<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ending September 30, 1998
OR
[ ] 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 000-25374
GENERAL MAGIC, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0250147
(State of incorporation) (IRS Employer Identification Number)
420 NORTH MARY AVENUE
SUNNYVALE, CALIFORNIA 94086
(408) 774-4000
(Address and telephone number of principal executive offices)
Indicate by check mark whether 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, and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
30,321,333 shares of the Registrant's Common Stock, $0.001 par value, were
outstanding as of October 31, 1998.
<PAGE> 2
GENERAL MAGIC, INC.
FORM 10-Q, September 30, 1998
C O N T E N T S
<TABLE>
<CAPTION>
Item Number Page
- ----------- ----
<S> <C> <C>
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
a. Condensed Consolidated Balance Sheets - September 30, 1998, and
December 31, 1997 3
b. Condensed Consolidated Statements of Operations - Three-Month
Periods Ended September 30, 1998 and 1997, and Nine-Month
Periods Ended September 30, 1998 and 1997 4
c. Condensed Consolidated Statements of Cash Flows - Nine-Month
Periods Ended September 30, 1998 and 1997 5
d. Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
PART II: OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 2. Changes in Securities and Use of Proceeds 25
Item 3. Defaults Upon Senior Securities 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 25
Signatures 26
Exhibits
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
September 30, December 31,
ASSETS 1998 1997
------------- ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents (including restricted cash of $3,028 and $3,300
in 1998 and 1997) $ 32,114 $ 17,414
Short-term investments 14,660 11,387
Other current assets 4,207 1,206
--------- ---------
Total current assets 50,981 30,007
--------- ---------
Property and equipment, net 7,931 5,148
Other assets 954 1,142
--------- ---------
$ 59,866 $ 36,297
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,205 $ 952
Accrued expenses 10,352 7,191
Current portion of long-term debt 1,810 801
Other current liabilities 61 224
--------- ---------
Total current liabilities 14,428 9,168
Deferred revenue 2,000 4,186
Long-term debt 3,539 3,199
Other long-term liabilities 756 2,446
--------- ---------
Total liabilities 20,723 18,999
--------- ---------
Commitments
Redeemable, convertible Series C preferred stock, $0.001 par value
Stated at involuntary liquidation preference
Authorized: 3 shares
Issued and outstanding: 1998 - 3; 1997 - None 39,407 --
Redeemable, convertible Series B preferred stock, $0.001 par value
Stated at involuntary liquidation preference
Authorized: 12 shares
Issued and outstanding: 1998 - 6; 1997 - None 7,430 --
Stockholders' equity:
Convertible Series A preferred stock, $0.001 par value
Liquidation preference: 1998 - $4,500; 1997 - None
Authorized: 50 shares
Issued and outstanding: 1998 - 50; 1997 - None -- --
Preferred stock, $0.001 par value
Authorized: 438 shares
Issued and outstanding: 1997 and 1996 - None -- --
Common stock, $0.001 par value
Authorized: 60,000 shares
Issued and outstanding: 1998 - 30,109; 1997 - 26,892 30 27
Additional paid-in capital 186,101 165,039
Deferred compensation -- (58)
Accumulated other comprehensive loss (1) 7
Deficit accumulated during development stage (193,785) (147,717)
--------- ---------
(7,665) 17,298
Less treasury stock , at cost: 1998 - 23; 1997 - 0 (39) --
--------- ---------
Total stockholders' equity (7,694) 17,298
--------- ---------
$ 59,866 $ 36,297
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE> 4
GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three-Month Periods Ended Nine-Month Periods Ended
September 30, September 30,
------------------------- -------------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue:
Licensing revenue $ 63 $ 2,228 $ 1,577 $ 2,438
Other revenue 311 325 583 901
-------- -------- -------- --------
Total revenue 374 2,553 2,160 3,339
-------- -------- -------- --------
Costs and expenses:
Cost of other revenue 191 291 389 828
Research and development 5,735 5,513 16,375 14,948
Sales, general and administrative 5,992 2,169 13,836 9,178
Write-off of in-process research and development -- -- 2,050 --
-------- -------- -------- --------
Total costs and expenses 11,918 7,973 32,650 24,954
-------- -------- -------- --------
Loss from operations (11,544) (5,420) (30,490) (21,615)
Total other income, net 1,498 582 6,703 2,269
-------- -------- -------- --------
Loss before income taxes (10,046) (4,838) (23,787) (19,346)
Income taxes -- 8 19 17
-------- -------- -------- --------
Net loss (10,046) (4,846) (23,806) (19,363)
Favorable conversion rights on convertible
Series A preferred stock issuance
-- -- (3,665) --
Favorable conversion rights on redeemable,
convertible Series B preferred stock
and warrants issuance and preferred stock dividend
-- -- (8,150) --
Favorable redemption rights on redeemable,
convertible Series C preferred stock issuance
-- -- (10,016) --
======== ======== ======== ========
Loss applicable to common stockholders $(10,046) $ (4,846) $(45,637) $(19,363)
======== ======== ======== ========
Basic and diluted loss per share $ (0.34) $ (0.18) $ (1.58) $ (0.72)
======== ======== ======== ========
Shares used in computing basic and diluted loss per share 30,017 26,854 28,849 26,741
======== ======== ======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE> 5
GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Nine -Month Periods Ended
September 30,
-------------------------
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(23,806) $(19,363)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation 2,237 2,150
Amortization of deferred gain from sale and leaseback financing -- (72)
Deferred revenue (2,186) (2,339)
Amortization of deferred compensation 451 77
Write-off of in-process research and development 1,850 --
Changes in items affecting operations:
Other current assets (3,001) 482
Accounts payable and accrued expenses 2,914 (5,472)
-------- --------
Net cash used in operating activities (21,541) (24,537)
-------- --------
Cash flows from investing activities:
Purchases of short-term investments (18,260) (51,260)
Proceeds from sales and maturities of short-term investments 14,978 72,741
Purchases of property and equipment (5,127) (1,629)
Other assets 295 (1,231)
-------- --------
Net cash provided by (used in ) investing activities (8,114) 18,621
-------- --------
Cash flows from financing activities:
Repayment of capital lease obligations (207) (590)
Proceeds from issuance of debt 1,905 --
Repayment of debt (556) --
Proceeds from sale of common stock 2,501 324
Purchase of treasury stock (39) --
Proceeds from sale of Series A preferred stock, net of offering costs 4,463 --
Proceeds from sale of Series B preferred stock, net of offering costs 6,915 --
Proceeds from sale of Series C preferred stock, net of offering costs 29,518 --
Other long-term liabilities (145) (191)
-------- --------
Net cash provided by (used in) financing activities 44,355 (457)
-------- --------
Net increase (decrease) in cash and cash equivalents 14,700 (6,373)
Cash and cash equivalents, beginning of period 17,414 23,706
-------- --------
Cash and cash equivalents, end of period $ 32,114 $ 17,333
======== ========
Supplemental disclosures of cash flow information:
Income taxes paid during the period $ 19 $ 15
======== ========
Interest paid during the period $ 415 $ --
======== ========
Noncash investing and financing activities:
Deferred compensation for restricted stock issuances $ 393 $ 155
======== ========
Business acquisition in exchange for shares of common stock $ 1,850 $ --
======== ========
Favorable conversion rights on Series A preferred stock issuance $ 3,665 $ --
======== ========
Favorable redemption and conversion rights on Series B
preferred stock and warrants issuance $ 8,150 $ --
======== ========
Series B preferred stock conversion to common stock $ 2,112 $ --
======== ========
Favorable redemption rights on Series C preferred stock issuance $ 10,016 $ --
======== ========
Reclassification of prepaid royalties from
deferred revenue to other long-term liabilities $ -- $ 1,500
======== ========
Reclassification of prepaid royalties from other
long-term liabilities to accrued expenses $ 1,500 $ --
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements
5
<PAGE> 6
GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission. In the opinion of management, the accompanying condensed
consolidated financial statements reflect all adjustments (consisting only of
normal recurring adjustments) considered necessary for a fair presentation of
the Company's financial condition, results of operations and cash flows for the
periods presented. These condensed consolidated financial statements should be
read in conjunction with the Company's audited consolidated financial statements
as of December 31, 1997 and 1996, and for each of the three years ended December
31, 1997, including notes thereto, included in the Company's Annual Report on
Form 10-K which was filed with the SEC on March 31, 1998.
The results of operations for the three-month and nine-month periods
ended September 30, 1998, are not necessarily indicative of the results expected
for the current year or any other period.
NOTE 2: BALANCE SHEET COMPONENTS
PROPERTY AND EQUIPMENT
A summary of property and equipment follows (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Office equipment and computers $13,612 $ 9,133
Furniture and fixtures 2,347 2,315
Leasehold improvements 969 546
------- -------
16,928 11,994
Less accumulated depreciation and amortization 8,997 6,846
------- -------
$ 7,931 $ 5,148
======= =======
</TABLE>
ACCRUED EXPENSES
A summary of accrued expenses follows (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Prepaid royalty payment and accrued interest $ 4,182 $ 3,318
Employee compensation 3,325 2,384
Other 2,845 1,489
------- -------
$10,352 $ 7,191
======= =======
</TABLE>
6
<PAGE> 7
NOTE 3: COMPREHENSIVE LOSS
Effective January 1998, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS
No. 130 requires disclosure of comprehensive loss in interim periods and
additional disclosures of the components of comprehensive loss on an annual
basis. Comprehensive loss includes all changes in equity during a period except
those resulting from investments by and distributions to the Company's
stockholders. For the three-month and nine-month periods ended September 30,
1998 and 1997, there were no material differences between the Company's
comprehensive loss and net loss.
NOTE 4: NET LOSS PER SHARE
The computation of diluted loss per share does not include common stock
issuable upon (i) the exercise of outstanding stock options and stock purchase
warrants and (ii) the conversion of preferred stock, because the inclusion of
these securities would have an anti-dilutive effect. As of September 30, 1998
and 1997, there were approximately 7,088,000 and 4,952,000 stock options
outstanding, respectively. As of September 30, 1998, there were warrants for the
purchase of 630,000 shares of common stock outstanding, 3,629,000 shares of
common stock issuable upon the conversion of Series A preferred stock, 1,917,000
shares of common stock issuable upon the conversion of Series B preferred stock,
and 5,273,000 shares of common stock issuable upon the conversion of Series C
preferred stock.
NOTE 5: INVESTMENTS IN CONITA TECHNOLOGIES, INC. AND ALTOCOM, INC.
In January 1998, the Company discontinued operations of its South
Carolina office and entered into an agreement with Conita Technologies, Inc.
("Conita"), a company founded by former employees of the South Carolina office.
Under the agreement, the Company obtained a minority interest in Conita through
the purchase of preferred stock for a total of $650,000.
During the three-month period ended June 30, 1998, the Company
recognized a $2,240,000 gain in connection with the sale of its minority
interest in AltoCom, Inc. ("AltoCom"). In the three-month period ended March 31,
1998, the Company also recognized $2,446,000 in other income for consideration
received pursuant to an agreement concluded during the quarter with AltoCom.
These events stem from a 1997 transaction in which the Company transferred its
software modem technology group to AltoCom. The Company retained a minority
interest in AltoCom and a share of its ongoing revenue stream. In January 1998,
the Company and AltoCom agreed to discontinue the revenue sharing agreement in
exchange for certain consideration, including the assumption by AltoCom of a
$2,240,000 obligation to one of the Company's legacy partners. In the
three-month period ended June 30, 1998, the Company sold its minority interest
in AltoCom.
NOTE 6: ACQUISITION OF NETPHONIC COMMUNICATIONS, INC.
On March 6, 1998, the Company acquired all of the outstanding shares of
common and preferred stock of NetPhonic Communications, Inc. ("NetPhonic"), a
development stage enterprise, for a total consideration of $2,050,000,
consisting of $200,000 cash and 1,342,524 shares of the Company's common stock.
The Company's common stock was issued to NetPhonic shareholders of record as of
the date of the transaction. NetPhonic has developed a patent-pending audio
browser that enables users to access documents from the Web using a touch-tone
telephone. The acquisition was accounted for under the purchase method and,
accordingly, the results of operations of NetPhonic have been included in the
Company's condensed
7
<PAGE> 8
consolidated financial statements as of the date of acquisition. The Company
allocated the total purchase price to acquired in-process research and
development that had not yet reached technological feasibility and had no
alternative future use to the Company. As a result, the Company recognized a
charge of $2,050,000 for the write-off of in-process research and development as
of the date of the acquisition. The value assigned to purchased in-process
research and development was determined by identifying the cost to develop the
purchased technology into a commercially viable feature of the Company's
advanced network service, estimating the resulting net cash flows for this
project, and discounting the net cash flows back to their present value. The
efforts to develop the purchased in-process technology center around the
integration of the purchased touch-tone web access technology into the
magicTalk(TM) voice-user interface platform utilized in the Company's advanced
voice-activated network service, called Portico(TM). The estimated cost to be
incurred to develop the purchased technology into a commercially viable feature
of Portico is approximately $2,330,000 in the aggregate through the year 1999
($845,000 in 1998 and $1,485,000 in 1999). The Company expects this effort to be
completed by the end of 1999 and to benefit from the effort beginning in the
year 2000. However, the Company continuously evaluates technologies for
inclusion in its Portico service, and may choose to implement an alternative, in
which case the NetPhonic technology will not be adopted. The Company believes
that any value attributable to other intangible assets is either immaterial or
would be immediately expensed because of the uncertainty surrounding the
realizability of the intangible assets when considering the Company's stage of
development.
NOTE 7: PREFERRED STOCK
On February 27, 1998, the Company entered into an agreement with
Microsoft Corp. ("Microsoft") for the sale of 50,000 shares of Series A
Convertible Preferred Stock and the license of certain of the Company's
technology. The aggregate consideration for the sale of Series A preferred stock
was $4,500,000. Series A preferred stock is eligible to vote with common stock
on an "as if converted" basis. Each share of Series A preferred stock is
entitled to receive, if and when the Company's Board of Directors declares a
dividend payable on common stock, a dividend equal to the dividend per share of
common stock on an "as if converted" basis. Series A preferred stock dividends
are payable in preference to any dividends on the Company's common stock and are
non-cumulative. The liquidation preference of each share of Series A preferred
stock is $90 plus any declared but unpaid dividends. Subject to adjustment in
certain circumstances, each share of Series A preferred stock is convertible
into shares of the Company's common stock at a conversion rate obtained by
dividing $90 by the applicable conversion value which, as of September 30, 1998,
was $1.24. As of September 30, 1998, 3,629,000 shares of the Company's common
stock were issuable upon conversion of the Series A preferred stock,
representing 7.5% of the Company's then outstanding common stock and common
stock equivalents on a fully diluted basis.
On March 3, 1998, the Company entered into a financing transaction with
a group of private investors that provided $5,000,000 in cash to the Company
from the sale of 5,000 shares of its 5 1/2% Cumulative Convertible Series B
Preferred Stock. Each share of Series B preferred stock is entitled to one vote
and has special voting rights with respect to matters that adversely affect the
rights of holders of Series B preferred stock. Each share of Series B preferred
stock is entitled to receive cumulative dividends at 5 1/2% per annum of the
liquidation preference of the Series B preferred stock, which are payable in
preference to any dividends on the Company's common stock. The liquidation
preference of Series B preferred stock is $1,000 per share plus any accrued but
unpaid dividends and is payable pari-passu with the Company's Series A preferred
stock. Subject to adjustment in certain circumstances, each share of Series B
preferred stock is convertible into shares of the Company's common stock at a
conversion rate obtained by dividing the liquidation preference by the lesser of
$3.00 or 85% of the lowest sales price per share of common stock during the five
trading days prior to conversion. The holders of Series B preferred stock have
the right to require the Company to redeem
8
<PAGE> 9
any or all then outstanding Series B preferred stock at 130% of the liquidation
preference upon the occurrence of certain events, including a change of control
transaction, bankruptcy or insolvency of the Company. The Company has the right
to redeem all then outstanding Series B preferred stock at 120% of the
liquidation preference upon a change of control transaction. As part of the
financing transaction, the Company issued warrants to acquire 400,000 shares of
common stock at an exercise price of $3.38 per share. The warrants have a
five-year term and are immediately exercisable.
On June 25, 1998, for an aggregate purchase price of $2,000,000, certain
holders of the Company's Series B preferred stock exercised their right to
purchase 2,000 additional shares of Series B preferred stock and warrants to
acquire an additional 160,000 shares of the Company's common stock at an
exercise price of $18.75 per share. The holders of Series B preferred stock also
agreed to convert at least 2,500 then outstanding shares of Series B preferred
stock into common stock. The Company waived its rights to require the holders of
the Series B preferred stock to purchase an additional 5,000 shares of Series B
preferred stock and warrants to acquire 400,000 shares of common stock. As of
September 30, 1998, a total of 2,397,000 shares of common stock were issuable
upon the conversion of all Series B preferred stock and associated warrants,
representing 4.9% of the Company's then outstanding common stock and common
stock equivalents on a fully diluted basis.
On June 25, 1998, the Company entered into a financing transaction with
a group of private investors that provided $30,000,000 in cash to the Company
from the sale of 3,000 shares of its Series C Convertible Preferred Stock. Each
share of Series C preferred stock has special voting rights with respect to
matters that adversely affect the rights of holders of Series C preferred stock
and otherwise has no voting rights except as may be required by law. Each share
of Series C preferred stock is entitled to receive cumulative dividends at 5%
per annum of the stated value ($10,000 per share) of the Series C preferred
stock, which are payable in preference to any dividends on the Company's common
stock. The liquidation preference of Series C preferred stock is $10,000 per
share plus any accrued but unpaid dividends and penalties, and is payable
pari-passu with the Series A and Series B preferred stock. Subject to adjustment
in certain circumstances, each share of Series C preferred stock is convertible
into shares of the Company's common stock at a conversion rate obtained by
dividing the liquidation preference by the lesser of $19.49 ("Fixed Conversion
Price") or the average of the four lowest closing bid prices per share of the
Company's common stock for the 20 trading days prior to the conversion date
("Floating Conversion Price") which, as of September 30, 1998, was $5.77.
On October 22, 1998, the holders of the Series C preferred stock and the
Company entered into a Voting and Waiver Agreement pursuant to which the holders
agreed to amend the Certificate of Designations, Preferences and Rights of the
Series C Convertible Preferred Stock ("Certificate of Designations") to provide
the Company the flexibility to issue shares of its common stock in connection
with mergers, acquisitions and other strategic transactions without triggering
anti-dilution protection-related adjustments to the number of shares of common
stock into which the Series C preferred stock may be converted in exchange for a
reduction of the Fixed Conversion Price from $19.49 to $10.00. This amendment is
subject to stockholder approval which must be obtained by the Company on or
before January 31, 1999. The amendment is further subject to stockholder
approval of the issuance of the Company's common stock upon the conversion of
the Series C preferred stock in excess of certain limits imposed by the rules of
the NASDAQ National Market ("Discounted Securities Limit"), which approval must
also be obtained by January 31, 1999. If the Company does not obtain stockholder
approval of the amendment to the Certificate of Designations, the Fixed
Conversion Price will be reduced from $19.49 to $6.00 as a result of the
Company's issuance of common stock in connection with an asset acquisition
which, in the absence of the amendment, would have triggered a reduction in the
Fixed Conversion Price. As of September 30, 1998, a total of 5,423,000 shares of
the Company's common stock were issuable upon the conversion of the Series C
preferred stock and exercise of associated warrants, representing 11.2% of the
Company's then outstanding common stock and common stock
9
<PAGE> 10
equivalents on a fully diluted basis. The Series C preferred stock is not
convertible into common stock until five months after the date of issuance,
subject to certain exceptions which, among other things permit conversion on any
day on which the common stock trades at a price greater than or equal to (i)
115% of the Floating Conversion Price or (ii) the Fixed Conversion Price.
Pursuant to this provision, as of November 12, 1998, 1,451 shares of Series C
preferred stock had been submitted for conversion into 2,857,000 shares of
common stock.
In certain circumstances (including upon a change of control
transaction, the transfer of substantially all of the assets of the Company, or
a tender offer made to and accepted by holders of more than 50% of the
outstanding common stock of the Company), the holders of Series C preferred
stock may require the Company to redeem any or all of the then outstanding
Series C preferred stock at 130% of the liquidation preference and, in more
limited circumstances (relating to the registration and listing of the common
stock of the Company issuable upon conversion of the Series C preferred stock;
the Company's timely conversion of such stock; and stockholder approval on or
before January 31, 1999, of the issuance of common stock in excess of the
Discounted Securities Limit), may require the Company to redeem any or all of
the then outstanding Series C preferred stock at the greater of 130% of the
liquidation preference or the then applicable closing bid price per common share
equivalent. If the stockholders do not approve the issuance of the Series C
preferred stock and warrants issued in connection therewith and the issuance of
shares of common stock in excess of the Discounted Securities Limit by January
31, 1999, the holders of the Series C preferred stock will be entitled to
several alternative remedies including the right to require the Company to
redeem the outstanding shares of the Series C preferred stock at a price per
share equal to 130% of the liquidation preference. Upon submission of Series C
preferred stock for conversion at a conversion price of less than $5.00, the
Company has the option to redeem any or all of such stock at 110% of the
liquidation preference. As part of the financing transaction, the Company issued
warrants to acquire 150,000 shares of common stock at a price of $17.22 per
share. The warrants have a three-year term and are immediately exercisable.
Adjustments to accumulated deficit of approximately $3,665,000 were
recorded during the nine-month period ended September 30, 1998, to recognize the
value of favorable conversion rights associated with the Series A preferred
stock issued during the period, representing the difference between the fair
market value of the Company's common stock on the date of the agreement of $2.25
and the sale price of $1.24 per common share equivalent. Adjustments to the
accumulated deficit of approximately $8,150,000 were recorded in the nine-month
period ended September 30, 1998, to recognize the value of favorable conversion
and exercise rights associated with the Series B preferred stock and related
warrants, respectively, issued during the period. The adjustments principally
represent the difference between the fair market value of the Company's common
stock on the date of the financing transactions of $3.69 at March 3, 1998, and
$12.50 at June 25, 1998, and the per share conversion price of $3.00.
Adjustments to the accumulated deficit of approximately $10,016,000 were
recorded in the nine-month period ended September 30, 1998, to recognize the
value of the favorable redemption rights associated with the Series C preferred
stock. The adjustments principally represent the difference between the
redemption value (130% of the liquidation preference) and the amount of the
liquidation preference.
NOTE 8: COMMITMENTS
PURCHASE COMMITMENTS
In April 1998, the Company entered into an agreement with Qwest
Communications International, Inc. to purchase telecommunications services at
fixed prices for an initial term of three years. The Company is obligated to
purchase $13,000,000 in telecommunications services during the three-year period
ending April 30, 2001. The charges underlying this commitment will be expensed
in the periods in which they occur.
10
<PAGE> 11
During 1997, the Company entered into an OEM agreement with Oki Electric
Industry Co., Ltd. ("Oki Electric") for the manufacture of handheld
communication devices. In connection therewith, the Company obtained an
irrevocable letter of credit with a term of one year to collateralize the
Company's obligations under the OEM agreement ("Letter of Credit"). In September
1998, the Company amended the terms of the Letter of Credit, in connection with
an agreement reached with DataRover Mobile Systems, Inc. (see Note 9), to
increase the total purchase commitment and to allow for an extension in the
delivery dates. As of September 30, 1998, the Company had $3,028,000 on deposit
as security with the financial institution issuing the Letter of Credit. This
commitment is denominated in Japanese yen and, as a result, is at risk of
foreign currency fluctuations. The Company's purchase commitment was valued at
$2,509,000 as of September 30, 1998. Of this amount, $544,000 was expected to be
due before the end of 1998, and $1,965,000 was expected to be due in the first
three months of 1999. The liability will be recorded upon acceptance of units
shipped by Oki Electric.
LONG-TERM DEBT
In December 1997, the Company entered into a $4,000,000 term loan with a
financial institution. The loan bears interest at 0.25% above the financial
institution's prime rate (8.5% as of June 30, 1998), and has a term of 40 months
with interest only due in the first four months and principal and interest due
monthly thereafter. This loan is secured by all of the assets of the Company,
including its intellectual property.
In June 1998, the Company secured a $3,000,000 term loan facility with
the same financial institution. The loan bears interest at the financial
institution's prime rate (8.5% as of September 30, 1998), and has a term of 42
months with interest only due in the first six months and principal and interest
due monthly thereafter. This loan is secured by all of the assets of the
Company, including its intellectual property. As of September 30, 1998,
$1,905,000 was outstanding under this term loan facility.
As of September 30, 1998, the current and non-current portions due under
these loans were $1,810,000 and $3,539,000, respectively.
Note 9: Subsequent Events
INVESTMENT IN DATAROVER MOBILE SYSTEMS, INC.
In October 1998, the Company entered into an agreement with DataRover
Mobile Systems, Inc. ("DSI"), a company founded to develop, market and sell
DataRover handheld communications devices. Pursuant to the agreement, the
Company contributed cash and other assets of its DataRover handheld products
division totaling $3,361,000, and licensed certain technology, in exchange for
non-voting, non-redeemable preferred stock and 49% of the common stock of DSI.
The Company does not expect to recognize any gain or loss as a result of this
divestiture, and will account for the investment using the equity method. The
Company will continue to purchase units from Oki Electric for DSI under the
Letter of Credit as amended (see Note 8), and will be reimbursed the actual cost
of such units by DSI upon the earlier of five (5) days following the sale of the
units by DSI or 120 days following shipment by Oki Electric. DSI's obligation to
reimburse the Company is secured by all personal property of DSI. In connection
with this divestiture, approximately 30 employees of the Company became
employees of DSI. The Company provided for accelerated vesting of options to
acquire 305,000 shares of the Company's common stock held by such employees, and
granted an additional 330,000 options to acquire the Company's common stock to
such employees. The newly granted options will vest over a two-year period. The
Company expects to record compensation expense associated with the fair value of
the accelerated and newly granted options over the vesting period of the
options.
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Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This Management's Discussion and Analysis of Financial Condition and
Results of Operations includes a number of forward-looking statements which
reflect the Company's current views with respect to future events and financial
performance. These forward-looking statements are subject to certain risks and
uncertainties, including those discussed in the Risk Factors section of this
Item 2 that could cause actual results to differ materially from historical
results or those anticipated. In this report, the words "anticipates,"
"believes," "expects," "future," "intends," and similar expressions identify
forward-looking statements. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the date hereof.
OVERVIEW
General Magic, Inc. (the "Company") develops and markets integrated
voice and data applications. The Company has developed an advanced network
service to meet the communication and information management requirements of
today's mobile professionals. The advanced network service is named Portico(TM)
and was commercially released on July 30, 1998. Portico allows subscribers to
access and respond to information, either through magicTalk(TM), the Company's
intelligent voice user interface platform, or through a leading Web browser.
Among other things, Portico (i) manages the subscriber's inbound and outbound
calls; (ii) collects and consolidates the subscriber's email, and notifies the
subscriber upon receipt; (iii) maintains the subscriber's calendar, address book
and task list; (iv) collects and forwards stock quotes, selected news and
information based on subscriber preferences; and (v) retrieves press releases
and other news and information concerning thousands of publicly traded
companies. The Company is currently distributing its Portico service through
value-added resellers and is conducting trials of the service with
telecommunications carriers. The Company is also leveraging its magicTalk voice
user interface platform to provide telephony access to internet-based
information and electronic commerce services.
The Company is at an early stage of development in its new business
strategy and is subject to all of the risks inherent in the establishment of a
new business enterprise. To address these risks, the Company must, among other
things, continue to develop and enhance its Portico service, enter into
strategic development and distribution arrangements, respond to competitive
developments, and attract, retain and motivate qualified personnel. The
Company's decision to focus its efforts as a provider of an advanced network
service is predicated on the assumption that in the future, the number of
subscribers of the Company's network service will be large enough to permit the
Company to operate profitably. There can be no assurance that the Company's
assumption will be correct or that the Company will be able to successfully
compete as a network service provider. Any failure to achieve these goals could
have a material adverse effect upon the Company's business, operating results
and financial condition.
RESULTS OF OPERATIONS
For the three-month period ended September 30, 1998, the Company
incurred a net loss of $10.0 million, or $0.34 per share, compared to a net loss
of $4.8 million, or $0.18 per share, for the three-month period ended September
30, 1997. For the nine-month period ended September 30, 1998, the net loss was
$1.58 per share compared to the loss of $0.72 per share recorded for the same
period in 1997. The net loss per share for the nine-month period ended September
30, 1998, included the net loss for the period and $21.8 million in adjustments
to accumulated deficit related to preferred stock with favorable conversion and
redemption rights
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issued during the period. Excluding the effect of these adjustments, the loss
per share for the period would have been $0.83 per share.
Revenue for the three-month period ended September 30, 1998, was $374
thousand compared to $2.6 million for the three-month period ended September 30,
1997. The decrease in revenue in the three-month period is due to $2.0 million
in non-recurring royalty revenue recognized in the three-month period ended
September 30, 1997, under an existing master license agreement. For the
nine-month period ended September 30, 1998, revenues were $2.2 million compared
to $3.3 million for the same period in 1997. The decrease in revenue in the
nine-month period is due to $2.0 million in non-recurring royalty revenue
recognized in the three-month period ended September 30, 1997 under an existing
master license agreement, offset by $1.5 million in Microsoft Corp. licensing
fees recorded in the first three months of 1998. The Company anticipates a
decrease in total revenue in 1998 compared to 1997 due to lower licensing and
other revenue and the divestiture of its DataRover handheld communications
devices division ("DataRover Division") in October 1998. Revenue from the
Company's Portico service is not expected to be significant through 1998, but is
expected to increase beginning in the first quarter of 1999.
Cost of other revenue was $191 thousand for the three-month period ended
September 30, 1998, compared to $291 thousand for the same three-month period in
1997. The decrease in the three-month period is due to a reduction in personnel
support costs offset by increased device costs associated with sales of the
DataRover handheld communications device ("DataRover 840"). For the nine-month
period ended September 30, 1998, cost of other revenue was $389 thousand
compared to $828 thousand for the same period in 1997. The decrease in the
nine-month period was due principally to the decline in personnel support costs,
offset by costs associated with sales of the DataRover 840. Cost of revenue is
expected to decrease in 1998 compared to 1997 due to further decreases in
personnel support costs and the divestiture of the DataRover Division.
Research and development expenses for the three-month period ended
September 30, 1998, were $5.7 million compared to $5.5 million for the
three-month period ended September 30, 1997. For the nine-month period ended
September 30, 1998, research and development expenses were $16.4 million
compared to $14.9 million for the same period in 1997. The increase in both the
three and nine-month periods is due to an increase in costs associated with the
development of the Portico service and the DataRover 840. The Company expects
that these expenses will decline for the remainder of 1998 due to the
divestiture of the DataRover Division, offset by expenses in connection with
continued development work to support the customization of the magicTalk voice
user interface platform for use in the telecommunications and internet channels.
Selling, general and administrative expenses for the three-month period
ended September 30, 1998, were $6.0 million compared to $2.2 million for the
three-month period ended September 30, 1997. For the nine-month period ended
September 30, 1998, selling, general and administrative expenses were $13.8
million compared to $9.2 million for the same period in 1997. The increase in
both the three and nine-month periods is attributable to staffing increases and
additional advertising and marketing expenses to support the progressive rollout
of the Portico service. The Company expects selling, general and administrative
expenses to continue to increase in both amount and rate of growth in 1998 as
compared to 1997 in connection with its continued efforts to develop market
demand and distribution channels for the Portico service.
During the nine-month period ended September 30, 1998, the Company
recognized a $2.1 million charge for the write-off of acquired in-process
research and development in connection with the acquisition of all the
outstanding stock of NetPhonic Communications, Inc., a development stage
enterprise.
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Total other income, net, for the three-month period ended September 30,
1998, was $1.5 million compared to $0.6 million for the three-month period ended
September 30, 1997. The increase in the three-month period is attributable to a
gain of $0.9 million recognized in connection with the sale of the Company's
minority investment in Starfish Software, Inc. (`Starfish"), which was purchased
by Motorola, Inc. in September 1998.
For the nine-month period ended September 30, 1998, total other income,
net, was $6.7 million compared to $2.3 million for the same period in 1997.
During the nine-month period ended September 30, 1998, the Company recognized a
$2.2 million gain in connection with the sale of its minority interest in
AltoCom, Inc. ("AltoCom") and the Company recognized $2.4 million in other
income for consideration received pursuant to an agreement concluded during the
quarter ended March 31, 1998 with AltoCom. These events stem from a 1997
transaction in which the Company transferred its software modem technology group
to AltoCom. The Company retained a minority interest in AltoCom and a share of
its ongoing revenue stream. In January 1998, the Company and AltoCom agreed to
discontinue the revenue sharing agreement in exchange for certain consideration,
including the assumption by AltoCom of a $2.2 million obligation to one of the
Company's legacy partners. In the three-month period ended June 30, 1998, the
Company sold its minority interest in AltoCom.
Excluding the investment gain from Starfish and gains from the AltoCom
transactions, total other income, net, consisted primarily of interest income
and expense. Interest income, net, was consistent in the three-month period
ended September 30, 1998, as compared to the same period in 1997. Interest
income, net, declined in the nine-month period ended September 30, 1998, as
compared to the same period in 1997 due to the decline in the weighted average
cash and cash equivalent balances during the respective periods.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of liquidity are its cash, cash
equivalents and short-term investment balances that totaled $46.8 million as of
September 30, 1998, up from the $28.8 million as of December 31, 1997.
On February 27, 1998, the Company entered into an agreement with
Microsoft Corp. ("Microsoft") for the sale of 50 thousand shares of Series A
Convertible Preferred Stock and the license of certain of the Company's
technology. The aggregate consideration for the sale of Series A preferred stock
was $4.5 million. Each share of Series A preferred stock is eligible to vote
with common stock on an "as if converted" basis. Each share of Series A
preferred stock is entitled to receive, if and when the Company's Board of
Directors declares a dividend payable on common stock, a dividend equal to the
dividend per share of common stock on an "as if converted" basis. Series A
preferred stock dividends are payable in preference to any dividends on the
Company's common stock and are non-cumulative. The liquidation preference of
each share of Series A preferred stock is $90 plus any declared but unpaid
dividends. Subject to adjustment in certain circumstances, each share of Series
A preferred stock is convertible into shares of the Company's common stock at a
conversion rate obtained by dividing $90 by the applicable conversion value
which, as of September 30, 1998, was $1.24. As of September 30, 1998, 3.6
million shares of the Company's common stock were issuable upon conversion of
the Series A preferred stock, representing 7.5% of the Company's then
outstanding common stock and common stock equivalents on a fully diluted basis.
On March 3, 1998, the Company entered into a financing transaction with
a group of private investors that provided $5.0 million in cash to the Company
from the sale of 5,000 shares of its 5 1/2% Cumulative Convertible Series B
Preferred Stock. Each share of Series B preferred stock is entitled to one vote
and has special voting rights with respect to matters that adversely affect the
rights of holders of Series B preferred stock. Each share of Series B preferred
stock is entitled to receive cumulative dividends at 5 1/2% per annum
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of the liquidation preference of the Series B preferred stock, which are payable
in preference to any dividends on the Company's common stock. The liquidation
preference of Series B preferred stock is $1,000 per share plus any accrued but
unpaid dividends and is payable pari-passu with the Company's Series A preferred
stock. Subject to adjustment in certain circumstances, each share of Series B
preferred stock is convertible into shares of the Company's common stock at a
conversion rate obtained by dividing the liquidation preference by the lesser of
$3.00 or 85% of the lowest sales price per share of common stock during the five
trading days prior to conversion. The holders of Series B preferred stock have
the right to require the Company to redeem any or all then outstanding Series B
preferred stock at 130% of the liquidation preference upon the occurrence of
certain events, including a change of control transaction, bankruptcy or
insolvency of the Company. The Company has the right to redeem all then
outstanding Series B preferred stock at 120% of the liquidation preference upon
a change of control transaction. As part of the financing transaction, the
Company issued warrants to acquire 400 thousand shares of common stock at an
exercise price of $3.38 per share. The warrants have a five-year term and are
immediately exercisable.
On June 25, 1998, for an aggregate purchase price of $2.0 million,
certain holders of the Company's Series B preferred stock exercised their right
to purchase 2,000 additional shares of Series B preferred stock and warrants to
acquire an additional 160 thousand shares of the Company's common stock at an
exercise price of $18.75 per share. The holders of Series B preferred stock also
agreed to convert at least 2,500 then outstanding shares of Series B preferred
stock into common stock. The Company waived its rights to require the holders of
the Series B preferred stock to purchase an additional 5,000 shares of Series B
preferred stock and warrants to acquire 400 thousand shares of common stock. As
of September 30, 1998, a total of 2.4 million shares of common stock were
issuable upon the conversion of all Series B preferred stock and associated
warrants, representing 4.9% of the Company's then outstanding common stock and
common stock equivalents on a fully diluted basis.
On June 25, 1998, the Company entered into a financing transaction with
a group of private investors that provided $30.0 million in cash to the Company
from the sale of 3,000 shares of its Series C Convertible Preferred Stock. Each
share of Series C preferred stock has special voting rights with respect to
matters that adversely affect the rights of holders of Series C preferred stock
and otherwise has no voting rights except as may be required by law. Each share
of Series C preferred stock is entitled to receive cumulative dividends at 5%
per annum of the stated value ($10,000 per share) of the Series C preferred
stock, which are payable in preference to any dividends on the Company's common
stock. The liquidation preference of Series C preferred stock is $10,000 per
share plus any accrued but unpaid dividends and penalties, and is payable
pari-passu with the Series A and Series B preferred stock. Subject to adjustment
in certain circumstances, each share of Series C preferred stock is convertible
into shares of the Company's common stock at a conversion rate obtained by
dividing the liquidation preference by the lesser of $19.49 ("Fixed Conversion
Price") or the average of the four lowest closing bid prices per share of the
Company's common stock for the 20 trading days prior to the conversion date
("Floating Conversion Price") which, as of September 30, 1998, was $5.77.
On October 22, 1998, the holders of the Series C preferred stock and the
Company entered into a Voting and Waiver Agreement pursuant to which the holders
agreed to amend the Certificate of Designations, Preferences and Rights of the
Series C Convertible Preferred Stock ("Certificate of Designations") to provide
the Company the flexibility to issue shares of its common stock in connection
with mergers, acquisitions and other strategic transactions without triggering
anti-dilution protection-related adjustments to the number of shares of common
stock into which the Series C preferred stock may be converted in exchange for a
reduction of the Fixed Conversion Price from $19.49 to $10.00. This amendment is
subject to stockholder approval which must be obtained by the Company on or
before January 31, 1999. The amendment is further subject to stockholder
approval of the issuance of the Company's common stock upon the conversion of
the Series C preferred stock in excess of certain limits imposed by the rules of
the NASDAQ National Market
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("Discounted Securities Limit"), which approval must also be obtained by January
31, 1999. If the Company does not obtain stockholder approval of the amendment
to the Certificate of Designations, the Fixed Conversion Price will be reduced
from $19.49 to $6.00 as a result of the Company's issuance of common stock in
connection with an asset acquisition which, in the absence of the amendment,
would have triggered a reduction in the Fixed Conversion Price. As of September
30, 1998, a total of 5.4 million shares of the Company's common stock were
issuable upon the conversion of the Series C preferred stock and exercise of
associated warrants, representing 11.2% of the Company's then outstanding common
stock and common stock equivalents on a fully diluted basis. The Series C
preferred stock is not convertible into common stock until five months after the
date of issuance, subject to certain exceptions which, among other things permit
conversion on any day on which the common stock trades at a price greater than
or equal to (i) 115% of the Floating Conversion Price or (ii) the Fixed
Conversion Price. Pursuant to this provision, as of November 12, 1998, 1,451
shares of Series C preferred stock had been submitted for conversion into 2.9
million shares of common stock.
In certain circumstances (including upon a change of control
transaction, the transfer of substantially all of the assets of the Company, or
a tender offer made to and accepted by holders of more than 50% of the
outstanding common stock of the Company), the holders of Series C preferred
stock may require the Company to redeem any or all of the then outstanding
Series C preferred stock at 130% of the liquidation preference and, in more
limited circumstances (relating to the registration and listing of the common
stock of the Company issuable upon conversion of the Series C preferred stock;
the Company's timely conversion of such stock; and stockholder approval on or
before January 31, 1999, of the issuance of common stock in excess of the
Discounted Securities Limit), may require the Company to redeem any or all of
the then outstanding Series C preferred stock at the greater of 130% of the
liquidation preference or the then applicable closing bid price per common share
equivalent. If the stockholders do not approve the issuance of the Series C
preferred stock and warrants issued in connection therewith and the issuance of
shares of common stock in excess of the Discounted Securities Limit by January
31, 1999, the holders of the Series C preferred stock will be entitled to
several alternative remedies including the right to require the Company to
redeem the outstanding shares of the Series C preferred stock at a price per
share equal to 130% of the liquidation preference. Upon submission of Series C
preferred stock for conversion at a conversion price of less than $5.00, the
Company has the option to redeem any or all of such stock at 110% of the
liquidation preference. As part of the financing transaction, the Company issued
warrants to acquire 150 thousand shares of common stock at a price of $17.22 per
share. The warrants have a three-year term and are immediately exercisable.
Adjustments to accumulated deficit of approximately $3.7 million were
recorded during the nine-month period ended September 30, 1998, to recognize the
value of favorable conversion rights associated with the Series A preferred
stock issued during the period, representing the difference between the fair
market value of the Company's common stock on the date of the agreement of $2.25
and the sale price of $1.24 per common share equivalent. Adjustments to the
accumulated deficit of approximately $8.2 million were recorded in the
nine-month period ended September 30, 1998, to recognize the value of favorable
conversion and exercise rights associated with the Series B preferred stock and
related warrants, respectively, issued during the period. The adjustments
principally represent the difference between the fair market value of the
Company's common stock on the date of the financing transactions of $3.69 at
March 3, 1998, and $12.50 at June 25, 1998, and the per share conversion price
of $3.00. Adjustments to the accumulated deficit of approximately $10.0 million
were recorded in the nine-month period ended September 30, 1998, to recognize
the value of the favorable redemption rights associated with the Series C
preferred stock. The adjustments principally represent the difference between
the redemption value (130% of the liquidation preference) and the amount of the
liquidation preference.
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In December 1997, the Company entered into a $4.0 million term loan with
a financial institution. The loan bears interest at 0.25% above the financial
institution's prime rate (8.5% as of September 30, 1998), and has a term of 40
months with interest only due in the first four months and principal and
interest due monthly thereafter. This loan is secured by all of the assets of
the Company, including its intellectual property.
In June 1998, the Company secured a $3.0 million term loan facility with
the same financial institution. The loan bears interest at the financial
institution's prime rate (8.5% as of September 30, 1998), and has a term of 42
months with interest only due in the first six months and principal and interest
due monthly thereafter. This loan is secured by all of the assets of the
Company, including its intellectual property. As of September 30, 1998, $1.9
million was outstanding under this term loan facility.
As of September 30, 1998, the current and non-current portions due under
these loans were $1.8 million and $3.5 million, respectively.
In April 1998, the Company entered into an agreement with Qwest
Communications International, Inc. to purchase telecommunications services at
fixed prices for an initial term of three years. The Company is obligated to
purchase $13.0 million in telecommunications services during the three-year
period ending April 30, 2001. The charges underlying this commitment will be
expensed in the periods in which they occur.
During 1997, the Company entered into an OEM agreement with Oki Electric
Industry Co., Ltd. ("Oki Electric") for the manufacture of handheld
communication devices. In connection therewith, the Company obtained an
irrevocable letter of credit with a term of one year to collateralize the
Company's obligations under the OEM agreement ("Letter of Credit"). In September
1998, the Company amended the terms of the letter of credit, in connection with
an agreement reached with DataRover Mobile Systems, Inc. (see Note 9 to the
Condensed Consolidated Financial Statements), to increase the total purchase
commitment and to allow for an extension in the delivery dates. As of September
30, 1998, the Company had $3.0 million on deposit as security with the financial
institution issuing the Letter of Credit. This commitment is denominated in
Japanese yen and, as a result, is at risk of foreign currency fluctuations. The
Company's purchase commitment was valued at $2.5 million as of September 30,
1998. Of this amount, $544 thousand was expected to be due before the end of
1998 and $2.0 million was expected to be due in the first three months of 1999.
The liability will be recorded upon acceptance of units shipped by Oki Electric.
In connection with its prior strategy, the Company entered into Magic Cap
master license agreements with eight of its stockholders. The Company has
satisfied its obligations under five of these agreements, and is subject to the
following obligations under the remaining three agreements. The Company must
refund to one licensee a prepaid royalty, together with interest, which totaled
$2.7 million as of September 30, 1998. This amount will be paid upon demand, and
was classified in accrued expenses as of September 30, 1998. The Company has
agreed to refund a second licensee the amount of a $1.5 million unrecouped
prepaid royalty. The refund is secured by a license in certain of the Company's
intellectual property, is non-interest bearing and is payable in August 1999.
The amount of this refund was also classified in accrued expenses as of
September 30, 1998. Finally, the Company has agreed to refund the third licensee
any amount of a $2.0 million prepaid royalty not recouped by January 1, 2003,
plus accrued interest. The amount of any such refund is payable on or before
December 31, 2003. As of September 30, 1998, this obligation was classified in
deferred revenue, noncurrent. There can be no assurance that the third such
licensee will develop products that incorporate the Company's Magic Cap
technology. It is uncertain when prepaid royalties currently classified as
noncurrent deferred revenue will be recognized as licensing revenue or if they
will ever be fully recouped.
The Company uses a significant number of computer systems and software
applications in its internal operations, and in its services. To the extent that
these systems and applications are unable to appropriately
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interpret the upcoming calendar year "2000," some level of modification or even
replacement of such systems and applications may be necessary. The Company is
conducting a comprehensive inventory and evaluation of its business systems and
applications, equipment and facilities. For the "Year 2000" non-compliance
issues identified to date, the cost of upgrade or remediation is not expected to
be material to the Company's business, operating results or financial condition.
The Company expects to conclude evaluation of its exposure, remediation
requirements, and estimates of cost by the end of the calendar year. If
implementation of replacement systems is delayed, or if significant new
non-compliance issues are identified, the Company's business, results of
operations and financial condition could be materially adversely affected. The
Company is also in the process of contacting its key suppliers to determine that
their operations and the products and services they provide are "Year 2000"
compliant. The Company presently believes that non-compliance of products and
services supplied by third parties, such as the Company's billing system and
network operations center software and equipment, or of third party products and
services over which it has no control, such as telecommunications and power,
present the most reasonably likely worst-case scenarios that the Company may
confront with respect to "Year 2000" issues. For example, if the
telecommunications service or power, or the network operations center software
or equipment were to fail, Portico subscribers would be unable to access the
Portico service; and if the billing system were to fail, the Company would be
unable to invoice its subscribers. The Company has already obtained written
assurance from certain of its suppliers, including the developer of its billing
system, that their products and services are "Year 2000" compliant. The Company
also presently believes that its network operations center software and
equipment, including its Portico service application, is "Year 2000" compliant,
but will begin detailed testing in the first quarter of 1999. Where practicable,
the Company will attempt to mitigate its risk with respect to failures of
third-party suppliers to be "Year 2000" ready. In the event that suppliers are
not "Year 2000" compliant, the Company will seek alternative suppliers whose
products and services are "Year 2000" compliant. The Company has in place a
business resumption plan that addresses recovery from certain disasters,
including recovery from significant loss of voice/data communications access.
The Company is using that plan as a starting point for developing specific "Year
2000" contingency plans, which the Company expects to complete by approximately
the second quarter of 1999. However, there can be no assurance that the Company
will be able to complete its contingency planning on that schedule. Failure of
the Company's suppliers to achieve "Year 2000" compliance, or of the Company to
timely complete its contingency plans, may result in a material adverse affect
on the Company's business, operating results and financial condition.
The Company expects that its cash, cash equivalents and short-term
investment balances of $46.8 million as of September 30, 1998 will be adequate
to fund the Company's operations through 1999. The Company's capital
requirements will depend on many factors, including, but not limited to, the
market acceptance and competitive position of its new Portico service; the
equipment requirements to support the network operations for the Portico
service; the levels of promotion and advertising required to market its products
and Portico service and attain a competitive position in the marketplace; the
extent to which the Company invests in new technology and management and staff
infrastructure to support its business; and the response of competitors to the
Company's services. To the extent that the Company needs additional public or
private financing, no assurance can be given that additional financing will be
available or that, if available, it will be available on terms favorable to the
Company or its stockholders. If adequate funds are not available to satisfy
either short- or long-term capital requirements, or if the objectives of the
Company relative to the market acceptance of its Portico service are not
achieved, the Company may be required to significantly limit its operations,
which would have a material adverse effect on the Company's business, financial
condition and results of operations.
As part of its business strategy, the Company assesses opportunities to
enter into joint ventures, to acquire or sell businesses, products or
technologies and to engage in other like transactions. The Company has made no
significant commitment or agreement with respect to any such transactions at
this time.
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RISK FACTORS
In addition to the other information in this Form 10-Q, the following
factors should be considered carefully in evaluating the Company and its
business before purchasing or selling shares of the Company's stock.
CHANGE IN STRATEGY
The Company is at an early stage of development in its new business
strategy and is subject to all of the risks inherent in the establishment of a
new business enterprise. To address these risks, the Company must, among other
things, continue to develop and enhance the Portico service, enter into
strategic development and distribution arrangements, respond to competitive
developments, and attract, retain and motivate qualified personnel. The
Company's decision to become a provider of an advanced network service is
predicated on the assumption that in the future, the number of subscribers to
the service will be large enough to permit the Company to operate profitably.
There can be no assurance that the Company's assumption will be correct or that
the Company will be able to successfully compete as a network service provider.
If the Company's assumption is not accurate, or if the Company is unable to
compete as a network service provider, the Company's business, operating results
and financial condition will be materially adversely affected.
MINIMAL REVENUES; HISTORY OF AND ANTICIPATION OF LOSSES
The Company has generated minimal revenues, has incurred significant
losses and has substantial negative cash flow. As of September 30, 1998, the
Company had an accumulated deficit of $193.8 million, with net losses of $23.8
million, $28.4 million, and $45.6 million for the nine-month period ended
September 30, 1998, and the years ended December 31, 1997 and 1996,
respectively.
Historically, a large percentage of the total revenue earned by the
Company to date has been attributable to up-front license fees and customer
support fees, as opposed to recurring royalty revenue. As a consequence of the
Company's recent change in business strategy, the Company expects that a
significant portion of future revenues will be derived from direct sales of its
services and not from license fees or royalties. The Company's Portico service
was released in a progressive rollout beginning on July 30, 1998. However, the
Company expects to incur significant losses at least through 1998. There can be
no assurance that the Company will achieve or sustain significant revenues or
become cash flow positive or profitable at any time in the future.
POTENTIAL DILUTIVE EFFECTS
The number of shares of common stock which may be issued upon conversion
of the Series B preferred stock is dependent upon the trading price of the
Company's common stock at the time of conversion. If the lowest sales price of
the common stock in the five trading days prior to conversion is less than
$3.45, the number of shares of common stock issuable upon conversion of the
Series B preferred stock will increase. The number of shares of common stock
which may be issued upon conversion of the Series C preferred stock is also
dependent upon the trading price of the common stock during the 20 days prior to
the time of conversion. If the sales price of the common stock decreases, the
number of shares of common stock issuable upon conversion of the Series C
preferred stock will increase.
TECHNOLOGY DEVELOPMENT
The Company's future success is based substantially upon its ability to
develop new technology to enable it to provide as well as bill for the Portico
service, and to enhance and extend its existing products and
19
<PAGE> 20
technologies. Software product development schedules are difficult to predict
because they involve creative processes, use of new development tools and
learning processes associated with development of new technologies, as well as
other factors. The Company has in the past experienced delays in its software
development efforts and there can be no assurance that the Company will not
experience future delays in connection with its current development or future
development activities. Delays or difficulties associated with the development
of new, and the enhancement of existing, technologies could have a material
adverse effect on the Company's business, operating results and financial
condition. Moreover, software products as complex as those being developed for
the Company's Portico service frequently contain undetected errors or
shortcomings, and may fail to perform or to scale as expected. Although the
Company has tested and will continue to test its Portico service, such tests may
not accurately simulate actual use of the service by subscribers. As a result,
errors may be found in the commercial release of the Portico service which may
result in loss of or a delay in market acceptance of the Company's Portico
service.
DISTRIBUTION RISKS
In connection with the change in its business strategy, the Company must
establish and maintain relationships with new distribution channels for its
Portico service. The Company believes that in order to successfully market its
Portico service, it must, among other things, enter into distribution
arrangements with resellers, telephony providers such as wireless and wireline
carriers, as well as device manufacturers and Internet service providers.
Competition in establishing such relationships is extremely intense. In
addition, decisions by such parties, particularly cellular carriers, to enter
into a distribution relationship with the Company can entail a lengthy process
during which the Company may be required to incur significant expenditures
without any assurance of success. There can be no assurance that the Company
will succeed in establishing distribution relationships on terms favorable to
the Company, if at all, or that if established, the Company will be able to
maintain such relationships or that such relationships will result in sales of
the Company's Portico service. The failure of the Company to establish and then
successfully maintain distribution relationships for its Portico service will
have a material adverse effect on the Company's business, operating results and
financial condition.
DEPENDENCE ON EMERGING MARKETS; ACCEPTANCE OF THE COMPANY'S SERVICES AND
PRODUCTS
The Company's future financial performance will depend in large part on
the growth in demand for the Portico service by mobile business professionals
and other consumers. This market is new and emerging, is rapidly evolving, is
characterized by an increasing number of market entrants and will be subject to
frequent and continuing changes in customer preferences and technology. As is
typical in new and evolving markets, demand and market acceptance for the
Company's technologies is subject to a high level of uncertainty. Because the
market for the Company's Portico service is evolving, it is difficult to assess
or predict with any assurance the size or growth rate, if any, of this market.
There can be no assurance that the market for the Company's Portico service will
develop, that it will develop as quickly as expected or that it won't attract
new competitors. In addition, even if a market develops for an advanced network
service, there can be no assurance that the market for the Company's Portico
service will develop, or that the Company's Portico service will be adopted. If
the market fails to develop, develops more slowly than expected or attracts new
competitors, or if the Company's Portico service does not achieve market
acceptance, the Company's business, operating results and financial condition
will be materially adversely affected.
DEPENDENCE ON THIRD PARTY TECHNOLOGY AND PRODUCTS
To develop its Portico service, the Company has incorporated and will
continue to incorporate technology developed by third parties. In addition to
all the risks associated with the development of complex
20
<PAGE> 21
technologies, the Company has limited control over whether or when such third
party technologies will be developed or enhanced. Moreover, the Company has
limited control over whether or to what extent interests in such third parties
or third-party technologies are acquired by companies with which the Company may
now or in the future compete. A third party's failure or refusal, for any
reason, to timely develop, license or support the software technology, or the
occurrence of errors in such technology, could prevent or delay introduction or
market acceptance, or continued maintenance and support, of the Company's
Portico service, which could have a material adverse effect on the Company's
business, operating results and financial condition.
COMPETITION
Many of the companies with which the Company competes, or which are
expected to offer products or services based on alternatives to the Company's
technologies, have substantially greater financial resources, research and
development capabilities, sales and marketing staffs, and better developed
distribution channels than the Company. There can be no assurance that the
Company's Portico service will achieve sufficient quality, functionality or
cost-effectiveness to compete with existing or future alternatives. Furthermore,
there can be no assurance that the Company's competitors will not succeed in
developing products or services which are more effective and lower cost than
those offered by the Company, or which render the Company's Portico service
obsolete. The Company believes that its ability to compete depends on factors
both within and outside its control. The principal competitive factors affecting
the market for the Company's products and services are the availability of the
Company's products and services; the quality, performance and functionality of
the Portico service developed and marketed by the Company; the effectiveness of
the Company in marketing and distributing its products and services; and price.
There can be no assurance that the Company will be successful in the face of
increasing competition from new technologies, products or services introduced by
existing competitors and by new companies entering the market.
INTELLECTUAL PROPERTY
The Company seeks to protect its proprietary information and technology
through contractual confidentiality provisions and the application for United
States and foreign patents, trademarks and copyrights. There can be no assurance
of patents, trademarks or copyrights or that third parties will not seek to
challenge, invalidate or circumvent such applications or resulting patents,
trademarks or copyrights. Additionally, competitors may independently develop
equivalent or superior, non-infringing technologies. The Company's revenue could
be materially adversely affected to the extent that such technologies avoid
infringement of the Company's patents. Furthermore, there can be no assurance
that third parties will not assert claims of infringement of intellectual
property rights against the Company and that such claims will not lead to
litigation and/or require the Company to significantly modify or even
discontinue sales of its services. Any such event may have a material adverse
effect on the Company's business, operating results and financial condition.
POTENTIAL SECURITY ISSUES
The implementation of the Portico service poses several security issues,
including the possibility of break-ins and other similar disruptions. The
Company continues to incorporate authentication, encryption and other security
technologies in its Portico service. There can be no assurance that such
technologies will be adequate to prevent break-ins. In addition, as is generally
known, weaknesses in the medium by which users may access the Company's Portico
service, including the Internet, telephones, cellular phones and other wireless
devices, may compromise the security of the confidential electronic information
accessed from the Portico service. There can be no assurance that the Company
will be able to provide a safe and secure service. The Company's failure to
provide a secure service may result in significant liability to the Company and
may deter potential
21
<PAGE> 22
users of the service. The Company intends to limit its liability to users,
including liability arising from failure of the authentication, encryption and
other security technologies incorporated into its Portico service, through
contractual provisions. However, there can be no assurance that such limitations
will be effective. The Company currently does not have liability insurance to
protect against risks associated with forced break-ins or disruptions. There can
be no assurance that security vulnerabilities and weaknesses will not be
discovered in the Company's Portico service or licensed technology incorporated
into such service or in the mediums by which subscribers access the Portico
service. Any security problems in the Portico service or the licensed technology
incorporated in such service may require significant expenditures of capital and
resources by the Company to alleviate such problems, may result in lawsuits
against the Company, may limit the number of subscribers of the Portico service
and may cause interruptions or delays in the development of enhancements to, or
the cessation of, the Company's service. Any such expenditures, lawsuits,
reduction of subscribers, interruptions or delays in enhancement to the Portico
service, or the cessation of such service by the Company, could have a material
adverse effect on the Company's business, operating results and financial
condition.
PERSONNEL
The Company must continue to attract, retain and motivate qualified
personnel. Silicon Valley remains a highly competitive job market, and there can
be no assurance that key Company management, engineering, marketing, sales,
administrative, and customer support personnel will remain employed by the
Company, or that the Company will be able to attract sufficient additional
personnel to execute its business plan. The Company experienced significant
attrition of engineering, marketing, administrative and sales personnel during
the latter part of 1996 and the first half of 1997, including an approximate
one-half reduction in its workforce between October 1996 and January 1997. These
reductions adversely affected, and may in the future adversely affect, the
Company's ability to attract, retain and motivate qualified personnel. There can
be no assurance that the Company's current employees will continue to work for
the Company or that the Company will be able to obtain the services of
additional personnel necessary for the Company's growth. Failure to attract or
retain qualified personnel could have a material adverse effect on the Company's
business, operating results and financial condition.
LIMITED RESOURCES
Building, maintaining and enhancing the Portico service is a complex
process that requires significant engineering and financial resources. Among
other things, the Company must develop enhancements to the Portico service,
establish strategic distribution arrangements and undertake a substantial
marketing campaign. The Company has limited technical, sales and marketing
staffs and there can be no assurance that such personnel will be able to manage
and successfully complete all of the tasks necessary to support the Company's
Portico service. In addition, because the Company has generated minimal revenues
to date and does not expect to generate substantial revenues in 1998, the
Company must conserve cash. As a result, the Company may not be able to fund the
marketing efforts required to successfully introduce the service to customers.
Alternatively, in the event the market accepts the Portico service, it may
overwhelm the Company's limited staffs such that the Company is unable to
adequately respond to and satisfy customers' demand for the Portico service. The
Company's failure to timely enhance its Portico service, or to respond to market
demand for the service, will likely have a material adverse effect on the
Company's business, operating results and financial condition.
FUTURE CAPITAL REQUIREMENTS AND AVAILABILITY OF ADDITIONAL FINANCING
If expenditures required to achieve the Company's plans are greater than
projected or if the Company is unable to generate adequate cash flow from sales
of its Portico service, the Company may need to seek
22
<PAGE> 23
additional sources of capital. The Company has no other commitments or
arrangements to obtain any additional funding and there can be no assurance that
the Company will be able to obtain such additional funding, if necessary, on
acceptable terms or at all. The unavailability or timing of any financing could
prevent or delay the continued development and marketing of the services of the
Company and may require curtailment of operations of the Company. The failure to
raise needed funds on sufficiently favorable terms or at all could have a
material adverse effect on the Company's business, operating results and
financial condition.
EXTREME VOLATILITY OF STOCK PRICE
Like the stock of other high technology companies, the market price of the
Company's common stock has been and may continue to be extremely volatile. Since
its initial public offering in February 1995, the market price of the Company's
common stock has ranged from a high of $26.625 to a low of $0.938 per share.
Factors such as quarterly fluctuations in the Company's results of operations or
the announcements of technological innovations or strategic alliances or the
introduction of new products or services by the Company or its competitors may
have a significant impact on the market price of the Company's common stock.
RAPID TECHNOLOGICAL CHANGE
The communications technology market is characterized by rapid
technological change, changing customer needs, frequent new product
introductions and evolving industry standards. The introduction of products or
services embodying new technologies and the emergence of new industry standards
could render the Company's products or services obsolete and unmarketable. The
Company's future success will depend upon its ability to timely develop and
introduce new products and services, as well as enhancements to such products
and services, to keep pace with technological developments and emerging industry
standards and address the increasingly sophisticated needs of the user. There
can be no assurance that the Company will be successful in developing and
marketing new products and services that respond to technological changes or
evolving industry standards, that the Company will not experience difficulties
that could delay or prevent the successful development, introduction and
marketing of new products and services, or that its new products and services
will adequately meet the requirements of the marketplace and achieve market
acceptance. If the Company is unable, for technological or other reasons, to
timely develop and introduce new products and services in response to changing
market conditions or consumer requirements, the Company's business, operating
results and financial condition will be materially adversely affected.
DEPENDENCE ON AND RESPONSIVENESS TO THE INTERNET
The Company believes that its future success is in part dependent upon
continued growth in the use of the Internet. The Internet may prove not to be a
viable means of conducting commerce or communications for a number of reasons,
including, but not limited to, potentially unreliable network infrastructure, or
untimely development of performance improvements including high speed modems. In
addition, to the extent that the Internet continues to experience significant
growth in the number of users and level of use, there can be no assurance that
the Internet infrastructure will continue to be able to support the demands
placed on it by any such growth. Failure of the Internet as a mode of conducting
commerce and communications could have a material adverse effect on the
Company's business, operating results and financial condition.
SINGLE CALIFORNIA LOCATION
Currently, the Company's only network operations center is located at
its headquarters in Sunnyvale, California. Operation of the Portico service is
dependent in part upon the Company's ability to protect the
23
<PAGE> 24
network operations center against physical damage from power outages,
telecommunications failures, physical break-ins and other similar events. In
addition, Northern California historically has been vulnerable to certain
natural disasters and other risks, such as earthquakes, fires and floods, which
at times have disrupted the local economy and pose physical risks to the
Company's property. The Company presently does not have redundant, multiple site
capacity in the event of a technical failure of its Portico service or a natural
disaster. In the event of such a failure or disaster, the Company's business,
operating results and financial condition could be materially adversely
affected.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
No disclosure is required.
24
<PAGE> 25
GENERAL MAGIC, INC.
FORM 10-Q, September 30, 1998
Part II--Other Information
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
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) The following exhibit is filed with this report:
27.1 Financial Data Schedule
(b) No reports on Form 8-K were filed during the quarter for which this
report is filed.
25
<PAGE> 26
GENERAL MAGIC, INC.
FORM 10-Q, September 30, 1998
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.
DATE: November 13, 1998 /s/ STEVEN MARKMAN
-----------------------------------------
Name: Steven Markman
Title: Chairman and Chief Executive
Officer (Principal Executive Officer)
DATE: November 13, 1998 /s/ JAMES P. MCCORMICK
-----------------------------------------
Name: James P. McCormick
Title: Chief Financial Officer
(Principal Financial
and Accounting Officer)
26
<PAGE> 27
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 32,114
<SECURITIES> 14,660
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 50,981
<PP&E> 16,928
<DEPRECIATION> 8,997
<TOTAL-ASSETS> 59,866
<CURRENT-LIABILITIES> 14,428
<BONDS> 4,295
46,837
0
<COMMON> 30
<OTHER-SE> (7,724)
<TOTAL-LIABILITY-AND-EQUITY> 59,866
<SALES> 0
<TOTAL-REVENUES> 2,160
<CGS> 0
<TOTAL-COSTS> 389
<OTHER-EXPENSES> 32,261
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 416
<INCOME-PRETAX> (23,787)
<INCOME-TAX> 19
<INCOME-CONTINUING> (23,806)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (23,806)
<EPS-PRIMARY> (1.58)
<EPS-DILUTED> (1.58)
</TABLE>
