<PAGE>

                      SECURITIES AND EXCHANGE COMMISSION
                             Washington, DC 20549

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


For the Fiscal Year Ended                               Commission File Number
      June 30, 2000                                            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.)

                        6509 Windcrest Drive, Suite 120
                              Plano, Texas 75024
                           Telephone (972) 265-4000
              (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
                                        ---      ---

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
          ---

On September 19, 2000, the aggregate market price of the voting stock held by
non-affiliates of the Company was approximately $123,780,000 (For purposes
hereof, directors, executive officers and 10% or greater shareholders have been
deemed affiliates.)

On September 19, 2000, there were 26,241,648 outstanding shares of Common Stock,
no par value.


                      DOCUMENTS INCORPORATED BY REFERENCE
                      -----------------------------------

Portions of the Proxy Statement for the 2000 Annual Meeting of Shareholders,
expected to be filed within 120 days from the Company's fiscal year-end, are
incorporated by reference into Part III.

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                                DATA RACE, Inc.
                              INDEX TO FORM 10-K
<TABLE>
<CAPTION>
                                                                                    Page
                                                                                  Number
<S>                                                                               <C>
PART I.
-------
Item 1.   Business..............................................................       3

Item 2.   Properties............................................................      18

Item 3.   Legal Proceedings.....................................................      18

Item 4.   Submission of Matters to a Vote of Security Holders...................      18

PART II.
--------
Item 5.   Market for Registrant's Common Stock and Related Stockholder Matters..      19

Item 6.   Selected Financial Data...............................................      20

Item 7.   Management's Discussion and Analysis of Financial
          Condition and Results of Operations...................................      21

Item 8.   Financial Statements and Supplementary Data...........................      25

Item 9.   Changes in and Disagreements with Accountants on
          Accounting and Financial Disclosure...................................      43

PART III.
---------
Item 10.  Directors and Executive Officers of the Registrant....................      44

Item 11.  Executive Compensation................................................      44

Item 12.  Security Ownership of Certain Beneficial Owners and Management........      44

Item 13.  Certain Relationships and Related Transactions........................      44

PART IV.
--------
Item 14.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K......      45

</TABLE>

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                                    PART I.

ITEM 1. BUSINESS
----------------

DATA RACE, Inc. ("DATA RACE" or the "Company"), currently doing business as IP
AXESS, designs, manufactures, and markets a line of innovative communications
products to meet the needs of remote workers. The Company's lead product, the
VocalWare(TM) IP remote access system, provides virtual presence to the
corporate environment by allowing a remote worker to connect to the corporate
office over a normal dial-up telephone line or a number of broadband access
mediums such as DSL, cable modems, ISDN, ATM and frame relay, and simultaneously
have full access to the corporate data network, the office phone extension, and
the office fax system.

Historically, the Company's revenue has come from custom modem and network
multiplexer products.  The Company's modem business comprised the design and
manufacture of special custom modems on an OEM basis for the manufacturers of
notebook computers.  Today's notebook computers generally do not use such custom
modems.  The market for the Company's network multiplexer products has been in a
state of steady decline. These units, deemed counterproductive to the future of
the Company, have been either sold or discontinued.  To develop a more reliable
revenue base and a return to profitability, the Company is depending on the
success of the VocalWare IP product line.

The Company's VocalWare IP product line is intended to capitalize on the
communications requirements of the rapidly growing number of "teleworkers" who
need convenient simultaneous access to all of their corporate information assets
- voice, data and fax - when working from home or on the road.  With VocalWare
IP, a user can be logged in from home, a hotel room, or an airport lounge,
reading e-mail and browsing the web.  If a call comes into his normal office
phone extension, an image of his office phone pops up on the screen and rings,
showing Caller ID information.  He can answer the phone, conference in
colleagues, and transfer the call, all while continuing his data work.  At the
same time, he can read faxes sent to his office or can send faxes.  The Company
refers to this set of capabilities as Telepresence(TM).  If working at home,
normal home phone calls can also ring through while the data session continues,
without requiring a second phone line.

Since its introduction, VocalWare IP has received numerous accolades from the
trade press, including Computer Telephony Magazine and Fortune Magazine. The
coverage we have received in the last year has been in the form of "Product of
the Year" awards, including Computer Telephony Spring Expo, March 2000 "Best of
Show Award," C@ll Center CRM Solutions, January 2000 "Product of the Year Award"
             ----
and Communications Solutions Expo, fall 1999 "Best of Show Award."  The product
has also received consistently positive comments from its users for its
functionality and ease of use.

The company completed its second generation development efforts in August 2000,
completing the evolution of its Be There! narrowband remote access solution into
a integrated narrowband and broadband access server. This second generation
solution allows users to access their office voice, data and fax resources over
any access medium and works with all of the leading manufacturers of voice and
data products.

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The Company seeks to capture a leadership position in the market for remote
access solutions by capitalizing on its unique advanced technology, its patents,
other intellectual property and on developing relationships with leading network
and solution companies, which have influence with enterprise customers.


                               Industry Overview

The Company operates within the remote access segment of the digital
communication products industry. VocalWare IP represents a new product category
in this industry bridging the gap between traditional voice and data
solutions. This industry has been characterized by high rates of growth and
change due to the emergence of the Internet and e-commerce.  As the basis for
value within the global economy shifts from goods to information, global
instantaneous access to all forms of information, whether by phone, fax, or data
link, is transitioning from a luxury to a necessity for businesses. This need to
give dispersed-knowledge workers and consumers' instantaneous access to all
forms of information has created a multi-billion dollar remote access market.

The Enterprise Market

As the workforce shifts from production worker to knowledge worker, the need for
companies to physically cluster their workers is diminishing in many industries.
Allowing employees to work at home or another location remote from the corporate
office offers substantial advantages to the employer, to the employee, and to
society as a whole. To the employer, remote work can yield improved
productivity, reduced turnover, reduced facility cost, the ability to hire from
a broader national labor pool, and an economical way of complying with the
mandates of legislative initiatives such as the Clean Air Act, the Americans
with Disabilities Act, and the Family and Medical Leave Act. To the employee,
remote work offers improved quality of life by reducing commuting time and
frustration, providing more family time, and the flexibility to live further
from the workplace. To society, remote work can offer reduced traffic congestion
and pollution.

Traditionally, companies have provided remote access services to their employees
by purchasing and deploying data-only remote access hardware and software within
the company. Recently, an increasing number of companies have begun to outsource
their remote access capabilities to outside service companies.

The VocalWare IP remote access family of products is intended to meet the needs
of teleworkers; specifically mobile professional telecommuters and remote call
center agents.  Jack M. Nilles, a noted analyst of and consultant for
telecommuting and president of JALA International, Inc., estimates that there
are approximately 20 million teleworkers in the United States in 2000. He also
projects a growth rate of 18%, which would represent more than 45 million
teleworkers in 2005 and 104 million in 2010.

Mobile Professional

The Company's VocalWare IP product line addresses the needs of so-called "mobile
professionals," traveling workers who require efficient, readily available,
phone, data, and fax connectivity to their offices.  Because mobile
professionals are often highly compensated, any increase in their productivity
is generally worth a great deal to their employers.  When working from a hotel
room or airport lounge, a mobile professional often needs to retrieve and reply
to e-mail, voice mail, and fax traffic, all within a very limited time.  At
other times, the mobile

                                       4
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professional may need to work collaboratively with a colleague on a document
while discussing it on the phone.

The Company believes that the needs of the mobile professional are uniquely met
by the VocalWare IP system. VocalWare IP can increase a mobile professional's
productivity by providing simultaneous phone, fax, and data connectivity to the
office.  When working from a hotel room or airport lounge, a mobile professional
can use the VocalWare IP system to quickly retrieve and reply to e-mail and fax
traffic while simultaneously making phone calls and taking calls placed to his
or her personal office phone. In addition to productivity improvements,
VocalWare IP can yield substantial hard-dollar savings for companies as a result
of reduced cellular phone costs, hotel telephone surcharges and calling card
rate long-distance charges.

Telecommuters

Over the past several years, an increasing number of companies have adopted
telecommuting programs, either on a trial basis or as permanent programs, due to
a variety of economic, social, and legislative pressures. Studies in the last
few years have shown that there are substantial economic benefits to
corporations with telecommuting programs. More importantly, numerous studies of
telecommuting programs done in recent years have documented productivity
improvements among telecommuters, typically in the range of 10% to 30%.
Contributing to this improvement is the reduction in non-business discussions
with colleagues and the longer hours worked after dinner or at other periods
outside the traditional working day by someone whose office is in the home.
Because a commute is not required, companies are able to tap into labor
resources for short peak-hour periods during the day in ways that were
impractical before telecommuting. The economic benefits currently outweigh the
incremental costs by such a large margin that for the foreseeable future,
technology, not price, will remain one of the major selection criteria for
telecommuting products. There are also a variety of legislative forces behind
the increases in telecommuting. The Clean Air Act of 1990 encourages cities in
non-attainment zones to implement plans to reduce automobile emissions.
Telecommuting is a convenient and economical method of reducing such emissions.
The Family and Medical Leave Act and the Americans with Disabilities Act both
require companies to offer accommodations to workers who may not be able to work
daily in the corporate office, but who may be able to work from home for all or
part of a day.

In addition to the legislative and economic forces, there are significant social
forces driving the increase in telecommuting.  Eliminating the daily commute has
clear benefits for the environment and for traffic.  Telecommuting also improves
workers' lifestyles as the time lost to commuting is recovered for more
leisurely activities.  In addition, the ability to spend the day at home with
the family is attractive to many workers.  For these and other reasons, studies
report that telecommuting improves employee morale and reduces employee
turnover.

With VocalWare IP, a telecommuter can use the office PBX or Centrex and its many
features to send or receive network faxes and check e-mail all at one time using
one conventional phone line. Incoming calls to the business phone ring
immediately in the home so that telecommuting is completely transparent. Four-
digit extension calls transfer automatically, so even co-workers can't tell who
is working from home. VocalWare IP makes telecommuters more productive by
allowing them to accomplish multiple tasks simultaneously.

                                       5
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Remote Call Center Workers

Call center workers are generally groups of workers that deal with customers
over the telephone.  Airline reservation centers are such an example in which
workers are connected by phone to the customers and by a network to a computer
database containing flight and space availability information.  In certain
applications, workers must also send and receive faxes.  Incoming phone calls
are typically routed through specialized computer systems to the next available
worker.  Computers allow the monitoring of individual and overall performance.

Hiring and employee scheduling are two of the most challenging and costly
aspects of call center management.  Many call centers operate on a 24 hour-a-
day, 7 day-a-week basis, with peak call hours varying by industry, and by
whether the call center is inbound, outbound or both.  It is often more
economical to staff the call center, at least partially, with part-time
employees working from home.  Such remote call center workers, often parents of
young children who cannot afford to be away from home, can nevertheless work
productively for a limited number of hours while their children are napping, at
school, or otherwise occupied.  Such part-time employees typically receive
reduced benefits, making them less costly to their employers.  Very substantial
capital savings may also be realized, as additional facilities do not need to be
built to house these workers. DataMonitor a leading research firm in the call
center market estimates a cost saving of approximately $6,000 per agent when
using the VocalWare IP remote agent solution.

Without VocalWare IP, connecting remote workers to call centers is problematic.
Such workers need a telephone connection to the customer and a simultaneous data
connection to the database, and often the ability to send and receive faxes.  To
enable a remote call center worker to operate in this mode would generally
require the installation of multiple additional telephone or ISDN lines to the
worker's home.  In addition to the expense of these connections, it may take
several months to get the service installed, connected, and operating properly.
With the high turnover rates common among call center employees, it may not be
feasible to have these services installed during the employee's tenure, and is
typically economically impractical.

With the VocalWare IP system, the remote call center agent can use the office
PBX and ACD systems with all of their functionality while they simultaneously
access the corporate LAN for account information, as well as process screen
pops.  That means remote agents can send a network fax, access the Internet,
talk to a customer and review account information all at the same time.
Incoming calls ring immediately at the remote site.  Furthermore, a unique
feature of the VocalWare IP system allows any calls placed to the worker's home
phone to be re-routed through the call center and back to the worker.  In this
way, an emergency call from the school nurse, for example, will not be blocked
because the worker's phone line is tied up with the connection to the call
center.  VocalWare IP provides the cost-effective, comprehensive solution that
allows call center agents to work from home as productively as they would in the
office.

Remote Offices

The benefits that VocalWare IP brings to the branch office are the ability to do
true dynamic office space allocation.  The flexibility of the VocalWare IP
server and combination of voice and data over any IP connection enables the
facilities manager to make every LAN outlet a portal to the enterprise's entire
communication network. VocalWare IP reduces the need for customer premise
equipment, such as physical devices, which many PBX extender products require.
VocalWare IP can save companies up to $500 per user for every employee that is
relocated to a

                                       6
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branch office by eliminating the need for a switch technician to establish
telephone service and reassign telephone numbers and reallocate inside wire to
the new user. The enterprise VocalWare IP solution enables greater economies of
scale and communications by aggregating all of the branch office traffic into
headquarters, thereby allowing effective utilization of inter-exchange carriers
and local exchange carriers. Once again, the enterprise is able to achieve
greater economies of scale and communications by aggregating all of the branch
office traffic into headquarters. Another important feature for the branch
offices is total flexibility no matter where the user moves in the enterprise.
Whether the user is at the headquarters location or at a branch location, the
LAN and voice communications are the same. With common dialing users retain all
of their phone features. This means that employees who move between headquarters
and branch locations are able to keep their same phone number and even more
importantly, they do not have to learn new phone features and dial-in protocols.
Since we are utilizing the centralized PBX instead of buying remote key systems
and other remote access devices, we are getting more effective utilization of
the enterprise network, thus enabling a greater ability to manage bandwidth
requirements.

The use of hoteling or telecenters for office space allocation allows
enterprises with a highly mobile workforce to dynamically assign office space
based upon the need at that current time.  Some of the key applications that fit
a hoteling model are consulting firms, auditors, and in general any employer
that has numerous employees that travel a good portion of the time.


                                   Strategy

The Company's strategy is to provide innovative, first-to-market, high-value-
added solutions.  In devising product solutions, the Company typically attempts
to obtain input from prospective customers throughout the development process.
The Company applies substantial engineering and technical capabilities to
incorporate current remote access technologies, as well as the Company's own
technological innovations and advances to the design of products intended to
meet the market needs of the customer.  Products are typically manufactured
through outside contract manufacturing. The Company has a growing direct and
channel sales operation to manage corporate accounts and strategic partnerships.

The Company believes that it has developed unique remote access technology for
the integration of voice and data using Internet Protocols, and it has
incorporated this technology into its VocalWare IP product line. The Company has
focused its VocalWare IP sales efforts on the enterprise market segment.  Its
strategy has been to maintain a direct sales force while simultaneously
developing distribution partners.  The direct sales force is intended to sell
directly to large potential customers and to support the initial sales efforts
of the partners.  The Company's sales process relies on a four-step selling
cycle.  First, the salesperson calls upon a sales prospect to present and
demonstrate the VocalWare IP product.  In the second step, upon receipt of a
conditional purchase order from the customer, the Company installs a trial
system in the corporate offices of a prospect for technical evaluation. At the
end of the specified trial period (usually 30 days) the Company will invoice the
customer for the VocalWare product. In the fourth step, the Company anticipates
that the number of users would then expand, as the benefits were experienced
first-hand within the operating groups of the large target companies.

The Company believes that its strategy to generate significant sales to the
enterprise market is dependent upon success in two important areas.  First, the
Company's sales resources are

                                       7
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focused upon moving its early customers to rolling out the VocalWare IP products
to a large number of their employees. The Company believes that such large-scale
operational reference customers are critical to overcoming the Company's lack of
name recognition and credibility in convincing new prospects to buy VocalWare
IP. Second, the Company is attempting to establish one or more strategic
relationships with other companies who have established name recognition and
sales/distribution capabilities. The Company believes that such partnerships
greatly increase the visibility of its product with prospective customers and
provide these partners with a unique solution to offer their customers. The
company has achieved significant progress in the development of these strategic
relationships with companies such as Time Warner Cable-San Antonio,
MCI\Worldcom, Amartech LTD. and Associated Global Partners/Lynxus, Inc.

                                   Products

VocalWare IP Remote Access System

VocalWare IP is a remote access system which allows a worker who is away from
his office to connect in over a conventional phone line, or broadband connection
such as DSL, ISDN or cable modem service, and have simultaneous access to his
office telephone, fax, data network and Internet connections. The user can be
connected from home or from a hotel room, anywhere in the world that Internet
access is available. While reading and writing e-mail, synchronizing notes and
calendars and surfing the Internet, a colleague or an outside caller calls the
user's office. An image of the user's office phone pops up on his screen, rings
and presents the caller's ID without interrupting the data connections. He
answers the phone and carries on a normal business conversation while continuing
to read e-mail and do other data work. He can also send a fax to the person he
is talking to (or to anyone else) and receive faxes sent to his office while
continuing to talk and use the full data capabilities. He can conference in
colleagues in his office or transfer the call to colleagues by simply using the
same button sequence on his phone that he would use if he were in the corporate
office. The user is provided with Telepresence(TM) in his remote office - the
ability to work as if he were in his office, so transparently that callers
cannot tell the difference. Unlike other solutions, the telephone conversation
is of such high quality that typical callers will likely not be able to tell
that he is using a technology other than his normal office phone even during
periods of large data transfers on that same line.


Existing Approaches

The needs of teleworkers are currently being met by a variety of partial
solutions, including computer modems and remote access servers to provide data
connectivity; telephones (including cellular phones), PBX extenders, DSL, and a
variety of software products and communications services providing some degree
of phone access; and fax servers, fax modems, and software, as well as remote
physical fax machines to support remote fax access. Although technology is
advancing rapidly, the partial solutions currently available typically require
multiple phone lines or ISDN lines, which are often unavailable and are
generally expensive where they are available. These solutions also generally
require that the user act as systems integrator to cause all of these disparate
systems and services to function in unison. Such partial solutions fail to
accomplish the fundamental objective of a remote access system, namely to allow
teleworkers to perform their jobs at remote locations just as effectively as
they would in their offices.

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The VocalWare IP Solution

To address the teleworker market needs, the Company has developed the VocalWare
IP system.  With the VocalWare IP remote access system, e-mail, file server,
intranet, Internet, fax and other data connections are supported, as they would
be in the office.  An image of the worker's office telephone appears on the
worker's computer screen and has the same functions it would have in the office.
The teleworker can dial colleagues or place local or long-distance calls through
the company's WATS lines as if present in the office.  Colleagues who dial a
teleworker's extension, or outsiders who call in on the teleworker's corporate
office direct line, will automatically and immediately be connected to the
teleworker in the remote location, all without disturbing the data connections
on which the teleworker is reading e-mail or browsing the Web.  At the same
time, the teleworker can send and receive faxes over the company's fax server,
again without interrupting the phone and data connections.  The Company refers
to this transparent combination of data, fax, and voice features that enable a
remote worker to operate just as he or she would in the office as
Telepresence/TM/.

Current Product

A VocalWare IP remote access system is made up of client software and accessory
products installed on the user's desktop or notebook computer, and a server
installed at the office.  These components, along with their connections, are
diagrammed in Figure 1.

                                  [FIGURE 1]

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                   Figure 1 - VocalWare IP System Components


VocalWare IP is the next generation of the Company's integrated IP based voice
and data solutions. The VocalWare IP, boasting patented voice-quality
technology, utilizes the powerful new generation of Pentium processors to
perform speech and data compression, as well as multiplexing functions while
using the computer's microphone speaker and sound systems to act as a telephone.
The equipment is easy to install, use and manage and the VocalWare IP Enterprise
Access server is able to communicate with any industry-standard v.80-capable
modem. VocalWare also features a comprehensive suite of simulated phones that
provide a user-friendly interface and function as a user's own office
environment. This allows employees to spend less time learning new software and
more time being productive using VocalWare's phone, fax, e-mail and Internet
capabilities.

The Company is also releasing two other client accessory products for inclusion
in the VocalWare IP family - VocalWare Turbo/TM/, and VocalWare RealPhone/TM/.
These new products will provide the benefits of VocalWare 56k bandwidth,
improved voice quality and flexibility for those users whose systems do not
fully meet the basic requirements for VocalWare.

The VocalWare Turbo is designed to work with laptops. It takes the place of the
sound-system and off-loads voice compression from the CPU. The RealPhone, which
targets desktop systems, connects to a standard home telephone (including
cordless phones) and features an industry-standard modem in addition to the
functions of VocalWare Turbo. This enables it to replace the previous generation
of client cards. Both the VocalWare Turbo and VocalWare RealPhone products will
increase the market of users able to enjoy the benefits of working with
VocalWare IP.

The VocalWare IP Enterprise Access Server transforms a computer into an office.
When in the office, a user simply connects to the office network and works
normally. When at home, the user can connect with cable modem, DSL line, ISDN
line or a dial-up modem and click on the VocalWare IP icon to be connected to
the office network, telephone and fax. The VocalWare IP Enterprise Access Server
supports V.90 (so-called "56k") connections, higher port densities to support
greater numbers of users per server, redundant fault-tolerant configurations,
voice over IP connections and users connecting over Local Area Networks (LANs),
DSL lines and cable modems.

                      Technology and Product Development

The Company believes that the extension and enhancement of the existing
VocalWare product line and the development of new products that leverage state-
of-the-art local and wide-area connectivity technologies to provide remote
access to both corporate data and telephony facilities are critical to its
future success.  The Company seeks to implement its innovative products using
the latest industry standards and technologies, thus enabling the Company to
develop and introduce products quickly in response to customer requirements and
identified market trends.

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When appropriate industry standards are not available, the Company may, from
time to time, introduce and promote the required new standards in the various
industry forums and standards organizations.

The Company regularly uses information derived from interaction with key
customers, its distribution channel partners, participation in industry
standards organizations, and market and technical research to set its
development directions and make design and product decisions.

Users of the Company's products for telephone communication expect a standard of
reliability closer to that for normal telephony than that for normal data
communications software and other software applications.  As a result, the
Company's development priorities include significant testing, quality assurances
as well as focus on development and planning methodology and processes.

Company-sponsored research and development expenses for continuing operations
were $3.3 million, $2.4 million, and $3.1 million for fiscal years 2000, 1999,
and 1998, respectively.

                          Manufacturing and Suppliers

The Company purchases key components used in the manufacture of its products
from third-party suppliers. The Company ordinarily avoids fixed long-term
commitments for components. This allows the Company to better coordinate
component inventory build-up and to select suppliers who have the most
technologically advanced, cost-effective components available at the time.

The Company has moved all of its production for customer goods to outside
turnkey system integrators. We qualify and monitor our system integrators and
subcontractors through a stringent vendor-quality program to ensure they
consistently provide a quality product on time. This strategy was adopted to
increase our flexibility and effectiveness in responding to customer needs. At
the same time, it allows us to reduce our overall manufacturing costs by
leveraging key strategic partnerships developed by our system integrators with
their suppliers. We are continually searching to find top quality system
integrators and subcontractors to ensure that we can always meet our customers'
requirements with the highest quality product.

                  Marketing, Sales, Distribution and Support

In order to successfully penetrate the enterprise market, the Company believes
that it will need to maintain a small direct sales force while simultaneously
developing distribution partners.  The small direct sales force is intended to
sell directly to large potential customers and to support the initial sales
efforts of the partners.

                                  Competition

Historically, there has been little to no other direct competition with
VocalWare. However, there are alternative solutions available today and other
related products and services have recently been announced.  Many prospective
customers, especially "mobile professionals", can use a cell phone along with a
notebook computer and modem to receive many of the benefits of VocalWare.
Certain PBX extender products (including those from MCK, Multitech, and TelTone)
can provide some of the benefits of VocalWare to teleworkers working from home.
In addition, ISDN, DSL and cable modem services provide some of the benefits of
VocalWare, in that they can provide simultaneous voice and data without tying up
the primary home phone line.

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<PAGE>

In this dynamic market, new products or services are announced frequently and
many of these may provide competitive solutions to the Company's prospective
customers.

There can be no assurance that competitors will not introduce comparable or
superior products incorporating more advanced technology at lower prices.  See
"Certain Business Risks - Competition From Companies Having Greater Resources
Could Adversely Affect Us."

                             Intellectual Property

The Company's success depends in part upon its proprietary technology, including
both its software programs and its hardware designs. The Company relies upon
patent, copyright, trademark, and trade secret laws to protect its proprietary
technology. The Company generally enters into nondisclosure agreements with
persons to whom it reveals its proprietary information, such as component
suppliers, subcontractors, and OEMs that the Company works with concerning
future products. Although it is unusual in the industry for patents to be of
substantial strategic value, the Company has ongoing programs seeking patent and
other intellectual property protection for its technologies and products, and it
sometimes grants licenses of its technology to other companies. There can be no
assurance that the Company's present protective measures will be adequate to
prevent misappropriation of its technology or independent third party
development of the same or similar technology. Many foreign jurisdictions offer
less protection of intellectual property rights than the United States, and
there can be no assurance that the protection provided to the Company's
proprietary technology by the laws of the United States or foreign jurisdictions
will be sufficient to protect the Company's technology.

While the Company's competitive position may be affected by its ability to
protect its proprietary information, the Company believes that the rapid pace of
technological change in the remote access products industry will cause other
factors to be more significant in maintaining the Company's competitive
position. These factors include the technical expertise, knowledge and
innovative skill of the Company's management and technical personnel, name
recognition, the timeliness and quality of support services provided by the
Company and its ability to rapidly develop, produce, enhance, and market
innovative products.

In the current market, in which voice and data communications are converging
rapidly, the Company believes that the intellectual property of its "virtual
presence to an office" product innovations may be of significant strategic
value.  Therefore, the Company protects its new ideas by regularly filing patent
applications on new product concepts and implementation methods.  In June 1998,
the United States Patent and Trademark Office issued patent number 5,764,639
entitled "System and Method for Providing a Remote User with a Virtual Presence
to an Office."  The patented system and method provide remote users with the
ability to work outside of the office just as if they were physically located in
the corporate office.  The Company also has other patents issued and pending
related to the VocalWare IP product technology.  The Company intends to
aggressively protect its rights under its patents.  See "Certain Business Risks
- Intellectual Property Disputes Could Be Costly and Disruptive and Affect the
Validity of Our Patents."

The Company commonly enters into licensing agreements with suppliers of
components that the Company desires to incorporate into its products.  The
Company may choose to obtain additional licenses in the future, but believes
that any necessary licenses could be obtained on terms that would not have a
material adverse effect on the Company.

                                       12
<PAGE>

It is common in the computer industry for companies to assert intellectual
property infringement claims against other companies.  As a consequence, the
Company indemnifies some OEM customers in certain respects against intellectual
property claims relating to the Company's products.  The Company presently is
unaware of any material intellectual property claims pending against it.  If an
intellectual property claim were brought against the Company and one of the
Company's products were found to be infringing upon the rights of others, the
Company could be required to pay infringement damages, pay licensing fees,
modify its products so that they are not infringing, or discontinue offering
products that were found to be infringing, any of which could materially
adversely affect the Company and its results of operations.  In addition, the
assertion of such claims against one or more of the Company's vendors could
adversely affect the availability from those vendors of components used by the
Company.

                                    Backlog

The Company's backlog at June 30, 2000 was approximately $6,600,000.  The
Company does not believe that its backlog as of any particular date is
necessarily indicative of future sales because, as is customary in the industry,
the Company often allows changes in delivery schedules or certain order
cancellations without significant penalty, and because the time between order
placement and shipment is short.

                                   Employees

As of June 30, 2000, the Company employed 59 employees, including 5 in
manufacturing, 23 in engineering, 19 in sales, marketing and customer support,
and 12 in general and administration.  None of the Company's employees are
represented by a labor union.  The Company believes its relations with its
employees are good.  Competition for qualified personnel is intense, especially
for talented engineers and senior marketing personnel, and the Company believes
that its prospects for future growth and success will depend, in a significant
part, on its ability to retain and continue to attract highly skilled and
capable personnel in all areas of operations.

                                       13
<PAGE>

                            Certain Business Risks

This Report contains certain "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934.  Such forward-looking statements, which are often
identified by words such as "believes", "anticipates", "expects", "estimates",
"should", "may", "will" and similar expressions, represent our expectations or
beliefs concerning future events.  Numerous assumptions, risks, and
uncertainties, including the factors set forth below, could cause actual results
to differ materially from the results discussed in the forward-looking
statements.

Our Future Success Depends on the Success of Recently Introduced VocalWare
Products

Our success depends almost entirely on the success of our VocalWare product
line.  The failure of our VocalWare products to achieve success would likely
have a material adverse effect on our business and our ability to continue
operations.  The Be There! system which was the predecessor to VocalWare had
very limited success and failed to generate significant revenue since its
release in 1997.  The majority of our historical revenue has come from products
other than Be There!/VocalWare, and we are no longer manufacturing or selling
those other products.  In March 2000, we sold our network multiplexer business
segment to concentrate all our efforts on the VocalWare product line.  The
market may not accept our VocalWare products for a variety of reasons.  Our
inability to penetrate our target markets and increase VocalWare sales would
adversely affect our business and operations.

Our Success is Dependent on Relationships with a Strategic Partner

Our business strategy is heavily dependent on our ability to establish and
sustain strategic relationships with one or more partners who can enhance our
market presence and credibility and who can provide needed capital.  Our
inability to develop and sustain such strategic relationships could have a
material adverse effect on our business and prospects.

Our Dependence on Third Party Manufacturers Increases Potential Manufacturing
Problems and Other Risks

Our dependence on third party manufacturers could adversely affect our business,
customer relationships, or operating results.  We use third party manufacturers
to assemble our products.  Because of this reliance on third party manufacturers
we cannot always exercise direct control over manufacturing quality and costs.
We may also have problems with production schedules of our products because of
other demands placed on the third party manufacturers.

We Will Likely Need Additional Capital to Sustain Operations

We may be required to suspend some or all of our operations if we cannot obtain
additional capital when needed. It is possible that sources of capital, such as
investors, lenders or strategic partners, may perceive our recent history of
losses, current financial condition, or lack of significant VocalWare product
sales as too great a risk to bear. As a result, we may not be able to obtain
additional capital on favorable terms, if at all. Further, if we issue equity
securities, shareholders may experience additional dilution or the new equity
securities may have rights and preferences senior to the common stock. Even if
our sales grow, we may require additional capital to hire additional personnel
and increase inventory levels. We cannot predict the timing and amount of our
future capital requirements.

                                       14
<PAGE>

We Have a History of Operating Losses and Expect to Have Continued Losses

We have suffered substantial recurring losses, and our VocalWare products have
not generated significant revenue.  We may never return to profitability or
generate future revenue levels sufficient to support our operations.  In recent
years we have funded operations from the sale of equity securities.  We expect
to continue to incur significant product development, sales and marketing, and
administrative expenses and, as a result, will need to generate significant
revenue to achieve profitability.

The Market for Our VocalWare Products May Not Develop as We Anticipated

The VocalWare products have not yet been and may never be widely accepted in the
market. We can not be assured that we will establish a market for VocalWare
products or establish our credibility in that market. The market may elect to
embrace alternative products or service solutions to satisfy the need for
communication between the corporate headquarters and workers who are away from
their headquarters. The potential market for our VocalWare products may be
affected by various factors, including changes in market trends and market needs
and changes in technology. The actual rate of growth and size of the market may
not reach expected levels. Our business will be adversely affected if the market
does not develop or we are not able to penetrate it as we hope.

Rapid Technological Change Could Adversely Affect Our Business

The rapid pace of technological change may prevent us from developing and
marketing new products, enhancing our existing products, or responding
effectively to emerging industry standards or new product introductions by
others.  Our future success will be largely dependent on our ability to enhance
our existing products and to develop and introduce successful new products.
Rapidly changing technology, emerging industry standards, product proliferation
and short product life cycles characterize the market for our products.  As the
technical complexity of new products increases, it may become increasingly
difficult to introduce new products quickly and according to schedule.  Delays
in developing or shipping new or enhanced products could adversely affect our
operating results.

Competition from Companies Having Greater Resources Could Adversely Affect Us

The communications industry is intensely competitive. The competitive pressures
we face could materially and adversely affect our business, financial condition
or operating results. Several of our existing and potential competitors have far
more extensive financial, engineering, product development, manufacturing, and
marketing resources than we have.  As a result, these competitors may be able to
respond more quickly to new or emerging technologies and changes in customer
requirements, or to devote much greater resources to the development, promotion,
and sale of their products and services than we can. Many of these competitors
have far greater brand recognition, which places us at a competitive
disadvantage. In addition, some competitors have a lower cost structure that
gives them a competitive advantage on the basis of price.  There is a growing
array of solutions for communication between the corporate headquarters and
remote workers, presenting a variety of alternatives to our VocalWare products.
We expect new competing alternatives to arise as new technologies develop.

Our Business Could Suffer if We Lose Key Personnel or Cannot Attract Qualified
Personnel

The loss of key personnel could have a material adverse effect on our business.
Our success is dependent largely on the skills, experience and performance of
key management, sales and technical personnel.  We are especially dependent on
our president and chief executive officer

                                       15
<PAGE>

and other senior officers, and our VocalWare products sales executives. We are
also dependent on key technical personnel to introduce new products and to
remain in the forefront of technological advances. All of our senior executives
and other employees are employed on an "at-will" basis. We do not have any
insurance on our employees. Our future success will also depend on our ability
to attract highly skilled personnel. Competition for qualified personnel is
intense in our industry and we may not be able to retain our key employees or
attract and retain other qualified personnel.

Our Limited Customer Base Could Adversely Affect Our Operating Business

We have a limited number of customers for our products and a loss of a key
customer or a reduction or delay in orders from the customer could materially
and adversely affect operating results.  In addition, although we have not yet
recorded significant revenue from our VocalWare products, we are currently
attempting to market them to large corporations, as well as to smaller
businesses.  If we do succeed in attracting large customers, the revenue from
VocalWare products could fluctuate significantly according to the purchasing
cycle of those limited number of large customers.  We do not generally have and
may not obtain minimum product purchase commitments from our customers.
Cancellation of orders by important customers could have a substantial effect on
our revenue.

The Inability to Protect Our Proprietary Technology Could Reduce Our Competitive
Advantage

Intellectual property laws of the United States and foreign countries may not be
adequate to protect our proprietary rights.  Because our success depends in part
on our technological expertise and proprietary technologies, the loss of our
proprietary rights could have a material adverse effect on our business.  We
rely on trade secret protection and, to a lesser extent, on patents and
copyrights to protect our proprietary technologies.  These steps may not be
adequate to deter misappropriation or infringement of our proprietary
technologies.  Competitors may also independently develop technologies that are
similar or superior to our technology.  In addition, the laws of some foreign
countries do not protect proprietary rights to the same extent as do the laws of
the United States.

Intellectual Property Disputes Could Be Costly and Disruptive and Affect the
Validity of Our Patents

We may be involved in intellectual property litigation, which could adversely
affect our intellectual property rights, could be costly, and could divert
management's attention away from the business.  We believe that the
communications industry is a competitive environment where intellectual property
disputes are likely to arise.  We may be required to bring or defend against
litigation to enforce our patents, to protect our trademarks, trade secrets, and
other intellectual property rights, to defend against infringement claims, to
resolve disputes under technology license arrangements, and to determine the
scope and validity of our proprietary rights or those of others.  In addition,
intellectual property disputes may be initiated against us for tactical purposes
to gain competitive advantage or overcome competitive disadvantage, even if the
merits of a specific dispute are doubtful.  Our limited resources may limit our
ability to bring or defend against intellectual property litigation.  Adverse
determinations in litigation, including litigation we initiate, could result in
the loss of our proprietary rights, subject us to significant liabilities,
require us to seek licenses from third parties, or prevent us from manufacturing
or selling our products.  In addition, any litigation can be expensive and
divert management resources.  Any of these consequences could materially
adversely affect our business, financial condition and operating results.

                                       16
<PAGE>

Our Financial Condition and Operating Results Could be Adversely Affected If We
Do Not Manage Inventory

Our business and financial condition could be materially adversely affected if
we do not effectively manage purchasing activities in the face of uncertain
revenue levels.  In the past we have substantially increased our inventory
levels to meet anticipated shipment requirements.  Increased levels of inventory
could adversely affect our liquidity or increase the risk of inventory write-
offs.

We Could Be Adversely Affected If Our Products Fail to Meet FCC and Other
Regulatory Standards

The failure of our products to conform to the regulations established by the
Federal Communications Commission or similar foreign regulatory bodies or to
meet applicable testing requirements could adversely affect our business.  The
FCC and other foreign regulators regulate aspects of our products.  Our products
must typically be tested before they are sold.  Foreign authorities often
establish telecommunications standards different from those in the United
States, making it difficult and more time consuming to obtain the required
regulatory approvals.  A significant delay in obtaining regulatory approvals
could delay the introduction of our products into the market and adversely
affect operating results.  In addition, changes in regulations or requirements
applicable to our products could affect the demand for our products or result in
the need to modify products, either of which could involve substantial costs or
delays in sales and adversely affect our operating results.

Future Sales of Shares Could Adversely Affect Our Stock Price and Impair Our
Ability to Raise Capital

The sale or availability for sale of a significant number of shares of common
stock in the public market could adversely affect the market price of the common
stock, which is already volatile. In addition, the sale of these shares could
impair our ability to raise additional equity capital. We have also previously
registered for resale shares of common stock including preferred stock and
warrants, which have not been sold into the public market. We may elect to
reserve and issue additional shares in the future.

Our Stock Price is Highly Volatile

The market price of our common stock in the past has been highly volatile, and
for the foreseeable future will likely continue to be highly volatile. This is
caused in part by the relatively low aggregate market value of our publicly
traded shares. Events or circumstances may cause a much greater percentage
change in the market price of our shares than the market price of a company with
a higher aggregate market value. There are many events or circumstances,
including those highlighted in these risk factors, which could cause the market
price of our stock to fluctuate. Many of those events or circumstances are
outside our control. In addition, stock prices for many technology companies
fluctuate widely for reasons unrelated to their business, financial condition or
operating results.

Our Business May Be Adversely Affected by Class Action Litigation Due to Stock
Price Volatility

The filing of securities class action litigation against companies often occurs
following periods of volatility in the market price of a company's securities.
We have in the past and may in the future be a target of securities litigation.
Securities litigation could have a material adverse effect on our business if it
is filed against us because it could result in substantial costs and a

                                       17
<PAGE>

diversion of management's attention and resources. It may also adversely affect
our ability to raise capital, our sales efforts, and our ability to attract a
strategic partner.

Anti-Takeover Measures Could Prevent or Delay a Change in Control of Our Company

Our shareholder rights plan could have the effect of delaying, deferring, or
preventing a change of control of our company and might make it difficult to
replace incumbent management.  In addition, provisions of our Articles of
Incorporation may have the effect of discouraging unsolicited proposals to
acquire control over us.  Our Board of Directors can, without obtaining
shareholder approval, issue shares of preferred stock having rights that could
adversely affect the voting power of holders of our common stock, including the
right to vote as a class on any proposed change of control.  In addition, Texas
corporate laws, including the Texas Business Combination Law, could also have
the effect of hindering or delaying a takeover bid for the company. These laws
may inhibit takeover bids and decrease the chance of shareholders realizing a
premium to the then current market price of the common stock as a result of a
takeover bid.  The Business Combination Law prohibits a publicly traded Texas
corporation from engaging in a broad range of business combinations with a
person who, together with affiliates and associates, owns or did own 20% or more
of the corporation's voting stock, for a period of three years after the date of
the transaction in which the person first became a 20% owner, unless the
business combination is approved in a prescribed manner.


ITEM 2. PROPERTIES
------------------

The Company's corporate headquarters, sales and marketing, product development
and engineering are located in one building totaling approximately 10,000 square
feet of leased space in Plano, Texas. Also, the Company has a facility for
distribution, co-engineering, accounting, and sales and technical support in one
building totaling approximately 21,000 square feet of leased space in San
Antonio, Texas. A second building located in San Antonio, Texas of approximately
29,000 square feet is being subleased. The building located in Plano, Texas, is
subject to a five-year lease that commenced in June 2000. The buildings located
in San Antonio, Texas, consisting of approximately 21,000 and 29,000 square
feet, are subject to ten- and seven-year leases, respectively, which commenced
in April 1996. The Company believes that its existing facilities are adequate to
meet current requirements, including foreseeable short-term requirements to
support the growth of its VocalWare product line.

ITEM 3.  LEGAL PROCEEDINGS
--------------------------

In October 1999, the United States District Court for the Western District, San
Antonio Division issued its opinion in the Company's patent infringement lawsuit
against Lucent Technologies. The court found that the Lucent Virtual Telephone
product does not infringe upon the Company's patent claims. The court also found
that Lucent had failed in its challenge to the patent's validity and
enforceability. The Company has discontinued its pursuit of an appeal of this
decision.

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

None.

                                       18
<PAGE>

                                    PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
-----------------------------------------------------------------------------

The Company's Common Stock has been traded on the NASDAQ National Market under
the symbol RACE since the Company's initial public offering on October 7, 1992.
For the two most recent fiscal years ended June 30, 1999 and June 30, 2000, the
following table lists on a per share basis for the period indicated, the high
and low reported sale prices for the Company's Common Stock as quoted on the
NASDAQ National Market.  These price quotations reflect inter-dealer prices,
without adjustment for retail mark-ups, markdowns or commissions and may not
necessarily represent actual transactions.

                                               High        Low
     July 1, 1998 to September 30, 1998        2  1/2        9/16
     October 1, 1998 to December 31, 1998      4  1/2        7/8
     January 1, 1999 to March 31, 1999         9  3/8      3 3/16
     April 1, 1999 to June 30, 1999            5  11/16    3 1/4
     July 1, 1999 to September 30, 1999        3  3/4      2 1/4
     October 1, 1999 to December 31, 1999      5             7/8
     January 1, 2000 to March 31, 2000         6  7/16     2 1/2
     April 1, 2000 to June 30, 2000            8  1/2      2 13/16

As of September 19, 2000, the last sale price of the Company's Common Stock was
$5.44 as reported on the NASDAQ National Market.  As of September 19, 2000,
there were 243 shareholders of record, although the Company believes that the
number of beneficial owners is significantly greater.

The Company has never declared or paid cash dividends on the Common Stock.  The
Company presently intends to retain earnings, if any, for the operation and
development of its business and does not anticipate paying any cash dividends on
the Common Stock in the foreseeable future.    Future earnings, capital
requirements, the financial condition and prospects of the Company, and other
relevant factors as determined by the Board of Directors, will influence the
determination of any future cash dividend decisions.  There is no assurance that
the Company will pay any dividends in the future.

                                       19
<PAGE>

ITEM 6.  SELECTED FINANCIAL DATA
--------------------------------

The selected financial data presented below for, and as of the end of, each of
the fiscal years in the five-year period ended June 30, 2000, are derived from
the audited financial statements of DATA RACE, Inc.  The selected financial data
should be read in conjunction with the Company's financial statements and notes
thereto appearing elsewhere in this report and "Management's Discussion and
Analysis of Financial Condition and Results of Operations".
<TABLE>
<CAPTION>
                                                                              Fiscal Years Ended June 30,
                                                  ------------------------------------------------------------------------------
                                                      2000            1999             1998             1997             1996
                                                  -----------     -----------      -----------      -----------      -----------
                                                                       (in thousands, except per share data)
<S>                                               <C>             <C>              <C>              <C>              <C>
Operating Statement Data:
Revenue from continuing operations...........     $       316     $       836      $     1,951      $         -      $         -

Cost of revenue..............................             762           1,533            2,409                -                -
                                                  -----------     -----------      -----------      -----------      -----------
   Gross profit from continuing operations...            (446)           (697)            (458)               -                -

Total operating expenses from continuing
   operations................................           9,030           8,603            8,936                -                -
                                                  -----------     -----------      -----------      -----------      -----------

   Operating loss............................          (9,476)         (9,300)          (9,394)               -                -
Other income, net............................             440             135              136              201              386
                                                  -----------     -----------      -----------      -----------      -----------
   Loss from continuing operations...........          (9,036)         (9,165)          (9,258)             201              386
Income (loss) from discontinued operations...             218             620              229           (6,493)          (8,705)
                                                  ===========     ===========      ===========      ===========      ===========
   Net income (loss).........................     $    (8,818)    $    (8,545)     $    (9,029)     $    (6,292)     $    (8,319)
                                                  ===========     ===========      ===========      ===========      ===========
Earnings (loss) per share:
   Net income (loss).........................     $    (8,818)    $    (8,545)     $    (9,029)     $    (6,292)     $    (8,319)
   Effect of beneficial conversion features
     of convertible preferred stock..........            (235)         (3,889)            (457)          (2,063)               -
                                                  -----------     -----------      -----------      -----------      -----------
   Net income (loss) applicable to common
     stock...................................     $    (9,053)    $   (12,434)     $    (9,486)     $    (8,355)     $    (8,319)
                                                  ===========     ===========      ===========      ===========      ===========
   Net income (loss) per common share -
     basic and diluted.......................     $     (0.41)    $     (0.77)     $     (1.60)     $     (1.71)     $     (1.77)
                                                  ===========     ===========      ===========      ===========      ===========

Weighted average shares outstanding..........          21,940          16,119            5,937            4,873            4,688
                                                  ===========     ===========      ===========      ===========      ===========


Balance Sheet Data (at year end):
Working capital..............................     $    10,290     $     7,506      $     1,056      $     4,888      $     5,644
Total assets.................................          13,192           9,520            4,009            9,470           12,495
Shareholders' equity.........................          11,728           8,716            2,557            6,863            7,956
</TABLE>

                                       20
<PAGE>


ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
--------------------------------------------------------------------------------
OF OPERATIONS
-------------

Results of Operations

From its inception in 1983, the Company has designed, manufactured, and marketed
advanced technology communication products.  The Company's strategy is to
provide innovative, first-to-market, high-value-added solutions to meet the
needs of knowledge workers remote from their headquarters office.

The Company's goal of returning to profitability and developing a more
dependable revenue base depends on the success of the VocalWare IP product line.
The VocalWare IP product line represents a type of product that is significantly
different from the Company's previous custom modem and network multiplexer
products. Although the Company has not recorded significant revenue from sales
of the VocalWare IP product line, the Company has expended substantial resources
on its development and market introduction.

The Company expects that significant additional resources are necessary to
adequately penetrate the emerging teleworker and remote call center markets.
Resources are being added to continue VocalWare product and development and to
further assure that product introductions are properly paced and timed to the
emerging market.  Marketing expenditures and additional resources are being
deployed to effectively communicate to the emerging target markets, the
VocalWare IP product line under the new IP Axess identity.  The Company added
and continues to add sales resources to train, deploy, and manage a highly
effective and skilled sales team necessary to reach targeted market prospects.
Other company infrastructure is being added to support the Company's
development, sales and marketing, product delivery and customer support systems.

Fiscal 2000 Compared to Fiscal 1999 for Continuing Operations

In March 2000, the Company sold its network multiplexer line to HT
Communications. Also during the second quarter of fiscal 1999, the Company did
not bid on additional custom modem business.  Therefore, the following
discussion is limited to the Company's continuing operations of its VocalWare IP
business segment.  Discontinued operations are separately discussed below.

Total revenue from continuing operations in fiscal 2000 decreased 62.2% to
$316,000 from $836,000 in fiscal 1999.  The decrease is primarily due to
decreased shipments to Sabratek Inc, as a result of that customer's bankruptcy
filing and declines in custom modem revenue from fiscal 1999. Also impacting
revenue is the Company's decision to discontinue the first generation Be There!
remote access system in favor of the Company's new generation of VocalWare IP
products scheduled to release throughout fiscal 2001.

Gross profit margins for fiscal 2000 from continued operations decreased to
(140.9)% from (83.4)% for fiscal 1999.  The decline in gross margin from
continuing operations is directly related to decreased shipments to Sabratek
Inc. and manufacturing variances caused by the decreased volumes.

Engineering and product development expenses increased by 38.1% to $3.3 million
in fiscal 2000 from $2.4 million in fiscal 1999.  This increase is primarily due
to workforce increases and outside project development contracts associated with
development expenditures necessary for the Company's new VocalWare IP product
line.

Sales and marketing expenses increased 35.7% during fiscal 2000 to $2.6 million
from $1.9 million in fiscal 1999.  This increase is primarily due to the Company
ramping up its sales and marketing forces in anticipation of delivering its new
VocalWare IP product line to the market in early fiscal 2001.

General and administrative expenses decreased 27.3% during fiscal 2000 to $3.1
million from $4.3 million in fiscal 1999. This decrease is attributable to
decreases in non-cash expenses associated with a consulting agreement and non-
cash legal expenses associated with a patent infringement lawsuit.  The decrease
is offset in part by severance and retirement packages for two officers totaling
approximately $480,000

                                       21
<PAGE>

Income tax benefits related to losses for fiscal year 2000 are not recognized
because the utilization of such benefits cannot be assured.  Accordingly, a 100%
valuation allowance has been recorded against the Company's deferred income tax
asset.  As of June 30, 2000, the Company had federal and state tax net operating
loss carryforwards of approximately $53,664,000 which expire beginning in 2009.
The Internal Revenue code section 382 limits NOL carryforwards when an ownership
change of more than 50% of the value of stock in a loss corporation occurs
within a three year period.  Accordingly, the ability to utilize remaining NOL
carryforwards may be significantly restricted.

Fiscal 1999 Compared to Fiscal 1998 for Continuing Operations

In March 2000 the Company sold its network multiplexer line to HT
Communications.  Also during the second quarter of fiscal 1999, the Company
discontinued custom modem production. Therefore, the following discussion is
limited to the Company's continuing operations of its VocalWare IP product lines
business segment.  Discontinued operations are separately discussed below.

Total revenue from continuing operations in fiscal 1999 decreased 57.2% to $0.8
million from $2.0 million in fiscal 1998.  The decrease was primarily due to the
completion during the second quarter of fiscal 1998 of substantially all
shipments under add-on custom modem contracts and was offset in part by
increased Be There! sales.

Gross profit margin from continuing operations of (83.4)% for fiscal 1999 was
down from (23.5)% for fiscal 1998.  The decrease was primarily due to increased
manufacturing variances attributable to reduced production volumes.

Engineering and product development expenses decreased 22.2% to $2.4 million in
fiscal 1999 from $3.1 million in fiscal 1998.  This decrease was primarily due
to reductions in development expenditures for custom modem business segment.

Sales and marketing expenses decreased 45.4% during fiscal 1999 to $1.9 million
from $3.5 million in fiscal 1998. These decreases were primarily due to the
Company's reductions in sales and marketing expenditures for the custom modem
business segment.

General and administrative expenses increased 83.3% during fiscal 1999 to $4.3
million from $2.3 million in fiscal 1998.  This increase was primarily due to
non-cash expenses associated with a consulting agreement and legal expenses
associated with a patent infringement lawsuit.  The increases were offset in
part by spending reductions over the fiscal year.

Income tax benefits relating to losses for fiscal year 1999 were not recognized
because the utilization of such benefits cannot be assured.

Discontinued Operations

The majority of the Company's revenue in fiscal 1999 and in prior years resulted
from operations that the Company has now exited.  Revenues from discontinued
operations decreased 64.0% in fiscal 2000 to $720,000 from $1,999,000 in fiscal
1999 as a result of the Company's decision to exit that market.  Revenues from
discontinued operations decreased 27.8% in fiscal

                                       22
<PAGE>

1999 to $1,999,000 from $2,556,000 in fiscal 1998 primarily as a result of the
company's decision to discontinue bidding on custom modem business in the second
quarter of fiscal 1999.

Liquidity and Capital Resources

Operating losses have had and continue to have a substantial negative effect on
the Company's cash balance.  At June 30, 2000, the Company had approximately
$11,059,000 in cash and cash equivalents, compared to $7,115,000 at March 31,
2000.

Historically, the majority of the Company's revenue was derived from shipments
of custom modem and network multiplexer products. Revenue from shipments of
custom modems has ended as the market has shifted away from custom modem
products. The Company in March 2000, sold its network multiplexer products
business to HT Communications, Inc. for $350,000, which will be paid out in 15
equal monthly payments beginning September 2000. Also effective in May 2000, the
Company discontinued its internet service provider OnePhoneLine.net. The Company
is focusing its resources on the VocalWare business.

The Company's strategy is to focus its sales efforts on developing an increasing
number of large customers using the VocalWare IP products, to develop a new
generation of products that will address the market's need for an easy-to-
install software client that can run over the new broadband communications
services, including DSL, cable modems, and IP networks, and to establish one or
more strategic partnerships with well-established companies that would enhance
the Company's market presence and credibility and provide financial assistance.
The ability of the Company to successfully execute its strategy to increase
sales is subject to numerous risks and such success cannot be assured.  The
Company's return to profitability and development of a more dependable revenue
base depends on the success of the VocalWare IP product line, which has not
generated substantial revenue to date.  The Company does not anticipate a return
to profitability as long as its expenditures on the VocalWare IP system remain
disproportionate to attendant revenue.

In December 1999, the Company received net proceeds of approximately $3,700,000
from the issuance of common stock and warrants in its December 1999 private
placement.

In June 2000, the company received net proceeds of approximately $5,580,000 from
the issuance of common stock and warrants in its June 2000 private placement.

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 develop and sustain strategic relationships.  The
failure to obtain such financing when needed and to attract a strategic partner
would have a substantial adverse effect on the Company.  See "Business Risks -
Our Success is Dependent on Relationships with a Strategic Partner" and "We Will
Likely Need Additional Capital to Sustain Operations".  The timing and amount of
the Company's future capital requirements cannot be accurately predicted.  The
Company believes its current cash balances will be sufficient to meet its
anticipated cash needs for the next 12 months.

                                       23
<PAGE>

Disclosures About Market Risk

The following discusses our exposure to market risk related to changes in
interest rates, equity prices and foreign currency exchange rates.  This
discussion contains forward-looking statements that are subject to risks and
uncertainties.  Actual results could vary materially as a result of a number of
factors including those set forth in the "Certain Business Risk" section.

At June 30, 2000, we had short-term investments of $7.1 million and had no
indebtedness, and no liabilities other than ordinary course trade payables.  All
short-term investments consisted of highly liquid investments with less than 90
days remaining until maturity from date of purchase.  These investments are
subject to interest rate risk and could decrease in value if market interest
rates increase.  A hypothetical increase or decrease in market interest rates by
10% from the June 30, 2000 rates would cause the fair value of these short-term
investments to change by an insignificant amount.  We have the ability to hold
these investments until maturity, and therefore we do not expect the value of
these investments to be affected to any significant degree by the effect of a
sudden change in market interest rates.  Declines in interest rates over time
will, however, reduce our interest income.

At June 30, 2000 we did not own any equity investments.  Therefore, we did not
have any direct equity price risk.

Substantially all Company revenues are realized in U.S. dollars and no
significant asset or cash account balances are maintained in currencies other
than the United States dollar.  Therefore, we do not have any significant direct
foreign currency exchange rate risk.

                                       24
<PAGE>

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
----------------------------------------------------

Index to Financial Statements
<TABLE>
<S>                                                                                         <C>
                                                                                            PAGE
Independent Auditors' Report...............................................................  26
Financial Statements
     Balance Sheets as of June 30, 2000 and 1999...........................................  27
     Statements of Operations for the years ended June 30, 2000, 1999 and 1998.............  28
     Statements of Shareholders' Equity for the years ended June 30, 2000 1999 and 1998....  29
     Statements of Cash Flows for the years ended June 30, 2000, 1999 and 1998.............  32
     Notes to Financial Statements.........................................................  33
</TABLE>

All schedules are omitted, because they are not required, are not applicable, or
the information is included in the financial statements and notes thereto.

                                       25
<PAGE>

INDEPENDENT AUDITORS' REPORT

Board of Directors and Shareholders

DATA RACE, Inc.:

We have audited the accompanying balance sheets of Data Race, Inc. as of June
30, 2000 and 1999, and the related statements of operations, shareholders'
equity, and cash flows for each of the years in the three-year period ended June
30, 2000. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Data Race, Inc. as of June 30,
2000 and 1999, and the results of its operations and its cash flows for each of
the years in the three-year period ended June 30, 2000, in conformity with
generally accepted accounting principles.



                                         KPMG LLP

San Antonio, Texas
September 11, 2000

                                       26
<PAGE>

                                DATA RACE, Inc.
                                BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                  As of June 30,
                                                                    -----------------------------------------
                                                                           2000                     1999
                                                                    ----------------         ----------------
ASSETS
<S>                                                                 <C>                      <C>
Current assets:
   Cash and cash equivalents..................................      $     11,059,061         $      7,654,978
   Accounts receivable, net...................................                 6,401                   55,068
   Note receivable, current...................................               233,333                        -
   Inventory..................................................               249,876                   95,095
   Prepaid expenses and deposits..............................               206,001                  153,615
   Net assets of discontinued operations......................                     -                  319,351
                                                                    ----------------         ----------------
       Total current assets...................................            11,754,672                8,278,107

Note receivable, non-current..................................               116,667
Property and equipment, net...................................             1,235,919                1,178,309
Other assets..................................................                84,630                   25,389
                                                                    ----------------         ----------------
       Total assets...........................................      $     13,191,888         $      9,481,805
                                                                    ================         ================
LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
   Accounts payable...........................................      $        504,001         $        230,216
   Accrued expenses...........................................               960,386                  535,974
                                                                    ----------------         ----------------
       Total current liabilities..............................             1,464,347                  766,190

Shareholders' equity:
   Convertible preferred stock, no par value, 2,000,000
     shares authorized:
     Series E 750 shares issued, 750 shares outstanding at
     June 30, 1999, no shares outstanding at June 30, 2000....                     -                  809,999
     Series F 750 shares issued, 750 shares outstanding at
     June 30, 1999, no shares outstanding at June 30, 2000....                     -                  650,557
   Common stock, no par value, 70,000,000 shares authorized
     26,083,364 and 20,184,523 shares issued and outstanding
     at June 30, 2000 and 1999, respectively..................            59,806,425               46,489,610
   Additional paid-in capital.................................             7,673,310                7,464,287
   Accumulated deficit........................................           (55,752,194)             (46,698,838)
                                                                    ----------------         ----------------
       Total shareholders' equity.............................            11,727,541                8,715,615
                                                                    ----------------         ----------------
         Total liabilities and shareholders' equity...........      $     13,191,888         $      9,481,805
                                                                    ================         ================
</TABLE>
                See accompanying notes to financial statements

                                       27
<PAGE>

                                DATA RACE, Inc.
                           STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                                    Years Ended June 30,
                                                            --------------------------------------------------------------------
                                                                    2000                     1999                     1998
                                                            ------------------       ------------------       ------------------
<S>                                                         <C>                      <C>                      <C>
Total revenue from continuing operations......              $          316,212       $          835,798       $        1,951,331

Cost of revenue...............................                         761,759                1,532,733                2,409,030
                                                            ------------------       ------------------       ------------------

     Gross profit ............................                        (445,547)                (696,935)                (457,699)
                                                            ------------------       ------------------       ------------------

Operating expenses:
  Engineering and product development.........                       3,293,231                2,384,787                3,066,391
  Sales and marketing.........................                       2,618,432                1,927,894                3,529,424
  General and administration..................                       3,118,612                4,290,885                2,340,642
                                                            ------------------       ------------------       ------------------
     Total operating expenses.................                       9,030,275                8,603,566                8,936,457

     Operating loss...........................                      (9,475,822)              (9,300,501)              (9,394,156)

Other income..................................                         440,450                  135,189                  135,766
                                                            ------------------       ------------------       ------------------

Loss from continuing operations...............                      (9,035,372)              (9,165,312)              (9,258,390)

Income from discontinued operations...........                         217,734                  620,452                  229,401
                                                            ------------------       ------------------       ------------------

     Net loss.................................              $       (8,817,638)      $       (8,544,860)      $       (9,028,989)
                                                            ==================       ==================       ==================

Per share data:
  Net loss....................................              $       (8,817,638)      $       (8,544,860)      $       (9,028,989)
  Effect of beneficial conversion feature of
     convertible preferred stock..............                        (235,718)              (3,888,923)                (457,229)
                                                            ------------------       ------------------       ------------------

  Net loss applicable to common stock.........              $       (9,053,356)      $      (12,433,783)      $       (9,486,218)
                                                            ==================       ==================       ==================

  Net basic and diluted loss from
     continuing operations per common share...              $            (0.42)      $            (0.81)      $            (1.64)
                                                            ==================       ==================       ==================
  Net basic and diluted loss per common
     share....................................              $            (0.41)      $            (0.77)      $            (1.60)
                                                            ==================       ==================       ==================

Weighted average shares outstanding...........                      21,940,000               16,119,000                5,937,000
                                                            ==================       ==================       ==================
</TABLE>

                See accompanying notes to financial statements

                                       28
<PAGE>

                                DATA RACE, Inc.
                      STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
                               Series A Convertible Preferred    Series C Convertible Preferred    Series D Convertible Preferred
                                           Stock                             Stock                             Stock
                               --------------------------------------------------------------------------------------------------
                                   Shares              Amount        Shares              Amount        Shares              Amount
                               --------------------------------------------------------------------------------------------------
<S>                                <C>            <C>                <C>            <C>                <C>               <C>
Balance at June 30, 1997            3,280         $ 3,079,447          -            $     -              -           $      -
Net loss                              -                 -              -                  -              -                  -
Issuance of convertible
 preferred stock, net of
 offering cost of $385,808            -                 -            5,000            4,614,192          -                  -
Accretion of beneficial
 conversion feature on
 convertible preferred stock          -               250,523          -                 84,809          -                  -
Conversion of convertible
 preferred stock to common
 stock                             (3,105)         (3,105,000)      (3,319)          (3,319,000)         -                  -
Exercise of stock options and         -                 -              -                  -              -                  -
 warrants
Employee stock purchase plan          -                 -              -                  -              -                  -
                               --------------------------------------------------------------------------------------------------
Balances at June 30, 1998             175             224,970        1,681            1,380,001          -                  -
Net loss                              -                 -              -                  -              -                  -
Issuance of convertible
 preferred stock, net of
 offering cost of $248,820            -                 -              -                  -            2,500               60,688
Redemption of preferred stock        (124)           (165,653)         -                  -              -                  -
Issuance of restricted common
 stock and warrants, net
 offering costs of $552,475           -                 -              -                  -              -                  -
Accretion of beneficial
 conversion feature on
 convertible preferred stock          -                 -              -                  -              -              2,478,655
Conversion of convertible
 preferred stock to common
 stock                                (51)            (59,317)      (1,681)          (1,380,001)      (2,500)          (2,539,343)
Common stock issued for legal
 and consulting services              -                 -              -                  -              -                  -
Exercise of stock options and
 warrants                             -                 -              -                  -              -                  -
Employee stock purchase plan          -                 -              -                  -              -                  -
                               --------------------------------------------------------------------------------------------------
Balances at June 30, 1999             -                 -              -                  -              -                  -
Net loss                              -                 -              -                  -              -                  -
Issuance of common stock and
 warrants, net of offering
 costs of  $300,000                   -                 -              -                  -              -                  -
Issuance of common stock and
 warrants, net of offering
 costs of $419,999                    -                 -              -                  -              -                  -
Accretion of beneficial
 conversion feature on
 convertible preferred stock          -                 -              -                  -              -                  -
Conversion of convertible
 preferred stock to common
 stock                                -                 -              -                  -              -                  -
Common stock issued for legal
 and consulting services              -                 -              -                  -              -                  -
Exercise of stock options and
 warrants                             -                 -              -                  -              -                  -
Employee stock purchase plan          -                 -              -                  -              -                  -
                               --------------------------------------------------------------------------------------------------
Balances at June 30, 2000             -           $     -              -            $     -              -           $      -
                               ==================================================================================================
</TABLE>

                See accompanying notes to financial statements

                                       29
<PAGE>

                                DATA RACE, Inc.
                      STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                  Series E Convertible Preferred      Series F Convertible Preferred
                                              Stock                             Stock                          Common Stock
                                  -----------------------------------------------------------------------------------------------
                                       Shares          Amount             Shares           Amount           Shares      Amount
                                  -----------------------------------------------------------------------------------------------
<S>                               <C>               <C>                   <C>          <C>                <C>        <C>
Balance at June 30, 1997                 -          $    -                  -          $     -            5,137,741  $ 26,680,686
Net loss                                 -               -                  -                -                -            -
Issuance of convertible
 preferred stock, net of
 offering cost of $385,808               -               -                  -                -                -            -
Accretion of beneficial
 conversion feature on
 convertible preferred stock             -               -                  -                -                -           121,897
Conversion of convertible
 preferred stock to common stock         -               -                  -                -            3,969,256     6,424,000
Exercise of stock options and
 warrants                                -               -                  -                -                  337         1,517
Employee stock purchase plan             -               -                  -                -               19,072       106,679
                                  -----------------------------------------------------------------------------------------------
Balances at June 30, 1998                -               -                  -                -            9,126,406    33,334,779
Net loss                                 -               -                  -                -                -            -
Issuance of convertible
 preferred stock, net of
 offering cost of $248,820              750           473,425              750            491,113             -            -
Redemption of preferred stock            -               -                  -                -                -            -
Issuance of restricted common
 stock and warrants, net of
 offering costs of $552,475              -               -                  -                -            3,134,064     5,705,745
Accretion of beneficial
 conversion feature on
 convertible preferred stock             -            336,574               -             159,444             -            -
Conversion of convertible
 preferred stock to common stock         -               -                  -                -            4,499,567     3,978,661
Common stock issued for legal
 and consulting services                 -               -                  -                -            2,325,300     2,318,938
Exercise of stock options and
 warrants                                -               -                  -                -            1,080,895     1,126,998
Employee stock purchase plan             -               -                  -                -               18,291        24,489
                                  -----------------------------------------------------------------------------------------------
Balances at June 30, 1999               750           809,999              750            650,557        20,184,523    46,489,610
Net loss                                 -               -                  -                -                -            -
Issuance of common stock and
 warrants, net of offering
 costs of  $300,000                      -               -                  -                -            1,904,761     3,700,000
Issuance of common stock and
 warrants, net of offering
 costs of $419,999                       -               -                  -                -            1,572,738     5,580,001
Accretion of beneficial
 conversion feature on
 convertible preferred stock             -             53,426               -             182,292             -            -
Conversion of convertible
 preferred stock to common stock       (750)         (863,425)            (750)          (832,849)        1,094,447     1,696,274
Common stock issued for legal
 and consulting services                 -               -                  -                -              190,000       520,088
Exercise of stock options and
 warrants                                -               -                  -                -            1,131,602     1,807,517
Employee stock purchase plan                                                                                  5,293        12,935
                                  -----------------------------------------------------------------------------------------------
Balances at June 30, 2000                -          $    -                  -          $     -           26,083,364  $ 59,806,425
                                  ===============================================================================================
</TABLE>

                 See accompanying notes to financial statements

                                       30
<PAGE>

                                DATA RACE, Inc.
                       STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                     Additional Paid-In Capital  Accumulated Deficit   Total Shareholders' Equity
                                    ------------------------------------------------------------------------------
<S>                                         <C>                    <C>                        <C>
Balances at June 30, 1997                     $1,882,303              $(24,778,837)             $ 6,863,599
Net loss                                           -                    (9,028,989)              (9,028,989)
Issuance of convertible preferred
stock, net of offering cost of
$385,808                                           -                        -                     4,614,192
Accretion of beneficial conversion
feature on convertible preferred
stock                                              -                     (457,229)                    -
Conversion of convertible preferred
stock to common stock                              -                        -                         -
Exercise of stock options and
warrants                                           -                        -                         1,517
Employee stock purchase plan                       -                        -                       106,679
                                    ------------------------------------------------------------------------------
Balances at June 30, 1998                      1,882,303              (34,265,055)                2,556,998
Net loss                                           -                   (8,544,860)               (8,544,860)
Issuance of convertible preferred
stock, net of offering cost of
$248,820                                       2,725,954                    -                     3,751,180
Redemption of preferred stock                      -                        -                      (165,653)
Issuance of restricted common stock
and warrants, net of offering
costs of $552,475                              1,941,780                    -                     7,647,525
Accretion of beneficial conversion
feature on convertible preferred
stock                                            914,250               (3,888,923)                    -
Conversion of convertible preferred
stock to common stock                              -                        -                         -
Common stock issued for legal and
consulting services                                -                        -                     2,318,938
Exercise of stock options and
warrants                                           -                        -                     1,126,998
Employee stock purchase plan                       -                        -                        24,489
                                    ------------------------------------------------------------------------------
Balances at June 30, 1999                      7,464,287              (46,698,838)                8,715,615
Net loss                                           -                   (8,817,638)               (8,817,638)
Issuance of common stock and
warrants, net of offering costs of
$300,000                                           -                        -                     3,700,000
Issuance of common stock and
warrants, net of offering costs of
$419,999                                           -                        -                     5,580,001
Accretion of beneficial conversion
feature on convertible preferred
stock                                              -                     (235,718)                    -
Conversion of convertible preferred
stock to common stock                              -                        -                         -

Common stock issued for legal and
consulting services                              209,023                    -                       729,111
Exercise of stock options and
warrants                                           -                        -                     1,807,517
Employee stock purchase plan                       -                        -                        12,935
                                    ------------------------------------------------------------------------------
Balances at June 30, 2000                     $7,673,310             $(55,752,194)              $11,727,541
                                    ==============================================================================
</TABLE>

                 See accompanying notes to financial statements

                                       31
<PAGE>

                                DATA RACE, Inc.
                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                    Years Ended June 30,
                                                   ------------------------------------------------------
<S>                                                <C>                 <C>                <C>
                                                         2000               1999               1998
                                                   ----------------    ---------------    ---------------
  Cash flows from operating activities:
   Net loss from continuing operations...........  $     (9,035,372)   $    (9,165,312)   $    (9,258,390)
   Adjustments to reconcile net loss from
    continuing operatons to net cash
    provided by (used in) operating activities:
     Depreciation and amortization...............           297,454            310,795            286,025
     Non-cash consulting and legal fees..........           729,111          2,318,939              -
     Loss on sales of property and equipment.....             3,773              -                  -
     Changes in assets and liabilities:
      Accounts receivable........................            48,667             22,703            (77,490)
      Inventory..................................          (154,781)           309,210            (82,162)
      Prepaid expenses, deposits and other
       assets....................................          (111,627)          (153,615)            40,189
      Accounts payable...........................           273,785            (65,778)            70,472
      Accrued expenses...........................            74,372           (568,936)          (588,355)
                                                   ----------------    ---------------    ---------------
       Net cash used in operating activities.....        (7,874,618)        (6,991,994)        (9,609,711)
                                                   ----------------    ---------------    ---------------

  Cash flows from investing activities:
   Purchase of property and equipment............          (339,351)           (27,411)           (78,057)
   Proceeds from sale of property and equipment..             -                  3,235              2,420
                                                   ----------------    ---------------    ---------------
       Net cash used in investing activities.....          (339,351)           (24,176)           (75,637)
                                                   ----------------    ---------------    ---------------

  Cash flows from financing activities:
   Redemption of Series A preferred stock........             -               (165,653)             -
   Net proceeds from the issuance of preferred
     stock.......................................             -              3,751,180          4,614,192
   Net proceeds from issuance of common stock....        11,100,453          8,799,012            108,196
                                                   ----------------    ---------------    ---------------
       Net cash provided by financing
        activities...............................        11,100,453         12,384,539          4,722,388
                                                   ----------------    ---------------    ---------------

  Cash flows provided by discontinued operations            517,599            642,315          2,071,486

  Net increase (decrease) in cash and cash
  equivalents...................................          3,404,083          6,010,684         (2,891,474)


  Cash and cash equivalents at beginning of
  year..........................................          7,654,978          1,644,294          4,535,768
                                                   ----------------    ---------------    ---------------

  Cash and cash equivalents at end of year......   $     11,059,061    $     7,654,978    $     1,644,294
                                                   ================    ===============    ===============
</TABLE>

                 See accompanying notes to financial statements

                                       32
<PAGE>

                                DATA RACE, INC.
                         NOTES TO FINANCIAL STATEMENTS
                         June 30, 2000, 1999, and 1998


1) Description of Business and Summary of Significant Accounting Policies
-------------------------------------------------------------------------

Description of Business
-----------------------

DATA RACE, Inc. ("DATA RACE" or the "Company"), currently doing business as IP
Axess, pending shareholder approval to formally change the name to IP Axess,
Inc. provides integrated IP based remote work solutions over multiple access
media.  The Company's VocalWare IP client/server product line provides users in
remote locations with simultaneous access to critical corporate resources
including phone, fax, Internet, and E-mail over a single connection via: DSL,
cable modem, LAN, Frame Relay, ATM or high speed dial up through VPN, local ISP
POP, or PSTN.  The Company, after exiting the network multiplexer business,
operates in one business segment.

Summary of Significant Accounting Policies
------------------------------------------

Use of Estimates

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid debt instruments with original
maturities of three months or less to be cash equivalents.

Accounts Receivable

Accounts receivable as shown is net of allowance for doubtful accounts of
approximately $500 and $11,500 at June 30, 2000 and 1999, respectively.

Inventory

Inventory is valued at the lower of cost (principally standard cost which
approximates first-in, first-out) or market (net realizable value).  Costs
include materials, labor, overhead, and subcontract charges as applicable.

Property and Equipment

Property and equipment are stated at cost.  Equipment under capital leases is
stated at the present value of minimum lease payments.  Major renewals and
betterments are charged to the property accounts while replacements,
maintenance, and repairs that do not improve or extend the lives of the
respective assets are expensed currently.  Depreciation of property and
equipment is provided at amounts calculated to amortize the cost of the assets
over their useful economic lives using the straight-line method for financial
reporting purposes and accelerated methods for income tax purposes.  Equipment
held under capital leases and leasehold improvements are amortized over the
shorter of the lease term or estimated useful life of the asset.

                                       33
<PAGE>

Convertible Preferred Securities

The beneficial conversion features of the Series A, C, D, E and F Convertible
Preferred Stock ("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 on the Preferred
Stock and the value attributed to the warrants. The conversion discount is
calculated as of 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,
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 the Black-Scholes option pricing model and
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 results in non-cash charges
to the loss available to common shareholders in the computation of loss per
common share over the conversion period from July 1996 through June 2000.  As a
result, approximately $236,000,  $3,889,000, and $457,000 in non-cash charges
are reflected in the loss per common share for the years ended June 30, 2000,
1999, and 1998, respectively.

Fair Value of Financial Instruments

The Company's financial instruments consist primarily of cash and cash
equivalents, accounts receivable, and accounts payable.  The book value of cash
and cash equivalents, accounts receivable, notes receivable and accounts payable
are representative of their respective fair values due to the short-term
maturity of those instruments.

Income Taxes

Income taxes are accounted for under the asset and liability method.  Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carryforwards.  Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled.  The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.

Revenue Recognition

Revenue is generally recognized upon shipment of products to customers or when
contractual services have been provided to customers.  The Company recognizes
revenue and gross profit from trial units only upon receipt of payment or
receipt of a purchase order without significant contingencies.

Comprehensive Income

The Financial Accounting Standards Board ("FASB") issued Statement No. 130,
"Reporting Comprehensive Income", in June of 1997. This statement established
standards for reporting and display of comprehensive income and its components
in a full set of general-purpose financial statements. The Company adopted the
provisions of Statement 130 during 1998. For all periods presented, no elements
of comprehensive income exist other than loss from operations.

Warranty Expense

The Company generally offers one or two year warranty coverage on the majority
of its products.  Warranty costs are accrued and expensed when revenue is
recognized based upon the Company's experience with such costs.

                                       34
<PAGE>

Research and Development

All engineering and product research and development expenditures are charged
against operations as incurred.  Research and development costs charged to
continuing operations aggregated approximately $3,293,000, $2,385,000 and
$3,066,000 in fiscal 2000, 1999, and 1998 respectively.

Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of

Long-lived assets and certain identifiable intangibles are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable.  Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to undiscounted future net cash flows expected to be generated by the asset.  If
such assets are considered to be impaired on this basis, the impairment loss to
be recognized is measured by the amount by which the carrying amount of the
assets exceeds the fair value of the assets.  Assets to be disposed of are
reported at the lower of the carrying amount or fair value less costs to sell.

Stock Based Compensation

The Company accounts for stock-based compensation using the intrinsic value
method described in Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB No. 25") and related interpretations.
Accordingly, compensation cost for stock options is measured as the excess, if
any, of the quoted market price of the Company's Common Stock at the date of the
grant over the amount an employee must pay to acquire the stock.  The Company
has adopted the disclosure requirements of SFAS No. 123, "Accounting for Stock
Based Compensation."

Earnings (Loss) Per Share

Net loss per share of common stock is presented in accordance with the
provisions of Statement of Financial Accounting Standards ("SFAS") No. 128,
Earnings Per Share.  Under SFAS No. 128, basic earnings/loss per share excludes
dilution for potentially dilutive securities and is computed by dividing income
or loss available to common stockholders by the weighted average number of
common shares outstanding during the period.  Diluted earnings/loss per share
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock.
Potentially dilutive securities are excluded from the computation of diluted
earnings/loss per share when their inclusion would be antidilutive.  The Company
had approximately 2,734,000 and 1,690,000 options outstanding as of June 30,
2000 and 1999, respectively.  The Company had no preferred stock outstanding as
of June 30, 2000.  As of June 30, 1999 the Company had 750 shares of Series E
Preferred Stock and 750 shares of Series F Preferred Stock outstanding.  As of
June 30, 2000, the Company had warrants outstanding to purchase 2,808,139 shares
of common stock. As of June 30, 1999 the Company had warrants outstanding to
purchase 2,340,281 shares of common stock.

2) Discontinued Operations
--------------------------

The Board of Directors approved discontinuing the network multiplexer product
business segment effective in January 2000. Accordingly, the financial
statements have been restated to reflect the operations of the multiplexer
product business as a discontinued operation. The product line was subsequently
sold to HT Communications Inc. in March 2000 for a non-interest bearing note
receivable of $350,000. The purchase price is scheduled to be paid in 15 equal
monthly installments starting in September of 2000. The Company deferred the
recognition of the $335,000 gain on the sale and will recognize the gain using
the installment method of accounting.

The agreement between DATA RACE, Inc. and HT Communications Inc. also provides
for the receipt of royalties and licensing fees.  The royalty payments are
payable monthly for equipment

                                       35
<PAGE>

sold by HT Communications Inc. coinciding with the note terms and expires at the
time the note is paid in full. A 2% licensing fee on sales of former DATA RACE,
Inc. products is due quarterly beginning September 2000 and expires August 2003.

3) Accounts Receivable and Major Customers
------------------------------------------

Revenue from shipments to and fees from Sabratek represented 65.2% of  revenue
from continuing operations for fiscal 2000 and 50% of revenue from continuing
operations in fiscal 1999.  Credit limits, ongoing credit evaluation, and
account-monitoring procedures are used by the Company to minimize the risk of
loss on accounts receivable.  Generally, collateral is not required.  Export
revenues were 4%, and 7% of total revenue for fiscal 1999, and 1998,
respectively.  Export revenues were not significant during fiscal 2000.

4) Inventory
-------------

<TABLE>
<CAPTION>
Inventory from continuing operations consists of the following:
                                                   June 30, 2000            June 30, 1999
                                              -----------------------    --------------------
<S>   <C>                                         <C>                    <C>
      Finished goods..........................    $           138,014    $             14,943
      Work in progress........................                 80,151                  18,536
      Raw materials...........................                 31,711                  61,616
                                              -----------------------    --------------------
      Total inventory.........................    $           249,876    $             95,095
                                              =======================    ====================
</TABLE>

Net inventory from discontinued operations as of June 30, 1999 is $123,153.
There is no inventory from discontinued operations as of June 30, 2000.

5) Property and Equipment
-------------------------

Property and equipment from continuing operations consists of the following:
<TABLE>
<CAPTION>

                                                         June 30,         June 30,          Useful
                                                           2000             1999            Lives
                                                     ---------------    --------------    -----------
<S>                                                  <C>                <C>               <C>
      Leasehold improvements..................       $     1,560,385    $    1,560,385              *
      Furniture, fixtures and equipment.......             2,345,925         2,384,908    2 -  5 yrs.
                                                     ---------------    --------------
                                                           3,906,310         3,945,293
      Accumulated depreciation................            (2,670,391)       (2,766,984)
                                                     ---------------    --------------
      Total property and equipment                   $     1,235,919    $    1,178,309
                                                     ===============    ==============
</TABLE>
* remaining lease life, primarily 4 to 6 years.

Net property and equipment from discontinued operations as of June 30, 1999 is
$5,653.  There is no net property and equipment from discontinued operations as
of June 30, 2000.

6) Accrued Expenses
-------------------

Accrued expenses from continuing operations consists of the following:

<TABLE>
<CAPTION>
                                                              June 30, 2000          June 30, 1999
                                                          -------------------------------------------
<S>                                                       <C>                    <C>
Deferred gain...........................................  $         334,788      $           -
Severance...............................................            215,833                  -
Accrued vacation........................................             82,164                125,136
Other...................................................            327,561                410,838
                                                          -------------------------------------------
     Total accrued expenses from continuing operations    $         960,346      $         535,974
                                                          ===========================================
</TABLE>

                                       36
<PAGE>

7) Income Taxes
---------------

There was no income tax expense (benefit) for the fiscal years ended June 30,
2000, and 1999. The tax effects of temporary differences that give rise to
significant portions of the deferred tax assets and liabilities at June 30, 2000
and 1999 are presented below:

<TABLE>
<CAPTION>
                                                                                         June 30,
                                                                       -----------------------------------------
<S>                                                                      <C>                     <C>
Deferred tax assets:                                                           2000                  1999
                                                                       -------------------    ------------------
  Accounts receivable due to allowances for financial reporting
        purposes....................................................   $               192    $            4,441
  Inventory, principally due to write-down for financial reporting
        purposes....................................................               208,312               395,466
  Property and equipment, due to difference in depreciation.........               223,007               226,292
  Accrued expenses..................................................               128,240                62,673
  Net operating loss carryforwards..................................            19,514,286            16,338,020
  Alternative minimum tax credit carryforwards......................                83,645                83,645
  Research and experimentation credit carryforwards.................               678,176               682,072
  Other, net........................................................                 4,068                 7,512
                                                                       -------------------    ------------------
     Total gross deferred tax assets................................            20,839,926            17,800,121
     Less valuation allowance.......................................           (20,839,926)          (17,800,121)
                                                                       -------------------    ------------------
     Net deferred tax asset.........................................   $             -        $            -
                                                                       ===================    ==================
</TABLE>


The valuation allowance related to deferred tax assets increased by
approximately $3,040,000 and $3,444,000 during the years ended June 30, 2000 and
1999, respectively.

In assessing the realization of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized.  The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible.  Based upon the level of
historical taxable income, management has provided a 100% valuation allowance
for the Company's deferred tax assets at June 30, 2000.  The amount of the
deferred tax asset considered realizable, however, could fluctuate in the near
term if estimates of future taxable income during the carryforward period are
adjusted.

Reconciliation of the U.S. Federal statutory rate to the Company's effective tax
rate for each fiscal year is as follows:

<TABLE>
<S>                                                  <C>                <C>                 <C>
                                                         2000               1999               1998
                                                   ---------------    ---------------     --------------
  U. S. Federal statutory rate..................         34.0%              34.0%              34.0%
  Increase (reduction) in income taxes
   resulting from:
  Provision for valuation
   allowance....................................        (34.0)             (34.0)             (34.0)
                                                   ---------------    ---------------     --------------
  Net effective tax rate........................          -                  -                  -
                                                   ===============    ===============     ==============
</TABLE>

At June 30, 2000, the Company had net operating loss ("NOL") carryforwards for
federal and state income tax purposes of approximately $53,664,000, which expire
beginning in 2008.  The Company also has research and experimentation credit
carryforwards for federal income tax purposes of approximately $678,000 which
expire beginning in 2000, and alternative minimum tax credit carryforwards of
approximately $84,000.  The Internal Revenue Code section 382 limits NOL and tax
credit carryforwards when an ownership change of more than fifty percent of

                                       37
<PAGE>

the value of stock in a loss corporation occurs within a three year period. In
fiscal 1999, 1998 and 1997 the Company issued preferred stock which coverts into
common stock. Accordingly, the ability to utilize remaining NOL and tax credit
carryforwards may be significantly restricted.

8) Shareholders' Equity
-----------------------

June 2000 Private Placement

On June 13, 2000, the Company completed a private placement of 1,572,738 shares
of its common stock and warrants to purchase 471,822 shares of common stock to
six institutional investors including three investors from the Company's June
1999 and December 1999 private placements for an aggregate price of $6,000,000.
Each warrant entitles the holder to purchase one share of common stock at an
exercise price of $5.45 at any time through June 12, 2002.

December 1999 Private Placement

On December 10, 1999, the Company completed a private placement of 1,904,761
shares of its common stock and warrants to purchase 571,429 shares of common
stock to three institutional investors for an aggregate price of $4,000,000.
Each warrant entitles the holder to purchase one share of common stock at an
exercise price of $3.00 through December 10, 2001.

June 1999 Private Placement

In June 1999, the Company completed a private placement of 2,132,955 shares of
its common stock, and warrants to purchase 639,888 shares of common stock to
three institutional investors for an aggregate price of $6,000,000. Each
investor purchased one-third of the securities issued in the private placement.
Each warrant entitles the holder to purchase one share of common stock at an
exercise price of $4.02 through June 2001.

November 1998 Private Placement

In November 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 former President and CEO and Liviakis
Financial Communications Inc. ("LFC").

Series E & F Convertible Preferred Stock
In July 1998, the Company completed the first closing of a private placement of
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 L.P. (the "Class B Investor"), an investment firm managed by the
Company's Chairman of the Board, at an aggregate price of $750,000.  In January
1999, the Company completed the second closing of the private placement of its
Series F Convertible Preferred Stock (Series F Preferred Stock) and related
Class B Warrants to the Class B Investor for an aggregate price of $750,000.

In June 2000 all of the 750 shares of Series E Preferred Stock and 750 shares of
Series F Preferred Stock had been converted and all the Class B Warrants were
exercised.

                                       38
<PAGE>

Warrants

The following table shows the outstanding warrants for each of the fiscal years
ending June 30, 2000, 1999 and 1998 respectively. Each warrant in the table is
convertible to one share of the Company's common stock for the indicated price.

<TABLE>
<S>                                      <C>              <C>             <C>           <C>        <C>
Warrants outstanding as of  June 30,        2000            1999            1998          Price    Expiration
------------------------------------   --------------   -------------   -------------   -----------------------
June 2000 private placement                471,822            -               -         $  5.45      Jun 2002
December 1999 private placement            571,429            -               -            3.00      Dec 2001
June 1999 private placement                693,888          693,888           -            4.02      Jun 2001
November 1998 private placement            956,655        1,001,109           -            2.25      Nov 2000
Series C Warrants                           53,977           53,977        53,977          6.435     Nov 2000
Class A and B second close                  24,968          249,383           -            0.6625    Jul 2000
Class A and B first close                   35,400           35,400           -            0.6625    Jul 2000
Class A & B first and second close             -            281,250           -            0.80      Jul 2000
Series A Warrants                              -             25,274        25,274         16.375     Jan 2000
                                       --------------   -------------   -------------
     Total warrants outstanding          2,808,139        2,340,281        79,251
                                       ==============   =============   =============
</TABLE>

Stock Option Plans
------------------

Under the Company's existing stock option plans (the "Plans"), stock options to
purchase up to 3,637,500 shares of common stock were originally authorized to be
granted to employees, directors, and certain other persons.  As of June 30,
2000, stock options covering 2,733,708 shares of common stock were outstanding
under the Plans and 697,784 shares were available for issuance upon exercise of
options, which may be granted in the future under the Plans.

Options under the Plans may either be incentive stock options or non-qualified
stock options (except in the case of the Company's non-qualified stock option
plan which permits only the issuance of non-qualified stock options).  Options
under the Plans may be granted for a term not to exceed ten years (five years
with respect to incentive stock options granted to any person having 10% or more
voting power of the Company) and are not transferable other than by will or the
laws of descent and distribution.  Incentive stock options may be exercised
within 90 days after the optionee's termination of employment (to the extent
exercisable prior to such termination), and one year after the optionee's
disability.  The exercise price of the options under the Plans must be at least
equal to the fair market value of the common stock on the date of grant, or 110%
of such value for incentive stock options granted to any person having 10% or
more of the voting power of the Company.  The aggregate fair market value of the
common stock for which any employee may be granted incentive stock options which
first become exercisable in any one calendar year may not exceed $100,000.
Options may be exercised by payment of cash or by tender of shares of common
stock (valued at their then current market value).  The Compensation Committee
of the Board of Directors administers the Plans.

On December 10, 1998, the Compensation Committee and the Board of Directors
authorized and granted the Board of Directors and the Chief Executive Officer of
the Company the right to exchange up to 100% of their outstanding options, both
vested and unvested, for replacement options at a rate of three replacement
options for every four options surrendered.  These replacement options are
exercisable at a price of $3.625 per share (the fair market value at the date of
repricing).  A total of 609,500 options were exchanged for 442,125 replacement
options.  The replacement options vest in two equal installments on June 10,
1999 and December 10, 1999.

On September 12, 2000, the Company's Board of Directors adopted the Stock Option
Plan, authorizing the grant of incentive stock options and non-qualified stock
options to employees,

                                       39
<PAGE>

directors and certain other persons. No options have been granted under the 2000
Stock Option Plan. Shareholder approval of the 2000 Stock Option Plan is being
sought.

On April 21, 1998, the Board of Directors authorized and granted the non-officer
employees of the Company, the right to exchange up to 100% of their outstanding
options, both vested and unvested, for replacement options at a rate of one
replacement option for each option surrendered.  These replacement options are
exercisable at a price of $1.7813 per share (the fair market value at the date
of repricing).  A total of 341,604 options were exchanged.  Officers, other than
the Chief Executive Officer, were authorized and granted the right to exchange
up to 100% of their outstanding options, both vested and unvested, for
replacement options at a rate of two replacement options for every three options
surrendered.  These replacement options are exercisable at a price of $1.7813
per share (the fair market value at the date of repricing).  A total of 294,750
options were exchanged for 196,499 replacement options.  The replacement options
vest in two equal installments on October 21, 1998 and April 21, 1999.

A summary of option activity under the Plans for the fiscal years ended June 30,
2000, 1999 and  1998 is as follows:

<TABLE>
<S>                       <C>            <C>             <C>           <C>             <C>         <C>
                                      2000                           1999                        1998
                          -----------------------------  ----------------------------  ----------------------------
                                            Weighted                      Weighted                      Weighted
                                             Average                       Average                       Average
                                            Exercise                      Exercise                      Exercise
                              Shares         Price         Shares          Price         Shares          Price
                          ------------  ---------------  -----------  ---------------  -----------  ---------------

Outstanding at
 beginning of year.....      1,689,516  $          3.21    1,494,898  $          5.00    1,280,073  $          9.23
Granted................      2,147,650             3.63    1,292,380             3.50    1,257,373             3.04
Exercised..............        565,132             2.28      292,233             2.02          337             4.50
Expired................        538,326             2.99      805,529             7.86    1,042,211             6.43
                          ------------  ---------------  -----------  ---------------  -----------  ---------------

Outstanding at year
end....................      2,733,708  $          3.77    1,689,516  $          3.21    1,494,898  $          5.00
                          ============  ===============  ===========  ===============  ===========  ===============
Options exercisable at
 year end..............      1,373,145  $          3.51      911,498  $          2.68      458,925  $          9.24
Shares available for
 future grant..........        697,784             -         574,758             -         410,950             -
</TABLE>

The following summarizes information regarding the Company's stock options
outstanding at June 30, 2000:

<TABLE>
<CAPTION>
                                                  Weighted
       Range of                                    Average            Weighted            Number              Weighted
       Exercise                 Number            Remaining            Average           Exercisable           Average
         Price               Outstanding         Contractual          Exercise           at June 30,          Exercise
                                                 Life Years            Price                2000                Price
-----------------------   ----------------   -----------------   -------------------   ----------------   ---------------
<S>           <C>                <C>                      <C>      <C>                        <C>           <C>
     1.41          1.78            401,195                 8.8                  1.70            226,194              1.77
     1.88          2.06             87,500                 8.1                  1.90             87,500              1.90
     2.50          2.94            388,550                 9.7                  2.68            178,800              2.50
     3.19          3.96            743,613                 8.8                  3.61            503,301              3.63
     4.06          8.88          1,097,850                 9.8                  5.04            362,350              4.90
    13.00         14.50             15,000                 5.5                 14.00             15,000             14.00
---------   -----------   ----------------   -----------------   -------------------   ----------------   ---------------
     1.63         14.50          2,733,708                 9.3                  3.77          1,373,145              3.51
=========   ===========   ================   =================   ===================   ================   ===============
</TABLE>

                                       40
<PAGE>

The Company applies APB Opinion No. 25 and related interpretations in accounting
for its stock option and stock purchase plans.  Had compensation cost been
recognized consistent with SFAS No. 123, the Company's net loss and loss per
share would have been increased to pro forma amounts indicated below for the
years ended June 30, 2000, 1999 and 1998:

<TABLE>
<S>                  <C>              <C>                          <C>                      <C>
                                                        2000                      1999                    1998
                                      ----------------------       -------------------      ------------------
Net loss applicable  As Reported      $           (9,053,356)      $       (12,433,783)     $       (9,486,218)
to common stock      Pro Forma                   (11,699,109)              (13,415,803)            (10,451,918)

Net loss per share   As Reported      $                (0.41)      $             (0.77)     $            (1.60)
                     Pro Forma                         (0.53)                    (0.83)                  (1.76)
</TABLE>

The per share weighted average value of stock options issued by the Company
during fiscal 2000, 1999 and 1998 was $5.81, $2.80 and $2.04 respectively, on
the date of grant using the Black-Scholes option-pricing model.  The Company
used the following weighted-average assumptions to determine the fair value of
stock options granted for the fiscal years ended June 30, 2000, 1999 and 1998:


<TABLE>
<CAPTION>
                                                Stock                                          Employee Stock
                                            Option Plans                                        Purchase Plan
<S>                       <C>              <C>              <C>               <C>             <C>              <C>
                                2000           1999           1998                 2000           1999            1998
                          ----------------------------------------------      ----------------------------------------------
Dividend yield                   0.0%           0.0%           0.0%                 0.0%           0.0%            0.0%
Expected volatility            137.3%         142.0%          95.7%                92.3%          92.3%           92.3%
Risk-free rate of return        5.23%           4.7%           5.4%                5.23%           4.7%            5.4%
Average expected option
 life                          3.6yrs         3.6yrs         3.6yrs               0.5yrs         0.5yrs          0.5yrs
</TABLE>

Consultant and Advisor Stock Plan

In April of 1999, the Company established a Consultant and Advisor Stock Plan
(the "Consultant and Advisor Stock Plan") for the purpose of providing
incentives to and compensating consultants and advisors for their contributions
to the Company.  Under the Consultant and Advisor Stock Plan, the Company may
issue up to an aggregate of 500,000 shares of Common Stock to consultants and
advisors whom are natural persons providing bona fide services to the Company.
Shares may not be issued under the Consultant and Advisor Stock Plan to
directors or officers of the Company, or for services rendered in promoting or
maintaining a market in the Company's securities. For the years ended June 30,
2000 and 1999, the Company issued approximately 190,000 and 100,000 shares of
common stock with a value of approximately $520,000 and $428,000 respectively.

                                       41
<PAGE>

9) Commitments
--------------

The Company's facilities consist of three buildings of approximately 21,000,
29,000 and 10,000 square feet, which are subject to ten, seven and five year
operating leases, respectively.  The total rent expense charged to operations
was approximately $286,000, $302,000, and $302,000 in fiscal 2000, 1999 and 1998
respectively.


The following is a schedule of future minimum lease payments under non-
cancelable operating leases as of June 30, for each fiscal year shown below:

<TABLE>
<CAPTION>
                                                        Operating
Fiscal year ending June 30,                              Leases
----------------------------------------------------  ------------
        <S>                                           <C>
        2001........................................  $    364,000
        2002........................................       387,000
        2003........................................       347,000
        2004........................................       229,000
        2005........................................       229,000
        Thereafter..................................       148,000
                                                      --------------
                                                      $  1,704,000
                                                      ==============
</TABLE>


10) Related Party Transactions
------------------------------

Certain outside directors also receive consulting fees for services rendered
from time to time to the Company. In fiscal 1999 and 1998, no such person
received in excess of $60,000 for such services. In fiscal 2000, First Capital
Group of Texas II, L.P., an investment firm managed by Jeffry P Blanchard,
the Company's Chairman of the Board of Director's received $71,000 in consulting
fees.

In July 1998, and January 1999, the Company completed the first and second
closings respectively, of a Private Placement (as defined in Footnote 7 above)
involving, among other things, the sale of its Series E and F Preferred Stock
and related Common Stock Purchase Warrants to First Capital Group of Texas II,
L.P., an investment firm managed by Jeffery P. Blanchard, the Company's Chairman
of the Board, at an aggregate amount of $750,000 for each closing.

In fiscal 2000, two officers resigned their positions with the Company. The
total severance and retirement package was approximately $480,000 and was
recorded as an expense in fiscal 2000.

11) Employee Benefit Plans
--------------------------

Effective March 1, 1992, the Company adopted the DATA RACE, Inc. 401(k) Plan
under section 401(k) of the Internal Revenue Code of 1986, as amended.  Under
the Plan, substantially all employees eligible to participate may elect to
contribute up to the lesser of 15% of their salary or the maximum allowed under
the Code.  All full time employees with at least one year of continuous service
and who have completed 1,000 work hours are eligible for the Plan.  The Company
may elect to make contributions to the Plan at the discretion of the Board of
Directors.  The Company made contributions of approximately $65,000 in fiscal
2000, $68,000 in fiscal 1999, and $45,000 in fiscal 1998

In December 1993, the Company adopted the DATA RACE, Inc. Employee Stock
Purchase Plan ("ESPP") pursuant to which eligible employees may purchase up to
an aggregate of 200,000 shares of the Company's common stock at 85% of the fair
market value of the common stock through payroll deductions.  In 1997, the ESPP
was amended to offer two consecutive six-month plan periods, beginning February
1 and August 1, respectively.  Of the 200,000 shares available in this Plan,
approximately 103,000 shares have been purchased as of June 30, 2000.

                                       42
<PAGE>

12) Liquidity and Capital Resources
-----------------------------------

Operating losses have had and continue to have a substantial negative effect on
the Company's cash balance.  The Company's goal of returning to profitability
and developing a more dependable revenue base depends on the success of the
VocalWare IP product line.  To successfully penetrate the target markets, the
Company expects that significant additional resources will need to be expended
in order to expand its sales and marketing infrastructure and operation systems,
and to finance inventory and receivables.

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 develop
and maintain adequate liquidity.  The Company believes its current cash balances
will be sufficient to meet its anticipated cash needs for the next 12 months.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
---------------------------------------------------------

ACCOUNTING AND FINANCIAL DISCLOSURE
-----------------------------------

None.

                                       43
<PAGE>

                                   PART III*

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
------------------------------------------------------------

ITEM 11.  EXECUTIVE COMPENSATION
--------------------------------

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
------------------------------------------------------------------------

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
--------------------------------------------------------

* The information required by Part III of this Annual Report on Form 10-K is
incorporated by reference from the Registrant's Definitive Proxy Statement to be
filed pursuant to Regulation 14A not later than 120 day after the Registrant's
fiscal year end.

                                       44
<PAGE>

                                    PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
--------------------------------------------------------------------------

(a) 1.  Financial Statements
----------------------------

        Independent Auditors' Report

        Balance Sheets as of June 30, 2000 and 1999

        Statements of Operations for the fiscal years ended June 30, 2000, 1999,
                and 1998

        Statements of Shareholders' Equity for the fiscal years ended June 30,
                2000, 1999, and 1998

        Statements of Cash Flows for the fiscal years ended June 30, 2000, 1999,
                and 1998

        Notes to Financial Statements

    2.  Financial Statement Schedules
    ---------------------------------

        Schedules are either not required or the necessary information is
        included in the financial statements or notes thereto.

    3.  Exhibits
    ------------

    3.1   Articles of Amendment to and Restatement of the Articles of
          Incorporation of the Company, filed December 27, 1991. (a)

    3.2   Articles of Correction to Articles of Amendment to and Restatement of
          the Articles of Incorporation of the Company, filed August 13, 1992.
          (a)

    3.3   Articles of Amendment to the Articles of Incorporation of the Company,
          filed August 21, 1992. (a)

    3.4   Bylaws of the Company and Amendment to Bylaws. (a)(b)

    3.5   Statement of Resolution Establishing Series B Participating Cumulative
          Preferred Stock. (f)

    3.6   Articles of Amendment to the Articles of Incorporation of the Company,
          filed January 21,1999 (i)

    4.1   Specimen Common Stock Certificate. (a)

    4.2   Form of Class A Stock Purchase Warrants, representing a series of
          warrants issued by the Company pursuant to the Purchase Agreement
          dated July 24, 1998. (h)

    4.3   Form of Class B Stock Purchase Warrants, representing a series of
          warrants issued by the Company pursuant to the Purchase Agreement
          dated July 24, 1998. (h)

   10.1   *401(k) Profit Sharing Plan, effective March 1, 1992. (a)

                                       45
<PAGE>

   10.2   Form of Indemnification Agreement between the Company and each
          director. (c)

   10.3   *Amended and Restated Employee Stock Purchase Plan adopted in February
          1996. (e)

   10.4   *1994 Stock Option Plan. (d)

   10.5   *1995 Stock Option Plan. (e)

   10.6   *1997 Stock Option Plan. (g)

   10.7   *1998 Stock Option Plan. (j)

   10.8   *1999 Stock Option Plan (n)

   10.9   Securities Purchase Agreement, dated July 24, 1998, between the
          Company, Sovereign Partners L.P., Dominion Capital Fund Ltd., and
          First Capital Group of Texas II, L.P.(h)

   10.10  Registration Rights Agreement, dated July 24, 1998, between the
          Company, Sovereign Partners L.P., Dominion Capital Fund Ltd., and
          First Capital Group of Texas II, L.P.(h)

   10.11  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. (k)

   10.12  Consulting Agreement between the Company and Liviakis Financial
          Communications, Inc.(i)

   10.13  Amendment No. 1 to Consulting Agreement between the Company and
          Liviakis Financial Communications, Inc. (k)

   10.14  Securities Purchase Agreement, dated June 25, 1999, by and among DATA
          RACE, Inc. and Cranshire Capital, L.P., Keyway Investments Ltd., and
          Lionhart Investments Ltd., as the Investors. (l)

   10.15  Registration Rights Agreement, dated June 25, 1999, by and among DATA
          RACE, Inc. and Cranshire Capital, L.P., Keyway Investments Ltd., and
          Lionhart Investments Ltd., as the Investors. (l)

   10.16  Warrant Agreements dated June 25, 1999, issued to Cranshire Capital,
          L.P., Keyway Investments Ltd., and Lionhart Investments Ltd. (l)

   10.17  Securities Purchase Agreement, dated December 10, 1999, between the
          Company, Cranshire Capital, L.P., Keyway Investments Ltd., and
          Lionhart Investments Ltd. (m)

   10.18  Registration Rights Agreement, dated December 10, 1999, between the
          Company, Cranshire Capital, L.P., Keyway Investments Ltd., and
          Lionhart Investments Ltd. (m)

   10.19  Warrant Agreement dated December 10, 1999 issued to Cranshire Capital,
          L.P., Keyway Investments Ltd., and Lionhart Investments Ltd. (m)

                                       46
<PAGE>

   10.20  Securities Purchase Agreement, dated June 12, 2000, between the
          Company, Cranshire Capital, L.P., Keyway Investments Ltd., Lionhart
          Investments Ltd., EURAM Cap Strat. "A" Fund Limited, ICN Capital Ltd.,
          and G-Bar Limited Partnership (o)

   10.21  Registration Rights Agreement, dated June 12, 2000, between the
          Company, Cranshire Capital, L.P., Keyway Investments Ltd., Lionhart
          Investments Ltd., EURAM Cap Strat. "A" Fund Limited, ICN Capital Ltd.,
          and G-Bar Limited Partnership (o)

   10.22  Warrant Agreement, dated June 12, 2000, between the Company, Cranshire
          Capital, L.P., Keyway Investments Ltd., Lionhart Investments Ltd.,
          EURAM Cap Strat. "A" Fund Limited, ICN Capital Ltd., and G-Bar Limited
          Partnership (o)

   10.23  Consultant and Advisor Stock Plan (l)

   10.24  Description of Transaction Bonus Plan (l)

   23.1   Consent of KPMG LLP (p)

   24     Powers of Attorney to sign amendments to this report. Reference is
          made to the signature page of this report.

   27     Financial Data Schedule (p)

___________________

(a)  Filed as an exhibit to Form S-1 Registration Statement No. 33-51170,
     effective October 7,   1992.

(b)  Filed as an exhibit to Form 10-Q for the quarter ended December 31, 1996.

(c)  Filed as an exhibit to Form 10-K Annual Report for fiscal year ended June
     30, 1993.

(d)  Filed as an exhibit to Form 10-K Annual Report for fiscal year ended June
     30, 1995.

(e)  Filed as an exhibit to Form 10-K Annual Report for fiscal year ended June
     30, 1996.

(f)  Filed as an exhibit to Form 10-K Annual Report for fiscal year ended June
     30, 1997.

(g)  Incorporated by reference to appendix A of the Company's Definitive Proxy
     Statement dated December 12, 1997.

(h)  Filed as an exhibit to Form 8-K filed on August 4, 1998.

(i)  Filed as an exhibit to Form S-3 Registration Statement No. 333-71319,
     effective April 20, 1999.

(j)  Incorporated by reference to appendix A of the Company's Definitive Proxy
     Statement dated October 14, 1998.

(k)  Filed as an exhibit to Form 10-Q for the quarter ended December 31, 1998.

(l)  Filed as an exhibit to Form 8-K filed on June 25, 1999.

                                       47
<PAGE>

(m)  Filed as an exhibit to Form 8-K filed on December 17, 1999.

(n)  Incorporated by reference to appendix A of the Company's Definitive Proxy
     Statement dated October 12, 1999.

(o)  Filed as an exhibit to Form 8-K filed on June 21, 2000

(p)  Filed herewith.


*   Management contract or compensatory plan, contract or arrangement

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

     A report on Form 8 K was filed on June 21, 2000 to report the completion of
a private placement.

                                       48
<PAGE>

                                   SIGNATURES

   Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended the Registrant has duly caused this report to
be signed on behalf of the undersigned, thereunto duly authorized.

                               DATA RACE, INC., DBA IP Axess

                               By:  /s/ MICHAEL MC DONNELL
                                    ----------------------
                                        Michael Mc Donnell
                                    President and Chief Executive Officer

                               By:  /s/ JAMES G. SCOGIN
                                    -------------------
                                        James G. Scogin
                                    Senior Vice President-Finance, Chief
                                    Financial Officer, Treasurer and Secretary

                               Date:  September 28, 2000

   Each person whose signature appears below authorizes and, or either of them,
each of whom may action without joinder of the other, to execute in the name of
each such person who is then an officer or director of the Registrant and to
file any amendments to this annual report on Form 10-K necessary or advisable to
enable the Registrant to comply with the Securities Exchange Act of 1934, as
amended, and any rules, regulations and requirements of the Securities and
Exchange Commission in respect thereof, which amendments may make such changes
in such report as such attorney-in-fact may deem appropriate.

   Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
                 Name                                     Title                             Date
                 ----                                     -----                             ----
<S>                                      <C>                                       <C>
/s/MICHAEL MC DONNELL                    President, Chief Executive Officer and    September 28, 2000
---------------------------------------  Director
Michael McDonnell

/s/JAMES G. SCOGIN                       Senior Vice President-Finance, Chief      September 28, 2000
---------------------------------------  Financial Officer, Treasurer and
 James G. Scogin                         Secretary

/s/JEFFREY P. BLANCHARD                  Chairman of the Board of Directors        September 28, 2000
---------------------------------------
 Jeffrey P. Blanchard

/s/THOMAS BISHOP                         Director                                  September 28, 2000
---------------------------------------
Thomas Bishop

/s/GEORGE R. GRUMBLES                    Director                                  September 28, 2000
---------------------------------------
 George R. Grumbles

/s/MATTHEW A. KENNY                      Director                                  September 28, 2000
---------------------------------------
 Matthew A. Kenny

/s/BYRON SMITH                           Director                                  September 28, 2000
---------------------------------------
Byron Smith
</TABLE>

                                       49