<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
/X/ Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended March 31, 1998
/ / Transition report pursuant to Section 13 or 15(d) of the Exchange Act
For the transition period from _______ to ________
Commission file number 000-24119
-------------------------------------------------------
THE PATHWAYS GROUP, INC.
- ------------------------------------------------------------------------------
(Exact name of small business issuer as specified in its charter)
Delaware 91-1617556
- -------------------------------- ------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
14201 N.E. 200th Street, Woodinville, WA 98072
- ------------------------------------------------------------------------------
(Address of principal executive offices)
(425) 483-3411
- ------------------------------------------------------------------------------
(Issuer's telephone number, including area code)
- ------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 No X
----- -----
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by court.
Yes ______ No ______
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: As of March 31, 1998:
12,904,487 shares of Common Stock, par value $0.01 per share.
Transitional Small Business Disclosure Format (check one):
Yes No X
----- -----
<PAGE>
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
The financial statements for the Company's fiscal quarter
ended March 31, 1998 are attached to this Report, commencing at page F-1.
Item 2. Management's Discussion and Analysis or Plan of Operation
Except for historical information, the material contained in
this Management's Discussion and Analysis or Plan of Operation is
forward-looking. This discussion includes, in addition to historical
information, forward looking statements which involve risks and uncertainties.
The Company's actual results could differ materially from the results discussed
in the forward looking statements. Factors that could cause or contribute to
such differences are discussed below and in the Company's Registration Statement
on Form 10-SB filed with the Securities and Exchange Commission. These risks and
uncertainties include the rate of market development and acceptance of smart
card technology, the unpredictability of the Company's sales cycle, the limited
revenues and significant operating losses generated to date, and the possibility
of significant ongoing capital requirements. For the purposes of the safe harbor
protection for forward-looking statements provided by the Private Securities
Litigation Reform Act of 1995, readers are urged to review the list of certain
important factors set forth in "Cautionary Statement for Purposes of the "Safe
Harbor" Provisions of the Private Securities Litigation Reform Act of 1995".
General
The Pathways Group, Inc. and its subsidiaries ("Pathways" or
the "Company") designs, markets and services custom smart card applications. The
Company develops unique solutions for creating and processing data and ensuring
secure electronic transactions by utilizing proprietary hardware and application
software systems. Pathways' technology establishes electronic commerce in closed
system environments. A key element of the Company's business plan is the
processing of transactions associated with its current and prospective smart
card installations. The Company also manufactures and markets automated
ticketing kiosks that the Company anticipates will be integrated with its smart
card 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. In May 1997 the Company reincorporated
in Delaware. The Company's executive offices are located at 14201 NE 200th
Street, Woodinville, Washington 98072 and its telephone number is (425)
483-3411. A primary processing center opened in September 1997, located at 1221
North Dutton Avenue, Santa Rosa, California 95404, and its telephone number is
(707) 546-3010.
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 of the Company, par value
$.01 per share, 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 currently has
12,904,487 shares outstanding.
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. Revenues generated in the three months ended March 31, 1998 and 1997
relate to credit card processing fees from its unattended ticketing kiosks
installed in several ski area and amusement park venues and, in 1997, sales of
smart cards and affinity cards.
-2-
<PAGE>
Revenues decreased $12,718 for the three months ended March 31, 1998, as
compared to the corresponding period in 1997 due to a decrease in sales of smart
and affinity cards in 1997, and lower credit card transaction fees in 1998 vs.
1997. Credit card transaction fees were lower for 1998 as compared to 1997 due
to a decrease in the number of kiosks in operation as a result of the Company's
concentration on its smart card systems marketing efforts.
The Company's business model is based upon the Company's
contracting large membership based businesses to be a turnkey provider of smart
card based systems. The Company anticipates licensing its software for use by
its clients and entering into agreements whereby the Company will perform all
backroom processing of the transactions that occur over the system in addition
to selling smart cards and smart card readers programmed by the Company. The
Company expects to receive transaction processing fees for its backroom
processing services. The Company anticipates that revenue generation from
contracts will be dominated initially by the sales of smart card terminals and
readers and smart cards in order to develop an appropriate concentration of
merchants and smart card users in a market area. After this initial phase, the
sales mix for a contract is expected to consist of a relatively high
concentration of transaction processing fees.
The Company has signed pilot agreements with the Department of
Education in the State of Hawaii for the implementation of an electronic school
lunch program, and with First Hawaiian bank for the use of smart cards in a
retail program. The Company believes it will continue to report minimal revenues
until additional significant contracts are signed or until the existing
contracts proceed through the pilot stage to a full rollout.
Gross margin. The Company's gross margin as a percentage of
revenues is primarily a function of the sales mix between high margin
transaction processing fees and lower margin smart card and terminal sales.
Gross margin percentage was 61% and 60% for the three months ended March 31,
1998 and 1997, respectively.
The Company's future gross margin percentages is expected to
fluctuate depending on the sales mix between hardware sales and transaction
processing fees. Although this mix is difficult to predict, margins generally
will be lower at the beginning of a new client system rollout due to the
concentration of smart card readers and smart card sales. Once the initial
rollout is completed, gross margins are expected to increase due to increases in
use of the smart card by cardholders and the resulting transaction processing
fees.
Selling, General and Administrative Expenses. Selling, general
and administrative expenses increased $636,705 or 112% during the three months
March 31, 1998, as compared to the corresponding period in 1997. This increase
is primarily the result of expanded payroll and employee support costs
associated with an increased number of full-time and contract employees. The
Company had approximately forty-three full-time employees at March 31, 1998, as
compared to eighteen in 1997. In addition, the Company has incurred increases 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 administration costs to increase
substantially as a result of increased marketing activities and an increase in
the number of operating and technical personnel necessary to support its
expected sales efforts and continued development of new products and concepts.
The Company has leased an 8,700 square foot facility in Santa Rosa, California,
which has been refurbished into a new state-of-the-art transaction-processing
center. Construction of the facility build-out occurred in the second and third
quarters of 1997 and the Company occupied this new facility in September, 1997.
Additionally, the Company incorporated a wholly-owned subsidiary and opened a
sales and marketing office in Honolulu, Hawaii, during the third quarter 1997.
The Company anticipates substantial investments in its sales, marketing and
product development activities in the foreseeable future as it seeks to expand
sales of its smart card systems and transaction processing fees.
Amortization of Software Costs. Amortization of software costs
increased $19,829 or 14% for the three months ended March 31, 1998 compared to
the corresponding period in 1997. This increase
-3-
<PAGE>
is due to continued capitalization of software costs as a result of the
Company's product development efforts. Software costs capitalized were higher in
1997, as compared to 1998, due to software costs acquired in connection with the
purchase of minority interest in SPRINTICKET, Inc. (see Note 4 under Notes to
Consolidated Financial Statements).
The Company notes that given 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 $38,368 for the three
months ended March 31, 1998, as compared to the corresponding periods in 1997
primarily due to an increase in capital expenditures. Capital expenditures
increased during 1998 as compared to 1997 due to the addition of computer
equipment to support an increase in marketing and technical activities and
personnel, the build-out of the Company's Santa Rosa, California transaction
processing center, and the opening of its Hawaii office.
Interest Expense (Net). For the three months ended March 31,
1998, the Company had net interest income as compared to interest expense for
the three months ended March 31, 1997. The decrease in net interest expense was
due to reductions in the total debt outstanding and increased interest income
from the investment of available funds from common stock sales.
Liquidity And Capital Resources
The Company's working capital was $1,385,390 and $3,148,595 at
March 31, 1998 and December 31, 1997, respectively. The higher working capital
at December 31, 1997, as compared to March 31, 1998, was primarily the result of
the receipt of proceeds from the Company's Initial Public Offering of common
stock and the exercise of common stock warrants in 1997, and the net loss
incurred in the first quarter of 1998. In May 1997, the Company issued and sold
833,333 shares of common stock pursuant to the filing of Form 1-A (No. 24-3750)
with the Securities and Exchange Commission. The net proceeds from the sale of
the shares were $4,857,958. Also in 1997, the Company entered into a master
lease agreement with a Bank which provided up to $400,000 of credit to the
Company for the lease of certain computer and office equipment and furniture for
a period of three years and contains an option to acquire the equipment at the
end of the lease term. The lease provisions require the Company to maintain
$200,000 in a certificate of deposit at the bank as collateral for the lease and
to deposit additional funds if the Company's available cash and cash equivalents
are not maintained above $850,000.
The Company incurred increased capital expenditures in 1998 as
compared to 1997 primarily due to the purchase of computer equipment required to
support increased marketing and technical activities and personnel. In addition,
the Company has spent $394,436 in leasehold improvement and computer equipment
costs to build out its new transaction processing facility in Santa Rosa, CA.
The Company expects to continue to incur substantial costs to complete this
facility and its new office in Honolulu, Hawaii, including amounts for office
furniture and computer equipment.
The Company has historically relied upon proceeds from the
sale or issuance of its common shares and from the issuance of notes payable 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 they are 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. However, the Company believes that the potential
revenue to be realized from the rollout of its current contracts, its current
cash resources and available trade and other credit facilities are sufficient to
meet its present anticipated working capital needs for
-4-
<PAGE>
1998. 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.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
<TABLE>
<S> <C>
Exhibit 11 -- Computation of Earnings per Common Share
Exhibit 27 -- Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
None.
-5-
<PAGE>
THE PATHWAYS GROUP, INC.
Index to Consolidated Financial Statements (Unaudited)
for the Fiscal Quarter Ended March 31, 1998
<TABLE>
<S> <C>
Consolidated Balance Sheets F-2
Consolidated Statements of Income F-3
Consolidated Statements of Cash Flows F-4
Notes to Consolidated Financial Statements F-5
</TABLE>
F-1
<PAGE>
Consolidated Balance Sheets
(Unaudited)
ASSETS
<TABLE>
<CAPTION>
March 31, 1998 December 31, 1997
-------------- -----------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $2,140,041 $3,759,720
Accounts receivable 76,438 66,493
Inventory 214,531 202,749
Prepaid expenses and deposits 92,599 101,407
----------- ------------
Total current assets 2,523,609 4,130,369
Restricted cash 200,000 70,500
Software, net 1,519,102 1,605,098
Property and equipment, net 980,177 722,678
Other assets 79,028 188,195
----------- ------------
Total assets $5,301,916 $6,716,840
----------- ------------
----------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable to banks, current maturities $569,359 $551,991
Accounts payable 375,524 206,986
Accrued expenses 193,336 222,797
----------- ------------
Total current liabilities 1,138,219 981,774
Notes payable to banks, net of current maturities 364,069 509,900
----------- ------------
Total liabilities $1,502,288 $1,491,674
----------- ------------
Stockholders' equity:
Preferred stock, $0.01 par value; 1,000,000 shares
authorized; no shares issued and outstanding
Common stock, $0.01 par value; 50,000,000 shares $129,045 $129,045
authorized; 12,904,487 issued and outstanding at
March 31, 1998 and December 31, 1997
Additional paid in capital 18,052,730 18,052,730
Accumulated deficit (14,382,147) (12,956,609)
----------- ------------
Total stockholders' equity 3,799,628 5,225,166
----------- ------------
Total liabilities and stockholders' equity $5,301,916 $6,716,840
----------- ------------
----------- ------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-2
<PAGE>
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
For the
three months ended
March 31, 1998 March 31, 1997
-------------- --------------
<S> <C> <C>
Sales, net $ 1,644 $ 14,362
Cost of sales 659 5,666
-------------- --------------
Gross margin 985 8,696
-------------- --------------
Selling, general and administrative expenses 1,205,969 569,264
Amortization of software 161,239 141,410
Depreciation 74,460 36,092
-------------- --------------
Total operating expenses 1,441,668 746,766
-------------- --------------
Loss from operations (1,440,683) (738,070)
Net interest income (expense) 15,154 (62,487)
-------------- --------------
Net loss $(1,425,529) $(800,557)
-------------- --------------
-------------- --------------
Net loss per share $ (0.11) $ (0.07)
Weighted average shares outstanding 12,904,487 11,740,320
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
F-3
<PAGE>
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
For the
three months ended
March 31, 1998 March 31, 1997
-------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(1,425,529) $(800,557)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation 74,460 36,092
Amortization of software 161,239 141,410
Effects of changes in operating assets and liabilities:
Accounts receivable (9,945) 10,997
Prepaid expenses and deposits 8,808 (67,082)
Inventory (11,782) 23,821
Other assets 109,168
Accounts payable 168,538 (226,417)
Accrued expenses (29,471) (51,054)
-------------- --------------
Net cash used in operating activities (954,514) (932,790)
-------------- --------------
Cash flows from investing activities:
Capital expenditures (331,959) (78,190)
Capitalized software development costs (75,243) (161,501)
Restricted cash (129,500) --
-------------- --------------
Net cash used in investing activities (536,702) (239,691)
-------------- --------------
Cash flows from financing activities:
Principal payments on notes payable to banks (128,463) (2,500)
Repurchase of common stock -- (28,000)
-------------- --------------
Net cash used in financing activities (128,463) (30,500)
-------------- --------------
Decrease in cash and cash equivalents (1,619,679) (1,202,981)
Cash and cash equivalents, beginning of period 3,759,720 2,390,127
-------------- --------------
Cash and cash equivalents, end of period $2,140,041 $1,187,146
-------------- --------------
-------------- --------------
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
F-4
<PAGE>
Notes to Consolidated Financial Statements
(Unaudited)
1. Unaudited Interim Financial Information
The accompanying consolidated financial statements are unaudited, but
include all adjustments (consisting only of normal recurring adjustments) which
are, in the opinion of management, necessary for a fair presentation of the
financial position at such dates and the operations and cash flows for the
periods then ended. The financial information is presented in a condensed format
and, it does not include all of the footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles. Operating results for the periods ended March 31, 1998 and 1997 are
not necessarily indicative of results that may be expected for the entire year.
The preparation of financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities and reported amounts of revenue
and expenses during the reporting period. Actual results could differ materially
from such assumptions and estimates. The accompanying financial statements and
related footnotes should be read in conjunction with the Company's audited
financial statements, included in its Form 1-A (No. 24-3750) and Form 10-SB
(File No. 000-24119) filed with the Securities and Exchange Commission.
2. The Company
The accompanying consolidated financial statements include the accounts
of The Pathways Group, Inc. ("TPG") and its wholly-owned subsidiaries. All
intercompany balances and transactions have been eliminated. TPG's subsidiaries
include Pathways International, Ltd. ("PIL"), SPRINTICKET, Inc. ("ST"), PT Link,
Inc. ("PT Link") and The Pathways Group, Inc., a wholly-owned subsidiary
incorporated in the State of Hawaii. TPG and its subsidiaries (the "Company")
are primarily engaged in providing specialized transaction processing services
through the development of proprietary software and hardware systems including
credit card and multiple application smart card technologies. The Company
derives its revenue principally from transaction processing fees charged to the
merchant and the sale of related terminals, hardware systems and smart cards.
The Company has invested heavily in designing and developing its proprietary
hardware and application software systems and in establishing and expanding its
sales and marketing capabilities. The Company plans to continue these efforts in
preparation for, and in anticipation of, the growth in smart card-based
electronic commerce that the Company anticipates will create a substantial
market for its data and transaction processing services.
3. Inventories
Inventories consisted of the following:
<TABLE>
<CAPTION>
March 31, 1998 December 31, 1997
-------------- -----------------
<S> <C> <C>
Smart cards and related packaging $160,229 $149,204
Smart card terminals and computer hardware 54,302 53,545
---------- ----------
$214,531 $202,749
---------- ----------
---------- ----------
</TABLE>
4. Capital Stock Transactions/Initial Public Offering
Purchase of Minority Interest
In March, 1997, TPG acquired all of the remaining minority interest in
its majority-owned subsidiary, ST, through a payment of $75,000. This
transaction was accounted for as a purchase in accordance with
generally accepted accounting principles. The purchase price of
F-5
<PAGE>
$75,000 was allocated to software and is being amortized in accordance
with the Company's amortization policy.
Reincorporation
In May, 1997, The Pathways Group, Inc. reincorporated in the State of
Delaware. At such time, the number of authorized shares of common stock
was reduced to 50,000,000, the par value of common shares was changed
to $0.01, and 1,000,000 shares of preferred stock were authorized. All
prior periods presented have been adjusted to reflect these changes in
the capital stock accounts.
Initial Public Offering.
In July, 1997, the Company received net proceeds of $4,857,958 from the
sale of 833,333 shares of common stock. These shares were sold pursuant
to Regulation A under the Securities Exchange Act of 1933. The
Company's common stock is traded in the over-the-counter market under
the trading symbol PTHW.
5. Supplemental Disclosures of Cash Flow Information
<TABLE>
<CAPTION>
For the For the
three months ending three months ending
March 31, 1998 March 31, 1997
-------------- --------------
<S> <C> <C>
Cash paid for interest $34,652 $90,934
Non-cash transactions:
Notes payable converted to common stock -- $3,000
</TABLE>
F-6
<PAGE>
SIGNATURE
In accordance with the requirements of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
THE PATHWAYS GROUP, INC.
By /s/ CAREY F. DALY, II
-----------------------------------------
Carey F. Daly, II
President and Chief Executive Officer
Date: May 14, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS INDICATED BELOW AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 2,140,041
<SECURITIES> 0
<RECEIVABLES> 76,438
<ALLOWANCES> 0
<INVENTORY> 214,531
<CURRENT-ASSETS> 2,523,609
<PP&E> 1,466,240
<DEPRECIATION> 486,063
<TOTAL-ASSETS> 5,301,916
<CURRENT-LIABILITIES> 1,138,219
<BONDS> 364,069
0
0
<COMMON> 129,045
<OTHER-SE> 3,670,583
<TOTAL-LIABILITY-AND-EQUITY> 5,301,916
<SALES> 1,644
<TOTAL-REVENUES> 1,644
<CGS> 659
<TOTAL-COSTS> 659
<OTHER-EXPENSES> 1,441,668
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 24,629
<INCOME-PRETAX> (1,425,529)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,425,529)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,425,529)
<EPS-PRIMARY> (0.11)
<EPS-DILUTED> (0.11)
</TABLE>
