<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Quarter Ended Commission File Number
September 30, 1998 0-20706
DATA RACE, INC.
(Exact name of registrant as specified in its charter)
Texas 74-2272363
(State of Incorporation) (I.R.S.Employer Identification No.)
12400 Network Boulevard
San Antonio, Texas 78249
Telephone (210) 263-2000
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days . YES X NO ___
---
On November 11, 1998, there were 14,537,140 outstanding shares of Common Stock,
no par value.
1
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DATA RACE, INC.
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
Page
Number
------
PART I. FINANCIAL INFORMATION
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<S> <C>
Item 1. Interim Condensed Financial Statements (Unaudited):
Condensed Balance Sheets as of September 30, 1998 and June 30, 1998..... 3
Condensed Statements of Operations for the Three Months
Ended September 30, 1998 and 1997........................................ 4
Condensed Statements of Cash Flows for the Three Months
Ended September 30, 1998 and 1997........................................ 5
Notes to Interim Condensed Financial Statements.......................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...................................... 10
PART II. OTHER INFORMATION
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Item 1. Legal Proceedings........................................................ 13
Item 2. Changes in Securities.................................................... 13
Item 3. Defaults Upon Senior Securities.......................................... 15
Item 4. Submission of Matters to a Vote of Security Holders...................... 15
Item 5. Other Information........................................................ 17
Item 6. Exhibits and Reports on Form 8-K......................................... 17
SIGNATURES........................................................................ 18
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</TABLE>
2
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PART I. FINANCIAL INFORMATION
------------------------------
ITEM 1. INTERIM CONDENSED FINANCIAL STATEMENTS
- -----------------------------------------------
DATA RACE, INC.
CONDENSED BALANCE SHEETS
UNAUDITED
<TABLE>
<CAPTION>
AS OF
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SEPT. 30, 1998 JUNE 30, 1998
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ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents..................................... $ 2,298,054 $ 1,644,294
Accounts receivable, net...................................... 342,885 321,103
Inventory..................................................... 500,967 542,963
-------------- --------------
Total current assets........................................ 3,141,906 2,508,360
Property and equipment, net..................................... 1,380,679 1,475,132
Other assets, net............................................... 25,389 25,389
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Total assets................................................ $ 4,547,974 $ 4,008,881
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LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable.............................................. $ 403,509 $ 346,973
Accrued expenses.............................................. 731,006 1,104,910
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Total current liabilities................................... 1,134,515 1,451,883
Commitments and contingencies
Shareholders' equity............................................ 3,413,459 2,556,998
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Total liabilities and shareholders' equity................. $ 4,547,974 $ 4,008,881
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</TABLE>
See accompanying notes to interim condensed financial statements
3
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DATA RACE, INC.
CONDENSED STATEMENTS OF OPERATIONS
UNAUDITED
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------------
1998 1997
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<S> <C> <C>
Total revenue.................................................................. $ 911,024 $ 1,153,925
Cost of revenue................................................................ 599,196 1,004,604
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Gross profit................................................................ 311,828 149,321
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Operating expenses:
Engineering and product development........................................... 594,532 1,073,419
Sales and marketing........................................................... 620,175 1,087,062
General and administration.................................................... 1,442,628 759,538
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Total operating expenses.................................................... 2,657,335 2,920,019
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Operating loss.............................................................. (2,345,507) (2,770,698)
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Other income................................................................... 27,381 46,509
Loss before income taxes....................................................... (2,318,126) (2,724,189)
Income tax benefit............................................................. - -
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Net loss.................................................................... $ (2,318,126) $ (2,724,189)
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Per share data:
Net loss.................................................................... (2,318,126) (2,724,189)
Effect of beneficial conversion feature of convertible
preferred stock............................................................. (1,281,547) (143,231)
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Net loss applicable to common stock......................................... (3,599,673) (2,867,420)
------------- ------------
Net basic and diluted loss per share applicable to common stock............. $ (0.26) $ (0.54)
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Weighted average shares outstanding............................................ 13,836,000 5,264,000
------------- ------------
</TABLE>
See accompanying notes to interim condensed financial statements
4
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DATA RACE, INC.
CONDENSED STATEMENTS OF CASH FLOWS
UNAUDITED
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------------
1998 1997
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<S> <C> <C>
Cash flows from operating activities:
Net loss....................................................................... $ (2,318,126) $ (2,724,189)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization............................................... 91,618 155,020
Non-cash consulting fee..................................................... 1,265,813 -
Gain on sale of property and equipment...................................... - (2,320)
Changes in assets and liabilities:
Accounts receivable......................................................... (21,782) 976,448
Inventory................................................................... 41,996 18,706
Accounts payable............................................................ 56,536 (169,750)
Accrued expenses............................................................ (373,904) (342,384)
Other current liabilities................................................... - (932)
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Net cash used in operating activities..................................... (1,257,849) (2,089,401)
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Cash flows from investing activities:
Purchase of property and equipment............................................. - (24,622)
Proceeds from sale of property and equipment................................... 2,835 2,320
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Net cash provided by (used in) investing activities......................... 2,835 (22,302)
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Cash flows from financing activities:
Net proceeds from issuance of preferred stock.................................. 1,894,346 -
Net proceeds from issuance of common stock..................................... 14,428 85,827
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Net cash provided by financing activities................................... 1,908,774 85,827
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Net increase (decrease) in cash and cash equivalents............................. 653,760 (2,025,876)
Cash and cash equivalents at beginning of period................................. 1,644,294 4,535,768
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Cash and cash equivalents at end of period....................................... $ 2,298,054 $ 2,509,892
------------- --------------
</TABLE>
See accompanying notes to interim condensed financial statements
5
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DATA RACE, INC.
NOTES TO INTERIM CONDENSED FINANCIAL STATEMENTS
UNAUDITED
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ------------------------------------------
DESCRIPTION OF BUSINESS
DATA RACE, Inc. ("DATA RACE" or the "Company") designs, manufactures, and
markets a line of communication products for remote access to the corporate
environment. Its unique client/server product, the Be There! Remote Access
System, gives teleworkers access to all elements of corporate communications
networks, including the PBX, Intranet, and Internet. Through Be There!, remote
workers send and receive e-mail, fax and phone calls simultaneously over a
single phone line. The Company also designs and manufactures advanced network
multiplexers that carry data, network, voice, and fax traffic among a company's
multiple offices.
BASIS OF PRESENTATION
The unaudited interim financial statements reflect all adjustments (consisting
of normal recurring accruals) that in the opinion of management are necessary
for a fair presentation of the financial position, results of operations and
cash flows for such periods. These financial statements should be read in
conjunction with the Company's financial statements and notes thereto included
in the June 30, 1998 Annual Report on Form 10-K. The condensed balance sheet
data as of June 30, 1998 included herein has been derived from such audited
financial statements. Interim period results are not necessarily indicative of
the results to be expected for any future periods or the full year.
2) EARNINGS PER SHARE
- ----------------------
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 128, Earnings Per Share. FASB
Statement No. 128 supersedes APB Opinion No. 15, Earnings Per Share, and
specifies the computation, presentation, and disclosure requirements for
earnings per share ("EPS"). It replaces Primary EPS and Fully Diluted EPS with
Basic EPS and Diluted EPS, respectively. Basic EPS, unlike Primary EPS,
excludes all dilution while Diluted EPS, like Fully Diluted EPS, reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the entity. Diluted
loss per share approximates basic loss per share as no potential common shares
are to be included in the computation when a loss from continuing operations
available to common shareholders exists. The Company had approximately 1,682,000
and 1,354,000 options outstanding as of September 30, 1998 and 1997
respectively. The Company had 1,500 shares of Series D Convertible Preferred
Stock and 750 shares of Series E Convertible Preferred Stock outstanding as of
September 30, 1998 and 805 shares of Series A Convertible Preferred Stock
outstanding as of September 30, 1997. The Company had warrants to purchase
679,246 shares of common stock at $0.6625, 140,625 shares of common stock at
$0.80, 45,800 shares of common stock at $16.375 and 139,861 shares of common
stock at $6.435 outstanding as of
6
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September 30, 1998. The Company had warrants to purchase 45,800 shares of common
stock at $16.375 and 139,861 shares of common stock at $6.435 outstanding as of
September 30, 1997. No Series D or E Convertible Preferred Stock were
outstanding as of September 30, 1997. All previously reported per share amounts
have been restated to conform to the new presentation.
3) INVENTORY
- -------------
Inventory is valued at the lower of cost (principally standard cost which
approximates first-in, first-out) or market (net realizable value). Inventory
consists of the following:
<TABLE>
<CAPTION>
September 30, June 30,
1998 1998
-------------------- --------------------
<S> <C> <C>
Finished goods $ 2,692 $ 13,859
Work in process 354,857 256,285
Raw materials 143,418 272,819
-------------------- --------------------
Total inventory $ 500,967 $ 542,963
==================== ====================
</TABLE>
4) CONVERTIBLE PREFERRED STOCK
- -------------------------------
On July 24, 1998, the Company completed the first closing of a private placement
(the "Private Placement") of its Series D Convertible Preferred Stock ("Series D
Preferred Stock") and related Common Stock Purchase Warrants ("Class A
Warrants") to Sovereign Partners L.P. and Dominion Capital Fund, Ltd. (the
"Class A Investors"), for an aggregate price of $1,500,000, and its Series E
Convertible Preferred Stock ("Series E Preferred Stock") and related Common
Stock Purchase Warrants ("Class B Warrants") to First Capital Group of Texas II,
L.P. (the "Class B Investor"), an investment firm managed by the Company's
Chairman of the Board, for a price of $750,000. At such time, the Class A
Investors agreed to purchase at a second closing additional shares of Series D
Preferred Stock and Class A Warrants for an aggregate price of $1,000,000, and
the Class B Investor agreed to purchase at a second closing additional shares
of Series F Convertible Preferred Stock ("Series F Preferred Stock") and Class B
Warrants for an aggregate price of $750,000. The second closing is scheduled to
occur on or before January 31, 1999, and is subject to the Company's
satisfaction of certain conditions, including, among others, the following: the
average closing bid price of the Company's Common Stock during the five trading
days prior to the closing is at least $1.50; in the case of the closing with
respect to the Class B Investor, the Company has a minimum of $750,000 in
revenue for the quarter ending September 30, 1998 or December 31, 1998 (which
has been satisfied); and there is no material adverse change in the Company's
financial condition, business or prospects. In addition, the Company must obtain
shareholder approval to increase its authorized shares in order to have reserved
a sufficient number of authorized shares of common stock for issuance upon
conversion or exercise of the securities to be issued in the second closing. The
Company has used and intends to use the proceeds from the Private Placement
primarily to promote Be There! remote access system product line and for working
capital.
7
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Each of the Series D Preferred Stock, Series E Preferred Stock and Series F
Preferred Stock (the "Preferred Stock") has a stated value of $1,000 per share;
bears an 8% premium payable upon conversion or redemption or in liquidation (in
the case of conversion the Company may elect to pay such premium in Common
Stock); is non-voting except in limited circumstances; ranks senior to the
Common Stock in liquidation; and is redeemable at a premium at the option of the
holder upon the occurrence of certain major corporate transactions and
triggering events.
The Series D Preferred Stock is convertible into Common Stock of the Company
("Common Stock") at the option of the holder beginning 90 days after the
issuance date (subject to acceleration in certain events), at a conversion price
equal to 80% of the trailing five-day average closing bid price of the Common
Stock on the conversion date, subject to a minimum conversion price equal to the
trailing 15-day average closing bid price of the Common Stock 90 days after
issuance, which is $1.583 for the first closing, and subject to a maximum
conversion price equal to the lesser of $3.00 or the trailing five-day average
closing bid price of the Common Stock 90 days after issuance, which is $1.956
for the first closing. The Series E Preferred Stock is convertible into Common
Stock at the option of the holder beginning one year after the issuance date
(subject to acceleration in certain events), at a conversion price equal to
$1.00 (which represents a premium to the Common Stock closing price of $0.5938
on July 8, 1998, the date the Company reached an agreement in principle with the
Investors regarding the terms of the Private Placement). The Series F Preferred
Stock is convertible into Common Stock at the option of the holder beginning one
year after the second closing (subject to acceleration in certain events), at a
conversion price equal the trailing five-day average closing bid price of the
Common Stock on the date of the second closing. In each case, the number of
shares of Common Stock issuable upon conversion of one share of Preferred Stock
is computed by dividing the share's stated value of $1,000 by the applicable
conversion price (plus any premium to the extent paid in shares).
The Class A Warrants issued at the first closing are exercisable for an
aggregate of 339,623 shares of Common Stock at a price of $0.6625 per share,
beginning on the earlier of the effective date of the applicable registration
statement or 90 days after issuance (subject to acceleration in certain events).
The Class B Warrants issued at the first closing are exercisable for an
aggregate of 140,625 shares of Common Stock at a price of $0.80 per share, one
year after issuance (subject to acceleration in certain events).
As of November 11, 1998 no shares of the initial 1,500 shares of the Series D
Preferred Stock had been converted. As of November 11, 1998 no shares of the
initial 750 shares of the Series E Preferred Stock had been converted.
8
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5) ACCOUNTING TREATMENT FOR CONVERTIBLE PREFERRED SECURITIES
- -------------------------------------------------------------
The value attributed to the Warrants and the non-cash offering costs of the
Series D and Series E Preferred Stock have been recognized by allocating a
portion of the proceeds to additional paid-in-capital. The beneficial
conversion feature of the Series E Preferred Stock has not been allocated a
portion of the offering proceeds, rather, the beneficial conversion feature will
be accreted into additional paid-in-capital over the one year holding period.
The beneficial conversion feature is calculated, at the date of issuance, as the
difference between the conversion price and the fair value of the common stock
into which the security is convertible at the date the transaction closed.
Because the security provides for more than one conversion rate, in conformity
to the SEC announcement, the computation is made using the conversion terms most
beneficial to the investor, regardless of the actual discount applied upon
conversion. The value of the Warrants is calculated using a Black-Scholes model
and may or may not correspond to a market value.
The calculated intrinsic value of the beneficial conversion features of the
Preferred Stock, the offering costs and the premium will result in non-cash
charges of approximately $2,701,000 to earnings (loss) available to common
shareholders in the computation of earnings (loss) per common share over the
conversion period as required by the SEC guidelines. As of September 30, 1998
approximately $1,282,000 has been charged, with approximately $794,000 to be
charged in the next fiscal quarter. As a result, the Company will show these
non-cash charges to earnings (loss) available to common shareholders in the
computation of earnings (loss) per common share over the period from July 1998
through June 1999.
6) CONSULTING AGREEMENT
- ------------------------
On July 13, 1998, the Company entered into a consulting agreement with Liviakis
Financial Communications, Inc. ("LFC"). LFC agreed to advise and assist the
Company in developing and implementing appropriate plans and materials for
presenting the Company and its business plans, strategy and personnel to the
financial community, establishing an image for the Company in the financial
community, and creating the foundation for subsequent financial public relations
efforts. The Company issued to LFC 1,406,475 shares of Common Stock and 468,825
shares of Common Stock to Robert P. Prag ("Prag"), an officer of LFC, and
recorded an expense of approximately $1,172,000. The Company also issued to a
third party which assisted the Company in negotiating its agreement with LFC
150,000 shares of Common Stock and recorded an expense of approximately $94,000.
9
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
RESULTS OF OPERATIONS
Total revenue for the three months ended September 30, 1998 decreased 21% to
$911,024 from $1,153,925 in the same period of the prior fiscal year. This
decrease was primarily due to a decline in revenue from network multiplexers.
Gross profit margin was 34% for the three months ended September 30, 1998. The
increased gross profit margin from 13% for the comparable period of the prior
fiscal year is primarily due to decreased manufacturing variances attributable
to a 37% workforce reduction in custom modem manufacturing and an approximately
$200,000 inventory obsolescence reversal consistent with the Company's current
revenue and activity levels.
Engineering and product development expenses for the three months ended
September 30, 1998 decreased 45% from the comparable period for the prior fiscal
year. This decrease was primarily due to a 51% workforce reduction in custom
modem development partially offset by amounts paid to outside consultants.
Sales and marketing expenses for the three months ended September 30, 1998
decreased 43% from the comparable period of the prior fiscal year. This
decrease was primarily due to the Company's suspension of most outside
advertising and a 20% workforce reduction.
General and administrative expenses for the three months ended September 30,
1998 increased 90% from the comparable period of the prior fiscal year. This
increase was attributable to the non-cash expense associated with the consulting
agreement with LFC for investor relations services, offset in part by a 33%
workforce reduction and other Company cost-saving measures, and further offset
by approximately $300,000 attributable to satisfaction during the quarter of
certain past due receivables, an occupational injury reversal due to the Company
obtaining workmans compensation insurance and other reserve adjustments
consistent with the Company's current revenue levels.
Income tax benefits related to the losses for the three months ended September
30, 1998 were not recognized because the realization of such benefits is not
assured. As of September 30, 1998, the Company had federal tax net operating
loss carry forwards of approximately $37,500,000 which expire beginning in 2010.
The value of these net operating loss carryforwards is dependent on future
events and complex tax code provisions, and cannot be assured or stated with
certainty.
10
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LIQUIDITY AND CAPITAL RESOURCES
Operating losses have had and continue to have a significant negative effect on
the Company's cash balance. At September 30, 1998, the Company had
approximately $2,298,000 in cash and cash equivalents.
In July 1998, the Company received net proceeds of $1,894,000 from the issuance
of Preferred Stock and Warrants to purchase shares of Common Stock (the "July
Private Placement"). In addition, the purchasers of the Preferred Stock and
Warrants have agreed to purchase, subject to the Company's satisfaction of
certain conditions (as to which there can be no assurance), an additional
$1,750,000 of Preferred Stock and Warrants at a second closing on or before
January 31, 1999. The Preferred Stock is redeemable under certain circumstances.
See note 4 to the Company's unaudited interim condensed financial statements and
Item 2 of this Report.
As previously announced, on November 15, 1998, the Company obtained binding
commitments for an immediate $2.2 million private placement of Common stock and
common stock purchase warrants. Closing is scheduled to occur by November 20,
1998. The Company considers the financing an important step in the Company's
plan to maintain its listing on the Nasdaq National Market. The Company was
recently notified by The Nasdaq Stock Market that the Company has not met the
net tangible assets requirement for continued listing. The Company has
requested a hearing with Nasdaq to review the matter and has been advised that
the hearing will be scheduled for early January 1999. The Company's shares will
remain listed until the hearing at which the Company will present its plan to
achieve compliance.
As part of its strategic objective, the Company has also retained Robinson-
Humphrey to advise the Company and assist the Company in its efforts to develop
strategic and financial partnerships with third parties.
The Company's ability to sustain operations, make future capital expenditures
and fund the development and marketing of new or enhanced products are highly
dependent on existing cash, the ability to raise additional capital, the cash
requirements to pay the premium and penalties (if any) on the Preferred Stock,
and the Company's return to profitability. The Company's continued listing on
the Nasdaq National Market is also dependent in part on its capital position.
The timing and amount of the Company's future capital requirements can not be
accurately predicted. The Company does not anticipate a return to profitability
as long as its expenditures on the Be There! system remain disproportionate to
attendant revenue. The Company will likely require additional financing in the
future; the failure to obtain such financing when needed would have a
substantial adverse effect on the Company. Moreover, although the Company
intends to seek shareholder approval to increase its authorized shares,
substantially all of the Company's authorized shares have been issued or
reserved for issuance to satisfy conversions or exercises of outstanding
securities; the failure to obtain such shareholder approval would likely have a
material adverse effect on the Company's ability to complete future financings
(including the second closing of the July Private Placement).
YEAR 2000 COMPLIANCE
The Company has been evaluating and adjusting all known date-sensitive systems
and equipment for the Year 2000 compliance. The assessment phase of the Year
2000 project is substantially complete. Virtually all of the compliance was
performed by Company personnel. The total estimated cost of the Year 2000
conversion is not deemed material to the Company and is being expensed as
incurred.
In addition to internal Year 2000 implementation activities, the Company is in
communication with third party suppliers and vendors with whom which the
Company's systems communicate and interact to determine the extent to which
those companies are addressing their Year 2000 compliance problems. There can
be no assurance that there will not be an adverse effect on the Company if third
parties, such as suppliers or service providers, do not bring their systems into
compliance in a timely manner. However, management believes that ongoing
communication with, assessment of, and coordination with these parties, will
help to minimize these risks.
11
<PAGE>
Although the Company anticipates minimal business disruption will occur as a
result of Year 2000 issues, possible consequences include, but are not limited
to, disruption of voice mail communications, purchase order processing, and
other normal business activities.
To date, the Company has not established a contingency plan for possible Year
2000 issues. Where needed, the Company will establish contingency plans based
on its actual testing experience and assessment of outside risks. The Company
anticipates contingency plans to be in place by June 30, 1999.
The cost of and the completion dates are based on management's best estimates
and may be updated as additional information becomes available.
RISKS REGARDING FORWARD-LOOKING STATEMENTS
This Report contains various "forward-looking statements" which represent the
Company's expectations or beliefs concerning future events. The Company
cautions that these forward-looking statements involve a number of risks and
uncertainties and are qualified by important factors that could cause actual
results to differ materially from those in the forward-looking statements. The
Company cautions that there can be no assurance that the Company will be able to
fully satisfy Nasdaq's concerns at the planned hearing regarding the Company's
satisfaction on an on-going basis of the net tangible assets requirement. The
Company's ability to maintain compliance with the Nasdaq National Market
requirement depends, in part, on the Company's ability to complete additional
equity financings (including the second closing of the July Private Placement)
or other capital infusions. Future capital raising efforts depend upon various
factors, including satisfaction of closing conditions, availability of capital,
and an increase in the number of authorized shares. The Company further cautions
that there can be no assurance that the Company will succeed in its efforts to
develop new strategic and financial partnerships. Additional factors which
qualify forward-looking statements are set forth in the Company's other SEC
filings including its 10-K for the 1998 fiscal year.
12
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DATA RACE, INC.
ITEM 1. LEGAL PROCEEDINGS
- --------------------------
None.
ITEM 2. CHANGES IN SECURITIES
- ------------------------------
On July 13, 1998, the Company entered into a consulting agreement with Liviakis
Financial Communications, Inc. ("LFC"). The Company issued to LFC 1,406,475
shares of Common Stock and 468,825 shares of Common Stock to Robert P. Prag, an
officer of LFC. A third party assisted the Company in arranging the consulting
agreement with LFC. The Company issued to the third party as compensation
150,000 shares of Common Stock.
On July 24, 1998, the Company completed the first closing of a private placement
(the "Private Placement") of its Series D Convertible Preferred Stock ("Series D
Preferred Stock") and related Common Stock Purchase Warrants ("Class A
Warrants") to Sovereign Partners L.P. and Dominion Capital Fund, Ltd. (the
"Class A Investors"), for an aggregate price of $1,500,000, and its Series E
Convertible Preferred Stock ("Series E Preferred Stock") and related Common
Stock Purchase Warrants ("Class B Warrants") to First Capital Group of Texas II,
L.P. (the "Class B Investor"), an investment firm managed by the Company's
Chairman of the Board, for a price of $750,000. At such time, the Class A
Investors agreed to purchase at a second closing additional shares of Series D
Preferred Stock and Class A Warrants for an aggregate price of $1,000,000, and
the Class B Investor agreed to purchase at a second closing shares of Series F
Convertible Preferred Stock ("Series F Preferred Stock") and Class B Warrants
for a price of $750,000. The second closing is scheduled to occur on or before
January 31, 1999, and is subject to the Company's satisfaction of certain
conditions, including, among others, the following: the average closing bid
price of the Company's Common Stock during the five trading days prior to the
closing is at least $1.50; in the case of the closing with respect to the Class
B Investor, the Company has a minimum of $750,000 in revenue for the quarter
ending September 30, 1998 or December 31, 1998 (which has been satisfied); the
shares of the Company's Common Stock issuable upon conversion of the Preferred
Stock ("Conversion Shares") and upon exercise of the Warrants ("Warrant Shares")
are registered for resale pursuant to the Securities Act of 1933, as amended
(the "Securities Act") (which has been satisfied as to the securities issued in
the first closing); the Company's shareholders approve the potential issuance of
the Conversion Shares and Warrant Shares in excess of certain limits imposed by
Nasdaq Marketplace Rules (which has been satisfied); the Company is in
compliance with Nasdaq listing requirements (the Company has been notified by
Nasdaq of its non-compliance with such continued listing requirements); and
there is no material adverse change in the Company's financial condition,
business or prospects. In addition, the Company must obtain shareholder approval
to increase its authorized shares in order to have reserved a sufficient number
of authorized shares of Common Stock for issuance upon conversion or exercise of
the securities to be issued in the second closing. There can be no assurance
that the conditions precedent to the second closing will be satisfied. The
Company has used and intends to use the proceeds from the Private Placement
primarily to promote its Be There! remote access system product line and for
working capital.
Each of the Series D Preferred Stock, Series E Preferred Stock and Series F
Preferred Stock (the "Preferred Stock") has a stated value of $1,000 per share;
bears an 8% premium payable upon conversion or redemption or in liquidation (in
the case of conversion the Company may elect to pay such premium in Common
Stock); is non-voting except in limited circumstances; ranks senior to the
Common Stock in liquidation (and ranks equally with each other series of
Preferred Stock); and is redeemable at a premium at the option of the holder
upon the occurrence of certain major corporate transactions and other triggering
events.
13
<PAGE>
The Series D Preferred Stock is convertible into Common Stock of the Company
("Common Stock") at the option of the holder beginning 90 days after the
issuance date (subject to acceleration in certain events), at a conversion price
equal to 80% of the trailing five-day average closing bid price of the Common
Stock on the conversion date, subject to a minimum conversion price equal to the
trailing 15-day average closing bid price of the Common Stock 90 days after the
issuance date and subject to a maximum conversion price equal to the lesser of
$3.00 or the trailing five-day average closing bid price of the Common Stock 90
days after the issuance date. The Series E Preferred Stock is convertible into
Common Stock at the option of the holder beginning one year after the issuance
date (subject to acceleration in certain events), at a conversion price equal to
$1.00. The Series F Preferred Stock will be convertible into Common Stock at
the option of the holder beginning one year after the second closing (subject to
acceleration in certain events), at a conversion price equal to the trailing
five-day average closing bid price of the Common Stock on the date of the second
closing. Subject to certain limitations, all Preferred Stock outstanding five
years after the issuance date will convert automatically into Common Stock at
the applicable conversion price. In each case, the number of shares of Common
Stock issuable upon conversion of one share of Preferred Stock is computed by
dividing the share's stated value of $1,000 by the applicable conversion price
(plus any premium to the extent paid in shares).
If the Common Stock ceases to be listed on the Nasdaq National Market, the
Company must pay the holders of the Preferred Stock a cash penalty of 1% per
day, for up to 24 days, of the stated value of the Preferred Stock outstanding.
If the Company does not pay such penalty, the holders may require the Company to
redeem their shares of Preferred Stock.
The Class A Warrants are exercisable after the earlier of registration of the
underlying shares or 90 days after issuance (subject to acceleration in certain
events), at an exercise price equal to 120% of the average of the three lowest
closing bid prices during the 22 trading days prior to the first closing date,
up to a maximum price of $.80 per share (the "Class A Warrant Exercise Price"),
to purchase that number of shares of Common Stock equal to 15% of the stated
value of the Series D Preferred Stock issued at each closing, divided by the
Class A Warrant Exercise Price. Based on such formula, the Company issued at the
first closing Class A Warrants to purchase an aggregate of 339,623 shares of
Common Stock at an exercise price of $0.6625 per share. The Class B Warrants are
exercisable one year after issuance (subject to acceleration in certain events),
at an exercise price of $0.80 per share (the "Class B Warrant Exercise Price"),
to purchase that number of shares of Common Stock equal to 15% of the stated
value of the Series E Preferred Stock
14
<PAGE>
and Series F Preferred Stock issued at each closing, divided by the Class B
Warrant Exercise Price. Based on such formula, the Company issued at the first
closing, and is obligated to issue at the second closing, Class B Warrants to
purchase 140,625 shares of Common Stock at an exercise price of $0.80 per share.
On July 8, 1998, the date the Company reached an agreement in principle with the
Investors regarding the terms of the Private Placement, the closing price of the
Common Stock was $0.5938. The Class A Warrants and the Class B Warrants (the
"Warrants") each expire two years after the date of their issuance.
The Company agreed to file a registration statement under the Securities Act
covering the resale of the Conversion Shares and Warrant Shares. The failure of
such registration statement to be filed and declared effective within certain
prescribed time periods will result in cash penalties payable by the Company to
the holders of Preferred Stock. A registration statement with respect to the
shares underlying the outstanding preferred stock and warrants has previously
been declared effective. The Class A Investors and the Class B Investor (the
"Investors") have agreed not to effect any short sales of Common Stock during
the one-year period following each closing.
Two persons assisted the Company in arranging the Private Placement with the
Class A Investors. As compensation for the investment by the Class A Investors
in the first closing, the Company agreed to pay a cash fee equal to 6% of the
gross proceeds received from the Class A Investors and to issue Class A Warrants
to purchase approximately the same number of shares that may be purchased
pursuant to the Class A Warrants issued to the Class A Investors. As
compensation for the investment by the Class A Investors in the second closing,
the Company agreed to pay a cash fee equal to 3% of the gross proceeds received
from the Class A Investors and to issue Class A Warrants to purchase
approximately one-half of the number of shares that may be purchased pursuant to
the Class A Warrants to be issued to the Class A Investors.
THE SUMMARY OF THE PRIVATE PLACEMENT SET FORTH ABOVE IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO THE PURCHASE AGREEMENT AND THE OTHER DOCUMENTS EXECUTED
BY THE COMPANY IN CONNECTION WITH THE PRIVATE PLACEMENT. SUCH DOCUMENTS ARE
FILED (OR INCORPORATED BY REFERENCE) AS EXHIBITS TO THIS FORM 10-Q.
On November 15, 1998, the Company obtained a binding commitment for a $2.2
million private placement of securities to up to five accredited investors,
including Liviakis Financial Communications, Inc. Closing is schedule to occur
by November 20, 1998. The private placement contemplates the issuance by the
Company of 977,778 shares of Common Stock and two-year warrants to purchase an
additional 977,778 shares of Common Stock at a warrant exercise price of $2.25
per share. Exercise of the warrants is contingent upon shareholder approval to
increase the Company's authorized shares. The investors agreed to a minimum of
a one-year lock up on the resale of the shares. The Company has agreed to
register the shares on a piggy-back basis on any registration statement which
the Company may file after such time as the Company obtains shareholder approval
to increase the Company's authorized shares and otherwise to register the shares
for resale on or before the first anniversary of the closing date.
The offer and sale by the Company of the securities described above were, and,
to the extent not yet issued, will be, made in reliance upon Section 4(2) of the
Securities Act, the non-public offering exemption from the registration
requirements of the Securities Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
- ----------------------------------------
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
An annual meeting of shareholders of the Company was held on November 13, 1998.
Dr. W. B. Barker, Jeffery P. Blanchard, Matthew A. Kenny, George R. Grumbles,
Dwight E. Lee and Edward A. Masi were elected as directors of the Company, each
to hold office until the next annual meeting of shareholders or until his
successor has been elected and qualified, subject to earlier resignation or
removal. Additionally,
15
<PAGE>
the shareholders approved the DATA RACE, Inc. 1998 Stock Option Plan, authorized
the issuance of certain securities of the Company and ratified the appointment
of KPMG Peat Marwick LLP as independent accountants for the 1999 fiscal year.
Although the Company received the affirmative vote of approximately 92% of the
votes cast for the proposal to increase the Company's authorized shares, the
Company believes that the relatively short proxy solicitation lead time hindered
the Company's ability to obtain the requisite vote of holders of two-thirds of
the Company's outstanding shares. The Company intends to call a special meeting
of shareholders for January 1999 to consider a similar proposal.
The results of the voting at the annual meeting of the shareholders were as
follows:
Proposal No. 1
(Election of Directors)
Company Nominee For Withheld Non- Votes
- --------------- --- -------- ----------
Dr. W. B. Barker 13,839,187 141,023 -
Jeffery P. Blanchard 13,841,257 138,953 -
Matthew A. Kenny 13,396,557 583,653 -
George R. Grumbles 13,396,525 583,685 -
Dwight E. Lee 13,396,025 584,185 -
Edward A. Masi 13,840,025 140,185 -
Proposal No. 2
(Approval of DATA RACE, Inc. 1998 Stock Option Plan)
For Against Abstain Non-Votes
5,224,933 784,020 73,809 7,897,448
Proposal No. 3
(Approval of amendment to the Company's Articles of Incorporation increasing the
authorized number of shares of capital stock)
For Against Abstain Non-Votes
5,846,312 423,876 76,970 7,633,052
Proposal No. 4
(Authorization of issuance of certain securities of the Company)
For Against Abstain Non-Votes
5,790,657 238,541 53,564 7,897,448
Proposal No. 5
(Ratification of KPMG Peat Marwick LLP as independent accountants)
For Against Abstain Non-Votes
13,868,852 60,434 50,924 -
16
<PAGE>
ITEM 5. OTHER INFORMATION
- --------------------------
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------
(a) Exhibits.
- ---------
Exhibit Description
- ------- -----------
3.1 Statement of Designation, Preferences and Rights of Series D
Convertible Preferred Stock.(a)
3.2 Statement of Designation, Preferences and Rights of Series E
Convertible Preferred Stock.(a)
4.1 Form of Class A Stock Purchase Warrant, representing a series of
warrants issuable by the Company pursuant to the Purchase
Agreement dated July 24, 1998.(a)
4.2 Form of Class B Stock Purchase Warrant, representing a series of
warrants issuable by the Company pursuant to the Purchase
Agreement dated July 24, 1998.(a)
10.1 Rights Agreement dated as of September 15, 1997, between Data
Race, Inc. and ChaseMellon Shareholders Services, L.L.P., as
Rights Agent.(b)
10.2 Consulting Agreement, dated July 13, 1998, between the Company
and Liviakis Financial Communications, Inc.(c)
10.3 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.(a)
10.4 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.(a)
10.5 Form of Statement of Designation, Preferences and Rights of
Series F Convertible Preferred Stock.(a)
10.6 Modification Agreement, dated November 5, 1998, between the
Company, Sovereign Partners L.P., Dominion Capital Fund, Ltd.,
and First Capital Group of Texas II, L.P.(d)
- ---------------
(a) Filed as an exhibit to Form 8-K filed on August 4, 1998.
(b) Filed as an exhibit to Form 8-A filed on October 30, 1998.
(c) Filed as an exhibit to Form 10-K filed on September 28, 1998.
(d) Filed as an exhibit to Form S-3 Registration Statement filed on November 6,
1998.
(b) Reports on Form 8-K.
- -------------------------
A report was filed on Form 8-K on August 4, 1998, to report the Company
completed the first closing of a private placement of its Series D Convertible
Preferred Stock and related Common Stock Purchase Warrants for an aggregate
price of $1,500,000 and its Series E Convertible Preferred Stock and related
Common Stock Purchase Warrants for an aggregate price of $750,000.
17
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DATA RACE, INC.
By: /s/ Gregory T. Skalla
---------------------
Gregory T. Skalla, Senior Vice President-Finance,
Chief Financial Officer, Treasurer and Secretary
(Principal Financial and Accounting Officer)
Date: November 17, 1998
18
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM DATA RACE,
INC. FINANCIAL STATEMENTS AS OF AND FOR THE THREE MONTHS ENDED SEPTEMBER 30,
1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 2,298
<SECURITIES> 0
<RECEIVABLES> 343
<ALLOWANCES> 0
<INVENTORY> 501
<CURRENT-ASSETS> 3,142
<PP&E> 4,068
<DEPRECIATION> (2,687)
<TOTAL-ASSETS> 4,548
<CURRENT-LIABILITIES> 1,135
<BONDS> 0
0
1,606
<COMMON> 36,059
<OTHER-SE> (34,252)
<TOTAL-LIABILITY-AND-EQUITY> 4,548
<SALES> 911
<TOTAL-REVENUES> 911
<CGS> 599
<TOTAL-COSTS> 3,256
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (2,318)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,318)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,318)
<EPS-PRIMARY> (0.26)
<EPS-DILUTED> (0.26)
</TABLE>
