 PERCENT OF COMMON
BENEFICIAL OWNERS AND                                      SHARES OF COMMON STOCK   STOCK BENEFICIALLY
DIRECTORS AND OFFICERS                                       BENEFICIALLY OWNED           OWNED
------------------------------------------------------------------------------------------------------
<S>                                                            <C>                        <C>
5% BENEFICIAL OWNERS:
Allen & Company Incorporated(1)                                 2,780,932(2)               19.0%
711 Fifth Avenue
New York, New York 10022
------------------------------------------------------------------------------------------------------
Deferred Compensation Trust for Carey F. Daly, II(3)            1,876,978                  12.8%
1221 North Dutton Ave.
Santa Rosa, California 95401
------------------------------------------------------------------------------------------------------
Joseph A. Jolson                                                1,156,565(4)                7.9%
Jolson Merchant Partners Group LLC
Joseph A. Jolson 1991 Trust
JMP Asset Management LLC
Mitchum Jones & Templeton Group, Inc.
Mitchum Jones & Templeton, Inc.
Harvest Opportunity Partners I, LLC
Harvest Opportunity Partners II, LLC
One Embarcadero Center, Suite 2150
San Francisco, California 94111
------------------------------------------------------------------------------------------------------
OFFICERS AND DIRECTORS:
Carey F. Daly, II                                                 685,972(5)                 4.6%
1221 North Dutton Ave.
Santa Rosa, California 95401
------------------------------------------------------------------------------------------------------
Robert E. Boeck                                                        --(6)                  --
1221 North Dutton Ave.
Santa Rosa, California 95401
------------------------------------------------------------------------------------------------------
Charles W. Dunn                                                        --(7)                  --
1221 North Dutton Ave.
Santa Rosa, California 95401
------------------------------------------------------------------------------------------------------
Robert J. Fishman                                                      --(8)                  --
Pacific Tower
1001 Pacific Street
Honolulu, Hawaii 96813
------------------------------------------------------------------------------------------------------
Mark T. Schuur                                                     35,000(9)                  *
14201 NE 200th Street
Woodinville, Washington 98072
------------------------------------------------------------------------------------------------------
Glenn A. Okun                                                     511,303(10)                3.5%
Mitchum Jones & Templeton, Inc.
One Embarcadero Center, Suite 2150
San Francisco, California 94111
------------------------------------------------------------------------------------------------------
Monte P. Strohl                                                    67,000(11)                 *
14201 NE 200th Street
Woodinville, Washington 98072
------------------------------------------------------------------------------------------------------
Linda Wing                                                             --(12)                 --
6117 Wilryan Avenue
Minneapolis, Minnesota 55436
------------------------------------------------------------------------------------------------------
Robert W. Haller                                                   63,633(13)                 *
14201 NE 200th St.
Woodinville, Washington 98072
------------------------------------------------------------------------------------------------------
Christopher R. Miller                                                  --(14)                 --
1221 North Dutton Avenue
Santa Rosa, California 95401
------------------------------------------------------------------------------------------------------


                                       38
<PAGE>

<CAPTION>

NAME AND ADDRESS OF                                                                 PERCENT OF COMMON
BENEFICIAL OWNERS AND                                      SHARES OF COMMON STOCK   STOCK BENEFICIALLY
DIRECTORS AND OFFICERS                                       BENEFICIALLY OWNED           OWNED
------------------------------------------------------------------------------------------------------
<S>                                                            <C>                        <C>
Officers and Directors as a Group (10 persons)                  1,362,908                     8.8%
------------------------------------------------------------------------------------------------------
</TABLE>

*        Less than 1%.


(1)      Allen & Company Incorporated, a New York corporation, is wholly-owned
         by Allen Holding Inc., a Delaware corporation of which members of the
         Allen family are beneficial owners of a majority of the shares. The
         remaining shares of Allen Holding Inc. are owned by officers of Allen
         actively involved in its business.

(2)      Excludes approximately 1,578,000 additional shares owed by persons
         affiliated with Allen & Company Incorporated.

(3)      Mr. Daly has no voting power over or power to dispose of the 1,876,978
         shares held in the trust. Mr. Edward L. Mueller, General Counsel to the
         Company, is the trustee.

(4)      Jolson Merchant Partners Group LLC ("JMP Group"), of which
         Mr. Jolson is the manager, holds 20,000 shares of the Company's
         Common Stock. Mitchum Jones & Templeton Group, Inc. ("MJT Group"),
         of which JMP Group is the sole shareholder, holds 4,500 shares of
         Common Stock and immediately exercisable warrants to acquire 150,000
         shares of Common Stock. Mitchum Jones & Templeton, Inc., of which MJT
         Group is the sole shareholder, holds 18,765 shares of Common Stock. The
         Joseph A. Jolson 1991 Trust holds 32,000 shares of the Company's
         Common Stock and immediately exercisable warrants to acquire 100,000
         shares of Common Stock. Harvest Opportunity Partners I, LLC
         ("Harvest I"), holds immediately exercisable warrants to acquire
         800,000 shares of Common Stock. Harvest Opportunity Partners II, LLC
         ("Harvest II"), holds 31,300 shares of Common Stock. JMP Asset
         Management LLC, of which JMP Group is the sole member, is the manager
         of both Harvest I and Harvest II.

(5)      Includes options to acquire 200,000 shares, which options are currently
         exercisable. Excludes (a) 119,000 shares owned by Mr. Daly's wife, (b)
         options to acquire 223,000 shares, which options are not currently
         exercisable and (c) 1,876,978 shares held in the Deferred Compensation
         Trust for Carey F. Daly, II, over which Mr. Daly has no power to vote
         or dispose.

(6)      Excludes options to acquire 100,000 options, which are not currently
         exercisable, granted pursuant to the Company's Amended and Restated
         Stock Incentive Plan.

(7)      Excludes options to acquire 100,000 options, which are not currently
         exercisable, granted pursuant to the Company's Amended and Restated
         Stock Incentive Plan.

(8)      Excludes options to acquire 10,000 shares, which are not currently
         exercisable granted pursuant to the Directors Stock Option Plan.

(9)      Includes options to acquire 6,666 shares, which are currently
         exercisable.

(10)     Includes 75,000 shares owned by Mr. Okun jointly with his wife.
         Excludes 149,955 shares held in an account of a client of Mr. Okun,
         shares over which Mr. Okun has the power to vote and discretion to
         dispose. Mr. Okun disclaims beneficial ownership of the 149,955 shares.
         Also excludes options to acquire 10,000 shares, which options are not
         currently exercisable, granted pursuant to the Directors Stock Option
         Plan.

(11)     Excludes (i) options to acquire 10,000 shares, which are not currently
         exercisable, granted pursuant to the Directors Stock Option Plan and
         (ii) options to acquire 100,000 shares, which are not currently
         exercisable, granted pursuant to the Company's Amended and Restated
         Stock Incentive Plan. Mr. Strohl is no longer able to participate under
         the Company's Director Stock Option now that Mr. Strohl participates
         under the Amended and Restated Stock Incentive Plan.

(12)     Excludes options to acquire 10,000 shares, which options are not
         currently exercisable, granted pursuant to the Directors Stock Option
         Plan.


                                       39
<PAGE>

(13)     Includes options to acquire 15,000 shares, which are currently
         exercisable. Excludes options to acquire 110,834 shares, which are not
         currently exercisable, granted pursuant to the Company's Amended and
         Restated Stock Incentive Plan.

(14)     Excludes options to acquire 100,000 shares, which are not currently
         exercisable, granted pursuant to the Company's Amended and Restated
         Stock Incentive Plan.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         In 1996, the Company issued to Allen & Company Incorporated, a former
financial advisor to the Company, 300,000 shares of its Common Stock in payment
for $300,000 in fees owed by the Company to Allen & Company for financial
consulting services. Allen & Company purchased shares of Common Stock of the
Company (including the 1996 fee for services) in connection with a series of
transactions at a weighted average price per share of $0.70. Mr. Glenn Okun, a
director of the Company, was also a Director and Vice President of Allen &
Company until April 1998.

         In connection with the Company's private offering of Common Stock
pursuant to Rule 506 of Regulation D of the Securities Act, commenced in July
1998 and completed in August 1998, the Company entered into a Placement
Agency Agreement with Allen & Company Incorporated, whereby the Company
agreed to pay Allen & Company Incorporated a placement fee of 5% of the
aggregate amount of Common Stock purchased by a subscriber. The Company paid
Allen & Company Incorporated an aggregate amount of $349,974 as its placement
fee. In addition, Mitchum Jones & Templeton, Inc. ("MJT"), an investment
banking firm for whom Mr. Okun is now a principal, received a 5% placement
fee in connection with a subscription for Common Stock of the Company by one
of that firm's clients. MJT received $100,000 as its placement fee for that
purchase. Allen & Company Incorporated did not receive a placement fee in
connection with the subscription by MJT's client.

         The Company engaged MJT as its placement agent in connection with its
private offering of Common Stock in August and September 1999. MJT received
immediately exercisable warrants to acquire 150,000 shares of the Company's
Common Stock as its placement fee.

         Commencing in 1999, the Company began using the services of Sunset
Aviation, Inc. ("Sunset Aviation") to charter private aircraft for business
travel. In making private charter flight arrangements on behalf of the Company,
Sunset Aviation frequently used an aircraft owned by DHS Aviation, Inc. ("DHS
Aviation"), a corporation of which Mr. Daly is the sole stockholder. During the
1999 fiscal year, the Company paid Sunset Aviation $448,319 for its charter
services, $24,535 of which was paid to DHS Aviation.

         In March 2000, the President and Chief Executive Officer of the
Company committed to provide the Company with a personal guarantee for one
year of up to $3,000,000 to support bank loans to the Company. The President
and Chief Executive Officer will be provided Common Stock warrant coverage
equal to 25% of the value committed under the guarantee. Presently, bank
loans have been applied for but are not yet completed.

         In connection with the agreement with Scrip Advantage, Scrip Advantage
has agreed to elect a Company designee to its Board of Directors. Initially,
Carey F. Daly II, the President and Chief Executive Officer of the Company, will
be elected to such Board. The Company has advanced


                                       40
<PAGE>

$50,000 to Scrip Advantage in exchange for a demand promissory note. The note is
convertible into equity of Scrip Advantage at the Company's sole option.

         The Company believes that the terms of the transactions with affiliates
of the Company are fair and reasonable in light of prevailing market conditions
at the time when such arrangements were implemented and in light of the
circumstances under which such arrangements were made. The disinterested members
of the Board of Directors will continue to review any ongoing relationships with
such affiliates to assure that such transactions are consistent with the
fiduciary duties of the directors to the stockholders of the Company.

                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a) The following Exhibits are filed as part of this Report:

-------  -----------------------------------------------------------------------
3.1      Certificate of Incorporation of the Company(1)
-------  -----------------------------------------------------------------------
3.2      Amended and Restated By-Laws of the Company(1)
-------  -----------------------------------------------------------------------
3.3      Certificate of Designations for Series A Preferred Stock of the
         Company(2)
-------  -----------------------------------------------------------------------
3.4      Form of Common Stock Purchase Warrant(2)
-------  -----------------------------------------------------------------------
4.1      Form of Subscription Agreement for the shares of Common Stock sold
         during the 1998 private placement(3)
-------  -----------------------------------------------------------------------
10.1     Joint Marketing and Servicing Agreement, dated as of February 19, 1998,
         between First Hawaiian Bank and The Pathways Group, Inc.(1)
-------  -----------------------------------------------------------------------
10.2     Development Agreement, dated as of June 5, 1995, between Stephen A.
         Gregg and The Pathways Group, Inc.(1)
-------  -----------------------------------------------------------------------
10.3     Authorization and Loan Agreement (Guaranty Loans) , dated February 13,
         1992, among Towne Bank of Woodinville, U.S. Small Business
         Administration and Pathways International Ltd.(1)
-------  -----------------------------------------------------------------------
10.4     Restructure and Extension Agreement, dated as of July 1, 1996, between
         SeaFirst Bank and The Pathways Group, Inc. and Pathways International
         Ltd.(1)
-------  -----------------------------------------------------------------------
10.5     Restructure and Extension Agreement, dated as of July 1, 1997, between
         SeaFirst Bank and PT Link Corporation and The Pathways Group, Inc.(1)
-------  -----------------------------------------------------------------------
10.6     Schlumberger Associate Program Agreement, dated June 16, 1997, between
         Schlumberger Technologies, Inc. and The Pathways Group, Inc., together
         with Addendum No. 1 thereto(3)
-------  -----------------------------------------------------------------------
10.7     Executive Employment Agreement, dated as of November 1, 1999, between
         The Pathways Group, Inc. and Carey F. Daly, II (filed herewith)
-------  -----------------------------------------------------------------------
10.8     Executive Employment Agreement, dated as of February 8, 2000, between
         The Pathways Group, Inc. and Charles W. Dunn (filed herewith)
-------  -----------------------------------------------------------------------


                                       41
<PAGE>

-------  -----------------------------------------------------------------------
10.9     Executive Employment Agreement, dated as of February 14, 2000, between
         The Pathways Group, Inc. and Robert Boeck (filed herewith)
-------  -----------------------------------------------------------------------
10.10    Executive Employment Agreement, dated as of November 1, 1999, between
         The Pathways Group, Inc. and Monte Strohl (filed herewith).
-------  -----------------------------------------------------------------------
10.11    Executive Employment Agreement, dated as of November 1, 1999, between
         The Pathways Group, Inc. and Robert W. Haller (filed herewith).
-------  -----------------------------------------------------------------------
10.12    Executive Employment Agreement, dated as of November 1, 1999, between
         The Pathways Group, Inc. and Christopher R. Miller (filed herewith)
-------  -----------------------------------------------------------------------
10.13    Letter of Intent, dated December 12, 1997, from The Pathways Group,
         Inc. and The Department of Education, State of Hawaii(4)
-------  -----------------------------------------------------------------------
10.14    Equipment Lease Agreement, dated August 25, 1997, between Union Bank of
         California, N.A., and The Pathways Group, Inc., together with Addendums
         A and B dated September 16, 1997, Conditional Sales Lease dated
         September 8, 1997 and Covenant Agreement, dated February 25, 1998(4)
-------  -----------------------------------------------------------------------
10.15    Master Project Agreement, dated June 19, 1998, between Scrip Advantage,
         Inc. and The Pathways Group, Inc., together with a Promissory Note,
         dated June 19, 1998, given by Scrip Advantage, Inc. to The Pathways
         Group, Inc.(4)
-------  -----------------------------------------------------------------------
10.16    Covenant Agreement, dated August 13, 1998, between Union Bank of
         California and The Pathways Group, Inc.(3)
-------  -----------------------------------------------------------------------
10.17    Placement Agency Agreement, dated July 22, 1998 between The Pathways
         Group, Inc. and Allen & Company Incorporated(3)
-------  -----------------------------------------------------------------------
10.18    Amended and Restated Stock Incentive Plan(3)
-------  -----------------------------------------------------------------------
10.19    Directors Stock Option Plan(5)
-------  -----------------------------------------------------------------------
10.20    Letter of Intent, dated November 4, 1998, between The Pathways Group,
         Inc. and LinkOpp Marketing, Inc.(5)
-------  -----------------------------------------------------------------------
10.21    Letter of Intent, dated February 1, 1999, between The Pathways Group,
         Inc. and Consolidated Amusement Company, Inc.(5)
-------  -----------------------------------------------------------------------
10.22    Amended Bank Lease Agreement dated as of June 22, 1999, between Union
         Bank of California and the Pathways Group, Inc.(2)
-------  -----------------------------------------------------------------------
10.23    Agreement, dated July 20, 1999, between Hawaiian Millenium Commission
         and The Pathways Group (Hawaii)(2)
-------  -----------------------------------------------------------------------
10.24    License Agreement, dated May 13, 1999, between Proton World
         International S.A. and the Pathways Group, Inc. (filed herewith)
-------  -----------------------------------------------------------------------
21       Subsidiaries of Registrant (filed herewith)
-------  -----------------------------------------------------------------------
27       Financial Data Schedule (filed herewith)
-------  -----------------------------------------------------------------------


----------
1        Incorporated herein by reference to the exhibit contained in the
         Company's Registration Statement on Form 10SB under the Securities
         Exchange Act of 1934, as amended, filed with the Securities and
         Exchange Commission on April 29, 1998.

2        Incorporated herein by reference to the exhibit contained in the
         Company's Quarterly Report in Form 10- QSB, for the fiscal quarter
         ended June 30, 1999.


                                       42
<PAGE>

3        Incorporated by reference to the exhibit contained in the Company's
         Registration Statement on Form SB-2 under the Securities Act of 1933,
         as amended, filed with the Securities and Exchange Commission on
         September 24, 1998.

4        Incorporated herein by reference to the exhibit contained in the
         Company's Registration Statement on Form 10SB/A-1 under the Securities
         Exchange Act of 1934, as amended, filed with the Securities and
         Exchange Commission on August 7, 1998.

5        Incorporated herein by reference to the exhibit contained in the
         Company's Annual Report on Form 10-K for the fiscal year ended December
         31, 1998, filed with the Securities and Exchange Commission on March
         31, 1999.

(b)  REPORTS ON FORM 8-K

         None.







                                       43
<PAGE>




THE PATHWAYS GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS
WITH REPORT OF INDEPENDENT
ACCOUNTANTS FOR THE YEARS ENDED
DECEMBER 31, 1999, 1998 AND 1997





<PAGE>

                        REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors and Stockholders
The Pathways Group, Inc. and Subsidiaries

In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of stockholders' equity (deficit) and of
cash flows present fairly, in all material respects, the financial position of
The Pathways Group, Inc. and Subsidiaries at December 31, 1999 and 1998, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1999, in conformity with accounting principles
generally accepted in the United States. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States, which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As described in Note 1 to the
financial statements, the Company has incurred recurring losses and negative
cash flows from operations and has deficits in working capital. These matters
raise substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these matters are also described in
Note 1. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.


PRICEWATERHOUSECOOPERS LLP

Seattle, Washington
April 12, 2000


                                      F-1
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                    1999              1998
                                                                ------------      ------------
<S>                                                             <C>               <C>
ASSETS
CURRENT ASSETS:
     Cash and cash equivalents                                  $    645,065      $  4,628,544
     Accounts receivable                                               5,523           102,793
     Inventories                                                     338,438           361,467
     Prepaid expenses and other current assets                       260,664           168,779
                                                                ------------      ------------
                 TOTAL CURRENT ASSETS                              1,249,690         5,261,583
                                                                ------------      ------------

   Restricted cash                                                   272,000           222,000
   Software, net of accumulated amortization of $3,292,221
     and $2,528,560                                                  666,283         1,256,020
   Property and equipment, net                                     1,003,231         1,100,061
   Software license                                                1,000,000                --
   Deposits and other assets                                          85,481           139,024
                                                                ------------      ------------
                 TOTAL ASSETS                                   $  4,276,685      $  7,978,688
                                                                ------------      ------------

LIABILITIES, MANDITORILY REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
     Notes payable to banks, current maturities                 $    108,908      $    336,947
     Accounts payable                                                319,646           251,140
     Accrued expenses and unearned revenue                           552,368           854,030
     Software license fee payable                                    700,000                --
                                                                ------------      ------------
                 TOTAL CURRENT LIABILITIES                         1,680,922         1,442,117

   Notes payable to banks, net of current maturities                  60,781           170,903
                                                                ------------      ------------
                 TOTAL LIABILITIES                                 1,741,703         1,613,020
                                                                ------------      ------------

     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 outstanding; aggregate
       liquidation preference of $3,075,000                        1,489,527
                                                                ------------
   STOCKHOLDERS' EQUITY
     Common stock, $.01 par value; 50,000,000 shares
       authorized; 14,410,862 and 13,565,662 shares
       issued and outstanding, respectively                          144,109           135,657
     Additional paid in capital                                   30,639,640        26,439,081
     Unearned compensation                                          (495,833)
     Accumulated deficit                                         (29,242,461)      (20,209,070)
                                                                ------------      ------------
                 TOTAL STOCKHOLDERS' EQUITY                        1,045,455         6,365,668
                                                                ------------      ------------

                 TOTAL LIABILITIES, MANDITORILY REDEEMABLE
                   PREFERRED STOCK AND STOCKHOLDERS' EQUITY     $  4,276,685      $  7,978,688
                                                                ------------      ------------
</TABLE>

        The accompanying notes are an integral part of these consolidated
                             financial statements.

                                      F-2
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                     1999              1998              1997
                                                 ------------      ------------      ------------
<S>                                              <C>               <C>               <C>
Sales, net                                       $    186,309      $     76,565      $     61,785
Cost of goods sold                                     63,469            34,863            19,492
Write-off of inventories                              132,000
Selling, general and administrative expenses        7,142,012         5,918,513         2,673,507
Research & development                                599,746           474,120           102,000
Amortization of software                              766,877           621,642           593,459
Depreciation                                          484,899           364,144           208,814
                                                 ------------      ------------      ------------
               TOTAL OPERATING EXPENSES             9,189,003         7,413,282         3,597,272
                                                 ------------      ------------      ------------

LOSS FROM OPERATIONS
                                                   (9.002,694)       (7,336,717)       (3,535,487)
                                                 ============      ============      ============

Other income (expense)
  Interest income, net                                 44,303            84,256           (51,034)
  Loan guarantee fees to stockholder                       --                --                --
                                                 ------------      ------------      ------------

               NET LOSS                            (8,958,391)       (7,252,461)       (3,586,521)
                                                 ============      ============      ============

Basic and diluted net loss per share             $      (0.68)     $      (0.55)     $      (0.30)
Shares used in per share calculation               13,615,613        13,148,939        12,102,755

</TABLE>


        The accompanying notes are an integral part of these consolidated
                             financial statements.

                                      F-3
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDING DECEMBER 31, 1999, 1998, AND 1997
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                              COMMON STOCK           ADDITIONAL
                                         ------------------------      PAID-IN         UNEARNED       ACCUMULATED
                                           SHARES        AMOUNT        CAPITAL       COMPENSATION       DEFICIT          TOTAL
                                         ----------    ----------    ------------   -------------    ------------    ------------
<S>                                      <C>           <C>           <C>            <C>              <C>             <C>
Balance at December 31, 1996             11,756,004    $  117,560    $ 12,214,123                    $ (9,370,088)   $  2,961,595
Redemption of common stock for cash         (33,737)         (337)        (27,663)                                        (28,000)
Issuance of common stock for
   convertible debenture                      3,000            30           2,970                                           3,000
Issuance of common stock upon exercise
   of stock options and warrants            345,887         3,459       1,013,677                                       1,017,136
Net proceeds from initial public
offering of common stock                    833,333         8,333       4,849,623                                       4,857,956

Net loss                                                                                               (3,586,521)     (3,586,521)
                                         ----------    ----------    ------------    ------------    ------------    ------------

Balance at December 31, 1997             12,904,487       129,045      18,052,730                     (12,956,609)      5,225,166
Net proceeds from private placement of
   common stock                             654,508         6,545       8,379,284                                       8,385,829
Issuance of common stock upon exercise
   of stock options                           6,667            67           7,067                                           7,134

Net loss                                                                                               (7,252,461)     (7,252,461)
                                         ----------    ----------    ------------    ------------    ------------    ------------

Balance at December 31, 1998             13,565,662       135,657      26,439,081                     (20,209,070)      6,365,668

Net proceeds from private placement of
common stock                                845,200         8,452       2,143,223                                       2,151,675

Value ascribed to warrants issued in
conjunction with sale of mandatorily
redeemable preferred stock                                              1,445,244                                       1,445,244

Warrants issued for placement fees                                        253,681                                         253,681
Accretion of manditorily redeemable
preferred stock                                                          (166,589)                                       (166,589)
Preferred stock dividends                                                                                 (75,000)        (75,000)
Unearned compensation                                                     525,000    $   (525,000)
Amortization of unearned compensation                                                      29,167                          29,167

Net loss                                                                                               (8,958,391)     (8,958,391)
                                         ----------    ----------    ------------    ------------    ------------    ------------
Balance at December 31, 1999             14,410,862    $  144,109    $ 30,639,640    $   (495,833)   $(29,242,461)   $  1,045,455
                                         ==========    ==========    ============    ============    ============    ============
</TABLE>


        The accompanying notes are an integral part of these consolidated
                             financial statements.

                                      F-4
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDING DECEMBER 31, 1999, 1998, AND 1997
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>

                                                                     1999            1998             1997
                                                                  -----------     -----------     -----------
<S>                                                               <C>             <C>             <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
     Net loss                                                     $(8,958,391)    $(7,252,461)    $(3,586,521)
     Adjustments to reconcile net loss to net
       cash used in operating activities:
        Depreciation                                                  484,899         364,144         208,354
        Amortization                                                  796,372         621,642         593,459
        Write-off of inventories                                      132,000              --              --
        Write-off of note receivable                                   50,000              --              --
        Effects of changes in operating assets and liabilities
            Accounts receivable                                        97,270         (36,300)         36,018
            Inventories                                              (108,971)       (158,718)         56,963
            Prepaid expense and other current assets                  (91,885)        (67,372)       (101,407)
            Other assets                                                              (18,917)       (137,913)
            Accounts payable                                           68,506          44,154        (335,404)
            Accrued expenses and unearned revenue                    (301,662)        631,233        (120,839)
                                                                  -----------     -----------     -----------
        Net cash used in operating activities                      (7,831,862)     (5,872,595)     (3,387,290)
                                                                  ===========     ===========     ===========

CASH FLOWS FROM INVESTING ACTIVITIES:
     Capital expenditures                                            (388,069)       (623,439)       (542,752)
     Capitalized software development costs                          (173,924)       (272,564)       (439,707)
     Restricted cash                                                  (50,000)       (151,500)        (70,500)
     Advance to Scrip Advantage                                            --         (50,000)             --
     Software licenses                                               (300,000)             --              --
                                                                                  -----------     -----------
                                                                  -----------     -----------     -----------
        Net cash used in investing activities                        (911,993)     (1,097,503)     (1,052,959)
                                                                  ===========     ===========     ===========

CASH FLOWS FROM FINANCING ACTIVITIES:
     Principal payments on notes payable to banks
                                                                     (338,162)       (554,041)        (34,750)
     Principal payments on notes payable to stockholders                   --              --          (2,500)
     Redemption of common stock                                            --              --         (28,000)
     Proceeds from issuance of mandatorily preferred
     stock, net of cash offering costs of $265,214                  2,946,863              --              --
     Net proceeds from issuing common stock, net of
     offering costs of $150,000, $597,980, and $142,040
     for 1999, 1998 and 1997 respectively                           2,151,675       8,392,963       5,875,092
                                                                  -----------     -----------     -----------

        NET CASH PROVIDED BY FINANCING ACTIVITIES
                                                                    4,760,376       7,838,922       5,809,842
                                                                  ===========     ===========     ===========

(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                   (3,983,479)        868,824       1,369,593
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR                        4,628,544       3,759,720       2,390,127
                                                                  -----------     -----------     -----------

CASH AND CASH EQUIVALENTS, END OF YEAR                            $   645,065     $ 4,628,544     $ 3,759,720
                                                                  ===========     ===========     ===========
</TABLE>

        The accompanying notes are an integral part of these consolidated
                             financial statements.

                                      F-5
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

1.   ORGANIZATION AND BASIS OF PRESENTATION:

     THE COMPANY

     The accompanying consolidated financial statements include the accounts of
     The Pathways Group, Inc. ("TPG") and its wholly-owned and majority-owned
     subsidiaries. All intercompany balances and transactions have been
     eliminated. TPG's subsidiaries include Pathways International, Ltd.
     ("PIL"), SPRINTICKET, Inc. ("ST"), PT Link, Inc. ("PT Link") and The
     Pathways Group, a wholly-owned subsidiary incorporated in the state of
     Hawaii in August of 1997. TPG and its subsidiaries (the "Company") are
     primarily engaged in providing specialized transaction processing services
     through the development of proprietary software and hardware systems
     including credit card and multiple application smart card technologies. The
     Company derives its revenue principally from transaction processing fees
     charged to the merchant and the sale of related terminals, hardware systems
     and smart cards.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern and do not include any adjustments to
reflect the possible future effects on the recoverability and classification of
assets and liabilities that may result from this uncertainty. The Company has
incurred substantial operating loses during the last three years as a result of
its research and development efforts. In addition, the Company has also
experienced negative cash flows from operations and its balance sheet reflects a
deficit in working capital at December 31, 1999. These matters raise substantial
doubt about the Company's ability to continue as a going concern, without
additional financing.

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.

Management has made the following arrangements to obtain sufficient funds to
satisfy the Company's cash requirements:

         The Company has engaged an investment banking firm to conduct a best
efforts basis offering of shares of the Company's common stock for gross
proceeds of up to $15,000,000. The offering requires the filing of a
registration statement and registration of a sufficient number of shares of the
Company's common stock to cover the shares to be issued under the offering. The
purchase price of the shares to be sold under the offering will be 90% of
average daily prices as defined in the agreement.

          In addition, the investment bank has offered a $1,500,000 bridge loan
to be funded on a best efforts basis.

         The President and Chief Executive Officer of the Company has committed
to provide the Company with his personal guarantee of up to $3,000,000 to
support bank loans to the Company. The President will be provided common stock
warrant coverage equal to 25% of the value committed under the guarantee.
Presently, bank loans have been applied for but are not yet completed.

         In the event that the above financings are not completed or are not
sufficient in amount or timeliness, the Company has identified reductions in
staffing, rent and other expenses to be made if necessary.

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.


2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

     CASH AND CASH EQUIVALENTS

     For purposes of the consolidated statements of cash flows, the Company
     considers all highly liquid debt securities purchased with an original
     maturity of three months or less to be cash equivalents. As of December 31,
     1999 and 1998, cash equivalents consisted of money market accounts
     principally invested in U.S.
     government obligations.

     RESTRICTED CASH

     The Company entered into an operating lease agreement whereby the Company
     is required to maintain a certificate of deposit at the bank as collateral
     for the lease. As of December 31, 1999 $272,000 has been classified as
     restricted cash.

     INVENTORIES

     Inventories are stated at the lower of cost (as determined by the first-in,
     first-out method) or market.

     PROPERTY AND EQUIPMENT

     Property and equipment are stated at cost. Depreciation expense is provided
     by the straight-line method over the estimated useful lives of the property
     and equipment which is estimated to be five years, with the exception of
     computer equipment as to which the life is three years. Leasehold
     improvements are amortized over the lesser of the estimated useful lives of
     the improvement or the related lease term. Expenditures for renewals and
     betterments are capitalized; expenditures for maintenance and repairs are
     charged to expense as incurred. The cost and accumulated depreciation of
     assets sold or otherwise disposed of are removed from the accounts, and the
     related gains and losses are included in the results of operations.

                                      F-6
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:  (CONTINUED)

     SOFTWARE

     Software development costs incurred in conjunction with product development
     are charged to expense until technological feasibility is established.
     Thereafter, all software development costs are capitalized and reported at
     the lower of unamortized cost or net realizable value of each product. The
     establishment of technological feasibility and the on-going assessment of
     the recoverability of costs require considerable judgement by the Company
     with respect to certain external factors, including, but not limited to,
     anticipated future gross product revenues, estimated economic life and
     changes in software and hardware technology. After consideration of the
     above factors, the Company amortizes capitalized software costs by the
     greater of (a) the ratio that current gross revenues for a product bear to
     the total of current and anticipated future gross revenues for that product
     or (b) the straight-line method over the remaining estimated economic life
     of the product including the period being reported on, ranging from three
     to five years.

     In 1999, the Company changed the estimate of economic useful lives of
     capitalized software costs for certain applications from five years to
     three years due to new information and developments arising from customer
     negotiations. The effect of this change on 1999 results of operations was
     to increase net loss by approximately $206,000 or $.015 per share.

     RESEARCH AND DEVELOPMENT

     Research and development costs are expensed as incurred in accordance with
     Statement of Financial Standards (SFAS) No. 2, Accounting for Research and
     Development Costs.

     INCOME TAXES

     Deferred tax assets and liabilities are recorded for differences between
     the financial statement and tax bases of the assets and liabilities that
     will result in taxable or deductible amounts in the future based on enacted
     tax laws and rates applicable to the periods in which the differences are
     expected to affect taxable income. Valuation allowances are established
     when necessary to reduce deferred tax assets to the amount expected to be
     realized. Income tax expense is recorded for the amount of income tax
     payable or refundable for the period, increased or decreased by the changes
     in deferred tax assets and liabilities during the period.

     FAIR VALUE OF FINANCIAL INSTRUMENTS

     The carrying amounts of cash and cash equivalents and accounts receivable
     approximate fair value due to their short-term maturities. The carrying
     value of mandatorily redeemable preferred stock and debt approximate
     estimated fair value because the rates of interest on the debt approximate
     current interest rates for similar obligations with like maturities.

     CONCENTRATIONS OF CREDIT RISK

     Financial instruments which potentially subject the Company to
     concentrations of credit risk consist principally of cash and accounts
     receivable. The Company places its cash with high quality financial
     institutions. At times, such cash may exceed federally insured limits.

                                      F-7
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:  (CONTINUED)

     REVENUE RECOGNITION AND REVENUE SHARING AGREEMENTS

     Revenue from hardware and software sales are recognized when a product is
     shipped. The revenue for sales of ticket dispensers and manager
     workstations are recognized when on site installation is completed. The
     Company has revenue sharing and transaction processing agreements with
     merchants who process commercial transactions through the Company's
     hardware and software systems provided on site to the merchants.
     Transaction processing fee revenue is recognized at the time transactions
     processing services are performed and earned. Revenues collected for
     warranty services to be performed in the future are deferred and recognized
     ratably over the related contract period.

     USE OF ESTIMATES AND ASSUMPTIONS

     The preparation of financial statements in conformity with generally
     accepted accounting principles requires management to make estimates and
     assumptions that affect the reported amounts of assets and liabilities and
     disclosure of contingent assets and liabilities at the date of the
     financial statements and the reported amounts of revenues and expenses
     during the reporting period. Accordingly, actual results could differ from
     those estimates and assumptions.

     It is reasonably possible that the estimates of anticipated future gross
     revenues and the remaining estimated economic lives used to calculate
     depreciation and amortization of the Company's long lived assets and
     software may be reduced significantly in the near term. As a result, the
     carrying amount of the capitalized software costs ($666,283) may be reduced
     entirely in the near term. In addition, the carrying amount of long lived
     assets may be reduced materially in the near term.

     NET LOSS PER SHARE

     Statement of Financial Accounting Standards No. 128 (SFAS NO. 128),
     "Earning 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>
                                                             YEAR ENDED
                                               1999             1998             1997
                                           ------------     ------------     ------------
<S>                                        <C>              <C>              <C>
Net Loss                                   $ (8,958,391)    $ (7,252,461)    $ (3,586,521)
Accretion of manditorily redeemable
convertible preferred stock                    (166,589)
Preferred stock dividends                       (75,000)
                                           ------------     ------------     ------------
Net loss for common stock                  $ (9,199,980)    $ (7,252,461)    $ (3,586,521)
                                           ============     ============     ============

Weighted average shares of common stock      13,615,613       13,148,939       12,102,755
outstanding
Basic and diluted net loss per share       $      (0.68)    $      (0.55)    $      (0.30)
</TABLE>

                                      F-8
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:  (CONTINUED)

     RECENT ACCOUNTING PRONOUNCEMENTS

     In June 1997, the Financial Accounting Standards Board ("FASB") issued
     Statement of Financial Accounting Standards ("SFAS") No. 130,
     "Comprehensive Income". This statement establishes standards for reporting
     and display of comprehensive income and its components in a full set of
     financial statements. Comprehensive income includes items such as foreign
     currency translation adjustments. Management believes this standard is not
     applicable as the Company does not have any items in its financial
     statements meeting the criteria for comprehensive income.

     In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of
     an Enterprise and Related Information," which changes the way public
     companies report information about operating segments. This statement,
     which is based on the management approach to segment reporting, establishes
     requirements to report selected segment information quarterly and to report
     entity-wide disclosures about products and services, major customers and
     the major countries in which the Company holds assets and reports revenues.
     Management believes this standard is not applicable as the Company
     currently operates as one segment.

3.  INVENTORIES:

    Inventories at December 31,1999 and 1998 consisted of the following:

                                                     1999        1998
                                                   --------    --------

     Smart cards and related packaging             $ 74,705    $158,917
     Smart card terminals                            72,840      61,846
     Assembled unattended kiosks and components     190,893     140,704
                                                   --------    --------
                                                   $338,438    $361,467
                                                   ========    ========


     In 1999, the Company wrote off $132,000 of smart card inventory.

                                      F-9
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

4.    PROPERTY AND EQUIPMENT:

     Property and equipment at December 31, 1999 and 1998 consisted of the
     following:

                                                        1999           1998
                                                     -----------   -----------

     Ticket dispensing systems                       $   476,318   $   476,318
     Computer equipment and software                   1,215,136       853,670
     Furniture and fixtures                              220,023       211,360
     Leasehold improvements                              348,474       334,461
                                                     -----------   -----------
                                                       2,259,951     1,875,809
     Less accumulated depreciation and amortization   (1,256,720)     (775,748)
                                                     -----------   -----------
                                                     $ 1,003,231   $ 1,100,061
                                                     ===========   ===========

5.   NOTE RECEIVABLE:

     In 1998 the Company advanced $50,000 to Scrip Advantage, Inc. in exchange
     for a demand note receivable with interest bearing at 10%, which is
     included in deposits and other assets in the accompanying consolidated
     balance sheet. The note receivable is convertible into common stock of
     Scrip Advantage at the Company's option. As of December 31, 1999, the
     Company has determined that the receivable was not collectible, and the
     amount was written off as bad debt expense in Selling General and
     Administrative Expense.



                                      F-10
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

6.   NOTES PAYABLE TO BANKS:

     Notes payable to banks at December 31, 1999 and 1998 consisted of the
     following:

<TABLE>
<CAPTION>
                                                                                      1999                1998
                                                                                    ----------         ----------
<S>                                                                                 <C>                <C>
   Note payable to bank, interest at bank's prime rate (7.75% at December 31,
      1998) plus 1.5%, principal due in various Installments from May 1998
      through February 1999, interest due monthly, guaranteed by certain
      stockholders and Collateralized by substantially all of the assets of PIL              -         $  130,000

   Note payable to bank, interest at prime (7.75% at December 31, 1998) plus
      1.5%, principal due in various installments from February 1998 through May
      1, 1999 (however, the note payable will be due in full upon sale or
      transfer of either a Controlling ownership interest in PT Link or
      substantially all of PT Link's assets occurring prior to May 1, 1999),
      interest due monthly and collateralized by substantially all of the
      assets of PT Link                                                                      -            110,000

   Note payable to bank, interest at 10.5%,
      principal due in various installments
      from February 1998 through September 2001, interest due
      monthly, guaranteed by certain stockholders and
      Collateralized by substantially all of the assets of PIL                      $  169,689            267,850
                                                                                    ----------         ----------
                                                                                                          507,850
   Less current maturities                                                            (108,908)          (336,947)
                                                                                    ----------         ----------

                                                                                    $   60,781         $  170,903
                                                                                    ==========         ==========
</TABLE>

     The contractual principal maturities of notes payable to banks at December
     31, 1999 are as follows:

                         2000               $108,908
                         2001                 60,781
                                            --------
                                            $169,689
                                            ========


                                      F-11
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

6.    ACCRUED EXPENSES AND UNEARNED REVENUE:

     Accrued expenses and unearned revenue at December 31, 1999 and 1998
     consisted of the following:

                                                    1999        1998
                                                  --------    --------

     Interest payable                             $     --    $  1,912
     Accrued payroll, bonus, and related taxes     360,815     599,339
     Insurance premium payable                     120,197      90,262
     Other accrued expenses                         65,906     159,122
     Unearned revenue                                5,450       3,395
                                                  --------    --------
                                                  $552,368    $854,030
                                                  ========    ========

8.   SOFTWARE LICENSE AGREEMENT:

     In May 1999, the Company entered into a License Agreement (the "Agreement")
     with Proton World International S.A. As of December 31, 1999 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 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. There was no amortization expense recorded for
     the year ended December 31, 1999, as the testing and acceptance of the
     system had not been completed and the underlying system had not been placed
     into service.


                                      F-12
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

9.   INCOME TAXES:

     At December 31, 1999, the Company had accumulated net operating loss
     carryforwards for tax purposes of approximately $28,500,000 which expire
     through 2019. As a result of acquisitions, the availability of these net
     operating losses to offset future taxable income will be limited to a
     prescribed amount each year as specified in the Internal Revenue Code. Net
     operating losses accumulated through the dates of acquisition for companies
     acquired may be limited to their separate taxable income.

     The following is a reconciliation of the income tax benefit to the amount
     based on the statutory Federal rate of 34%:

<TABLE>
<CAPTION>
                                                         1999            1998            1997
                                                     -----------     -----------     -----------
<S>                                                  <C>             <C>             <C>
     Federal income tax benefit at statutory rate    $(3,045,853)    $(2,465,837)    $(1,219,417)
     Losses which provide no current tax benefit       3,037,701       2,458,918       1,215,851
     Other, net                                            8,152           6,919           3,566
                                                     -----------     -----------     -----------
         Income tax benefit                          $        --     $        --     $        --
                                                     ===========     ===========     ===========
</TABLE>

     Deferred income taxes under the liability method reflect the net tax
     effects of temporary differences between the carrying amounts of assets and
     liabilities for financial reporting purposes and the amounts used for
     income tax purposes.

                                      F-13
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

9.   INCOME TAXES:  (CONTINUED)

     The significant components of the Company's deferred income tax assets and
     liabilities at December 31, 1999 and 1998 are as follows:

                                                1999              1998
                                             ------------     ------------
     Deferred income tax assets:
       Tax loss carryforwards                $  9,766,907     $  5,929,544
       Debt guarantee fees to stockholder         439,466          439,466
       Accrued compensation                       111,246          204,150
       Depreciation                                    --           50,615
       Other                                      127,078               --
                                             ------------     ------------
           Deferred income tax assets          10,444,697        6,623,775
                                             ------------     ------------
     Deferred income tax liability:
       Depreciation                                69,024               --
       Other                                        1,222            1,222
                                             ------------     ------------
           Deferred income tax liability           70,246            1,222
                                             ------------     ------------
     Valuation allowance                      (10,374,451)      (6,622,553)
                                             ------------     ------------
           Net deferred income tax assets    $         --     $         --
                                             ============     ============

     A full valuation allowance has been recorded at December 31, 1999 and 1998
     based on management's determination that the recognition criteria for
     realization have not been met.


                                      F-14
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

10.  COMMITMENTS:

     LEASE COMMITMENTS

     The Company leases its facilities in Woodinville, WA, Santa Rosa, CA and
     Honolulu, HI and also leases certain vehicles and office equipment under
     operating lease agreements expiring in the years 2000 to 2004. In 1997, the
     Company entered into a master lease agreement with a bank that provides up
     to $400,000 of credit to the Company for the lease of certain computer and
     office equipment and furniture. The lease is for a period of 34 months and
     contains an option to acquire the equipment at the end of the lease term
     for the fair market value of the equipment. The lease provisions require
     the Company to maintain $200,000 in a certificate of deposit at the bank as
     collateral for the lease, and to deposit additional funds if the Company's
     cash and cash equivalents are not maintained above $850,000. 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.
     As of December 31, 1999 $272,000 has been classified as restricted cash. 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.

     The leases above and other equipment leases have been accounted for as
     operating leases. As of December 31, 1999 the Company has drawn all
     $400,000 of the lease line. The approximate future minimum rental
     commitments as of December 31, 1999 under all operating leases are as
     follows:

              2000                          $   578,000
              2001                              429,000
              2002                              307,000
              2003                              117,000
              2004                               20,000
                                            -----------

                                            $ 1,451,000
                                            ===========

     Lease expense for the years ended December 31, 1999, 1998 and 1997 was
     approximately $603,000, $463,000, and $147,000 respectively.

11.  EMPLOYMENT AGREEMENTS AND STOCK OPTIONS:

     EMPLOYMENT AGREEMENTS

     The Company has entered into employment agreements with certain employees
     and officers. The agreements provide for future salary, benefits and stock
     option grants to the employee/officers during their terms of employment.
     The agreements also contain non-compete restrictions on the
     employee/officers and provide for certain severance obligations in the
     event of termination with cause (as defined). In addition, one of the
     officers receives one-half share of TPG common stock for each dollar of
     debt personally guaranteed by the officer.

                                      F-15
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

11.  EMPLOYMENT AGREEMENTS AND STOCK OPTIONS:  (CONTINUED)

     STOCK OPTIONS

     In December 1997, the Company's Board of Directors adopted The Pathways
     Group, Inc. 1996 Stock Incentive Plan (the "Plan"), which provides for the
     issuance of incentive stock options ("ISOs") and non-qualified options to
     key management and reserved a total of 2,000,000 shares of common stock
     pursuant to the Plan.

     ISOs may be issued to employees of the Company and have a maximum term of
     10 years from the date of the grant. The exercise price for ISOs may not be
     less than 100% of the estimated fair market value of common stock at the
     time of the grant, and the aggregate fair market value (as determined at
     the date of the grant) of shares issuable upon the exercise of ISOs for the
     first time by an employee in any one calendar year may not exceed $100,000.
     In the case of options granted to holders of more than 10% of the voting
     power of the Company, the exercise price may not be less than 110% of the
     estimated fair market value of the common stock at the time of grant, and
     the term of the option may not exceed five years. Options become
     exercisable in whole or in part from time to time as determined by the
     Board of Directors, which will administer the Plan.
     Generally, options vest over periods ranging from one to three years.

     The Company has adopted the disclosure only provisions of Statement of
     Financial Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for
     Stock Based Compensation". The Company has elected to account for
     stock-based compensation using the intrinsic value method prescribed in
     Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to
     Employees" and related interpretations. Accordingly, compensation cost for
     stock options is measured as the excess, if any, of the fair value of the
     Company's stock at the date of grant over the exercise price to be paid to
     acquire the stock.

     In December 1998, the Company adopted the Pathways Group, Inc. Directors
     stock option plan to assist the Company in attracting and retaining outside
     directors. The terms of the plan reserve a total of 100,000 shares of
     common stock for issuance to outside non-employee directors. Initial grants
     of options to acquire 10,000 shares were granted to three non-employee
     directors in December 1998.


                                      F-16
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

11.  EMPLOYMENT AGREEMENTS AND STOCK OPTIONS:  (CONTINUED)

     STOCK OPTIONS (CONTINUED)

     Option activity for each of the three years ended December 31, 1999 is as
     follows:

                                                   WEIGHTED
                                     SHARES        AVERAGE
                                                EXERCISE PRICE

     Balance December 31, 1996       230,000     $    2.83


     Granted                         214,000         19.79
     Exercised                       (10,001)         1.71
     Cancelled                        (6,666)         3.00
                                  ----------     ---------
     Balance December 31, 1997       427,333         11.35


     Granted                          84,000         14.88
     Exercised                        (6,667)         1.07
     Cancelled                       (57,000)        24.00
                                  ----------     ---------
     Balance December 31, 1998       447,666         10.55


     Granted                         979,862
                                                      5.32
     Exercised                             0
     Cancelled                      (161,245)        13.04
                                  ----------     ---------

     Balance December 31, 1999     1,266,283     $    6.18
                                  ==========     =========

     No compensation expense has been recorded for options granted in 1998 and
     1997 because the exercise price of the options granted was equal to the
     fair value of the related shares based upon the price of the Company's
     common stock. During 1999, the Company granted options to employees with
     exercise prices less than the fair value of the related shares based upon
     the price of the Company's common stock. This resulted in recording
     unearned compensation of $525,000, which is being amortized over the
     vesting period of the individual options using the straight-line basis.
     Compensation expense of $29,167 was recognized in 1999.


                                      F-17
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

11.  EMPLOYMENT AGREEMENTS AND STOCK OPTIONS:  (CONTINUED)

     STOCK OPTIONS (CONTINUED)

     The following table summarizes information about options outstanding at
     December 31, 1999:

<TABLE>
<CAPTION>

                     OPTIONS OUTSTANDING                                 OPTIONS EXERCISABLE
     ---------------------------------------------------- --------------------------------------------------

       ACTUAL EXERCISE        NUMBER         WEIGHTED         WEIGHTED         NUMBER           WEIGHTED
            PRICES              OF            AVERAGE         AVERAGE            OF              AVERAGE
                              SHARES      EXERCISE PRICES    REMAINING         SHARES        EXERCISE PRICES
                                                            CONTRACTUAL
                                                          LIFE (IN YEARS)
<S>                        <C>              <C>                 <C>        <C>                   <C>
               $1.07           6,666        $     1.07           7              6,666            $ 1.07

      $2.75 -  $3.00         807,000        $     3.00           9            200,000            $ 3.00
      $7.75 - $9.875         285,784        $     8.97           9                  0            $   --
     $12.00 - $15.00         120,333        $    14.33           8             46,999            $13.64
              $24.00          46,500        $    24.00           8             43,500            $24.00
     ---------------       ---------        ----------                     ----------            ------
                           1,266,283        $     6.18                        297,165            $ 7.71
                           =========        ==========                     ==========            ======
</TABLE>

     Pro forma information regarding the net loss is required by SFAS No. 123,
     and has been determined as if the Company had accounted for its employee
     stock options granted after December 31, 1995 under the fair value method
     of that statement.

     For purposes of pro forma disclosures, the estimated fair value of the
     options is amortized to expense over the options' vesting periods. The
     following table presents pro forma net loss and net loss per share for the
     year ending December 31,1999 and 1998 as if the Company accounted for
     compensation expense related to stock options under the fair value method
     prescribed by SFAS 123:

                                     DECEMBER 31,       DECEMBER 31,
                                        1999               1998

     Pro forma net loss             $(10,067,227)      $(8,514,217)
     Pro forma net loss per share   $      (0.75)      $     (0.65)


                                      F-18
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

10.  EMPLOYMENT AGREEMENTS AND STOCK OPTIONS:  (CONTINUED)

     STOCK OPTIONS (CONTINUED)

     The fair value of options granted was estimated on the date of grant using
     the Black-Scholes option pricing model under the following assumptions:

<TABLE>
<CAPTION>
                                        1999              1998              1997
<S>                                <C>               <C>               <C>
      Risk free interest rate      5.07% to 6.13%    4.13% to 5.61%    5.79% to 5.93%
      Expected lives                3 to 5 years      3 to 5 years      3 to 5 years
      Volatility                         98%               83%               55%
      Expected dividend rate              0                 0                 0
</TABLE>


     The weighted average fair value of options granted in 1999, 1998 and 1997,
     as calculated using the Black-Scholes option pricing model, was $4.05,
     $9.28 and $9.85 per option respectively.

<TABLE>
<CAPTION>
                                                                   YEAR ENDED DECEMBER 31,
                                                           1999              1998             1997
<S>                                                        <C>              <C>              <C>
     Weighted average fair value of options granted
     with exercise price less than the fair value of       $1.92              $ -              $ -
     the stock on the date of grant

     Weighted average fair value of options granted
     with exercise price equal to the fair value of        $7.29            $ 9.28           $ 9.85
     the stock on the date of grant

     Weighted average exercise price of options
     granted with exercise price less than the fair        $3.00              $ -              $ -
     value of the stock on the date of grant

     Weighted average exercise price of options
     granted with exercise price equal to the fair         $5.92            $ 10.55          $ 11.35
     value of the stock on the date of grant
</TABLE>

11.  CAPITAL STOCK TRANSACTIONS:

     COMMON STOCK

     In July 1997, the Company sold 833,333 shares of common stock in an initial
     public offering at $6.00 per share. The net proceeds from the offering were
     $4,857,956.

     In July and August of 1998, the Company sold 654,508 shares of common stock
     through a private placement at $13.75 per share. The net proceeds from the
     sale shares were $8,385,829.

     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.

                                      F-19
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

12.  CAPITAL STOCK TRANSACTIONS:  (CONTINUED)

     PREFERRED STOCK

     In August 1999, the Company entered into an agreement with an investment
     bank, whose chief executive officer is a director of the Company, for a
     firm commitment financing for $3,000,000 of units, with each unit comprised
     of one share of redeemable preferred stock and four common stock purchase
     warrants. Each unit has a subscription price of $10.00, and each warrant
     has an exercise price of $2.50 per share and a term of three years. In the
     aggregate, the firm commitment offering required the Company to issue
     300,000 shares of preferred stock and warrants to purchase 1,200,000
     shares. The preferred stock is redeemable at any time, but no later than
     December 31, 2001; requires quarterly dividends payable at 6 percent per
     annum or an in kind dividend at a rate of 10 percent per annum; contains
     provisions relating to preferential liquidation rights, voting rights for
     the warrants issuable under the preferred stock and registration
     provisions.

     In accordance with generally accepted accounting principles, the Company
     has allocated the proceeds from the sale of preferred stock between the
     common stock warrants issued and the redeemable preferred stock based on
     their relative fair market values. Accordingly, the Company has recorded
     $1,445,244 as discount on preferred stock and as additional paid in
     capital. In addition, the Company has recorded the estimated fair value of
     warrants issued for investment banking services of $253,681 as offering
     costs of preferred stock and additional paid in capital. The difference
     between the recorded amount of preferred stock and the amount mandatorily
     redeemable on December 31, 2001 is being amortized through periodic
     accretion, using the effective interest method, which increases preferred
     stock and reduces additional paid in capital. The following table
     summarizes the recording of the sale of redeemable preferred stock and the
     balance as of December 31, 1999:

<TABLE>
<S>                                                                                        <C>
     Gross proceeds                                                                        $ 3,000,000
        Discounts recorded on preferred stock                                               (1,445,244)
        Cash paid for offering costs                                                           (53,137)
        Value of warrants issued for investment banking fee                                   (253,681)
                                                                                           -----------
     Preferred stock at issuance                                                             1,247,938
     Accretion of preferred stock                                                              166,589
     Dividend shares issued                                                                     75,000
                                                                                           -----------
     Preferred stock balance at December 31, 1999                                          $ 1,489,527
                                                                                           ===========

        Paid in Capital
        Increase in paid in capital for value of warrants issued to investors              $ 1,445,244
        Increase in paid in capital for value of warrants issued for investment banking        253,681
        services
        Accretion on preferred stock                                                          (166,589)
                                                                                           -----------
        Net increase in paid in capital                                                    $ 1,532,336
                                                                                           ===========
</TABLE>


                                      F-20
<PAGE>

THE PATHWAYS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

12.  SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

<TABLE>
<CAPTION>
                                                                     1999            1998           1997
<S>                                                              <C>             <C>            <C>
     Cash paid during the year for interest                      $    37,695     $    98,227    $   241,637

     Non-cash transactions:
        Notes payable converted to common stock                                                       3,000
        Proton License agreement                                     700,000
        Value ascribed to warrants issued in conjunction with      1,445,244
        sale of preferred stock
        Accretion of manditorily redeemable preferred stock         (166,589)
        Warrants issued for placement fees                           253,681
        Unearned compensation                                        525,000
        Dividends in kind shares on Series A Preferred Stock         (75,000)
</TABLE>


13.  RELATED PARTY TRANSACTIONS:

     In 1998, the Company paid a total of $505,602 to Allen and Company
     Incorporated, a shareholder, and Mitchum, Jones and Templeton, whose chief
     executive officer is a director and stockholder of the Company for
     investment banking services and direct expenses in connection with the
     Company's private placement.







                                      F-21
<PAGE>

                                   SIGNATURES

                  Pursuant to the requirements of Section 13 or 15(d) 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.


April 14, 2000                    By: /s/ CAREY F. DALY, II
                                      ------------------------------------------
                                      Carey F. Daly, II
                                      President, Chief Executive Officer and
                                      Chairman of the Board (principal executive
                                      officer)

                  Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.

       Signature                         Title                         Date
       ---------                         -----                         ----

/s/ CAREY F. DALY, II           President, Chief Executive        April 14, 2000
-----------------------------   Officer, Chairman of the
    Carey F. Daly, II           Board and Director


/s/ CHARLES W. DUNN             Chief Financial Officer and       April 14, 2000
-----------------------------   Director
     Charles W. Dunn


/s/ ROBERT E. BOECK             Director                          April 14, 2000
-----------------------------
     Robert E. Boeck


/s/  ROBERT J. FISHMAN          Director                          April 14, 2000
-----------------------------
     Robert J. Fishman


/s/ ROBERT W. HALLER            Director                          April 14, 2000
-----------------------------
     Robert W. Haller


<PAGE>


       Signature                         Title                         Date
       ---------                         -----                         ----

/s/ GLENN A. OKUN               Director                          April 14, 2000
-----------------------------
     Glenn A. Okun


/s/ MARK T. SCHUUR              Director                          April 14, 2000
-----------------------------
     Mark T. Schuur


/s/ MONTE P. STROHL             Director                          April 14, 2000
-----------------------------
     Monte P. Strohl


                                Director
-----------------------------
     Linda Wing