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
December 31, 1998 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 February 5, 1999, there were 17,044,235 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 Condensed Financial Statements (Unaudited):

Condensed Balance Sheets as of December 31, 1998 and June 30, 1998.. 3

Condensed Statements of Operations for the Three Months
and Six Months Ended December 31, 1998 and 1997..................... 4

Condensed Statements of Cash Flows for the Six Months
Ended December 31, 1998 and 1997.................................... 5

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

Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................. 11

Item 3. Quantitative and Qualitative Disclosures About Market Risk.......... 13

PART II. OTHER INFORMATION
- ---------------------------

Item 1. Legal Proceedings................................................... 14

Item 2. Changes in Securities............................................... 14

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

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

Item 5. Other Information................................................... 17

Item 6. Exhibits and Reports on Form 8-K.................................... 18

SIGNATURES.................................................................. 19
- ----------

PART I. FINANCIAL INFORMATION

ITEM 1. INTERIM CONDENSED FINANCIAL STATEMENTS
- -----------------------------------------------

DATA RACE, INC.
CONDENSED BALANCE SHEETS
UNAUDITED

AS OF
-------------------------------------------------
DEC. 31, 1998 JUNE 30, 1998
----------------------- ----------------------

ASSETS

Current assets:
Cash and cash equivalents...................................... $ 3,726,374 $ 1,644,294
Accounts receivable, net....................................... 442,056 321,103
Inventory...................................................... 568,333 542,963
----------------------- ----------------------
Total current assets......................................... 4,736,763 2,508,360

Property and equipment, net...................................... 1,302,489 1,475,132
Other assets, net................................................ 25,389 25,389
Total assets................................................. $ 6,064,641 $ 4,008,881
======================= ======================

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Accounts payable............................................... $ 444,828 $ 346,973
Accrued expenses............................................... 463,634 1,104,910
----------------------- ----------------------
Total current liabilities.................................... 908,462 1,451,883

Series D convertible preferred stock............................. 339,966 -

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

Shareholders' equity:
Series A convertible preferred stock........................... - 224,970
Series C convertible preferred stock........................... - 1,380,001
Series E convertible preferred stock........................... 641,712 -
Common stock................................................... 40,609,052 33,334,779
Additional paid in capital..................................... 4,836,495 1,882,303
Retained earnings (deficit).................................... (41,271,047) (34,265,055)
Total shareholders' equity................................... 4,816,213 2,556,998
Total liabilities and shareholders' equity.................. $ 6,064,641 $ 4,008,881
======================= ======================

See accompanying notes to interim condensed financial statements

DATA RACE, Inc.
CONDENSED STATEMENTS OF OPERATIONS
UNAUDITED

Three Months Ended Dec. 31, Six Months Ended Dec. 31,
-------------------------------------------- -------------------------------------------
1998 1997 1998 1997
--------------------- ------------------- ------------------- --------------------

Total revenue........................... $ 787,583 $ 1,574,317 $ 1,698,607 $ 2,728,242

Cost of revenue......................... 553,666 1,179,688 1,152,862 2,184,292
--------------------- ------------------- ------------------- --------------------

Gross profit......................... 233,917 394,629 545,745 543,950
--------------------- ------------------- ------------------- --------------------

Operating expenses:
Engineering and product 584,479 1,177,660 1,179,011 2,251,079
development...........................
Sales and marketing.................... 531,913 1,126,264 1,152,088 2,213,326
General and administration............. 1,380,104 580,218 2,822,732 1,339,756
--------------- ----------------
Total operating expenses............. 2,496,496 2,884,142 5,153,831 5,804,161
--------------------- ------------------- ------------------- --------------------

Operating loss....................... (2,262,579) (2,489,513) (4,608,086) (5,260,211)

--------------------- ------------------- ------------------- --------------------

Other income............................ 28,748 32,752 56,129 79,261
--------------------- ------------------- ------------------- --------------------

Loss before income taxes........... (2,233,831) (2,456,761) (4,551,957) (5,180,950)

Net loss............................. $ (2,233,831) $ (2,456,761) $ (4,551,957) $ (5,180,950)

===================== =================== =================== ====================

Per share data:
Net loss............................. (2,233,831) (2,456,761) (4,551,957) (5,180,950)

Effect of beneficial conversion
feature of convertible preferred
stock............................... (1,172,488) (107,292) (2,454,035) (250,523)

--------------------- ------------------- ------------------- --------------------
Net loss applicable to common
stock............................... (3,406,319) (2,564,053) (7,005,492) (5,431,473)

Net basic and diluted loss per
share applicable to common stock $ (0.22) $ (0.46) $ (0.48) $ (1.00)

===================== =================== =================== ====================

Weighted average shares outstanding..... 15,645,000 5,549,000 14,741,000 5,407,000
--------------------- ------------------- ------------------- --------------------

See accompanying notes to interim condensed financial statements

DATA RACE, Inc.
CONDENSED STATEMENTS OF CASH FLOWS
UNAUDITED

Six Months Ended Dec. 31,
----------------------------------------------------
1998 1997
------------------------- ----------------------

Cash flows from operating activities:
Net loss........................................................ $ (4,551,957) $ (5,180,950)
Adjustments to reconcile net loss to net cash provided by (used
in) operating activities:
Depreciation and amortization.................................. 175,503 294,515
Non-cash consulting fee........................................ 1,890,813 -
Gain on sales of property and equipment........................ - (1,639)
Changes in assets and liabilities:
Accounts receivable............................................ (120,953) 1,213,254
Inventory...................................................... (25,370) 175,368
Prepaid expenses, deposits, and other assets................... - 23,189
Accounts payable............................................... 97,855 (373,276)
Accrued expenses............................................... (641,276) (126,703)
Other current liabilities...................................... - (932)
------------------------- ----------------------
Net cash used in operating activities......................... (3,175,385) (3,977,174)
------------------------- ----------------------

Cash flows from investing activities:
Purchase of property and equipment.............................. (5,695) (30,909)
Proceeds from sale of property and equipment.................... 2,835 2,420
------------------------- ----------------------
Net cash used in investing activities......................... (2,860) (28,489)
------------------------- ----------------------

Cash flows from financing activities:
Net proceeds from the issuance of preferred stock............... 2,859,346 4,616,724
Net proceeds from the issuance of common stock.................. 2,400,979 85,828
------------------------- ----------------------
Net cash provided by financing activities..................... 5,260,325 4,702,552
------------------------- ----------------------

Net increase (decrease) in cash and cash equivalents............. 2,082,080 696,889

Cash and cash equivalents at beginning of period................. 1,644,294 4,535,768
------------------------- ----------------------

Cash and cash equivalents at end of period....................... $ 3,726,374 $ 5,232,657
========================= ======================

See accompanying notes to interim condensed financial statements

DATA RACE, Inc.
NOTES TO INTERIM CONDENSED 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 for remote access to the corporate
environment. Its unique client/server product, the Be There! Remote Access
System, gives teleworkers access to all elements of corporate communications
networks, including the PBX, Intranet, and Internet. Through Be There!, remote
workers send and receive e-mail, fax and phone calls simultaneously over a
single phone line. The Company also designs and manufactures advanced custom
modem products and network multiplexers that carry data, network, voice, and fax
traffic among a company's multiple offices.

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 June 30, 1998 Annual Report and the Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998. The condensed balance sheet data as of June
30, 1998 included herein has been derived from such audited financial
statements. Interim period results are not necessarily indicative of the
results to be expected for any future periods or the full year.

2) Earnings Per Share
- -----------------------

In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 128, Earnings Per Share. FASB
Statement No. 128 supersedes APB Opinion No. 15, Earnings Per Share, and
specifies the computation, presentation, and disclosure requirements for
earnings per share ("EPS"). It replaces Primary EPS and Fully Diluted EPS with
Basic EPS and Diluted EPS, respectively. Basic EPS, unlike Primary EPS,
excludes all dilution while Diluted EPS, like Fully Diluted EPS, reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the entity.
Diluted loss per share approximates basic loss per share as no potential common
shares are to be included in the computation when a loss from continuing
operations available to common shareholders exists. The Company had
approximately 1,585,000 and 1,475,000 options outstanding as of December 31,
1998 and 1997 respectively. The Company had 1,000 shares of Series D Convertible
Preferred Stock and 750 shares of Series E Convertible Participating Preferred

Stock outstanding as of December 31, 1998. The Company had 705 shares of Series
A Convertible Preferred Stock and 5,000 shares of Series C Convertible
Participating Preferred Stock outstanding as of December 31, 1997. The Company
had warrants to purchase 713,089 shares of common stock at $.06625, 140,625
shares of common stock at $0.80, 933,334 shares of common stock at $2.25, 25,274
shares of common stock at $16.375 and 53,977 shares of common stock at $6.435
outstanding at December 31, 1998. The Company had warrants to purchase 45,800
shares of common stock at $16.375 and 139,861 shares of common stock at $6.435
outstanding at December 31, 1997. No Series D or Series E Convertible Preferred
Stock and related warrants were outstanding as of December 31, 1997. All
previously reported per share amounts have been restated to conform to the new
presentation.

3) 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:

December 31, June 30,
1998 1998
------------ ------------
Finished goods $ 12,356 $ 13,859
Work in process 405,151 256,285
Raw materials 150,826 272,819
------------ ------------
Total inventory $ 568,333 $ 542,963
============ ============

4) Convertible Preferred Stock
- ------------------------------

In July 1998, the Company completed the first closing of a private placement
(the "July Private Placement") of its Series D Convertible Preferred Stock
("Series D Preferred Stock") and related Common Stock Purchase Warrants ("Class
A Warrants") to Sovereign Partners L.P. and Dominion Capital Fund, Ltd. (the
"Class A Investors"), for an aggregate price of $1,500,000, and its Series E
Convertible Preferred Stock ("Series E Preferred Stock") and related Common
Stock Purchase Warrants ("Class B Warrants") to First Capital Group of Texas II,
L.P. (the "Class B Investor"), an investment firm managed by the Company's
Chairman of the Board, for a price of $750,000.

On December 17, 1998, the Company completed the second closing of the July
Private Placement of Series D Preferred Stock and related Class A Warrants to
the Class A Investors for an aggregate price of $1,000,000. On January 7, 1999,
the Company issued its call to the Class B Investor and on January 22, 1999
completed the second closing of the July Private Placement of Series F Preferred
Stock and related Class B Warrants for an aggregate price of $750,000. The
Company has used and intends to use the proceeds for general corporate purposes,
primarily for working capital to promote and further develop the Be There!
remote access system product line.

Each of the Series D Preferred Stock, Series E Preferred Stock and Series F
Preferred Stock (the "Preferred Stock") has a stated value of $1,000 per share;
bears an 8% premium payable upon conversion or redemption or in liquidation (in
the case of conversion the Company may elect to pay such premium in Common
Stock); is non-voting except in limited circumstances; ranks senior to the
Common Stock in liquidation; and is redeemable at a premium at the option of the
holder upon the occurrence of certain major corporate transactions and
triggering events.

The Series D Preferred Stock is convertible into Common Stock of the Company
("Common Stock") at the option of the holder beginning March 17, 1999 (subject
to acceleration in certain events), at a conversion price equal to 80% of the
trailing five-day average closing bid price of the Common Stock on the
conversion date, subject to a minimum conversion price equal to the trailing 15-
day average closing bid price of the Common Stock 90 days after issuance and
subject to a maximum conversion price equal to the lesser of $3.00 or the
trailing five-day average closing bid price of the Common Stock 90 days after
issuance. The Series E Preferred Stock is convertible into Common Stock at the
option of the holder beginning July 24, 1999 (subject to acceleration in certain
events), at a conversion price equal to $1.00 (which represents a premium to the
Common Stock closing price of $0.5938 on July 8, 1998, the date the Company
reached an agreement in principle with the Investors regarding the terms of the
July Private Placement). The Series F Preferred Stock is convertible into Common
Stock at the option of the holder beginning on January 22, 2000 (subject to
acceleration in certain events), at a conversion price of $3.4313 (representing
the trailing five-day average closing bid price of the Common Stock on the date
the Company issued the call notice to the Class B Investor). In each case, the
number of shares of Common Stock issuable upon conversion of one share of
Preferred Stock is computed by dividing the share's stated value of $1,000 by
the applicable conversion price (plus any premium to the extent paid in shares).

The Class A Warrants issued at the first closing have been exercised in full.
The Class A Warrants issued at the second closing are exercisable for an
aggregate of 226,415 shares of Common Stock at a price of $0.6625 per share,
beginning on the earlier of the effective date of the applicable registration
statement or March 17, 1999 (subject to acceleration in certain events). The
Class B Warrants issued at the first and second closing are exercisable for an
aggregate of 281,250 shares of Common Stock at a price of $0.80 per share, one
year after their respective issuance dates (subject to acceleration in certain
events). These warrant exercise prices for the Class A and Class B Warrants
represent a premium to the Common Stock closing price of $0.5938 on July 8,
1998, the date the Company reached an agreement in principle with the Investors
regarding the terms of the July Private Placement.

As of November 18, 1998 all shares of the initial 1,500 shares of Series D
Preferred Stock had been converted into 779,386 shares of Common Stock. As of
February 5, 1999 none of the 1,000 shares of Series D Preferred Stock issued in
the second closing had been converted. As of February 5, 1999 none of the 750
shares of Series E Preferred Stock or 750 shares of Series F Preferred Stock had
been converted.

5) Restricted Common Stock
- --------------------------

On November 15, 1998, the Company obtained a binding commitment for a private
placement (the "November Private Placement") of its restricted common stock and
common stock purchase warrants to up to five accredited investors, for an
aggregate price of $2,200,000. The purchase price for one share of common stock
and one warrant was $2.25. Each warrant entitles the holder to purchase one
share of common stock at an exercise price of $2.25 per share, at any time on or
before the second anniversary of the closing date.

The investors included the Company's President and CEO and Liviakis Financial
Communications Inc. ("LFC"). The investors other than LFC are prohibited from
selling any common stock or warrants from the November Private Placement prior
to the first anniversary date of the closing. LFC is prohibited from selling
any common stock or warrants from the November Private Placement prior to
January 1, 2000.

As of February 5, 1999, 977,778 restricted common stock shares and 977,778
restricted purchase warrants were outstanding, of which 488,889 restricted
common stock shares and 488,889 restricted purchase warrants belong to LFC and
44,444 restricted common stock shares and 44,444 restricted purchase warrants
belong to the Company's President and CEO. In addition as described in Note 7,
the Company issued restricted common stock to LFC in connection with the
extension of the LFC consulting agreement.

6) Accounting Treatment for Convertible Preferred Securities
- ------------------------------------------------------------

The value attributed to the Warrants and the non-cash offering costs of the
Series D and Series E Preferred Stock have been recognized by allocating a
portion of the proceeds to additional paid-in-capital. The beneficial
conversion feature of the Series E Preferred Stock has not been allocated a
portion of the offering proceeds, rather, the beneficial conversion feature will
be accreted into additional paid-in-capital over the one year holding period.
The beneficial conversion feature 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 at the date the transaction closed. 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
Series D and Series E Preferred Stock, the offering costs and the premium will
result in non-cash charges of approximately $3,729,000 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 of
December 31, 1998 approximately $2,454,000 has been charged. 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 July 1998 through June 1999.

The Series D Preferred Stock issued in the December 1998 second closing is
presented in the accompanying balance sheet as debt to the Company because the
registration statement registering the resale of Common Stock into which such
Series D Preferred Stock is convertible has not been declared effective by the
SEC. At such time as the registration statement is declared effective, the
Series D Preferred Stock will be reclassified as equity of the Company.

7) Consulting Agreement
- -----------------------

In July 1998, the Company entered into a consulting agreement with Liviakis
Financial Communications Inc. ("LFC"). The Company issued shares of Common Stock
pursuant to this consulting agreement and recorded a non-cash expense of
approximately $1,266,000.

In November 1998, the Company extended the consulting agreement with LFC in
exchange for 200,000 shares of restricted Common Stock. As a result the Company
recorded a $625,000 non-cash expense in the quarter ended December 31, 1998. As
part of the consulting agreement extension, LFC agreed to extend the lock-up on
its portion of the original consulting agreement shares until January 1, 2000
and Prag agreed to extend the lock-up on his portion of the original consulting
agreement shares until January 1, 2000, or until he is no longer an officer of
the LFC, whichever comes first.

8) Subsequent Events
- --------------------

On January 15, 1999, the Company held a special shareholders meeting to consider
a proposal to approve an amendment to the Company's Articles of Incorporation,
increasing the authorized number of shares of Common Stock. The proposal was
approved.

On January 22, 1999, the Company completed the second closing of the Private
Placement of Series F Preferred Stock and related Class B Warrants to the Class
B Investor for an aggregate price of $750,000. See Note 4.

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

Results of Operations

Total revenue for the three months ended December 31, 1998 decreased 50% to
$788,000 from $1,574,000 in the comparable period of the prior fiscal year.
Revenue for the six months ended December 31, 1998 decreased 38% to $1,699,000
from $2,728,000 in the comparable period of the prior fiscal year. These
decreases were primarily due to the completion during the second quarter of the
prior year of substantially all shipments under existing custom modem contracts.

Gross profit margin was 30% and 32% for the three and six months ended December
31, 1998, up from 25% and 20% from the comparable periods of the prior fiscal
year. The increased gross margins are primarily due to decreased manufacturing
variances primarily attributable to reduced manufacturing spending and inventory
obsolescence reserve adjustments consistent with the Company's current inventory
levels and projected activity levels.

Engineering and product development expenses for the three and six months ended
December 31, 1998 decreased 50% and 48% respectively from the comparable periods
of the prior fiscal year. These decreases were primarily due to reductions in
outside development contracts for Be There! products and reduced development
payroll for the custom modem and network multiplexer products.

Sales and marketing expenses for the three and six months ended December 31,
1998 decreased 53% and 48% respectively from the comparable periods of the prior
fiscal year. These decreases were primarily due to the Company's suspension of
most outside advertising.

General and administrative expenses for the three and six months ended December
31, 1998 increased 138% and 111% respectively from the comparable periods of the
prior fiscal year. These increases were attributable to non-cash expenses
associated with a consulting agreement, and legal expenses associated with the
patent infringement lawsuit. This was offset in part by spending reductions
over the six-month period, and accrual and reserve adjustments consistent with
the Company's current activity levels.

Income tax benefits related to the losses for the three and six months ended
December 31, 1998 were not recognized because the utilization of such benefits
is not assured. As of December 31, 1998, the Company had federal tax net
operating loss carryforwards of approximately $40,000,000, which expire
beginning in 2009. The value of these net operating loss carryforwards is
dependent on future events and complex tax code provisions, and cannot be
assured or stated with certainty.

Liquidity and Capital Resources

Operating losses have had and continue to have a substantial negative effect on
the Company's cash balance. At December 31, 1998, the Company had approximately
$3,726,000 in cash and cash equivalents.

The Company received proceeds of approximately $2,200,000 from the issuance of
the November Private Placement of restricted common stock and warrants. See
Item 2 of this report for a more complete description of the terms of the
transaction. In December 1998, the Company completed the second closing of the
private placement of the Series D Preferred Stock and related Class A Warrants
for an aggregate price of $1,000,000. In January 1999, the Company completed
the second closing of the private placement of the Series F Preferred Stock and
related Class B Warrants for an aggregate price of $750,000. The Preferred
Stock is redeemable under certain circumstances.

In January 1999, the Company had a hearing before the Nasdaq Listing
Qualifications Panel concerning non-compliance with the net tangible asset
requirement for continued listing on the Nasdaq National Market. In February
1999, the Company was notified that the Panel determined that the Company had
demonstrated compliance with all requirements for continued listing and the
Panel decided to continue the listing of the Company's securities on the Nasdaq
National Market.

The Company's ability to sustain operations, make future capital expenditures
and fund the development and marketing of new or enhanced products is highly
dependent on existing cash, the ability to raise additional capital, and the
ability to successfully attract a strategic partner. The timing and amount of
the Company's future capital requirements can not be accurately predicted. The
Company does not anticipate a return to profitability as long as its
expenditures on the Be There! system remain disproportionate to attendant
revenue. The Company will likely require additional financing in the future; the
failure to obtain such financing when needed would have a substantial adverse
effect on the Company.

Year 2000 Compliance

The Company has been evaluating and adjusting all known date-sensitive systems
and equipment for the Year 2000 compliance. The assessment phase of the Year
2000 project is substantially complete. Company personnel performed virtually
all of the compliance. The total estimated cost of the Year 2000 conversion is
not deemed material to the Company and is being expensed as incurred.

In addition to internal Year 2000 implementation activities, the Company is in
communication with certain third party suppliers, vendors and customers to
determine the extent to which those companies are addressing their Year 2000
compliance problems. There can be no assurance that there will not be an
adverse effect on the Company if third

parties, such as suppliers, service providers or customers, do not bring their
systems into compliance in a timely manner. However, management believes that
ongoing communication with, assessment of, and coordination with these parties
will help minimize these risks.

Although the Company anticipates minimal business disruption will occur as a
result of Year 2000 issues, possible consequences include, but are not limited
to, disruption of voice mail communications, purchase order processing, and
other normal business activities. The Company can not be certain that unexpected
Year 2000 compliance problems of its products, or its computer systems or the
systems of its vendors, customers and service providers, will not materially and
adversely affect the Company's business, financial condition or operating
results.

To date, the Company has not established a contingency plan for possible Year
2000 issues. Where needed, the Company will establish contingency plans by June
30, 1999, based on its actual testing experience and assessment of outside
risks. The cost of and the completion dates are based on management's best
estimates and may be updated, as additional information becomes available.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
- ------------------------------------------------------------------

The Company does not believe that it is currently exposed to material risks
associated with market risk sensitive instruments.

PART II - OTHER INFORMATION

DATA RACE, INC.

ITEM 1. LEGAL PROCEEDINGS
- --------------------------

NONE.

ITEM 2. CHANGES IN SECURITIES
- ------------------------------

On December 17, 1998, the Company completed the second closing of the July
Private Placement of Series D Preferred Stock and related Class A Warrants to
the Sovereign Partners L.P. and Dominion Capital Funds Ltd. (the "Class A
Investors") for an aggregate price of $1,000,000. The Company has used and
intends to use the proceeds for general corporate purposes, primarily for
working capital to promote and further develop the Be There! remote access
system product line.

The Series D Preferred Stock has a stated value of $1,000 per share; bears an 8%
premium payable upon conversion or redemption or in liquidation (in the case of
conversion the Company may elect to pay such premium in Common Stock); is non-
voting except in limited circumstances; ranks senior to the Common Stock in
liquidation; and is redeemable at a premium at the option of the holder upon the
occurrence of certain major corporate transactions and triggering events,
including (i) the change of control or sale of the Company, (ii) the failure of
the registration statement covering the resale of Common Stock underlying the
Series D Preferred Stock to be declared effective before May 16, 1999, (iii) the
failure of the registration statement to be available for the resale of shares
for 30 trading days, (iv) the Company's voluntary termination of the listing of
the Common Stock on the Nasdaq National Market, (v) the Company's failure to
deliver Common Stock upon conversion of Series D Preferred Stock, (vi)
bankruptcy filing by the Company, or (vii) the Company's failure to pay
penalties resulting from a delisting of the Common Stock from the Nasdaq
National Market.

If the Common Stock ceases to be listed on the Nasdaq National Market, the
Company must pay the holders of the Series D Preferred Stock a cash penalty of
1% per day for up to 24 days, of the stated value of the Series D Preferred
Stock outstanding. If the Company does not pay such penalty, the holders may
require the Company to redeem their shares of Series D Preferred Stock.

The Class A Warrants issued at the second closing are exercisable for an
aggregate of 226,415 shares of Common Stock at a price of $0.6625 per share,
beginning on the earlier of the effective date of the applicable registration
statement or March 17, 1999 (subject to acceleration in certain events). The
warrant exercise price for the Class A Warrants represents a premium to the
Common Stock closing price of $0.5938 on July 8, 1998, the date the Company
reached an agreement in principle with the Investors regarding the terms of the
July Private Placement.

The Company has filed a registration statement under the Securities Act covering
the resale of the shares underlying the Series D Preferred Stock and Warrants.
The failure of such registration statement to be declared effective by April 16,
1999 will result in cash penalties payable by the Company to the holders of
Preferred Stock. The Class A Investors have agreed not to effect any short
sales of Common Stock prior to December 17, 1999, and the Class B Investor has
agreed not to effect any short sales of the Common Stock prior to January 22,
2000.

Two persons assisted the Company in arranging the Private Placement with the
Class A Investors. As compensation for the investment by the Class A Investors
in the second closing, the Company agreed to pay a cash fee equal to 3% of the
gross proceeds received from the Class A Investors and to issue Class A Warrants
to purchase approximately one-half of the number of shares that may be purchased
pursuant to the Class A Warrants issued to the Class A Investors.

THE SUMMARY OF THE JULY PRIVATE PLACEMENT SET FORTH ABOVE IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO THE PURCHASE AGREEMENTS AND THE OTHER DOCUMENTS
EXECUTED BY THE COMPANY IN CONNECTION WITH THE PRIVATE PLACEMENT. SUCH
DOCUMENTS ARE FILED (OR INCORPORATED BY REFERENCE) AS EXHIBITS TO THIS FORM 10-Q
OR THE 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 1998.

On November 15, 1998, the Company obtained a binding commitment for a $2.2
million private placement of securities (the "November Private Placement"). The
securities were sold to five accredited investors including Liviakis Financial
Communications Inc. and Dr. W. Barker. The private placement involved the
issuance by the Company of 977,778 shares of Common Stock and two-year warrants
to purchase additional 977,778 shares of Common Stock at a warrant price of
$2.25 per share. The investors agreed to a minimum of a one-year lock-up on the
resale of the shares. The Company has filed a registration statement covering
the resale of the shares.

THE SUMMARY OF THE NOVEMBER PRIVATE PLACEMENT SET FORTH ABOVE IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO THE SUBSCRIBTION AGREEMENTS AND THE OTHER DOCUMENTS
EXECUTED BY THE COMPANY IN CONNECTION WITH THE PRIVATE PLACEMENT. SUCH
DOCUMENTS ARE FILED AS EXHIBITS TO THIS FORM 10-Q.

The offer and sale by the Company of the securities in the July and November
Private Placements were made in reliance upon Section 4(2) of the Securities
Act, the non-public offering exemption from the registration requirements of the
Securities Act.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES
- ----------------------------------------

NONE.

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

An annual meeting of shareholders of the Company was held on November 13, 1998.
Dr. W. B. Barker, Jeffery P. Blanchard, Matthew A. Kenny, George R. Grumbles,
Dwight E. Lee and Edward A. Masi were elected as directors of the Company, each
to hold office until the next annual meeting of shareholders or until his
successor has been elected and qualified, subject to earlier resignation or
removal. Additionally, the shareholders approved the DATA RACE, Inc. 1998 Stock
Option Plan, authorized the issuance of certain securities of the Company and
ratified the appointment of KPMG LLP as independent accountants for the 1999
fiscal year. The Company did not receive the requisite vote of holders of two-
thirds of the Company's outstanding shares for the proposal to increase the
Company's authorized shares. The Company called a special meeting of
shareholders for January 15, 1999 to consider a similar proposal to increase
authorized shares. The proposal to approve an amendment to the Company's
Articles of Incorporation, increasing the authorized number of shares of Common
Stock, was approved at the special meeting.

The results of the voting at the annual shareholders meeting held on November
13, 1998 were as follows:

Proposal No. 1
(Election of Directors)

Company Nominee For Withheld Non-Votes
- --------------- --- -------- ----------
Dr. W. B. Barker 13,839,187 141,023 -
Jeffery P. Blanchard 13,841,257 138,953 -
Matthew A. Kenny 13,396,557 583,653 -
George R. Grumbles 13,396,525 583,685 -
Dwight E. Lee 13,396,025 584,185 -
Edward A. Masi 13,840,025 140,185 -

Proposal No. 2
(Approval of DATA RACE, Inc. 1998 Stock Option Plan)

For Against Abstain Non-Votes
5,224,933 784,020 73,809 7,897,448

Proposal No. 3
(Approval of amendment to the Company's Articles of Incorporation increasing
the authorized number of shares of capital stock)

For Against Abstain Non-Votes
5,846,312 423,876 76,970 7,633,052

Proposal No. 4
(Authorization of issuance of certain securities of the Company)

For Against Abstain Non-Votes
5,790,657 238,541 53,564 7,897,448

Proposal No. 5
(Ratification of KPMG LLP as independent accountants)

For Against Abstain Non-Votes
13,868,852 60,434 50,924 -

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

None.

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

(a) Exhibits.
- --------------

Exhibit Description
- ------- -----------

3.1 Articles of Amendment to the Articles of Incorporation of the Company,
filed January 21, 1999. (a)
3.2 Statement of Designation, Preferences and Rights of Series F Convertible
Preferred Stock. (a)
10.1 Modification Agreement, dated November 5, 1998, between the Company,
Sovereign Partners L.P., Dominion Capital Fund, Ltd., and First Capital
Group of Texas II, L.P. (b)
10.2 Subscription Agreements between DATA RACE, Inc. and Liviakis Financial
Communications, Inc., Robert S. London, Anthony Altavilla, Timothy D.
Wilson, Sr. and Dr. W. B. Barker. (c)
10.3 Amendment No. 1 to Consulting Agreement Between the Company and Liviakis
Financial Communications, Inc. (c)
27.0 Financial Data Schedule. (c)

- --------------------

(a) Filed as an exhibit to Form S-3 Registration Statement filed on January 28,
1999.
(b) Filed as an exhibit to Form S-3 Registration Statement filed on November 6,
1998.
(c) Filed herewith

(b) Reports on Form 8-K.
- --------------------------

None

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, Senior Vice President, Finance
Chief Financial Officer, Treasurer and Secretary
(Principal Financial and Accounting Officer)

Date: February 12, 1999