GENERAL MAGIC INC, 10-K, 1998-03-31

GENERAL MAGIC INC
10-K, 1998-03-31
PREPACKAGED SOFTWARE

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------

FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

[ ] 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: 0-25374

GENERAL MAGIC, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

<TABLE>
<S> <C>
DELAWARE 77-0250147
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
</TABLE>

420 NORTH MARY AVENUE, SUNNYVALE, CALIFORNIA 94086
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

(408) 774-4000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

<TABLE>
<CAPTION>
TITLE OF EACH CLASS NAME OF EXCHANGE ON WHICH REGISTERED
------------------- ------------------------------------
<S> <C>
None None
</TABLE>

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.001 PAR VALUE
(TITLE OF CLASS)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]

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

The aggregate market value of registrant's voting stock held by
nonaffiliates of registrant, based upon the closing sale price of the common
stock on February 27, 1998, as reported on the Nasdaq National Market, was
approximately $56,245,541. Shares of common stock held by each officer, director
and holder of 5% or more of the outstanding common stock have been excluded in
that such persons may be deemed to be affiliates. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.

Outstanding shares of registrant's common stock, $.001 par value, as of
February 27, 1998: 26,927,886

DOCUMENTS INCORPORATED BY REFERENCE

Parts of the definitive Proxy Statement for registrant's 1998 Annual
Meeting of Stockholders to be filed with the Commission pursuant to Regulation
14A not later than 120 days after the end of the fiscal year covered by this
Form are incorporated by reference into Part III of this Form 10-K Report.

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PART I

This report includes a number of forward-looking statements. Such
statements reflect the Company's current views with respect to future events and
financial performance and are subject to risks and uncertainties that could
cause the Company's actual results and financial position to differ materially.
These factors include, but are not limited to, the Company's ability to
successfully execute its new business strategy; the risks inherent in the
development and delivery of complex technologies; the emergence of new markets
for the Company's products and services, and the Company's ability to compete in
those markets; the Company's dependence on the establishment of distribution
arrangements and other strategic partnerships; the Company's limited financial
resources; and the Company's ability to attract, retain and motivate qualified
personnel. A further discussion of these and other risk factors is contained in
"Item 7 -- Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Risk Factors" and elsewhere in this report.

ITEM 1. BUSINESS

COMPANY

General Magic, Inc. (the "Company") develops and markets integrated voice
and data applications. The Company is currently developing an advanced network
service, code-named Serengeti, to meet the communication and information
management requirements of today's mobile professionals. The advanced network
service will allow subscribers to access and respond to information important to
their success, either through a highly developed voice user interface or a
leading Web browser. Among other things, the service is expected to (i) manage
the subscriber's inbound and outbound calls; (ii) collect and consolidate the
subscriber's email, and notify the subscriber upon receipt of priority messages;
(iii) maintain the subscriber's calendar, address book and task list; (iv)
collect and forward stock quotes, news and selected public information based on
subscriber preferences; and (v) retrieve 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-access
and communication needs of mobile workers in the health care, utilities and
transportation industries.

The Company's current business strategy was announced early in 1997. In
prior years, the Company had developed and licensed two platform technologies,
Magic Cap and Telescript. Magic Cap is an integrated communication applications
platform, initially designed for handheld communication devices. Telescript was
the first implementation of the Company's patented agent technology. It was
comprised of two significant components: a programming language that enabled the
creation of agents, and a virtual machine that executed agents and transported
them from one device to another over a network. The Company initially licensed
its Magic Cap and Telescript platform technologies to multinational consumer
electronics companies and to telecommunications network operators. The consumer
market for handheld communication devices was slow to develop, however, and the
Company did not generate significant royalty revenues in connection with its
licensing efforts. In addition, the Internet emerged as the public data
communications network of choice, significantly reducing the market opportunity
for the proprietary Telescript platform.

During this period, demand for products and services that address the
communication and information management needs of an increasingly mobile society
rapidly expanded as evidenced by the proliferation of electronic devices and the
explosive growth of the Internet, corporate intranets and network services.
Advances in wireless telecommunication technologies enabled the growth of paging
and cellular telephone networks. Devices such as notebook and subnotebook
computers with modems (both wireline and wireless) allowed mobile professionals
to connect to their PCs from almost any location, as well as to access on-line
information and electronic mail services while traveling worldwide. In response
to the growing demand of users for a single resource to access and manage
communication and information, the Company adopted its new business strategy
designed to establish the Company as a leading provider of integrated voice and
data applications. The Company is developing the Serengeti service to provide a,
single, easy-to-use, cost-effective solution to mobile professionals who need to
access, sort through and respond to a multitude of messages, manage their
business information, and obtain relevant news and other information on demand.

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The Company was incorporated in California in May 1990 and was reorganized
as a Delaware corporation in February 1995. This Form 10-K contains trademarks
of General Magic and other companies.

STRATEGY

The Company's goal is to become a leading provider of integrated voice and
data applications for the mobile user community. The Company's strategy for
achieving that goal includes the following key elements:

Launch Advanced Network Service. The Company intends to commercially launch
its Serengeti service in the middle of 1998. This advanced network service is
designed as a second generation virtual assistant for today's mobile
professionals, allowing them to access and manage their information through the
most natural interface known -- their own words. The advanced network service
will be supported by network operations centers, the first of which is located
in the Company's Sunnyvale, California, office and is designed to serve more
than 100,000 subscribers. The network operations centers will feature a
high-availability architecture and built-in fault tolerance to ensure maximum
uptime to users.

Embrace Standard Devices, Applications and Technologies. The Company
believes that by embracing devices and applications commonly used by mobile
professionals, and by incorporating industry standard technologies, the
Serengeti service will offer ready access and greater functionality and service
to a broader potential subscriber base. The Serengeti service will be accessible
from any phone or via the current versions of leading Web browsers. The Company
also expects the Serengeti service to synchronize with popular desktop
information managers such as Microsoft Outlook, Microsoft Schedule+, Lotus
Organizer, Symantec ACT! and Starfish Sidekick, as well as Windows CE-based
devices and the PalmPilot. In addition, the architecture of the Serengeti
service is based on recognized industry standards that will enable the Company
to incorporate next generation features and technologies as they are developed.

Build Subscriber Base. As it readies the Serengeti service for commercial
launch later this year, the Company is pursuing a number of efforts to build its
subscriber base. The Company is engaged in discussions with cellular carriers,
enhanced telecommunication service resellers, telecommunication companies,
wireless data service providers, portable device manufacturers and Internet
service providers for the distribution of its advanced network service. The
Company believes that its network operations center model will be appealing to
these potential channel partners because it minimizes the capital investment
required of them or their customers. In addition, the Company is executing a
marketing strategy intended to create awareness of and preference for the
Serengeti service among potential channel partners and subscribers.

Develop Enhancements to the Advanced Network Service. To ensure that the
Serengeti service offers subscribers the latest available features and
functions, the Company actively seeks to independently develop enhancements and
to establish strategic relationships with technology developers and providers.
The Company is currently extending its patented agent technology for application
in the Serengeti service. In addition, in 1997, the Company entered into
strategic relationships with AcuVoice, Inc. ("AcuVoice"), Alpha Microsystems,
Inc. ("Alpha Microsystems"), Ensemble Information Systems ("Ensemble") and
Starfish Software, Inc. to enhance the functionality of its advanced network
service. The Company will continue to pursue such relationships in order to
expand and improve the Serengeti service on an ongoing basis.

Penetrate Additional Markets. The Company is engaged in product marketing
and research and development efforts to identify and penetrate additional
markets for its Serengeti service. Currently, the Company is prototyping new
communication devices to extend the reach of the Serengeti service to other
markets, including the consumer and enterprise markets. The prototypes are based
on Internet standards and employ an advanced standards-based version of the
Magic Cap platform technology initially developed for handheld communication
devices.

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SERVICES, PRODUCTS AND COMPETITION

THE SERENGETI NETWORK SERVICE

Overview

The Company's Serengeti service is a second generation virtual assistant
for today's mobile professionals that will allow them to access and manage their
key information through the most natural interface known -- their own words. The
first release of the service is expected, among other things, to (i) manage the
subscriber's inbound and outbound calls; (ii) collect and consolidate the
subscriber's email, and notify the subscriber upon receipt of priority messages;
(iii) maintain the subscriber's calendar, address book and task list; (iv)
collect and forward stock quotes, news and selected public information based on
subscriber preferences; and (v) retrieve press releases and other news and
information concerning thousands of publicly traded companies. The Serengeti
service will be supported by network operations centers, the first of which is
located in the Company's Sunnyvale, California, office and is designed to serve
more than 100,000 subscribers.

The Company has performed internal and external tests of the Serengeti
service and anticipates further field tests in the second quarter of 1998. The
Company currently expects to make the Serengeti service commercially available
in the middle of 1998. The Company's success is dependent upon the results of
the field tests and commercial release of the Serengeti service. There can be no
assurance that the field tests will be successful. If such tests are not
successful, the Company will be required to attempt to enhance or modify the
Serengeti service. There can be no assurance that the Company will be able to
modify the Serengeti service so that positive field tests result. Even if the
field tests are successful, there can be no assurance that subscribers will be
satisfied with the operation or functionality of the Serengeti service. Failure
of the advanced network service to achieve market acceptance will have a
material adverse effect on the Company's business, financial condition and
operating results.

The Company believes that its Serengeti service will provide a single,
easy-to-use, cost-effective solution to mobile professionals who need to access,
sort through and respond to a multitude of messages, manage their business
information, and obtain relevant news and other information on demand. There can
be no assurance, however, that the Company will be able to develop the Serengeti
service it envisions, or that such service will be commercially successful at
any time in the future. The Company is subject to all of the risks inherent in
the establishment of a new business enterprise. The Company must, among other
things, establish technical feasibility and complete development of its advanced
network service, enter into strategic development and distribution arrangements,
respond to competitive developments, and attract, retain and motivate qualified
personnel. The failure to accomplish any of these objectives could have a
material adverse effect on the Company's business, operating results and
financial condition. See "Item 7 -- Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Risk Factors."

Accessing the Serengeti Service Via a Phone or Web Browser

The Serengeti service may be accessed either through a phone or the current
versions of leading Web browsers. By entering a subscriber ID and password,
subscribers to the Serengeti service will have access to, and control of,
messages delivered via a telephone and email. In addition, the subscriber will
be able to maintain an address book and calendar and to access other relevant
news and information. As a second generation virtual assistant, the Serengeti
service will feature a highly developed natural language voice user interface
("VUI"). The VUI is designed to act on plain English instructions, rather than
requiring the subscriber to memorize specific commands or follow lengthy menus.

Integrating and Managing Telephone, Email, Fax and Paging Communications

The Serengeti service will manage both inbound and outbound calls. The
advanced network service will answer inbound calls to subscribers and either
allow the caller to leave a message or, if a subscriber has so elected, route
the call to different phone numbers in an effort to locate the subscriber. If
the caller leaves a message, the subscriber can later retrieve the message and,
if desired, verbally instruct the virtual assistant to return the call. In
addition, the Serengeti service will be able to collect email messages from one
or multiple email accounts, read the email to the subscriber utilizing
text-to-speech technology licensed from AcuVoice,
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and enable the subscriber to respond to the email by return email, or by calling
the sender. The subscriber can also set parameters so that only emails from
known contacts or with certain key words are collected. The Serengeti service is
also expected to enable subscribers to send and obtain faxes and to page them
based on parameters set by subscribers.

A Business Information Manager

Like a personal assistant, the Serengeti service will maintain the
subscriber's address book and calendar. The Serengeti service is expected to
synchronize with such popular desktop information managers as Microsoft Outlook,
Microsoft Schedule+, Lotus Organizer, Symantec ACT! and Starfish Sidekick, as
well as Windows CE-based devices and the PalmPilot. The Company is also
designing Serengeti based on technology from Ensemble that allows subscribers to
set their preferences for news and information that may be read, emailed or
faxed to them. The Serengeti service will also retrieve on demand news and
information concerning thousands of publicly traded companies. In addition, the
Company has licensed technology from Alpha Microsystems that will allow
subscribers to retrieve stock prices, to track their portfolio, and to receive
notification of changes in the prices of portfolio stocks based on preferences
established by the subscriber.

Network Operations Centers

Construction of the first of the Company's network operations centers was
completed in the fourth quarter of 1997. The center features a high availability
architecture and a fault-tolerant ATM network backbone running Pentium II-based
Windows NT-equipped computers. The center has been designed based on industry
standards in order to allow the Company to optimize the configuration of the
Serengeti service on an ongoing basis, and to incorporate next generation
features and technologies as they are developed. The Company believes that the
network operations center model will differentiate the Serengeti service from
the offerings of its competitors by minimizing any capital investment required
of potential channel partners or their customers.

Customer Service and Support

The Company believes that a high level of customer service and support is
important to the success of the Serengeti service. The Company has established a
customer service department that will be responsible for educating, enrolling
and assisting subscribers of the Serengeti service and, in consultation with the
Company's technical support personnel, resolving any technical difficulty
subscribers may have in using the service. The Company currently anticipates
that its customer service department will be staffed 24 hours a day, seven days
a week, and will be accessible by a toll-free call or over the Web. In addition,
the Company expects that all members of its customer service department will be
trained in all aspects of customer service in order to enable them to respond to
any service-related question a subscriber may have. There can be no assurance
that the Company's customer service and support will satisfy the requirements of
its subscribers. The Company's failure to adequately service and support its
customers could have a material adverse effect on the Company's business,
operating results and financial condition.

Competition

Competition in network services for communication and information
management is intense, rapidly evolving and subject to rapid technological
change. The Company expects competition to increase in the future. Many of the
Company's current and potential competitors have longer operating histories,
greater name recognition, established customer bases and substantially greater
financial, personnel, marketing, engineering, technical and other resources than
the Company. Such competition could have a material adverse effect on the
Company's business, operating results and financial condition.

The Company believes it has a competitive advantage because it will be one
of the first to offer an advanced network service to address the communication
and information management needs of mobile professionals. The Company also
believes that its network operations center model will distinguish the Serengeti
service from the offerings of its competitors by minimizing the capital
investment required of its

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potential channel partners or their customers. The Company is engaged through
its direct sales and business development team in discussions with cellular
carriers, enhanced telecommunication service resellers, telecommunication
companies, wireless data service providers, portable device manufacturers and
Internet service providers. The Company believes that the principal competitive
factors affecting the market for network services for communication and
information management are price, performance, quality and functionality. The
Company believes that it will be able to compete effectively in these areas.

Other companies currently offer some of the functionality that the Company
expects its Serengeti service will provide. For example, the call forwarding and
voice mailbox features of the Company's Serengeti service are offered by
companies such as AT&T Corp., MCI Communications Corporation and Sprint
Corporation, as well as the regional telephone operating companies and other
independent voice mail vendors. The electronic mail reading feature of the
Serengeti service is provided by such companies as Intellivoice Communications,
Inc., Premiere Technologies Inc., Webley Systems, Inc. and Wildfire
Communications, Inc. While the Company is not currently aware of any major
competitor that offers or is attempting to offer a service identical to the
Serengeti service being developed by the Company, many of the Company's
competitors and potential competitors have substantial resources and technical
expertise and could likely develop such a service. The Company believes that
existing competitors such as the regional telephone operating companies may
extend their service offerings to compete with the Company's Serengeti service.
In addition, software developers such as Microsoft Corporation and Oracle
Corporation, and voicemail hardware, software and service providers such as
AccessLine Technologies, Inc., Call Sciences Ltd., Centigram Communications
Corporation, Intellivoice Communications, Inc., International Business Machines
Corporation, Lucent Technologies, Inc., Premiere Technologies Inc., Wildfire
Communications, Inc. and others may extend the capability of their offerings to
include many, if not all, of the features being developed for the Company's
advanced network service. On-line service providers and Internet service
providers such as America Online, Inc. may enhance their services to compete
with the Company's advanced network service. Such increased competition could
have a material adverse effect on the Company's business, operating results and
financial condition. See "Item 7 -- Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Risk Factors -- Competition."

THE DATAROVER PRODUCTS

Overview

In February 1998, the Company commercially released its DataRover 840
device, the first of a family of handheld devices designed to meet the
data-access and communication needs of mobile workers in the health care,
utilities and transportation industries. The DataRover 840 is based on the
Company's Magic Cap technology, which provides a complete communication
applications platform for the development of applications customized for the
Company's targeted markets. In addition, the DataRover 840 features an
innovative user interface that allows mobile workers to adopt and use the device
with a minimum of training and support. The DataRover 840 is compatible with
industry standard communication protocols, which permit transmission, access and
retrieval of key information from the Internet or corporate intranets while in
the field. The DataRover 840 is distinguished by its easy-to-use tablet design,
and is lightweight, portable and durable.

The Company has also introduced the DataRover Remote Access Kit, a rapid
application development tool. This tool, which the Company expects to be
commercially available in the second quarter of 1998, will enable the rapid
development of custom forms-based mobile data access applications in a
Windows-based environment. The Company believes that applications created with
the DataRover Remote Access Kit will interact with a variety of network database
applications from companies such as Informix Corporation, Microsoft Corporation,
Oracle Corporation and Sybase, Inc.

In August 1997, the Company entered into an OEM arrangement with Oki
Electric Industry Co., Ltd. ("Oki Electric") for the manufacture of DataRover
840 devices. Under the terms of the Agreement, Oki Electric is obligated to
supply DataRover 840 devices to the Company for at least the next twelve (12)
months. 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. See,
also, Note 10 to the Company's Consolidated Financial Statements.
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The Company maintains a direct sales force at its Sunnyvale, California,
headquarters to sell the DataRover 840 device. There can be no assurance that
the DataRover 840 will gain market acceptance. Failure of the product to gain
market acceptance, or any delay in acceptance, could have a material adverse
effect on the Company's business, operating results and financial condition. See
"Item 7 -- Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Risk Factors."

Competition

Competition in handheld communication devices is intense and acutely
influenced by advances in technology, product improvements, new product
introductions, and price competition. The Company competes principally on the
basis of price, performance, quality, and functionality, including ease of use
and communication and customization capabilities. With its DataRover line of
products, the Company faces competition from companies that offer operating
system software for handheld communication devices, including Microsoft
Corporation. In addition, the Company's DataRover products compete with certain
existing solutions in the field service market. Principal competitors include
Fujitsu Limited, Intermec Technologies Corporation, Symbol Technologies, Inc.,
Telxon Corporation and other companies, such as CASIO Computer Co., Ltd. and
Philips Electronics N.V., that manufacture and sell Windows CE-based devices.
Many of these firms have far greater financial, marketing and technical
resources than the Company. There can be no assurance that the Company's
DataRover products will achieve sufficient cost-effectiveness, performance,
quality or functionality to compete with existing or future alternatives.
Failure of the DataRover products to successfully compete with existing and
future handheld devices could have a material adverse effect on the Company's
business, operating results and financial condition. See "Item 7 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Risk
Factors -- Competition."

RESEARCH AND DEVELOPMENT

Since its inception, the Company has made substantial investments in
research and development. The Company believes that its future performance will
depend in large part on its ability to maintain and enhance the features and
functionality of its advanced network service, including its network operations
centers, and to develop additional services and products that achieve market
acceptance, maintain technological competitiveness and meet an expanding range
of customer requirements.

The Company's total expenses for research and development for the years
ended December 31, 1997, 1996 and 1995 were $20.5 million, $23.0 million and
$19.3 million, respectively. The Company expects that it will continue to invest
substantial funds in research and development activities. A current project
involves prototyping new communication devices to extend the reach of the
Serengeti service. The Company is also extending its patented agent technology
for application in the Serengeti service. There can be no assurance that the
Company will develop and commercially release the Serengeti service, new
DataRover products, enhancements to these offerings, or other new products and
services in a timely or cost-effective manner. To the extent the Company's
development efforts are not successful, the Company's business, operating
results and financial condition will be materially adversely affected.

MARKETING

The Company's marketing activities consist primarily of product marketing,
marketing programs, interactive marketing and corporate communications. The
Company's product marketing activities include market research, product and
service definition and strategy, and strategic partnering and business
development efforts. The Company's marketing programs, interactive marketing and
corporate communications activities are intended to establish the corporate
identity of the Company and its brands and create awareness of and preference
for the Serengeti service among potential channel partners and subscribers.
Marketing program activities include the preparation of corporate brochures,
pamphlets, videos and other educational materials in support of conferences,
trade shows, marketing programs and the distribution channels; interactive
marketing activities include the design, development and deployment of the
Company's Web site; and corporate communications activities include press
communications and public relations.

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The Company has increased its marketing staff in anticipation of the
commercial release of the Serengeti service and the DataRover products, and
expects that a further increase will be necessary. Competition for such
personnel is intense and there can be no assurance that the Company will be able
to attract, assimilate or retain such personnel. Failure of the Company to hire
and train qualified marketing personnel on a timely basis in the future may have
a material adverse effect on the Company's business, operating results and
financial condition. See "Item 7 -- Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Risk Factors -- Personnel."

PROPRIETARY RIGHTS AND LICENSES

The Company's success will depend in part on its ability to obtain and
enforce intellectual property protection for its technology in both the United
States and other countries. In February 1997, the United States Patent and
Trademark Office ("PTO") issued the Company a pioneering patent with respect to
its agent technology. The Company has filed counterpart patent applications in
Canada, Europe and Japan. Also in 1997, the PTO issued the Company three patents
regarding certain features of the Magic Cap operating system software, and a
fourth with respect to a component of the Magic Cap hardware reference design.
There can be no assurance that the patent laws will provide effective legal or
injunctive remedies to stop any infringement of these patents, or that the
patents will not be challenged, invalidated or circumvented. Also, there can be
no assurance that the rights granted under these patents will provide
competitive advantages to the Company, or that the Company's competitors will
not independently develop or patent technologies that are substantially
equivalent to or superior to the Company's technology.

The Company has also filed with the PTO eight patent applications, three of
which have been allowed but not yet granted. One of these applications relates
to the Company's agent technology, and the balance relate to certain features or
components of the Magic Cap operating system software or the Magic Cap hardware
reference design. No assurance can be given that the Company's pending patent
applications will result in the issuance of patents, or that any patents will
provide competitive advantages to the Company or will not be invalidated or
circumvented by competitors.

The Company relies in part on copyright laws to prevent unauthorized
duplication of its software and documentation. The Company has not sought
protection of its semiconductor designs under the mask work rights laws, but may
do so in the future. However, existing copyright and mask work laws afford only
limited protection, especially in certain jurisdictions outside the United
States where the Company may license its technology, or sell products or
services incorporating its technology. Unauthorized parties may copy the
Company's technologies or reverse engineer or otherwise obtain and use
information that the Company regards as proprietary. Moreover, the protection
provided to the Company's proprietary technology by the laws and courts of
foreign nations against piracy and infringement will not, in all cases, be
substantially similar to the remedies available under U.S. law.

The Company also relies on certain software that it currently licenses and
will license from third parties, including software that will be integrated with
internally developed software and used in the Company's advanced network service
to perform key functions. There can be no assurance that such third parties will
remain in business, that they will develop or support their technology or that
third party technology will be available to the Company in the future on
commercially reasonable terms. The inability to secure and maintain these
software licenses could result in delays or cancellations in the development or
deployment of the Company's advanced network service. Any such delay or
cancellation could materially adversely affect the Company's business, operating
results and financial condition.

From time to time, the Company has received communications from third
parties claiming that features or content of certain of its products, services
and/or technologies may infringe intellectual property rights of such parties.
It is the Company's practice to review all such claims and determine if a
license is appropriate. To date, no such claim has resulted in litigation
against the Company. However, if litigation were to be commenced against the
Company, the asserting parties are likely to claim damages and/or seek to enjoin
commercial activities relating to the Company's technology or products affected
by such parties' rights. There can be no assurance that any infringement or
indemnification claims will not be made against the Company in

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the future. Any such claims could be costly and a diversion of management's
attention, which alone could have a material adverse effect on the Company's
business, results of operations and financial condition. Adverse determinations
in any such dispute could result in the loss of the Company's proprietary
rights, subject the Company to significant liabilities, require the Company to
seek licenses from third parties or enjoin the Company's commercial activities,
any of which could have a material adverse effect on the Company's business,
financial condition and results of operations.

YEAR 2000 COMPLIANCE

Based on a preliminary study, the Company does not expect that its costs
for the conversion of computer information systems to enable proper processing
of transactions relating to the year 2000 and beyond will be material. The
Company continues to evaluate appropriate courses of corrective action. The
Company does not expect any amounts that it may be required to expense over the
next two years will have a material adverse effect on its business, financial
position or results of operations. However, there can be no assurance that the
systems of other companies on which the Company's systems rely will be timely
converted or that any such failure to convert by another company would not have
a material adverse effect on the Company's systems. See "Item 7 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Risk
Factors -- Year 2000 Compliance."

EMPLOYEES

As of December 31, 1997, the Company had 130 full-time employees, of whom
77 were primarily engaged in engineering, 5 in customer service and support and
48 in sales, general and administrative. The Company has experienced no work
stoppages and believes that its employee relations are good. Competition for
employees in the computer and software industries is intense. The Company
believes that its future success will depend, in part, on its ability to
continue to attract, assimilate and retain highly skilled technical, sales,
marketing and management personnel. See "Item 7 -- Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Risk
Factors -- Limited Resources, -- Personnel."

EXECUTIVE OFFICERS OF THE REGISTRANT

As of February 27, 1998, the executive officers of the Company, who are
elected by and serve at the discretion of the Board of Directors, were as
follows:

<TABLE>
<CAPTION>
NAME POSITION WITH THE COMPANY AGE EMPLOYED SINCE
---- ------------------------- --- --------------
<S> <C> <C> <C>
Steven Markman, Ph.D. ... Chairman, Chief Executive Officer and President 52 September 1996
Mary E. Doyle............ Vice President of Business Affairs, General 45 July 1996
Counsel and Secretary
Linda A. Hayes........... Vice President of Marketing 56 September 1997
James P. McCormick....... Vice President of Finance and Administration, 39 June 1997
and Chief Financial Officer
Elena M. Morera.......... Vice President of Human Resources 46 July 1996
Steven D. Schramm........ Vice President and General Manager, 38 March 1992
Communication Products Division
Kevin J. Surace.......... Vice President and General Manager, Products 35 November 1996
and Network Solutions Division
</TABLE>

STEVEN MARKMAN joined the Company as Chairman, Chief Executive Officer and
President in September 1996. Prior to joining the Company, Dr. Markman served
Novell, Inc. as executive vice president and general manager of the Products
Group from January 1996 to September 1996, and as the executive vice president
and general manager of the Information Access and Management Group from August
1994 until January 1996. Dr. Markman was vice president of engineering at First
Pacific Networks from March 1994 to August 1994, and was a principal at Venture
Consulting from September 1993 through March 1994. From February 1993 to May
1993, Dr. Markman was acting Chief Executive Officer of Adaptive Corporation,
which was merged with Network Equipment Technologies ("NET") in May 1993. Dr.
Markman served as

8
<PAGE> 10

senior vice president and general manager of the Network Systems Group of NET
from April 1991 to May 1993. Dr. Markman holds a B.S. and a M.S. in Electrical
Engineering and Electrophysics, respectively, from the Polytechnic Institute of
Brooklyn. He also received a Ph.D. in Electrophysics from the Polytechnic
Institute of New York.

MARY E. DOYLE joined the Company in July 1996 as General Counsel and
Secretary, and has served as its Vice President of Business Affairs since
January 1997. Before joining the Company, Ms. Doyle served Teledyne, Inc. as
general counsel of the Aerospace and Electronics segment from January 1995
through July 1996, as Assistant General Counsel from 1990 through 1994, and as
Counsel from 1984 through 1989. Ms. Doyle received an A.B. in Biology and
Economics from the University of California, Santa Cruz, and a J.D. from the
University of California, Berkeley.

LINDA A. HAYES joined the Company in September 1997 as Vice President of
Marketing. Ms. Hayes was Vice President of Marketing for Pretty Good Privacy,
Inc. ("PGP") from August 1996 to September 1997. Prior to joining PGP, she
served as Vice President of Marketing at Novell, Inc. from September 1995 to
August 1996. Ms. Hayes was Vice President of Marketing Communications Worldwide
for Zenith Data Systems from January 1993 to September 1995. Previously, from
January 1987 to January 1993, Ms. Hayes held a variety of management positions
at Motorola Inc. in worldwide marketing communications and public relations. Ms.
Hayes holds an A.B. in English from Kansas State University, and has completed
the Corporate Communications Program at Northwestern University's Kellogg
Graduate School.

JAMES P. MCCORMICK joined the Company in June 1997 as Vice President of
Finance and Administration and Chief Financial Officer. From September 1996 to
June 1997, Mr. McCormick was Vice President of Finance and Administration and
Chief Financial Officer for UB Networks ("UB"), and from July 1994 through
September 1995, he served first as Director and then as Group Director of
Financial Planning and Analysis for UB. Before joining UB, Mr. McCormick worked
with Tandem Computers in a variety of management capacities from July 1989
through May 1994, most recently as Senior Finance Manager for Revenue
Forecasting and Planning. Mr. McCormick received his B.S. in Business
Administration (Accounting) from the University of Toledo, and his M.B.A. from
the University of Michigan.

ELENA M. MORERA joined the Company in July 1996 as Vice President of Human
Resources. Before joining the Company, Ms. Morera served as vice president of
human resources for Scantron Corporation from July 1992 to July 1996.
Previously, Ms. Morera was manager of employment and employee relations for
Calcomp, Inc. from April 1988 through July 1992. Ms. Morera holds a B.S. in
Education from Florida International University, and earned her M.A. in
Management from the Claremont Graduate School.

STEVEN D. SCHRAMM has served as Vice President and General Manager of the
Company's Communication Products Division since June 1996. He served as Vice
President and General Manager of the Company's Magic Cap Division from September
1995 to June 1996. From September 1994 to September 1995, Mr. Schramm served as
Vice President, Engineering, and from March 1992 to September 1994, as Director
of Communication Engineering of the Company. Before joining the Company, Mr.
Schramm served as a program manager at Teknekron Communication Systems, from
January 1990 to March 1992, where he led the development of network management
systems. Mr. Schramm holds a B.S. in Mathematical Sciences from Stanford
University.

KEVIN J. SURACE joined the Company in November 1996 as Vice President of
Telephony Solutions, and has served as its Vice President of Products and
Network Solutions since January 1997. From March 1996 until November 1996, Mr.
Surace was an independent executive consultant in the Internet, wireless,
software and telecommunications industries. From 1992 through 1996, he held
several positions with Air Communications, including president and chief
executive officer. Prior to joining Air Communications, Mr. Surace was director
of marketing and sales for Hestia Technologies from October 1989 through
September 1992. Mr. Surace earned his B.S. in Electrical Engineering Technology
from the Rochester Institute of Technology.

9
<PAGE> 11

ITEM 2. PROPERTIES

The Company's principal administrative, marketing, manufacturing and
research and development operations are located in a single building in
Sunnyvale, California. This facility consists of three floors, each comprising
approximately 39,000 square feet and is occupied under a lease that expires in
June 2002. In April 1997, the Company surrendered one floor of its Sunnyvale
facility, and terminated office leases in both Paris, France and Tokyo, Japan.

ITEM 3. LEGAL PROCEEDINGS

None.

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

None.

10
<PAGE> 12

PART II

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

The Company effected an initial public offering ("IPO") on February 9,
1995, with its Common Stock traded on the Nasdaq National Market under the
symbol "GMGC." As of December 31, 1997, there were 350 stockholders of record of
the Company's Common Stock. Because many of such shares are held by brokers and
other institutions on behalf of stockholders, the Company is unable to estimate
the total number of stockholders represented by these holders of record. The
following table sets forth, for the quarters indicated, the high and low bid
price per share of the Company's Common Stock for the last two fiscal years as
reported on the Nasdaq National Market:

<TABLE>
<CAPTION>
PRICE RANGE
-------------------
HIGH LOW
------ -----
<S> <C> <C>
CALENDAR 1997:
First Quarter........................................... $ 2.63 $1.00
Second Quarter.......................................... 2.06 0.94
Third Quarter........................................... 2.22 2.19
Fourth Quarter.......................................... 3.38 1.38

CALENDAR 1996:
First Quarter........................................... $11.75 $5.50
Second Quarter.......................................... 8.75 3.88
Third Quarter........................................... 7.38 3.50
Fourth Quarter.......................................... 4.25 2.06
</TABLE>

The Company has never paid cash dividends on its capital stock. The Company
currently expects that it will retain its future earnings for use in the
operation and expansion of its business and does not anticipate paying cash
dividends in the foreseeable future.

11
<PAGE> 13

ITEM 6. SELECTED FINANCIAL DATA

The following selected consolidated financial data is derived from the
Company's audited consolidated financial statements. This data should be read in
conjunction with Item 8, Consolidated Financial Statements and Supplementary
Data thereto, and with Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations.

<TABLE>
<CAPTION>
PERIOD FROM
YEARS ENDED DECEMBER 31, 5/1/90
---------------------------------------------------- (INCEPTION)
1997 1996 1995 1994 1993 TO 12/31/97
-------- -------- -------- -------- -------- -----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenue..................... $ 3,456 $ 5,917 $ 14,165 $ 2,500 $ -- $ 26,038
Research and development.......... 20,548 23,028 19,297 13,426 8,914 93,423
Selling, general and
administrative.................. 12,676 23,944 18,092 10,394 8,483 80,196
Write-off of acquired technology
and in-process research and
development..................... -- 1,542 -- -- -- 1,542
Restructuring..................... -- 3,170 -- -- -- 3,170
Loss from operations.............. (30,696) (48,527) (25,337) (21,320) (17,397) (158,094)
Net loss.......................... (28,384) (45,634) (20,619) (21,531) (17,441) (147,717)
Basic and diluted loss per
share........................... (1.06) (1.74) (0.84) (1.36) (1.11)
BALANCE SHEET DATA:
Total assets...................... $ 36,297 $ 75,936 $115,866 $ 45,891 $ 13,432
Deferred revenue, noncurrent...... 4,186 8,200 15,760 10,600 8,000
Long-term debt.................... 3,199 -- -- -- --
Other long-term liabilities....... 2,446 1,369 2,702 2,539 442
Redeemable convertible preferred
stock........................... -- -- -- -- 30,454
Total stockholders' equity
(deficit)....................... 17,298 45,462 89,092 24,929 (30,618)
</TABLE>

12
<PAGE> 14

ITEM 7. 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 7 and elsewhere in this Form 10-K 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 will allow
subscribers to access and respond to information important to their success,
either through a highly developed voice user interface or a leading Web browser.
Among other things, the service is expected to (i) manage the subscriber's
inbound and outbound calls; (ii) collect and consolidate the subscriber's email,
and notify the subscriber upon receipt of priority messages; (iii) maintain the
subscriber's calendar, address book and task list; (iv) collect and forward
stock quotes, news and selected public information based on subscriber
preferences; and (v) retrieve 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-access
and communication 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, establish technical feasibility and complete development of its advanced
network 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 users 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

The Company reported a net loss of $28.4 million, or $1.06 per share, for
the year ended December 31, 1997, compared to a net loss of $45.6 million, or
$1.74 per share, for the year ended December 31, 1996, and compared to a net
loss of $20.6 million, or $0.84 per share, in 1995.

TOTAL REVENUE

Total revenue was $3.5 million, $5.9 million and $14.2 million in 1997,
1996 and 1995, respectively. The Company's total revenue consists of license
fees for Magic Cap, Telescript and software modem technologies and other
revenue. Licensing revenue primarily represents revenue from nonrefundable
license fees for the Company's technologies. Other revenue represents fees
earned under customer specific engineering, maintenance and support services
contracts. Fees from customer-specific engineering projects were recognized
under the percentage-of-completion method based on achievement and acceptance of
milestones or performance of services, as applicable. Support and maintenance
fees were recognized over the period the service or maintenance was provided.

13
<PAGE> 15

The decrease in total revenue from 1996 to 1997 was due to a decline in
support services provided by the Company to licensees of its Magic Cap
technology. The decrease in total revenue from 1995 to 1996 was primarily due to
reduced licensing revenue resulting from a lack of demand for products
incorporating the Company's Magic Cap and Telescript technologies.

The Company anticipates an increase in total revenue in 1998 compared to
1997 due to the anticipated release of its advanced network service and the
release of the DataRover 840 device. There can be no assurance that the advanced
network service will be released on time or at all, or that either the advanced
network service or the DataRover 840 device will achieve market acceptance. To
the extent that either the advanced network service or the DataRover 840 device
does not achieve market acceptance, the Company's business, financial condition
and results of operations will be materially adversely affected.

COST OF OTHER REVENUE

Cost of other revenue, which consists primarily of personnel and equipment
costs, was $928,000, $2.8 million and $2.1 million in 1997, 1996 and 1995,
respectively. The decrease from 1996 to 1997 was due to a decline in support
services in 1997. The increase from 1995 to 1996 was due to increased costs
related to customer-specific services in 1996. Cost of revenue is expected to
increase in 1998 compared to 1997 as a result of the anticipated release of the
Company's advanced network service and the release of the DataRover 840 device.

RESEARCH AND DEVELOPMENT

Research and development expenses were $20.5 million, $23.0 million and
$19.3 million in 1997, 1996 and 1995, respectively. The decrease from 1996 to
1997 was primarily the result of savings attributed to reductions in headcount
and discretionary spending, partially offset by $1.1 million in one-time charges
for technology license fees related to the development of the Company's advanced
network service. The increase from 1995 to 1996 was primarily due to research
and development expenses incurred by the Company in connection with the
redirection of its product offerings for its Magic Cap and Telescript
technologies to the personal computing and Internet markets. To date, the
Company has expensed all software development costs as incurred.

The Company expects research and development expenses to increase in 1998
as compared to 1997 in connection the anticipated release of its advanced
network service and the release of the DataRover 840 device, as well as the
continued development of its products and services.

SELLING, GENERAL AND ADMINISTRATIVE

Selling, general and administrative expenses were $12.7 million, $23.9
million and $18.1 million in 1997, 1996 and 1995, respectively. The decrease
from 1996 to 1997 was primarily due to the implementation of the Company's 1996
restructuring plan, which resulted among other things in a decrease in headcount
and reduced sales and marketing programs. In addition, the Company closed its
sales offices in France and Japan during 1997. The increase from 1995 to 1996
was primarily due to additional marketing programs, expansion of the Company's
domestic and international sales effort, and increased staffing and facility
costs to support headcount growth prior to the Company's implementation of its
restructuring plan in the fourth quarter of 1996.

The Company expects that selling, general and administrative expenses will
increase in 1998 compared to 1997 as a result of the anticipated release of its
advanced network service and the release of the DataRover 840 device, as well as
the continued development of markets for its products and services.

WRITE-OFF OF ACQUIRED TECHNOLOGY AND IN-PROCESS RESEARCH AND DEVELOPMENT

In 1996, the Company recognized a one-time charge of $1.5 million. Included
in this charge was a $1.3 million writeoff of the purchase cost of acquired
software technology previously capitalized and $200,000 of in-process research
and development.

14
<PAGE> 16

RESTRUCTURING

In the fourth quarter of 1996, the Company announced and began to implement
a restructuring plan designed to reduce costs and achieve long-term
profitability in the Company's operations. Adoption of the restructuring plan
resulted in a charge of $3.2 million in 1996. From the inception of the plan
through 1997, the Company incurred cash expenditures of $2.4 million relating to
involuntary employee terminations, canceled and vacated leases, and contract
settlement costs. In addition, the Company incurred noncash expenditures of
$789,000 related to the disposal of office and computer equipment. No other
similar charge was taken in 1997, nor does the Company anticipate taking any
such charge in 1998.

TOTAL OTHER INCOME, NET

Total other income, net was $2.3 million, $3.0 million and $5.9 million in
1997, 1996 and 1995, respectively. Total other income, net consisted primarily
of interest income and expense. The decreases from 1996 to 1997, and from 1995
to 1996 were primarily due to the Company's declining cash, cash equivalent and
short-term investment balances. In addition, in 1996 the Company began accruing
for interest due under certain license agreements. Future interest income is
likely to decrease as cash equivalents and short-term investments are consumed
by the Company's normal operating requirements, unless the Company generates
additional cash.

INCOME TAXES

Income taxes were $17,000, $131,000 and $1.2 million in 1997, 1996 and
1995, respectively. Income taxes were related to foreign withholding taxes on
revenue generated from the Company's Japan-based customers.

As of December 31, 1997, the Company had cumulative federal net operating
losses of $136.4 million, which can be used to offset future income subject to
federal income taxes. The federal tax loss carryforwards will expire from 2006
through 2012. The Company has cumulative California net operating losses of
$63.5 million, which can be used to offset future income subject to California
income taxes. The California tax loss carryforwards will expire from 1998
through 2002.

As of December 31, 1997, foreign tax credits of $1.7 million were available
to reduce future federal income taxes. Foreign tax credit carryforwards expire
from 1999 through 2000.

As of December 31, 1997, unused research and development tax credits of
$4.4 million and $2.3 million were available to reduce future federal and
California income taxes, respectively. Federal credit carryforwards will expire
from 2007 through 2012; California credits will carry forward indefinitely.

LIQUIDITY AND CAPITAL RESOURCES

The Company's principal sources of liquidity are its cash, cash equivalents
and short-term investment balances that totaled $28.8 million as of December 31,
1997, down $39.1 million from $67.9 million as of December 31, 1996. The
decrease was primarily due to 1997 operating losses and capital expenditures, as
well as payment of obligations accrued by 1996, including costs associated with
commitments to Magic Cap licensees and restructuring costs.

In connection with the Company's initial strategy to promote its Magic Cap
and Telescript technologies, the Company entered into various contractual
arrangements with certain stockholders. Significantly all of the Company's total
revenue from May 1, 1990 (inception) through December 31, 1997, was generated
from such stockholders, or their affiliates.

Five companies, which became stockholders of the Company prior to 1993,
entered into license agreements to pay royalties for the Company's Magic Cap
technology. The agreements each provided for the payment of up to $2.5 million
in prepaid royalties by each licensee in the event that the Company met certain
technology development milestones. These prepayments were to be offset at a rate
of $0.50 for every dollar of royalties payable by the licensees upon shipments
of products incorporating the Company's technology. If the

15
<PAGE> 17

prepayments were not fully recouped by the fifth anniversary of the license
agreements (November 30, 1997), the licensees were each entitled to demand
repayment of the unrecouped amount plus interest.

In September 1996, the Company entered into an agreement with one of these
five Magic Cap licensees which, among other things, permitted the licensee to
recoup 100% of any royalties owed to the Company under a separate software modem
license agreement against the Magic Cap royalty prepayment, amended the Magic
Cap license agreement to provide for 100% recoupment of any royalties due
thereunder, extended the date for refund of unrecouped prepaid royalties to
November 2, 1999, and provided that no interest will be due upon any refund. As
a result of this new agreement, the unrecouped prepaid royalty of $2.2 million
remained in noncurrent deferred revenue as of December 31, 1997.

As of December 31, 1997, three of the remaining four companies had demanded
and received repayment of the unrecouped prepaid royalties, excluding a portion
of interest due. The obligations outstanding under the agreements with these
five companies as of December 31, 1997, totaled $3.3 million and was classified
in current liabilities.

Additionally, in 1994 and 1995, the Company entered into Magic Cap
technology license agreements with three other stockholders. These license
agreements each provided for the payment of a $2.5 million up front,
nonrefundable, nonrecoupable license fee. The agreements also provided for the
payment of up to $2.5 million in prepaid royalties, payable in installments upon
the Company's achievement of certain technology milestones. Failure to deliver
the technology milestones entitled each licensee to terminate its agreement and
obtain a refund of unrecouped prepaid royalties in two equal annual installments
of principal, plus interest from the date of termination, payable commencing one
year following termination of the agreement. During the fourth quarter of 1996,
each of the three licensees demanded delivery of the final milestone due under
the license agreements. The Company delivered the final milestone in January
1997.

In June 1997, the Company reached an agreement to resolve the claims of,
and terminate the license agreement with, one of these three licensees. In
consideration therefor, the Company agreed to refund the unrecouped prepaid
royalties of $1.5 million (previously classified as noncurrent deferred
revenue), waive any further payments otherwise due under the agreement
(including $500,000 classified in accounts receivable and noncurrent deferred
revenue), and grant a royalty-free license to certain software modem technology.
The $1.5 million refund is secured by a license in certain of the Company's
intellectual property, is non-interest bearing and is payable in August 1999. In
September 1997, the Company reached agreement with a second of the three
licensees providing for acceptance of the final milestone, subject to certain
conditions which were satisfied by the Company later that month. Pursuant to
this agreement, the Company waived payment of the final $500,000 installment of
the prepaid royalties and recognized $2.0 million in licensing revenue
previously classified as noncurrent deferred revenue. In October 1997, the
Company reached agreement with the third licensee, also providing for acceptance
of the final milestone. Pursuant to this agreement, the Company waived payment
of the final $500,000 installment of the prepaid royalties and agreed to refund
prepaid royalties not recouped by January 1, 2003, plus any accrued interest, on
or before December 31, 2003. As of December 31, 1997, the Company had $1.5
million classified in other long-term liabilities and $2.0 million classified in
noncurrent deferred revenue related to its remaining obligations under
agreements with these three licensees.

The following table is a summary of obligations for all of the Magic Cap
licensees (in thousands):

<TABLE>
<CAPTION>
NONCURRENT OTHER
ACCRUED DEFERRED LONG-TERM
LIABILITIES REVENUE LIABILITIES TOTAL
----------- ---------- ----------- -------
<S> <C> <C> <C> <C>
As of December 31, 1996............ $10,012 $8,200 $ -- $18,212
As of December 31, 1997............ 3,317 4,186 1,500 9,003
</TABLE>

There can be no assurance that any of the Company's licensees will continue
to develop products that incorporate the Company's Magic Cap technology.
Therefore, it is uncertain when prepaid royalties (currently classified as
noncurrent deferred revenue) will be recognized as licensing revenue or if they
will be fully recouped.

16
<PAGE> 18

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 obligation to Oki Electric for the purchase of these devices. The
Company has placed on deposit $3.3 million 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. As
of December 31, 1997, the Company's purchase commitment was $2.6 million due to
favorable changes in the exchange rate. Management continually assesses the
currency risk associated with this commitment, and may enter into agreements in
the future to mitigate this risk.

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 (8.75% as of December 31, 1997), and has a term of
forty months with interest only due in the first four months and principal and
interest due monthly thereafter. This loan is subject to certain financial
covenants measured on a monthly basis, and is secured by all of the assets of
the Company, including intellectual property. As of December 31, 1997, the
current and noncurrent portions of debt due under this loan were $801,000 and
$3.2 million, respectively.

On February 27, 1998, the Company entered into an agreement with Microsoft
Corporation. The terms of the agreement include an equity investment of
approximately 12% in the Company, and a license of certain Company technology in
return for a total of $6.0 million in cash.

On March 3, 1998, the Company entered into a private financing transaction
that provided $5.0 million in cash to the Company from the sale of convertible
preferred stock. As part of the transaction, the Company also issued five-year
warrants to purchase additional shares of common stock at a premium to the
common stock price as of the date of the private financing transaction. The
Company has the option to secure an additional $5.0 million in financing on
similar terms based on certain conditions, including share price, average
trading volume and total equity.

On March 6, 1998, the Company acquired all of the outstanding shares of
common and preferred stock of NetPhonic Communications, Inc. for $2.1 million,
comprised of $200,000 cash and 1,342,524 shares of newly-issued shares of the
Company's common stock. The acquisition will be accounted for under the purchase
method. The Company expects that a significant component of the purchase price
will be attributable to in-process research and development.

The Company expects that its cash, cash equivalents and short-term
investment balances of $28.8 million as of December 31, 1997, together with the
additional financing received in the first quarter of 1998, will be adequate to
fund the Company's operations for at least the next twelve months. However, the
Company will continue to evaluate additional sources of capital. The Company's
capital requirements will depend on many factors, including, but not limited to,
the market acceptance and competitive position of its new products and services;
the levels of promotion and advertising required to launch and market such
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 and 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 release and market acceptance of its
advanced network 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,
17
<PAGE> 19

financial condition and results of operations. In the event that the Company
raises additional equity financing, further dilution to investors in the Company
will result.

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-K, the following
factors should be considered carefully in evaluating the Company and its
business before purchasing 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, establish technical feasibility and complete development of its advanced
network 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 December 31, 1997, the Company had
an accumulated deficit of $147.7 million, with net losses of $28.4 million,
$45.6 million and $20.6 million for the years ended December 31, 1997, 1996 and
1995, 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 advanced network
service is expected to be released by the middle of the year. 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.

LIMITED RESOURCES

Building an advanced network service is a complex process that requires
significant engineering and financial resources. Among other things, to
implement its advanced network service, the Company must develop certain
technologies and license other technologies from third parties, establish
strategic distribution and development 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 develop and launch the
Company's advanced network 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 its advanced network
service may overwhelm the Company's limited staffs such that the Company is
unable to adequately respond to and satisfy customers' demand for the advanced
network service. The Company's failure to develop and launch its advanced
network service, or to respond to market
18
<PAGE> 20

demand for its advanced network service, will likely have a material adverse
effect on the Company's business, operating results and financial condition.

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 an advanced
network 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 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 advanced network 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 advanced network service prior
to releasing it, such tests may not accurately simulate actual use of the
service by customers. As a result, errors may be found in the advanced network
service after it is commercially released which may result in loss of or a delay
in market acceptance of the Company's advanced network 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
advanced network service and DataRover 840 devices. The Company believes that in
order to successfully market its advanced network service, it must, among other
things, enter into distribution arrangements with telephony providers such as
wireless and wireline carriers, as well as resellers, 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 advanced network
service. The failure of the Company to establish and then successfully maintain
distribution relationships for its advanced network service will have a material
adverse effect on the Company's business, operating results and financial
condition.

The Company plans to distribute its DataRover family of products 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 one VAR, the Fuld Institute for
Technology in Nursing Education. 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 products. 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 devices 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 device for the particular
customer. If a customer decides not to purchase the DataRover devices, 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 products will have a lengthy sales cycle during
which the Company may expend substantial funds and significant sales and
technical effort.
19
<PAGE> 21

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.

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 an advanced network 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 advanced network 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 advanced network service will develop, or that it will not
develop more slowly than expected or 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 service will develop, or that the Company's
service will be adopted. If the market fails to develop, develops more slowly
than expected or attracts new competitors, or if the Company's advanced network
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 advanced network 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. A third party's failure to timely develop or
license the software technology, or the occurrence of errors in such technology,
could prevent or delay introduction or market acceptance of the Company's
advanced network service, which could have a material adverse effect on the
Company's business, operating results and financial condition.

With respect to its DataRover devices, 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 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 advanced network service or DataRover devices 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 services and products are the availability of the Company's products
and services; the quality, performance and functionality of the advanced network
service and DataRover
20
<PAGE> 22

products 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. Any such event may have a material adverse effect on the Company's
business, operating results and financial conditions.

POTENTIAL SECURITY ISSUES

The implementation of the advanced network service poses several security
issues, including the possibility of break-ins and other similar disruptions.
The Company intends to incorporate authentication, encryption and other security
technologies in its advanced network service. However, there can be no assurance
that such technology 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 advanced network service, including the Internet, telephones, cellular
phones and other wireless devices, may compromise the security of the
confidential electronic information accessed from the advanced network service.
There can be no assurance that the Company will be able to provide a safe and
secure advanced network service. The Company's failure to provide a secure
advanced network 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 that will be
incorporated into its advanced network 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
advanced network service or licensed technology incorporated into such service
or in the mediums by which subscribers access the advanced network service. Any
security problems in the advanced network 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 users of the advanced network
service and may cause interruptions or delays in the development and completion
of, or the cessation of, the Company's advanced network service. Any such
expenditures, lawsuits, reduction of users, interruptions or delays in the
development and commercial release of the advanced network 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 and engineering 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

21
<PAGE> 23

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.

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
embodying new technologies and the emergence of new industry standards could
render the Company's products and services obsolete and unmarketable. The
Company's future success will depend upon its ability to timely develop and
introduce new products and services, including the advanced network service, 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.

YEAR 2000 COMPLIANCE

The Company uses a significant number of computer software programs and
operating systems in its internal operations, including applications used in
financial business systems and various administration functions. To the extent
that these software applications contain source code that is unable to
appropriately interpret the upcoming calendar year "2000," some level of
modification or even replacement of such source code or applications will be
necessary. The Company is in the process of identifying the software
applications that are not "Year 2000" compliant. Given the information known at
this time about the Company's systems, coupled with the Company's ongoing
efforts to upgrade or replace business critical systems as necessary, it is
currently not anticipated that these "Year 2000" costs will have a material
adverse impact on the Company's business, financial condition and results of
operations. However, the Company is still analyzing its software applications
and, to the extent they are not fully "Year 2000" compliant, there can be no
assurance that the costs necessary to update software or potential systems
interruptions would not have a material adverse effect on the Company's
business, financial condition and results of operations.

SINGLE CALIFORNIA LOCATION

Currently, the Company's only network operations center is located at its
office in Sunnyvale, California. Operation of the advanced network service is
dependent in part upon the Company's ability to protect the network operation
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
22
<PAGE> 24

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 advanced network 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 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Financial Statements and Supplementary Data of the Company required by
this Item are set forth at the pages indicated at Item 14(a).

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

None.

PART III

Certain information required by Part III is omitted from this report in
that the Company intends to file its definitive proxy statement pursuant to
Regulation 14A (the "definitive Proxy Statement") not later than 120 days after
the end of the fiscal year covered by this report, and certain information
therein is incorporated herein by reference.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this Item is incorporated by reference to
information set forth in the definitive Proxy Statement under the heading
"Proposal No. 1 -- Election of Directors" and in Part I of this Report under the
heading "Executive Officers of the Registrant."

The information required by this Item with respect to compliance with
Section 16(a) of the Securities Exchange Act of 1934 is incorporated by
reference to information set forth in the definitive Proxy Statement under the
heading "Executive Compensation and Other Matters."

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is incorporated by reference to
information set forth in the definitive Proxy Statement under the heading
"Executive Compensation and Other Matters."

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this Item is incorporated by reference to
information set forth in the definitive Proxy Statement under the heading "Stock
Ownership of Certain Beneficial Owners and Management."

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this Item is incorporated by reference to
information set forth in the definitive Proxy Statement under the heading
"Certain Relationships and Related Transactions."

23
<PAGE> 25

PART IV

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

(a) The following documents are filed as part of this Form:

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
1. Financial Statements
Report of Management................................... F-1
Report of Independent Auditors......................... F-2
Consolidated Balance Sheets............................ F-3
Consolidated Statements of Operations.................. F-4
Consolidated Statements of Stockholders' Equity
(Deficit)............................................. F-5
Consolidated Statements of Cash Flows.................. F-6
Notes to Consolidated Financial Statements............. F-7
</TABLE>

2. Financial Statement Schedules

All schedules have been omitted because the required information is not
present or not present in amounts sufficient to require submission of the
schedules or because the information required is included in the
Consolidated Financial Statements or Notes thereto.

3. Exhibits

See Index to Exhibits. The Exhibits listed in the accompanying Index to
Exhibits are filed as part of this report.

(b) Reports on Form 8-K

None.

24
<PAGE> 26

REPORT OF MANAGEMENT

Responsibility for the preparation, integrity, and objectivity of the
financial information presented in this annual report rests with the management
of General Magic, Inc. (the "Company"). The accompanying consolidated financial
statements have been prepared in conformity with generally accepted accounting
principles, applying certain estimates and judgments as required.

The Company maintains a system of internal accounting control designed to
be cost-effective while providing reasonable assurance that assets are
safeguarded and that transactions are executed in accordance with management's
authorization and are properly recorded in the financial records. Internal
control effectiveness is supported through careful selection and training of
personnel and quarterly financial reviews with the Company's senior management.
Management believes that the Company's accounting controls provide reasonable
assurance that errors or irregularities that could be material to the
consolidated financial statements are prevented or would be detected within a
timely period by employees in the normal course of performing their assigned
functions.

KPMG Peat Marwick LLP, independent auditors, are retained to express an
opinion on the Company's consolidated financial statements. Their opinion is
based on procedures believed by them to be sufficient to provide reasonable
assurance that the consolidated financial statements are free of material
misstatement.

The Audit Committee of the Board of Directors is composed solely of
nonemployee directors, and is responsible for recommending to the Board the
independent auditors firm to be retained for the coming year, subject to
stockholder approval. The Audit Committee meets periodically and privately with
the independent accountants and with the Company's management to review
accounting, auditing, financial control, and financial reporting matters.

Steven Markman
Chairman of the Board, Chief Executive
Officer,
and President

James P. McCormick
Vice President of Finance and
Administration
and Chief Financial Officer

F-1
<PAGE> 27

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Stockholders of General Magic, Inc.:

We have audited the accompanying consolidated balance sheets of General
Magic, Inc. (a development stage enterprise) and subsidiary as of December 31,
1997 and 1996, and the related consolidated statements of operations,
stockholders' equity (deficit), and cash flows for each of the years in the
three-year period ended December 31, 1997, and for the period from May 1, 1990
(inception) to December 31, 1997. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of General
Magic, Inc. (a development stage enterprise) and subsidiary as of December 31,
1997 and 1996, and the results of their operations and their cash flows for each
of the years in the three-year period ended December 31, 1997, and for the
period from May 1, 1990 (inception) to December 31, 1997, in conformity with
generally accepted accounting principles.

KPMG Peat Marwick LLP

Mountain View, California
January 23, 1998, except for note 12,
which is as of March 6, 1998

F-2
<PAGE> 28

GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

ASSETS

<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1997 1996
--------- ---------
<S> <C> <C>
Current assets:
Cash and cash equivalents (including restricted cash of
$3,300 in 1997)........................................ $ 17,414 $ 23,706
Short-term investments.................................... 11,387 44,157
Other current assets...................................... 1,206 1,712
--------- ---------
Total current assets........................................ 30,007 69,575
--------- ---------
Property and equipment, net................................. 5,148 5,915
Other assets................................................ 1,142 446
--------- ---------
Total assets................................................ $ 36,297 $ 75,936
========= =========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 952 $ 1,284
Accrued expenses.......................................... 7,191 18,274
Current portion of long-term debt......................... 801 --
Other current liabilities................................. 224 1,347
--------- ---------
Total current liabilities................................... 9,168 20,905
--------- ---------
Deferred revenue, noncurrent................................ 4,186 8,200
Long-term debt.............................................. 3,199 --
Other long-term liabilities................................. 2,446 1,369
--------- ---------
Total liabilities........................................... 18,999 30,474
--------- ---------
Commitments
Stockholders' equity:
Preferred stock, $0.001 par value
Authorized: 1997 and 1996 -- 500
Issued and outstanding: 1997 and 1996 -- None.......... -- --
Common stock, $0.001 par value
Authorized: 1997 and 1996 -- 60,000
Issued and outstanding: 1997 -- 26,892;
1996 -- 26,419........................................ 27 26
Additional paid-in capital................................ 165,039 164,534
Other..................................................... (51) 235
Deficit accumulated during development stage.............. (147,717) (119,333)
--------- ---------
Total stockholders' equity.................................. 17,298 45,462
--------- ---------
Total liabilities and stockholders' equity.................. $ 36,297 $ 75,936
========= =========
</TABLE>

See accompanying notes to consolidated financial statements.
F-3
<PAGE> 29

GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
PERIOD FROM
MAY 1, 1990
(INCEPTION)
TO
YEARS ENDED DECEMBER 31, DECEMBER 31,
-------------------------------- ------------
1997 1996 1995 1997
-------- -------- -------- ------------
<S> <C> <C> <C> <C>
Revenue:
Licensing revenue........................... $ 2,454 $ 2,451 $ 9,890 $ 17,295
Other revenue............................... 1,002 3,466 4,275 8,743
-------- -------- -------- ---------
Total revenue................................. 3,456 5,917 14,165 26,038
-------- -------- -------- ---------
Costs and expenses:
Cost of other revenue....................... 928 2,760 2,113 5,801
Research and development.................... 20,548 23,028 19,297 93,423
Selling, general and administrative......... 12,676 23,944 18,092 80,196
Write-off of acquired technology and
in-process research and development...... -- 1,542 -- 1,542
Restructuring............................... -- 3,170 -- 3,170
-------- -------- -------- ---------
Total costs and expenses...................... 34,152 54,444 39,502 184,132
-------- -------- -------- ---------
Loss from operations.......................... (30,696) (48,527) (25,337) (158,094)
Other income (expense):
Investment income........................... 2,917 4,691 6,288 15,286
Other expense, net.......................... (588) (1,667) (356) (2,622)
-------- -------- -------- ---------
Total other income, net....................... 2,329 3,024 5,932 12,664
-------- -------- -------- ---------
Loss before income taxes...................... (28,367) (45,503) (19,405) (145,430)
Income taxes.................................. 17 131 1,214 2,287
-------- -------- -------- ---------
Net loss...................................... $(28,384) $(45,634) $(20,619) $(147,717)
======== ======== ======== =========
Basic and diluted loss per share.............. $ (1.06) $ (1.74) $ (0.84)
======== ======== ========
Shares used in computing per share amounts.... 26,778 26,181 24,451
======== ======== ========
</TABLE>

See accompanying notes to consolidated financial statements.
F-4
<PAGE> 30

GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)

<TABLE>
<CAPTION>
DEFICIT
COMMON ACCUMULATED TOTAL
PREFERRED STOCK STOCK ADDITIONAL DURING STOCKHOLDERS'
---------------- ------------ PAID-IN DEVELOPMENT EQUITY
SHARES AMT SHARES AMT CAPITAL OTHER STAGE (DEFICIT)
-------- ----- ------ --- ---------- ----- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Issuance of common stock..................... -- $ -- 6,480 $ 6 $ 417 $ -- $ -- $ 423
Issuance of stock warrants................... -- -- -- -- 250 -- -- 250
Transfer of equipment from a related party,
at fair market value....................... -- -- -- -- 35 -- -- 35
Net loss..................................... -- -- -- -- -- -- (474) (474)
------- ---- ------ --- -------- ----- --------- -------
Balances, December 31, 1990.................. -- -- 6,480 6 702 -- (474) 234
------- ---- ------ --- -------- ----- --------- -------
Issuance of common stock..................... -- -- 1,350 1 134 -- -- 135
Issuance of common stock under employee stock
option plan................................ -- -- 26 -- 2 -- -- 2
Termination of stock warrants ............... -- -- -- -- (250) -- -- (250)
Contribution of capital...................... -- -- -- -- 125 -- -- 125
Net loss..................................... -- -- -- -- -- -- (3,579) (3,579)
------- ---- ------ --- -------- ----- --------- -------
Balances, December 31, 1991.................. -- -- 7,856 7 713 -- (4,053) (3,333)
------- ---- ------ --- -------- ----- --------- -------
Issuance of common stock under employee stock
option plan................................ -- -- 557 1 55 -- -- 56
Net loss..................................... -- -- -- -- -- -- (10,055) (10,055)
------- ---- ------ --- -------- ----- --------- -------
Balances, December 31, 1992.................. -- -- 8,413 8 768 -- (14,108) (13,332)
------- ---- ------ --- -------- ----- --------- -------
Issuance of common stock under employee stock
option plan................................ -- -- 102 1 27 -- -- 28
Employee compensation for founder stock gift
to employees, at fair market value......... -- -- -- -- 127 -- -- 127
Net loss..................................... -- -- -- -- -- -- (17,441) (17,441)
------- ---- ------ --- -------- ----- --------- -------
Balances, December 31, 1993.................. -- -- 8,515 9 922 -- (31,549) (30,618)
------- ---- ------ --- -------- ----- --------- -------
Issuance of common stock under employee stock
option plan................................ -- -- 273 -- 111 -- -- 111
Termination of preferred stock redemption
feature.................................... 6,843 7 -- -- 30,447 -- -- 30,454
Repurchase of common stock................... -- -- (800) (1) (51) -- -- (52)
Issuance of Series I through N preferred
stock...................................... 3,609 3 -- -- 46,562 -- -- 46,565
Net loss..................................... -- -- -- -- -- -- (21,531) (21,531)
------- ---- ------ --- -------- ----- --------- -------
Balances, December 31, 1994.................. 10,452 10 7,988 8 77,991 -- (53,080) 24,929
------- ---- ------ --- -------- ----- --------- -------
Proceeds from issuance of common stock in
initial public offering, net of expenses... -- -- 6,325 7 81,248 -- -- 81,255
Conversion of preferred stock into common
stock...................................... (10,452) (10) 10,452 10 -- -- -- --
Issuance of common stock under stock option
and purchase plans......................... -- -- 1,024 1 3,356 -- -- 3,357
Unrealized gain on investments............... -- -- -- -- -- 170 -- 170
Net loss..................................... -- -- -- -- -- -- (20,619) (20,619)
------- ---- ------ --- -------- ----- --------- -------
Balances, December 31, 1995.................. -- -- 25,789 26 162,595 170 (73,699) 89,092
------- ---- ------ --- -------- ----- --------- -------
Purchase of technology in exchange for shares
of common stock............................ -- -- 141 -- 697 -- -- 697
Issuance of common stock under stock option
and purchase plans......................... -- -- 489 -- 1,242 -- -- 1,242
Unrealized gain on investments............... -- -- -- -- -- 65 -- 65
Net loss..................................... -- -- -- -- -- -- (45,634) (45,634)
------- ---- ------ --- -------- ----- --------- -------
Balances, December 31, 1996.................. -- -- 26,419 26 164,534 235 (119,333) 45,462
------- ---- ------ --- -------- ----- --------- -------
Issuance of common stock under stock option
and purchase plans......................... -- -- 293 1 261 -- -- 262
Issuance of restricted common stock.......... -- -- 135 -- 169 (155) -- 14
Amortization of deferred compensation........ -- -- -- -- -- 97 -- 97
Purchase of technology in exchange for shares
of common stock............................ -- -- 45 -- 75 -- -- 75
Unrealized loss on investments............... -- -- -- -- -- (228) -- (228)
Net loss..................................... -- -- -- -- -- -- (28,384) (28,384)
------- ---- ------ --- -------- ----- --------- -------
Balances, December 31, 1997.................. -- $ -- 26,892 $27 $165,039 $ (51) $(147,717) $17,298
======= ==== ====== === ======== ===== ========= =======
</TABLE>

See accompanying notes to consolidated financial statements.
F-5
<PAGE> 31

GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

<TABLE>
<CAPTION>
PERIOD FROM
MAY 1, 1990
YEARS ENDED DECEMBER 31, (INCEPTION) TO
-------------------------------- DECEMBER 31,
1997 1996 1995 1997
-------- -------- -------- --------------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $(28,384) $(45,634) $(20,619) $(147,717)
Adjustments to reconcile net loss to net cash used in
operating activities:
Employee compensation for founder stock gift to
employees, at fair market value....................... -- -- -- 127
Depreciation and amortization........................... 2,849 3,233 2,189 10,749
Amortization of deferred gain from sale and leaseback
financing............................................. (72) (96) (94) (285)
Deferred revenue........................................ (2,339) 200 3,532 15,235
Amortization of deferred compensation................... 97 -- -- 97
Write-off of acquired technology........................ -- 1,343 -- 1,343
Changes in items affecting operations:
Other current assets.................................. 6 2,294 (3,518) (1,706)
Accounts payable and accrued expenses................. (10,775) 4,570 1,891 (335)
-------- -------- -------- ---------
Net cash used in operating activities....................... (38,618) (34,090) (16,619) (122,492)
-------- -------- -------- ---------
Cash flows from investing activities:
Purchases of short-term investments....................... (53,352) (52,338) (123,520) (253,745)
Proceeds from sales and maturities of short-term
investments............................................. 85,894 72,408 66,254 242,365
Purchases of property and equipment....................... (2,716) (2,203) (4,689) (15,259)
Other assets.............................................. (630) (902) 462 (1,975)
-------- -------- -------- ---------
Net cash provided by (used in) investing activities......... 29,196 16,965 (61,493) (28,614)
-------- -------- -------- ---------
Cash flows from financing activities:
Proceeds from sale and leaseback financing................ -- -- -- 1,885
Repayment of capital lease obligations.................... (985) (718) (571) (2,344)
Proceeds from issuance of debt............................ 4,000 -- -- 4,000
Proceeds from sale of common stock and warrants, net of
offering cost........................................... 351 1,242 84,612 87,120
Proceeds from sale of redeemable preferred stock.......... -- -- -- 44,000
Proceeds from sale of preferred stock..................... -- -- -- 33,019
Repurchase of common stock................................ -- -- -- (52)
Other long-term liabilities............................... (236) (256) 613 892
-------- -------- -------- ---------
Net cash provided by financing activities................... 3,130 268 84,654 168,520
-------- -------- -------- ---------
Net (decrease) increase in cash and cash equivalents........ (6,292) (16,857) 6,542 17,414
Cash and cash equivalents, beginning of year/period......... 23,706 40,563 34,021 --
-------- -------- -------- ---------
Cash and cash equivalents, end of year/period............... $ 17,414 $ 23,706 $ 40,563 $ 17,414
======== ======== ======== =========
Supplemental disclosures of cash flow information:
Income taxes paid during the year/period.................. $ 22 $ 136 $ 1,214 $ 2,047
Noncash investing and financing activities:
Deferred compensation for restricted stock issuances.... 155 -- -- 155
Reclassification of advance royalties from deferred
revenue to other long-term liabilities................ 1,500 -- -- 1,500
Purchase of technology in exchange for common shares.... 75 697 -- 772
Reclassification of advance royalties from deferred
revenue to accrued liabilities........................ -- 9,049 -- 9,049
Capital equipment acquired under capital lease
obligations........................................... -- -- 441 2,622
Conversion of redeemable preferred stock into preferred
stock................................................. -- -- -- 44,000
</TABLE>

See accompanying notes to consolidated financial statements.
F-6
<PAGE> 32

GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1: SUMMARY OF THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES

The Company

The Company has generated minimal revenues to date and, as a consequence of
its change in business strategy, expects to incur significant losses through
1998. There can be no assurances that the Company will achieve or sustain
significant revenues or become cash flow positive or profitable at any time in
the future. The Company expects that its cash, cash equivalents, and short-time
investment balances as of December 31, 1997, together with the additional
financing received in the first quarter of 1998, will be adequate to fund the
Company's operations for at least the next twelve (12) months (see, also, Note
12).

Foreign Currency and International Operations

The Company's operations outside the United States related primarily to
foreign sales offices in Europe and Japan. In November 1995, the Company formed
a wholly-owned subsidiary, General Magic France, to centralize its European
sales and marketing efforts. As a result of the restructuring plan adopted and
implemented by the Company in the fourth quarter of 1996, the Company closed its
sales offices in Japan and France. The assets, liabilities and results of these
foreign operations were not significant for any of the years presented. The
Company denominated substantially all of its transactions in the U.S. dollar.
Gains and losses on foreign currency transactions were not significant.

F-7
<PAGE> 33
GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiary. All significant intercompany
accounts and transactions have been eliminated in consolidation.

Revenue Recognition

Licensing revenue primarily represents revenue from nonrefundable,
nonrecoupable license fees for the Company's technologies, royalty revenue from
original equipment manufacturer ("OEM") shipments of devices incorporating the
Company's technology and revenue from network operators for license and usage
fees. Other revenue represents fees earned under customer-specific engineering,
maintenance and support services contracts.

In compliance with the American Institute of Certified Public Accountants'
Statement of Position 91-1, "Software Revenue Recognition," and the Financial
Accounting Standards Board's ("FASB") Statement of Financial Accounting
Standards ("SFAS") No. 48, "Revenue Recognition When Right of Return Exists,"
the Company recognizes nonrefundable, nonrecoupable license fees upon delivery
of its technology to its licensees. Licensing revenue associated with OEM
licensees is recognized upon shipment of the product incorporating the Company's
technology to the OEM's customers provided that the collection of the related
receivable is deemed probable. Royalties associated with potential OEM product
returns are estimated and provided for in the period of sale. Licensing revenue
from network operators is recognized as earned based upon usage and, in certain
cases, based on subscriber registration. Advance payments of licensing revenue
and fees received prior to revenue recognition are recorded as deferred revenue.

Fees from customer-specific engineering projects are recognized under the
percentage-of-completion method based on achievement and acceptance of
milestones or performance of services. Support and maintenance fees are
recognized over the period the service or maintenance is provided.

Cash Equivalents and Short-Term Investments

The Company considers all highly liquid debt instruments with remaining
maturities of three months or less at the date of acquisition to be cash
equivalents. Cash equivalents consist primarily of commercial paper and money
market mutual funds.

In connection with a purchase commitment, the Company had $3,300,000 in
restricted cash as of December 31, 1997 (see Note 10, "Commitments").

The Company has classified its investments as "available-for-sale."
Investments are recorded at fair value and unrealized gains and losses, if
material, are recorded as a separate component of equity until realized.
Interest income is recorded using the effective interest rate, with amortization
of associated premium or discount included in "investment income." The cost of
securities sold is determined based upon the specific identification method.

Property and Equipment

Property and equipment are recorded at original cost less accumulated
depreciation. Depreciation and amortization are provided using the straight-line
method over the estimated useful lives of the respective assets, generally three
to five years. Assets recorded under capital leases are amortized on a
straight-line basis over the shorter of the lease terms or the estimated useful
lives of the respective assets.

F-8
<PAGE> 34
GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Software Development Costs

Development costs incurred in the research and development of new software
products are expensed as incurred until technological feasibility has been
established. Software development expenses incurred for product enhancements
after the product has reached technological feasibility have not been material
and, accordingly, also have been charged to operations as incurred. From
inception through December 31, 1997, no software development costs have been
capitalized.

Income Taxes

The Company provides for income taxes using the asset and liability method
under which provision for deferred income taxes is based on enacted tax laws and
rates applicable to the periods in which the taxes become payable.

Net Loss Per Share

Effective December 31, 1997, the Company adopted SFAS No. 128, "Earnings
Per Share." In accordance with SFAS No. 128, primary earnings per share have
been replaced with basic earnings per share, and fully diluted earnings per
share have been replaced with diluted earnings per share. Prior and current
periods have been recalculated to conform to SFAS No. 128. However, as the
Company has had net losses for all periods presented, basic and diluted loss per
share are no different than the primary loss per share previously disclosed. As
of December 31, 1997, 1996 and 1995, there were 4,991,000, 3,926,000 and
3,779,000 options outstanding, respectively, that were not included in the
calculation of diluted earnings per share in any of the periods presented
because to do so would have had an anti-dilutive effect as the Company had net
losses for all such periods.

Basic and diluted loss per share are computed by dividing loss available to
holders of common stock by the weighted-average number of shares of common stock
outstanding during the period.

Accounting Estimates

The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Significant estimates of the Company relate to the computation and
classification of deferred revenue, including the accrual, if applicable, of
interest payable thereon.

Reclassifications

Certain amounts in the prior year consolidated balance sheet have been
reclassified to conform with the current year classification.

Stock-Based Compensation

The Company has elected to continue to use the intrinsic value-based method
of Accounting Principles Board (APB) Opinion No. 25, as allowed under SFAS No.
123, "Accounting for Stock-Based Compensation," to account for all of its
employee stock-based compensation plans. The adoption of SFAS No. 123 did not
have a material effect on the Company's consolidated financial position or
results of operations.

F-9
<PAGE> 35
GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Comprehensive Income

In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 establishes standards for reporting and displaying
comprehensive income and its components in financial statements. It does not,
however, require a specific format for the disclosure, but requires the Company
to display an amount representing total comprehensive income for the period of
its consolidated financial statements. The Company is required to implement SFAS
No. 130 in 1998.

Segment Reporting

Also in June 1997, the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131 establishes
standards for the manner in which public companies report information about
operating segments in annual and interim financial statements. The Company is
currently evaluating the operating segment information that it will be required
to report. The Company is required to implement SFAS No. 131 with respect to its
1998 annual consolidated financial statements.

NOTE 2: REVENUE BY CUSTOMER AND GEOGRAPHIC AREA

For the year ended December 31, 1997, revenue from two major customers,
both stockholders in the Company, accounted for 69% and 13% of total revenue,
respectively. For the year ended December 31, 1996, revenue from two major
customers, both stockholders in the Company, accounted for 33% and 11% of total
revenue, respectively; also, one other major customer accounted for 13% of total
revenue in the period. For the year ended December 31, 1995, revenue from four
major customers, all stockholders in the Company, accounted for 22%, 19%, 20%
and 18% of total revenue, respectively.

From date of inception through the year ended December 31, 1996, the
Company operated in one industry segment, the development and licensing of
object-oriented software platform technologies. In 1997, the Company began
developing and marketing an advanced network service for communication and
information management based on telecommunications, computing and Internet
standards.

The Company's revenue was generated principally from its headquarters in
North America. Revenue from customers in Japan amounted to $2,875,000,
$3,516,000 and $10,454,000 for the years ended December 31, 1997, 1996 and 1995,
respectively. For the years ended December 31, 1997, 1996 and 1995, revenue from
customers in Europe amounted to none, $54,000 and $3,350,000, respectively.

NOTE 3: AGREEMENTS WITH STOCKHOLDERS AND DEFERRED REVENUE

In connection with the Company's initial strategy to promote its Magic Cap
and Telescript technologies, the Company entered into various contractual
arrangements with certain stockholders. Significantly all of the Company's
revenue from May 1, 1990 (inception) through December 31, 1997, was generated
from such stockholders, or their affiliates.

Five companies, which became stockholders of the Company prior to 1993,
entered into license agreements to pay royalties for the Company's Magic Cap
technology. The agreements provided for the payment of up to $2,500,000 in
prepaid royalties by each licensee in the event the Company met certain
technology development milestones. These prepayments were to be offset at a rate
of $0.50 for every dollar of royalties payable by the licensees upon shipments
of products incorporating the Company's technology. If the prepayments were not
fully recouped by the fifth anniversary of the license agreements (November 30,
1997), the licensees were each entitled to demand repayment of the unrecouped
amount plus interest.

F-10
<PAGE> 36
GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

under a software modem license agreement against the Magic Cap royalty
prepayment, amended the Magic Cap license agreement to provide for 100%
recoupment of any royalties due thereunder, extended the date for refund of
unrecouped prepaid royalties to November 2, 1999, and provided that no interest
will be due upon any refund. As a result of this new agreement, the unrecouped
prepaid royalty of $2,186,000 remains in noncurrent deferred revenue as of
December 31, 1997.

As of December 31, 1997, three of the remaining four companies had demanded
and received repayment of the unrecouped prepaid royalties, excluding a portion
of interest due. The obligations outstanding under the agreements with the five
companies as of December 31, 1997, amounted to $3,318,000 and was classified in
current liabilities.

Additionally, in 1994 and 1995, the Company entered into Magic Cap
technology license agreements with three other stockholders. These license
agreements each provided for the payment of a $2,500,000 up front,
nonrefundable, nonrecoupable license fee. The agreements also provided for the
payment of up to $2,500,000 in prepaid royalties, payable in installments upon
the Company's achievement of certain technology milestones. Failure to deliver
the technology milestones entitled each licensee to terminate its agreement and
obtain a refund of unrecouped prepaid royalties in two equal annual installments
of principal, plus interest from the date of termination, payable commencing one
year following termination of the agreement. During the fourth quarter of 1996,
each of the three licensees demanded delivery of the final milestone due under
the license agreements. The Company delivered the final milestone in January
1997.

In June 1997, the Company reached an agreement to resolve the claims of,
and terminate the license agreement with, one of the three licensees. In
consideration therefor, the Company agreed to refund the unrecouped prepaid
royalties of $1,500,000 (previously classified as noncurrent deferred revenue),
waive any further payments otherwise due under the agreement (including $500,000
classified in accounts receivable and noncurrent deferred revenue), and grant a
royalty-free license to certain software modem technology. The $1,500,000 refund
is secured by a license in certain of the Company's intellectual property, is
non-interest bearing and is payable in August 1999. In September 1997, the
Company reached agreement with a second of the three licensees providing for
acceptance of the final milestone, subject to certain conditions which were
satisfied by the Company later that month. Pursuant to this agreement, the
Company waived payment of the final $500,000 installment of the prepaid
royalties and recognized $2,000,000 in licensing revenue previously classified
as noncurrent deferred revenue. In October 1997, the Company reached agreement
with the third licensee, which also provided for acceptance of the final
milestone. Pursuant to this agreement, the Company waived payment of the final
$500,000 installment of the prepaid royalties and agreed to refund prepaid
royalties not recouped by January 1, 2003, plus any accrued interest, on or
before December 31, 2003. As of December 31, 1997, the Company had $1,500,000
classified in other long-term liabilities and $2,000,000 classified in
noncurrent deferred revenue related to its remaining obligations under the
agreements with the three licensees.

NOTE 4: RESTRUCTURING

In the fourth quarter of 1996, the Company announced and implemented a
restructuring plan designed to reduce costs and achieve long-term profitability
in the Company's operations. The Company's restructuring consisted primarily of
terminating approximately 60 employees; vacating certain facilities and
canceling auto leases related to these employee terminations; disposing of
certain office and computer equipment; and settling a contractual obligation
resulting from a change in the Telescript product strategy.

The restructuring resulted in an initial charge of $3,170,000. From the
inception of the restructuring plan through December 31, 1997, the Company
incurred cash expenditures of $2,381,000 and noncash expenditures of $789,000.

F-11
<PAGE> 37
GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Restructuring costs and related accrual consisted of the following (in
thousands):

<TABLE>
<CAPTION>
ACCRUED ACCRUED
BALANCE AS OF BALANCE AS OF
DECEMBER 31, DECEMBER 31,
COMPONENTS 1996 SPENDING ADJUSTMENTS 1997
---------- ------------- -------- ----------- -------------
<S> <C> <C> <C> <C>
Payments to employees
involuntarily terminated(C)..... $ 823 $ 724 $(99) $ --
Payments on canceled or vacated
facilities and auto leases(C)... 394 394 -- --
Disposal of office and computer
equipment(NC)................... 690 789 99 --
Contract settlement costs(C)...... 900 900 -- --
------ ------ ---- ----
$2,807 $2,807 $ -- $ --
====== ====== ==== ====
</TABLE>

- ---------------
(C): Cash; (NC): Noncash.

NOTE 5: WRITE-OFF OF ACQUIRED TECHNOLOGY AND IN-PROCESS RESEARCH AND DEVELOPMENT

In April 1996, the Company purchased rights to two Internet applications
from Active Paper, Inc. Upon the date of acquisition, $1,596,000 associated with
the purchase cost of this acquired developed technology was capitalized. In
September 1996, the Company conducted an analysis of expected cash flows and
determined that the carrying amount of the asset of $1,343,000, net of $253,000
in amortization, was in excess of the expected undiscounted cash flows
associated with the asset. As the fair value of the asset, which was calculated
using the discounted expected future cash flows method, was not significant, the
Company recognized in the third quarter of 1996 an impairment loss equal to the
carrying amount of the asset.

In July 1996, the Company acquired certain assets from Conterra, Inc. for
approximately $230,000 and recognized a $199,000 charge for in-process research
and development costs in connection with the acquisition.

F-12
<PAGE> 38
GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 6: BALANCE SHEET COMPONENTS

Cash Equivalents and Short-Term Investments

Cash equivalents and short-term investments consisted of the following (in
thousands):

<TABLE>
<CAPTION>
ESTIMATED
UNREALIZED UNREALIZED FAIR
AS OF DECEMBER 31, 1997 COST GAINS LOSSES VALUE
----------------------- ---- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Money market funds............... $10,717 $ -- $ -- $10,717
Certificates of deposit.......... 3,324 -- -- 3,324
Commercial paper................. 13,875 7 -- 13,882
------- ---- ---- -------
$27,916 $ 7 $ -- $27,923
======= ==== ==== =======
</TABLE>

<TABLE>
<CAPTION>
ESTIMATED
UNREALIZED UNREALIZED FAIR
AS OF DECEMBER 31, 1996 COST GAINS LOSSES VALUE
----------------------- ---- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Money market funds............... $14,522 $ -- $(1) $14,521
Commercial paper................. 25,857 235 -- 26,092
U.S. government securities....... 27,373 1 -- 27,374
Taxable municipal bonds.......... 250 -- -- 250
------- ---- --- -------
$68,002 $236 $(1) $68,237
======= ==== === =======
</TABLE>

The Company's investments were classified as follows (in thousands):

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------
1997 1996
------- -------
<S> <C> <C>
Cash equivalents......................................... $16,536 $24,080
Short-term investments................................... 11,387 44,157
------- -------
$27,923 $68,237
======= =======
</TABLE>

All short-term investments have weighted average original maturities of
less than one year.

Property and Equipment

The components of property and equipment were as follows (in thousands):

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------
1997 1996
------- -------
<S> <C> <C>
Office equipment and computers........................... $ 9,133 $ 9,149
Furniture and fixtures................................... 2,315 2,775
Leasehold improvements................................... 546 489
------- -------
11,994 12,413
Less accumulated depreciation and amortization........... 6,846 6,498
------- -------
$ 5,148 $ 5,915
======= =======
Capital lease equipment included in property and
equipment consisted of:
Cost................................................... $ 688 $ 2,664
Less accumulated amortization.......................... 516 1,635
------- -------
$ 172 $ 1,029
======= =======
</TABLE>

F-13
<PAGE> 39
GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Accrued Expenses

Accrued expenses consisted of the following (in thousands):

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------
1997 1996
------- --------
<S> <C> <C>
Prepaid royalty payment and accrued interest................ $3,318 $10,012
Employee compensation....................................... 2,384 3,569
Restructuring (See Note 4).................................. -- 2,807
Other....................................................... 1,489 1,886
------ -------
$7,191 $18,274
====== =======
</TABLE>

NOTE 7: FINANCIAL INSTRUMENTS

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist primarily of cash and cash equivalents and
short-term investments. The Company invests its excess cash in U.S. government
securities, commercial paper and corporate debt securities. These investments
typically bear minimal risk. This diversification of risk is consistent with the
Company's policy to ensure safety of principal.

The Company maintains cash and cash equivalents and certain other financial
instruments with various financial institutions. These financial institutions
are located in the United States, and the Company's policy is designed to limit
exposure to any one institution. The Company's periodic evaluations of the
relative credit standing of these financial institutions are considered in the
Company's investment strategy.

Fair Value of Financial Instruments

For certain of the Company's financial instruments, including cash and cash
equivalents, accounts receivable, accounts payable, and other accrued
liabilities, the carrying amounts approximate fair value.

NOTE 8: STOCKHOLDERS' EQUITY

Initial Public Offering and Preferred Stock

The Company completed an initial public offering ("IPO") on February 9,
1995, issuing 6,325,000 shares of its common stock at $14.00 per share. The
proceeds, net of commissions and expenses, totaled $81,255,000.

As of December 31, 1994, the Company had authorized 30,000,000 shares of
convertible preferred stock. Upon the closing of the Company's IPO on February
9, 1995, all outstanding preferred stock automatically converted into common
stock. The Board of Directors has since authorized 500,000 shares of preferred
stock, none of which were issued and outstanding as of December 31, 1997 and
1996.

Common Stock

The Company is authorized to issue 60,000,000 shares of common stock. On
February 7, 1995, a one-for-two reverse stock split of the common stock
occurred. All data related to shares and per share amounts for all periods
presented have been adjusted to reflect the effect of the reverse stock split.

F-14
<PAGE> 40
GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Accounting for Stock-Based Compensation

As of December 31, 1997, the Company had three stock-based compensation
plans, which consist of two stock option plans and an employee stock purchase
plan. The Company applies APB Opinion No. 25 and related interpretations in
accounting for its plans. Accordingly, no compensation cost has been recognized
for its stock option plans and for its employee stock purchase plan because the
exercise price of the stock options equals or exceeds the fair value of the
underlying common stock at the date of grant and the employee stock purchase
plan qualifies as a noncompensatory plan. The Company has adopted the pro forma
disclosure provisions of SFAS No. 123. Had compensation cost for the Company's
three stock-based compensation plans been determined based on the fair value
approach described in SFAS No. 123, the Company's net loss and loss per share
would have been increased to the pro forma amounts indicated below. In the
initial phase-in period, the effects of applying SFAS No. 123 for disclosing
compensation cost may not be representative of the effects on reported net
income or loss for future years.

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C>
Net loss
As reported.................................. $(28,384) $(45,634) $(20,619)
Pro forma.................................... (30,641) (48,224) (21,289)
Net loss per share
As reported.................................. $ (1.06) $ (1.74) $ (0.84)
Pro forma.................................... (1.14) (1.84) (0.87)
</TABLE>

Stock Option Plans

The Company has two stock option plans, the Amended and Restated 1990 Stock
Option Plan ("1990 Stock Option Plan") and the 1994 Outside Directors Stock
Option Plan, as amended ("Directors Option Plan"). Under the 1990 Stock Option
Plan, the Company has reserved an aggregate of 8,020,000 shares of common stock
for issuance. The 1990 Stock Option Plan provides that stock options may be
granted to employees (including officers), consultants, advisers and other
independent contractors, at an exercise price not less than 100% of the fair
market value, as determined by the Board of Directors, for incentive stock
options, and 50% of the fair market value for nonqualified stock options, at the
grant date. All options granted under the 1990 Stock Option Plan must have a
term not greater than 10 years from the date of grant. The Board of Directors
determines the number of shares for which an option may be granted. Options
issued generally vest 25% after one year and then ratably at 1/48 per month
thereafter. However, in April 1997, 1,184,000 options were granted to Company
employees (excluding officers), subject to acceleration of vesting upon
achievement of certain milestones. The effect of issuing options to nonemployees
is not material to the accompanying consolidated statements of operations for
any of the periods presented.

In order to retain and motivate the Company's employees, the Board of
Directors approved repricings of certain stock options issued under the 1990
Stock Option Plan. Under the February 27, 1996, repricing, holders of stock
options with exercise prices in excess of $7.44 could elect to surrender any or
all of their outstanding options for options priced at $7.44, the fair market
value of the Company's common stock on February 27, 1996, as determined by the
Board of Directors. The vesting period for the repriced February 27, 1996,
options commenced on February 27, 1996. Under the November 12, 1996, repricing,
holders of stock options with exercise prices in excess of $2.84, including
those options previously repriced, could elect to surrender any or all of their
outstanding options for options priced at $2.84, the fair market value of the
Company's common stock on November 12, 1996, as determined by the Board of
Directors. Each option that was repriced on November 12, 1996, was subject to
the vesting schedule of the surrendered option it replaced.

F-15
<PAGE> 41
GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

On February 27, 1996, and November 12, 1996, options for an aggregate of
1,597,183 and 2,948,846 shares of common stock, respectively, were repriced.

Under the Directors Option Plan, the Company has reserved an aggregate of
300,000 shares of common stock for issuance. The Directors Option Plan provides
for the automatic grant of nonqualified stock options to directors of the
Company who are not employees of (i) the Company, (ii) a stockholder of the
Company, (iii) a holder of a technology license from the Company, or (iv) any
parent or subsidiary of the same ("Eligible Outside Directors"). Each person who
is newly elected or appointed as an Eligible Outside Director is automatically
granted an option to purchase 40,000 shares of common stock. Each Eligible
Outside Director is automatically granted an option to purchase 10,000 shares of
common stock on the day following each anniversary date of election or
appointment, subject to the director's option to decline the grant. The exercise
price of the options in all cases is equal to the fair market value of common
stock on the grant date. The initial grant options generally vest and become
exercisable 25% after the first year and then ratably at 1/48 per month
thereafter. The anniversary grant options generally vest and become exercisable
at the rate of 1/12 per month beginning three years after the grant date.
Generally, options must be exercised within 10 years.

Under SFAS No. 123, the fair value of each option grant and option
repricing under the two stock option plans is estimated on the respective date
of grant or repricing using the Black-Scholes option pricing model with the
following weighted-average assumptions used for 1997, 1996 and 1995: zero
dividend yield; expected volatility of 70%, 70% and 63%, respectively; risk free
interest rates of 6.42%, 6.12% and 6.02%, respectively; and expected lives of
3.24, 3.14 and 3.21 years, respectively. The expected volatility assumption was
estimated based on historical industry stock price volatility and assumes
increases and decreases in stock prices. The expected volatility assumption used
in the Black-Scholes option pricing model may not be indicative of the historic
or future performance of the Company's common stock.

F-16
<PAGE> 42
GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Option activity under the Company's two stock option plans was as follows
(in thousands, except per share amounts):

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1997 1996 1995
------- ------- ------
<S> <C> <C> <C>
Outstanding, beginning of year................. 3,926 3,779 3,651
Granted........................................ 3,494 2,902 1,711
Exercised...................................... (208) (367) (995)
Canceled....................................... (2,221) (2,388) (588)
Repriced -- granted............................ -- 4,546 --
Repriced -- canceled........................... -- (4,546) --
------- ------- ------
Outstanding, end of year....................... 4,991 3,926 3,779
Shares available for future grant.............. 802 2,074 2,438
Options authorized to be issued................ 8,320 8,320 8,170
Options exercisable, end of year............... 1,387 1,031 1,253
------- ------- ------
Weighted-average exercise prices:
Outstanding at beginning of year............. $ 3.17 $ 10.08 $ 5.65
Granted...................................... 1.78 5.23 14.71
Exercised.................................... 0.63 1.50 3.02
Canceled..................................... 3.22 12.57 8.01
Repriced -- granted.......................... -- 4.46 --
Repriced -- canceled......................... -- 6.72 --
Outstanding, end of year..................... 2.28 3.17 10.08
Options exercisable, end of year............... 2.99 3.36 5.61
------- ------- ------
Weighted-average fair value of options granted
during the year.............................. $ 0.95 $ 2.70 $ 7.10
======= ======= ======
</TABLE>

The following table summarizes information about options outstanding under
the Company's two stock option plans as of December 31, 1997 (shares in
thousands):

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------------------- OPTIONS EXERCISABLE
WEIGHTED- -----------------------
AVERAGE WEIGHTED- WEIGHTED-
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE PRICE OUTSTANDING PRICE
- ------------------------ ----------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
$0.40 to $2.75......... 2,698 9.37 years $1.57 193 $1.85
$2.84.................. 2,149 8.87 2.84 1,111 2.84
$4.31 to $13.06........ 144 7.78 7.21 83 7.59
----- ---------- ----- ----- -----
$0.40 to $13.06........ 4,991 9.11 years $2.28 1,387 $2.99
===== ========== ===== ===== =====
</TABLE>

1994 Employee Stock Purchase Plan

As of December 31, 1997, the Company had reserved an aggregate of 505,000
shares of common stock for issuance under the 1994 Employee Stock Purchase Plan,
as amended ("Purchase Plan"). The Purchase Plan permits eligible employees to
purchase common stock at a discount through payroll deductions during 24 month
offering periods. The price at which stock is purchased under the Purchase Plan
is equal to 85% of the fair market value of common stock on the first day of the
offering period or the last day of the purchase period, whichever is lower.
However, the price for the initial offering period is equal to 85% of the fair
market value of

F-17
<PAGE> 43
GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

common stock at the close of business on the day prior to the first day of the
initial offering period or the fair market value of common stock on the last day
of the purchase period, whichever is lower. Under the Purchase Plan, the Company
sold 84,890, 121,445 and 29,572 shares to its employees in 1997, 1996 and 1995,
respectively.

Under SFAS No. 123, compensation cost is recognized for the fair value of
employees' purchase rights, which cost was estimated using the Black-Scholes
model with the following assumptions for 1997, 1996 and 1995: zero dividend
yield and expected life of fifteen months for each year; expected volatility of
70%, 70% and 63%, respectively; and risk free interest rates of 5.53%, 5.20% and
5.74%, respectively. The expected volatility assumption was estimated based on
historical industry stock price volatility and assumes increases and decreases
in stock prices. The expected volatility assumption used in the Black-Scholes
option pricing model may not be indicative of the historic or future performance
of the Company's common stock. The weighted-average fair value of purchase
rights (including the 15% discount off of the quoted market price of common
stock) granted in 1997, 1996 and 1995 was $0.70, $2.08 and $4.84, respectively.

Restricted Stock Grant

During 1997, the Company sold to its Chairman, Chief Executive Officer and
President 135,000 shares of restricted common stock for $0.10 per share. The
Company recorded approximately $155,000 of deferred compensation in connection
with the sale of these shares and is amortizing the compensation expense related
to this transaction over the two-year vesting period on a straight-line basis.

NOTE 9: RETIREMENT PLAN

The Company has a deferred compensation plan for all employees who are at
least 21 years of age. Under the plan, which qualifies under Section 401(k) of
the Internal Revenue Code of 1986, as amended, eligible employees may contribute
from 2% to 20% of their pretax compensation, up to the annual limits imposed by
the Internal Revenue Service.

The Company may, at its discretion, contribute amounts to the plan. No
employer contributions have been made in any of the periods presented.

NOTE 10: COMMITMENTS

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 (8.75% as of December 31, 1997), and has a term of
forty months with interest only due in the first four months and principal and
interest due monthly thereafter. This loan is subject to certain financial
covenants measured on a monthly basis, and is secured by all of the assets of
the Company, including intellectual property. As of December 31, 1997, the
current and noncurrent portions of debt due under this loan were $801,000 and
$3,199,000, respectively.

Purchase Commitments and Letter of Credit

F-18
<PAGE> 44
GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

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. As of December 31, 1997, the Company's purchase commitment was
$2,648,000 due to favorable changes in the exchange rate.

Lease Commitments

The Company leases its facilities under an operating lease extending
through 2002. The lease requires the Company to pay all executory costs, such as
maintenance and insurance, and provides for escalating rent payments. The
Company is amortizing the total rent payments over the lease term on a
straight-line basis. In addition, the Company also leases certain phone
equipment and computers under capital lease agreements.

Rent expense was approximately $790,000, $1,690,000 and $1,452,000 for the
fiscal years ended December 31, 1997, 1996 and 1995, respectively.

Future minimum lease payments under noncancelable capital and operating
leases and the present value of minimum lease payments under capital leases as
of December 31, 1997 are as follows (in thousands):

<TABLE>
<CAPTION>
CAPITAL OPERATING
YEARS ENDING DECEMBER 31, LEASES LEASE
------------------------- ------- ---------
<S> <C> <C>
1998...................................................... $233 $ 391
1999...................................................... 57 379
2000...................................................... -- 436
2001...................................................... -- 458
2002...................................................... -- 223
2003 and thereafter....................................... -- --
---- ------
Total minimum lease payments.............................. 290 $1,887
------
Less amount representing interest......................... 12
----
Present value of minimum lease payments................... 278
Less current obligation under capital leases.............. 224
----
Obligations under capital leases, excluding current
installments............................................ $ 54
====
</TABLE>

NOTE 11: INCOME TAXES

Income tax expense for the years ended December 31, 1997, 1996 and 1995 is
comprised primarily of foreign withholding taxes.

Total income tax expense differs from expected tax expense (benefit),
computed by multiplying the U.S. income statutory rate of 34% by loss before
income tax, as a result of the following (in thousands):

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------
1997 1996 1995
------- -------- -------
<S> <C> <C> <C>
Computed expected tax benefit................ $(9,645) $(15,471) $(6,598)
Losses and temporary difference for which no
tax benefit was recognized................. 9,265 14,776 6,368
Nondeductible expenses....................... 397 695 230
Foreign tax withholding...................... -- 131 1,214
------- -------- -------
Total tax expense............................ $ 17 $ 131 $ 1,214
======= ======== =======
</TABLE>

F-19
<PAGE> 45
GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets are as follows (in thousands):

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------
1997 1996
------- -------
<S> <C> <C>
Deferred tax assets:
Accruals and other reserves.............................. $ 1,670 $ 2,592
Deferred revenue......................................... 1,793 3,652
Loss carryovers and deferred start-up expenditures....... 53,110 40,400
Foreign tax credit carryforward.......................... 1,740 1,740
Research and development credit carryforward............. 6,650 4,976
Fixed assets............................................. 787 1,310
------- -------
Total gross deferred tax assets.......................... 65,750 54,670
Less valuation allowance................................. 65,750 54,670
------- -------
Net deferred tax assets.................................. $ -- $ --
======= =======
</TABLE>

Deferred tax assets as of December 31, 1997, include approximately
$2,746,000 relating to the exercise of stock options, which will be credited to
equity if and when realized.

As of December 31, 1997, the Company had cumulative federal net operating
losses of approximately $136,100,000, which can be used to offset future income
subject to federal income taxes. The federal tax loss carryforwards will expire
from 2006 through 2012. The Company has cumulative California net operating
losses of approximately $63,300,000, which can be used to offset future income
subject to California income taxes. The California tax loss carryforwards will
expire from 1998 through 2002.

As of December 31, 1997, foreign tax credits of approximately $1,740,000
were available to reduce future federal income taxes. Foreign tax credit
carryforwards expire from 1999 through 2000.

As of December 31, 1997, unused research and development tax credits of
approximately $4,353,000 and $2,298,000 were available to reduce future federal
and California income taxes, respectively. Federal credit carryforwards will
expire from 2007 through 2012; California credits will carry forward
indefinitely.

NOTE 12: SUBSEQUENT EVENTS

Financing Transactions

On March 3, 1998, the Company entered into a private financing transaction
that provided $5,000,000 in cash to the Company from the sale of convertible
preferred stock. As part of the transaction, the Company also issued five-year
warrants to purchase additional shares of common stock at a premium to the
common stock price as of the date of the private financing transaction. The
Company has the option to secure an additional $5,000,000 in financing on
similar terms based on certain conditions, including share price, average
trading volume and total equity.

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. for $2,050,000,
comprised of $200,000 cash and 1,342,524 shares of newly-issued shares of the
Company's common stock. The acquisition will be accounted for under the purchase

F-20
<PAGE> 46
GENERAL MAGIC, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

method. The Company expects that a significant component of the purchase price
will be attributable to in-process research and development.

Key Employee Agreement

On February 6, 1998, the Company issued 280,000 shares of restricted common
stock pursuant to a retention agreement with a key employee. Pursuant to this
agreement, the Company also loaned the employee $382,000, which loan is secured
by real estate and the shares of restricted stock.

F-21
<PAGE> 47

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.

GENERAL MAGIC, INC.

By: /s/ STEVEN MARKMAN
------------------------------------
Steven Markman
Chairman of the Board, Chief
Executive
Officer and President

Dated: March 31, 1998

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Steven Markman and Mary E. Doyle his true
and lawful attorney-in-fact and agent, with full power of substitution and, for
him/her and in his/her name, place and stead, in any and all capacities to sign
any and all amendments to this Report on Form 10-K, and to file the same, with
all exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorney-in-fact and
agent full power and authority to do and perform each and every act and thing
requisite and necessary to be done in connection therewith, as fully to all
intents and purposes as he/she might or could do in person, hereby ratifying and
confirming all that said attorney-in-fact and agent, or his/her substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.

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

<TABLE>
<CAPTION>
SIGNATURE TITLE: DATE:
--------- ------ -----
<S> <C> <C>
By: /s/ STEVEN MARKMAN Chairman and Chief Executive March 31, 1998
-------------------------------------------- Officer (Principal
Steven Markman Executive)

By: /s/ JAMES P. MCCORMICK Chief Financial Officer March 31, 1998
-------------------------------------------- (Principal Financial and
James P. McCormick Accounting Officer)

By: /s/ MICHAEL E. KALOGRIS Director March 31, 1998
--------------------------------------------
Michael E. Kalogris

By: /s/ CARL F. PASCARELLA Director March 31, 1998
--------------------------------------------
Carl F. Pascarella

By: /s/ ROEL PIEPER Director March 31, 1998
--------------------------------------------
Roel Pieper

By: /s/ SUSAN G. SWENSON Director March 31, 1998
--------------------------------------------
Susan G. Swenson

By: /s/ DENNIS F. STRIGL Director March 31, 1998
--------------------------------------------
Dennis F. Strigl
</TABLE>
<PAGE> 48

GENERAL MAGIC, INC.

EXHIBITS
TO
FORM 10-K ANNUAL REPORT
FOR THE YEAR ENDED DECEMBER 31, 1997

<TABLE>
<CAPTION>
SEQUENTIALLY
NUMBERED
EXHIBIT NUMBER DESCRIPTION PAGE
-------------- ----------- ------------
<C> <S> <C>
23.1 Consent of Independent Auditors.............................
24.1 Power of Attorney (See signature page)......................
27.1 Financial Data Schedule.....................................
</TABLE>

<PAGE> 1
Exhibit 23.1

CONSENT OF INDEPENDENT AUDITORS

The Board of Directors
General Magic, Inc.

We consent to incorporation by reference in the registration statements (Nos.
333-12667, 333-33329, and 333-45751) on Form S-8 of General Magic, Inc. of our
report dated January 23, 1998, except for note 12 which is as of March 6, 1998,
relating to the consolidated balance sheets of General Magic, Inc., and
subsidiary (a development stage enterprise) as of December 31, 1997 and 1996,
and the related consolidated statements of operations, stockholders' equity
(deficit), and cash flows for each of the years in the three-year period ended
December 31, 1997, which report appears in the December 31, 1997, annual report
on Form 10-K of General Magic, Inc.

/s/ KPMG Peat Marwick

Mountain View, California
March 30, 1998

<ARTICLE> 5
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 17,414
<SECURITIES> 11,387
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 30,007
<PP&E> 11,994
<DEPRECIATION> 6,846
<TOTAL-ASSETS> 36,297
<CURRENT-LIABILITIES> 9,168
<BONDS> 5,645
0
0
<COMMON> 27
<OTHER-SE> 17,271
<TOTAL-LIABILITY-AND-EQUITY> 36,297
<SALES> 0
<TOTAL-REVENUES> 3,456
<CGS> 0
<TOTAL-COSTS> 928
<OTHER-EXPENSES> 33,224
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 349
<INCOME-PRETAX> (28,367)
<INCOME-TAX> 17
<INCOME-CONTINUING> (28,384)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (28,384)
<EPS-PRIMARY> (1.06)
<EPS-DILUTED> (1.06)

</TABLE>