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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-QSB
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Quarterly period ended September 30, 1998
or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _______ to _______
Commission File number 000-21907
Racom Systems, Inc.
(Exact name of small business issuer as specified in its charter)
Delaware 84-1182875
------------ --------------
State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
6080 Greenwood Village, CO
Greenwood Village, CO 80111
-------------------------------
(Address of principal executive offices)
(303) 771-2077
----------------
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes X No
There are 13,442,532 shares of the registrant's common stock, $.01 par value
outstanding as of November 6, 1998.
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RACOM SYSTEMS, INC.
FORM 10-QSB
INDEX
<TABLE>
<CAPTION>
Part I Financial Information Page
<S> <C>
Item 1. Balance Sheets as of September 30, 1998 and December 31, 1997 3
Statements of Operations for the three and nine months ended
September 30, 1998 and 1997 4
Statements of Cash Flows for the nine months ended
September 30, 1998 and 1997 5
Notes to Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 7
Part II Other Information and Signatures 12
</TABLE>
2
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RACOM SYSTEMS, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
-------------- -------------
(Unaudited)
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 584,722 $ 1,198,567
Accounts receivable-trade, net of reserve of $32,000
and $-0- in 1998 and 1997, respectively 20,271 43,042
Accounts receivable-related parties -- 26,720
Inventory 152,428 122,875
Prepaid and other expenses 40,810 62,833
------------ ------------
798,231 1,454,037
------------ ------------
PROPERTY AND EQUIPMENT:
Machinery and equipment 523,634 449,432
Furniture and fixtures 59,767 59,404
Leasehold improvements 3,328 3,328
------------ ------------
586,729 512,164
Less-accumulated depreciation (410,537) (351,982)
------------ ------------
176,192 160,182
------------ ------------
OTHER ASSETS:
Technology license from related party, net of
accumulated amortization of $960,775 and $842,541
in 1998 and 1997, respectively 1,439,225 1,557,459
------------ ------------
TOTAL ASSETS 2,413,648 3,171,678
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued liabilities 322,861 359,069
Accounts payable-related parties 20,000 20,780
Capital lease obligation 13,934 16,594
------------ ------------
356,795 396,443
------------ ------------
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value, 40,000,000 and 20,000,000
shares authorized, 13,442,532 and 13,222,532 shares
issued and outstanding, respectively 134,425 132,225
Additional paid-in capital 16,717,043 16,499,243
Accumulated deficit (14,794,615) (13,856,233)
------------ ------------
2,056,853 2,775,235
------------ ------------
$ 2,413,648 $ 3,171,678
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of these balance sheets.
3
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RACOM SYSTEMS, INC.
STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three months ended September 30 Nine months ended September 30
----------------------------------- ----------------------------------
1998 1997 1998 1997
---------------- ------------------ ---------------- -----------------
<S> <C> <C> <C> <C>
REVENUES:
Product sales $ 6,202 $ 51,625 $ 99,349 $ 157,561
Product sales-related parties -- 6,943 44,141 71,398
License revenues -- -- 1,500,000 --
License revenues-related party -- 10,650 -- 448,908
Research and development fees 15,000 -- 15,000 --
--------------- --------------- --------------- --------------
21,202 69,218 1,658,490 677,867
COST OF REVENUES:
Cost of revenues 4,017 74,433 80,061 318,283
Inventory write-down 22,000 -- 22,000 --
-------------- --------------- --------------- --------------
26,017 74,433 102,061 318,283
-------------- --------------- --------------- --------------
GROSS MARGIN (4,815) (5,215) 1,556,429 359,584
OPERATING EXPENSES
Research and development 241,438 272,675 725,505 829,936
General and administrative 397,037 279,567 1,015,539 753,303
Sales and marketing 214,996 258,992 681,580 748,345
Equity in loss of Racom Japan -- (42,669) -- 155,705
Amortization expense 39,411 39,411 118,233 119,090
-------------- --------------- --------------- --------------
892,882 807,976 2,540,857 2,606,379
LOSS FROM OPERATIONS (897,697) (813,191) (984,428) (2,246,795)
OTHER INCOME (EXPENSE)
Interest expense (535) (525) (1,730) (137,658)
Interest expense-related parties -- -- -- (17,405)
Interest income 12,201 30,544 46,730 80,346
Other 148 (8,529) 1,046 (63,319)
-------------- --------------- --------------- --------------
NET LOSS $ (885,883) $ (791,701) $ (938,382) $ (2,384,831)
-------------- --------------- --------------- --------------
-------------- --------------- --------------- --------------
NET LOSS PER SHARE-BASIC AND
DILUTED $ (0.07) $ (0.06) $ (0.07) $ (0.19)
WEIGHTED AVERAGE SHARES
OUTSTANDING 13,442,532 12,633,643 13,359,455 12,633,643
</TABLE>
The accompanying notes are an integral part of these financial statements.
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RACOM SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine months ended September 30
---------------- ----------------
1998 1997
---------------- ----------------
<S> <C> <C>
CASH FLOWS USED IN OPERATING ACTIVITIES:
Net loss $ (938,382) $ (2,384,831)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation and amortization 176,789 191,360
Bad debt expense 32,000 --
Inventory reserve 22,000 --
Equity in loss of Racom Japan -- 155,705
Amortization of debt offering costs -- 97,799
Decrease (increase) in:
Accounts receivable-trade (9,229) 37,356
Accounts receivable-related parties 26,720 9,699
License revenue receivable -- 646,162
Inventory (51,553) 7,120
Prepaid expenses and other 22,023 (49,159)
Increase (decrease) in:
Accounts payable and accrued liabilities (36,208) (237,572)
Accounts payable-related parties (780) (545,098)
Deferred license revenue -- (248,892)
Accrued interest -- 39,102
Accrued interest-related party -- 17,405
------------- -------------
NET CASH USED IN OPERATING ACTIVITIES (756,620) (2,263,844)
------------- -------------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchases of fixed assets (74,565) (50,220)
------------- -------------
NET CASH FLOWS USED IN INVESTING ACTIVITIES (74,565) (50,220)
------------- -------------
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Proceeds from issuance of common stock 220,000 7,125,000
Payment of deferred offering costs -- (1,020,484)
Payments on notes payable-related parties -- (2,126,103)
Payments on capital lease obligation (2,660) (867)
------------- -------------
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES 217,340 3,977,546
------------- -------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (613,845) 1,663,482
CASH AND CASH EQUIVALENTS, beginning of period 1,198,567 314,202
------------- -------------
CASH AND CASH EQUIVALENTS, end of period $ 584,722 $ 1,977,684
------------- -------------
------------- -------------
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 1,560 $ 39,852
Interest-related parties -- 287,001
Income taxes -- --
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
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RACOM SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
Note 1 - Basis of Presentation
The accompanying unaudited financial statements have been prepared without
audit pursuant to the rules and regulations of the Securities and Exchange
Commission. The financial statements reflect all adjustments which, in the
opinion of management, are necessary to present fairly the financial
position, results of operations and cash flows of Racom Systems, Inc. as of
September 30, 1998 and 1997 and for the periods then ended. Operating results
for the three and nine month periods ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 1998.
The unaudited financial statements should be read with the complete financial
statements and footnotes thereto included in the Company's Form 10-KSB for
the year ended December 31, 1997 previously filed with the Securities and
Exchange Commission.
As reflected in the accompanying financial statements, the Company has
generated substantial operating losses since inception and has yet to
generate sufficient revenues to fund its operations. During 1998, the
Company's primary source of cash was from the license fee received from
Hitachi (see Note 3) and the sale of 220,000 shares of common stock at $1.00
per share under the Company's employee stock option plan. Management intends
to fund its remaining operations through cash on hand at September 30, 1998.
The Company is currently in the process of identifying sources of short-term
and longer term debt and equity financing; however, there can be no assurance
that financing will be available or that the financing will include terms
acceptable to the Company. Subsequent to September 30, 1998, the Company
began to reduce its administrative, sales and engineering costs; however, if
the Company cannot increase revenues generating sufficient gross profit or
obtain financing, the Company will have to curtail further its operations.
These factors raise substantial doubt about the ability of the Company to
continue as a going concern. The financial statements do not include any
adjustments relating to the recoverability of assets and carrying amounts of
liabilities that might be necessary should the Company be unable to continue
as a going concern.
Note 2 - New Accounting Standards
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share." Under SFAS 128, primary earnings per share previously required under
Accounting Principles Board No. 15 is replaced with basic earnings per share.
Basic earnings per share is computed by dividing reported earnings available
to common stockholders by weighted average shares outstanding. No dilution
for any potentially dilutive securities is included. Diluted earnings per
share reflects the potential dilution assuming the issuance of common shares
for all dilutive potential common shares outstanding during the period. The
adoption of SFAS No. 128 had no effect on the previously reported loss per
share.
In June 1997, the FASB issued SFAS 130, "Reporting Comprehensive Income,"
which establishes standards for reporting and displaying comprehensive income
and its components (revenues, expenses, gains and losses) in a full set of
general purpose financial statements. SFAS 130 requires that all items that
are required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed
with the same prominence as other financial statements. SFAS 130 does not
require a specific format for that financial statement but requires that the
enterprise display an amount representing total comprehensive income for the
period in that financial statement. SFAS 130 is effective for financial
statements for periods beginning after December 15, 1997. No differences
exist between comprehensive income and net income for the Company for the
period ending September 30, 1998 or 1997.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" effective for fiscal years beginning
after June 15, 1999. SFAS No. 133 establishes accounting and reporting
standards requiring that every derivative instrument (including certain
derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. It
also requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met.
Special accounting for qualifying hedges allows a derivative's gains and
losses to offset related results on the hedged item in
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the income statement, and requires that a company must formally document,
designate, and assess the effectiveness of transactions that receive hedge
accounting. SFAS No. 133 may not be applied retroactively, and must be
applied to (a) derivative instruments and (b) certain derivative instruments
embedded in hybrid contracts that were issued, acquired, or substantively
modified after December 31, 1997 (and, at the company's election,before
January 1, 1998). Management believes that the impact of SFAS No. 133 will
not significantly affect its financial reporting.
In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of Start-Up
Activities". This statement is effective for financial statements for fiscal
years beginning after December 15, 1998. In general, SOP 98-5 requires costs
of start-up activities and organization costs to be expensed as incurred.
Initial application of SOP 98-5 should be reported as the cumulative effect
of a change in accounting principle. Management believes that SOP 98-5 will
not have a material impact on the financial statements.
Note 3 - License of Technology to Hitachi, Ltd.
On January 15, 1998, the Company executed an agreement, in conjunction with
Ramtron International Corporation ("Ramtron"), granting Hitachi Ltd.
("Hitachi") a worldwide, non-exclusive license to design, manufacture and
sell smart card products based on the Company's contactless, ferroelectric
smart card technology, and Ramtron's proprietary ferroelectric random access
memory ("FRAM") technology. In addition to these license rights, the Company
granted Hitachi option rights, for a predetermined option fee, to its Radio
Frequency Identification ("RFID") Technology, as defined in the agreement,
for a period up to December 31, 1999. As consideration for the rights granted
under the agreement, Hitachi will pay certain license fees and royalties to
the Company as defined in the agreement. The Company received the first
payment on the license on January 29, 1998, and the second payment on May 9,
1998. As additional consideration for the rights granted under the agreement,
Hitachi will provide engineering services for development of the Company's
RFID Products, as defined in the contract, and the Company and Ramtron have a
certain defined percentage call (subject to a maximum quantity) on Hitachi's
production capacity of RFID Products. The agreement remains effective until
expiration of the last of the Company's and Ramtron's patents.
Note 4 - Technology License
The Company's primary asset is a technology license related to the design and
manufacture of its products. The net book value of the technology license at
September 30, 1998 was $1,439,225. The Company has the rights under an
agreement to sublicense the technology to no more than five (5) separate
parties subject to certain approvals. The Company has, to date, sublicensed
such technology to three separate companies. Although the Company is
currently marketing products utilizing the technology and believes that the
unamortized cost of the technology can be recovered from product sales or
sublicensing agreements, given the Company's current financial position, the
Company's ability to execute its business plan and recover the carrying
amount is uncertain. The Company has not made a provision in the accompanying
financial statements for any loss which may result should the remaining cost
of the technology license not be recovered.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
The results of operations for the quarter and nine month period ended
September 30, 1998 are not necessarily indicative of the Company's expected
performance for any future period. Information contained herein is
supplemental to the Company's annual report on Form 10-KSB for the year ended
December 31, 1997 and the Company's Prospectus filed effective March 12, 1997.
Investors should carefully consider the following information as well as
other information contained in this Report before making an investment in the
Common Stock. Information contained in this Report contains "forward-looking
statements" which can be identified by the use of forward-looking terminology
such as "believes," "expects," "may," "should" or "anticipates" or the
negative thereof or other variations thereon or comparable terminology, or by
discussions of strategy. No assurance can be given that the future results
covered by the forward-looking statements will be achieved. The following
matters constitute cautionary statements identifying important factors with
respect to such forward-looking statements, including certain risks and
uncertainties, that could cause actual results to vary materially from the
future results covered in such forward-looking statements. Other factors
could also cause actual results to vary materially from the future results
covered in such forward-looking statements.
The Company is a developer and marketer of contactless smart card systems
("Smart Card(s)") used primarily in electronic commerce. Generally the size
of a credit card, Smart Cards are used in a number of consumer applications
including (i) access to restricted areas (replacing keys and identification
cards), (ii) public transportation fare collection (replacing bus tokens,
taxi cab charge cards, airline or railway tickets and the like), (iii) point
of sale purchases (replacing cash or credit cards at cafeterias, newsstands
and related point of sale locations where speed of purchase is important),
and (iv) miscellaneous small monetary transactions (replacing coins and cash
at parking lots, in vending
7
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machines and public telephones, etc.). Smart Card technology is also used in
industrial applications by attaching a "tag" containing the Smart Card
technology to the manufactured product in order to track the product from the
assembly line through quality control, warehousing, inventory control,
distribution and warranty.
The Company's Smart Cards are both "contactless" and "batteryless" and
therefore do not require the use of a magnetic stripe or insertion into a
terminal as is required by contacted cards ("Contacted Card(s)"), such as
credit cards and ATM cards. Contacted Cards in use today are typically
limited to storing information as opposed to "intelligent" Smart Cards, which
have processing capabilities similar to that of a personal computer. The
Company's Smart Card System involves direct wireless radio frequency
communications and magnetic induction between a chip in the Smart Card and a
terminal. Moreover, the Company's contactless Smart Card Systems do not
require insertion in a terminal or the use of a keypad and therefore may be
used by all members of the population regardless of age or physical ability
and in both indoor and outdoor locations.
The Company believes it was the first to successfully develop and introduce
contactless Smart Cards using FRAM technology and batteryless, radio
frequency ("RF") communications. The Company has primarily relied on its
licensed FRAM technology for the memory component of the Smart Cards.
Although the FRAM memory demonstrates quantifiable benefits by improving
processing speeds and reliability over competing memory technologies, it is
not currently being produced in sufficient volumes by a significant number of
manufacturers to achieve competitive costs. Complementary to its FRAM
technology, the Company also utilizes Electronically Erasable Programmable
Read-Only Memory ("EEPROM") technology in its Smart Card Systems, allowing
the Company to offer higher volume Smart Cards at a more competitive price.
The Company principally generates revenues from licensing, fee based custom
product development projects and sale of its Smart Card systems. In the
future, the Company anticipates that a substantial portion of its revenues
will be generated from custom product development projects, the sale of its
Smart Card systems and services. If the Company is unable to continually
replace larger custom product development projects as these projects are
completed, its operations will be adversely affected. Custom product
development projects are billed in stages based on certain agreed upon
performance milestones. Accordingly, financial results for any calendar
quarter may fluctuate widely depending on the stage of a project or the
amount of licensing payments in a particular quarter.
As reflected in the Company's Financial Statements, the Company has generated
substantial operating losses since inception and has yet to generate
substantial revenues to fund its operations. To date, the Company has
completed a series of smaller scale projects; however, the Company has not
yet completed a significant number of larger projects, and as a result, it is
uncertain whether the Company will be able to successfully market and sell
its Smart Card products in sufficient quantities and at sufficient prices and
volumes to fund its operations. During 1997, the Company experienced
significant cash flow deficits and liquidity shortages and funded its
operations primarily through licensing transactions and proceeds from the
sale of its Common Stock. During the nine months ended September 30, 1998,
the Company's operating revenues have been generated primarily from a
licensing transaction.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED
TO THE THREE MONTHS ENDED SEPTEMBER 30, 1997
REVENUES. Revenues decreased 69% to $21,202 for the three months ended
September 30, 1998 ("Third Quarter 1998"), from $69,218 for the three months
ended September 30, 1997 ("Third Quarter 1997"). Revenues for any calendar
quarter may fluctuate widely depending of the timing of a product shipment,
the stage of a project or the amount of licensing payments in a particular
quarter.
Product Sales. Product sales decreased 89% to $6,202 for Third Quarter 1998,
from $58,568 for Third Quarter 1997. To date, the Company has completed a
series of projects, many of which are small scale "pilot" projects, but may
have the potential for implementation on a larger scale. In some cases, these
demonstration projects are "rolled out" for full scale implementation,
however the demonstration phase often takes six to twelve months or longer.
Product sales in the Third quarter 1997 included approximately $7,000 of
sales of product to Racom Japan ("RJ"), of which the Company owns 19.9%, as
compared to no sales to RJ in the Third Quarter 1998.
License Revenues. License revenues in the Third Quarter 1997 represented
$10,650 for the recognition of deferred revenues on a license from RJ for the
manufacture and sale of FRAM based radio frequency products in Japan.
8
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COST OF REVENUES AND GROSS MARGIN. As a percentage of revenues, gross margin
decreased to (23)% in Third Quarter 1998, from (7)% for Third Quarter 1997.
Product Costs. The Company has not generated significant margin on product
sales in part because of competition with Contacted Cards which typically are
sold at a lower price than the Company's Smart Cards. Currently, production
volumes of the Company's products may not be sufficient to cover
manufacturing costs which are included in Cost of Revenues. Due to an
increase in availability of FRAM memory chips resulting in lower component
costs, and the use of EEPROM memory chips which are already available at
lower component costs, the Company expects to be able to lower its prices
while improving gross margin. In the Third Quarter 1998, the Company
established a $22,000 reserve to state its inventory at net realizable value.
License revenues. In both periods presented, gross margin is primarily a
result of license revenues which have no direct cost of revenues.
RESEARCH AND DEVELOPMENT EXPENSES ("R&D"). R&D decreased $31,237 from
$272,675 in Third Quarter 1997 to $241,438 in Third Quarter 1998. The
decrease is primarily due to the Company focusing on its internal engineering
resources and not utilizing the services of contractors in new product
development projects during Third Quarter 1998. During November 1997, a group
of engineers responsible for a specific project left the Company upon
completion of the project. Additional engineers with skills necessary to
complete new product development were hired. In Third Quarter 1997, the
Company incurred approximately $47,000 on outside engineering contractors for
software and hardware development and on contract services to develop card
packaging for its Smart Card products.
GENERAL AND ADMINISTRATIVE EXPENSES ("G&A"). G&A expenses increased $117,470
from $279,567 in Third Quarter 1997 to $397,037 in Third Quarter 1998. The
increase is primarily due to $45,000 severance costs to the former President
and CEO, $30,000 for the current Chairman for his services as interim
President and CEO, $43,000 for recruiting costs for the new President and CEO
hired in August 1998, and $23,000 for a consultant who is assisting the
Company in finding interim and longer term financing.
SALES AND MARKETING EXPENSES. Sales and marketing expenses decreased $43,996
from $258,992 in Third Quarter 1997 to $214,996 in Third Quarter 1998. Travel
expenses decreased approximately $10,000 between the Third Quarter periods.
Third Quarter 1997 included costs of approximately $19,000 for printing of
sales literature and $15,000 for outside consultants which were not incurred
in Third Quarter 1998.
EQUITY IN LOSS OF JOINT VENTURE. The Company currently owns 19.9% of RJ. RJ
was formed in 1993 for the purpose of marketing, distributing and supporting
the Company's Smart Card products to be sold in Japan. The Company accounts
for its investment on the cost method. In Third Quarter 1997, the Company
owned 22.8% of RJ and accounted for its investment under the equity method,
recognizing its proportionate share of RJ's losses.
AMORTIZATION EXPENSE. The Company's primary asset is a technology license
related to the design and manufacture of its Smart card products. The asset
is amortized over its estimated useful life on a straight line basis.
OTHER INCOME (EXPENSE). During Third Quarter 1998 and 1997, the Company
earned $12,201 and $30,544, respectively, in interest income on its cash
balances held primarily in a government obligations fund with an average
maturity of less than 90 days.
NET LOSS. The Company is a C Corporation under the Internal Revenue Code and
for income tax reporting purposes as of December 31, 1997, has approximately
$13,700,000 of net operating loss carryforwards that expire at various dates
through 2012. The Tax Reform Act of 1986 contains provisions which may limit
the net operating loss carryforwards available to the Company in any given
year if certain events occur, including significant changes in ownership
interests.
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RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED
TO THE NINE MONTHS ENDED SEPTEMBER 30, 1997
REVENUES. Revenues increased 145% to $1,658,490 for the nine months ended
September 30, 1998 ("Interim 1998"), from $677,867 for the nine months ended
September 30, 1997 ("Interim 1997"). Revenues for any calendar quarter may
fluctuate widely depending on the timing of a product shipment, the stage of
a project or the amount of licensing payments in a particular quarter.
Product Sales. Product sales decreased 37% to $143,490 for Interim 1998, from
$228,959 for Interim 1997. To date, the Company has completed a series of
projects, many of which are small scale "pilot" projects, but may have the
potential for implementation on a larger scale. In some cases, these
demonstration projects are "rolled out" for full scale implementation,
however the demonstration phase often takes six to twelve months or longer.
Product sales in Interim 1998 included approximately $44,000 of sales of
product to RJ, of which the Company owns 19.9%, as compared to approximately
$71,000 for Interim 1997.
License Revenues. License revenues increased 234% to $1,500,000 for Interim
1998, from $448,908 for Interim 1997. Interim 1997 included the recognition
of deferred revenues on a license from RJ for the manufacture and sale of
FRAM based radio frequency products in Japan of $238,242. In 1996, pursuant
to the technology license discussed above, RJ entered into a custom product
development project with Fujitsu, Ltd. under which the Company is entitled to
50% of all sublicense revenue earned by RJ. This sublicense resulted in the
Company recording and receiving sublicense revenue of $210,666 during Interim
1997. The increase in license revenues reflects the execution of the
licensing contract with Hitachi, Ltd. which closed in January 1998, and under
which the Company received the first installment of the initial license fee
payment in January 1998 and the final initial license fee payment in May 1998.
COST OF REVENUES AND GROSS MARGIN. As a percentage of revenues, gross margin
increased to 94% in Interim 1998, from 53% for the same period in 1997.
Product Costs. The Company has not generated significant margin on product
sales in part because of competition with Contacted Cards which typically are
sold at a lower price than the Company's Smart Cards. Currently, production
volumes of the Company's products may not be sufficient to cover
manufacturing costs which are included in Cost of Revenues. Due to an
increase in availability of FRAM memory chips resulting in lower component
costs, and the use of EEPROM memory chips which are already available at
lower component costs, the Company expects to be able to lower its prices
while improving gross margin. In the Third Quarter 1998, the Company
established a $22,000 reserve to state its inventory at net realizable value.
License revenues. In both periods presented, gross margin is primarily a
result of license revenues which have no direct cost of revenues.
RESEARCH AND DEVELOPMENT EXPENSES ("R&D"). R&D decreased $104,431 from
$829,936 in Interim 1997 to $725,505 in Interim 1998. The decrease is
primarily due to changes in the personnel responsible for the product
development. In November 1997, a group of engineers responsible for a
specific project left the Company upon completion of the project. Additional
engineers with skills necessary to complete new product development were
hired. Overall, these changes resulted in a small increase in personnel
expenses. Additionally, the changes resulted in the Company focusing on its
internal engineering resources and not utilizing the services of contractors
in new product development projects. During Interim 1997, the Company
incurred approximately $152,000 on outside engineering contractors for
software and hardware development and on contract services to develop card
packaging for its Smart Card products.
GENERAL AND ADMINISTRATIVE EXPENSES ("G&A"). G&A increased $262,236 from
$753,303 in Interim 1997 to $1,015,539 in Interim 1998. Interim 1998 includes
increasing expenditures approximating $30,000 relating to investor relations
consulting, securities legal and Nasdaq filing expenses incurred after the
Company's initial public offering ("IPO") which was completed on March 12,
1997. The Company also recognized approximately $17,000 of additional expense
relating to the Directors and Officers Liability Insurance policy which was
not effective until March, 1997, and was renewed in March 1998. Interim 1998
also includes an increase in consulting and office expenses of approximately
$67,000 due to increased audit fees, mergers & acquisitions research
consulting and legal consulting expenses. Interim 1998 also includes $45,000
in severance costs for the former President and CEO, $30,000 for the
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current Chairman for his services as interim President and CEO, $68,000 for
recruiting costs for the new President and CEO hired in August 1998 and
$23,000 for a consultant who is assisting the Company in finding interim and
longer term financing.
SALES AND MARKETING EXPENSES. Sales and marketing expenses decreased $66,765
from $748,345 in Interim 1997 to $681,580 in Interim 1998. Sales & Marketing
expenses for the Interim 1997 included $32,000 in recruiting costs as well as
expenses for sales literature and outside consultants which where not
incurred in Interim 1998.
EQUITY IN LOSS OF JOINT VENTURE. The Company currently owns 19.9% of RJ. RJ
was formed in 1993 for the purpose of marketing, distributing and supporting
the Company's Smart Card products to be sold in Japan. The Company accounts
for its investment on the cost method. In Interim 1997, the Company owned
22.8% of RJ and accounted for its investment under the equity method,
recognizing its proportionate share of RJ's losses.
AMORTIZATION EXPENSE. The Company's primary asset is a technology license
related to the design and manufacture of its Smart card products. The asset
is amortized over its estimated useful life on a straight line basis.
OTHER INCOME (EXPENSE). During Interim 1997, the Company incurred $58,396 in
interest expense on various notes payable to Intag International Limited
("Intag") and Ramtron International Corporation ("Ramtron") and a group of
lenders. The notes to Intag carried interest at 10% and the notes to Ramtron
and the group of lenders carried interest at prime plus 2%. The notes and
accrued interest were paid in 1997 upon completion of the Company's initial
public offering. Other expenses during Interim 1997 included $29,000 withheld
from the proceeds of the license revenue earned on the sublicense to Fujitsu
for Japanese taxes and $22,000 in currency exchange losses.
NET LOSS. The Company is a C Corporation under the Internal Revenue Code and
for income tax reporting purposes as of December 31, 1997, has approximately
$13,700,000 of net operating loss carryforwards that expire at various dates
through 2012. The Tax Reform Act of 1986 contains provisions which may limit
the net operating loss carryforwards available to the Company in any given
year if certain events occur, including significant changes in ownership
interests.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary need for capital has been to finance expansion of
research and development of new Smart Card products, sales and marketing of
its products and operations. Annual product revenues growth has been limited
due to limited financial resources and an inability to expand receivables,
build inventory and effectively sell and market Smart Card products.
The Company had cash and cash equivalents of $1,198,567 and $584,722 as of
December 31, 1997 and September 30, 1998, respectively. During Interim 1998,
the Company's primary source of cash was from the initial license fee
payments received under the Hitachi license agreement, and the sale of
220,000 shares of common stock to a former employee upon the exercise of
employee stock options at $1.00 per share. During the Third Quarter 1998, the
Company generated losses of approximately $886,000 because the Company had no
license revenues, minimal product sales and $893,000 of operating expenses.
Management of the Company intends to fund its remaining 1998 operations
through cash on hand at September 30, 1998. The Company is in the process of
identifying sources of short-term and longer term debt and equity financing.
There can be no assurance that financing will be made available or that the
financing will include terms acceptable to the Company. Subsequent to
September 30, 1998, the Company began to reduce its administrative, sales and
engineering costs, however; if the Company cannot increase revenues
generating sufficient gross profit or obtain financing, the Company will have
to curtail further its operations.
The Company must also maintain certain requirements in order to be listed on
Nasdaq. These requirements include maintaining a specified level of net
tangible assets, as defined, market capitalization or net income.
Additionally, the Company must maintain a specified level of publicly traded
shares, market value of the publicly traded shares, minimum bid price, number
of market makers and shareholders. The minimum bid price of the Company's
stock was listed below $1.00 for three consecutive days. The Company has
received a delisting notification from Nasdaq and
11
<PAGE>
intends to discuss the notification with officials of Nasdaq. However, there
can be no assurance that the Company's efforts will be successful or that the
Company will be able to maintain its Nasdaq listing.
YEAR 2000
The Company utilizes software and related technologies throughout its
business and relies on many suppliers of services and materials that will be
affected by the date change in the year 2000. The Year 2000 issue exists
because many computer systems and applications currently use two-digit fields
to designate a year. As the century date change occurs, date-sensitive
systems will recognize the year 2000 as 1900, or not at all. This inability
to recognize or properly treat the Year 2000 may cause systems to process
critical financial and operational information incorrectly.
The Company has completed an internal study to determine the full scope and
related costs to insure that the Company's systems continue to meet its
internal needs and those of its customers. The results of the internal study
indicate that its products are not affected by the Year 2000 issue. In
addition, the results of the internal study indicate that certain software
utilized by the Company's internal systems will be affected by the Year 2000
issue, and steps to upgrade the software have begun. Management believes
these amounts are not significant and such expenditures will continue through
the year 1999 as upgrades become available.
The Company believes that there is a greater risk that its vendors, clients
and strategic partners will be affected by the Year 2000 problem. The Company
is currently unable to assess, and may be unable to accurately determine, the
magnitude of any Year 2000 problems that may reside in the computer and
information systems of its clients, vendors and strategic partners, or the
impact that any such problems could have on the products and services
provided by the Company to such clients. In addition to the internal study,
the Company has begun assessing the existence of any Year 2000 problems that
may reside in the computer systems and products of its vendors, clients and
strategic partners. The Company expects to complete the assessment phase by
December 31, 1998. The Company believes, based upon the progress to date,
that its suppliers and strategic partners are either Year 2000 compliant, or
are themselves in an assessment phase. However, there can be no assurance
that all such problems will be resolved. The Company plans to develop a
contingency plan as a result of its findings during this assessment phase.
The occurrence of Year 2000 related failures in the computer and information
systems of any of the Company's significant clients, vendors or strategic
partners could have a materially adverse effect on the business, results of
operations and financial condition of the Company.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
-----------------
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
-----------------------------------------
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
-------------------------------
None
12
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
A Special Meeting of Stockholders was held on September 15, 1998. The
following proposals were approved by the stockholders.
Proposal #1 - To increase the Company's authorized shares of common
stock from 20,000,000 shares to 40,000,000 shares.
<TABLE>
<CAPTION>
For Against Withheld
<S> <C> <C>
12,181,131 266,121 16,400
</TABLE>
Proposal #2 - To increase the number of shares reserved for issuance
under the Company's 1993 Employee Stock Option Plan from 1,700,000
shares to 3,200,000 shares.
<TABLE>
<CAPTION>
For Against Withheld Not Voted
<S> <C> <C> <C>
10,591,915 288,481 4,025 1, 579,231
</TABLE>
ITEM 5. OTHER INFORMATION
------------------
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
----------------------------------
(a.) Exhibits:
<TABLE>
<CAPTION>
Exhibit No. Title
----------- ---------
<S> <C>
27 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
None
13
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
Racom Systems, Inc.
/s/Arthur B. Rancis Date: November 16, 1998
- -------------------
Arthur B. Rancis
President, Chief Executive Officer and
Chief Financial Officer
/s/ Margaret Von der Schmidt Date: November 16, 1998
- -----------------------------
Margaret Von der Schmidt
Controller
14
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 584,722
<SECURITIES> 0
<RECEIVABLES> 52,271
<ALLOWANCES> (32,000)
<INVENTORY> 152,428
<CURRENT-ASSETS> 798,231
<PP&E> 586,729
<DEPRECIATION> 410,537
<TOTAL-ASSETS> 2,413,648
<CURRENT-LIABILITIES> 356,795
<BONDS> 0
0
0
<COMMON> 134,425
<OTHER-SE> 1,922,428
<TOTAL-LIABILITY-AND-EQUITY> 2,413,648
<SALES> 143,490
<TOTAL-REVENUES> 1,658,490
<CGS> 102,061
<TOTAL-COSTS> 2,642,918
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,730
<INCOME-PRETAX> (938,382)
<INCOME-TAX> 0
<INCOME-CONTINUING> (938,382)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (938,382)
<EPS-PRIMARY> (.07)
<EPS-DILUTED> (.07)
</TABLE>
