<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
|_| TRANSITION REPORT PURSUANT TO 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)
<TABLE>
<CAPTION>
DELAWARE 91-1617556
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<S> <C>
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
</TABLE>
14201 N.E. 200TH STREET, WOODINVILLE, WASHINGTON 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)
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 |_|
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Indicate by check mark whether the registrant filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by court.
Yes |_| No |_|
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's
classes of common equity, as of the latest practicable date: AS OF MAY 11,1999:
13,565,662 SHARES OF COMMON STOCK, PAR VALUE $0.01 PER SHARE.
<PAGE>
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The unaudited financial statements for the Company's fiscal quarter
ended March 31, 1999 are attached to this Report, commencing at page F-1.
ITEM 2. 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 of Financial Condition and Results 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 Statements on Form 10-SB, as amended, Form SB-2 and its most
recently filed Form 10-K, each as filed with the Securities and Exchange
Commission. These risks and uncertainties include the rate of market development
and acceptance of smart card technology, the unpredictability of the Company's
sales cycle, the limited revenues and significant operating losses generated to
date, 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 (collectively, "Pathways"
or the "Company") designs, markets and services custom smart card applications.
The Company believes that it 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. The Company
believes that a key element of its 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
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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 is located at 1221 North Dutton Avenue, Santa Rosa, California
95404, and its telephone number is (707) 546-3010. A sales and marketing office
is located at Grosvenor Center, 2500 Makai Tower, 733 Bishop Street, Honolulu,
Hawaii 96813.
RESULTS OF OPERATIONS
REVENUES. The Company has generated limited revenues from operations to
date as it has continued to develop and market its smart card systems. The
Company believes it will continue to report minimal revenues until additional
significant contracts are signed or until the existing contracts, discussed
below, proceed through the pilot stage to a full rollout. Revenues generated in
the three month periods ended March 31, 1999 and 1998, primarily relate to
credit card processing fees from its unattended ticketing kiosks installed in
several ski area and amusement park venues. Revenues increased $4,608, or 280%,
for the three months ending March 31, 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.
Starting in late 1997 and throughout 1998, the Company developed an
upgraded version of its unattended kiosk to, among other things, accommodate
acceptance and vending of smart cards and also engineered and developed an
indoor kiosk that the Company plans to be utilized as a smart card recharge
device. The Company began marketing its new indoor and outdoor kiosk products in
the first quarter of 1999. The Company has 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 new 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.
In the fourth quarter of 1998, the Company installed its Tikitbox II
unattended ticketing system at Winter Park Ski Resort in Colorado and upgraded
its existing systems at Six Flags Great Adventure and Magic Mountain Amusement
Parks. These contracts are accompanied by transaction processing arrangements at
fees generally ranging from 2% to 5%. In addition, the Company has a number of
units installed on a pilot basis, such as at Deer Valley, Utah, and is involved
in negotiations with those customers for the purchase of multiple units. These
pilot agreements provide for the Company to charge transaction fees of generally
5% during the pilot period. Although there can be no assurance of the successful
outcome of the pilot programs or negotiations, the Company expects to increase
its kiosk sales in 1999 compared to previous years.
With the exception of the installation of its initial smart card system
and resulting sales cards and terminals in 1996, the Company has not realized
meaningful revenues from its smart card system products. The Company's marketing
efforts have resulted in a number of letters of intent and pilot agreements,
including installing a pilot program in Honolulu, Hawaii
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<PAGE>
and signing of a letters of intent with Linkopp Marketing (an internet small
business membership organization) and Consolidated Theatres. Although these
efforts have not resulted in significant revenues to date, the Company believes
that its agreements and activities demonstrate that a substantial market exists
for smart card systems in the United States.
The Company's business model is based upon the Company's contracting
with 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 initial revenue generated from
contracts will be derived largely from the sales of smart card terminals,
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.
GROSS MARGIN. Gross margin was 95% for the three months ended March 31,
1999 as compared to 60% for the three months ended March 31, 1998. The increase
in gross margin for the three month period in 1999 as compared with 1998 relates
to lower charge backs from credit card transactions. In its new transaction
processing contracts, effective for 1999, the Company no longer accepts
liability for charge backs to a merchant or amusement/ski area as it has in
prior years. As a result the Company expects gross margins on its credit card
processing fees to be higher than in past years.
The Company's gross margin as a percentage of revenues is primarily a
function of the sales mix between higher margin transaction processing fees and
lower margin smart card and terminal sales. The Company expects potential
competition and the sales mix between hardware sales and transaction processing
fees to influence heavily the future gross margin percentages. Although this
sales 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 cards by
cardholders and the resulting transaction processing fees.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $325,693, or 28.8%, during the three months
ended March 31, 1999, as compared to the corresponding period in 1998. This
increase is primarily the result of expanded payroll and employee support costs
associated with an increased number of full-time employees. The Company had 58
full-time employees at March 31, 1999, as compared to 43 as of March 31, 1998.
In addition, the Company has incurred increases in sales and marketing related
expenditures commensurate with the increase in marketing personnel. The level of
selling, general and administrative costs is expected to continue to increase,
although more modestly than in the past four quarters, as a result of ongoing
marketing and customer support
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<PAGE>
activities, and an increase in the number of operating and technical personnel
necessary to support the Company's expected sales, product development, and
customer support activities.
The Company leased, in the second quarter of 1997, an 8,700 square foot
facility in Santa Rosa, California, which has been refurbished into a new
state-of-the-art transaction processing center. The Company, through its
wholly-owned subsidiary, opened a sales and marketing office in Honolulu,
Hawaii, during the third quarter 1997 and expanded the office in September 1998.
In October 1998, the Company also leased and occupied a 6,390 square foot
research and development facility. The Company also uses this space for
assembling and testing Tikitbox II unattended ticketing and smart card systems.
Consequently, the selling, general, and administrative expenses for the three
months ended March 31, 1999, reflect the costs of operating the Company's
expanded Hawaii office and new research and development facility whereas the
corresponding periods in 1998 do not reflect these operating expenses. The
Company anticipates substantial investments in its sales, marketing and product
development activities in the foreseeable future as it seeks to expand sales of
smart card systems. The table below details the changes in selling, general, and
administrative expenses for major categories for the three months periods ended
March 31, 1999 and 1998.
<TABLE>
<CAPTION>
INCREASE (DECREASE) IN THE THREE
MONTHS ENDED MARCH 31, 1999
SG&A INCREASE ATTRIBUTABLE TO: VS. THE THREE MONTHS ENDED
MARCH 31, 1998
<S> <C>
Payroll and payroll related expenses $235,487
Rent, office, and facility (including equipment)
expenses $ 77,671
Marketing, selling, and travel related expenses $ 53,739
Other SG&A related expenses $(41,204)
Total Increase in SG&A $325,693
</TABLE>
RESEARCH AND DEVELOPMENT. Research and development costs increased
$69,891 in the first three months of 1999 as compared to the same period in
1998. The increase in 1999 over 1998 reflects the increase in programming staff
and their related research and development efforts and the expenditures on
equipment and software used for testing new product technologies and offerings.
AMORTIZATION OF SOFTWARE COSTS. Amortization of software costs increased
$25,119 for the three months ended March 31, 1999 compared to the corresponding
period in 1998. This increase is primarily due to a change in the estimated
useful lives of certain applications from five years to three years. The effect
of this change in amortization expense for the quarter ended March 31, 1999, was
$35,019 after tax and $0.0026 per share. See Note 8 to the unaudited financial
statements commencing on page F-1.
In accordance with generally accepted accounting principles 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
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<PAGE>
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 $42,447 for the three months ended
March 31, 1999, as compared to the corresponding period in 1998 primarily due to
continued increases in capital expenditures. Capital expenditures in 1999 and
1998 include the addition of computer equipment to support an increase in
marketing and technical activities and personnel, the leasehold improvements at
the Company's Santa Rosa transaction processing center and research and
development facility, and the opening and expansion of its Hawaii office.
INTEREST INCOME (NET). The Company had an increase of $16,907 in net
interest income for the three months ended March 31, 1999, as compared to 1998
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 $2,056,829 and $3,819,466 at March 31,
1999 and December 31, 1998, respectively. The decrease in working capital at
March 31, 1999 compared to December 31, 1998 is primarily due to the Company's
net loss in the quarter, and the resulting use of cash for operating expenses
and the payment of accrued expenses.
In March of 1999, the Company received a firm commitment for additional
funding of $3,000,000. The Company believes that its existing cash reserves,
planned expenditure reductions (if necessary), revenues and proceeds from the
equity funding (if required) will be adequate to fund the Company's operations
through 1999. In addition to this commitment, the Company is actively seeking
additional funding commitments to continue to aggressively pursue and expand its
marketing efforts and operations. The Company is investigating expanding its
marketing efforts to Europe and additional funding would be necessary to execute
such plans.
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
Registration Statement on Form SB-2 filed with the Securities and Exchange
Commission on September 24, 1998. The registration statement became effective on
October 9, 1998.
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<PAGE>
The Company's capital expenditures to date decreased by $261,794 for the
first quarter of 1999 as compared to the first quarter of 1998. This decrease is
primarily due to significant costs incurred in the first quarter of 1998 for
computer equipment and leasehold improvements for its transaction processing
center in Santa Rosa, California. Although capital expenditures decreased for
the quarter, the Company expects continued investments in capital expenditures
for increased personnel, and transaction processing infrastructure to support
more complex operations and high volumes.
The Company 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 in the
foreseeable future 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, including proceeds from the
pending private placement, reduction in expenditures (if necessary) and
available trade and other credit facilities are sufficient to meet its present
anticipated working capital needs for the next twelve months. In the event the
Company is unable to generate significant revenues from the rollout of its
current contracts or additional contracts the Company may negotiate, the Company
will be required to seek alternative sources of financing to fund its
operations. The Company's estimate of its cash requirements and its ability to
meet them are forward-looking statements, and there can be no assurance that the
Company's cash requirements will be met without additional debt or equity
financing. There can be no assurance that, if needed, additional financing will
be available on acceptable terms to the Company, if at all.
YEAR 2000
During recent years, there has been 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 is aware of the potential year 2000 problem, and
has undertaken a Year 2000 project to address the Company's readiness and
exposure to Year 2000 issues. The Year 2000 project addresses 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 has 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 has 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
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Company's control (see below). In addition, the Company's evaluation is based on
a limited number of actual customer installations.
The Company has 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 is now substantially complete. For the
internally used operating systems, software, and technology the Company has
identified as material, the Company is assessing the Year 2000 exposure through
testing and vendor inquiry. Material operating systems, software, and other
technology deemed to be adversely affected by the Year 2000 problem will be
upgraded or replaced. The Company currently estimates the range of costs to
upgrade or replace systems it believes may be impacted by the Year 2000 issues
to be from $50,000 to $150,000. 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 may be affected by the Year 2000 problem.
The Company has identified major suppliers and other third party vendors
integral to the operations of the Company's business. The Company has 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 will identify alternative providers of products and services deemed
material to the Company's operations. However, the Company has no control over
and cannot predict the corrective actions of these third party vendors and
suppliers. The Company intends to arrange, to the extent available, alternate
supplier arrangements in the event a third party vender is materially impacted
by Year 2000 issues. While the Company expects that it will be able to resolve
any significant Year 2000 problems related to third party products and services,
there can be no assurance that it will 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 a material
adverse effect on the Company's business, financial condition, and results of
operations.
The discussions of the Company's efforts relating to Year 2000
compliance are forward-looking statements. The Company's ability to achieve Year
2000 compliance and the associated level of incremental costs could be adversely
impacted by, among other things, the availability and cost of programming and
testing resources, vendors' ability to modify proprietary software, and other
unanticipated problems. The failure to correct a material Year 2000 problem
could result in an interruption of certain normal business activities or
operations. Such failures could materially affect the Company's results of
operations, liquidity and financial condition. Due to the general uncertainty
inherent in the Year 2000 problem, the Company is unable at this time to
determine those consequences. The Company believes that, with the completion of
the Year 2000 project as scheduled, the possibility of significant interruptions
of normal operations should be reduced or eliminated.
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<PAGE>
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
Certain statements contained in this quarterly report contain
"forward-looking statements" within the meaning of the private Securities
Litigation Reform Act of 1995. These are statements that do not relate strictly
to historical or current facts. Such forward-looking statements involve known
and unknown risks and uncertainties. The Company's actual results could differ
materially from the results discussed in the forward looking statements. Factors
that could cause or contribute to such differences are discussed below and in
the Company's Registration Statements on Form 10-SB, as amended, Form SB-2 and
its most recently filed Form 10-K, each as filed with the Securities and
Exchange Commission. These risks and uncertainties include, without limitation:
o The rate of market development and acceptance of smart card
technology.
o The unpredictability of the Company's sale cycle.
o The limited revenues and significant operating losses
generated to date.
o The possibility of significant ongoing capital requirements.
o The loss of any significant customer.
o The ability of the Company to compete successfully with the
other providers of smart cards and smart card services.
o The ability of the Company to secure additional financing as
and when necessary.
o The ability of the Company to retain the services of its key
management, and to
attract new members of the management team.
o The ability of the Company to effect and retain appropriate
patent, copyright and
trademark protection of its products.
o The ability of the Company to achieve adequate levels of
revenue to recover its investment in capitalized software
development costs.
For the purposes of the safe harbor protection for forward-looking statements
provided by the Private Securities Litigation Reform Act of 1995, readers are
urged to review the list of certain important factors set forth in "Cautionary
Statement for Purposes of the 'Safe Harbor' Provisions of the Private Securities
Litigation Reform Act of 1995".
The Company undertakes no obligation to release publicly any revisions
to the forward-looking statements or to reflect events or circumstances after
the date of this Report.
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<PAGE>
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
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
Exhibit 27 Financial Data Schedule
b. Reports on Form 8-K
None.
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<PAGE>
THE PATHWAYS GROUP, INC.
Index to Consolidated Financial Statements (Unaudited)
for the Fiscal Quarter Ended March 31, 1999
<TABLE>
<CAPTION>
<S> <C>
Consolidated Balance Sheets F-2
Consolidated Statements of Operations F-3
Consolidated Statements of Cash Flows F-4
Notes to Consolidated Financial Statements F-5
</TABLE>
F-1
<PAGE>
CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
ASSETS
MARCH 31, DECEMBER 31,
------------ ------------
1999 1998
---- ----
<S> <C> <C>
Current assets:
Cash and cash equivalents $2,227,558 $4,628,544
Accounts and interest receivable 83,420 102,793
Inventories 368,258 361,467
Prepaid expenses and deposits 123,194 168,779
------------ ------------
Total current assets 2,802,430 5,261,583
Restricted cash 222,000 222,000
Software, net 1,158,493 1,256,020
Property and equipment, net 1,053,319 1,100,061
Deposits and other assets 152,303 139,024
------------ ------------
TOTAL ASSETS $5,388,545 $7,978,688
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable to banks, current maturities $219,729 $336,947
Accounts payable 278,027 251,140
Accrued expenses and unearned revenue 247,845 854,030
------------ ------------
Total current liabilities 745,601 1,442,117
Notes payable to banks, net of current maturities 144,085 170,903
------------ ------------
TOTAL LIABILITIES 889,686 1,613,020
------------ ------------
Commitments and Contingencies
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 authorized; 135,657 135,657
13,565,662 issued and outstanding at March 31, 1999
and December 31, 1998
Additional paid in capital 26,439,081 26,439,081
Accumulated deficit (22,075,879) (20,209,070)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 4,498,859 6,365,668
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $5,388,545 $7,978,688
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE
THREE MONTHS ENDED
MARCH 31, MARCH 31,
--------- ---------
1999 1998
---- ----
<S> <C> <C>
Sales, net $ 6,252 $ 1,644
Cost of sales 304 659
--------- ---------
Gross profit 5,948 985
--------- ---------
Selling, general and administrative expenses 1,458,368 1,132,675
Research and development 143,185 73,294
Amortization of software 186,358 161,239
Depreciation 116,907 74,460
--------- ---------
Total operating expenses 1,904,818 1,441,668
--------- ---------
Loss from operations (1,898,870) (1,440,683)
Interest income, net 32,061 15,154
------ ------
NET LOSS $ (1,866,809) $ (1,425,529)
------------ ------------
------------ ------------
Basic and diluted net loss per share $ (0.14) $ (0.11)
Shares used in per share calculations 13,565,662 12,904,487
The accompanying notes are an integral part of these consolidated financial
statements
</TABLE>
F-3
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE
THREE MONTHS ENDED
MARCH 31, MARCH 31,
--------- ---------
1999 1998
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net loss $(1,866,809) $(1,425,529)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation 116,907 74,460
Amortization of software 186,358 161,239
Effects of changes in operating assets and liabilities:
Accounts and interest receivable 19,373 (9,945)
Inventories (6,791) 8,808
Prepaid expenses and deposits 45,585 (11,782)
Other assets (13,279) 109,168
Accounts payable 26,887 168,538
Accrued expenses (606,185) (29,471)
----------- -----------
Net cash used in operating activities (2,097,954) (954,514)
----------- -----------
Cash flows from investing activities:
Capital expenditures (70,165) (331,959)
Capitalized software development costs (88,831) (75,243)
Restricted cash 0 (129,500)
----------- -----------
Net cash used in investing activities (158,996) (536,702)
----------- -----------
Cash flows from financing activities:
Principal payments on notes payable to banks (144,036) (128,463)
----------- -----------
Net cash used in financing activities (144,036) (128,463)
----------- -----------
Decrease in cash and cash equivalents (2,400,986) (1,619,679)
Cash and cash equivalents, beginning of period 4,628,544 3,759,720
----------- -----------
Cash and cash equivalents, end of period $2,227,558 $2,140,041
----------- -----------
----------- -----------
The accompanying notes are an integral part of these consolidated financial statements
</TABLE>
F-4
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. UNAUDITED INTERIM FINANCIAL INFORMATION
The accompanying consolidated financial statements are
unaudited, but include all adjustments (consisting only of normal recurring
adjustments) which are, in the opinion of management, necessary for a fair
presentation of the financial position at such dates and of the operations and
cash flows for the periods then ended. The financial information is presented in
a condensed format, and it does not include all of the footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles. Operating results for the periods ended March
31, 1999 and 1998 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 December 31, 1998
Form 10-K 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.
F-5
<PAGE>
3. INVENTORIES
Inventories consisted of the following:
<TABLE>
<CAPTION>
MARCH 31, 1999 DECEMBER 31, 1998
<S> <C> <C>
Smart cards and related packaging $158,999 $158,917
Smart card terminals and computer hardware 59,036 61,846
Assembled unattended kiosks and components 150,223 140,704
-------- --------
$368,258 $361,467
-------- --------
-------- --------
</TABLE>
4. CAPITAL STOCK TRANSACTIONS
In March 1999, the Company received a firm commitment for
additional funding of $3,000,000. The Company believes that its existing cash
reserves, planned expenditure reductions (if necessary), and revenues will be
adequate to fund the Company's operations through 1999.
In August 1998, the Company received net proceeds of
$8,385,829 from the sale of 654,508 shares of common stock. The offering was
conducted pursuant to Rule 506 of Regulation D under the Securities Act. These
shares were subsequently registered for sale pursuant to a Registration
Statement on Form SB-2 that was declared effective by the Securities and
Exchange Commission on October 9, 1998.
5. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
FOR THE FOR THE
THREE MONTHS THREE MONTHS
ENDING ENDING
MARCH 31, 1999 MARCH 31, 1998
-------------- --------------
<S> <C> <C>
Cash paid for interest $9,143 $34,652
</TABLE>
6. BANK AGREEMENTS
In 1997, the Company entered into a master lease agreement
with a Bank which provided up to $400,000 of credit to the Company for the lease
of certain computer and office equipment and furniture for a period of 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 1998, the Company determined that it was in
breach of one of the financial covenants contained in its $400,000 lease
financing arrangement. The Company received a waiver from the
F-6
<PAGE>
bank in August 1998. The Company has been in compliance with the Bank's lease
provisions since receiving the waiver.
7. EARNINGS PER SHARE
The Company calculates earnings per share based on SFAS
No.128, "Earnings Per Share". Basic earnings per share is calculated using the
average number of common shares outstanding. Potentially dilutive shares
resulting from common stock options have been excluded from the computation of
diluted earnings per share for the three months ended March 31, 1999 and 1998 as
they are antidilutive. The number of common stock options outstanding at March
31, 1999 and 1998 that could be potentially dilutive are 446,166 and 425,833
respectively.
8. CHANGE IN ACCOUNTING ESTIMATE.
In the first quarter of 1999, the Company changed the
estimated economic life of capitalized software costs for certain applications
from five years to three years due to new information and developments arising
from recent customer negotiations. The cumulative impact of this change in
estimated economic life on net income for the three months ended March 31, 1999
was $35,019, and $.0026 per share.
F-7
<PAGE>
SIGNATURES
Pursuant to 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.
Date: May __, 1999 By /S/ CAREY F. DALY, II
---------------------
Carey F. Daly, II
President and Chief Executive Officer
Date: May ___, 1999 By /S/ MARK T. SCHUUR
------------------
Mark T. Schuur
Senior Vice President and Chief Financial
Officer
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S UNAUDITED FINANCIAL STATEMENTS FOR THE PERIOD ENDED MARCH 31, 1999,
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 2,227,558
<SECURITIES> 0
<RECEIVABLES> 83,420
<ALLOWANCES> 0
<INVENTORY> 368,258
<CURRENT-ASSETS> 2,802,430
<PP&E> 1,945,840
<DEPRECIATION> (892,521)
<TOTAL-ASSETS> 5,388,545
<CURRENT-LIABILITIES> 745,601
<BONDS> 144,085
0
0
<COMMON> 135,657
<OTHER-SE> 4,363,202
<TOTAL-LIABILITY-AND-EQUITY> 5,388,545
<SALES> 6,252
<TOTAL-REVENUES> 6,252
<CGS> 304
<TOTAL-COSTS> 304
<OTHER-EXPENSES> 1,904,818
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (32,061)
<INCOME-PRETAX> (1,866,809)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,866,809)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,866,809)
<EPS-PRIMARY> (0.14)
<EPS-DILUTED> (0.14)
</TABLE>
