SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-Q
QUARTERLY REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarter Ended Commission File Number
March 31, 1997 0-20706

DATA RACE, INC.
(Exact name of registrant as specified in its charter)

Texas 74-2272363
(State of Incorporation) (I.R.S.Employer Identification No.)

12400 Network Boulevard
San Antonio, Texas 78249
Telephone (210) 263-2000
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock

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

On MAY 6, 1997, there were 5,018,888 outstanding shares of Common Stock, no par
value.

DATA RACE, INC.
INDEX TO FORM 10-Q

Page
Number
------
PART I. FINANCIAL INFORMATION

Item 1. Interim Financial Statements (Unaudited):

Balance Sheets as of March 31, 1997 and June 30, 1996.......... 3

Statements of Operations for the Three Months and Nine Months
Ended March 31, 1997 and 1996................................... 4

Statements of Cash Flows for the Nine Months
Ended March 31, 1997 and 1996................................... 5

Notes to Interim Financial Statements........................... 6

Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................. 10

PART II. OTHER INFORMATION

Item 1. Legal Proceedings............................................... 15

Item 2. Changes in Securities........................................... 15

Item 3. Defaults Upon Senior Securities................................. 16

Item 4. Submission of Matters to a Vote of Security Holders............. 16

Item 5. Other Information............................................... 16

Item 6. Exhibits and Reports on Form 8-K................................ 16

SIGNATURES............................................................... 18

PART I. FINANCIAL INFORMATION

ITEM 1. INTERIM FINANCIAL STATEMENTS

DATA RACE, INC.
BALANCE SHEETS
UNAUDITED

AS OF
---------------------------------
MARCH 31, 1997 JUNE 30, 1996
----------------- -------------
ASSETS

Current assets:
Cash and cash equivalents............. $ 6,377,489 $ 3,990,435
Accounts receivable, net.............. 2,062,679 2,034,874
Inventory............................. 1,779,927 4,111,209
Prepaid expenses and deposits......... 36,973 46,906
-------------- --------------
Total current assets................ 10,257,068 10,183,424

Property and equipment, net............. 2,039,653 2,198,954
Other assets, net....................... 42,689 112,392
Total assets........................ $ 12,339,410 $ 12,494,770
-------------- --------------

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Accounts payable...................... $ 1,834,820 $ 2,400,507
Accrued expenses...................... 1,623,609 1,652,641
Other taxes payable................... - 166,156
Other current liabilities............. 336,580 319,923
-------------- --------------
Total current liabilities........... 3,795,009 4,539,227

Commitments and contingencies...........

Shareholders' equity:
Preferred stock, no par value,
2,000,000 shares authorized
5,000 shares issued and outstanding
at March 31, 1997 and none issued at
June 30, 1996........................ 4,219,874 -
Common stock, no par value,
20,000,000 shares authorized,
4,931,565 and 4,746,192 shares
issued and outstanding at
March 31, 1997 and June 30, 1996,
respectively........................ 24,904,957 24,379,642
Additional Paid-In Capital............ 1,882,303 -
Retained earnings (deficit)........... (22,462,733) (16,424,099)
-------------- --------------
Total shareholders' equity.......... 8,544,401 7,955,543
Total liabilities and shareholders'
equity............................ $ 12,339,410 $ 12,494,770
-------------- --------------

See accompanying notes to financial statements

DATA RACE, INC.
STATEMENTS OF OPERATIONS
UNAUDITED

THREE MONTHS ENDED MARCH 31, NINE MONTHS ENDED MARCH 31,
---------------------------- ----------------------------
1997 1996 1997 1996
------------ ------------ ------------ ------------

Total revenue........................... $ 3,902,257 $ 2,026,358 $ 16,270,501 $ 14,178,592

Cost of revenue......................... 2,712,369 1,301,696 12,401,828 10,526,208
------------ ------------ ------------ ------------

Gross profit......................... 1,189,888 724,662 3,868,673 3,652,384
------------ ------------ ------------ ------------

Operating expenses:
Engineering and product development.... 1,197,750 1,255,088 3,623,155 3,380,931
Sales and marketing.................... 1,330,107 1,057,815 3,007,673 2,941,201
General and administration............. 612,372 741,311 1,962,069 2,070,197
------------ ------------ ------------ ------------
Total operating expenses............. 3,140,229 3,054,214 8,592,897 8,392,329
------------ ------------ ------------ ------------

Operating loss....................... (1,950,341) (2,329,552) (4,724,224) (4,739,945)
------------ ------------ ------------ ------------

Other income (expense):
Interest income........................ 62,998 124,058 119,250 303,377
Other.................................. 5,514 - 20,705 -
------------ ------------ ------------ ------------
Total other income................... 68,512 124,058 139,955 303,377
------------ ------------ ------------ ------------

Income (loss) before income taxes....... (1,881,829) (2,205,494) (4,584,269) (4,436,568)
Income tax benefit...................... - - - -
------------ ------------ ------------ ------------

Net income (loss).................... $ (1,881,829) $ (2,205,494) $ (4,584,269) $ (4,436,568)
============ ============ ============ ============
Per share data:
Net income (loss)...................... $ (1,881,829) $ (2,205,494) $ (4,584,269) $ (4,436,568)
Effect of beneficial conversion
feature of convertible preferred stock (1,454,365) - (1,454,365) -

Net income (loss) applicable to common
stock................................. $ (3,336,194) $ (2,205,494) $ (6,038,634) $ (4,436,568)
============ ============ ============ ============
Net income (loss) per share applicable
to common stock....................... $ (0.68) $ (0.47) $ (1.25) $ (0.95)
============ ============ ============ ============
Weighted average common shares
outstanding........................... 4,892,826 4,697,791 4,817,002 4,676,681
============ ============ ============ ============

See accompanying notes to financial statements

DATA RACE, INC.
STATEMENTS OF CASH FLOWS
UNAUDITED

NINE MONTHS ENDED MARCH 31,
-----------------------------
1997 1996
------------- ------------
Cash flows from operating activities:
Net loss............................... $ (4,584,269) $ (4,436,568)
Adjustments to reconcile net loss to
net cash provided by (used in)
operating activities:
Depreciation and amortization......... 410,040 1,200,544
Decrease (increase) in accounts
receivable........................... (27,805) 6,234,888
Decrease (increase) in inventory...... 2,331,282 1,897,639
Decrease (increase) in prepaid
expenses, deposits and
other assets......................... 79,636 (556,546)

Increase (decrease) in accounts
payable.............................. (565,687) (1,178,159)
Increase (decrease) in accrued
expenses............................. (29,032) (46,951)
Increase (decrease) in other current
liabilities.......................... (149,499) 321,365
------------- ------------
Net cash provided by (used in)
operating activities................ (2,535,334) 3,436,212
------------- ------------

Cash flows from investing activities:
Purchase of property and equipment..... (294,189) (1,331,152)
Proceeds from sale of property and
equipment............................. 43,451 -
Expenditures for capitalized software.. - (20,000)
------------- ------------
Net cash used in investing
activities.......................... (250,738) (1,351,152)
------------- ------------
Cash flows from financing activities:
Net proceeds from issuance of preferred
stock and related warrants............ 4,647,811 -
Stock option transactions.............. 525,315 43,224
------------- ------------
Net cash provided by financing
activities.......................... 5,173,126 43,224
------------- ------------

Net increase (decrease) in cash and
cash equivalents....................... 2,387,054 2,128,284

Cash and cash equivalents at beginning
of period.............................. 3,990,435 6,092,382
------------- ------------

Cash and cash equivalents at end of
period................................. $ 6,377,489 $ 8,220,666
------------- ------------

See accompanying notes to financial statements

DATA RACE, INC.
NOTES TO INTERIM FINANCIAL STATEMENTS
UNAUDITED

1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

DESCRIPTION OF BUSINESS

DATA RACE, Inc. ("DATA RACE" or the "Company") designs, manufactures, and
markets a line of communication products that meet the need for "Remote Access
to the Corporate Environment." These products include the recently launched Be
There! Personal Multiplexer system, a unique client/server product that enables
teleworkers to access all elements of the corporate communications network.
With Be There!, teleworkers access the corporate intranet, LAN and the Internet,
while sending and receiving e-mail, faxes and phone calls-simultaneously-over a
single phone line. The Company also designs and manufactures advanced
communications subsystems for manufacturers of notebook computers, as well as a
line of network multiplexers which carry data, LAN, voice, and fax traffic
between a company's branch and headquarters offices, over a broad range of wide
area communications speeds and services.

BASIS OF PRESENTATION

The unaudited interim financial statements reflect all adjustments (consisting
of normal recurring accruals) that in the opinion of management are necessary
for a fair presentation of the financial position, results of operations and
cash flows for such periods. These financial statements should be read in
conjunction with the Company's financial statements and notes thereto included
in the Annual Report on Form 10-K for the fiscal year ended June 30, 1996, and
the Quarterly Reports on Form 10-Q for the quarters ended September 30, 1996 and
December 31, 1996. The balance sheet data as of June 30, 1996 included herein
has been derived from the audited financial statements in the June 30, 1996
Annual Report on Form 10-K. Interim period results are not necessarily
indicative of the results to be expected for any future periods or the full
year.

Earnings (loss) per share are computed using the weighted average number of
common and common equivalent shares (when dilutive) outstanding during each
period. Common equivalent shares include stock options and warrants. As
discussed in Note 6 to the interim financial statements, Net Income applicable
to Common Stock has been reduced to reflect the effect of the beneficial
conversion features of the Convertible Preferred Stock and related Warrants.

2) INVENTORY

Inventory is valued at the lower of standard cost (approximates first-in, first-
out) or market (net realizable value). Inventory consists of the following:

March 31, 1997 June 30, 1996
-------------- -------------
Finished goods $ 205,679 $ 366,824
Work in process 1,327,815 2,778,064
Raw materials 246,433 966,321
Total inventory $ 1,779,927 $ 4,111,209
============ ============
3) LINE OF CREDIT

The Company maintains a $1,500,000 revolving line of credit from a financial
institution. The line of credit has a term of one year and an interest rate of
prime plus 1%. The Company must meet certain covenants, including profitability
covenants, to draw under the line of credit. The line of credit is secured by a
first lien on the Company's assets. The Company is prohibited from taking
certain actions, including paying dividends, without the lender's consent. As of
March 31, 1997, the Company has not drawn on the line of credit.

4) LITIGATION

On November 28, 1995, Guy and Carolyn Caspary and Tarik Hussain filed a class
action shareholder lawsuit against the Company and certain of its officers -
Herbert T. Hensley, former Chairman of the Board, W. B. Barker, President and
Chief Executive Officer, Gregory T. Skalla, Vice President-Finance and Chief
Financial Officer, and Leven E. Staples, former Vice President and Chief
Technical Officer. The lawsuit was filed in the United States District Court in
San Antonio, Texas. The plaintiffs allege that the defendants violated certain
provisions of the federal securities laws, including Rule 10b-5 under the
Securities Exchange Act of 1934. The plaintiffs claim that during a class
period of January 26, 1995 through October 13, 1995, the Company issued
misleading and incomplete information to the investing public for the purpose of
raising the price of the Company's stock, thereby permitting some of the
defendants to profit from this rise by selling their stock at artificially
inflated prices. The plaintiffs claim that public statements made during the
class period touting the growth of the Company's backlog were misleading because
the Company did not also disclose that orders included in its backlog were
subject to cancellation and that revenues were likely to be short lived due to
the limited duration of shipments under the contract. On December 15, 1995, a
lawsuit was filed with identical allegations by Sylvio L. Marcoccia, on behalf
of himself and all others similarly situated. On February 23, 1996, the Caspary
and Marcoccia cases were consolidated, and the case is now styled In re Data
Race, Inc. Securities Litigation.

The defendants answered the lawsuit denying any liability to the plaintiffs and
filed a counterclaim (which was subsequently dismissed) for abuse of process and
conspiracy to

abuse process. Class certification was granted in October 1996. The parties have
unsuccessfully attempted to mediate the case. Discovery is in progress.

The Company believes that the case is absolutely without merit and is vigorously
defending against the claims made in the lawsuit. Although the Company does not
believe it probable that the resolution of the matter will have a material
adverse effect on the Company's financial condition or results of operations,
the Company is unable to predict the costs to be incurred to resolve the
lawsuit. The Company is required under certain circumstances to indemnify the
named officers against losses incurred as a result of lawsuits against the named
officers.

There were no material developments in the shareholder lawsuit during the
quarter ended March 31, 1997.

5) CONVERTIBLE PREFERRED STOCK

On January 10, 1997, the Company completed the first closing of a private
placement of its 1997 Series A Convertible Preferred Stock ("Preferred Stock")
and Stock Purchase Warrants ("Warrants") with Credit Suisse First Boston
Corporation, Capital Ventures International and Zanett Lombardier, Ltd. (the
"Investors"), at an aggregate price of $5,000,000. At such time, the Investors
agreed to purchase at a second closing, on or before October 31, 1997,
additional shares of Preferred Stock and Warrants at an aggregate price of
$2,500,000, subject to reduction to the extent that the total number of shares
of Common Stock underlying the Preferred Stock and Warrants issued at the first
closing and issuable at the second closing exceeds 15% of the outstanding shares
of Common Stock on January 10, 1997 (i.e., 724,219 shares). The second closing
is subject to certain conditions, including the collection by the Company of at
least $2 million in any three month period before October 15, 1997, on account
of revenues from its Be There! products. The Company has used and intends to
use the proceeds from the sale of the Preferred Stock and Warrants for the
development and launch of new products, including the Company's Be There!
products, and for working capital.

The Preferred Stock bears no dividends, is non-voting except in limited
circumstances, has senior rights in liquidation, and is redeemable at the option
of the holders in limited circumstances upon the Company's breach of certain
covenants imposed by the Preferred Stock. The Preferred Stock is convertible
into Common Stock at the option of each holder beginning April 10, 1997, at a
percentage of the then prevailing average market price (as defined in the
Statement of Designation establishing the Preferred Stock) of the Common Stock
equal initially to 85%, decreasing on July 9, 1997 to 80%, and decreasing on
January 5, 1998, to the lower of 75% or the average price (as defined in the
Statement of Designation) of the Common Stock on the first anniversary of the
first closing. Upon conversions after the first anniversary, in certain
circumstances the holders will receive a premium on the Preferred Stock
converted, payable in cash or stock at the Company's option, equal to 1% per
annum based on the number of days elapsed since the first closing. Any
Preferred Stock outstanding on January 10, 1999, will convert automatically into
Common Stock. Pursuant to regulations

of the National Association of Securities Dealers, in the absence of shareholder
approval, the aggregate number of shares of Common Stock issuable upon
conversion of the Preferred Stock and exercise of the Warrants may not exceed
19.99% of the outstanding shares of Common Stock on January 10, 1997 (i.e.,
965,925 shares); any Preferred Stock which may not be converted because of such
limitation must be redeemed by the Company in cash.

The Warrants issued at the first closing are exercisable for an aggregate of
45,800 shares of Common Stock at a price of $16 3/8 per share through the third
anniversary of the date of issuance. The Warrants to be issued at the second
closing are exercisable for an aggregate of 22,900 shares of Common Stock on
substantially the same terms. The Warrants become exercisable in two equal
installments on July 10, 1997, and October 10, 1997, but only in the same
proportion which the number of shares of Preferred Stock then outstanding bears
to the number of shares of Preferred Stock initially issued.

6) ACCOUNTING TREATMENT FOR CONVERTIBLE PREFERRED SECURITIES

On March 13, 1997, the SEC staff announced its position on the accounting
treatment for the issuance of convertible preferred stock and debt securities
with beneficial conversion features such as those contained in the Preferred
Stock issued in January 1997.

In accordance with the SEC staff's announcement, the beneficial conversion
features of the Preferred Stock have been recognized by allocating a portion of
the proceeds to additional paid-in capital. The amount allocated to additional
paid-in capital consists of the conversion discount of the Preferred Stock and
the value attributed to the Warrants. The conversion discount is calculated, at
the date of issuance, as the difference between the conversion price and the
fair value of the common stock into which the security is convertible. Because
the security provides for more than one conversion rate, in conformity to the
SEC announcement, the computation is made using the conversion terms most
beneficial to the investor, regardless of the actual discount applied upon
conversion. The value of the Warrants is calculated using a Black-Scholes model
and may, or may not, correspond to a market value.

The calculated intrinsic value of the beneficial conversion features of the
Preferred Stock, the offering costs and the premium will result in non-cash
charges of $2,285,000 to earnings (loss) available to common shareholders in the
computation of earnings (loss) per common share over the conversion period as
required by the SEC guidelines. As a result, the Company will show these non-
cash charges to earnings (loss) available to common shareholders in the
computation of earnings (loss) per common share over the period from January
1997 through December 1997. As of May 13, 1997, 1,350 shares of the initial
5,000 shares of the 1997 Series A Convertible Preferred Stock had been converted
into 142,612 shares of common stock.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

RESULTS OF OPERATIONS

Total revenue in the third quarter of fiscal 1997 was $3,902,000, down 12% from
$4,425,000 in the second quarter of fiscal year 1997 primarily due to decreased
revenue from both custom modem and network multiplexer products. Revenue
increased 93% from $2,026,000 in the comparable quarter of the prior fiscal
year, during which there was no significant custom modem revenue. During the
third quarter of fiscal 1997, the majority of the Company's revenue from custom
modem products was derived from shipments to NEC Technologies, Inc., and to a
lesser extent to AST Research, Inc. These custom modems are approaching the end
of their anticipated market life.

Total revenue for the nine months ended March 31, 1997 increased 15% to
$16,271,000 from $14,179,000 in the same period of the prior fiscal year,
primarily due to increased custom modem shipments partially offset by a decline
in revenue from network multiplexer products.

Gross profit margin was 30% for the quarter ended March 31, 1997. This gross
profit margin is down from 36% for the comparable quarter of the prior fiscal
year primarily because lower-margined custom modem shipments represented a
greater portion of total revenue in the quarter ended March 31, 1997.

Engineering and product development expenses decreased 5% to $1,198,000 for the
quarter ended March 31, 1997 from $1,255,000 in the comparable quarter of the
prior fiscal year. Year-to-date engineering and product development expenses
increased 7% to $3,623,000 from $3,381,000 for the comparable nine-month period
of the prior fiscal year, due primarily to increased development expenses for
the Company's Be There!(TM) product line, partially offset by a reduction in
network multiplexer development expenses.

Sales and marketing expenses increased 26% during the third quarter of fiscal
1997 to $1,330,000 from $1,058,000 during the comparable quarter of the prior
fiscal year. Year-to-date sales and marketing expenses also increased 2% to
$3,008,000 from $2,941,000 for the comparable nine-month period of the prior
fiscal year. These increases were primarily due to increased sales and
marketing expenses for the new Be There! product line, partially offset by a
reduction in network multplexer product line expenses.

General and administrative expenses decreased 17% to $612,000 during the third
quarter of fiscal 1997 from $741,000 during the comparable quarter of the prior
fiscal year. Year-to-date general and administrative expenses also decreased 5%
to $1,962,000 from $2,070,000 for the comparable nine month period of the prior
fiscal year. These decreases were primarily due to decreased legal expenses.

In February 1997, the Company introduced its new Be There! Personal Multiplexer
product line at InfoWorld's DEMO '97. The product was selected as one of eight
Premiere products at this showcase and has since been featured in a variety of
other publications, including being designated as a Best of Show product by Call
Center Magazine.

As the Company rolled out Be There! to its first beta test site, certain
telephone company line quality problems were encountered that impaired the
quality of the speech transmitted over the Company's product. In the ensuing
months, significant development effort was invested in improving the product's
performance under less than ideal line conditions, and in other speech quality
improvements. The Company currently believes that the product's speech quality
is sufficient to meet the needs of a substantial portion of the potential
market.

At the time of the Be There! announcement, the Company had four beta test
installations, including a press organization. These beta customers have not
purchased the Be There! system nor have they returned the equipment. Since the
announcement, the Company has shipped trial systems to a very modest number of
potential distribution partners and end-user customers. While the Company has
only a very small number of customers and has not yet recorded significant
revenue from the Be There! product line, the Company is gratified over the
positive initial reactions from the press and prospective customers.

The direct sales cycle for implementing a novel technology in Fortune-500
companies typically involves multiple decision-makers from a variety of
departments, and appears to be longer than the Company had anticipated. The
Company's expanding sales force is pursuing new sales opportunities and is
continuing to attempt to convert the beta test and trial installations into
revenue.

In addition to the focus on building its Be There! sales force, significant
attention has been placed in recent months on developing sales channels. The
Company expects the majority of Be There! revenue to come from indirect sales
and is currently pursuing distribution partnerships with a small number of
billion dollar-class companies. The Company hopes to conclude negotiations with
the first of these organizations in the coming weeks.

Be There! was designed to meet the needs of the teleworker market, including
road warriors, telecommuters and remote call center workers. The Company
believes that the road warrior segment represents a near-term revenue
opportunity. The Be There! system is unique in this market. When traveling,
multiple phone lines or ISDN service is generally not available in the airport
lounges or hotel rooms. With Be There!, road warriors can connect to their
corporation and work just as they would in their office.

As is typical with new product efforts, there are numerous risks associated with
the development and launch of the Company's Be There! product line. In
particular, establishment of adequate distribution partnerships, market
acceptance of the product concept, alternative product offerings by others, and
the Company's inability to deliver product performance, including voice quality,
sufficient to meet customers' requirements, all could affect the timing and
levels of revenue and potential profit from the Be There! products.

The Company believes that a potential customer may have a variety of objections
to purchasing the Be There! product, including cost and budget, voice quality, a
prior decision to implement another solution, inadequate quality of telephone
line service, and concerns about DATA RACE's strength in the marketplace. While
certain analysts have expressed disappointment at the product pricing, the
Company does not believe that price has been a substantial impediment to
purchasing the product within the Company's primary target markets. At this
early stage, the Company has limited information to accurately identify the
duration and strategies for success of the direct sales cycle.

Recently, a number of products have been discussed or released that have certain
characteristics in common with the Be There! product line, and may represent
competitive alternatives to prospective Be There! customers. Several of these
products have yet to be introduced to the market, and the information that the
Company has on them is limited. The Company is not currently aware of any
product that offers capabilities directly competitive with those of the Be
There! product line, particularly in the areas of Telepresence(TM) transparent
access and low-delay multiplexing of voice, data, and fax.

In its current embodiment, the Be There! personal multiplexer system requires
DATA RACE-manufactured hardware at both the client and the remote access server.
Until such time as industry-standard platforms are able to support the personal
multiplexer capability, the market penetration of the concept may be limited.

Despite the foregoing concerns, the Company believes that the opportunity to
capture a leadership position in what is broadly predicted to be a fast-growth,
multi-billion dollar market is sufficient to justify the allocation of a major
portion of the Company's resources in advance of corresponding revenue.

LIQUIDITY AND CAPITAL RESOURCES

During the first nine months of fiscal 1997, the Company financed its operations
by drawing on available cash and cash equivalents. At March 31, 1997, the
Company had $6,377,000 in cash and cash equivalents. Expenditures for capital
equipment for the first nine months of fiscal 1997 were $294,000.

In January 1997, the Company received net proceeds of $4,648,000 from the
issuance of convertible preferred stock and related warrants to purchase 45,800
shares of common stock at an exercise price of $16 3/8. At such time, the
investors agreed to purchase an

additional $2,500,000 of convertible preferred stock and warrants by October 31,
1997, subject to the Company's satisfaction of certain conditions. The
convertible preferred stock is redeemable under certain circumstances. See Item
2 for a more complete description of the terms of the transaction.

Operating losses continue to have a negative impact on the Company's cash
balance. As long as shipments of custom modem products to OEMs dominate the
Company's revenue, the Company expects to continue to have fluctuations in
reported revenue and resulting swings between profit and loss from the custom
modem products. The Company does not anticipate a return to profitability as
long as its expenditure on the Be There! product line remain disproportionate to
attendant revenue.

The ability to make future capital expenditures and fund the development and
launch of new products, including the Be There! line, are dependent on existing
cash and some or all of the following: demands on cash to support the custom
modem business, demands on cash arising from the redemption (if required) of the
convertible preferred stock, favorable settlement of the shareholder lawsuit,
and the Company's return to profitability. There can be no assurance that these
factors affecting cash will be resolved in a manner favorable to the Company.

NEW ACCOUNTING PRONOUNCEMENTS

In February 1997, the FASB issued Statement of Financial Accounting Standards
No. 128 (SFAS 128), "Earnings per Share," which specifies the computation,
presentation, and disclosure requirements for earnings per share (EPS). SFAS
128 supersedes ABP Opinion No. 15, and is effective for financial statements for
both interim and annual periods ending after December 15, 1997. The Statement
replaces Primary EPS and Fully Diluted EPS with Basic EPS and Diluted EPS,
respectively. SFAS 128 does not permit early application and, when adopted, all
prior period EPS data presented must be restated to conform with the Statement.
The Company will implement the Statement in the required period and does not
expect it to have a material effect on the Company's reported income (loss) per
share.

RISKS REGARDING FORWARD LOOKING STATEMENTS

Except for the historical information, this report contains various "forward-
looking statements" which represent the Company's expectations or beliefs
concerning future events, including the timing and levels of revenues from the
Company's teleworker

products, the length of sales cycles for the products, the Company's success in
developing distribution partnerships, customer acceptance of the teleworker
products, and the Company's position in and the size of the teleworker market.
The Company cautions that these forward-looking statements involve a number of
risks and uncertainties and are qualified by important factors that could cause
actual results to differ materially from those in the forward-looking
statements. Such factors include changing market trends and market needs;
uncertainty regarding the breadth of market acceptance of the teleworker
products' performance; rapid or unexpected technological changes; new or
increased competition from companies with greater resources than the Company;
inability to resolve technical issues or overcome other development obstacles;
insufficient capital; and certain other factors set forth in the Company's SEC
filings, including the Form 10-K for fiscal 1996 and Forms 10-Q for the quarters
ended September 30, 1996 and December 31, 1996. The Company's failure to succeed
in its efforts, including its sales efforts with respect to the teleworker
products, could have a material adverse effect on the Company's financial
condition and operations.

PART II - OTHER INFORMATION

DATA RACE, INC.

ITEM 1. LEGAL PROCEEDINGS

Reference is made to the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1996, for information regarding a shareholder lawsuit
against the Company. There were no material developments in the shareholder
lawsuit during the quarter ended March 31, 1997.

ITEM 2. CHANGES IN SECURITIES

Common Stock on January 10, 1997 (i.e., 965,925 shares); any Preferred Stock
which may not be converted because of such limitation must be redeemed by the
Company in cash.

The shares of Common Stock issuable upon conversion of the Preferred Stock and
upon exercise of the Warrants have been registered for resale pursuant to a
Registration Statement declared effective on April 10, 1997 under the Securities
Act of 1933, as amended (the "Securities Act").

The private placement was arranged by Zanett Securities, Inc. ("Zanett"), which
received a fee equal to 6% of the aggregate gross proceeds received by the
Company from the sale of the Preferred Stock and Warrants. Additionally,
pursuant to a separate consulting arrangement, the Company issued Warrants to
purchase 6,106 shares of Common Stock to a principal of Zanett. The Company
agreed to indemnify Zanett against certain liabilities, including liabilities
under the Securities Act.

The offer and sale of the Preferred Stock and Warrants were, and, in connection
with the second closing, will be, made in reliance upon Section 4(2) of the
Securities Act, the non-public offering exemption from the registration
requirements of the Securities Act.

As of May 13, 1997, 1,350 shares of the initial 5,000 shares of the 1997 Series
A Convertible Preferred Stock had been converted into 142,612 shares of common
stock.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

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

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits.

3.7* Statement of Designations, Preferences and Rights of 1997 Series A
Convertible Preferred Stock, filed January 10, 1997.

10.27* Securities Purchase Agreement, dated January 10, 1997, between the
Company, Capital Ventures International, Credit Suisse First Boston
Corporation, and Zanett Lombardier, Ltd.

10.28* Registration Rights Agreement, dated January 10, 1997, between the
Company, Capital Ventures International, Credit Suisse First Boston
Corporation, and Zanett Lombardier, Ltd.

10.29* Form of Stock Purchase Warrant issued on January 10, 1997, representing
a series of warrants issued by the Company to Capital Ventures
International, Credit Suisse First Boston Corporation, and Zanett
Lombardier, Ltd.

* Filed as exhibits to the Company's Quarterly Report on Form 10-Q for the
quarter ended December 31, 1996.

(B) Reports on Form 8-K.

No reports on form 8-K were filed during the quarter.

DATA RACE, INC.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

DATA RACE, INC.

By:/s/ Gregory T. Skalla
------------------------------------------------
Gregory T. Skalla, Vice President, Finance
Chief Financial Officer, Treasurer and Secretary
(Principal Financial and Accounting Officer)

Date: May 14, 1997