<PAGE>


                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                                   Form 10-QSB
                                   (Mark One)

     [X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
         Exchange Act of 1934

                For the Quarterly period ended September 30, 1998

                                       or

     [ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
         Exchange Act of 1934

                For the transition period from _______ to _______

                        Commission File number 000-21907

                               Racom Systems, Inc.
        (Exact name of small business issuer as specified in its charter)

             Delaware                            84-1182875
           ------------                        --------------
      State or other jurisdiction             (I.R.S. Employer
   of incorporation or organization)       Identification Number)

                           6080 Greenwood Village, CO
                           Greenwood Village, CO 80111
                         -------------------------------
                    (Address of principal executive offices)

                                 (303) 771-2077
                                ----------------
                           (Issuer's telephone number)









Check whether the issuer (1) filed all reports required to be filed by 
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for 
such shorter period that the registrant was required to file such reports), 
and (2) has been subject to such filing requirements for the past 90 days. 
Yes X No

There are 13,442,532 shares of the registrant's common stock, $.01 par value 
outstanding as of November 6, 1998.

<PAGE>

                               RACOM SYSTEMS, INC.

                                   FORM 10-QSB

                                      INDEX

<TABLE>
<CAPTION>

Part I   Financial Information                                                                         Page
<S>                                                                                                    <C>
            Item 1.    Balance Sheets as of September 30, 1998 and December 31, 1997                     3

                       Statements of Operations  for the three and nine months ended
                       September 30, 1998 and 1997                                                       4

                       Statements of Cash Flows for the nine months ended
                       September 30, 1998 and 1997                                                       5

                       Notes to Financial Statements                                                     6


            Item 2.    Management's Discussion and Analysis of
                       Financial Condition and Results of Operations                                     7


Part II  Other Information and Signatures                                                               12
</TABLE>

                                       2

<PAGE>

                               RACOM SYSTEMS, INC.

                                 BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                       September 30,        December 31,
                                                                           1998                 1997
                                                                      --------------       -------------
                                                                       (Unaudited)
                              ASSETS
<S>                                                                  <C>                  <C>
CURRENT ASSETS:
    Cash and cash equivalents                                        $    584,722         $  1,198,567
    Accounts receivable-trade, net of reserve of $32,000
       and $-0- in 1998 and 1997, respectively                             20,271               43,042
    Accounts receivable-related parties                                  --                     26,720
    Inventory                                                             152,428              122,875
    Prepaid and other expenses                                             40,810               62,833
                                                                     ------------         ------------
                                                                          798,231            1,454,037
                                                                     ------------         ------------

PROPERTY AND EQUIPMENT:
    Machinery and equipment                                               523,634              449,432
    Furniture and fixtures                                                 59,767               59,404
    Leasehold improvements                                                  3,328                3,328
                                                                     ------------         ------------
                                                                          586,729              512,164
    Less-accumulated depreciation                                        (410,537)            (351,982)
                                                                     ------------         ------------
                                                                          176,192              160,182
                                                                     ------------         ------------

OTHER ASSETS:
    Technology license from related party, net of
       accumulated amortization of $960,775 and $842,541
       in 1998 and 1997, respectively                                   1,439,225            1,557,459
                                                                     ------------         ------------

                    TOTAL ASSETS                                        2,413,648            3,171,678
                                                                     ------------         ------------
                                                                     ------------         ------------

               LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
    Accounts payable and accrued liabilities                              322,861              359,069
    Accounts payable-related parties                                       20,000               20,780
    Capital lease obligation                                               13,934               16,594
                                                                     ------------         ------------
                                                                          356,795              396,443
                                                                     ------------         ------------

STOCKHOLDERS' EQUITY:
    Common stock, $.01 par value, 40,000,000 and 20,000,000
     shares authorized, 13,442,532 and 13,222,532 shares
     issued and outstanding, respectively                                 134,425              132,225
    Additional paid-in capital                                         16,717,043           16,499,243
    Accumulated deficit                                               (14,794,615)         (13,856,233)
                                                                     ------------         ------------
                                                                        2,056,853            2,775,235
                                                                     ------------         ------------

                                                                     $  2,413,648         $  3,171,678
                                                                     ------------         ------------
                                                                     ------------         ------------
</TABLE>

           The accompanying notes are an integral part of these balance sheets.

                                        3

<PAGE>

                               RACOM SYSTEMS, INC.

                            STATEMENTS OF OPERATIONS
                                   (Unaudited)

<TABLE>
<CAPTION>
                                            Three months ended September 30         Nine months ended September 30
                                           -----------------------------------     ----------------------------------
                                                 1998               1997                 1998              1997
                                           ---------------- ------------------     ---------------- -----------------
<S>                                        <C>                <C>                  <C>                <C>
REVENUES:
   Product sales                           $          6,202   $         51,625     $         99,349   $       157,561
   Product sales-related parties                    --                   6,943               44,141            71,398
   License revenues                                 --                 --                 1,500,000          --
   License revenues-related party                   --                  10,650              --                448,908
   Research and development fees                     15,000            --                    15,000          --
                                            ---------------    ---------------      ---------------    --------------
                                                     21,202             69,218            1,658,490           677,867

COST OF REVENUES:
   Cost of revenues                                  4,017              74,433               80,061           318,283
   Inventory write-down                             22,000             --                    22,000          --
                                            --------------     ---------------      ---------------    --------------
                                                    26,017              74,433              102,061           318,283
                                            --------------     ---------------      ---------------    --------------

GROSS MARGIN                                        (4,815)             (5,215)           1,556,429           359,584

OPERATING EXPENSES
   Research and development                        241,438             272,675              725,505           829,936
   General and administrative                      397,037             279,567            1,015,539           753,303
   Sales and marketing                             214,996             258,992              681,580           748,345
   Equity in loss of Racom Japan                   --                  (42,669)             --                155,705
   Amortization expense                             39,411              39,411              118,233           119,090
                                            --------------     ---------------      ---------------    --------------
                                                   892,882             807,976            2,540,857         2,606,379


LOSS FROM OPERATIONS                              (897,697)           (813,191)            (984,428)       (2,246,795)

OTHER INCOME (EXPENSE)
   Interest expense                                   (535)               (525)              (1,730)         (137,658)
   Interest expense-related parties                --                  --                   --                (17,405)
   Interest income                                  12,201              30,544               46,730            80,346
   Other                                               148              (8,529)               1,046           (63,319)
                                            --------------     ---------------      ---------------    --------------

NET LOSS                                   $      (885,883)   $       (791,701)    $       (938,382)  $    (2,384,831)
                                            --------------     ---------------      ---------------    --------------
                                            --------------     ---------------      ---------------    --------------

NET LOSS PER SHARE-BASIC AND
   DILUTED                                 $         (0.07)   $          (0.06)    $          (0.07)  $         (0.19)

WEIGHTED AVERAGE SHARES
   OUTSTANDING                                  13,442,532          12,633,643           13,359,455        12,633,643
</TABLE>

    The accompanying notes are an integral part of these financial statements.


                                      4

<PAGE>

                                             RACOM SYSTEMS, INC.

                                           STATEMENTS OF CASH FLOWS
                                                 (Unaudited)

<TABLE>
<CAPTION>
                                                                                 Nine months ended September 30
                                                                               ---------------- ----------------
                                                                                     1998             1997
                                                                               ---------------- ----------------
<S>                                                                            <C>              <C>
CASH FLOWS USED IN OPERATING ACTIVITIES:
    Net loss                                                                   $      (938,382) $    (2,384,831)
    Adjustments to reconcile net loss to cash used in operating activities:
      Depreciation and amortization                                                    176,789          191,360
      Bad debt expense                                                                  32,000          --
      Inventory reserve                                                                 22,000          --
      Equity in loss of Racom Japan                                                    --               155,705
      Amortization of debt offering costs                                              --                97,799
      Decrease (increase) in:
         Accounts receivable-trade                                                      (9,229)          37,356
         Accounts receivable-related parties                                            26,720            9,699
         License revenue receivable                                                    --               646,162
         Inventory                                                                     (51,553)           7,120
         Prepaid expenses and other                                                     22,023          (49,159)
      Increase (decrease) in:
         Accounts payable and accrued liabilities                                      (36,208)        (237,572)
         Accounts payable-related parties                                                 (780)        (545,098)
         Deferred license revenue                                                      --              (248,892)
         Accrued interest                                                              --                39,102
         Accrued interest-related party                                                --                17,405
                                                                                  -------------    -------------
NET CASH USED IN OPERATING ACTIVITIES                                                 (756,620)      (2,263,844)
                                                                                  -------------    -------------
CASH FLOWS USED IN INVESTING ACTIVITIES:
    Purchases of fixed assets                                                          (74,565)         (50,220)
                                                                                  -------------    -------------
NET CASH FLOWS USED IN INVESTING ACTIVITIES                                            (74,565)         (50,220)
                                                                                  -------------    -------------


CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
    Proceeds from issuance of common stock                                             220,000        7,125,000
    Payment of deferred offering costs                                               --              (1,020,484)
    Payments on notes payable-related parties                                        --              (2,126,103)
    Payments on capital lease obligation                                                (2,660)            (867)
                                                                                  -------------    -------------
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES                                        217,340        3,977,546
                                                                                  -------------    -------------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                  (613,845)       1,663,482

CASH AND CASH EQUIVALENTS, beginning of period                                       1,198,567          314,202
                                                                                  -------------    -------------
CASH AND CASH EQUIVALENTS, end of period                                         $     584,722    $   1,977,684
                                                                                  -------------    -------------
                                                                                  -------------    -------------

Supplemental disclosure of cash flow information:
 Cash paid during the period for:
      Interest                                                                   $       1,560    $      39,852
      Interest-related parties                                                       --                 287,001
      Income taxes                                                                   --                 --
</TABLE>

   The accompanying notes are an integral part of these financial statements.


                                    5

<PAGE>

                               RACOM SYSTEMS, INC.
                          NOTES TO FINANCIAL STATEMENTS
                               SEPTEMBER 30, 1998

Note 1 - Basis of Presentation

The accompanying unaudited financial statements have been prepared without 
audit pursuant to the rules and regulations of the Securities and Exchange 
Commission. The financial statements reflect all adjustments which, in the 
opinion of management, are necessary to present fairly the financial 
position, results of operations and cash flows of Racom Systems, Inc. as of 
September 30, 1998 and 1997 and for the periods then ended. Operating results 
for the three and nine month periods ended September 30, 1998 are not 
necessarily indicative of the results that may be expected for the year ended 
December 31, 1998.

The unaudited financial statements should be read with the complete financial 
statements and footnotes thereto included in the Company's Form 10-KSB for 
the year ended December 31, 1997 previously filed with the Securities and 
Exchange Commission.

As reflected in the accompanying financial statements, the Company has 
generated substantial operating losses since inception and has yet to 
generate sufficient revenues to fund its operations. During 1998, the 
Company's primary source of cash was from the license fee received from 
Hitachi (see Note 3) and the sale of 220,000 shares of common stock at $1.00 
per share under the Company's employee stock option plan. Management intends 
to fund its remaining operations through cash on hand at September 30, 1998. 
The Company is currently in the process of identifying sources of short-term 
and longer term debt and equity financing; however, there can be no assurance 
that financing will be available or that the financing will include terms 
acceptable to the Company. Subsequent to September 30, 1998, the Company 
began to reduce its administrative, sales and engineering costs; however, if 
the Company cannot increase revenues generating sufficient gross profit or 
obtain financing, the Company will have to curtail further its operations. 
These factors raise substantial doubt about the ability of the Company to 
continue as a going concern. The financial statements do not include any 
adjustments relating to the recoverability of assets and carrying amounts of 
liabilities that might be necessary should the Company be unable to continue 
as a going concern.

Note 2 - New Accounting Standards

In February 1997, the Financial Accounting Standards Board ("FASB") issued 
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per 
Share." Under SFAS 128, primary earnings per share previously required under 
Accounting Principles Board No. 15 is replaced with basic earnings per share. 
Basic earnings per share is computed by dividing reported earnings available 
to common stockholders by weighted average shares outstanding. No dilution 
for any potentially dilutive securities is included. Diluted earnings per 
share reflects the potential dilution assuming the issuance of common shares 
for all dilutive potential common shares outstanding during the period. The 
adoption of SFAS No. 128 had no effect on the previously reported loss per 
share.

In June 1997, the FASB issued SFAS 130, "Reporting Comprehensive Income," 
which establishes standards for reporting and displaying comprehensive income 
and its components (revenues, expenses, gains and losses) in a full set of 
general purpose financial statements. SFAS 130 requires that all items that 
are required to be recognized under accounting standards as components of 
comprehensive income be reported in a financial statement that is displayed 
with the same prominence as other financial statements. SFAS 130 does not 
require a specific format for that financial statement but requires that the 
enterprise display an amount representing total comprehensive income for the 
period in that financial statement. SFAS 130 is effective for financial 
statements for periods beginning after December 15, 1997. No differences 
exist between comprehensive income and net income for the Company for the 
period ending September 30, 1998 or 1997.

In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative 
Instruments and Hedging Activities" effective for fiscal years beginning 
after June 15, 1999. SFAS No. 133 establishes accounting and reporting 
standards requiring that every derivative instrument (including certain 
derivative instruments embedded in other contracts) be recorded in the 
balance sheet as either an asset or liability measured at its fair value. It 
also requires that changes in the derivative's fair value be recognized 
currently in earnings unless specific hedge accounting criteria are met. 
Special accounting for qualifying hedges allows a derivative's gains and 
losses to offset related results on the hedged item in 

                                       6

<PAGE>

the income statement, and requires that a company must formally document, 
designate, and assess the effectiveness of transactions that receive hedge 
accounting. SFAS No. 133 may not be applied retroactively, and must be 
applied to (a) derivative instruments and (b) certain derivative instruments 
embedded in hybrid contracts that were issued, acquired, or substantively 
modified after December 31, 1997 (and, at the company's election,before 
January 1, 1998). Management believes that the impact of SFAS No. 133 will 
not significantly affect its financial reporting.

In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of Start-Up 
Activities". This statement is effective for financial statements for fiscal 
years beginning after December 15, 1998. In general, SOP 98-5 requires costs 
of start-up activities and organization costs to be expensed as incurred. 
Initial application of SOP 98-5 should be reported as the cumulative effect 
of a change in accounting principle. Management believes that SOP 98-5 will 
not have a material impact on the financial statements.

Note 3 - License of Technology to Hitachi, Ltd.

On January 15, 1998, the Company executed an agreement, in conjunction with 
Ramtron International Corporation ("Ramtron"), granting Hitachi Ltd. 
("Hitachi") a worldwide, non-exclusive license to design, manufacture and 
sell smart card products based on the Company's contactless, ferroelectric 
smart card technology, and Ramtron's proprietary ferroelectric random access 
memory ("FRAM") technology. In addition to these license rights, the Company 
granted Hitachi option rights, for a predetermined option fee, to its Radio 
Frequency Identification ("RFID") Technology, as defined in the agreement, 
for a period up to December 31, 1999. As consideration for the rights granted 
under the agreement, Hitachi will pay certain license fees and royalties to 
the Company as defined in the agreement. The Company received the first 
payment on the license on January 29, 1998, and the second payment on May 9, 
1998. As additional consideration for the rights granted under the agreement, 
Hitachi will provide engineering services for development of the Company's 
RFID Products, as defined in the contract, and the Company and Ramtron have a 
certain defined percentage call (subject to a maximum quantity) on Hitachi's 
production capacity of RFID Products. The agreement remains effective until 
expiration of the last of the Company's and Ramtron's patents.

Note 4 - Technology License

The Company's primary asset is a technology license related to the design and 
manufacture of its products. The net book value of the technology license at 
September 30, 1998 was $1,439,225. The Company has the rights under an 
agreement to sublicense the technology to no more than five (5) separate 
parties subject to certain approvals. The Company has, to date, sublicensed 
such technology to three separate companies. Although the Company is 
currently marketing products utilizing the technology and believes that the 
unamortized cost of the technology can be recovered from product sales or 
sublicensing agreements, given the Company's current financial position, the 
Company's ability to execute its business plan and recover the carrying 
amount is uncertain. The Company has not made a provision in the accompanying 
financial statements for any loss which may result should the remaining cost 
of the technology license not be recovered.

           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                            AND RESULTS OF OPERATIONS

GENERAL

The results of operations for the quarter and nine month period ended 
September 30, 1998 are not necessarily indicative of the Company's expected 
performance for any future period. Information contained herein is 
supplemental to the Company's annual report on Form 10-KSB for the year ended 
December 31, 1997 and the Company's Prospectus filed effective March 12, 1997.

Investors should carefully consider the following information as well as 
other information contained in this Report before making an investment in the 
Common Stock. Information contained in this Report contains "forward-looking 
statements" which can be identified by the use of forward-looking terminology 
such as "believes," "expects," "may," "should" or "anticipates" or the 
negative thereof or other variations thereon or comparable terminology, or by 
discussions of strategy. No assurance can be given that the future results 
covered by the forward-looking statements will be achieved. The following 
matters constitute cautionary statements identifying important factors with 
respect to such forward-looking statements, including certain risks and 
uncertainties, that could cause actual results to vary materially from the 
future results covered in such forward-looking statements. Other factors 
could also cause actual results to vary materially from the future results 
covered in such forward-looking statements.

The Company is a developer and marketer of contactless smart card systems 
("Smart Card(s)") used primarily in electronic commerce. Generally the size 
of a credit card, Smart Cards are used in a number of consumer applications 
including (i) access to restricted areas (replacing keys and identification 
cards), (ii) public transportation fare collection (replacing bus tokens, 
taxi cab charge cards, airline or railway tickets and the like), (iii) point 
of sale purchases (replacing cash or credit cards at cafeterias, newsstands 
and related point of sale locations where speed of purchase is important), 
and (iv) miscellaneous small monetary transactions (replacing coins and cash 
at parking lots, in vending

                                      7

<PAGE>

machines and public telephones, etc.). Smart Card technology is also used in 
industrial applications by attaching a "tag" containing the Smart Card 
technology to the manufactured product in order to track the product from the 
assembly line through quality control, warehousing, inventory control, 
distribution and warranty.

The Company's Smart Cards are both "contactless" and "batteryless" and 
therefore do not require the use of a magnetic stripe or insertion into a 
terminal as is required by contacted cards ("Contacted Card(s)"), such as 
credit cards and ATM cards. Contacted Cards in use today are typically 
limited to storing information as opposed to "intelligent" Smart Cards, which 
have processing capabilities similar to that of a personal computer. The 
Company's Smart Card System involves direct wireless radio frequency 
communications and magnetic induction between a chip in the Smart Card and a 
terminal. Moreover, the Company's contactless Smart Card Systems do not 
require insertion in a terminal or the use of a keypad and therefore may be 
used by all members of the population regardless of age or physical ability 
and in both indoor and outdoor locations.

The Company believes it was the first to successfully develop and introduce 
contactless Smart Cards using FRAM technology and batteryless, radio 
frequency ("RF") communications. The Company has primarily relied on its 
licensed FRAM technology for the memory component of the Smart Cards. 
Although the FRAM memory demonstrates quantifiable benefits by improving 
processing speeds and reliability over competing memory technologies, it is 
not currently being produced in sufficient volumes by a significant number of 
manufacturers to achieve competitive costs. Complementary to its FRAM 
technology, the Company also utilizes Electronically Erasable Programmable 
Read-Only Memory ("EEPROM") technology in its Smart Card Systems, allowing 
the Company to offer higher volume Smart Cards at a more competitive price.

The Company principally generates revenues from licensing, fee based custom 
product development projects and sale of its Smart Card systems. In the 
future, the Company anticipates that a substantial portion of its revenues 
will be generated from custom product development projects, the sale of its 
Smart Card systems and services. If the Company is unable to continually 
replace larger custom product development projects as these projects are 
completed, its operations will be adversely affected. Custom product 
development projects are billed in stages based on certain agreed upon 
performance milestones. Accordingly, financial results for any calendar 
quarter may fluctuate widely depending on the stage of a project or the 
amount of licensing payments in a particular quarter.

As reflected in the Company's Financial Statements, the Company has generated 
substantial operating losses since inception and has yet to generate 
substantial revenues to fund its operations. To date, the Company has 
completed a series of smaller scale projects; however, the Company has not 
yet completed a significant number of larger projects, and as a result, it is 
uncertain whether the Company will be able to successfully market and sell 
its Smart Card products in sufficient quantities and at sufficient prices and 
volumes to fund its operations. During 1997, the Company experienced 
significant cash flow deficits and liquidity shortages and funded its 
operations primarily through licensing transactions and proceeds from the 
sale of its Common Stock. During the nine months ended September 30, 1998, 
the Company's operating revenues have been generated primarily from a 
licensing transaction.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED 
TO THE THREE MONTHS ENDED SEPTEMBER 30, 1997

REVENUES. Revenues decreased 69% to $21,202 for the three months ended 
September 30, 1998 ("Third Quarter 1998"), from $69,218 for the three months 
ended September 30, 1997 ("Third Quarter 1997"). Revenues for any calendar 
quarter may fluctuate widely depending of the timing of a product shipment, 
the stage of a project or the amount of licensing payments in a particular 
quarter.

Product Sales. Product sales decreased 89% to $6,202 for Third Quarter 1998, 
from $58,568 for Third Quarter 1997. To date, the Company has completed a 
series of projects, many of which are small scale "pilot" projects, but may 
have the potential for implementation on a larger scale. In some cases, these 
demonstration projects are "rolled out" for full scale implementation, 
however the demonstration phase often takes six to twelve months or longer. 
Product sales in the Third quarter 1997 included approximately $7,000 of 
sales of product to Racom Japan ("RJ"), of which the Company owns 19.9%, as 
compared to no sales to RJ in the Third Quarter 1998.

License Revenues. License revenues in the Third Quarter 1997 represented 
$10,650 for the recognition of deferred revenues on a license from RJ for the 
manufacture and sale of FRAM based radio frequency products in Japan.

                                     8

<PAGE>

COST OF REVENUES AND GROSS MARGIN. As a percentage of revenues, gross margin 
decreased to (23)% in Third Quarter 1998, from (7)% for Third Quarter 1997.

Product Costs. The Company has not generated significant margin on product 
sales in part because of competition with Contacted Cards which typically are 
sold at a lower price than the Company's Smart Cards. Currently, production 
volumes of the Company's products may not be sufficient to cover 
manufacturing costs which are included in Cost of Revenues. Due to an 
increase in availability of FRAM memory chips resulting in lower component 
costs, and the use of EEPROM memory chips which are already available at 
lower component costs, the Company expects to be able to lower its prices 
while improving gross margin. In the Third Quarter 1998, the Company 
established a $22,000 reserve to state its inventory at net realizable value.

License revenues. In both periods presented, gross margin is primarily a 
result of license revenues which have no direct cost of revenues.

RESEARCH AND DEVELOPMENT EXPENSES ("R&D"). R&D decreased $31,237 from 
$272,675 in Third Quarter 1997 to $241,438 in Third Quarter 1998. The 
decrease is primarily due to the Company focusing on its internal engineering 
resources and not utilizing the services of contractors in new product 
development projects during Third Quarter 1998. During November 1997, a group 
of engineers responsible for a specific project left the Company upon 
completion of the project. Additional engineers with skills necessary to 
complete new product development were hired. In Third Quarter 1997, the 
Company incurred approximately $47,000 on outside engineering contractors for 
software and hardware development and on contract services to develop card 
packaging for its Smart Card products.

GENERAL AND ADMINISTRATIVE EXPENSES ("G&A"). G&A expenses increased $117,470 
from $279,567 in Third Quarter 1997 to $397,037 in Third Quarter 1998. The 
increase is primarily due to $45,000 severance costs to the former President 
and CEO, $30,000 for the current Chairman for his services as interim 
President and CEO, $43,000 for recruiting costs for the new President and CEO 
hired in August 1998, and $23,000 for a consultant who is assisting the 
Company in finding interim and longer term financing.

SALES AND MARKETING EXPENSES. Sales and marketing expenses decreased $43,996 
from $258,992 in Third Quarter 1997 to $214,996 in Third Quarter 1998. Travel 
expenses decreased approximately $10,000 between the Third Quarter periods. 
Third Quarter 1997 included costs of approximately $19,000 for printing of 
sales literature and $15,000 for outside consultants which were not incurred 
in Third Quarter 1998.

EQUITY IN LOSS OF JOINT VENTURE. The Company currently owns 19.9% of RJ. RJ 
was formed in 1993 for the purpose of marketing, distributing and supporting 
the Company's Smart Card products to be sold in Japan. The Company accounts 
for its investment on the cost method. In Third Quarter 1997, the Company 
owned 22.8% of RJ and accounted for its investment under the equity method, 
recognizing its proportionate share of RJ's losses.

AMORTIZATION EXPENSE. The Company's primary asset is a technology license 
related to the design and manufacture of its Smart card products. The asset 
is amortized over its estimated useful life on a straight line basis.

OTHER INCOME (EXPENSE). During Third Quarter 1998 and 1997, the Company 
earned $12,201 and $30,544, respectively, in interest income on its cash 
balances held primarily in a government obligations fund with an average 
maturity of less than 90 days.

NET LOSS. The Company is a C Corporation under the Internal Revenue Code and 
for income tax reporting purposes as of December 31, 1997, has approximately 
$13,700,000 of net operating loss carryforwards that expire at various dates 
through 2012. The Tax Reform Act of 1986 contains provisions which may limit 
the net operating loss carryforwards available to the Company in any given 
year if certain events occur, including significant changes in ownership 
interests.

                                      9

<PAGE>

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED 
TO THE NINE MONTHS ENDED SEPTEMBER 30, 1997

REVENUES. Revenues increased 145% to $1,658,490 for the nine months ended 
September 30, 1998 ("Interim 1998"), from $677,867 for the nine months ended 
September 30, 1997 ("Interim 1997"). Revenues for any calendar quarter may 
fluctuate widely depending on the timing of a product shipment, the stage of 
a project or the amount of licensing payments in a particular quarter.

Product Sales. Product sales decreased 37% to $143,490 for Interim 1998, from 
$228,959 for Interim 1997. To date, the Company has completed a series of 
projects, many of which are small scale "pilot" projects, but may have the 
potential for implementation on a larger scale. In some cases, these 
demonstration projects are "rolled out" for full scale implementation, 
however the demonstration phase often takes six to twelve months or longer. 
Product sales in Interim 1998 included approximately $44,000 of sales of 
product to RJ, of which the Company owns 19.9%, as compared to approximately 
$71,000 for Interim 1997.

License Revenues. License revenues increased 234% to $1,500,000 for Interim 
1998, from $448,908 for Interim 1997. Interim 1997 included the recognition 
of deferred revenues on a license from RJ for the manufacture and sale of 
FRAM based radio frequency products in Japan of $238,242. In 1996, pursuant 
to the technology license discussed above, RJ entered into a custom product 
development project with Fujitsu, Ltd. under which the Company is entitled to 
50% of all sublicense revenue earned by RJ. This sublicense resulted in the 
Company recording and receiving sublicense revenue of $210,666 during Interim 
1997. The increase in license revenues reflects the execution of the 
licensing contract with Hitachi, Ltd. which closed in January 1998, and under 
which the Company received the first installment of the initial license fee 
payment in January 1998 and the final initial license fee payment in May 1998.

COST OF REVENUES AND GROSS MARGIN. As a percentage of revenues, gross margin 
increased to 94% in Interim 1998, from 53% for the same period in 1997.

Product Costs. The Company has not generated significant margin on product 
sales in part because of competition with Contacted Cards which typically are 
sold at a lower price than the Company's Smart Cards. Currently, production 
volumes of the Company's products may not be sufficient to cover 
manufacturing costs which are included in Cost of Revenues. Due to an 
increase in availability of FRAM memory chips resulting in lower component 
costs, and the use of EEPROM memory chips which are already available at 
lower component costs, the Company expects to be able to lower its prices 
while improving gross margin. In the Third Quarter 1998, the Company 
established a $22,000 reserve to state its inventory at net realizable value.

License revenues. In both periods presented, gross margin is primarily a 
result of license revenues which have no direct cost of revenues.

RESEARCH AND DEVELOPMENT EXPENSES ("R&D"). R&D decreased $104,431 from 
$829,936 in Interim 1997 to $725,505 in Interim 1998. The decrease is 
primarily due to changes in the personnel responsible for the product 
development. In November 1997, a group of engineers responsible for a 
specific project left the Company upon completion of the project. Additional 
engineers with skills necessary to complete new product development were 
hired. Overall, these changes resulted in a small increase in personnel 
expenses. Additionally, the changes resulted in the Company focusing on its 
internal engineering resources and not utilizing the services of contractors 
in new product development projects. During Interim 1997, the Company 
incurred approximately $152,000 on outside engineering contractors for 
software and hardware development and on contract services to develop card 
packaging for its Smart Card products.

GENERAL AND ADMINISTRATIVE EXPENSES ("G&A"). G&A increased $262,236 from 
$753,303 in Interim 1997 to $1,015,539 in Interim 1998. Interim 1998 includes 
increasing expenditures approximating $30,000 relating to investor relations 
consulting, securities legal and Nasdaq filing expenses incurred after the 
Company's initial public offering ("IPO") which was completed on March 12, 
1997. The Company also recognized approximately $17,000 of additional expense 
relating to the Directors and Officers Liability Insurance policy which was 
not effective until March, 1997, and was renewed in March 1998. Interim 1998 
also includes an increase in consulting and office expenses of approximately 
$67,000 due to increased audit fees, mergers & acquisitions research 
consulting and legal consulting expenses. Interim 1998 also includes $45,000 
in severance costs for the former President and CEO, $30,000 for the

                                    10

<PAGE>

current Chairman for his services as interim President and CEO, $68,000 for 
recruiting costs for the new President and CEO hired in August 1998 and 
$23,000 for a consultant who is assisting the Company in finding interim and 
longer term financing.

SALES AND MARKETING EXPENSES. Sales and marketing expenses decreased $66,765 
from $748,345 in Interim 1997 to $681,580 in Interim 1998. Sales & Marketing 
expenses for the Interim 1997 included $32,000 in recruiting costs as well as 
expenses for sales literature and outside consultants which where not 
incurred in Interim 1998.

EQUITY IN LOSS OF JOINT VENTURE. The Company currently owns 19.9% of RJ. RJ 
was formed in 1993 for the purpose of marketing, distributing and supporting 
the Company's Smart Card products to be sold in Japan. The Company accounts 
for its investment on the cost method. In Interim 1997, the Company owned 
22.8% of RJ and accounted for its investment under the equity method, 
recognizing its proportionate share of RJ's losses.

AMORTIZATION EXPENSE. The Company's primary asset is a technology license 
related to the design and manufacture of its Smart card products. The asset 
is amortized over its estimated useful life on a straight line basis.

OTHER INCOME (EXPENSE). During Interim 1997, the Company incurred $58,396 in 
interest expense on various notes payable to Intag International Limited 
("Intag") and Ramtron International Corporation ("Ramtron") and a group of 
lenders. The notes to Intag carried interest at 10% and the notes to Ramtron 
and the group of lenders carried interest at prime plus 2%. The notes and 
accrued interest were paid in 1997 upon completion of the Company's initial 
public offering. Other expenses during Interim 1997 included $29,000 withheld 
from the proceeds of the license revenue earned on the sublicense to Fujitsu 
for Japanese taxes and $22,000 in currency exchange losses.

NET LOSS. The Company is a C Corporation under the Internal Revenue Code and 
for income tax reporting purposes as of December 31, 1997, has approximately 
$13,700,000 of net operating loss carryforwards that expire at various dates 
through 2012. The Tax Reform Act of 1986 contains provisions which may limit 
the net operating loss carryforwards available to the Company in any given 
year if certain events occur, including significant changes in ownership 
interests.

LIQUIDITY AND CAPITAL RESOURCES

The Company's primary need for capital has been to finance expansion of 
research and development of new Smart Card products, sales and marketing of 
its products and operations. Annual product revenues growth has been limited 
due to limited financial resources and an inability to expand receivables, 
build inventory and effectively sell and market Smart Card products.

The Company had cash and cash equivalents of $1,198,567 and $584,722 as of 
December 31, 1997 and September 30, 1998, respectively. During Interim 1998, 
the Company's primary source of cash was from the initial license fee 
payments received under the Hitachi license agreement, and the sale of 
220,000 shares of common stock to a former employee upon the exercise of 
employee stock options at $1.00 per share. During the Third Quarter 1998, the 
Company generated losses of approximately $886,000 because the Company had no 
license revenues, minimal product sales and $893,000 of operating expenses.

Management of the Company intends to fund its remaining 1998 operations 
through cash on hand at September 30, 1998. The Company is in the process of 
identifying sources of short-term and longer term debt and equity financing. 
There can be no assurance that financing will be made available or that the 
financing will include terms acceptable to the Company. Subsequent to 
September 30, 1998, the Company began to reduce its administrative, sales and 
engineering costs, however; if the Company cannot increase revenues 
generating sufficient gross profit or obtain financing, the Company will have 
to curtail further its operations.

The Company must also maintain certain requirements in order to be listed on 
Nasdaq. These requirements include maintaining a specified level of net 
tangible assets, as defined, market capitalization or net income. 
Additionally, the Company must maintain a specified level of publicly traded 
shares, market value of the publicly traded shares, minimum bid price, number 
of market makers and shareholders. The minimum bid price of the Company's 
stock was listed below $1.00 for three consecutive days. The Company has 
received a delisting notification from Nasdaq and

                                    11

<PAGE>

intends to discuss the notification with officials of Nasdaq. However, there 
can be no assurance that the Company's efforts will be successful or that the 
Company will be able to maintain its Nasdaq listing.

YEAR 2000

The Company utilizes software and related technologies throughout its 
business and relies on many suppliers of services and materials that will be 
affected by the date change in the year 2000. The Year 2000 issue exists 
because many computer systems and applications currently use two-digit fields 
to designate a year. As the century date change occurs, date-sensitive 
systems will recognize the year 2000 as 1900, or not at all. This inability 
to recognize or properly treat the Year 2000 may cause systems to process 
critical financial and operational information incorrectly.

The Company has completed an internal study to determine the full scope and 
related costs to insure that the Company's systems continue to meet its 
internal needs and those of its customers. The results of the internal study 
indicate that its products are not affected by the Year 2000 issue. In 
addition, the results of the internal study indicate that certain software 
utilized by the Company's internal systems will be affected by the Year 2000 
issue, and steps to upgrade the software have begun. Management believes 
these amounts are not significant and such expenditures will continue through 
the year 1999 as upgrades become available.

The Company believes that there is a greater risk that its vendors, clients 
and strategic partners will be affected by the Year 2000 problem. The Company 
is currently unable to assess, and may be unable to accurately determine, the 
magnitude of any Year 2000 problems that may reside in the computer and 
information systems of its clients, vendors and strategic partners, or the 
impact that any such problems could have on the products and services 
provided by the Company to such clients. In addition to the internal study, 
the Company has begun assessing the existence of any Year 2000 problems that 
may reside in the computer systems and products of its vendors, clients and 
strategic partners. The Company expects to complete the assessment phase by 
December 31, 1998. The Company believes, based upon the progress to date, 
that its suppliers and strategic partners are either Year 2000 compliant, or 
are themselves in an assessment phase. However, there can be no assurance 
that all such problems will be resolved. The Company plans to develop a 
contingency plan as a result of its findings during this assessment phase. 
The occurrence of Year 2000 related failures in the computer and information 
systems of any of the Company's significant clients, vendors or strategic 
partners could have a materially adverse effect on the business, results of 
operations and financial condition of the Company.


                           PART II. OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS
         -----------------
         None

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS
         -----------------------------------------
         None

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES
         -------------------------------
         None




                                      12

<PAGE>



ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
         ---------------------------------------------------
         A Special Meeting of Stockholders was held on September 15, 1998. The
following proposals were approved by the stockholders.

         Proposal #1 - To increase the Company's authorized shares of common
         stock from 20,000,000 shares to 40,000,000 shares.

<TABLE>
<CAPTION>
             For               Against        Withheld
             <S>               <C>            <C>
             12,181,131        266,121        16,400
</TABLE>

         Proposal #2 - To increase the number of shares reserved for issuance
         under the Company's 1993 Employee Stock Option Plan from 1,700,000
         shares to 3,200,000 shares.

<TABLE>
<CAPTION>
             For               Against        Withheld         Not Voted
             <S>               <C>            <C>              <C>
             10,591,915        288,481        4,025            1, 579,231
</TABLE>

ITEM 5.  OTHER INFORMATION
         ------------------

        None

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K
            ----------------------------------

    (a.)   Exhibits:

<TABLE>
<CAPTION>
            Exhibit No.              Title
            -----------              ---------
            <S>            <C>
             27            Financial Data Schedule
</TABLE>

    (b)  Reports on Form 8-K

          None



                                      13

<PAGE>


                                   SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant 
caused this report to be signed on its behalf by the undersigned, thereunto 
duly authorized.

Racom Systems, Inc.


/s/Arthur B. Rancis                               Date: November 16, 1998
-------------------
Arthur B. Rancis
President, Chief Executive Officer and
Chief Financial Officer


/s/ Margaret Von der Schmidt                      Date: November 16, 1998
-----------------------------
Margaret Von der Schmidt
Controller




                                      14