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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
(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 No. 0-27646
RACOM SYSTEMS, INC.
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(Name of Small Business Issuer in its Charter)
DELAWARE 84-1182875
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
6080 Greenwood Plaza Blvd.
Greenwood Village, CO 80111
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (303) 771-2077
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the
Exchange Act:
$.01 Par Value Common Stock
Common Stock Purchase Warrants
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(Title of Class)
Check whether the Issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the Company was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes X No ___
Check if there is no disclosure contained herein of delinquent filers in
response to Item 405 of Regulation S-B, and will not be contained, to the best
of the Company's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [ ]
The Issuer's revenues for its year ended December 31, 1997 were $902,280.
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As of March 16, 1998, the aggregate market value of the shares of the issuer's
Common Stock held by non-affiliates was approximately $1.531 per share based
upon the closing price per share as reported on the Nasdaq SmallCap Market.
There were 13,272,532 outstanding shares of the issuer's Common Stock on March
16, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Issuer's definitive Proxy Statement relating to the Annual
meeting of the Stockholders of the Issuer to be held on April 22, 1998, are
incorporated by reference into Part III of this Form 10-KSB.
FORWARD-LOOKING STATEMENTS
Statements contained in this Report which are not historical in nature are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements include
statements in "Item 1. Business," "Item 5. Market for Common Equity and Related
Stockholder Matters," and "Item 6. Management's Discussion and Analysis of
Financial Condition and Results of Operations," 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.
Such forward-looking statements involve certain risks and uncertainties that
could cause actual results to differ materially from anticipated results. These
risks and uncertainties include regulatory constraints, changes in laws or
regulations governing the Company's products and international trade, the
ability of the Company to market successfully its products in an increasingly
competitive worldwide market, changes in the Company's operating or expansion
strategy, failure to consummate or successfully integrate proposed product
developments, the ability of the Company to manage growth, the general economy
of the United States and the specific global markets in which the Company
competes, the availability of financing from internal and external sources and
other factors as may be identified from time to time in the Company's filings
with the Securities and Exchange Commission or in the Company's press releases.
No assurance can be given that the future results covered by the forward-looking
statements will be achieved. The matters identified in "Item 1. Business--Risk
Factors" contain 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.
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RACOM SYSTEMS, INC.
FORM 10-KSB
FOR THE YEAR ENDED DECEMBER 31, 1997
INDEX
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PART I PAGE
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Item 1. Business 4
Item 2. Properties 15
Item 3. Legal Proceedings 15
Item 4. Submission of Matters to a Vote of Security Holders 15
PART II
Item 5. Market for Common Equity and Related Stockholder Matters 16
Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations 20
Item 7. Financial Statements and Supplementary Data 27
Item 8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 27
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act 27
Item 10. Executive Compensation 27
Item 11. Security Ownership of Certain Beneficial Owners and Management 27
Item 12. Certain Relationships and Related Transactions 28
Item 13. Exhibits and Reports on Form 8-K 28
SIGNATURES
Signatures 30
EXHIBITS 31
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PART I
ITEM 1. BUSINESS
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COMPANY OVERVIEW
The Company was incorporated in June 1991 and is a leading developer and
marketer of contactless smart card systems ("Smart Card(s)" or "Smart Card
System(s)"). Generally the size of a credit card, Smart Cards add the ability
and intelligence to store and process information with a computer chip embedded
inside the 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), (iii) point of sale purchases
(replacing cash or supplementing 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 machines and public telephones and the like). Smart Card
technology is also used in industrial applications such as attaching a "Smart
Tag" containing the Smart Card technology to a 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.
For consumers and providers of goods and services, the Company's Smart Cards
offer the convenience and accuracy of high speed transaction processing without
the requirement of carrying cash, checks or credit cards, thereby reducing the
threat of theft, inventory shrinkage, and payment fraud resulting from the
handling of cash or the counterfeiting of cash or credit cards. Goods and
services providers do not risk loss from (i) accepting cash or checks which may
be subsequently stolen from them after payment by consumers or (ii) accepting
credit cards which may have been stolen prior to such payment. Consumer loss is
limited because the Smart Card is programmed to be used to purchase only
specific goods or services. Thus, the Smart Card is not as attractive to a thief
when compared to stolen cash, checks or credit cards.
The Smart Card is designed to complement credit cards rather than replace them
in that Smart Card applications involve the storage and handling of
substantially more data than credit cards and can therefore be used for other
applications (rather than just purchase and sale transactions) such as
identification of the user, loyalty programs and other portable data functions.
The Company sells its Smart Card Systems through its own direct sales force,
Original Equipment Manufacturers ("OEM's"), a combination of joint ventures and
strategic alliances and selective licensing and distributorship arrangements and
agreements with independent sales representatives in foreign countries.
Since 1993, the Company has supplied Smart Card Systems to over 100 customers in
cities throughout the world including Singapore, Macau, Hong Kong, Tokyo,
Manchester, Paris, Milan, Los Angeles, Chicago and Denver. 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 6-12 months or
longer. Examples of the Company's Smart Card projects (five of which are
discussed below as representative of the Company's projects) include the
following:
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USER (LOCATION) DESCRIPTION OF INSTALLATION
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Chep Lap Kok International Airport--(Hong Kong) access control, point of sale and payroll
City of Lompoc and Ventura County, California--
(United States) automatic fare collection
Lubbock International Airport--(United States) parking facility fee collection
Honeywell, Inc.--(United States) factory automation
Login BV --(Holland) access control, e-commerce &
facility management
Chicago Transit Authority--(United States) automatic fare collection
Yamatake Honeywell Limited--(Japan) factory automation
City of Winston-Salem Transit Authority--
(United States) automatic fare collection
LWD, Inc.--(United States) hazardous waste tracking
Microlise Engineering Limited--(United Kingdom) access control
Boreal Ridge Corp.--(United States) maintenance tracking
Nittetsu Shoji Co., Ltd.--(Japan) point of sale/cafeteria and access
control
ST Electronic & Engineering Limited-- (Singapore) access control
UVM s.r.l. Ufficio Vendita Macchine--(Italy) point of sale
Transmac Transportes Urbanos DeMacau, S.A.R.L.
("Transmac")--(Macau) automatic fare collection
Tyco Printed Circuit Group--(United States) factory automation
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A Smart Card System at the Chep Lap Kok International Airport under construction
in Hong Kong accepts the Company's Smart Cards as a form of access by employees
onto the airport site and is the only form of payment accepted at airport
cafeterias, in vending machines, and at other employee facilities. The Smart
Cards may be used to charge expenses to the employee's employer and offer an
additional purse for the employee's own purchases.
A Smart Card System operational in the City of Lompoc and in Ventura County,
California collects bus fares using the Company's Smart Card Systems. Passengers
purchase Smart Cards loaded with bus fares and wave the Smart Card near a
terminal as they board the bus. The Company has been advised that bus dwell time
has been reduced and passenger boarding has become substantially more efficient.
A parking facility payment system developed for use at Lubbock International
Airport uses the Company's Smart Card Systems for access into parking areas and
for fee collection. The Smart Card System allows parkers to enter the facility
by presenting the Smart Card at the gate. When leaving, the customer again
presents the Smart Card, which is debited for
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the parking fees. Parking lot management has reported that the Company's
Smart Card System has lowered overhead costs and decreased waiting times at
the parking gates.
Critical manufacturing data, such as routine information, job instructions and
status, is distributed and processed throughout the manufacturing floor between
the Company's Smart Tags, workstations and robots at a Honeywell, Inc.'s Home
Products Division site. The advanced Smart Tags automate the production of home
control thermostats.
Local children, families and senior citizens in Schagen and Vlaardingen,
Holland, are using the Company's Smart Card Systems to pay for access to
swimming pools, lockers and recreation amenities such as tanning salons, saunas
and automated vending machines. As a result, cash, tokens and keys have been
replaced, reducing risks and costs associated with cash-based equipment,
including theft and fraud. In other Dutch cities, a waste management system
enables residents to deposit household waste into underground bins located near
densely populated residential complexes. The Smart Cards assist in controlling
access to the bins and track the usage of the bins.
In 1997, the Company announced a third generation series of its advanced Smart
Card Products, the RX Series. The new RX series of Smart Card Systems offers a
level of security and flexibility in contactless operation that previously could
only be achieved in contacted operation. The RX series is designed to meet the
needs of multi-application environments. For example, they can support a
healthcare database, electronic commerce, travel, loyalty and access control in
one Smart Card, thereby reducing the quantity of plastic cards carried in a
wallet. Smart Cards to be developed under this new series are planned to include
disposable cards, which are not rechargeable and are disposed of after use, as
well as cards and systems that support user configurable, application-specific
programs with more powerful processors and larger amounts of memory for banking,
biometrics and other complex applications. The Company believes the RX Series
Smart Cards will be of interest to Smart Card System integrators who wish to
install contactless systems without substantially modifying their Contacted Card
applications software or to eliminate less reliable Contacted Card terminals and
related hardware.
SMART CARD INDUSTRY OVERVIEW
Smart Card products, including the Company's Smart Card (collectively referred
to as "generic smart cards"), are typically the size of a plastic credit/debit
card containing an integrated circuit chip ("chip") which can process and store
information. Today's generic smart cards typically have the processing power of
an early 1980's vintage personal computer, minus a keyboard, display and power
supply. Because generic smart cards are really portable computers, they can be
programmed to perform virtually any function which can be implemented by
software in the available memory space. Generic smart cards benefit directly
from ongoing advances in semiconductor technology making available continuously
increasing performance and features at declining cost.
There are two basic types of generic smart cards, memory cards and
microprocessor cards, each of which can interface between the generic smart card
and a terminal on a contacted or contactless basis. Memory cards are typically
used to store and retrieve information only and do not have the capability of
performing complex processing of information. Microprocessor cards are true
"smart" cards in that they contain a central processing unit within a chip which
can perform a number of functions, including complex arithmetic operations
required for security. In excess of 90% of all generic smart cards sold in 1995
were memory cards with contacted interfaces requiring alignment and insertion of
the generic smart card into a terminal to complete an electrical circuit with
the metal contacts on the surface of the card. While contacted generic smart
cards have found broad use in high volume, cost sensitive applications, such as
pay phone systems which use contacted generic smart cards, they are expensive to
maintain, less reliable and may be considered too slow for applications such as
transportation. To address the perceived shortcomings of the contacted generic
smart card, a contactless generic smart card was first developed and introduced
in the early 1990's. According to the consulting firm Frost & Sullivan, more
than 676 million generic smart cards were issued in 1996.
According to the U.S. Federal Reserve, 68% of the approximately 360 billion
financial transactions completed in 1995 were for transactions of less than
$2.00 each. Electronic commerce using electronic funds transfer, magnetic stripe
cards and generic smart cards accounted for less than ten percent of all such
transactions, but grew at an annual rate of 17% versus 1% growth for
transactions using cash, coin and checks. The Company believes that the
evolution of personal computers, the Internet and generic smart cards represent
technologies which will contribute to the growth of electronic commerce in the
future. According to a report by Killen & Associates, "Non-Banks Smart Card
Strategies: New Opportunities To Increase Sales and Profits," the generic smart
card market will triple to 30 billion transactions by 2005. Furthermore,
according to a report by International Data Corporation, as published by the
Smart Card Forum, a multi-
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industry group formed to explore the use of generic smart cards in various
applications, the growth in the number of online buyers and the amount of an
average transaction will drive electronic commerce up from $2.6 billion in
1996 to more than $220 billion in 2001.
According to market research performed by Dataquest, as published by the Smart
Card Forum, the generic smart card market will grow to 3.4 billion units by
2001, a rate of 30% each year. Dataquest has also determined that sales of
generic smart cards in Europe accounted for 90% of worldwide smart card
shipments in 1995, while the Americas accounted for only 2%. By the year 2001,
the ratios are expected to change to 40%, 25% and 20% for Europe, Asia and the
Americas, respectively. Asia, Latin America and North America are areas
generally believed to be of greatest potential for generic smart card growth in
the next three years.
Costs play an important role in this emerging industry. Recent reports in CARD
TECHNOLOGY magazine (September 1997) indicate that price competition is fierce.
Frost & Sullivan reported average selling prices of Contactless Smart Cards in
mid-1996 at $5.50 per unit at high volume. During 1997, the largest Contactless
Smart Card competitors sold these cards at $2.50 per unit, if not lower or even
below cost, affecting profit margins on the products.
Generic smart card products and markets have only recently begun to develop, are
rapidly evolving and are characterized by an increasing number of market
entrants who have developed or are developing a wide variety of products. As is
typical in a new and rapidly evolving industry, demand and market acceptance for
new products are subject to a high level of uncertainty. There is no assurance
that the Company's Smart Cards will become widely accepted. If the market fails
to develop, develops more slowly than expected or becomes saturated with
competitors, or if the Company's Smart Cards do not achieve market acceptance,
the Company's business, operating results and financial condition may be
materially adversely affected.
STRATEGY
The Company's mission is to achieve sustained leadership in developing and
delivering contactless Smart Card solutions for electronic commerce, while
securing worldwide acceptance and usage of its technology in Smart Card chips.
The following discussions represent the Company's business strategy.
PRODUCT DEVELOPMENT
The Company believes its technology provides distinct advantages over known
competing Smart Card Systems including: (i) higher speed making possible
real-time processing; (ii) lower power consumption with no battery requirements;
and (iii) reliability with a virtually unlimited card life. The Company
continues to demonstrate its abilities in the fields of radio frequency ("RF")
analog and digital circuit design. The RX Series of Smart Cards recently
developed by the Company offers a level of security and flexibility in
contactless operation that could only previously be achieved in contacted
operation.
Key to the success of new generations of Smart Card Systems is the Company's
strength in communication protocol implementation. This core competency is
important because of the continuous evolution of Smart Card standards. The
Company's product development team strives to develop Smart Card Systems which
will not only comply with the evolving standards, but will also continue to
communicate with existing Smart Card Systems.
In order to meet the needs of the various Smart Card applications, including
access control, electronic commerce and industrial automation, the Company's
Smart Card Systems must be adaptable to varying environments. The Company's
product development team has expertise in antenna design, encryption and
authentication algorithms, as well as operating systems.
The Company believes it was the first to successfully develop and introduce
contactless Smart Cards using ferroelectric random access memory ("FRAM")
technology and batteryless, RF communications. In previous years, the Company
has primarily relied on its proprietary 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 now 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. Utilizing both the FRAM and EEPROM
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memory technologies involves the coordination of a variety of Integrated
Circuit vendors and the management of semiconductor foundry development.
The Company intends to continue to design and develop Smart Card Systems
utilizing both the FRAM and EEPROM technologies in order to achieve leadership
in Contactless Smart Card technology. The Company's research and development
efforts will focus on developing new Smart Card products and systems for
automating financial transactions and further enhancing Smart Card performance,
reliability and cost effectiveness. However, there is no assurance that these
development efforts will result in commercially viable products.
The Company incurred R&D expenses of $1,234,096 in 1997 and $505,266 in 1996.
During 1997, the Company incurred approximately $250,000 for development of the
Company's latest products, the RX Series, not including personnel costs
associated with the RX Series product development. Generally, the costs of R&D
activities are borne by the Company.
MARKETING
The Company promotes and markets its Smart Card Systems on a worldwide basis
using a multi-faceted marketing and sales strategy.
The Company's near term strategy is designed to address primarily "closed"
systems in the transportation and entertainment and leisure market segments. A
"closed" system is one in which the cash purse on the card can only be used for
purchases at specific locations closely tied to the card issuer. These market
segments will be addressed by the Company's high end, transaction oriented,
Smart Card Systems. An example is a transit authority in which the card is used
to board buses and trains and has the capability to purchase coffee and
newspapers through merchants located in the transit station. In addition, the
Company is also pursuing the industrial automation and access control markets
with its lower end, memory based, systems. The Company believes that these
"closed" system applications offer the greatest opportunity for its products for
the next several years.
A key component of the Company's marketing strategy is to leverage its licensing
arrangements and strategic alliances to develop new products and increase market
share in its targeted markets. To that end, the Company is pursuing, and intends
to continue to pursue, joint product development efforts with licensees,
including Hitachi, Ltd. ("Hitachi"), Fujitsu, Ltd. ("Fujitsu") and Rohm Co.,
Ltd. ("Rohm"). Additionally, the Company will pursue co-op marketing activities
with these same licensees as well as other key strategic partners.
In late 1997, the Company recognized that a strategy of acting as the prime
contractor for Smart Card projects was not feasible due to the cost and risk
associated with these projects. Other direct sales efforts targeted at smaller
industrial installations, while successful, have also proven to be costly in
terms of the technical support required to sustain the installation. The
Company has therefore re-focused its efforts on developing an OEM sales
channel for the North American market. The Company believes that by developing
relationships with properly selected and trained OEMs, it can maximize revenue
and improve margins. Margin improvement will be derived from increased volumes
and decreased support costs.
The Company's sales and marketing group consists of 6 full-time employees and is
based at the Company's headquarters in Greenwood Village, Colorado. The Company
will continue to utilize its existing network of independent sales
representatives in Canada, Mexico, Germany, Italy, the Netherlands and the
United Kingdom. These representatives will focus their efforts on pursuing OEM's
and other large strategic accounts as defined by the Company.
In Japan, the Company has entered into agreements with Racom Japan, Inc. ("RJ")
to market and sell the Company's Smart Card Systems on a non-exclusive basis. RJ
is 19.9% owned by the Company and cooperates with the Company on hardware
development and licensing activities.
In France, the Company has entered into a non-exclusive distribution agreement
with Bull CP8, a division of Group Bull. Bull CP8 distributes the Company's
Smart Card products worldwide, with emphasis on the European market.
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The Company also markets its Smart Card Systems through participation in trade
shows, publication of trade articles, participation in industry forums and
technological standard-setting organizations and through distribution of sales
literature. The Company encourages customer referrals and has used certain
customer Smart Card installations as demonstration sites for its Smart Card
products. The Company has established an Internet web site and electronic mail
capability.
Four customers (Echelon Industries, Inc., Honeywell, Inc., Login BV, and Tyco
Printed Circuit Group, Inc.) each accounted for 10% or more of the Company's
non-related party net product sales for the year ended December 31, 1997, and
three customers (CP8 Transac, Impulse Enterprises, Inc. and Transmac) each
accounted for 10% or more of the Company's non-related party net product sales
for the year ended December 31, 1996. Net product sales to related parties for
both 1997 and 1996 consisted primarily of sales to RJ.
MANUFACTURING AND ASSEMBLY
Since inception, the Company has subcontracted substantially all of its
manufacturing operations. The Company will continue to contract with third
parties to manufacture the Company's Smart Card products in order to avoid
capital intensive investments and to focus the Company's limited resources on
new product applications and software development.
The Company's manufacturing and assembly operations consist primarily of final
assembly, test, burn-in and quality control of Smart Card terminals as well as
programming, testing and quality control of the Smart Cards themselves (and
Smart Tags in the case of industrial applications). The Company subcontracts
assembly of Smart Cards, terminals and card lamination to multiple United
States, Japanese, and Asian based companies who specialize in this kind of
contract work. With increasing production volumes, the Company intends to
consolidate its outside contract manufacturing in order to gain greater
economies of scale and to better control product quality. The Company also
operates its own prototype Smart Card manufacturing facility to support new
product introductions and lower volume customer requirements.
The Company purchases a wide variety of electrical and mechanical components
as well as sub-assemblies for integration into the Company's Smart Card
Systems. With two notable exceptions, most materials are available from
several supply sources. The FRAM chips used in the Company's Smart Cards and
Tags are currently supplied by two sources, Ramtron International Corporation
("Ramtron") located in Colorado Springs, Colorado, and Rohm located in Kyoto,
Japan. Ramtron and Rohm own 36.3% and 3.8%, respectively, of the Company's
Common Stock. During 1998, the Company expects that one, and possibly two,
additional semiconductor manufacturer(s) will be available to supply the
Company's FRAM chips. The Company is dependent on maintaining at least one
reliable source of supply for its FRAM chips and its business would be
materially adversely affected if no such source were available. Currently, all
of the Company's terminals include a component manufactured by only one United
States company, Microchip Technology. If necessary, the Company could redesign
its terminals to use a similar component available from other semiconductor
manufacturers, although such a redesign would be time-consuming and expensive
and may adversely affect the Company's operations.
COMPETITION
The market for Smart Card products is new, intensely competitive, quickly
evolving and subject to rapid technological change. Competitors may develop
superior products or products of similar quality for sale at lower prices.
Moreover, there can be no assurance that the Company's Smart Card will not be
rendered obsolete by changing technology or new industry standards. The Company
expects competition to persist and increase in the future. The Company's current
and potential competitors are primarily subsidiaries of multinational companies
with established Contacted and Contactless Smart Card Products that have longer
operating histories, greater name recognition, larger customer bases and
significantly greater financial, technical and marketing resources than the
Company. This intense level of competition could materially adversely affect the
Company's future business, operating results and financial condition.
Competitive factors in the industry include transaction speed, the extent and
flexibility of Smart Card memory, reliability, transaction accuracy and cost,
all of which are discussed below. There can be no assurance that the Company
will be able to compete successfully against current or future competitors or
that competitive pressures faced by the Company will not materially adversely
affect its business, operating results and financial condition. Many of the
Company's competitors have the financial resources necessary to enable them to
withstand substantial price and product competition, which are expected to
increase, and to implement extensive advertising and promotional programs, both
generally and in response to efforts by other competitors to enter into existing
markets or introduce new products. The
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industry is also characterized by frequent introductions of new products. The
Company's ability to compete successfully will be largely dependent on its
ability to anticipate and respond to various competitive factors affecting
the Smart Card industry, including new products which may be introduced,
changes in customer preferences, demographic trends, pricing strategies by
competitors and consolidation in the industry where smaller companies with
leading edge technologies may be acquired by larger multinational companies.
Contacted Cards represent the Company's primary competition in electronic
commerce applications. Contacted Card competitors include such multinational
firms as Gemplus, Schlumberger and Group Bull. The Company believes that it is
able to compete favorably against Contacted Cards because the Company's
contactless Smart Cards (i) operate at higher speeds, (ii) do not require the
time and effort involved in inserting the Smart Card in a terminal or removing
the Smart Card from a wallet or purse, (iii) use reliable solid state
electronics with no moving parts, exposed contact points or magnetic stripes
which can be erased by a magnetic field, and (iv) are lower in cost over the
product life.
The Company also competes against contactless Smart Cards designed by Philips
GmbH, Sony Corporation, Gemplus, Motorola and Micron Communications, Inc., which
use contactless technologies similar to the Company's technology. The Company
believes that its Smart Cards compete favorably against these other contactless
technologies because the Company's contactless Smart Cards operate at higher
speeds, have higher endurance and do not require batteries for power.
The Company's Smart Cards are priced at parity with competitors' contactless
Smart Card products but sell at a premium to Contacted Cards. The Company
expects that its Smart Card manufacturing costs will diminish as volumes
increase and as other semiconductor manufacturers begin to offer FRAM chips for
use in the Company's Smart Cards.
Matsushita Electronics Corporation ("Matsushita"), a multinational semiconductor
manufacturer, has announced its intention to market a ferroelectric chip-based
Smart Card which will also communicate by radio frequency. The Company believes
that Matsushita's initial Smart Cards may offer smaller memories than those of
the Company; however, there can be no assurance that the introduction of these
competitive Smart Cards, even with smaller memories, will not materially
adversely affect the Company's operations. To date, Matsushita has not
introduced ferroelectric-based smart card products to the market.
REGULATION
The Company's Smart Card products use radio frequency communications and other
technologies which make them subject to regulation by the Federal Communications
Commission ("FCC") in the United States and to export licensing by the United
States Government when sold internationally. Smart Card products are subject to
similar regulation by some foreign governments for use within their countries.
All of the Company's products currently comply with FCC regulations, similar
regulations of the foreign countries in which the Company sells its products and
United States export license requirements. Future compliance with FCC
regulations, similar regulations in foreign countries and United States export
license requirements may be costly and time-consuming and may limit the
Company's ability to sell its Smart Card Products in certain jurisdictions.
Market needs and competitive pressures will require that the Company's products
contain certain regulated cryptographic algorithms in order to protect
information and cash substitutes stored in the Smart Cards. Export, import and
usage of such cryptographic algorithms are covered by a large and changing body
of regulations in the United States.
Federal, state and local regulations impose various environmental controls on
the discharge of chemicals and gases which may be used in the Company's present
or future assembly processes. Moreover, changes in such environmental rules and
regulations may require the Company to invest in capital equipment and implement
compliance programs in the future. Any failure by the Company to comply with
environmental rules and regulations, including the discharge of hazardous
substances, could subject it to serious liabilities and could materially
adversely affect its operations.
A "Report to the Congress on the Application of the Electronic Fund Transfer Act
to Electronic Stored-Value Products", in March 1997, by the Board of Governors
of the Federal Reserve System considers regulation of electronic stored-value
systems under the scope of Regulation E, as promulgated by the Department of
Treasury under the Electronic Fund Transfer Act, which governs electronic
transfers and provides consumer protection. Although there are no clear
decisions as to the level of regulation to be imposed on the stored-value
products, any changes in the regulation may be costly to implement or even cost
prohibitive, and could materially adversely affect the Company's operations.
10
<PAGE>
PATENTS AND TRADE SECRETS
The Company relies on its own patents, trade secrets and copyrights as well as
the patents, trade secrets and copyrights of its licensors to protect its Smart
Card technology. Due to rapid changes in the generic smart card industry, the
Company believes that development of trade secrets and unpatented proprietary
knowledge in connection with new products and technologies are generally as
important as patent and copyright protection in establishing and maintaining a
competitive advantage. Nevertheless, the Company has obtained patents and
copyrights on certain of its Smart Card technologies and will continue to
aggressively pursue patents and copyrights when available. To date, the Company
has been awarded six United States patents and is pursuing additional patents,
both in the U.S. and in certain foreign countries. The Company has a license,
including the right to grant a limited number of sublicenses, to use Ramtron's
FRAM chip technology, patents and improvements specifically for the development,
manufacture and sale of radio frequency identification devices, including the
Company's contactless Smart Cards.
There can be no assurance that any of the Company's future patent applications
will be granted, that any current or future patent or patent application will
provide significant protection for the Company's products or technology, be of
commercial benefit to the Company, or that the validity of such patents or
patent applications will not be challenged. Furthermore, there can be no
assurance that any patent underlying licensed technology will not be challenged.
Moreover, there can be no assurance that foreign patent, trade secret or
copyright laws will protect the Company's technologies or that the Company will
not be vulnerable to competitors who attempt to copy or use the Company's Smart
Card products or processes.
EMPLOYEES
As of March 23, 1998, the Company has a total of twenty-two employees. The
Company believes its relations with its employees are satisfactory.
RISK FACTORS
INVESTORS SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS AND THE OTHER
INFORMATION CONTAINED IN THIS REPORT BEFORE MAKING AN INVESTMENT DECISION WITH
REGARD TO THE COMPANY'S 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. SEE, E.G., "ITEM 7. MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND
"ITEM 1. BUSINESS." 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.
LIMITED OPERATING HISTORY AND LIMITED REVENUES; LOSSES AND INDEPENDENT PUBLIC
ACCOUNTANTS GOING CONCERN OPINION. The Company began operations in June 1991
and has a limited operating history upon which potential investors may base an
evaluation of its performance. Since inception, the Company has focused its
efforts and resources on developing its technology and on identifying products
and applications for introduction into the market. The Company has only
recently begun generating revenues from its operations and therefore the
Company has historically incurred significant operating losses and cash flow
deficits. For the years ended December 31, 1997 and 1996, the Company had
revenues of $902,280 and $2,427,285, respectively, and net losses of
$3,702,581 and $1,303,837, respectively. Moreover, at December 31, 1997, the
Company had working capital of $1,057,594 and had an accumulated deficit of
$13,856,233. The Report of Independent Public Accountants covering the
Company's December 31, 1997 financial statements, included elsewhere in this
Report, contains an explanatory paragraph about the Company's ability to
continue as a going concern. There can be no assurance that the Company's
operations will generate sufficient revenues to fund its operations and to
allow it to become profitable. The likelihood of the Company's success must be
11
<PAGE>
considered relative to the problems, experiences, difficulties, complications
and delays frequently encountered in connection with the operation and
development of a new business and the competitive environment in which the
Company operates. See "Item 7. Financial Statements."
DEVELOPING MARKET; UNPROVEN MARKET FOR THE COMPANY'S SMART CARD PRODUCTS. Smart
Card products and markets have only recently begun to develop, are rapidly
evolving and are characterized by an increasing number of market entrants who
have developed or are developing a wide variety of products. As is typical in a
new and rapidly evolving industry, demand and market acceptance for new products
are subject to a high level of uncertainty. There can be no assurance that the
Smart Cards designed by the Company will become widely accepted. Because the
market for the Company's Smart Cards is new and evolving, it is also difficult
to predict with any assurance the future growth rate, if any, and size of the
market. If a market fails to develop, develops more slowly than expected or
becomes saturated with competitors, or if the Company's Smart Cards do not
achieve market acceptance, the Company's business, operating results and
financial condition may be materially adversely affected. See "Item 1.
Business."
COMPETITION; FREQUENT PRODUCT INTRODUCTIONS. The market for Smart Card products
is new, intensely competitive, quickly evolving and subject to rapid
technological change. Competitors may develop superior Smart Card products or
products of similar quality for sale at lower prices. Moreover, there can be no
assurance that the Company's Smart Cards will not be rendered obsolete by
changing technology or new industry standards. The Company expects competition
to persist and increase in the future. The Company's current and potential
competitors are primarily subsidiaries of multinational companies with
established Contacted Card and contactless Smart Card businesses which have
longer operating histories, greater name recognition, larger customer bases and
significantly greater financial, technical and marketing resources than the
Company. This intense level of competition could materially adversely affect the
Company's future business, operating results and financial condition.
Competitive factors in the industry include transaction speed, the extent and
flexibility of Smart Card memory, reliability, transaction accuracy and cost.
Current competitors include such multinational firms as Gemplus, Schlumberger
and Group Bull, which primarily offer Contacted Cards, and Philips GmbH,
Motorola, Sony Corporation and Micron Communications, Inc., which offer
primarily contactless Smart Cards.
There can be no assurance that the Company will be able to compete successfully
against current or future competitors or that competitive pressures faced by the
Company will not materially adversely affect its business, operating results and
financial condition. Many of the Company's competitors have the financial
resources necessary to enable them to withstand substantial price and product
competition, which are expected to increase, and to implement extensive
advertising and promotional programs, both generally and in response to efforts
by other competitors to enter into existing markets or introduce new products.
The industry is also characterized by frequent introductions of new products.
The Company's ability to compete successfully will be largely dependent on its
ability to anticipate and respond to various competitive factors affecting the
industry, including new products which may be introduced, changes in customer
preferences, demographic trends and pricing strategies by competitors, which
could adversely affect the Company's operating margins.
RISKS OF NEW PRODUCT DEVELOPMENT. The Company may experience difficulties that
could delay or prevent the development, introduction and marketing of new Smart
Card products. The Company will be substantially dependent in the near future
upon Smart Card products that are currently being developed. There can be no
assurance that, despite testing by the Company, errors will not be found in the
Company's Smart Card products, or, if errors are discovered, corrected in a
timely manner. If the Company is unable to develop on a timely basis existing or
new Smart Card products or enhancements to existing products, or if its Smart
Card products do not achieve market acceptance, the Company's business,
operating results and financial condition may be materially adversely affected.
RISKS ASSOCIATED WITH EXPANSION. The Company will seek to develop and expand its
Smart Card products and increase its marketing operations. Expansion will place
substantial strains on the Company's management and its operational, accounting
and information resources and systems. Successful management of growth will
require the Company to improve its financial controls, operating procedures and
information systems, and to hire, train, motivate and manage its employees. The
Company's failure to manage growth effectively would have a material adverse
effect on its results of operations and its ability to execute its business
strategy.
OBSOLESCENCE AND TECHNOLOGICAL CHANGE. The markets for Smart Card
products are characterized by rapidly changing technology and evolving industry
standards which result in product obsolescence and short product life cycles.
12
<PAGE>
Accordingly, the Company's success is dependent upon its ability to anticipate
technological changes in the industry and to continually identify, develop and
successfully market new Smart Card products that satisfy evolving technologies,
customer preferences and industry requirements. There can be no assurance that
competitors will not market Smart Card products which have perceived advantages
over those of the Company or which render the Company's Smart Card products
obsolete or less marketable.
IMPEDIMENTS TO MARKET ACCEPTANCE OF PRODUCTS. As with other new products
designed to replace existing products or change product designs, potential
customers may be reluctant to integrate the Company's Smart Card products into
their systems unless the products are proven to be both reliable and available
at a competitive price in an assured quantity. Even assuming product acceptance,
the Company's customers may be required to redesign their systems to effectively
use the Company's Smart Card products. The time and costs necessary for such
redesign could delay or prevent market acceptance of the Company's Smart Card
products. A lack of, or delay in, market acceptance of one or more of the
Company's Smart Card products could adversely affect the Company's operations.
DEPENDENCE ON MANUFACTURERS AND SUPPLIERS. The Company purchases FRAM
semiconductor chips for its Smart Card products from two affiliated
manufacturers, Ramtron and Rohm, and purchases other components used in assembly
of its Smart Cards from other key suppliers. The Company's reliance upon outside
manufacturers and suppliers is expected to continue and involves several risks,
including limited control over the availability of components, delivery
schedules, pricing and product quality. The Company may also experience delays,
expenses and lost sales should it be required to locate and qualify alternative
suppliers.
RELIANCE UPON PATENTS AND TRADE SECRETS. The Company relies on its
patents, trade secrets and copyrights and the patents, trade secrets and
copyrights of its licensors to protect its Smart Card technology. Although the
Company intends to enforce its patents, trade secrets and copyrights
aggressively, there can be no assurance that such protection will be available
in any particular instance or that the Company will have the financial resources
necessary to adequately enforce its rights. The unavailability of such
protection or the inability to enforce adequately such rights could materially
adversely affect the Company's business and operating results. The Company
operates in a competitive environment in which it would not be unlikely for a
third party to claim that certain of the Company's present or future Smart Card
products or licensed technology may infringe the patents or rights of such third
parties. If any such infringements exist or arise in the future, the Company may
be exposed to liability for damages and may be required to obtain licenses
relating to technology incorporated into the Company's products. The Company's
inability to obtain such licenses on acceptable terms or the occurrence of
related litigation could materially adversely affect the Company's operations.
NEED FOR ADDITIONAL FINANCING. The Company anticipates, based on currently
proposed plans and assumptions relating to its operations, that its current
cash, together with projected cash flow from operations, will be sufficient to
satisfy its contemplated cash requirements for at least 12 months following the
date of this Report. In the event that the Company's plans change, its
assumptions prove to be inaccurate or its cash flow prove to be insufficient
(due to unanticipated expenses, inadequate revenues, difficulties, problems or
otherwise), the Company may be required to seek additional financing or curtail
its activities. Any issuance of equity securities would result in dilution to
the interests of the Company's stockholders and any issuance of debt securities
would subject the Company to risks that interest rates may increase or cash flow
may be insufficient to repay such indebtedness. The Company has no arrangements
or understandings for additional financing and there can be no assurance that
additional financing will be available to the Company if required.
DEPENDENCE UPON CUSTOM SYSTEM DEVELOPMENT PROJECTS. The Company relies upon
custom system development projects for a significant part of its revenues. The
inability of the Company to replace completed projects with new projects would
adversely affect the Company's operations.
RISKS ASSOCIATED WITH GOVERNMENT REGULATIONS. The Company's Smart Card products
use radio frequency technologies, emit radio frequency energy emissions and
their assembly may require the disposal of chemicals and gases during the
assembly process. Current and future U.S. and foreign governmental regulations
concerning radio frequency technologies, energy emissions and waste disposal
could adversely affect the Company's business operations and results of
operations.
DEPENDENCE UPON QUALIFIED PERSONNEL AND EXECUTIVE OFFICERS. The Company's
operations depend in part upon its ability to retain and hire qualified
personnel, of which there can be no assurance. The Company's operations are also
dependent upon the continued services of Richard L. Horton, its Chief Executive
Officer and President, and certain other
13
<PAGE>
executive officers. The loss of services of any of the Company's executive
officers, whether as a result of death, disability or otherwise, could have a
material adverse effect upon the Company's operations. The Company does not
have employment agreements with any of its executive officers. The Company is
the beneficiary to a key person insurance policy insuring the life of Mr.
Horton in the amount of $1,000,000.
CONTROL BY PRINCIPAL STOCKHOLDERS; AUTHORIZATION AND ISSUANCE OF PREFERRED
STOCK; PREVENTION OF CHANGES IN CONTROL. At March 16, 1998, Ramtron and Intag
International Limited ("Intag") together own approximately 77.0% of the issued
and outstanding shares of Common Stock and continues to elect all of the
Company's directors and control the affairs of the Company. The Company's
Certificate of Incorporation authorizes the issuance of up to 5,000,000 shares
of Preferred Stock with such rights and preferences as may be determined from
time to time by the Board of Directors. Accordingly, under the Certificate of
Incorporation, the Board of Directors may, without shareholder approval, issue
Preferred Stock with dividend, liquidation, conversion, voting, redemption or
other rights which could adversely affect the voting power or other rights of
the holders of the Common Stock. The issuance of any shares of Preferred Stock
having rights superior to those of the Common Stock may result in a decrease
in the value or market price of the Common Stock and could further be used by
the Board of Directors as a device to prevent a change in control of the
Company. The Company has not issued any of the Preferred Shares to date and
has no plans to issue Preferred Shares. The Company has no other anti-takeover
provisions in its Certificate of Incorporation or Bylaws. Holders of the
Preferred Stock may have the right to receive dividends, certain preferences
in liquidation and conversion rights.
NO DIVIDENDS. The Company has not paid any dividends on its Common Stock and
does not intend to pay dividends in the foreseeable future.
POSSIBLE VOLATILITY OF SECURITIES PRICES. The market price of the Common Stock
and Warrants may be highly volatile. Factors such as the Company's operating
results or public announcements by the Company or its competitors may have a
significant effect on the market price of the securities. In addition, market
prices for the securities of many small capitalization companies have
experienced wide fluctuations due to variations in quarterly operating results,
general economic conditions and other factors beyond the Company's control.
SHARES ELIGIBLE FOR FUTURE SALE. Sales of substantial amounts of Common Stock in
the open market or the availability of such shares for sale could adversely
affect the market price of the securities. As of March 16, 1998, 3,041,500
shares of Common Stock, Warrants to purchase 1,500,000 shares of Common Stock
and Options to purchase 579,530 shares of Common Stock under the 1993 Employee
Stock Plan may be purchased and sold in the open market without restriction or
further registration under the 1933 Act. An additional 10,231,032 shares of
Common Stock, Warrants to purchase 983,218 shares of Common Stock and Options to
purchase 965,000 shares of Common Stock under the 1993 Employee Stock Plan are
"restricted securities" as that term is defined under Rule 144 of the 1933 Act,
all of which are currently eligible for resale. However, all of the Company's
officers, directors and 5% or greater stockholders have agreed, pursuant to a
lock-up agreement with Spencer Edwards, Inc. ("SEI"), not to dispose of more
than 50% of their shares of Common Stock until March 1999 without the prior
written consent of SEI. There are no arrangements, agreements or understandings
with respect to a release of the lock-up agreement by SEI and it is not SEI's
general policy to grant such a release. Nevertheless, SEI will consider requests
for such releases on an individual basis and may in the future grant such
requests in connection with this or other offerings.
NASDAQ SMALLCAP MARKET MAINTENANCE REQUIREMENTS. The Company must also maintain
certain requirements in order to be listed on the Nasdaq SmallCap Stock MarketSM
("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. As of December 31, 1997 the Company was in compliance with the
Nasdaq listing requirements. There is no assurance that the Company will
continue to meet the Nasdaq listing requirements.
LIMITATIONS ON LIABILITY OF DIRECTORS. The Company's Certificate of
Incorporation substantially limits the liability of the Company's directors to
the Company and its stockholders for breach of fiduciary or other duties to the
Company.
REDEMPTION OF WARRANTS. The Warrants may be redeemed by the Company under
certain circumstances upon 30 days' written notice to the Warrantholders at $.01
per Warrant. In such event, the Warrants will be exercisable until the close of
business on the date fixed for redemption in such notice. Any Warrants not
exercised by that time will cease to be exercisable, and the holders will be
entitled only to the redemption price, which is likely to be substantially less
than the market value of the Warrants. Accordingly, such redemption could force
the Warrantholders to exercise the Warrants
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<PAGE>
and pay the exercise price at a time when it might be disadvantageous for
them to do so or sell the Warrants at the then market price when they might
otherwise prefer to hold the Warrants.
ITEM 2. PROPERTIES
The Company's headquarters are located in an 8,900 square foot leased facility
in Greenwood Village, Colorado, a suburb of Denver, Colorado. The current lease
requires a base monthly rental of $8,419 and expires in November 1998. The
Company has the right to renew the lease for an additional three years at
then-current rental market rates on 180 days prior written notice to the
landlord. The Company has no rights of first refusal or purchase options under
the lease. The base rental may be increased during the term of the lease to
reflect the Company's share of any increases in specified operating expenses for
the facility, such as real estate taxes, insurance, utilities and the like. The
Company believes its existing facility is adequate for its current needs and
that suitable additional or substitute space will be available as needed on
commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
From time to time the Company is subject to litigation incidental to its
business. The Company is not presently a party to any material litigation. Such
claims, if successful, could result in damage awards exceeding, perhaps
substantially, applicable insurance coverage.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
15
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock and Warrants are quoted on Nasdaq under the symbols
"RCOM" and "RCOMW," respectively.
The following table sets forth, for the periods indicated the range of high and
low sales prices per share of the Company's Common Stock, as reported on Nasdaq.
<TABLE>
HIGH LOW
----- -----
<S> <C> <C>
By Quarter End
1997
First Quarter (beginning March 13, 1997) 4.375 2.625
Second Quarter....................................... 3.500 1.750
Third Quarter........................................ 2.875 1.531
Fourth Quarter....................................... 3.000 1.063
1998
First Quarter (ending March 16, 1998)................ 2.250 1.250
</TABLE>
As of March 16, 1998, the last reported sale price of the Company's Common Stock
was $1.531 per share, and there were approximately 1,295 holders of record of
the Common Stock.
The Company has not declared or paid dividends on its Common Stock since its
formation, and the Company does not anticipate paying dividends in the
foreseeable future. Although the Company does not currently have a credit
facility, future credit facilities, if any, are likely to prohibit the payment
of dividends. Declaration or payment of dividends, if any, in the future, will
be at the discretion of the Board of Directors and will depend on the Company's
then current financial condition, results of operations, capital requirements
and other factors deemed relevant by the Board of Directors.
In August 1997, the Company issued 160,000 common shares to INTAG for
consideration previously received related to amendments to the Technology
License and Supply Agreements.
In March 1997, the Company completed its initial public offering ("IPO") of
common stock at $4.75 per unit, each unit consisting of one share of $.01 par
value common stock and one common stock purchase warrant, pursuant to an
effective registration statement on Form SB-2 (SEC File No. 333-18351). Spencer
Edwards, Inc. was the managing underwriter. The gross proceeds generated were
$7,125,000 and the approximate expenses incurred were as follows: (i) $855,000
for underwriters discount and fees; (ii) $327,000 in other expenses, including
legal, accounting and printing fees. The Company used the net proceeds of
approximately $5,943,000 as follows: (i) approximately $2,126,000 to repay
outstanding debt and accrued interest ($950,000 to Intag and $97,000 to
Ramtron); (ii) to repay accounts payable to related parties (approximately
$483,000 to Ramtron) primarily for materials purchases; (iii) to purchase and
install machinery and equipment of approximately $80,000; (iv) for sales and
marketing activities of approximately $803,000; (v) for research and development
activities of approximately $978,000; (vi) and for working capital of
approximately $1,473,000. As of December 31, 1997, the Company had applied all
of the net offering proceeds from the March 1997 IPO.
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<PAGE>
During 1997, the Company sold the following shares of its Common Stock which
were not registered under the 1933 Act, as amended.
(i) In August 1997, the Company issued 160,000 common shares to Intag for
consideration previously received related to amendments to the Technology
License and Supply Agreements.
(ii) From time to time, the Company has issued stock options (aggregating
1,567,000 stock options as of December 31, 1997) to employees, officers
and directors under its 1993 Employee Stock Option Plan. In October 1997 the
Company registered the shares to be issued to Employees upon exercise of
options pursuant to a registration statement on Form S-8.
The sales of securities described in paragraph (i) were issued in reliance
upon the exemption from registration under the Securities Act provided by
Section 4(2) thereof or Regulation D thereunder. The purchasers were either
accredited investors as defined in Regulation D or sophisticated investors and
all had adequate access, through their relationships with the Company and its
Officers, to information about the Company. The purchasers represented their
intention to acquire the securities for investment only and not with a view to
or for sale in connection with any distribution thereof and appropriate
legends were placed on the share certificates or contained in the instruments
representing the securities. The sales of securities described in paragraph
(ii) were issued in reliance upon the exemption from registration under the
Securities Act of 1933 provided by Rule 701, promulgated thereunder, for
transactions pursuant to compensatory benefit plans as provided under Rule
701. The options granted under the 1993 Employee Stock Plan were granted to
employees and directors of the Company.
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<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following table sets forth certain selected financial data, which should be
read in conjunction with, and are qualified in their entirety by, the financial
statements and related notes thereto.
<TABLE>
STATEMENT OF OPERATIONS DATA 1997 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $ 902,280 $ 2,427,285 $ 1,147,915 $ 354,586
- ----------------------------------------------------------------------------------------------------------------------------
Gross margin 361,014 1,375,408 501,446 177,369
- ----------------------------------------------------------------------------------------------------------------------------
Loss from operations (3,620,967) (1,214,784) (2,837,935) (2,682,589)
- ----------------------------------------------------------------------------------------------------------------------------
Net loss (3,702,581) (1,303,837) (2,878,034) (3,480,171)
- ----------------------------------------------------------------------------------------------------------------------------
Net loss per share - Basic and Diluted $ (0.29) $ (0.11) $ (0.27) $ (0.44)
- ----------------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding 12,775,865 11,532,532 10,541,372 7,942,083
- ---------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA AT DECEMBER 31,
- ----------------------------------------------------------------------------------------------------------------------------
Cash $ 1,198,567 $ 314,202 $ 512,435 $ 228,675
- ----------------------------------------------------------------------------------------------------------------------------
Working capital (deficit) 1,057,594 (1,846,523) (580,150) (1,895,267)
- ----------------------------------------------------------------------------------------------------------------------------
Total assets 3,171,678 3,885,851 3,038,661 3,106,244
- ----------------------------------------------------------------------------------------------------------------------------
Total liabilities 396,443 3,651,587 1,500,560 2,923,907
- ----------------------------------------------------------------------------------------------------------------------------
Stockholders' equity 2,775,235 234,264 1,538,101 182,337
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
OVERVIEW
The Company principally generates revenues from licensing, fee based custom
product development projects and sales of its Smart Card products. If the
Company is unable to continually replace larger custom product development
projects as projects are completed, its operations may be adversely affected.
Custom product development projects are billed in stages based on contractual
performance milestones. Accordingly, financial results for any calendar quarter
may fluctuate widely depending on the stage of a custom product development
project or the amount of licensing payments in a particular quarter.
The Company is limited under its Tripartite Agreement (see Note 6 to financial
statements) with Ramtron and Intag to sublicense rights to Ramtron's
ferroelectric technology for use in RFID applications to no more than five
parties.
All custom product development revenues for the year ended December 31, 1996
were the result of a development contract with Bull CP8, a division of Group
Bull. For the years ended December 31, 1997 and 1996, four customers, and three
customers, respectively, each accounted for 10% or more of the Company's
non-related party net product sales, and one customer accounted for primarily
all net product sales to related parties. See "Item 1. Business."
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RESULTS OF OPERATIONS
<TABLE>
YEARS ENDED DECEMBER 31,
---------- --------- ---------
1997 1996 1995
---------- --------- ---------
<S> <C> <C> <C>
Revenue 100.0% 100.0% 100.0%
Cost of revenues 60.0% 43.3% 56.3%
Gross margin 40.0% 56.7% 43.7%
Research and development expenses 136.8% 20.8% 91.4%
General and administrative expenses 118.6% 34.4% 109.2%
Sales and marketing expenses 112.4% 35.8% 61.7%
Equity in loss of Racom Japan 22.3% 8.6% 13.9%
Loss on write off of investment in Racom Japan 33.7% - -
Amortization expense 17.5% 7.1% 14.7%
Loss from operations (401.3%) (50.0)% (247.2)%
Other income (expense) (9.1%) (3.7)% (3.5)%
Net loss (410.4%) (53.7)% (250.7)%
</TABLE>
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES. Revenues decreased 62.8% to $902,280 for the year ended December 31,
1997 from $2,427,285 for the year ended December 31, 1996.
Product Sales. Product sales decreased 23.0% to $305,327 for the year ended
December 31, 1997 from $396,345 for the year ended December 31, 1996. 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 6-12 months
or longer. In 1996, product sales included approximately $60,000 of product
sales to Transmac for an automatic fare collection project and approximately
$33,000 of product sales to Impulse Enterprises, Inc. These projects did not
generate any additional sales during 1997.
Custom Product Development Projects. There were no revenues from custom product
development projects for the year ended December 31, 1997. 1996 revenues reflect
the initial payment and completion of one milestone under a custom product
development contract totaling $600,000. No additional milestones were reached
during 1997.
License Revenues. License revenues decreased 58.3% to $596,953 for the year
ended December 31, 1997, from $1,430,940 for the year ended December 31, 1996.
In 1996, license revenues included the recognition of revenues on a license from
RJ for the manufacture and sale of FRAM based radio frequency products in Japan
of $537,031. The amount received for the license was $933,968. At the time of
sale, the Company owned a 50% interest in RJ and, accordingly, 50% of this
amount (representing the Company's intercompany profit due to its 50% equity
ownership in RJ on the date of the sublicense) was deferred and was being
recognized over the five-year life of the related technology license owned by
RJ, commencing on the date of sale. As of December 31, 1996, $70,047 had been
recognized.
Also in 1996, the Company consented to RJ entering into a custom product
development project with Fujitsu pursuant to the technology license discussed
above, under which the Company is entitled to 50% of all sublicense revenue
earned by RJ. This sublicense resulted in the Company recognizing $893,909 in
additional licensing revenues in 1996. The balance of the sublicense revenue on
this contract with Fujitsu, $200,016, was recorded as license revenues during
1997.
In 1997, the Company's equity ownership in RJ was reduced to 19.9% through a
combination of a sale of shares owned in RJ to a third party and RJ's issuance
of new shares to third parties. As a result of these changes in ownership and a
corresponding change to the cost method of accounting for the investment, the
Company recognized the balance of the deferred revenue during 1997, totaling
$396,937.
19
<PAGE>
The decrease in license revenues reflects the delay in closing the licensing
contract with Hitachi, which closed in January 1998. The Company had expected to
recognize the initial payment on the Hitachi contract in the fourth quarter of
1997.
COST OF REVENUES AND GROSS MARGIN. As a percentage of revenues, gross margin
decreased to 40.0% in 1997 from 56.7% in 1996.
PRODUCT COSTS. The Company has not generated any 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 are not sufficient to cover manufacturing costs which
are included in Cost of Revenues. Due to an increase in availability of FRAM
chips resulting in lower component costs, and the use of EEPROM chips which
are already available at lower component costs, the Company expects to be able
to lower its prices while improving gross margin. The Company anticipates that
cost efficiencies will allow the Company to compete more effectively with
Contacted Card products and to build sales volume for its Smart Cards. In
addition to ordinary product costs, 1997 cost of revenues includes a write
down of existing inventory of approximately $121,000 related to a revaluation
to market value for a specific component part.
CUSTOM PRODUCT DEVELOPMENT PROJECTS. Custom Product Development Projects for
1996 includes $530,337 of costs associated with a custom product development
project. Custom product development projects typically include research and
development activities performed on a contract basis. No additional costs were
incurred related to the custom product development project during 1997.
LICENSE REVENUES. In any given year, gross margin is primarily a result of
license revenues which have no direct cost of revenues.
RESEARCH AND DEVELOPMENT EXPENSES ("R&D"). R&D increased 144.2% to $1,234,096 in
1997 from $505,266 in 1996. R&D efforts relating to the Company's Smart Card
Systems have continued to expand from 1996 through 1997. During 1997, the
Company incurred approximately $250,000 for development of the Company's latest
products, the RX Series, not including personnel costs associated with the RX
Series product development. 1997 expenses also include a $63,000 increase in
wages and benefits due to the hiring of two additional engineers. During 1996,
the Company incurred expenses related to a joint development project with Bull
CP8. Engineering personnel resources and development costs totaling $388,158
were directly related to the project and are included in cost of revenues for
1996.
GENERAL AND ADMINISTRATIVE EXPENSES ("G&A"). G&A increased 28.4% to $1,070,404
for 1997 from $833,879 for 1996. This increase is primarily attributable to
expenses incurred to comply with the reporting obligations imposed on the
Company as a public entity, including approximately $40,000 for Investor
Relations expenses, approximately $5,000 for securities legal expenses, and
approximately $85,000 for D&O and Officer's life insurance premiums. Travel
expenses increased approximately $22,000 due to the travel required to attend
investor conferences. Wages and benefits attributable to G&A increased
approximately $52,000 due to the hiring of a management information systems
specialist and salary increases for five other employees.
SALES AND MARKETING EXPENSES. Sales and marketing expenses increased 16.7% to
$1,014,484 in 1997 from $869,401 in 1996. This increase is due to the hiring of
the Vice President of Business Development and the Vice President of Business
Solutions in June 1996, and a product manager in February 1997. Wages and
benefits for these three individuals resulted in an increase in expenses for
1997 of approximately $230,000 over 1996 expenses. Recruiting fees for the
product manager resulted in an increase of expenses of $20,000. The Vice
President of Sales and Marketing left the Company in December 1996, resulting in
a corresponding decrease in expenses of approximately $140,000.
EQUITY IN LOSS OF RACOM JAPAN. The Company currently owns 19.9% of RJ, decreased
from 40% as of December 31, 1996. 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 accounted for its investment on the equity method and
had recorded its share of RJ's losses in its financial statements to the extent
of capital invested in RJ by the Company. During 1997, the Company decreased its
ownership in RJ through a combination of sales of a portion of the Company's
investment to third parties and issuance of new shares by RJ to third parties,
and the Company changed to the cost method of accounting for its investment. The
equity in the losses of RJ were $209,248 in 1996 and $201,376 in 1997. The
loss in 1996 includes $141,953 from previous periods which were not recognized
because the Company's investment was reduced to zero. The increase in the loss
between years resulted from the purchase of sublicense rights from the Company
which increased RJ's amortization expense over the five year term of the
sublicense. RJ's losses were primarily related to ongoing research and
development activities as well as longer sales cycles and trial tests demanded
by Japanese customers. Based on RJ's continuing operating losses and new
20
<PAGE>
information obtained by the Company indicating that the carrying value of the
Investment in RJ was not realizable, the Company wrote off the balance of its
Investment in RJ, totaling $303,978.
AMORTIZATION EXPENSE. The Company's primary asset is a technology license
("Technology License") related to the design and manufacture of its Smart Card
products. The Company originally purchased the technology from Ramtron pursuant
to a technology license agreement for $2,000,000 in cash and 2,000,000 shares of
the Company's Common Stock. The technology license was recorded at the original
cash acquisition cost of $2,000,000. In 1995, the Company acquired certain
additional rights with respect to the technology. The net cost of obtaining the
additional rights was $400,000 and was capitalized in 1995. The asset is
amortized over its estimated useful life on a straight-line basis.
OTHER INCOME (EXPENSE). During 1997, the Company incurred $43,189 in interest
expense, primarily related to the bridge loan financing completed in 1996. The
bridge notes carried interest at prime plus 2% and matured the earlier of one
year from the Bridge Date or upon the closing on an IPO. Interest expense for
1997 also includes $96,667 related to the amortization of debt issuance costs
associated with the bridge notes. Additionally, during 1997 the Company incurred
$17,405 in interest expense on various notes payable to Intag and Ramtron. The
notes were due on demand and carried annual interest of 10% and prime plus 2%,
respectively. During March 1997, the Company completed its IPO and used
$2,126,103 to repay the outstanding debt and interest owed on the bridge loans,
to Intag and Ramtron. The remaining proceeds from the IPO were held in cash
equivalents during 1997 and resulted in interest income earned of $100,037.
Other income (expense) for 1997 also includes approximately $19,000 in exchange
rate losses due to exchange rate fluctuations at various times during the year
related to foreign transactions. During 1996, the Company incurred $64,400 in
interest expense on various notes payable to Intag and Ramtron. The Company also
recorded $28,367 in exchange rate losses due to exchange rate fluctuations at
the end of the year related to the license revenue receivable due from RJ.
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 and $221,000 of net operating loss and research and development tax
credit carryforwards that expire at various dates through the year 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.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
REVENUES. Revenues increased 111.5% to $2,427,285 for the year ended December
31, 1996 from $1,147,915 for the year ended December 31, 1995. This increase
reflects the initial payment and completion of one milestone under a custom
product development contract totaling $600,000 and recognition of revenues on a
license from RJ, for the manufacture and sale of FRAM based radio frequency
products in Japan of $537,031. The amount received for the license was $933,968.
At the time of sale, the Company owned a 50% interest in RJ and, accordingly,
50% of this amount (representing the Company's intercompany profit due to its
50% equity ownership in RJ on the date of the sublicense) was deferred and is
being recognized over the life of the related technology license asset owned by
RJ, which is five years, commencing on the date of sale, of which $70,047 had
been recognized as of December 31, 1996. During the year ended December 31,
1996, the Company consented to RJ entering into a custom product development
project with a Japanese company, pursuant to the technology license discussed
above, under which the Company is entitled to 50% of all sublicense revenue
earned by RJ. This sublicense resulted in the Company recognizing $893,909 in
additional licensing revenues.
COST OF REVENUES AND GROSS MARGIN. As a percentage of revenues, gross margin
increased to 56.7% in 1996 from 43.7% in 1995. The gross margin is primarily a
result of license revenues which have no direct cost of revenues. The Company
has not generated any margin on product sales in part because of competition
the Company encounters with Contacted Cards which typically are sold at a
lower price than the Company's Smart Cards. The Company expects to be able to
lower its prices to compete more directly in price with Contacted Card
products as it builds manufacturing volumes for its Smart Cards and
ferroelectric technology becomes available from additional licensed
semiconductor manufacturers. Cost of revenues for 1996 also includes $521,540
of costs associated with a custom product development project.
RESEARCH AND DEVELOPMENT EXPENSES ("R&D"). R&D decreased 51.8% to $505,266 in
1996 from $1,049,162 in 1995. R&D efforts relating to the Company's Smart Card
expanded significantly in 1995 and continued through 1996. During
21
<PAGE>
1996, the Company began work on a joint development project with Bull CP8.
Engineering personnel resources and development costs totaling $388,158 were
directly related to the project and are included in cost of revenues for 1996.
GENERAL AND ADMINISTRATIVE EXPENSES ("G&A"). G&A decreased 33.5% to $833,879 for
1996 from $1,253,252 for 1995. For 1995, the Company incurred salary, travel and
consulting expenses of approximately $465,000 including $105,848 of consolidated
expenses of Intag Systems, Inc. ("ISI"), a wholly-owned subsidiary, which was
sold in June 1995. In addition, the Company's legal fees decreased approximately
$76,000 between the years. Finally, the Company eliminated monthly fee payments
to directors in early 1995, resulting in a decrease of expenses of $12,000.
SALES & MARKETING EXPENSES. Sales and marketing expenses increased 22.7% to
$869,401 in 1996 from $708,566 in 1995. This increase is due to the hiring of
the Vice President of Product Development in June 1996. The Company also
increased its travel spending in conjunction with sales activities by
approximately $30,000 between years. Additionally, the Company paid $5,000 per
month beginning in July 1995 for consulting fees related to developing its
products for use in the airline industry.
EQUITY IN LOSS OF RACOM JAPAN. At December 31, 1996, the Company owned 40% of
RJ, decreased from 50% as of March 29, 1996. RJ was formed in 1993 for the
purpose of marketing, distributing and supporting the Company's Smart Card
products to be sold in Japan. In 1996, the Company accounted for its investment
on the equity method and has recorded its share of RJ's losses in its financial
statements to the extent of capital invested in RJ by the Company. The equity in
the losses of RJ increased 31.3% in 1996 to $209,248 from $159,403 in 1995. In
early 1996, the Company and NS invested an additional $466,984 each in RJ.
Subsequently, third parties also invested in RJ reducing the Company's ownership
to 40%. During 1995, the Company's portion of the net losses in RJ exceeded the
carrying value of the investment. During 1996, the Company recognized $141,953
of previously unrecognized losses from the prior year in excess of its
investment through December 31, 1995. RJ's losses were primarily related to
ongoing research and development activities as well as longer sales cycles and
trial tests demanded by Japanese customers.
AMORTIZATION EXPENSE. As discussed above, the Company's cash acquisition cost of
the Technology License is amortized over its estimated useful life on a
straight-line basis.
OTHER INCOME (EXPENSE). During 1996, the Company incurred $64,400 in interest
expense on various notes payable to Intag and Ramtron. The notes were due on
demand and carried interest at a rate of 10% and prime plus 2%, respectively.
The Company also recorded $28,367 in exchange rate losses due to exchange rate
fluctuations at the end of the year related to the license revenue receivable
due from RJ. Other income and expense in 1995 primarily included $143,645 in
interest expense related to the notes payable to Intag and a $170,647 gain on
the sale of ISI to Intag.
22
<PAGE>
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.
CASH FLOW
The Company had cash and cash equivalents of $1,198,567 and $314,202 as of
December 31, 1997 and 1996, respectively.
The following table summarizes, for the periods presented, certain items from
the Statements of Cash Flows of the Company.
<TABLE>
YEARS ENDED DECEMBER 31,
-------------------------------------------------
1997 1996 1995
-------------------------------------------------
<S> <C> <C> <C>
Net Cash Used in Operating Activities $ (3,115,406) $ (798,473) $ (2,089,990)
Net Cash Used in Investing Activities (76,068) (491,959) (25,410)
Net Cash Provided by Financing Activities 4,075,839 1,092,199 2,399,160
</TABLE>
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
OPERATING ACTIVITIES. Net cash used in operations increased to $3,115,406 in
1997 from $798,473 in 1996. The increase reflects the net loss for 1997 of
$3,702,581. Subsequent to December 31, 1997, the Company executed an
agreement, in conjunction with Ramtron, granting 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 FRAM technology. The Company received the first payment
on the license on January 29, 1998, improving its cash and working capital
position.
INVESTING ACTIVITIES. Net cash used in investing activities decreased to
$76,068 in 1997 from $491,959 in 1996. In 1997, the Company purchased $84,004
in fixed assets and sold a portion of its investment in RJ for $7,936. During
1996, the Company invested an additional $466,984 in RJ and purchased $25,572
in fixed assets. Capital expenditures in 1998 are expected to be
approximately $150,000, comprised of testing equipment for product
development, a voicemail system for the Company's office and software and
upgrades to the Company's existing computer systems.
FINANCING ACTIVITIES. Net cash provided by financing activities increased to
$4,075,839 in 1997 from $1,092,199 in 1996. This improvement is directly related
to the Company's IPO which raised $5,942,568, net of offering costs. The Company
used $2,126,103 of the IPO proceeds to retire the Bridge Loans, as defined
below, of $1,040,000 and related party debt and accrued interest of $1,086,103.
During 1997, a former employee exercised options issued under the 1993 Employee
Stock Plan to purchase 30,000 shares of the Company's Common Stock for $45,000.
During 1996, the Company borrowed $90,000 and $170,000 (net of repayments) from
Ramtron and Intag, respectively. Additionally, in December 1996, the Company
borrowed an aggregate of $1,040,000 from a group of lenders (the "Bridge
Loan(s)") evidenced by promissory notes which carried interest at 2% over the
prime interest rate. The Bridge Loans were repaid with proceeds from the
Company's IPO. As additional consideration for the Bridge Loans, the Company
issued one Bridge Warrant for each $4.00 loaned to the Company or a total of
260,000 Bridge Warrants. Each Bridge Warrant entitles the holder to purchase one
share of Common Stock at $5.94 per share through March 12, 1999. The Company
incurred $106,587 and $161,948 in 1996 for debt issuance costs related to the
Bridge Loan financing and costs related to the IPO, respectively.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
OPERATING ACTIVITIES. Net cash used in operations decreased to $798,473 in
1996 from $2,089,990 in 1995. This is a result of the improved operating
results (see "Results of Operations") in addition to the funding of
approximately $279,561 of the Company's FRAM chip purchases by Ramtron.
23
<PAGE>
INVESTING ACTIVITIES. Net cash used in investing activities increased to
$491,959 in 1996 from $25,410 in 1995. During 1996, the Company invested an
additional $466,984 in RJ and purchased $25,572 in fixed assets. In 1995, the
Company increased its investment in the Ramtron technology license by $400,000,
purchased $63,440 in fixed assets, and received $237,116 from a related party on
repayments of notes receivable. The Company also received $200,000 from Intag
for a technology sublicense.
FINANCING ACTIVITIES. Net cash provided by financing activities decreased to
$1,092,199 in 1996 from $2,399,160 in 1995. During 1996, the Company borrowed
$90,000 and $170,000 (net of repayments) from Ramtron and Intag, respectively.
Additionally, in December 1996, the Company completed the borrowing of an
aggregate of $1,040,000 from the Bridge Loans evidenced by promissory notes
which carried interest at 2% over the prime interest rate. As additional
consideration for the Bridge Loans, the Company issued one Bridge Warrant for
each $4.00 loaned to the Company or a total of 260,000 Bridge Warrants. Each
Bridge Warrant entitles the holder to purchase one share of Common Stock at
$5.94 per share through March 12, 1999. The Company incurred $106,587 and
$161,948 in 1996 for debt issuance costs related to the Bridge Loan financing
and costs related to the IPO, respectively. During 1995, the Company sold
500,000 shares of its Common Stock at $3.00 per share. Also, the Company
borrowed $900,000 (net of repayments) from Intag on short-term convertible notes
bearing interest at 10% during 1995.
CAPITALIZATION
The Company's capitalization of $2,775,235 as of December 31, 1997 is comprised
entirely of stockholders' equity, as compared to $2,069,596 of short-term debt
and $234,264 in stockholders' equity as of December 31, 1996. The increase is
primarily attributable to the issuance of 1,500,000 shares of Common Stock in
conjunction with the Company's IPO. A portion of the proceeds from the IPO was
used to repay the short-term debt outstanding as of December 31, 1996.
The Company has generated substantial operating losses since inception and has
yet to generate sufficient 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 substantial sales transactions covering
the application of its products and, as a result, an uncertainty exists as to
whether the Company will be able to successfully market and sell its products to
third parties at sufficient prices and volumes to fund its operations. During
1996 and 1997, the Company experienced significant cash flow deficits and
liquidity shortages and funded its operations primarily through the sale of
non-exclusive sublicenses to its technology, proceeds from the sale of its
common stock, bridge loan borrowings and related party borrowings.
During 1998, the Company anticipates that increased operating revenues will be
achieved through a combination of product sales, development contracts and the
sale of non-exclusive licenses. However, the Company is limited under its
Tripartite Agreement (see Note 6 to financial statements) with Ramtron and
Intag to sublicense rights to Ramtron's ferroelectric technology for use in
RFID applications to no more than five parties. In addition, the Company also
anticipates that it will maintain its current level of operating expenses,
including research and development expenditures which are required for the
Company to further develop and market its products and achieve successful
operations. However, there is no assurance the Company will be successful in
developing and marketing its products or that the Company's operations will
generate sufficient revenues to fund its operations and to allow it to become
profitable. Further, the Company anticipates capital expenditures of $150,000
in 1998.
Management of the Company intends to fund its 1998 operations through a
combination of product sales, technology sublicensing and possible offerings
of its common stock. There is no assurance that sales of common stock will occur
or that additional proceeds will be received from such offerings. The Company
currently does not have an available source for short-term borrowings.
These factors, among others, 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.
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. As of December 31, 1997 the Company was in compliance with the
Nasdaq listing requirements. There is no assurance that the Company will
continue to meet the Nasdaq listing requirements.
24
<PAGE>
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. An internal study is currently under way 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 Company will
begin to incur expenses in 1998 to resolve this issue. Management believes these
amounts are not significant and such expenditures will continue through the year
1999.
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements, which are included in this report on pages
F-1 through F-22, are incorporated herein by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Information is incorporated by reference from the Company's definitive Proxy
Statement to be filed with the Securities and Exchange Commission in connection
with the Company's Annual Meeting of Stockholders to be held on April 22, 1998.
ITEM 10. EXECUTIVE COMPENSATION
Information is incorporated by reference from the Company's definitive Proxy
Statement to be filed with the Securities and Exchange Commission in connection
with the Company's Annual Meeting of Stockholders to be held on April 22, 1998.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information is incorporated by reference from the Company's definitive Proxy
Statement to be filed with the Securities and Exchange Commission in connection
with the Company's Annual Meeting of Stockholders to be held on April 22, 1998.
25
<PAGE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information is incorporated by reference from the Company's definitive Proxy
Statement to be filed with the Securities and Exchange Commission in connection
with the Company's Annual Meeting of Stockholders to be held on April 22, 1998.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a). Exhibits:
<TABLE>
EXHIBIT NO. TITLE
- ----------- -----
<S> <C>
3.01 Restated Certificate of Incorporation of the Registrant (1)
3.02 Restated Bylaws of the Registrant (1)
4.01 1993 Employee Stock Plan (5)
4.02 Form of 1993 Employee Stock Agreement
under the 1993 Employee Stock Plan (5)
4.03 Form of Representative's Warrant (1)
4.04 Form of Warrant Agreement (1)
4.05 Form of Lock-Up Agreement (2)
10.01 Lease Agreement - Greenwood Village Office Facility (1)
10.02 Joint Venture Agreement (Racom Japan) (1)
10.03 Exclusive Distributor Agreement (Racom Japan) (1)
10.04 Technology License Agreement (Racom Japan) (1)
10.05 Exclusive Distributor Agreement (Racom Japan) (1)
10.06 Development and Supply Agreement (Bull CP-8) (1)
10.07 Agreement regarding ferroelectric RFID products (Rohm) (1)
10.08 Stock Purchase Agreement (Rohm) (1)
10.09 Settlement Agreement (Intag) (1)
10.10 Assignment and Security Agreement (Intag) (1)
10.11 Technology License Agreement (Ramtron) (1)
10.12 Amendment to Technology License Agreement (Ramtron) (1)
10.13 Second Amendment to Technology License Agreement (Ramtron) (1)
10.14 Tripartite Technology Agreement entered into April 15, 1997 between
Racom Systems, Inc., Ramtron International Corporation and Intag
International Limited (3)
26
<PAGE>
10.15 Amendment No. 3 RF/ID Products to High-Density FRAM Cooperation
Agreement between Racom Systems, Inc., Ramtron International
Corporation and Hitachi, Ltd. (4)
23.01 Consent of Arthur Andersen LLP (filed herewith)
27.01 Financial Data Schedule (filed herewith)
</TABLE>
- -------------------
(1) Incorporated by reference to the Company's Registration Statement on Form
SB-2 (SEC File No. 333-18351), as filed with the Securities and Exchange
Commission on December 20, 1996.
(2) Incorporated by reference to Amendment No. 1 to the Company's Registration
Statement on Form SB-2 (SEC File No. 333-18351), as filed with the Securities
and Exchange Commission on February 5, 1997.
(3) Incorporated by reference to the Company's Form 10-QSB (SEC File No.
000-21907), as filed with the Securities and Exchange Commission on May 15,
1997.
(4) Incorporated by reference to the Company's Form 8-K (SEC File No.
000-21907), as filed with the Securities and Exchange Commission on February 2,
1998.
(5) Incorporated by reference to the Company's Registration Statement on Form
S-8 (SEC File No. 333-38645), as filed with the Securities and Exchange
Commission on October 15, 1997.
(b). Reports of Form 8-K.
None.
27
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Company has duly
caused this Report to be signed on its behalf by the undersigned, thereunto duly
authorized, in Greenwood Village, Colorado on March 30, 1998.
RACOM SYSTEMS, INC., a Delaware corporation
By: /s/ RICHARD L. HORTON
-------------------------------
Richard L. Horton
Chief Executive Officer, President, Chief Financial Officer
and Director (PRINCIPAL EXECUTIVE OFFICER AND PRINCIPAL
FINANCIAL OFFICER)
By: /s/ LILLIAN V. BURKEY
-------------------------------------
Lillian V. Burkey
Controller and Acting Secretary (PRINCIPAL ACCOUNTING
OFFICER)
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Report has been signed below by the following persons on the dates indicated.
SIGNATURE TITLE DATE
- --------------------------- ---------------------------- ----------------
/s/ Charles A. Fear
- ---------------------------- Chairman of the Board of
Charles A. Fear Directors March 26, 1998
/s/ Mark R. Davison
- --------------------------- Director March 30, 1998
Mark R. Davison
/s/ Chas Yap Hockeng
- --------------------------- Director March 25, 1998
Chas Yap Hockeng
/s/ George J. Stathakis
- ---------------------------- Director March 24, 1998
George J. Stathakis
/s/ John A. Hinds
- ---------------------------- Director March 24, 1998
John A. Hinds
28
<PAGE>
EXHIBIT INDEX
EXHIBIT NO. TITLE
<TABLE>
<S> <C>
3.01 Restated Certificate of Incorporation of the Registrant (1)
3.02 Restated Bylaws of the Registrant (1)
4.01 1993 Employee Stock Plan (5)
4.02 Form of 1993 Employee Stock Agreement
under the 1993 Employee Stock Plan (5)
4.03 Form of Representative's Warrant (1)
4.04 Form of Warrant Agreement (1)
4.05 Form of Lock-Up Agreement (2)
10.01 Lease Agreement - Greenwood Village Office Facility (1)
10.02 Joint Venture Agreement (Racom Japan) (1)
10.03 Exclusive Distributor Agreement (Racom Japan) (1)
10.04 Technology License Agreement (Racom Japan) (1)
10.05 Exclusive Distributor Agreement (Racom Japan) (1)
10.06 Development and Supply Agreement (Bull CP-8) (1)
10.07 Agreement regarding ferroelectric RFID products (Rohm) (1)
10.08 Stock Purchase Agreement (Rohm) (1)
10.09 Settlement Agreement (Intag) (1)
10.10 Assignment and Security Agreement (Intag) (1)
10.11 Technology License Agreement (Ramtron) (1)
10.12 Amendment to Technology License Agreement (Ramtron) (1)
10.13 Second Amendment to Technology License Agreement (Ramtron)
(1)
10.14 Tripartite Technology Agreement entered into April 15, 1997
between Racom Systems, Inc., Ramtron International
Corporation and Intag International Limited (3)
10.15 Amendment No. 3 RF/ID Products to High-Density FRAM
Cooperation Agreement between Racom Systems, Inc., Ramtron
International Corporation and Hitachi, Ltd. (4)
23.01 Consent of Arthur Andersen LLP (filed herewith)
27.01 Financial Data Schedule (filed herewith)
</TABLE>
- -------------------
29
<PAGE>
(1) Incorporated by reference to the Company's Registration Statement on Form
SB-2 (SEC File No. 333-18351), as filed with the Securities and Exchange
Commission on December 20, 1996.
(2) Incorporated by reference to Amendment No. 1 to the Company's Registration
Statement on Form SB-2 (SEC File No. 333-18351), as filed with the
Securities and Exchange Commission on February 5, 1997.
(3) Incorporated by reference to the Company's Form 10-QSB (SEC File No.
000-21907), as filed with the Securities and Exchange Commission on May
15, 1997.
(4) Incorporated by reference to the Company's Form 8-K (SEC File No.
000-21907), as filed with the Securities and Exchange Commission on
February 2, 1998.
(5) Incorporated by reference to the Company's Registration Statement on Form
S-8 (SEC File No. 333-38645), as filed with the Securities and Exchange
Commission on October 15, 1997.
30
<PAGE>
RACOM SYSTEMS, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
Page
----
<S> <C>
Report of Independent Public Accountants F-2
Balance Sheets as of December 31, 1996 and 1997 F-3
Statements of Operations for the Years Ended December 31, 1996 and 1997 F-5
Statements of Stockholders' Equity for the Years Ended December 31, 1996 and 1997 F-6
Statements of Cash Flows for the Years Ended December 31, 1996 and 1997 F-7
Notes to Financial Statements F-9
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Racom Systems, Inc.:
We have audited the accompanying balance sheets of RACOM SYSTEMS, INC. (a
Delaware corporation) as of December 31, 1996 and 1997, and the related
statements of operations, stockholders' equity and cash flows for the years
then ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these 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 financial statements referred to above present fairly, in
all material respects, the financial position of Racom Systems, Inc. as of
December 31, 1996 and 1997, and the results of its operations and its cash
flows for the years then ended in conformity with generally accepted accounting
principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has generated significant operating losses
and operating cash flow deficits since inception which raise substantial doubt
about the ability of the Company to continue as a going concern. Management's
plans in regard to these matters are described in Note 2. The accompanying
financial statements do not include any adjustments relating to the
recoverability and classification of asset carrying amounts or the amounts of
liabilities that might result should the Company be unable to continue as a
going concern.
ARTHUR ANDERSEN LLP
Denver, Colorado,
February 27, 1998.
F-2
<PAGE>
Page 1 of 2
RACOM SYSTEMS, INC.
BALANCE SHEETS
<TABLE>
December 31,
----------------------------
ASSETS 1996 1997
------ ---------- ----------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 314,202 $1,198,567
Accounts receivable-
Trade 79,201 43,042
Related parties (Note 8) 33,558 26,720
Inventory (Note 3) 428,401 122,875
License revenue receivable - related party (Note 6) 646,162 -
Prepaid expenses and other - 62,833
---------- ----------
Total current assets 1,501,524 1,454,037
---------- ----------
PROPERTY AND EQUIPMENT, at cost (Note 3):
Machinery and equipment 351,120 449,432
Furniture and fixtures 56,801 59,404
Leasehold improvements 3,328 3,328
---------- ----------
411,249 512,164
Less- Accumulated depreciation (260,364) (351,982)
---------- ----------
150,885 160,182
---------- ----------
INVESTMENT IN RACOM JAPAN (Note 4) 257,736 -
---------- ----------
OTHER ASSETS (Notes 2, 3 and 6):
Technology license from related party, net of
accumulated amortization of $684,898 and
$842,541, respectively 1,715,102 1,557,459
Organization costs, net of accumulated amortization
of $24,873 and $25,730, respectively 857 -
Deferred offering costs 161,948 -
Debt issuance costs, net of accumulated amortization
of $8,788 and $106,587, respectively 97,799 -
---------- ----------
1,975,706 1,557,459
---------- ----------
$3,885,851 $ 3,171,678
---------- ----------
---------- ----------
</TABLE>
The accompanying notes to financial statements
are an integral part of these balance sheets.
F-3
<PAGE>
Page 2 of 2
RACOM SYSTEMS, INC.
BALANCE SHEETS
<TABLE>
December 31,
----------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY 1996 1997
------------------------------------ ----------- -----------
<S> <C> <C>
CURRENT LIABILITIES:
Accounts payable and accrued liabilities $ 631,425 $ 359,069
Accounts payable - related parties (Note 8) 552,298 20,780
Current portion of deferred license revenue - related
party (Notes 3, 4 and 6) 93,397 -
Notes and interest payable - related parties (Note 8) 1,029,596 -
Bridge notes payable (Note 9) 1,040,000 -
Capital lease obligation 1,331 16,594
----------- -----------
Total current liabilities 3,348,047 396,443
----------- -----------
DEFERRED LICENSE REVENUE--RELATED PARTY
(Notes 3, 4 and 6) 303,540 -
COMMITMENTS AND CONTINGENCIES
(Notes 2, 8, 10, 12 and 13)
STOCKHOLDERS' EQUITY (Notes 5 and 6):
Preferred stock, no par value, 5,000,000 shares authorized,
no shares issued or outstanding - -
Common stock, $.01 par value, 20,000,000 shares
authorized, 11,532,532 and 13,222,532 shares
issued and outstanding, respectively 115,325 132,225
Additional paid-in capital 10,272,591 16,499,243
Accumulated deficit (10,153,652) (13,856,233)
----------- -----------
Total stockholders' equity 234,264 2,775,235
----------- -----------
$ 3,885,851 $ 3,171,678
----------- -----------
----------- -----------
</TABLE>
The accompanying notes to financial statements
are an integral part of these balance sheets.
F-4
<PAGE>
RACOM SYSTEMS, INC.
STATEMENTS OF OPERATIONS
<TABLE>
Years Ended
December 31,
-----------------------------
1996 1997
----------- -----------
<S> <C> <C>
REVENUES:
Product sales $ 282,070 $ 210,694
Product sales - related parties 114,275 94,633
Custom product development projects 600,000 -
License revenues - related parties (Notes 4 and 6) 1,430,940 596,953
----------- -----------
2,427,285 902,280
COST OF REVENUES:
Product costs 530,337 541,266
Custom product development projects 521,540 -
----------- -----------
GROSS MARGIN 1,375,408 361,014
----------- -----------
EXPENSES:
Research and development 505,266 1,234,096
General and administrative 833,879 1,070,404
Sales and marketing 869,401 1,014,484
Equity in loss of Racom Japan (Notes 3 and 4) 209,248 201,376
Loss on write off of investment in Racom Japan
(Notes 3 and 4) - 303,978
Amortization expense 172,398 157,643
----------- -----------
2,590,192 3,981,981
----------- -----------
LOSS FROM OPERATIONS (1,214,784) (3,620,967)
OTHER INCOME (EXPENSE):
Interest expense (8,788) (140,714)
Interest expense - related parties (64,400) (17,405)
Interest income 13,426 100,037
Other (29,291) (23,532)
----------- -----------
NET LOSS $(1,303,837) $(3,702,581)
----------- -----------
----------- -----------
NET LOSS PER SHARE (Note 3)
BASIC AND DILUTED $ (.11) $ (.29)
----------- -----------
----------- -----------
WEIGHTED AVERAGE SHARES
OUTSTANDING (Note 3) 11,532,532 12,775,865
----------- -----------
----------- -----------
</TABLE>
The accompanying notes to financial statements
are an integral part of these statements.
F-5
<PAGE>
RACOM SYSTEMS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1997
<TABLE>
Common Stock Additional
---------------------- Paid-In Accumulated
Shares Amount Capital Deficit Total
---------- -------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
BALANCES, December 31, 1995 11,532,532 $115,325 $10,272,591 $ (8,849,815) $ 1,538,101
Net loss - - - (1,303,837) (1,303,837)
---------- -------- ----------- ------------ -----------
BALANCES, December 31, 1996 11,532,532 115,325 10,272,591 (10,153,652) 234,264
Issuance of common stock in conjunction
with initial public offering (net of
offering expenses of $1,182,432) (Note 5) 1,500,000 15,000 5,927,568 - 5,942,568
Common stock issued to related party
(Notes 5 and 6) 160,000 1,600 (1,600) - -
Gain from Racom Japan equity transactions
(Note 4) - - 255,984 - 255,984
Issuance of common stock upon exercise of
employee stock options (Note 5) 30,000 300 44,700 45,000
Net Loss - - - (3,702,581) (3,702,581)
---------- -------- ----------- ------------ -----------
BALANCES, December 31, 1997 13,222,532 $132,225 $16,499,243 $(13,856,233) $ 2,775,235
---------- -------- ----------- ------------ -----------
---------- -------- ----------- ------------ -----------
</TABLE>
The accompanying notes to financial statements
are an integral part of these statements.
F-6
<PAGE>
Page 1 of 2
RACOM SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
Years Ended
December 31,
1996 1997
----------- ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(1,303,837) $(3,702,581)
Adjustments to reconcile net loss to net
cash used in operating activities-
Depreciation and amortization 275,456 252,551
Equity in loss of Racom Japan 209,248 201,376
Loss on write off of investment in Racom Japan - 303,978
Provision to write down inventory to market - 121,382
Amortization of debt issuance costs 8,788 97,799
Loss on disposal of assets 926 430
Decrease (increase) in-
Accounts receivable - trade 78,990 36,159
Accounts receivable - related parties (5,468) 6,838
Inventory (206,707) 184,144
License revenue receivable-related party (646,162) 646,162
Prepaid expenses and other - (62,833)
Increase (decrease) in-
Accounts payable and accrued liabilities 233,225 (272,356)
Accounts payable - related parties 160,131 (531,518)
Deferred license revenue - related party 396,937 (396,937)
----------- ----------
Net cash used in operating activities (798,473) (3,115,406)
----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (25,572) (84,004)
Proceeds on sale of fixed assets 597 -
Proceeds from sale of investment in Racom Japan - 7,936
Investment in Racom Japan (466,984) -
----------- ----------
Net cash used in investing activities (491,959) (76,068)
----------- ----------
</TABLE>
The accompanying notes to financial statements
are an integral part of these statements.
F-7
<PAGE>
Page 2 of 2
RACOM SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
Years Ended
December 31,
----------------------------
1996 1997
---------- -----------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock $ - $ 7,170,000
Proceeds from bridge loan financing 1,040,000 -
Payment of common stock offering costs (161,948) (1,020,484)
Payment of debt issuance costs (106,587) -
Proceeds from notes payable - related parties 515,000 -
Payments on bridge loans - (1,040,000)
Payments on notes payable - related parties (193,379) (1,029,596)
Payments on capital lease obligation (887) (4,081)
---------- -----------
Net cash provided by financing activities 1,092,199 4,075,839
---------- -----------
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS (198,233) 884,365
CASH AND CASH EQUIVALENTS, beginning of period 512,435 314,202
---------- -----------
CASH AND CASH EQUIVALENTS, end of period $ 314,202 $ 1,198,567
---------- -----------
---------- -----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash was paid during the year for:
Interest $ - $ 44,649
Interest-related parties - 287,001
Income taxes - -
</TABLE>
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
During 1997, the Company purchased equipment under a capital lease totaling
$19,344.
During 1997, the Company recognized, as additional paid-in capital, a
$255,984 gain on its investment in Racom Japan as a result of the investee's
issuance of additional shares (Note 4).
During 1997, the Company issued 160,000 common shares to INTAG (Notes 5 and
6) related to consideration received in 1995.
The accompanying notes to financial statements
are an integral part of these statements.
F-8
<PAGE>
RACOM SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
(1) ORGANIZATION AND BUSINESS
Racom Systems, Inc. (the "Company") is a developer and marketer of contactless
smart cards and radio frequency identification ("RFID") contactless smart card
systems. The Company was initially formed as a joint venture between Intag
International Limited ("INTAG"), AWA Limited ("AWA") and Ramtron International
Corporation ("Ramtron"). In June 1993, INTAG acquired AWA's 2,000,000 shares
of common stock.
The Company was incorporated in the State of Delaware on June 3, 1991 and
commenced operations in February 1992. Sales of the Company's initial two
products utilizing ferroelectric random access memory ("FRAM") commenced in
1993. The Company announced the development of its advanced third generation
of smart card products in September 1997. Further developments to the product
lines are expected throughout 1998.
(2) GOING CONCERN AND ASSET REALIZATION
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. To date, the Company has completed
a series of smaller-scale projects; however, the Company has not yet completed
a significant number of substantial sales transactions covering the application
of its products and, as a result, an uncertainty exists as to whether the
Company will be able to successfully market and sell its products to third
parties at prices and volumes sufficient to fund its operations. During 1996
and 1997, the Company experienced significant cash flow deficits and liquidity
shortages and funded its operations primarily through the sale of non-exclusive
sublicenses to its technology, proceeds from the sale of its common stock,
bridge loan borrowings and related party borrowings. As of December 31, 1997
the Company had working capital of $1,057,594.
During 1998, the Company anticipates that increased operating revenues will be
achieved through a combination of product sales, development contracts and the
sale of non-exclusive licenses. However, the Company is limited under its
Tripartite Agreement (see Note 6) with Ramtron and INTAG to sublicense rights
to Ramtron's ferroelectric technology for use in RFID applications to no more
than five parties. In addition, the Company also anticipates increased
operating expenses and research and development expenditures which are
required for the Company to further develop and market its products and
achieve successful operations. However, there is no assurance the Company
will be successful in developing and marketing its products.
During March 1997, the Company completed its initial public offering ("IPO")
for gross proceeds of $7,125,000 (see Note 5). Net proceeds from the offering
were $5,942,568. Management's plans for the Company's 1998 operations include
funding through a combination of product sales and technology sublicensing and
offerings of its common stock. There is no assurance that such funding will
occur.
These factors, among others, 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.
The Company must also continue to satisfy certain requirements in order to
remain listed on The Nasdaq Stock Market-SM- ("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. As of
December 31, 1997 the Company was in compliance with the Nasdaq listing
requirements. There is no assurance that the Company will continue to meet the
Nasdaq listing requirements.
F-9
<PAGE>
ASSET REALIZATION
The Company's primary asset is a technology license related to the design and
manufacture of its products. The Company originally purchased the technology
from Ramtron pursuant to a technology license agreement (the "Technology
License"), for $2,000,000 in cash and 2,000,000 shares of the Company's common
stock. The Company also entered into a supply agreement in connection with the
Technology License (collectively, the "Technology License and Supply
Agreements"). See Note 6 for amendments to the Technology License and Supply
Agreements. The Technology License is protected by patents owned by Ramtron
and is further protected by the Company's own patents. No assurance can be
made that these patents will not be challenged.
The Technology License was recorded at the original cash acquisition cost of
$2,000,000. In connection with a Memorandum of Understanding ("MOU") signed in
May 1995, the Company acquired certain additional rights with respect to the
technology. The net $400,000 cost of obtaining the additional rights was
capitalized in 1995 (Note 6). The net book value of the Technology License was
$1,715,102 and $1,557,459, as of December 31, 1996 and 1997, respectively.
Although the Company is currently marketing products utilizing the technology
covered by this Technology License and believes the underlying 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. No provision for any loss that
may result should the carrying amount of the license not be recovered has been
made in the accompanying financial statements.
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include investments in highly liquid investments with
original maturities of three months or less.
INVENTORY
Inventory is stated at the lower of cost or market using the first-in, first-
out ("FIFO") method of accounting. Inventories at December 31, 1996 and 1997
consisted of the following:
<TABLE>
December 31,
1996 1997
-------- -----------
<S> <C> <C>
Raw materials $206,992 $ 50,200
Work in process 75,359 48,944
Finished goods 146,050 23,731
-------- -----------
$428,401 $ 122,875
-------- -----------
-------- -----------
</TABLE>
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and depreciation is provided using
the straight-line method over the estimated useful lives of three to five years
for the respective assets. Leasehold improvements are amortized over the lease
term or estimated useful life of the improvements, whichever is shorter.
Maintenance and repairs are expensed as incurred and improvements are
capitalized. Depreciation expense, including amortization of assets held under
capital leases, was $103,057 and $94,051 in 1996 and 1997, respectively.
F-10
<PAGE>
INVESTMENT IN RACOM JAPAN
During 1996 and the majority of 1997, the Company's investment in Racom Japan,
Inc. ("RJ") was accounted for under the equity method. In December 1997, the
Company reduced its ownership interest in RJ to 19.9% and prospectively adopted
the cost method. The investment is carried at zero as of December 31, 1997
(Note 4).
INTANGIBLE ASSETS
Intangible assets are recorded at cost and are amortized using the straight-
line method over the following estimated useful lives:
<TABLE>
Estimated
Useful Lives
(In Years)
------------
<S> <C>
Technology license 10-17
Organization costs 5
</TABLE>
The amortization lives assigned to the Technology License are based on the
remaining lives of the patents protecting the licensed technology. The Company
reviews its amortization lives on a periodic basis.
DEFERRED LICENSE REVENUE
Deferred license revenue at December 31, 1996 relates entirely to the March
1996 sublicense of the Technology License to RJ (Notes 4 and 6). Because the
Company owned 50% of RJ, half ($466,984) of the sublicense revenue was
deferred. Recognition of the amount deferred was matched with the Company's
share of RJ's amortization of the cost of the sublicense, recorded by the
Company as a component of its equity in RJ's net income. Revenue recognized in
1996 totaled $70,047. During 1997, the remainder of the deferred revenue was
recognized as the Company's investment in RJ was accounted for under the cost
method.
REVENUE RECOGNITION
Revenue from product sales to direct customers is recognized upon shipment.
Royalty revenue is recognized upon the Company's fulfillment of its contractual
obligations and determination of a fixed royalty amount, or, in the case of
ongoing unit royalties, upon sales by the licensee of royalty-bearing products,
as estimated by the Company.
Revenue from the sale of licenses of technology which are nonrefundable and for
which no significant future obligations exist, is recognized when the license
is signed. Revenue from the sale of licenses which are refundable or for which
future obligations exist, is recognized when the Company has completed its
obligations under the license.
Revenue from certain research and development activities conducted for third
parties is recognized as the services are performed.
RESEARCH AND DEVELOPMENT
Research and development costs are charged to operations when incurred and are
included in operating expenses.
DEFERRED OFFERING COSTS
Costs incurred during 1996 related to the Company's IPO were deferred as of
December 31, 1996 and charged against the net proceeds of the IPO in 1997.
F-11
<PAGE>
DEBT ISSUANCE COSTS
Costs incurred for issuance of the Bridge Notes (Note 9) were deferred and
amortized over the life of the related debt.
NET LOSS PER SHARE
Net loss per share has been computed based upon the weighted average number of
common shares.
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. As a result of
the Company's net losses, all potentially dilutive securities, 1,567,000
options and 2,483,218 warrants in 1997, and 1,559,000 options and 833,218
warrants in 1996, would be antidilutive and thus, diluted earnings per share is
not presented.
Pursuant to Securities and Exchange Commission ("SEC") rules, common stock and
common stock equivalent shares issued by the Company at prices below the IPO
price during the twelve month period prior to the offering ("cheap stock") were
previously included in the calculation as if they were outstanding for 1996,
regardless of whether they were antidilutive. In Staff Accounting Bulletin
("SAB") 98, the SEC redefined cheap stock. As a result, 312,261 shares which
were originally treated as cheap stock and included in the 1996 weighted
average shares outstanding of 11,844,793, have been excluded in the restated
1996 weighted average shares outstanding of 11,532,532. The adoption of SFAS
No. 128 and SAB 98 had no effect on the previously reported loss per share.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments consist of cash and cash equivalents, short-
term trade receivables and payables. At December 31, 1996 the Company also had
outstanding bridge loans and related party borrowings. The carrying values of
cash and cash equivalents, and short-term trade receivables and payables
approximate fair value. The fair value of the bridge loan and related party
borrowings was estimated based on current rates available for similar debt with
similar maturities and collateral, and at December 31, 1996, approximated their
carrying values.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions.
These estimates may affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
LONG-LIVED ASSETS
Long-lived assets and intangibles held and used by the Company are reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. If impaired, long-lived
assets and intangibles are adjusted downward to their estimated fair value.
F-12
<PAGE>
CONCENTRATION OF CREDIT RISK/TRANSACTIONS
DENOMINATED IN FOREIGN CURRENCIES
The Company does not enter into hedging or speculative derivative contracts and
has no off balance sheet risk from foreign exchange contracts, options
contracts or other hedging arrangements. Further, the Company has no obligation
denominated in foreign currencies nor has it guaranteed the obligations of
other parties.
The Company enters into sales and sublicense contracts denominated in foreign
currency. At December 31, 1996, the Company had recorded a license revenue
receivable of 75,000,000 Japanese yen ($646,162) related to a license contract
denominated in Japanese yen. Transaction gains and losses are included in
income (loss) in the period in which the exchange rate changes. During 1996
and 1997, the Company has recorded foreign exchange losses of $28,367 and
$21,934, respectively, which is included in other income (expense) in the
accompanying statements of operations.
The Company performs ongoing evaluations of its customers' financial condition
and generally does not require collateral, but often requires deposits on
certain international product orders. Its trade accounts receivable balances
are primarily domestic and are concentrated among companies within the high-
technology industry. The Company has not recorded an allowance against
uncollectible accounts at December 31, 1996 and 1997.
INCOME TAXES
The Company recognizes deferred income tax assets and liabilities for the
expected future income tax consequences, based on enacted tax laws, of
temporary differences between the financial reporting and tax bases of assets,
liabilities, and for carryforwards. Deferred tax assets are reduced, if deemed
necessary, by a valuation allowance for the amount of any tax benefits which,
more likely than not, based on current circumstances, are not expected to be
realized (Note 12).
(4) INVESTMENT IN RACOM JAPAN
In July 1993, the Company entered into a joint venture agreement with Nittetsu
Shoji Co. Ltd. ("NS") pursuant to which NS and the Company each received a 50%
ownership interest in RJ, a Japanese corporation. RJ was formed for the
purpose of marketing, distributing and supporting the Company's RFID products
in Japan. RJ had the exclusive right to distribute the Company's products in
Japan for two years commencing August 1995. In 1997, the Company extended RJ's
distribution rights to worldwide, nonexclusive rights. In March 1996, the
Company purchased an additional 1,000 shares of common stock in RJ at a
purchase price of 50,000 Japanese yen ($466.98 per share, or $466,984).
Additionally, in March 1996, NS and third parties purchased additional shares
of common stock, decreasing the Company's ownership of RJ to 40%. In May 1997,
RJ sold 3,020 shares of its stock (at 50,000 yen per share) to third parties,
reducing the Company's ownership to 22.8%. The Company recognized a $255,984
gain on its investment in RJ as a result of the investee's issuance of
additional shares. Due to RJ's history of continuing operating losses and
questions regarding RJ's ability to continue in existence, the Company
recognized the increase in the investment as an increase to additional paid-in
capital. During December 1997, the Company sold 40 shares of its investment in
RJ to a third party and RJ sold 800 shares of its stock to third parties.
These two transactions resulted in a decrease in ownership from approximately
22.8% to 19.9%. Effective December 1997, the Company changed its method of
accounting for its investment in RJ from the equity method to the cost method.
The investment in RJ was accounted for using the equity method through December
1997 and the Company has recorded its share of RJ's losses in 1996 and 1997 of
$209,248 and $201,376, respectively, as equity in loss of RJ in the
accompanying financial statements. The losses recorded for the year ended
December 31, 1996, include previously unrecognized losses which had not been
recorded as the Company's investment had been reduced to zero and it had no
obligation to fund such losses. However, upon the 1996 investment of $466,984,
previously unrecognized losses of $141,953 were recorded.
F-13
<PAGE>
During 1997, the Company determined that the carrying value of its investment
in RJ was impaired and accordingly wrote off its remaining investment of
$303,978. The investment is carried at zero as of December 31, 1997. The
Company has no obligation to provide additional funding to or on behalf of RJ.
(5) STOCKHOLDERS' EQUITY
During 1997, the Company issued 160,000 common shares to INTAG for
consideration previously received related to amendments to the Technology
License and Supply Agreements (Note 6).
In March 1997, the Company completed its IPO of common stock resulting in net
proceeds of $5,942,568. The Company sold 1,500,000 units (consisting of one
share of common stock and one common stock purchase warrant) for $4.75 per
unit. Each warrant is exercisable to purchase one share of common stock at
$5.94 per share for a period of two years. The warrants may be redeemed by the
Company for $.01 per warrant if the closing price of the common stock is at
least $7.13 per share for 20 consecutive trading days, ending not earlier than
five days before the warrants are called for redemption. Also in conjunction
with the IPO, the underwriters received the option to purchase an additional
150,000 units at $7.36 per unit at any time beginning 12 months from the
effective date of the IPO and continuing for 4 years thereafter. The Company
determined that the warrants had a nominal value at the date of issuance. As
of December 31, 1997, none of the warrants have been exercised.
During 1997, a former employee elected to exercise vested employee options to
purchase 30,000 shares of the Company's common stock at an exercise price of
$1.50 per share.
During 1996, the Company authorized 5,000,000 shares of preferred stock with no
par value. No preferred stock has been issued as of December 31, 1997.
The Company has granted warrants for the purchase of common stock to its
shareholders and lenders principally for providing financing to the Company.
The Company has also granted warrants in conjunction with the IPO. The
following warrants are outstanding as of December 31, 1997:
<TABLE>
Remaining
Exercise Life in
Quantity Price Years
-------- -------- ---------
<C> <C> <C>
1,500,000 $5.94 1.25
150,000 7.36 3.25
200,000 2.50 1.50
121,766 2.50 3.80
251,452 2.50 3.80
260,000 5.94 1.25
----------
2,483,218
----------
----------
</TABLE>
F-14
<PAGE>
(6) AMENDMENTS TO THE TECHNOLOGY LICENSE
AND SUPPLY AGREEMENTS
In 1994, Ramtron was issued an additional 2,000,000 shares of common stock in
connection with an amendment to the Technology License and Supply Agreements.
In 1995, the Company and Ramtron entered into a second amendment to the
Technology License and Supply Agreements and executed the MOU (Note 2) with
INTAG and Ramtron relating to further amendments to the Technology License and
Supply Agreements.
As further consideration for the additional rights obtained through the
amendments to the Technology License and Supply Agreements, the Company issued
to Ramtron 1,000,000 shares of common stock and caused Ramtron to be paid cash
of $1,000,000. The common shares issued to Ramtron were assigned no value
because the amendments were viewed as a modification of the original transfer
(Note 2) by a principal stockholder of intangible rights for which Ramtron had
no capitalized historical cost basis. INTAG paid $600,000 of the cash
consideration directly to Ramtron, which has been reflected as an addition to
the Company's paid-in capital. The remaining $400,000 balance paid to Ramtron
was loaned to the Company by INTAG and was payable contingent upon INTAG
generating sufficient sublicense revenue. During 1995, INTAG and the Company
agreed that the amount would no longer bear interest and may be converted, at
INTAG's option, into shares of the Company's common stock at a rate of $2.50
per share, no later than June 1997. INTAG simultaneously paid the Company
$200,000 for a sublicense. The Company had netted the $400,000 contingent
payable and the $200,000 sublicense payment against the $1,000,000 cash paid
to Ramtron, resulting in a net increase to the Technology License of $400,000
as of December 31, 1995. During 1997, the Company issued 160,000 common
shares to INTAG for consideration received related to the amendments to the
Technology License and Supply Agreements.
In June 1995, the Company entered into a Cooperative Agreement for Licensed
Manufacturing of Ferroelectric RFID Products with Rohm Co., Ltd. ("ROHM") of
Japan. The license gives ROHM a non-exclusive, non-sublicenseable, non-
transferable right and license to use the RFID technology in connection with
the design, development, manufacture and sale of Custom Ferroelectric RFID
Products for use within a defined territory (Japan). In consideration of this
license, ROHM purchased 300,000 shares of the Company's common stock, at $3.00
per share. ROHM also purchased 200,000 additional shares of the Company's
common stock, for a purchase price of $3.00 per share upon reaching certain
sales milestones. ROHM is also to pay a $1,000,000 license fee to the Company
in four equal installments upon reaching certain sales milestones. As of
December 31, 1996, the Company had received $500,000 in license fees from ROHM.
As of December 31, 1997, no additional milestones had been reached.
On March 22, 1996, the Company entered into a technology license and supply
agreement with RJ (see Note 4) for the common purpose of more fully developing
the Japanese market for ferroelectric RFID products. RJ paid $933,968 in cash
to the Company for the non-exclusive right and license to use its patented
ferroelectric RFID technology and all improvements, for the limited right to
design, develop and manufacture ferroelectric RFID products for sale and use
in Japan only. This license specifically excludes the right to use the
ferroelectric RFID technology in conveyor fed, airline, postal and courier
applications (as the rights to this technology were previously licensed to
INTAG). Under the agreement, RJ is obligated to pay 50% to the Company, of
all sublicense revenues and royalties, as defined in the agreement, on net
sales of ferroelectric RFID products which are sold to third parties. In
1997, the Company renegotiated the license rights granted to RJ, which granted
RJ worldwide nonexclusive rights to the technology in exchange for RJ
relinquishing its limited exclusive rights to license the technology in Japan.
In October 1996, the Company consented to allow RJ to enter into a custom
product development project with Fujitsu Limited of Japan ("Fujitsu"), pursuant
to the technology license and supply agreement granted to RJ on March 22, 1996,
under which the Company is entitled to 50% of all sublicense revenue earned by
RJ. The sublicense was for a specified amount, as defined in the contract, a
portion of which was due upon execution of the agreement and the remainder to
be paid upon RJ meeting certain performance criteria. Under the agreement
F-15
<PAGE>
with Fujitsu, RJ will be entitled to royalties, as defined in the contract,
through 2001. As of December 31, 1996, $893,909 had been recorded by the
Company related to its respective portion of sublicense revenue, of which
$646,162 remained outstanding at December 31, 1996, and was recorded as
license revenue receivable in the accompanying financial statements. Revenue
due to the Company of approximately $215,000 remaining under the agreement
between RJ and Fujitsu was recognized during 1997, upon completion of certain
performance criteria.
On April 15, 1997, the Company signed an agreement ("Tripartite Agreement")
with Ramtron and INTAG to significantly increase the availability of Ramtron's
FRAM technology for use in RFID markets and applications. The Tripartite
Agreement replaces all existing licensing, supply and memorandum of
understanding agreements between the related parties. Under the Tripartite
Agreement, the Company retained the rights to sublicense Ramtron's
ferroelectric technology for use in ferroelectric RFID products to no more
than five (5) parties pursuant to Ramtron's approval. The Company has, to
date, sublicensed such technology to two separate companies. Ramtron has
agreed to coordinate its own licensing of FRAM technology, including the
licensing of FRAM technology for use in RFID applications with the Company,
until such time as the Company completes its five sublicensing agreements.
The parties to the Tripartite Agreement have agreed to share, with certain
limitations, future licensing and royalty revenues associated with such
ferroelectric RFID licensing activities. In addition, Ramtron granted the
Company the right to purchase certain agreed upon percentages of its FRAM
product manufacturing capacity. As of December 31, 1997, the Company had not
received or paid any royalties under the Tripartite Agreement as there were no
sales of products through December 31, 1997. The Tripartite Agreement
eliminates the requirements that the Company purchase from Ramtron minimum
quantities of ferroelectric RFID semiconductor chips as originally required
under the Technology and Supply Agreements. For the years ended December 31,
1996 and 1997, the Company made purchases from Ramtron of approximately
$281,000 and $34,000, respectively. The Tripartite Agreement remains
effective until expiration of the last of Ramtron's patents.
(7) DEVELOPMENT AND SUPPLY AGREEMENT
On January 29, 1996, the Company signed an agreement with an unaffiliated third
party to develop a multi-application "smart card" based on the Company's
contactless smart card technology and the third party's bank and electronic
purse operating system. In combination, the two technologies form the basis
for a new product family which will combine contact and contactless operation
on a single, microprocessor smart card. Under the terms of the agreement, the
Company received an initial cash payment of $500,000 and will receive
additional payments based upon the achievement of certain production milestones
and delivery of specified products. As of December 31, 1996, the Company
recognized $600,000 of revenue as a result of the initial cash payment of
$500,000 and reaching the first milestone. As of December 31, 1997, no
additional milestones had been reached.
(8) OTHER RELATED PARTY TRANSACTIONS
During 1996, INTAG advanced approximately $340,000 to the Company under various
notes payable agreements, which carried interest at 10% per annum and were due
on demand. As of December 31, 1996, the related party notes payable to INTAG
had total principal and interest outstanding of $879,576. Additionally,
$55,452 of accrued interest remained outstanding from a working capital
facility previously provided the Company by INTAG. In 1996, Ramtron advanced
$175,000 to the Company under a note payable agreement which carried interest
at prime plus 2% (10.25% at December 31, 1996) and was due on demand. As of
December 31, 1996, the related party note payable to Ramtron had total
principal and interest outstanding of $94,568. During 1997, the Company used
proceeds from its IPO to repay all debt and interest outstanding to Ramtron and
INTAG.
As consideration for INTAG advancing a working capital facility in June 1994,
the Company granted INTAG 200,000 warrants for the Company's common stock at an
exercise price of $2.50 per share, which vested
F-16
<PAGE>
immediately and are exercisable over a five-year term. The Company
determined that these warrants had a nominal value at the date of issuance.
As of December 31, 1997, none of the warrants have been exercised.
In October 1996, the Company issued 121,766 and 251,452 warrants to purchase
the Company's common stock at an exercise price of $2.50 per share to INTAG and
Ramtron, respectively. The warrants were approved in consideration of
approximately $933,000 of short-term loans made to the Company during 1995 and
1996 from Ramtron and INTAG and deferred payment terms on product purchases
from Ramtron made to the Company, which were repaid with proceeds from the
Company's IPO. The warrants, which vested immediately, are exercisable for a
period of five years after the date of issuance. The Company determined that
these warrants had a nominal value at the date of issuance. As of December 31,
1997, none of the warrants have been exercised.
For the years ended December 31, 1996 and 1997 the statements of operations
include amounts attributable to related party transactions as follows:
<TABLE>
Years Ended
December 31,
--------------------------
1996 1997
----------- ----------
<S> <C> <C>
PRODUCT SALES
Sales to INTAG $ - $ 1,425
----------- ----------
----------- ----------
Sales to RJ $ 113,575 $ 92,968
----------- ----------
----------- ----------
Sales to Ramtron $ 700 $ 240
----------- ----------
----------- ----------
LICENSE REVENUES
RJ $ 1,430,940 $ 596,953
----------- ----------
----------- ----------
GENERAL AND ADMINISTRATIVE EXPENSES
Director travel expenses $ 29,111 $ 39,822
----------- ----------
----------- ----------
OTHER INCOME AND EXPENSE
Interest expense on notes payable to INTAG $ 59,833 $ 15,108
----------- ----------
----------- ----------
Interest expense on notes payable to Ramtron $ 4,567 $ 2,297
----------- ----------
----------- ----------
</TABLE>
(9) BRIDGE FINANCING
In December 1996, the Company completed a private offering of $1,040,000 of
promissory notes (the "Bridge Notes"). The Bridge Notes carried interest at
prime plus 2% per annum, computed as of the date of issuance (the "Bridge
Date"), and thereafter on a quarterly basis commencing December 31, 1996.
The Bridge Notes matured the earlier of one year from the Bridge Date or upon
the closing date of any IPO of the Company's securities. The Bridge Notes were
repaid during 1997 from the proceeds of the IPO. On the Bridge Date, the
Company also granted warrants (the "Bridge Warrants") entitling the holder to
purchase shares of the Company's common stock at 125% of the IPO price per
unit, beginning on the effective date of the IPO and continuing for two years
thereafter. The holders of the Bridge Notes received one warrant for every $4
of Bridge Note principal purchased, resulting in 260,000 Bridge Warrants being
issued in connection with the offering of the Bridge Notes. The Company
determined that these warrants had a nominal value at the date of issuance. As
of December 31, 1997, none of the warrants have been exercised.
F-17
<PAGE>
(10) COMMITMENTS AND CONTINGENCIES
The Company leases its facilities and certain equipment under noncancelable
operating lease agreements. Minimum future annual lease payments under these
leases as of December 31, 1997, are as follows:
<TABLE>
<S> <C>
1998 $ 79,095
--------
--------
</TABLE>
Total rent expense for noncancelable, cancelable and month-to-month operating
leases for the years ended December 31, 1996 and 1997 was $124,929 and
$116,706, respectively.
The Company leases equipment under capital leases. The leases commenced in
February 1995 and January 1997 and bear interest at a rate of 15% and 10%,
respectively.
(11) MAJOR CUSTOMERS & SUPPLIERS
The Company's product sales from non-related party customers in excess of 10%
of non-related party product sales for the years ended December 31, 1996 and
1997 are as follows:
<TABLE>
Years Ended
December 31,
--------------------
1996 1997
-------- --------
<S> <C> <C>
Customer A 21% 1%
Customer B 5% 12%
Customer C 13% 3%
Customer D 12% -
Customer E 9% 3%
Customer F 3% 15%
Customer G 1% 26%
Customer H - 11%
</TABLE>
The Company's accounts receivable balances from non-related party customers in
excess of 10% of the accounts receivable balance from non-related parties for
the years ended December 31, 1996 and 1997 are as follows:
<TABLE>
Years Ended
December 31,
--------------------
1996 1997
-------- --------
<S> <C> <C>
Customer C 37% 3%
Customer E 42% 12%
Customer F 4% 19%
Customer G 1% 46%
</TABLE>
The Company relies on certain vendors for purchasing raw materials used in its
manufacturing process. No assurance can be made that these vendors will be
able to continue to supply the Company. However, the Company believes adequate
alternative vendors can be located for the necessary materials.
F-18
<PAGE>
(12) INCOME TAXES
For income tax return reporting purposes, the Company has approximately
$13,700,000 and $221,000 of net operating loss and research and development tax
credit carryforwards, respectively, that expire at various dates through the
year 2012. The net operating loss for tax purposes differs from that for
financial reporting purposes due to differences in reporting certain
transactions for income tax and financial reporting purposes. These
differences primarily relate to the Technology License.
The Tax Reform Act of 1986 contains provisions which may limit the net
operating loss carryforwards available to be used in any given year if certain
events occur, including significant changes in ownership interests.
The Company has determined that approximately $6,182,000 and $7,547,000 of
deferred tax assets as of December 31, 1996 and 1997, respectively, did not
satisfy the realization criteria set forth in SFAS No. 109, "Accounting for
Income Taxes." Accordingly, a valuation allowance was recorded against the
entire net deferred tax asset.
The components of the net deferred income tax asset at December 31, 1996 and
1997 were as follows:
<TABLE>
1996 Change 1997
----------- ---------- -----------
<S> <C> <C> <C>
Technology license $ 2,005,000 $ (218,000) $ 1,787,000
Net operating loss carryforwards 3,630,000 1,566,000 5,196,000
Research and development
tax credits 136,000 85,000 221,000
Investment in Racom Japan 191,000 95,000 286,000
Deferred license revenue 151,000 (151,000) -
Other 69,000 (12,000) 57,000
Less- Valuation allowance (6,182,000) (1,365,000) (7,547,000)
----------- ----------- -----------
$ - $ - $ -
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The provision for income taxes includes the following for the years ended
December 31, 1996 and 1997:
<TABLE>
1996 1997
---------- -----------
<S> <C> <C>
Current -
Federal $ - $ -
State - -
---------- -----------
- -
---------- -----------
Deferred -
Federal $(456,000) $(1,221,000)
State (42,000) (144,000)
---------- -----------
Total deferred benefit (498,000) (1,365,000)
---------- -----------
Increase in valuation allowance 498,000 1,365,000
---------- -----------
Total provision $ - $ -
---------- -----------
---------- -----------
</TABLE>
F-19
<PAGE>
The difference between the statutory rate and the effective rate for the years
ended December 31, 1996 and 1997 is a result of the following:
<TABLE>
1996 1997
------- -------
<S> <C> <C>
Statutory rate (35.0)% (35.0)%
State taxes, net of federal benefit (3.3)% (3.3)%
Valuation allowance 38.2 % 36.9 %
Other .1 % 1.4 %
------- -------
0 % 0 %
------- -------
------- -------
</TABLE>
(13) EMPLOYEE BENEFIT PLANS
STOCK OPTION PLAN
In May 1993, the Company adopted the 1993 Employee Stock Plan which authorized
the granting of incentive and nonqualified stock options and restricted stock
(collectively, the "stock options") to acquire up to 1,700,000 shares of the
Company's common stock, of which 133,000 are available to be granted as of
December 31, 1997. The exercise terms for the stock options granted are
determined by the Board of Directors at the time the stock options are granted.
Stock options may be granted at an exercise price not less than the fair market
value on the date of grant with a maximum term of 10 years. The 1993 Employee
Stock Plan also permits the granting of limited stock appreciation rights
("SAR's") which, upon a change in control, as defined, entitle the holders to
exercise SAR's in an amount equal to the number of stock options held and at
terms similar to the terms of the related stock options. Upon exercise of the
stock options or SAR, the corresponding SAR or stock options are cancelled. As
of December 31, 1996 and 1997, the Company has issued 1,100,000 and 1,000,000
SAR's respectively, none of which have been exercised. The Company accounts
for the 1993 Employee Stock Plan under Accounting Principles Board ("APB")
Opinion No. 25, under which no compensation cost has been recognized.
In 1996, the Company adopted the disclosure provisions of SFAS No. 123
"Accounting for Stock Based Compensation." Had compensation cost for the 1993
Employee Stock Plan been determined consistent with SFAS No. 123, the Company's
net loss and net loss per share would have been increased to the following pro
forma amounts:
<TABLE>
1996 1997
----------- ------------
<S> <C> <C>
Net Loss:
As Reported $(1,303,837) $(3,702,581)
----------- -----------
----------- -----------
Pro Forma $(1,580,465) $(4,370,696)
----------- -----------
----------- -----------
Net Loss Per Share:
Basic and diluted - As Reported $ (.11) $ (.29)
----------- -----------
----------- -----------
Basic and diluted - Pro Forma $ (.13) $ (.34)
----------- -----------
----------- -----------
</TABLE>
Because the SFAS No. 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of that to be expected in future years.
F-20
<PAGE>
A summary of the status of the Company's 1993 Employee Stock Plan at
December 31, 1996 and 1997 and changes during the years then ended is presented
in the table and narrative below:
<TABLE>
1996 1997
----------------------- ----------------------
Wtd. Avg. Wtd. Avg.
Shares Ex Price Shares Ex Price
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Outstanding at beginning of year 1,512,000 $1.60 1,559,000 $1.67
Granted 289,000 $2.50 828,000 $1.34
Exercised - - (30,000) $1.50
Cancelled - - (565,000) $1.04
Forfeited (242,000) $2.17 (225,000) $2.23
--------- ---------
Outstanding at end of year 1,559,000 $1.67 1,567,000 $1.60
--------- ---------
--------- ---------
Exercisable at end of year 1,065,250 $1.34 1,110,250 $1.41
--------- ---------
--------- ---------
Weighted average fair value of
options granted during year $1.30 $1.02
</TABLE>
Of the 1,567,000 options outstanding at December 31, 1997, 1,480,800 have
exercise prices between $1.00 and $2.50, with a weighted average remaining
contractual life of 3.30 years and 86,200 have exercise prices between $2.78
and $2.94, with a weighted average contractual life of 4.47 years.
The 1,110,250 options exercisable at December 31, 1997 have exercise prices
between $1.00 and $2.50, with a weighted average remaining contractual life of
3.46 years.
The fair value of each option grant is estimated on the date of grant using the
Black Scholes option pricing model with the following weighted-average
assumptions used for grants in 1996 and 1997, respectively: risk-free interest
rates of 6.40% and 6.13%; no expected dividend yields; expected lives of 3.54
years and 5.00 years; expected volatility of 68.1% and 103.0%.
DEFINED CONTRIBUTION PLAN
The Company has a defined contribution plan (the "Plan") intended to qualify
under Section 401(k) of the Internal Revenue Code of 1986, as amended (the
"Code"), in which substantially all full-time employees are participants.
Participants in the Plan may make pre-tax contributions subject to limitations
imposed by the Code. The Company may make, at the Board of Directors'
discretion, an annual contribution on behalf of each participant. To date, no
amounts have been contributed by the Company under the Plan.
(14) SUBSEQUENT EVENTS
Subsequent to December 31, 1997, the Company executed an agreement, in
conjunction with 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 FRAM technology. In addition to these license rights, the Company
granted Hitachi option rights, for a predetermined option fee, to its 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. As
additional consideration for the rights granted under the agreement, Hitachi
will provide engineering
F-21
<PAGE>
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.
F-22
<PAGE>
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report dated February 27, 1998, included in this Form 10-KSB, into Racom
Systems, Inc.'s previously filed Registration Statement No. 333-38645 on Form
S-8.
Denver, Colorado
March 30, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 1,198,567
<SECURITIES> 0
<RECEIVABLES> 69,762
<ALLOWANCES> 0
<INVENTORY> 122,875
<CURRENT-ASSETS> 1,454,037
<PP&E> 512,164
<DEPRECIATION> 351,982
<TOTAL-ASSETS> 3,171,678
<CURRENT-LIABILITIES> 396,443
<BONDS> 0
0
0
<COMMON> 132,225
<OTHER-SE> 2,643,010
<TOTAL-LIABILITY-AND-EQUITY> 3,171,678
<SALES> 305,327
<TOTAL-REVENUES> 902,280
<CGS> 541,266
<TOTAL-COSTS> 541,266
<OTHER-EXPENSES> 3,981,981
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 158,119
<INCOME-PRETAX> (3,702,581)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,702,581)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,702,581)
<EPS-PRIMARY> (.29)
<EPS-DILUTED> (.29)
</TABLE>
