<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 June 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 [ ]
30,043,736 shares of the Registrant's Common Stock, $0.001 par value, were
outstanding as of July 31, 1998.
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GENERAL MAGIC, INC.
FORM 10-Q, June 30, 1998
CONTENTS
<TABLE>
<CAPTION>
Item Number Page
- ----------- ----
<S> <C> <C>
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
a. Condensed Consolidated Balance Sheets - June 30, 1998, and December 31, 1997 3
b. Condensed Consolidated Statements of Operations - Three-Month Periods Ended
June 30, 1998, and 1997 and Six-Month Periods Ended June 30, 1998 and 1997 4
c. Condensed Consolidated Statements of Cash Flows - Six-Month Periods Ended
June 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 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 22
PART II: OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 2. Changes in Securities and Use of Proceeds 23
Item 3. Defaults Upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 25
Exhibits
</TABLE>
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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>
June 30, December 31,
ASSETS 1998 1997
---------- -----------
<S> <C> <C>
Current assets:
Cash and cash equivalents (including restricted cash of
$3,103 and $3,300 in 1998 and 1997) $ 40,042 $ 17,414
Short-term investments 17,501 11,387
Other current assets 2,066 1,206
---------- ----------
Total current assets 59,609 30,007
---------- ----------
Property and equipment, net 5,833 5,148
Other assets 1,647 1,142
---------- ----------
$ 67,089 $ 36,297
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,096 $ 952
Accrued expenses 7,327 7,191
Current portion of long-term debt 1,651 801
Other current liabilities 104 224
---------- ----------
Total current liabilities 10,178 9,168
Deferred revenue, noncurrent 2,000 4,186
Long-term debt 4,032 3,199
Other long-term liabilities 2,321 2,446
---------- ----------
Total liabilities 18,531 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 39,032 --
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 7,374 --
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 - 29,860; 1997 - 26,892 30 27
Additional paid-in capital 185,581 165,039
Deferred compensation (110) (58)
Accumulated other comprehensive loss (2) 7
Deficit accumulated during development stage (183,308) (147,717)
---------- ----------
2,191 17,298
Less treasury stock, at cost: 1998 - 23; 1997 - 0 (39) --
---------- ----------
Total stockholders' equity 2,152 17,298
---------- ----------
$ 67,089 $ 36,297
========== ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three-Month Six-Month
Periods Ended Periods Ended
June 30, June 30,
----------------------- -----------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue:
Licensing revenue $ 4 $ 59 $ 1,514 $ 210
Other revenue 87 238 272 576
-------- -------- -------- --------
Total revenue 91 297 1,786 786
-------- -------- -------- --------
Costs and expenses:
Cost of other revenue 51 225 198 537
Research and development 5,591 4,455 10,640 9,435
Sales, general and administrative 4,302 2,978 7,844 7,009
Write-off of in-process research and
development -- -- 2,050 --
-------- -------- -------- --------
Total costs and expenses 9,944 7,658 20,732 16,981
-------- -------- -------- --------
Loss from operations (9,853) (7,361) (18,946) (16,195)
Total other income, net 2,535 654 5,205 1,687
-------- -------- -------- --------
Loss before income taxes (7,318) (6,707) (13,741) (14,508)
Income taxes 19 7 19 9
-------- -------- -------- --------
Net loss (7,337) (6,714) (13,760) (14,517)
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 (6,422) -- (8,150) --
Favorable redemption rights on redeemable,
convertible Series C preferred stock
issuance (10,016) -- (10,016) --
======== ======== ======== ========
Loss applicable to common stockholders $(23,775) $ (6,714) $(35,591) $(14,517)
======== ======== ======== ========
Basic and diluted loss per share $ (0.82) $ (0.25) $ (1.26) $ (0.54)
======== ======== ======== ========
Shares used in computing basic and diluted
loss per share 29,104 26,782 28,258 26,678
======== ======== ======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statement
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GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Six-Month Periods Ended
June 30,
-------------------------
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(13,760) $(14,517)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation 1,440 1,476
Amortization of deferred gain from sale and leaseback
financing -- (48)
Deferred revenue (2,186) (225)
Amortization of deferred compensation 341 58
Write-off of in-process research and development 1,850 --
Changes in items affecting operations:
Other current assets (860) 332
Accounts payable and accrued expenses 280 (4,540)
-------- --------
Net cash used in operating activities (12,895) (17,464)
-------- --------
Cash flows from investing activities:
Purchases of short-term investments (18,260) (47,999)
Proceeds from sales and maturities of short-term
investments 12,137 56,190
Purchases of property and equipment (2,233) (283)
Other assets (397) (929)
-------- --------
Net cash provided by (used in) investing activities (8,753) 6,979
-------- --------
Cash flows from financing activities:
Repayment of capital lease obligations (150) (475)
Proceeds from issuance of debt 1,905 --
Repayment of debt (222) --
Proceeds from sale of common stock 1,981 263
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 (95) (131)
-------- --------
Net cash provided by (used in) financing activities 44,276 (343)
-------- --------
Net increase (decrease) in cash and cash equivalents 22,628 (10,828)
Cash and cash equivalents, beginning of period 17,414 23,706
-------- --------
Cash and cash equivalents, end of period $ 40,042 $ 12,878
======== ========
Supplemental disclosures of cash flow information:
Income taxes paid during the period $ 19 $ 7
======== ========
Interest paid during the period $ 241 $ --
======== ========
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 $ 1,842 $ --
======== ========
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
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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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 six-month periods ended
June 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>
June 30, December 31,
1998 1997
-------- ------------
<S> <C> <C>
Office equipment and computers $11,025 $ 9,133
Furniture and fixtures 2,336 2,315
Leasehold improvements 673 546
------- -------
14,034 11,994
Less accumulated depreciation and amortization 8,201 6,846
------- -------
$ 5,833 $ 5,148
======= =======
</TABLE>
ACCRUED EXPENSES
A summary of accrued expenses follows (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
-------- ------------
<S> <C> <C>
Prepaid royalty payment and accrued interest $2,647 $3,318
Employee compensation 2,806 2,384
Other 1,874 1,489
------ ------
$7,327 $7,191
====== ======
</TABLE>
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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 six-month periods ended June 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 June 30, 1998 and
1997 there were approximately 4,330,000 and 4,563,000 stock options outstanding,
respectively. As of June 30, 1998, there were 710,000 stock purchase warrants
outstanding, 3,629,000 shares of common stock issuable upon the conversion of
Series A preferred stock, 1,891,000 shares of common stock issuable upon the
conversion of Series B preferred stock, and 2,788,000 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 an aggregate amount of $650,000. As of June 30,
1998, $195,000 was remaining to be paid of the original $650,000 commitment.
During the three-month period ended June 30, 1998, the Company recognized a
$2.2 million 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 $2.4 million in other income for consideration received
pursuant to an agreement concluded during the quarter with AltoCom. During 1997,
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.
NOTE 6: ACQUISITION OF NETPHONIC COMMUNICATION, 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 of $2,050,000, which consideration
consisted 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 voice
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 consolidated financial statements as of the date of
acquisition. During the six-month period ended June 30,
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1998, the Company recognized a $2,050,000 charge for the write-off of in-process
research and development in connection with this acquisition.
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.
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. Series A
preferred stock is eligible to vote with common stock on an "as if converted"
basis. 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 June 30, 1998, was $1.24. As of
June 30, 1998, 3,629,000 shares of the Company's common stock were issuable upon
conversion of Series A preferred stock, representing 8.4% of the Company's
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
private investment group 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 any or all 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 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 share 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
June 30, 1998, a total of 2,451,000 shares of common stock were issuable upon
the conversion of all Series B preferred stock and associated warrants,
representing 5.7% of the Company's outstanding common stock and common stock
equivalents on a fully diluted basis.
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On June 25, 1998, the Company entered into a financing transaction with a
private investment group 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 is entitled to one vote and has special voting
rights with respect to matters that adversely affect the rights of holders of
Series C preferred stock. Each share of Series C preferred stock is entitled to
receive cumulative dividends at 5% per annum of the stated value of the Series C
preferred stock ($10,000 per share), 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 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
which, as of June 30, 1998, was $10.77. As of June 30, 1998, a total of
2,938,000 shares of the Company's common stock were issuable upon the conversion
of the Series C preferred stock and associated warrants, representing 6.8% of
the Company's outstanding common stock and common stock equivalents on a fully
diluted basis. However, with limited exceptions, the Series C preferred stock is
not convertible into common stock until five months after the date of issuance.
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 and the Company's timely conversion
of such shares), 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.
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
shares at 110% of the liquidation price. 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 six-month period ended June 30, 1998, to recognize the value of
favorable conversion rights associated with 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 six-month period ended
June 30, 1998, to recognize the value of favorable conversion and exercise
rights of both sales associated with 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 six-month period ended June 30, 1998, to recognize the value of
the favorable redemption rights associated with 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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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.
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. The Company has $3,103,000 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. Due to favorable changes in the exchange rate and
partial performance of the contract, the Company's purchase commitment was
valued at $2,248,000 as of June 30, 1998.
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 June 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 intellectual property. As of June 30, 1998, $1,905,000 was outstanding
under this term loan facility.
As of June 30, 1998, the current and non-current portions due under these
loans were $1.7 million and $4.0 million, respectively.
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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 is currently developing 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 also developing and marketing handheld communication
devices based on its Magic Cap platform technology. The first of these devices,
the DataRover 840, was commercially released in February 1998, and is intended
to meet the data capture and data access needs of mobile workers in the health
care, utilities and transportation industries.
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 June 30, 1998, the Company incurred a net
loss of $7.3 million, or $0.82 per share, compared to a net loss of $6.7
million, or $0.25 per share, for the three-month period ended June 30, 1997. The
net loss per share for the three-month period ended June 30, 1998, included the
net loss for the period and $16.4 million in adjustments to accumulated deficit
related to preferred stock with favorable conversion and redemption rights
issued during the period. Excluding the effect of these adjustments, the loss
per share for the period would have been $0.25 per share. For the six-month
period ended June 30, 1998, the net loss was $1.26 per share compared to the
loss of $0.54 per share recorded for the same period in 1997. The net loss per
share for the six-month period ended June 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
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redemption rights issued during the period. Excluding the effect of these
adjustments, the loss per share for the period would have been $0.49 per share.
Revenue for the three-month period ended June 30, 1998, was $91 thousand
compared to $297 thousand for the three-month period ended June 30, 1997. For
the six-month period ended June 30, 1998, revenues were $1.8 million compared to
$786 thousand for the same period in 1997. The decrease in revenue for the
three-month period ended June 30, 1998, compared to the same period in 1997 is
due to the continued decline in licensing fees and support services related to
the Company's Magic Cap software technology. The increase in revenue for the
six-month period ended June 30, 1998, compared to the same period in 1997 is
primarily attributable to a $1.5 million nonrefundable fee from Microsoft Corp.
for the license of certain of the Company's technologies. The Company
anticipates a modest increase in total revenue in 1998 compared to 1997 due to
the Microsoft license, as well as the release of both the DataRover 840 device
and the Portico service. There can be no assurance that the Portico service or
the DataRover 840 device will achieve market acceptance. To the extent that the
Portico service does not achieve market acceptance, the Company's business,
financial condition and results of operations will be materially adversely
affected.
Cost of other revenue, which consisted primarily of personnel costs, was $51
thousand for the three-month period ended June 30, 1998, compared to $225
thousand for the same three-month period last year. For the six-month period
ended June 30, 1998, cost of other revenue was $198 thousand compared to $537
thousand for the same period in 1997. This decrease in both the three and
six-month periods was due to a decline in support services in both of the
periods. Cost of revenue is expected to increase in 1998 compared to 1997 as a
result of the costs associated with the Company's Portico service and sales of
the DataRover 840 device.
Research and development expenses for the three-month period ended June 30,
1998, were $5.6 million compared to $4.5 million for the three-month period
ended June 30, 1997. For the six-month period ended June 30, 1998, research and
development expenses were $10.6 million compared to $9.4 million for the same
period in 1997. The Company expects that these expenses will continue to
increase in 1998 and as compared to 1997 in connection with the research and
continued development of enhancements for both the Portico service and the
DataRover 840 device.
Selling, general and administrative expenses for the three-month period ended
June 30, 1998, were $4.3 million compared to $3.0 million for the three-month
period ended June 30, 1997. For the six-month period ended June 30, 1998,
selling, general and administrative expenses were $7.8 million compared to $7.0
million for the same period in 1997. The increase in both the three and six
month periods is attributable to staffing increases and additional marketing
expenses to support the progressive roll-out of the Portico service. The Company
expects selling, general and administrative expenses to continue to increase in
1998 and as compared to 1997 in connection with its continued efforts to develop
market demand and distribution channels for its products and services.
During the six-month period ended June 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.
Total other income, net, for the three-month period ended June 30, 1998, was
$2.5 million compared to $654 thousand for the three-month period ended June 30,
1997. For the six-month period ended June 30, 1998, total other income, net, was
$5.2 million compared to $1.7 million for the same period in 1997. During the
three-month period ended June 30, 1998, the Company recognized a $2.2 million
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 $2.4 million in other income for consideration received pursuant to
an
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agreement concluded during the quarter with AltoCom. During 1997, 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 AltoCom consideration, total other income, net, consisted
primarily of interest income and expense. Interest income decreased in both the
three- and six-month periods ended June 30, 1998, 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 $57.5 million as of June 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 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. Series A
preferred stock is eligible to vote with common stock on an "as if converted"
basis. 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 June 30, 1998, was $1.24. As of
June 30, 1998, 3.6 million shares of the Company's common stock were issuable
upon conversion of Series A preferred stock, representing 8.4% of the Company's
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
private investment group 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 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 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 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.
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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 share 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 June 30, 1998, a total of 2.5 million shares of common stock were issuable
upon the conversion of all Series B preferred stock and associated warrants,
representing 5.7% of the Company's 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
private investment group 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 is entitled to one vote and has special voting
rights with respect to matters that adversely affect the rights of holders of
Series C preferred stock. Each share of Series C preferred stock is entitled to
receive cumulative dividends at 5% per annum of the stated value of the Series C
preferred stock ($10 thousand per share), which are payable in preference to any
dividends on the Company's common stock. The liquidation preference of Series C
preferred stock is $10 thousand 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 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 which, as of June 30, 1998, was $10.77. As of June 30, 1998, a
total of 2.9 million shares of the Company's common stock were issuable upon the
conversion of the Series C preferred stock and associated warrants, representing
6.8% of the Company's outstanding common stock and common stock equivalents on a
fully diluted basis. However, with limited exceptions, the Series C preferred
stock is not convertible into common stock until five months after the date of
issuance. 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
and the Company's timely conversion of such shares), 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. 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 shares at 110% of the liquidation price. 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 six-month period ended June 30, 1998, to recognize the value
of favorable conversion rights associated with 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 six-month period
ended June 30, 1998, to recognize the value of favorable conversion and exercise
rights of both sales associated with 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
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per share conversion price of $3.00. Adjustments to the accumulated deficit of
approximately $10.0 million were recorded in the six-month period ended June 30,
1998, to recognize the value of the favorable redemption rights associated with
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.
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 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 $3.0 million term loan facility with the
same financial institution. The loan bears interest at the financial
institution's prime rate (8.5% as of June 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 intellectual property. As of June 30, 1998, $1.9 million was
outstanding under this term loan facility.
As of June 30, 1998, the current and non-current portions due under these
loans were $1.7 million and $4.0 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 DataRover 840
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. As of June 30, 1998, the Company had $3.1 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. Due to favorable changes in the exchange rate,
the Company's commitment was valued at $2.2 million as of June 30, 1998.
Management continually assesses the currency risk associated with this
commitment and may enter into one or more agreements in the future to mitigate
this risk.
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
$2.6 million as of June 30, 1998. This amount will be paid upon demand, and was
classified in accrued expenses as of June 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 classified in other long-term liabilities as of
June 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 June 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
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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 products and services. To
the extent that these systems and applications are unable to appropriately
interpret the upcoming calendar year "2000," some level of modification or even
replacement of such systems and applications may be necessary. The Company is in
the process of identifying its systems and applications that are not "Year 2000"
compliant. Given the information known at this time about the Company's systems
and applications, coupled with the Company's ongoing efforts to upgrade or
replace business critical systems and applications as necessary, it is currently
not anticipated that these "Year 2000" costs will have a material adverse effect
on the Company's business, operating results or financial condition. However,
the Company is still analyzing its systems and applications and, to the extent
they are not fully "Year 2000" compliant, there can be no assurance that the
costs necessary to update or that potential systems interruptions would not have
a material adverse effect on the Company's business, operating results or
financial condition. In addition, the Company is currently evaluating whether
the systems of other companies on which the Company relies, including its
customers and suppliers, will be "Year 2000" compliant. There can be no
assurance that a failure by another company to be "Year 2000" compliant would
not have a material adverse effect on the Company's business, operating results
or financial condition.
The Company expects that its cash, cash equivalents and short-term investment
balances of $57.5 million as of June 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 and DataRover 840 device; the
equipment requirements to support the network operations for the Portico
service; the levels of promotion and advertising required to launch and market
its products and services 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 products and 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.
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.
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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 June 30, 1998, the Company had an
accumulated deficit of $183.3 million, with net losses of $13.8 million, $28.4
million, and $45.6 million for the six-month period ended June 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 products and
services and not from license fees or royalties. The Company's DataRover 840
device was commercially released in February 1998, and its Portico service was
released in a progressive rollout beginning on July 30, 1998. However, the
Company expects to incur significant losses 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 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
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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 and DataRover 840 device. 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, 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.
The Company plans to distribute the DataRover 840 device through a variety of
distribution channels, including a direct sales force, value-added resellers
("VARs") and outside sales representatives. To date, the Company has established
distribution arrangements with three VARs. There can be no assurance that the
Company will be able to establish distribution relationships with additional
VARs and outside sales representatives for its DataRover 840 device. The
Company's failure to establish, or if established, successfully maintain such
relationships could have a material adverse effect on the Company's business,
operating results and financial condition.
LENGTHY SALES CYCLES
Sales of the Company's DataRover 840 device depend, in significant part, upon
the decision of a prospective customer to choose handheld devices as a means of
communication for its employees. As a result, the amount of time from the
initial contact with a customer to the customer's placement of an order may
range from a few weeks to many months, depending on such factors as the amount
of time required to test and customize the DataRover 840 device for the
particular customer. If a customer decides not to purchase the DataRover 840
device, the Company may not have another opportunity to sell its handheld
devices to that customer for a number of years, if at all. For these and other
reasons, the Company expects its DataRover 840 device will have a lengthy sales
cycle during which the Company may expend substantial funds and significant
sales and technical effort. There can be no assurance that the Company's
expenditures or efforts during the lengthy sales process with any potential
customer will result in sales.
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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 markets 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 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.
The Company has entered into an OEM agreement with Oki Electric for the
manufacture of DataRover 840 devices. To the extent Oki Electric fails to timely
manufacture the DataRover devices or meet the Company's volume and quality
requirements and delivery schedules, which has occurred in the past, the
Company's business, operating results and financial condition could be
materially adversely affected. In addition, because the Company currently
depends solely on Oki Electric for the manufacture of its DataRover devices, in
the event Oki Electric were to become unwilling or unable to manufacture the
DataRover devices, the Company would be required to identify and qualify an
acceptable replacement. The process of qualifying another manufacturer could be
lengthy, and no assurance can be given that another manufacturer would be
available to the Company on a timely basis. Because Oki Electric is located in
Japan, the Company is also directly affected by the political and economic
conditions of this region and subject to the risks normally attendant to the
conduct of foreign trade, including fluctuations in currency exchange rates and
longer delivery times.
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
services and products that the Company offers will
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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 or DataRover 840 device 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 and DataRover 840 device 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 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 certain of its
products or 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 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.
20
<PAGE> 21
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, market acceptance for the Portico service 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 products and services, the Company may need to seek 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 products and 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
21
<PAGE> 22
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 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.
22
<PAGE> 23
GENERAL MAGIC, INC.
FORM 10-Q, June 30, 1998
Part II--Other Information
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Information with respect to this item is incorporated by reference to Part I
- - Item 1 - Notes 6 and 7 to the Condensed Consolidated Financial Statements of
this Quarterly Report on Form 10-Q. The securities issued by the Company in each
of the transactions described therein were not registered under the Securities
Act of 1933, as amended (the "1933 Act"), in reliance upon the exemptions
provided by Section 4(2) of the 1933 Act and/or Regulation D promulgated
thereunder for transactions by an issuer not involving a public offering.
ITEM 3. DEFAULTS UPON SENIOR SECURITUES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of the Stockholders of General Magic, Inc. was held on
June 25, 1998.
A proposal to elect the following (7) directors to hold office until the 1999
Annual Meeting and until their successors are elected and qualified was approved
by the stockholders. The proposal received the following votes:
<TABLE>
<CAPTION>
For Against
---------- -------
<S> <C> <C>
Steven Markman 26,944,127 87,642
Michael E. Kalogris 26,947,068 84,701
Philip D. Knell 26,942,270 89,499
Carl F. Pascarella 26,879,138 152,631
Roel Pieper 26,935,749 96,020
Dennis F. Strigl 26,946,882 84,887
Susan G. Swenson 26,940,055 91,714
</TABLE>
A proposal to increase by 4,850,000 shares the aggregate number of shares
issuable under the Company's Amended and Restated 1990 Stock Option Plan was
approved by the shareholders. The proposal received the following votes:
<TABLE>
<S> <C>
For: 11,452,409
Against: 2,935,856
Abstained: 113,151
</TABLE>
23
<PAGE> 24
A proposal to increase by 250,000 shares the aggregate number of shares issuable
under the Company's 1994 Outside Directors Stock Option Plan was approved by the
shareholders. The proposal received the following votes:
<TABLE>
<S> <C>
For: 12,771,784
Against: 864,206
Abstained: 1,185,998
</TABLE>
A proposal to ratify the sale and issuance of the Company's 5-1/2 % Convertible
Series B Preferred Stock was approved by the shareholders. The proposal received
the following votes:
<TABLE>
<S> <C>
For: 12,743,582
Against: 1,611,418
Abstained: 146,416
</TABLE>
In addition, the stockholders ratified the appointment of KPMG Peat Marwick LLP
as the independent auditor of the Company for the fiscal year ending December
31, 1998. This proposal received the following votes:
<TABLE>
<S> <C>
For: 26,888,608
Against: 69,968
Abstained: 73,193
</TABLE>
Abstentions and broker non-votes are included in the determination of the number
of shares present and voting for purposes of determining the presence of a
quorum at the Company's annual meeting of stockholders. They are not, however,
counted for purposes of determining the number of votes cast for a proposal.
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) A report on Form 8-K was filed on June 29, 1998, to report under Item 5,
Other Events, a private placement of the Company's securities.
24
<PAGE> 25
GENERAL MAGIC, INC.
FORM 10-Q, June 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: August 14, 1998 /s/ STEVEN MARKMAN
-----------------------------------------
Name: Steven Markman
Title: Chairman and Chief
Executive Officer
(Principal Executive Officer)
DATE: August 14, 1998 /s/ JAMES P. MCCORMICK
-----------------------------------------
Name: James P. McCormick
Title: Chief Financial Officer
(Principal Financial and
Accounting Officer)
25
<PAGE> 26
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
26
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 40,042
<SECURITIES> 17,501
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 59,609
<PP&E> 14,034
<DEPRECIATION> 8,301
<TOTAL-ASSETS> 67,089
<CURRENT-LIABILITIES> 10,178
<BONDS> 6,353
46,406
0
<COMMON> 30
<OTHER-SE> 2,122
<TOTAL-LIABILITY-AND-EQUITY> 67,089
<SALES> 0
<TOTAL-REVENUES> 1,786
<CGS> 0
<TOTAL-COSTS> 198
<OTHER-EXPENSES> 20,534
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 256
<INCOME-PRETAX> (13,741)
<INCOME-TAX> 19
<INCOME-CONTINUING> (13,760)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (13,760)
<EPS-PRIMARY> (1.26)
<EPS-DILUTED> (1.26)
</TABLE>
