UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549





Form
10-KSB





(Mark
One)


[X]
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934





For
Fiscal Year Ended:March 31,
2008





[  ]
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934





For the
transition period from _______________ to __________________





Commission
file number:0-17304





Cistera
Networks, Inc.


(Name of
small business issuer in its charter)





Nevada
            91-1944887State
      or other jurisdiction of
            (I.R.S.
      Employerincorporation
      or organization
            Identification
      No.)





6509 Windcrest Drive, Suite
160, Plano, Texas  75024


(Address
of principal executive offices)  (zip code)





Issuer's
telephone
number                              (972)
381-4699





Securities
registered under Section 12(b) of the Act:  NONE


Securities
registered under Section 12(g) of the Act:





Common Stock Par Value
$0.001


(Title of
class)





Check
whether the issuer is not required to file reports pursuant to Section 13 or
15(d) of the Exchange Act. [  ]





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





Check if
there is no disclosure of delinquent filers pursuant to Item 405 of Regulation
S-B contained in this form, and no disclosure will 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-KSB or any amendment to
this form 10-KSB. [  ]





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes [  ]  No [X]





Total
revenues for fiscal year ended March 31, 2008 - $2,874,615





At August
5, 2008, the aggregate market value of all shares of voting and non-voting
common equity held by non-affiliates was approximately $5.8
million.  In determining this figure the issuer has assumed that all
directors and the named executive officer are affiliates.   This
assumption shall not be deemed conclusive for any other purpose.





The
number of shares outstanding of each class of the issuer's common equity, as of
August 5, 2008, was as follows: 17,038,068common
shares, $.001 par value per share.





Transitional
Small Business Disclosure Format (check one): Yes [  ] No
[X]





EXPLANATORY
NOTE





As
previously disclosed in a Form 8-K filing, dated August 6, 2008, the Board of
Directors of the Company, in consultation with management and an independent
consultant engaged by management, concluded that the Company’s financial
statements as of and for the fiscal year ended March 31, 2007 and the interim
financial statements as of and for the quarters ended June 30, 2007 and 2006, as
of and for the quarters and six month periods ended September 30, 2007 and 2006
and as of and for the quarters and nine month periods ended December 31, 2007
and 2006 should not be relied upon.  Accordingly, the Company has
restated the financial statements for the year ended March 31, 2007 contained in
this Annual Report on Form 10-KSB filing.  The Company intends to
restate and refile its Annual Report on Form 10-KSB for the fiscal year ended
March 31, 2007 and restate and refile its Quarterly Reports on Form 10-QSB for
the periods ended June 30, 2007, September 30, 2007 and December 31, 2007 in a
reasonably practicable time period.





The
Company is restating its Consolidated Statements of Operations, Consolidated
Statements of Stockholders’ Equity and Consolidated Statements of Cash
Flows for the year ended March 31, 2007 contained in this Annual
Report on Form 10-KSB to reflect: (i) a correction in its accounting for
its Senior Unsecured Convertible Promissory Notes and detachable warrants issued
in private placements during the period from December 2004 to April 2007 (the
“PP1 Notes,” “PP1 Warrants,” “PP2 Notes” and “PP2 Warrants”) and (ii)
share-based compensation related to employee stock options.  The Company
has concluded that its original accounting for the PP1 Notes and PP1 Warrants
issued in fiscal year 2005 and the PP2 Notes and PP2 Warrants issued in fiscal
years 2007 and 2008, and its recording of share-based compensation for fiscal
year 2007 were incorrect, and that the necessary adjustments were material to
the fiscal year 2007 consolidated financial statements.





further
discussion of the restatement of the fiscal year 2007 financial statements is
contained under “Part II, Item 6 – Management’s Discussion and Analysis or Plan
of Operations and Small Business Issuer Purchases of Equity Securities” and in
the Notes to the consolidated financial statements of this
Report.


1





CISTERA
      NETWORKS, INC.
              FORM
      10-K/SB
              TABLE
      OF CONTENTSItem Number and Caption
            PagePART IItem
      1.
            Description
      of Business
            3Item
      2.
            Description
      of Property
            18Item
      3.
            Legal
      Proceedings
            18Item
      4.
            Submission
      of Matters to a Vote of Security Holders
            18PART IIItem
      5.
            Market
      for Common Equity and Related Stockholder Matters and Small Business
      IssuerPurchases
      of Equity Securities
            19Item
      6.
            Management's
      Discussion and Analysis or Plan of Operations
            24Item
      7.
            Financial
      Statements
            39Item
      8.
            Changes
      in and Disagreements With Accountants on Accounting andFinancial
      Disclosure
            39Item
      8A(T).
            Controls
      and Procedures
            39Item
      8B.
            Other
      Information
            41PART IIIItem
      9.
            Directors,
      Executive Officers, Promoters and Control Persons and Corporate
      Governance;Compliance
      with Section 16(a) of the Exchange Act
            42Item
      10.
            Executive
      Compensation
            45Item
      11.
            Security
      Ownership of Certain Beneficial Owners and Management and RelatedStockholder
      Matters
            47Item
      12.
            Certain
      Relationships and Related Transactions, and Director
      Independence
            48Item
      13.
            Exhibits
            48Item
      14.
            Principal
      Accountant Fees & Services
            49





2











PART
I





ITEM
1:  DESCRIPTION OF BUSINESS





BACKGROUND




Cistera
Networks, Inc. (“we” or “the Company”) was incorporated in Delaware on April 15,
1987, under the name of I.S.B.C. Corp.  The Company subsequently
changed its name first to Coral Companies, Inc., and then to CNH Holdings
Company.  Domicile was changed to Nevada in 1997.  The
Company conducted an initial public and secondary offerings during the
1980's.  On June 15, 1998, the Company acquired Southport
Environmental and Development, Inc.  This acquisition, however, was
subsequently rescinded by agreement between the parties and made a formal order
of the court effective April 19, 2000.  This order put the Company in
the position that it occupied at June 14, 1998, as if none of the actions that
had occurred from that time to the date of rescission had
transpired.




The
Company was in the development stage from January 1, 1992 to May 5,
2003.  On May 5, 2003, the Company formed Corvero Networks, Inc., a
Florida corporation as a wholly owned subsidiary to acquire the use of certain
technology known as the XBridge Technology.  This technology was used
as its principal component of the Corvero Convergence Platform.  The
acquisition was accomplished by entering into a license agreement with XBridge
Software, Inc., a Delaware corporation.




On August
31, 2004, as part of a corporate restructuring aimed at simplifying the
Company’s operating structure, Corvero Networks merged into CNH Holdings and
began doing business as Cistera Networks.  As a continuation of this
restructuring, effective May 27, 2005, the Company acquired XBridge in a merger
of XBridge with a newly formed Company subsidiary.




On
September 27, 2005, we changed our name to Cistera Networks, Inc.




BUSINESS
OVERVIEW




We
provide an Enterprise Application Server for IP Communications that provides an
enterprise platform for the delivery of advanced application services, like
recording, monitoring and quality reporting for quality assurance and compliance
requirements; as well as broadcasting across IP phones, cell phones, overhead
speakers and two-way radios for event alerting and notification
requirements.  The solutions are used by organizations of all
sizes—large enterprises, small and mid-sized organizations, both in the
commercial and public sectors.  We offer our solution sets
predominately using a perpetual license and maintenance fee model, with
increasing movement to an annuity pricing structure for hosted application
services delivery (also referred to as Software-as-a-Service or
SaaS).




In 2007,
we began efforts to offer our solution sets in partnership with SIP-based Hosted
Service Providers (HSP) like AT&T, Qwest, British Telecom, and other telco
providers. We have engaged in rolling out these offerings with two basic models:
a license subscription model and a revenue share model. We are currently in
trials with HSP vendors to evaluate how best to deliver these services to
end-users. These environments are significantly more complex and demanding than
customer based solutions. Competitive Local Exchange Carriers (CLECS) must
conform to a more rigorous regulatory environment including a higher degree of
reliability and availability than what is required from an enterprise
installation. Cistera currently is working towards meeting all the requirements
of this environment.




Our
objective is to be the leading provider of enterprise application platforms that
enhance the ability of organizations to integrate key business processes into
their communications infrastructure. Our software-based solutions are delivered
on our flexible, open-standards-based platform known as the Cistera
ConvergenceServerTM (CCS). This allows administrators to centrally manage
advanced applications services for IP telephony




3


environments
across large single-site and multi-site private voice/data
networks.  Because our solutions enable organizations to coordinate,
collaborate and improve their customer facing interactions and processes, we
have found that our convergence solutions are considered complimentary to the
solutions offered by IP telephony providers such as Cisco, Nortel, Sylantro and
Avaya, to increase the overall return on investment (ROI) and value contribution
associated with IP based telephony systems.




This has
allowed us to establish strong cooperative relationships with IP telephony
solution providers, as well as large value added resellers (VARs) and systems
integrators (SIs) focused on delivering advanced IP telephony systems and
services.




We began
operations in May 2003, and first introduced our convergence solutions in
September 2003.  We initially offered our solutions at discounted
prices, to seed the market and to establish a reference-able customer
base.  From May 2003 through June 2005, we staffed our operations,
grew our reseller channel, built our infrastructure, created, marketed and
delivered our solutions and obtained an initial base of paying
customers.  From January 2005 to the present time, we increased
expansion efforts into Canada and Europe.  Our revenues grew from
$1,932,838 in fiscal 2007 to $2,874,615 in fiscal 2008, an increase of
48.7%.




Currently,
we offer new customers a variety of packaged applications and platform tools for
industry-specific requirements.  We market and sell our software and
hardware solutions through a VAR channel.  To ensure growth
scalability, our VAR channel is being trained to deliver professional services
for standard installations, which we believe will allow us to focus on advanced
professional services for complex installations.




We plan
to reinvest our earnings for the foreseeable future in the following ways:
hiring additional personnel, particularly in sales and engineering; expanding
our domestic and international selling and marketing activities; increasing our
research and development activities to upgrade and extend our solution offerings
and to develop new solutions and technologies; growing our VAR and systems
integration channel; adding to our infrastructure to support our growth; and
expanding our operational and financial systems to manage a growing
business.




We also
plan to aggressively pursue an annuity-based business through offering our
solutions through traditional perpetual license, maintenance and service fees;
subscription based and revenue share opportunities with our hosted partners and
through our own efforts. Currently over 20% of our business is recurring revenue
and we expect this number to grow significantly over time.




We
currently have 32 employees, including part-time employees, located
predominately in North America.




CERTAIN
RISK FACTORS




Business risk
factors





We cannot
be certain that our revenues will continue to grow or that we will achieve
profitability in the future.  We cannot accurately predict our future
growth rate, if any, or the ultimate size of our market. Our ability to increase
revenues and achieve profitability depends on a number of factors outside of our
control, including the extent to which:




Þ
            Our
      products and solutions are complex and are deployed in a wide variety of
      network environments. The proper use of our software requires extensive
      training and, if our software products are not used correctly or as
      intended, inaccurate results may be produced. Our products may also be
      intentionally misused or abused by clients who use our products. The
      incorrect or improper use of our products or our failure to properly
      provide training, consulting, implementation and maintenance services to
      our clients may result in losses suffered by our clients, which could
      result in negative publicity and product liability or other legal claims
      against us.




4


Þ
            We
      rely on technology and marketing relationships with major PBX vendors
      including Cisco, Sylantro, Nortel and others. We are required to maintain
      a certification level with these vendors in order to be recommended as a
      solution. These requirements may change over time and, as a result, we
      might be forced to limit the features available in our current or future
      product offerings and the commercial release of our products could be
      delayed.




Þ
            We
      are expanding our offerings to include hosted service providers who offer
      our solutions on a subscription model to end-users. As a result we will
      become subject to increased regulatory burdens including warranty and
      certification requirements for participation in public communications
      networks. We might, as a result, be forced to limit the features available
      in our current or future product offerings and the commercial release of
      our products could be delayed.




Þ
            We
      are expanding our offerings to include federal governments as well as
      state and local governments. As a result we will become subject to
      increased regulatory burdens including warranty and certification
      requirements for participation in government procurement networks. We
      might, as a result, be forced to limit the features available in our
      current or future product offerings and the commercial release of our
      products could be delayed within the government
  sector.




Þ
            We
      integrate various third party software products as components of our
      products. We utilize third party software products to enhance the
      functionality of our products. Our business could be disrupted if
      functional versions of this software were either no longer available to us
      or no longer offered to us on commercially reasonable terms. In either
      case, we would be required to spend additional capital to either redesign
      our software to function with alternate third party software or develop
      these components ourselves. We might, as a result, be forced to limit the
      features available in our current or future product offerings and the
      commercial release of our products could be
  delayed.




Þ
            As
      our market opportunities change, our reliance on particular distribution
      channels or other partners may increase, which may negatively impact gross
      margins. There can be no assurance that we will be successful in
      maintaining or expanding these channels. If we are not successful, we may
      lose sales opportunities, customers and market share. In addition, some of
      our distribution channels or our other partners are suppliers of
      telecommunication infrastructure
equipment.




Þ
            We
      rely on a combination of patent, trade secret, copyright and trademark
      law, together with non-disclosure and non-competition agreements, as well
      as third party licenses to establish and protect the technology used in
      our systems. However, we cannot assure you that such measures will be
      adequate to protect our proprietary technology, that competitors will not
      develop products with features based upon, or otherwise similar to our
      systems, or that third party licenses will be available to us or that we
      will prevail in any proceeding instituted by us in order to enjoin
      competitors from selling similar products. Although we believe that our
      products do not infringe upon the proprietary rights of third parties, we
      cannot assure you that one or more third parties will not make a contrary
      claim or that we will be successful in defending such
    claim.




Þ
            Certain
      of our software products contain a limited amount of open source code and
      we may use more open source code in the future. Open source code is code
      that is covered by a license agreement that permits the user to liberally
      use, copy, modify and distribute the software without cost, provided that
      users and modifiers abide by certain licensing requirements. The original
      developers of the open source code provide no warranties on such code. As
      a result of our use of open source software, we could be subject to
      lawsuits by parties claiming ownership of what we believe to be open
      source code and we may incur expenses in defending claims that we did not
      abide by the open source code license. If we are not successful in
      defending against such claims, we may be subject to monetary damages or be
      required to remove the open source code from our products. Such events
      could disrupt our operations and the sale of our products, which would
      negatively impact our revenues and cash flows. In addition, under certain
      conditions, the use of open source code to create derivative code may
      obligate us to make the resulting derivative code available to others at
      no cost. The circumstances under which our use of open source code would
      compel us to offer derivative code at no cost are subject to varying
      interpretations. If we are required to
publicly




5


disclose
the source code for such derivative products or to license our derivative
products that use an open source license, our previously proprietary software
products may be available to others without charge. If this happens, our
customers and our competitors may have access to our products without cost to
them, which could harm our business. We monitor our use of such open source code
to avoid subjecting our products to conditions we do not intend. The use of such
open source code, however, may ultimately subject some of our products to
unintended conditions so that we are required to take remedial action that may
divert resources away from our development efforts.




Þ
            Many
      of our customers use our solutions to record and to store recordings of
      commercial interactions. These recordings are used to provide back-up and
      verification of transactions and to guard against risks posed by lost or
      misinterpreted voice communications. These customers rely on our solutions
      to record, store and retrieve voice data in a timely, reliable and
      efficient manner. If our solutions fail to record our customers’
      interactions or our customers are unable to retrieve stored recordings
      when necessary, we may be subject to liability and our reputation may be
      harmed. Although we attempt to limit any potential exposure through
      quality assurance programs, insurance and contractual terms, we cannot
      assure you that we will eliminate or successfully limit our liability for
      any failure of our recording and storage
  solutions.




Financial risk
factors




In
addition to the other information in this report, the following factors should
be considered in evaluating our business and financial condition. We believe the
risks and uncertainties described below may materially affect our liquidity and
operating results. There also could be additional risks and uncertainties that
we are currently unaware of, or that we are aware of but currently do not
consider material. These could become important in the future or prove to be
material and affect our financial condition or results of
operations.





Our
ability to continue as a going concern is in doubt and we may not be successful
in generating revenue and gross profit at levels sufficient to cover our
operating costs and cash investment requirements.





Our
consolidated financial statements as presented in Item 7 “Financial Statements”
of this Report have been prepared in conformity with US GAAP, which contemplate
our continuation as a going concern. However, the report of our independent
registered public accounting firm on our consolidated financial statements, as
of and for the fiscal year ended March 31, 2008, contains an explanatory
paragraph expressing substantial doubt as to our ability to continue as a going
concern. The “going concern” qualification results from, among other things, the
substantial losses from operations that we have incurred since inception, our
current liquidity position, net losses of approximately $5.2 million for the
fiscal year ended March 31, 2008, which included non-cash charges of $1.9
million related to amortization of discounts associated with our sale and
issuance of Senior Unsecured Convertible Promissory Notes in the fiscal year
2005 (the “PP1 Notes”) and fiscal years 2007 and 2008 (“the PP2 Notes”),
negative working capital (current liabilities in excess of current assets) of
$3.0 million as of March 31, 2008 and other factors described in Note 1 to our
consolidated financial statements and included in “Item 6 Management's
Discussion and Analysis or Plan of Operations.” Accordingly, as of March 31,
2008, the recoverability of a major portion of the recorded asset amounts is
dependent on our continuing operations, which in turn is dependent on our
ability to maintain our current financing arrangements and our ability to become
profitable in our future operations.





In our
“Customer Premise Equipment” (CPE) segment, we continue to focus on growing our
volume with our top resellers. By instituting a new partner program that focuses
resources on the top producing reseller partners, the Company can increase
revenues while optimizing sales support and fulfillment resources. Our “Hosted”
segment is still in the development phase and is not expected to contribute
revenue until the third quarter of fiscal year 2009. If we are not successful in
these initiatives, it may be necessary to reduce costs, primarily through
personnel cuts.





Ongoing
concerns about our financial condition could also impact our dealings with third
parties, such as customers, suppliers and creditors, and the continuation of
such concerns could have a material adverse effect on our business and results
of operations in the future. Future liquidity issues could prevent us from
making timely payments to our suppliers which could restrict our ability to
obtain products and meet our customers’ demands, which could materially and
adversely impact our revenue, results of operations and financial condition, our
competitive position in our market, and possibly our ability to continue
operations.


6


We
may need to raise additional capital to fund our operations.





The
majority of the capital in our business has been funded through convertible debt
borrowings under two private placements (the “PP1 placement” and the “PP2
placement”). To fund future investment in our emerging hosted business and to
provide us with additional working capital, in June of 2008, we completed a
short-term incentive inducement program (the “Short Term Investment Incentive
Plan” or “STIIP”) for the private placement participants. The STIIP, which
concluded on June 24, 2008, significantly reduced our outstanding debt, provided
approximately $897,000 in new cash investment, and has positioned us for future
growth.





Also as
part of the STIIP and under the same pricing terms, net of the placement agent
fees, Roaring Fork Capital Partners (“Roaring Fork”), an investor in the PP2
placement, converted approximately 80% of their PP2 Notes, representing
approximately $1.1 million including accrued interest and penalties, and all of
their 1.3 million PP2 Warrants, representing approximately $400,000 in cash
proceeds. Additionally, we agreed with Roaring Fork to execute an agreement that
waived the registration requirement in exchange for 58,777 shares of our common
stock. After the funding from the STIIP, we still have principal and accrued
interest debt on our PP2 Notes of approximately $1.3 million that are due in
December 2006 and April 2009.





Our
current and primary source of cash availability is a credit facility with a
“factoring” institution, Allied Capital, in the amount of $1.5 million that is
based upon factoring of our accounts receivable. We believe that this liquidity
source is adequate to enable us to manage our cash position for operations,
assuming that we operate at current gross profit levels and that Allied Capital
continues to provide us with liquidity as they have done historically. However,
there can be no assurance that we will operate at sufficient gross profit levels
or that Allied Capital will continue to provide us with liquidity, in which case
it would be necessary to further cut costs, raise additional debt or equity
capital, or sell assets. Additionally, based on our current liquidity, we may
need to raise additional capital to pay the outstanding convertible notes due to
the PP2 placement investors in April 2009. No assurance can be given that
additional financing will be available or that, if available, it will be on
terms favorable to us.





Due
to the “project based” nature of our Customer Premise Equipment (CPE), or
“Enterprise” segment, and the early stage” of our Service Provider Equipment
(SPE) or “Hosted” segment, we have difficulty predicting revenue for future
periods, which may result in expense levels unsupported by actual
revenues.





We have
experienced, and expect to continue to experience, significant period-to-period
fluctuations in our revenue and operating results. As a consequence, our
financial results from any one period may not be indicative of results that will
be realized in future periods.





A number
of factors may contribute to fluctuations in our revenue and operating results.
Significant among these factors is the increasing size of individual customer
orders received; we have received orders of more than $500,000 in a single
transaction. The timing of large orders from customers and the product
integration cycle of those orders can cause significant fluctuations from period
to period. Other factors include the tendency of customers to change their order
requirements frequently with little or no advance notice to us; deferrals of
customer orders in anticipation of new products, services, or product
enhancements from us or our competitors; and the rate at which new markets
emerge for products we are currently developing. Additionally, our “Hosted”
segment is still in an “early stage,” and has yet to produce
revenue.




All
of our sales are currently to customers operating Cisco IP telephony
environments, and if we were to lose the relationship with Cisco, our sales
would decline significantly.





All of
our fiscal year 2008 consolidated sales were to Cisco customers. While we
currently enjoy a very strong relationship with Cisco, it is not guaranteed that
the partnership will continue.  We have achieved successful
verification testing and intend to maintain the approved status as a Technology
Development Partner (TDP) with Cisco, but we cannot guarantee that the
relationship could not weaken or cease to exist at the current
level.





7


Our
operations currently rely on continued access to our accounts receivable
factoring instrument and to trade credit from suppliers. If we lose access to
such financial instruments, our operations may be significantly
impaired.





Funds
available to us under the credit line with Allied Capital are limited by the
amount of eligible accounts receivable we hold at any given time. Additionally,
fluctuations in the timing of customer orders can adversely affect our ability
to draw on the line when required. Allied Capital may declare the loan in
default if we do not meet certain financial covenants. Although we have not been
in default under the covenants in the past; if we were to default under the
covenants and were unable to obtain a waiver, and if Allied Capital were to
accelerate the loan, we would need to obtain cash from other sources to repay
the loan.





Further,
we purchase over half of our products from one supplier—Equus Computer Systems.
(“Equus”). Equus provides Cistera with a line of credit equal to 30 days of
typical hardware purchase activity to meet the needs of Cistera’s normal
business requirements.  Equus has also provided additional lines of
credit to support larger purchase order demands on a “one-off basis” as
requested by the Company.  These additional lines of credit are
typically subject to faster re-payment terms than our standard line of credit
facility.  We purchase most of our other products from our other
suppliers on open trade credit terms. Equus and most of our suppliers set dollar
limits on the trade credit they will afford us at any given time. If Equus or
our other significant suppliers were to cease to sell to us on trade credit
terms, or were to substantially lower the credit limits they have set on our
open accounts, we would need to accelerate our payments to those vendors,
creating additional demands on our cash resources, or we would need to find
other sources for those goods.





We
have experienced a material weakness in our internal controls. If we fail to
maintain an effective system of internal controls over financial reporting, we
may not be able to accurately report our financial results or prevent fraud. As
a result, current and potential shareholders could lose confidence in our
financial reporting, which could negatively impact the value of our common
stock.




Effective
internal controls over financial reporting are necessary for us to provide
reliable financial reports, effectively prevent fraud and operate successfully
as a public company. If we cannot provide reliable financial reports or prevent
fraud, our reputation and operating results may be negatively affected. On
August 4, 2008, our Board of Directors concluded that it was appropriate to
restate our financial statements as of and for the fiscal year ended March 31,
2007 to reflect: (i) a correction in its accounting for its PP1 Notes,
PP1 Warrants, PP2 Notes and PP2 Warrants and (ii) share-based compensation
related to employee stock options.  The Company has concluded that its
original accounting for the PP1 Notes and PP1 Warrants issued in fiscal year
2005 and the PP2 Notes and PP2 Warrants issued in fiscal years 2007 and years
2008 and its recording of share-based compensation for fiscal year 2007 were
incorrect, and that the necessary adjustments were material to the fiscal year
2007 consolidated financial statements.  We evaluated the impact of
this restatement on our assessment of internal control over financial reporting
and concluded that the control deficiency related to the accounting for, and
reporting of, convertible debt, detachable warrants, beneficial conversion
features related to financial instruments and shares-based compensation
represented a material weakness as of March 31, 2008.




To
remediate the aforementioned deficiencies, and to strengthen internal control
over financial reporting for these issues, we engaged an independent consultant
to conduct a full analysis on the historical accounting  and
disclosure related to these issues.  In addition to restating our
fiscal year 2007 financials, we terminated our CFO and intend to initiate a
search for a new CFO.  In addition, we will review accounting
procedures over the evaluation and application of relevant accounting
pronouncements, rules, regulations and interpretations at the time these
transactions, or other complex transactions, are contemplated and completed.
These additional procedures include consultation with outside resources as may
be deemed appropriate.





We cannot
be certain that these measures, and any other steps we may take, will ensure
that we implement and maintain adequate controls over our financial processes
and reporting in the future. Any failure to implement required new or improved
controls, or difficulties encountered in their implementation, could harm our
operations or results or cause us to fail to meet our reporting obligations.
Ineffective internal controls over financial reporting could cause investors to
lose confidence in our reported financial information, which would likely have a
negative effect on the trading price of our common stock or could affect our
ability to access the capital markets.


8


The
amortization of the discount on our PP2 Notes significantly affected earnings
for the fiscal year ending March 2008 and will adversely affect earnings in
future periods and may negatively impact the share price of our common
stock.





As of
March 31, 2008, we had an unamortized discount on our PP2 Notes of approximately
$1.4 million, all of which will be amortized to expense during the 2009 fiscal
year.  $1.2 million was expensed as of the completion of the STIIP in
June 2008.




There
are risks associated with introducing new products. If we are not successful
with those product introductions, we will not realize on our investment in
developing those products.





Development
on the first version of our hosted solution was completed as of March 31, 2008,
and field trials are intended to begin in the first quarter of fiscal
2009.





We will
continue to evaluate opportunities to develop other product solutions, and if we
choose to develop other such products we will incur expenses in those
development efforts. Market acceptance of new products may be slow or less than
we expect. Our products also may not perform in a manner that is required by the
market, or our competitors may be more effective in reaching the market segments
we are targeting with these products. Slow market acceptance of these products
will delay or eliminate our ability to recover our investment in these products.
During any period that we unsuccessfully seek to market these products, we will
also incur marketing costs without corresponding revenue.




Our
ability to grow our business depends on relationships with our Value-Added
Resellers. If we were to lose those relationships, we could lose our ability to
sell our products.





Most of
our revenues come from our ability to sell products and services to our channel
partners (“Resellers” or “Value-Added Resellers (VARS)”) that, in turn, resell
our solutions to their customers.  This dependency means that if the
relationships were lost, our ability to generate revenue and profits would be
severely impacted. While our relationships change from time to time, some of our
most significant channel partners at this time are AT&T, INX, NETech,
Dimension Data, Calence/Insight.  If a given channel partner changes its
marketing strategy and de-emphasizes its use of solutions offered by us, our
ability to generate revenue from our products would diminish and our operations
and results of operations would be materially and adversely
affected.





We
are a relatively small company with limited resources compared to some of our
current and potential competitors, which may hinder our ability to compete
effectively.





Some of
our current and potential competitors have longer operating histories,
significantly greater resources, broader name recognition, and a larger
installed base of customers than we have. As a result, these competitors may
have greater credibility with our existing and potential customers. They also
may be able to adopt more aggressive pricing policies and devote greater
resources to the development, promotion and sale of their products than we can
to ours, which would allow them to respond more quickly than us to new or
emerging technologies or changes in customer requirements.




We
may be unable to hire and retain key personnel.





One of
the keys to our future success depends on our ability to attract qualified IP
Communications technology personnel. We may be unable to attract these necessary
personnel. If we fail to attract or retain skilled employees, or if a key
employee fails to perform in his or her current position, we may be unable to
generate sufficient revenue to offset our operating costs.




9


We
have a thinly-traded stock and public sale of shares by any major shareholder
could cause the market price of our shares to drop significantly.





As of
March 31, 2008, the three-month average daily trading volume was approximately
7,600 shares, with many days having no trades (-0- share volume).  If
any large shareholder were to begin selling shares in the market rather than
hold all of those shares over a longer term, the added available supply of
shares could cause the market price of our shares to drop. Furthermore, in light
of the large number of shares being held by some shareholders at a generally
lower acquisition cost of those shares through the STIIP, some shareholders
could be willing to sell shares at a price lower than the currently prevailing
market price, thereby depressing that price.




The
sale of securities by investors in the private placement could cause dilution of
existing holders of our common stock by decreasing the price of our common
stock.





The
market price of our common stock could be adversely affected by sales of
substantial amounts of common stock in the public market from investors in the
PP2 placement, including Roaring Fork Capital, by the perception that those
types of sales could occur or by the fact or perception of events which would
have a dilutive effect on the market for our common stock. As of August 5, 2008,
we had approximately 17.0 million shares of our common stock outstanding. If all
of our outstanding convertible promissory notes (“PP1 Notes” and “PP 2
Notes”)were converted and all of our outstanding options and warrants were
exercised, we could have up to approximately 20.2 million shares of common stock
outstanding. Future transactions with other investors, if any were to occur,
could further depress the price of our common stock because of additional
dilution.





We
could issue preferred stock that could adversely affect the rights of our common
stockholders.





We are
authorized to issue up to 1,000,000 shares of our preferred stock, $0.001 par
value per share. Our articles of incorporation give our board of directors the
authority to issue preferred stock without approval of our common stockholders.
We may issue preferred stock to finance our operations or for other purposes. We
may authorize the issuance of our preferred stock in one or more series. In
addition, we may set several of the terms of the preferred stock,
including:




·
            dividend
      and liquidation preferences,·
            voting
      rights,·
            conversion
      terms and privileges,·
            redemption
      terms and privileges, and·
            other
      privileges and rights of the shares of each authorized
    series.




At any
time our board of directors may issue additional shares of preferred stock
having, if so designated by our board of directors at the time of issuance,
dividend, liquidation, voting or other rights superior to those of the common
stock. Such issuances could cause the market price of our common stock to
decrease.




The
issuance of large blocks of preferred stock could have a dilutive effect on our
existing shareholders and it could negatively impact our existing stockholders’
liquidation preferences. In addition, while we would consider preferred stock in
our capitalization to improve our financial flexibility, we could possibly issue
our preferred stock to third parties as a method of discouraging, delaying or
preventing a change in control in our present management.




Future
issuances of securities could adversely affect the interests of our existing
shareholders.





In prior
years, we issued securities both to generate cash and to acquire other companies
and assets. We may need to issue additional equity securities to provide cash
and to fund any future acquisitions. Additionally, management may in the future
deem raising capital through the sale of securities to be preferable to bank
financing. Funds raised through the issuance of equity securities or securities
convertible into, or exercisable for, our common stock could dilute the
percentage ownership of existing shareholders, or result in our issuance of
securities with rights, preferences or privileges that may be senior to those of
shares of our common stock.


10


The
resale of our common stock by investors may be limited because of its low price
which could make it more difficult for broker/dealers to sell our common
stock.





The
Securities Enforcement and Penny Stock Reform Act of 1990, as amended, requires
additional disclosure relating to the market for penny stocks in connection with
trades in any stock defined as a penny stock. Regulations enacted by the SEC
generally define a penny stock as an equity security that has a market price of
less than $5.00 per share, subject to some exceptions. Unless an exception
applies, a disclosure schedule explaining the penny stock market and the risks
associated with investing in penny stocks must be delivered before any
transaction in penny stock can occur. Our common stock is currently subject to
the SEC’s “penny stock” rules and it is anticipated that trading in our common
stock will continue to be subject to the penny stock rules for the foreseeable
future.





Until
such time as our common stock meets an exception to the penny stock regulations
cited above, trading in our securities is covered by Rule 15g-2 and Rule 15g-9
promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange
Act”). Under Rule 15g-2, before a broker/dealer can consummate a trade in a
penny stock, the broker/dealer must send additional disclosure, receive a
written acknowledgement of such disclosure from the purchaser of the penny
stock, and wait two business days from the date the additional disclosure was
sent. Under Rule 15g-9, broker/dealers who recommend penny stocks to persons who
are not established customers or accredited investors must make a special
determination in writing for the purchaser that the investment is suitable, and
must also obtain the purchaser’s written agreement to a transaction before the
sale.





The
regulations could limit the ability of broker/dealers to sell our securities and
thus the ability of purchasers of our securities to sell their securities in the
secondary market for so long as our common stock has a market price of less than
$5.00 per share.




We
do not expect to pay cash dividends in the foreseeable future.





We have
never paid cash dividends on our common stock. We do not expect to pay cash
dividends on our common stock at any time in the foreseeable future since we
will use all of our earnings, if any, to finance current operations and the
possible expansion of our operations. The future payment of dividends directly
depends upon our future earnings, capital requirements, financial requirements
and other factors that our board of directors will consider. Since we do not
anticipate paying cash dividends on our common stock, return on investment in
our common stock, if any, will depend solely on an increase, if any, in the
market value of our common stock.





KEY
TERMS AND DEFINITIONS




Þ
            Enterprise Voice is
      defined as the combination of Enterprise Telephony and Enterprise VoIP
      Gateways.





Þ
            Enterprise Telephony is
      defined as the combination of Enterprise IP Telephony and traditional
      telephony (PBX/KTS).





Þ
            Enterprise IP Telephony
      is defined as the combination of LAN Telephony, Converged Telephony, and
      IP Phones.





Þ
            Enterprise VoIP Gateway
      is defined as a Layer 3 network device that provides the interconnection
      of CPE-based voice and data traffic across a WAN network or the PSTN, also
      refereed to as trunks. This device is typically a modular or standalone
      router specially equipped with voice DSP
  resources.





Þ
            LAN Telephony (IP-Only)
      is defined as those ports and systems which provide Enterprise Voice
      services over a LAN whereby both call control and voice traffic traverse a
      packet network, in most cases IP running over Ethernet. The use of a
      traditional PBX or KTS is not required. In most cases the three
      fundamental elements to this network architecture include a server running
      call control software, Ethernet switches, and IP
  Phones.


11


Þ
            Converged Telephony
      (TDM/IP) is defined as those lines and systems that provide voice
      services whereby voice traffic traverses TDM lines but call control is
      packet based.  In most cases this enables a traditional
      Enterprise Voice network to migrate its infrastructure to IP incrementally
      with the prime advantage of maintaining prior capital investment in PBXs
      and traditional phones. In most cases call control resides on a server,
      connected to a LAN, running call control software that provides call
      control to a PBX.  In this case, the end-points remain TDM but
      the call control is IP. Also, other form factors of this segment may not
      include traditional phone systems, but an integrated standalone device
      that integrates the functions of TDM and IP at a systems level. These
      standalone solutions are targeted to smaller deployments as found at
      branch offices or small offices.





Þ
            IP Phone is defined as a
      packet based telephone that has a Layer 3 IP address and a Layer 2 network
      connection (in most cases Ethernet or Voice over Ethernet). The functions
      of an IP Phone mirror that of a traditional phone. Technically, an IP
      Phone transmits voice traffic by first taking the Voice Payload and adding
      an RTP header, then a UDP header, then an IP header and finally an
      Ethernet header per frame. An IP Phone is an IP appliance, which has been
      optimized for voice applications. Given that it is more than a traditional
      telephone, other network services may be available to the IP Phone such as
      Internet browsing or other network services. An IP Phone can be a hard
      phone, soft phone, or wireless
device.





Þ
            Perpetual License Model
      – This is where the customer purchases the solution outright with the
      license to use the hardware and software. Typically the customer installs
      the Cistera solution on the customer premise and pays annual maintenance
      fees for support and upgrades.





Þ
            Subscription License –
      This is where the customer pays a monthly service fee for the right to use
      the services provided by the solution set. Typically our solution is
      installed in a third-party’s computer center and multiple clients take
      advantage of the solution. There is usually an upfront installation and
      configuration charge in addition to the monthly recurring software license
      fee.





Þ
            Revenue Share – This is
      where a third-party hosted service provider and Cistera share the revenue
      along with the cost of operating the solution. End user customers pay a
      determined fee each month to use the Cistera Services. It is typically
      sold as part of a complete IP Communications offering from a hosted
      service provider.





INDUSTRY
BACKGROUND




The term
"IP telephony" covers a range of technologies, including voice-over-IP (VoIP)
and fax-over-IP services, which are carried over both the Internet and private
IP-based networks. IP telephony connects across combinations of PCs, Web-based
telephones, and phones connected via public telephone lines to remote voice
gateways. Because information traveling through an IP-based network travels in
discrete packets, it does not need to rely on a continuously available switched
circuit as does information traveling in the analogue format used in traditional
telephony.  Consequently, IP-based services are very bandwidth and
cost-efficient.




Users of
IP telephony typically can save money because IP telephony operates more
efficiently than ordinary plain old telephone service (POTS) and because it
currently avoids most of the tariffs and tolls applicable when using POTS,
especially with respect to international telephone service.  IP-based
voice conversations require less than 10% of the bandwidth of
POTS.  This efficiency of bandwidth results from two factors: First,
compression techniques, such as G.723.1, a standard IP compression technique,
compresses a standard POTS transmission resulting in an overall bandwidth
reduction generally in the range of 6-to-1.  Second, POTS requires
full duplex—a simultaneous transmission in both directions—to support a
telephone conversation.  Tying up bandwidth in this fashion is
wasteful because in conversations, typically only one person is speaking at a
time.  Voice-over-IP (VoIP) products have the ability to sense the
silence and cease transmitting when one party is quiet.  This
technique almost halves the required bandwidth of a typical telephone
conversation.  As a result, IP telephony commonly consumes as little
as one-twelfth the bandwidth of POTS to transmit conversations.  In
addition, IP telephony provides carriers with the ability to lower costs by
consolidating both voice and data in one network instead of necessitating the
two separate networks required for traditional POTS and data.




12


VoIP
technologies convert digitized voice into data packets that are encapsulated in
Internet protocol, thus allowing IP Phone calls, faxes and voice traffic to be
relayed over corporate intranets or across the Internet.  As a result,
VoIP presents an opportunity for exciting new uses for IP-based phone systems,
such as: IP multicast conferencing and telephony distance learning applications,
phone directories and customer service monitoring and playback of calls via IP,
and “voice web browsing” where the caller can interact with a web page by
speaking commands.  The ability to access enterprise data and
applications through a device such as a web-browser enabled IP Phone has
presented an opportunity to position the IP Phone as a peer to the personal
computer in many work environments - especially where PC's are not appropriate
user interfaces for employees.  Apart from the economies provided by
moving a firm’s communications onto one network, it is IP convergence–the
uniting of voice, video and data–that has provided many companies with a
compelling reason to replace legacy phone systems with IP
telephony.




Market
Highlights:




·
            Total
      IP phone annual shipments are expected to grow from 10 million units in
      2006 to 164 million units in 2010 (still less than 5% of all communication
      devices sold) (According to research firm,
  In-Sat).




·
            Enterprise
      converged mobile device (SmartPhone) shipments were 7.3 million in 2005,
      and are projected to reach 63 million units worldwide by 2010 (According
      to research firm, IDC).




·
            Computer-Telephony
      Integration (CTI) was $5 Billion in 2005, and projected to be $12 Billion
      by 2010 (According to Telecommunication Industry Association - North
      America).




·
            $7.5
      Billion in revenue is expected to be reached by 2010 for the Land Mobile
      Radio market (LMR) (Venture Development Corporation – North
      America).




Limitations
of Existing IP Telephony Solutions




Existing
IP telephony solutions have been criticized for lacking the broad set of
features, or applications, such as voicemail, call transfer, and three-way
calling, that traditional PBX phone systems have developed over the past
century.  As an application development company for the IP telephony
market, we bridge the feature/function gap currently present in many major IP
telephony platforms like those provided by Cisco, Avaya, Nortel, Siemens and
others.  We believe that, just as happened with POTS, application
providers will flourish alongside the equipment providers as the IP telephony
market develops and matures.




THE
OPPORTUNITY FOR CONVERGENCE OF VOICE, VIDEO AND DATA




IP
telephony refers to the technology used in transmitting voice over a network
using open, standards-based IP.  Our Convergence IP telephony
solutions leverage a single network infrastructure for the transmission of data,
voice, and video traffic to deliver high-quality voice and fully integrated
communications and enable enterprises to realize the business benefits of a
converged network.  These benefits include increased productivity,
business flexibility, and reduced operational costs.




With the
mainstream adoption of enterprise IP communications, businesses are now
embracing the operational benefits of convergence at an accelerated
pace.  While the infrastructure benefits of IP telephony are well
documented, the user-level benefits are only now starting to
emerge.  Today, businesses deploying IP telephony are looking for
benefits that extend beyond VoIP into ways to integrate existing business data
into the telephony environment.




Collaboration
tools like video conferencing and multicasting can be delivered to every
desktop, enabling up-to-the minute information sharing between employees,
partners, suppliers and customers–improving the company's ability to respond and
collaborate at a fraction of the cost of other point solutions.




13


Unified
views of customer data also become a reality with the true integration of voice,
video and data.  Combined with the use of intelligent communication
devices like IP-based phones, critical information and important messages can
travel to the employees to enable them to work smarter and faster.




Finally,
a converged network is more capable of supporting a mobile
workforce.  By offering remote access to a corporate network and its
information, geographically dispersed locations or traveling employees can
access the tools they need to perform and interact with customers, thereby
increasing per capita efficiency.




The
movement towards incorporating voice, video and data into a single network is
referred to as "convergence".  IP telephony now allows the telephone
to serve up data in a manner similar to a PC or any other web-enabled
device.




Before
the introduction of our Cistera ConvergenceServerTM, most IP data-based
applications offered via IP Phones were limited by the phone's own ability to
navigate and/or manipulate data in a meaningful way.  The Cistera
ConvergenceServerTM, coupled with XML, other standard protocols and an IP
telephony environment, allows an enterprise to achieve unique client-application
integration through its IP Phones.  This integration is accomplished
in the network as a peer with other user interface devices such as PCs, PDAs,
wireless phones and point-of-sale devices, among others.  By coupling
an XML browser with voice services, we are able to combine voice, video and
powerful data query applications and deliver them through IP communications
devices.




OUR
STRATEGY




Our
objective is to be the leading provider of IP communications application
platforms and advanced application engines for businesses worldwide. To achieve
this objective, we are pursuing the following strategies:




Extend Our
Product and Technological Leadership. We believe our solution supports
more communications and data format standards across the broadest range of
communications systems than all other competing solutions, allowing us to
provide improved interoperability within a customer’s existing network
infrastructure.  We intend to build upon our IP communications
technology and improve our solution's functionality and ease-of-use for rapidly
designing, deploying and maintaining our communications solutions in a
customer’s environment.  We may also seek to enhance our products
through licensing or acquiring complementary technologies or
businesses.  We believe that we are also unique in delivering a full
suite of application engines to an IP communications end point and plan to
extend our application engine portfolio.




Expand Sales and
Distribution Channels.  We intend to pursue a multi-channel
distribution strategy by expanding our key relationships with system
integrators, VARs, OEMs and distributors.  We intend to increase our
domestic distribution by adding channel sales personnel.  We also plan
to continue to expand our indirect distribution through alliances with
additional system integrators, VARs and OEMs.  We intend to launch our
international distribution by developing additional relationships with
international distributors and creating strategic alliances with international
system integrators.  We anticipate that our primary means of
addressing the market will be through our indirect channel.




Capitalize on Our
Professional Services Capabilities.  We have established what
we believe to be highly successful relationships with customers and VARs by
assisting them in designing, developing and deploying our convergence
solutions.  Our professional services range from strategic and
architectural planning to complete integration and deployment of our
products.  We encourage our indirect channel partners to build out
professional services practices to support the Cistera solutions by offering
certification training classes. We will continue to extend our professional
services expertise in applying emerging standards, to create additional
solutions that capitalize on our technologies.  By offering a full
range of professional services, we believe we can strengthen our existing
customer and VAR relationships and foster new relationships, creating
opportunities to sell additional products.  Our current expectation is
for our VAR channel to handle the standard installation and configuration
requirements, thereby enabling us to focus on the more advanced customer
services requirements and to scale rapidly to meet the anticipated demand for
our convergence solutions.




14


Build a
comprehensive annuity business. Because the telecommunications industry
is predominately an annuity business, we intend to build out a platform and
services offering that creates a sustainable annuity structure, consisting of
the delivery of hosted application services that can be delivered through Hosted
Service Providers (HSPs). We believe that over time enhanced application
services delivery will become a significant component of the typical customer’s
overall enterprise communications budget and that customers will entertain
different financial models from those previously adopted by the traditional PBX
vendors. Examples of these financing options include perpetual licensing,
maintenance fees, services, subscription and lease-to-own options. We intend to
offer all of these financial models over time.




PRODUCTS




Our
convergence products consist of application appliances—hardware and software
combined to deliver a broad suite of feature-sets on a scalable
architecture:




Hardware platforms. The
Cistera platforms combine advanced software engines with hardware devices that
have been optimized and in some cases, specifically designed to deliver the
performance and scalability required for IP telephony application
environments.




Þ
            Cistera ConvergenceServerTM
      (CCSTM)the foundation of a Cistera IPT solution is available in six
      form factors—the CCS 1000, the CCS 1500, the CCS 2500, the CCS 5500 and
      the CCS 7500 are designed to support  “small”, “medium”, “large”
      and “service provider” performance requirements for specific customer
      locations.  The servers are rack-mountable, open standards-based
      hardware systems.





Þ
            Cistera ZoneControllerTM (CZCTM)enables IP phone systems to work with existing or newly installed
      overhead speakers to create a unified paging system.  Cistera’s
      solution is the only one that supports simultaneous broadcasting to IP
      phones and speakers.





Cistera 1.8 Software
Platform.  The Cistera 1.8 software platform is a
component-based architecture that enables enhanced scalability and management of
advanced IP Phone applications.  This platform has built in media
management engines that enable third-party application developers to leverage
our pre-built components—a voice recording engine, a broadcast engine, a content
streaming engine, a pin code and authentication engine, a ruleset engine and a
grouping engine—without having to create each component from the ground
up.  Our authorized developers can use our published APIs to invoke
many of these services and therefore focus their development efforts on the
workflow components critical for specific industries.  This platform
also provides configurable administration and management tools.




Cistera Advanced IP Phone Application
Solutions.  We believe that we have developed the broadest
suite of advanced IP communications solution sets available in the market
today.




Quality Assurance and Complianceare systems that allow organizations to better respond to the needs of
their customers and their partners. This solution enables organizations to build
feedback loops by automating audit and compliance needs through recording and
monitoring systems. Quality Assurance and Compliance Systems include recording,
monitoring, screen capture, supervisory intervention and reporting tools that
increase the organization’s ability to view and response to customer
experiences.




The
application engines include:




Þ
            QuickRecordTM - is a robust IP
      telephony voice recorder and media management service designed to support
      those environments requiring reliable call recording functionality on an
      adhoc basis, using major IP Telephony platforms like Cisco’s Call
      ManagerTM, Call Manager Express and Sylantro PBX
  platforms.





15


Þ
            CallCenterRecordTMStandard- Dynamic call
      recording and playback features for your IP phone network. Providing
      high-quality, continuous call recording capabilities that will become an
      integral part of the way you do business. With digitized recordings, you
      will be able to transport recorded calls in your network as you see fit —
      attach them to a problem ticket, analyze them for customer service,
      minimize potential liability to your
  organization.





Þ
            CallCenterRecordTM
      Enhanced -CallCenterRecord Enhanced builds on the successful
      CallCenterRecord. Enhanced provides for capabilities for the supervisor
      and auditor including Quality Reporting, Monitoring, and screen captures.
      Enhanced offers a complete recording and monitoring solution for small and
      medium contact centers.





Þ
            CallCenterRecordTM
      Enterprise-is Cistera’s premier solution for large-scale contact
      centers. It provides a comprehensive solution for unified contact centers
      and builds on the functionality of Enhanced including tighter integration
      with Cisco Unified Contact Center (TM) and Cistera QuickConnect outbound
      dialer, remote desktop control as well as comprehensive dashboarding
      functionality





Þ
            LMRRecord
      for Cisco IPICS-is Cistera’s solution specifically designed to
      support Cisco’s IP Interoperable Communications
      Solutions.  Cistera is the first and only recording solution
      designed and certified for Cisco’s IPICS offering.  With this
      solution, customers can record all two-way radio, cell phone, and
      traditional analog systems in a single “talk
  group”.





Event Alerting and Notification -Event Alerting and Notification Solutions allow customers to use their IP
Telephony Platform as the core to their alerting and notification
strategy.  Emergency alert and notification solutions help
organizations of all sizes communicate quickly and effectively during all types
of incidents and challenges.





Þ
            RapidBroadcastTM - Advanced,
      full-featured messaging service that links data and voice with your
      business’ communication devices. Instantly transmit text or voice messages
      or schedule pre-recorded broadcasts to your entire organization through IP
      phones or external overhead speakers. Easy to configure and administer,
      RapidBroadcastTM, and the entire suite of Cistera Networks applications, is
      managed via a web-based interface. Features include Whisper, Intercom,
      paging, text messaging and numerous other
  features.





Þ
            LMRConnectTM
      -Two-way radios are a communications cornerstone for public
      agencies, emergency operations and businesses around the world. However,
      until today, proprietary technology confined push-to-talk radios to their
      own networks—keeping them well-separated from convergence with IP
      Telephony. Recognizing the need to integrate, Cistera Networks has created
      the LandMobileRadio (LMR) Connect Application Engine—bringing two-way
      radios into the IPT network.





Þ
            MasterBellScheduler
      -Cistera provides a comprehensive solution for scheduled alerting
      and notification such as school bell ringing schedule. Using the popular
      RapidBroadcast Application Engine and the Cistera Convergence Server
      (CCS), education IT administrators can control all elements of school bell
      ringing. From short days, K-12 and High School to emergencies, the IT
      administrator can tailor a schedule unique to their
      environment.





Þ
            QuickConnect- is the premier engine for the delivery of event alerting and
      notification for cellular and analog phones.  As part of the
      Event Alerting and Notification Solution, QuickConnect extends the popular
      RapidBroadcast to launch notifications beyond IP Phones, overhead paging
      systems and two-way radios now to every communications device.
      QuickConnect as an outbound dialing engine, can manage communications for
      Contact Centers, Education facilities, Local Government and
      Healthcare.





16


Collaboration and Productivitysolutions provide businesses with features for IP Telephony that enable
improved business workflow and the streamlining of business processes. From
providing a single view of directory services, to improved voicemail and
conference services to implementing a more comprehensive presence strategy,
businesses can place more tools in the hands of the PC and phone users. Cistera
provides a platform for the seamless delivery of productivity, collaboration and
communication features while at the same time lowering the cost and complexity
of administering these features.





Þ
            VirtualDirectoryTM- a centralized
      directory system that allows telephone users, both internal and external,
      to traverse corporate information quickly without time consuming
      tree-based systems. Callers can use their touchtone or voice to request
      information or to be directed to the appropriate extension.  It
      supports LDAP integration into popular contact management
      systems.





Þ
            ContentStreamerTM - Bringing
      advanced voice, graphics, music, and data streaming capabilities to your
      IP phone network. You apply your own business logic, and let
      ContentStreamer work with your implementation of Cisco CallManagerTM to
      determine who is on-hold. ContentStreamer will then stream your message to
      that caller, conserving bandwidth.  ContentStreamer also
      provides NetRadio, the ability to stream media directly to the phone,
      Concerto, a picture management system for IP Phones, RSS Readers and RSS
      Feed Management, Podcasting and
more.





Þ
            PresenceManagerTM -Presence Manager
      allows IP phone users and administrators to tailor their environments
      based on multiple factors, including physical presence and availability.
      Presence Manager allows administrators to control Global Presence for
      phones, such as setting the phone access for phones in classrooms. The
      Cistera ConvergenceServer(TM) uses PresenceManager to appropriately
      deliver, record and playback calls, to present notifications and events
      correctly and to allow a more comprehensive real-time directory view of an
      organization.





Þ
            CentraMailTM - Cistera’s
      CentraMail offers unified voice mail and messaging capabilities in the
      Cisco and Nortel environments. CentraMail provides advanced
      functionality—a necessity no matter your organization’s size! With optimal
      flexibility and enterprise scalability, CentraMail fulfills all of your
      voice mail needs.





Þ
            QuickConference - offers
      high-level conferencing capabilities with easy-to-use administration.
      QuickConference gives every organization an advanced means to host
      multi-channel, multi-user conferences—a key to successful business
      communications.  Quick Conference is tightly integrated into IP
      phone environment to provide an unparalleled user
    experience.





Our
convergence solutions utilize several key technologies to provide integration
into IP communications environments, including XML, JTAPI, J2EE, SIP, H.323, and
others.




Our
convergence solutions have been designed to interoperate seamlessly within
network environments, by aligning with key industry standards.  There
are occasions where integration with certain legacy platforms requires that our
solutions interact with some proprietary protocols.  In these
situations, our convergence solution works to maintain open protocols for the
broad network functions, while supporting the proprietary codecs for the
specific areas of interoperability.  An example of this would be in
the way our products currently support Cisco’s proprietary SCCP
protocol.




We have
designed our solutions to provide support for many of the emerging industry XML
standards with minimal impact to existing business applications. We
believe this non-intrusive architecture is a key in enabling integration of IP
based voice, video and data; and will enable content to be delivered to a wide
array of devices, like IP Phones, wireless phones, PDAs, etc.




17


COMPETITION




Cistera
competes with a number of companies that derive revenues from telecommunications
budgets of the millions of SMB and Enterprise Businesses throughout the world
and specifically those that compete for the capital budgets for CPE. Cistera
earns 100% of its revenues currently from equipment purchased as part of an
Enterprise Telecommunications Infrastructure (CPE) and more recently through
VOIP based hosted service providers.





We have a
broad offering of functionality and services that we combine together on a
platform to create compelling application services for our end users. Therefore
we predominately compete with other companies that either (a) provide point
solutions that compete with one aspect of our offering such as Nice Systems,
Verint and others or  (b) compete with broader platforms solutions
with similar offerings such as Interactive Intelligence, Aspect and
Genesys.





ITEM
2:  DESCRIPTION OF PROPERTY





Our
corporate offices are located at 6509 Windcrest Drive, Plano,
TX  75024.  We lease this office space, which contains
approximately 9,767 rentable square feet, from GK II Plano, L.P.  Our
rent under this lease is approximately $11,226 per month and the lease expires
July 31, 2013.





ITEM
3:  LEGAL PROCEEDINGS





The
Company, and certain of its current and former officers and directors are
defendants in litigation pending in Dallas, Texas, styled KINGDON R. HUGHES VS.
GREGORY T. ROYAL, CYNTHIA A. GARR, JAMES T. MILLER, JR., CHARLES STIDHAM, CNH
HOLDINGS COMPANY D/B/A CISTERA NETWORKS AND XBRIDGE SOFTWARE, INC.; Cause No.
DV05-0600-G; G-134th District Court, Dallas County, Texas.  The
plaintiff has alleged a number of complaints against the defendants, including
breach of fiduciary duty, misappropriation of corporate opportunities, fraud,
fraudulent inducement, breach of contract, tortuous interference with contract,
fraudulent transfer, and shareholder oppression arising in connection with the
license agreement between the Company and XBridge in May 2003 and the
acquisition of XBridge by the Company in May 2005.  The parties held a
mediation conference in April 2006 and have come to an understanding with
respect to the principle elements of a potential settlement.  We are
currently in the process of negotiating definitive settlement
agreements.





ITEM
4:  SUBMISSION OF MATTERS TO A


VOTE
OF SECURITY HOLDERS





None.


18


PART
II





ITEM
5:  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND SMALL
BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES





Our common stock is presently traded in
the over-the-counter market and is listed on the Pink Sheets maintained by the
National Quotation Bureau, Inc., and on the Bulletin Board maintained by the
maintained by the Financial Industry Regulatory Authority (formerly known as the
National Association of Securities Dealers, Inc.), under the symbol CNWT. The
following table sets forth the range of high and low bid quotations for the
common stock during each calendar quarter beginning April 1, 2006, and ending
March 31, 2008.  The figures have been rounded to the nearest whole
cent.





High
            
            LowJune
      30, 2006
            
            $1.32
            
            $1.13September
      30, 2006
            
            $2.15
            
            $0.65December
      31, 2006
            
            $0.80
            
            $0.64March
      31, 2007
            
            $1.50
            
            $1.35June
      30, 2007
            
            $1.60
            
            $0.85September
      30, 2007
            
            $1.02
            
            $0.63December
      31, 2007
            
            $1.01
            
            $0.50March
      31, 2008
            
            $0.95
            
            $0.73





The above quotations reflect
inter-dealer prices, without retail mark-up, mark-down, or commission and may
not necessarily represent actual transactions.  The number of
shareholders of record of the Company's issued and outstanding common stock as
of March 31, 2008 was approximately 576.  Registered holders include
brokerage firms and clearinghouses holding our shares for their clientele, with
each brokerage firm and clearinghouse considered as one holder.





The Company has not paid any cash
dividends to date and does not anticipate paying cash dividends in the
foreseeable future.  It is the present intention of management to
utilize all available funds for the development of the Company's
business.





On
January 9, 2004, our Board of Directors approved a long-term incentive plan (the
“Plan”), under which we may issue compensation, including stock grants and stock
options up to a maximum of 2,000,000 shares.  The Plan has not yet
been approved by our shareholders.  As of August 5, 2008, we have
outstanding options to purchase 140,000 shares of common stock issued under the
Plan, subject to stockholder approval of the Plan.  In addition, in
connection with our acquisition of XBridge Software, options to purchase 150,246
shares of XBridge Software stock were converted into options to purchase 407,917
shares of our common stock.









19


The
following table summarizes our equity compensation plan information as of August
5, 2008




Equity
      Compensation Plan InformationPlan
      category
            
            Number
      of securities to be issued upon exercise of outstanding options, warrants
      and rights
              (a)
            
            Weighted-average
      exercise price of outstanding options, warrants and rights
              (b)
            
            Number
      of securities remaining available for future issuance under equity
      compensation plans (excluding securities reflected in column
      (a))
              (c)Equity
      Compensation Plans approved by security holders
            
            N/A
            
            N/A
            
            N/AEquity
      Compensation Plans not approved by security holders
            
            547,917
            
            $0.63
            
            1,452,083Total
            
            547,917
            
            $0.63
            
            1,452,083





EQUITY
COMPENSATION PLAN GRANTS NOT APPROVED BY SECURITY HOLDERS.




Under the
provisions of the Plan, on February 6, 2004, the Company granted non-statutory
options for 100,000 shares of common stock, to various employees in
consideration for employment with and services provided to the Company, and
non-statutory options for 275,000 shares of common stock to Mr. Derek Downs, our
current Chief Executive Officer, interim Chief Financial Officer and a
Director.  These options were issued with an exercise price of $1.30,
which was the closing trading price per share on the date of the grant. These
options vest over 4 years from the date of the grant, and may be exercised at
any time after vesting through January 2009.




Under the
provisions of the Plan, on October 1, 2004, the Company granted non-statutory
options for 550,000 shares of common stock, including options to purchase
275,000 shares to each of Mr. Greg Royal, our Executive Vice President, Chief
Technology Officer and Director and Ms. Cynthia Garr, a Director, in
consideration for employment with and services provided to the
Company.  These options were issued with an exercise price of $1.10,
which was the closing trading price per share on the date of the
grant.  Fifty percent of these options vested immediately and the
other 50% vested one year from the grant date and could be exercised at any time
after vesting through October 2009.  On April 1, 2007, the options
granted to each of Messrs. Downs and Royal and Ms. Garr were mutually cancelled
by the parties.  Additionally on October 1, 2004, the Company issued
90,000 non-statutory options for 90,000 shares of common stock to various
outside service providers and employees.  These options vested over a
range of immediately to four years and have five year contractual
lives.




Under the
provisions of the Plan, on January 3, 2005, the Company granted 304,550
restricted shares of common stock to various employees and consultants as
consideration for employment with and services provided to the
Company.  Of these shares, 123,132 restricted shares were granted to
Mr. Downs.  The market price of our common stock on January 3, 2005,
the date of these grants, was $3.00.  On April 1, 2006, the Company
granted an additional 2,000 restricted shares of our common stock under the
provisions of the Plan to another employee as consideration for employment with
the Company.  The market price of our common stock on April 1, 2006
was $0.95.




20


Recent
Sales of Unregistered Securities







Set forth
below is information regarding the issuance and sales of the Company’s
securities without registration for the past three (3) years .  No
such sales involved the use of an underwriter, no advertising or public
solicitation were involved, the securities bear a restrictive legend and no
commissions were paid in connection with the sale of any
securities.




On April
29, 2005, the Company issued 173,511 shares of common stock in exchange for the
conversion of accrued liabilities of $482,364.  The shares were issued
at $ 2.78 per share, which was equal to the average closing price of our common
stock over the ten trading days prior to the date of issuance.




Effective
May 27, 2005, we issued 4,150,000 shares of our common stock in connection with
the merger of XBridge with XBR Acquisition, Inc., a newly formed subsidiary of
the Company.  At the time of the merger, XBridge held 2,150,000 shares
of our common stock, which shares were cancelled.  In connection with
this merger, options and warrants to purchase 310,643 shares of XBridge common
stock were converted into options to purchase an additional 842,383 shares of
the Company's common stock, at exercise prices ranging from $0.01 to $0.46 per
share.  The Company also issued an additional 173,511 shares to
certain of the officers and consultants of XBridge in exchange for the
cancellation of $482,364 of XBridge debt held by these
individuals.  The debt represented trade accounts payable and accrued
consulting fees, notes payable and accrued interest that were unpaid by
XBridge.  Ms. Cynthia A. Garr, then the Company’s Executive Vice
President and acting Chief Financial Officer and also the President and a
director of XBridge, received 63,363 shares of our common stock in exchange for
the cancellation of $72,914 of unpaid expenses, $72,725 of notes payable and
accrued interest, and $30,510 of unpaid accrued consulting fees.  Mr.
Gregory T. Royal, then the Company’s Chief Technology Officer and a director and
also a Vice President and director of XBridge, received 108,081 shares of our
common stock in exchange for the cancellation of $8,564 of unpaid expenses and
$291,902 of unpaid accrued consulting fees.  Mr. Derek P. Downs, then
our acting Chief Executive Officer and a director and also a consultant to
XBridge, received 2,067 shares of our common stock in exchange for the
cancellation of $5,749 of unpaid expenses. The shares of our common stock issued
to these individuals was valued at $2.78 per share, which was the average
closing price of our common stock for the ten trading days prior to the
effective date of the merger.  This share value was also the value
used to determine the exchange ratio for the shares of our common stock to be
received by all other XBridge shareholders.




The
Company believes that the structure of the merger agreement with XBridge and the
issuance of shares were comparable to what the Company would have received
through arms-length negotiations with an unaffiliated party.  At the
time of the services agreement and the issuance of the shares, XBridge owned
approximately 51% of our outstanding shares of common stock, and a majority of
our then officers and directors were also officers and directors of
XBridge.  This transaction enabled us to obtain outright ownership of
the XBridge intellectual property upon which our products are based and
eliminate future product development and maintenance payments to
XBridge.  Costs associated with maintenance and support related to the
license agreement totaled $1.86 million during the first two years of the
twenty-year life of the agreement.  In addition, we believed that the
Company’s ownership of the XBridge intellectual property would prove to be
invaluable in both securing agreements with tier-one channel reseller partners
and in giving the Company flexibility for future growth and product line
expansion.  Based upon client driven product acceptance and sales
order growth, the Company believed that eliminating potential royalty
commitments was in the best interest of the Company's shareholders.




Including
the new shares issued in the merger, the elimination of the $1.86 million in
inter-company payables and XBridge’s outstanding debt of approximately $200,000
at the time of the merger, the total purchase price for the XBridge acquisition
was approximately $5.5 million.




On June
24, 2005, the Company issued 100,000 shares of common stock from the exercise of
outstanding stock options.  The exercise price of the options was
$2.00 per share.




On
December 13, 2004, the Company completed a private placement offering of Senior
Unsecured Promissory Notes (“PP1 Notes”), which included warrants (“PP1
Warrants”).  In September 2005, although the stock price had not
achieved the levels necessary to allow the Company to redeem the PP1 Warrants,
PP1 Warrant holders were offered an incentive of one-half warrant for each PP1
Warrant exercised.  This incentive expired on




21


December
31, 2005.  On that date, the Company raised an additional $405,080
from the issuance of 311,600 shares of stock in connection with the exercise of
311,600 PP1 Warrants and issued 155,800 “incentive” PP1 Warrants.  The
exercise price of the PP1 Warrants was $1.30 per share.




On
December 31, 2005, the Company issued 946,392 shares of stock upon conversion of
certain PP1 Notes.  The amount of principal converted was $859,000 and
the amount of accrued interest converted was $87,392.  These PP1 Notes
were converted at $1.00 per share.




On March
31, 2006, the Company issued 67,785 shares of stock upon conversion of certain
PP1 Notes.  The amount of principal converted was $57,000 and the
amount of accrued interest converted was $10,785.  These PP1 Notes
were converted at $1.00 per share.




On March
31, 2006 the Company issued 2,000 shares of stock to a former contractor for
providing project management services valued at $2,000.  As part of
the initial agreement with this contractor, these shares were to be issued upon
the delivery of services defined by the agreement.




On March
31, 2006, the Company reissued 8,000 shares of stock as part of a legal
settlement.  The shares had been previously issued and were cancelled
as part of a court order, but were never returned to the Company.  As
per the settlement, the 8,000 outstanding were cancelled and subsequently
reissued as unrestricted shares.




On July
1, 2006, the Company issued 70,803 shares of common stock in connection with the
exercise of warrants issued in the merger of the Company with XBridge Software,
Inc.  The exercise price of the warrants was $.46 per
share.  The warrants were exercised for notes payable totaling
$32,594.




On August
31, 2006, the Company issued 4,034 shares of common stock upon conversion of the
principal and accrued interest on a previously issued convertible
note.  The principal amount of the note converted was $1,000 and the
amount of accrued interest converted $3,034.  The notes converted at
$1.00 per share.




On
October 25, 2006, the Company issued 122,028 shares of common stock in
connection with the exercise of options issued in the merger of the Company with
XBridge Software, Inc.  The exercise price for these options was $.01
per share.




On
December 13, 2006, one PP1 Note holder converted the outstanding balance of his
note (based on $1.00 per share conversion), and the Company issued 17,931 shares
of its common stock in exchange for the conversion of $15,000 of principal and
accrued interest of $2,931 related to these PP1 Notes.  The Company
recorded this conversion transaction on December 13, 2006, but did not
physically issue the shares to the PP1 Note holder until January 23,
2008.  See further discussion under this Item.





On
December 29, 2006 we issued and sold an aggregate of $433,571 in principal
amount of Senior Unsecured Convertible Promissory Notes (“PP2 Notes”), and
issued warrants (“PP2 Warrants”) to purchase 433,571 shares of our common stock,
par value $0.001 per share.  Of the $433,571 in principal, we received
cash of $433,571.  On April 5, 2007, we issued and sold an aggregate
of $3,065,205 in principal amount of additional PP2 Notes, and issued additional
PP2 Warrants to purchase 3,065,205 shares of our common stock.  Of the
$3,065,205 in principal, we received cash of $2,416,429, and $648,776 in
principal amount of PP2 Notes was issued in connection with the cancellation of
an equal amount of the Company’s outstanding obligations. Included in the
outstanding obligations that were cancelled was $30,000 in past due compensation
to Mr. Derek Downs and $70,779 to Mr. Greg Royal.  As a result of the
cancellation of this debt, Mr. Downs was issued 30,000 shares in principal
amounts in PP2 Notes and 30,000 PP2 warrants to purchase 70,000 shares, and Mr.
Royal was issued 70,779 shares in principal amounts in PP2 Notes and 70,779 PP2
Warrants to purchase 165,151 shares, upon the same terms and conditions as
provided to the other investors in this private placement.  Of the
total proceeds, $1,805,606 was received prior to the closing date in the fiscal
year ended March 31, 2007, and was recorded as a long term liability under the
caption “convertible promissory notes” on our Consolidated Balance Sheet as of
March 31, 2007.





22


The PP2
Notes bear interest at the rate of 8% per annum, compounded quarterly on each
March 31, June 30, September 30 and December 31 anniversary that they are
outstanding (each, an interest compounding date).  The outstanding
principal and all accrued interest become due and payable two years from the
date of issuance of the PP2 notes.  The outstanding principal and
accrued interest are convertible into shares of common stock at a fixed rate of
$0.75 per share rate.  The PP2 Warrants have a term of five years and
are exercisable at an exercise price of $1.00 per share.  The PP2
Notes may be converted, in whole or in part, at the option of the PP2 Note
holder on any interest compounding date occurring after the effective date of a
registration statement covering the resale of shares of common stock to be
issued upon conversion of the PP2 Notes.





In
addition, if we subsequently issue or sell any new securities convertible,
exercisable or exchangeable into shares of our common stock (“convertible
securities”) in a private transaction and receives gross proceeds of at least
$500,000, the PP2 Notes may be converted, in whole or in part at the option of
the note holders, into the convertible securities, upon the same terms and
conditions governing the issuance of the convertible securities in the private
transaction.  The right of the PP2 Note holders to convert their notes
into convertible securities does not apply to any convertible securities issued
by us (a) in connection with a merger, acquisition or consolidation of the
Company, (b) in connection with strategic license agreements and other
partnering arrangements so long as such issuances are not for the purpose of
raising capital, (c) in connection with bona fide firm underwritten public
offerings of its securities, (d) pursuant to the Company’s incentive and stock
option plans, (e) as a result of the exercise of options or warrants or
conversion of convertible notes or preferred stock which were granted or issued
as of December 13, 2004.





We may
prepay the PP2 Notes in whole or in part, upon thirty days prior written notice
to note holders; provided that partial prepayments may be made only in
increments of $10,000 and, provided further, that the PP2 Note holders may
convert the amount of the proposed prepayment into shares of our common stock at
any time.





The PP2
Warrants have a term of five years and are exercisable at an exercise price of
$1.00 per share.  Subject to an effective registration statement
covering the resale of the shares of common stock issuable upon exercise of the
PP2 Warrants, we may, upon thirty days prior written notice, redeem the PP2
Warrants for $0.10 per share, in whole or in part, if our common stock closes
with a bid price of at least $3.50 for any ten (10) out of fifteen (15)
consecutive trading days.  Because at that price it would be
profitable for the PP2 Warrant holders to exercise their warrants rather than to
allow the redemption to proceed, we assume they would choose to exercise.
However, there can be no assurance that our stock price will rise to the $3.50
per share redemption trigger price, or that all of the PP2 Warrants will be
exercised.





In
January of 2008, the Company issued 3,815 shares of common stock upon conversion
of accrued interest on a previously issued convertible note.  The
amount of accrued interest converted was $3,815.  The interest
converted at $1.00 per share.




In
January of 2008, the Company issued 130,647 shares of common stock upon
conversion of accrued interest on a previously issued convertible
note.  The amount of accrued interest converted was
$130,647.  The interest converted at $1.00 per share.




On
January 23, 2008, the Company issued 17,931 shares of common stock upon
conversion of certain outstanding notes.  The amount of principal of
notes converted was $15,000 and the amount of accrued interest converted was
$2,391.  These notes were converted at $1.00 per share.





23


The
issuance of the shares of our common stock described above were made in private
transactions or private placements intending to meet the requirements of one or
more exemptions from registration.  In addition to any noted exemption
below, we relied upon Regulation D and Section 4(2) of the Securities Act of
1933, as amended (the “Act”).  The investors were not solicited
through any form of general solicitation or advertising, the transactions being
non-public offerings, and the sales were conducted in private transactions where
the investor identified an investment intent as to the transaction without a
view to an immediate resale of the securities; the shares were “restricted
securities” in that they were both legended with reference to Rule 144 as such
and the investors identified they were sophisticated as to the investment
decision and in most cases we reasonably believed the investors were “accredited
investors” as such term is defined under Regulation D based upon statements and
information supplied to us in writing and verbally in connection with the
transactions.  We never utilized an underwriter for an offering of our
securities and no sales commissions were paid to any third party in connection
with the above-referenced sales.  Other than the securities mentioned
above, we have not issued or sold any securities during the period covered by
this Report.







ITEM
6:  MANAGEMENT’S DISCUSSION AND


ANALYSIS
OR PLAN OF OPERATIONS





The
following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our consolidated financial
statements and related notes that appear in this filing.  In addition
to historical financial information, the following discussion contains
forward-looking statements that reflect our plans, estimates and
beliefs.  Our actual results could differ materially from those
discussed in the forward-looking statements.  Factors that could cause
or contribute to these differences have been included throughout the public
filings from the Company.





RESTATEMENT OF PREVIOUSLY
ISSUED CONSOLIDATED FINANCIAL STATEMENTS





The
Company is restating its  Consolidated Statements of Operations,
Consolidated Statements of Stockholders’ Equity and Consolidated Statements of
Cash Flows for the year ended March 31, 2007 to reflect: (i) a
correction in its accounting for its Senior Unsecured Convertible Promissory
Notes and detachable warrants issued in private placements during the period
from December 2004 to April 2007 (the “PP1 Notes,” “PP1 Warrants,” “PP2 Notes,”
and “PP2 Warrants”) and (ii) share-based compensation related to employee stock
options.  The adjustments required by this restatement had no impact on net
cash used in operations, net cash used in investing activities or net cash from
financing activities.





The
impact of the restatement is summarized in the table below:








Adjustments
      to Statements of OperationsConvertible
      Promissory Notes and Warrants
            
            
            Stock
      Compensation Expense
            
            
            TotalYear
      ended March 31, 2007
            
            $
            (665,195
            )
            
            $
            (101,700
            )
            
            $
            (766,895
            )Cumulative
      effect at April 1, 2006
            
            
            (621,472
            )
            
            
            -
            
            
            
            (621,472
            )Total
            
            $
            (1,286,667
            )
            
            $
            (101,700
            )
            
            $
            (1,388,367
            )





Convertible Promissory Notes
and Warrants





The
Company has concluded that its original accounting for the PP1 Notes and PP1
Warrants issued in fiscal year 2005 and the PP2 Notes and PP2 Warrants issued in
fiscal year 2007 and fiscal year 2008 was incorrect and that the necessary
adjustments were material for the fiscal year 2007 consolidated financial
statements.





24


The
Company based its conclusion upon a further review of the documents associated
with the Notes and Warrants and considered the following sources as relevant
guidance in determining the proper accounting treatment for the Notes and
Warrants.





·
            SFAS
      133, Accounting for
      Derivative Instruments and Hedging Activities(“SFAS
      133”),


·
            APB
      Opinion 14, Accounting
      for Convertible Debt and Debt Issued with Stock Purchase Warrants
      (“APB   14”),


·
            Emerging
      Issues Task Force (EITF) Issue 00-19, Accounting for Derivative
      Financial Instruments Indexed to, and Potentially Settled in, a Company’s
      Own Stock(“EITF 00-19”),


·
            EITF
      05-2,The Meaning of
      “Conventional Convertible Debt Instrument”(“EITF
      05-2”),


·
            EITF
      98-5, Accounting for
      Convertible Securities with Beneficial Conversion Features or Contingently
      Adjustable Conversion Ratios (“EITF
  98-5”),


·
            EITF
      00-27, Application of
      Issue No. 98-5 to Certain Convertible Instruments (“EITF
      00-27”),


·
            SEC
      Staff Accounting
      Bulletin No. 107(“SAB 107”)




Conversion feature of the
Notes





The
Company concluded that the Notes meet the definition of “conventional
convertible debt” (as defined in EITF 00-19 and affirmed in EITF
05-2).  EITF 00-19, paragraph 4 states: “The Task Force observed that,
pursuant to paragraphs 11(a) and 12(c) of Statement 133, if an embedded
derivative is indexed to the reporting entity's own stock and would be
classified in stockholders' equity if it was a freestanding derivative, that
embedded derivative is not considered a derivative for purposes of SFAS 133. The
Task Force reached a consensus that for purposes of evaluating under SFAS 133
whether an embedded derivative indexed to a company's own stock would be
classified in stockholders’ equity if freestanding, the requirements of
paragraphs 12–32 of this Issue do not apply if the hybrid contract is a
conventional convertible debt instrument in which the holder may only realize
the value of the conversion option by exercising the option and receiving the
entire proceeds in a fixed number of shares or the equivalent amount of cash (at
the discretion of the issuer).”





Therefore,
the Company has concluded that the conversion feature of the convertible debt
did not meet the definition of a derivative under SFAS 133 and did not require
separate accounting from the debt instrument.





Valuation of Notes and
Warrants and beneficial conversion feature





APB 14
addresses the accounting for convertible debt with a nondetachable (embedded)
conversion feature, the terms of which provide for an initial conversion price
that is greater than the market value at the date of issuance and a conversion
price that does not decrease, except under antidilution protection, but does not
explicitly address situations in which the embedded conversion feature is
“in-the money” at issuance.  The Notes, including any accrued
interest, were exercisable into the Company’s common stock at less than the
closing price of the Company’s stock on the dates of issuance, and the Company
considered this conversion to be an “embedded beneficial conversion
feature.”





EITF 98-5
requires “that embedded beneficial conversion features present in convertible
securities should be valued separately at issuance.” Further, EITF 98-5 states
“that the intrinsic value of the beneficial conversion feature may be greater
than the proceeds allocated to the convertible instrument,” and as such, “that
the amount of the discount assigned to the beneficial conversion feature is
limited to the amount of the proceeds allocated to the convertible instrument.”
EITF 00-27 further states “that the effective conversion price based on the
proceeds received for or allocated to the convertible instrument should be used
to compute the intrinsic value, if any, of the embedded
conversion option. As a result of this consensus, an issuer should first
allocate the proceeds received in a financing transaction that includes a
convertible instrument to the convertible instrument and any other detachable
instruments included in the exchange (such as detachable warrants) on a relative
fair value basis. Then, the Issue 98-5 model should be applied to the amount
allocated to the convertible instrument, and an effective conversion price
should be calculated and used to measure the intrinsic value, if any, of the
embedded conversion option.”


25





Accordingly,
we calculated the fair value of both the convertible Notes and the Warrants and
allocated the respective relative fair value percentages of each in determining
the initial values of the convertible Notes and the Warrants.  Because
the Warrants were determined to be derivative liabilities (see conclusion in
next section below and in Note 2 to the consolidated financial statements), the
Company recorded them at fair value as calculated under the Black-Scholes option
pricing model (“BS model”).  For Notes and Warrants issuances where
the net cash proceeds were greater than the fair value of the Warrants, this
difference was allocated to the value of the Notes.  The amount
assigned to the Warrants represented a debt discount on the Notes, which is
amortized over the life of the Notes.  For Notes and Warrants
issuances where the net cash proceeds were less than the fair value of the
Warrants, the Warrants were recorded at fair value and the difference was
recorded as a charge to the consolidated Statement of Operations at
inception.  This second situation occurred with issuance of the PP1
Notes in December 2004 and resulted in a charge to the Statement of Operations
of approximately $230,000; and no value was allocated to the Notes, with a full
debt discount recorded and amortized over the life of the Notes.





After
determining the recorded value of the Warrants and Notes (if any), we calculated
the beneficial conversion feature of the Notes, which resulted in an additional
debt discount which was amortized over the life of the Notes.





Classification and
accounting for Warrants





We
evaluated the Warrants as a potential free standing derivative under the
criteria in paragraph 11(a) of SFAS 133, which require that a contract
(Warrants) issued by a reporting entity be accounted for as a derivative unless
it is both (1) indexed to its own stock and (2) classified in stockholders’
equity in its statement of financial position. We concluded that the Warrants
were indexed to the Company’s own stock and should be classified in
stockholders’ equity and would qualify for the scope exception contained in this
paragraph.  The Company was required to further review the
requirements for equity classification contained in paragraphs 12-32 of EITF
00-19.  The Company concluded that it had not met criteria (2) above
based on the requirements for equity classification in EITF
00-19.  Specifically, both the PP1 and PP2 Notes contain registration
rights agreements (the “RR agreements”) that stipulate that the Company must
register all “registrable securities” (defined as the “shares of Common Stock
issuable upon conversion of the Notes and the shares of Common Stock issuable
upon exercise of the Warrants”) within a time frame (and this was deemed to be
outside of the control of the Company).  In the event of not filing a
registration statement by a specified date or by not having a registration
effective by a specified date, the Company was obligated to pay liquidated
damages in the amount of 1% of the then current outstanding amount of the Notes
plus accrued interest.  The Company accrued all required liquidated
damages, beginning in FY 2005 with the PP1 Notes. Liquidated damages required
under the RR Agreement for the PP1 Notes ceased on September 25, 2005, which was
the date that the Company filed its initial registration statement for the PP1
Notes and PP1 Warrants.





Accordingly,
the Company concluded that the Warrants did not satisfy the requirement for
equity classification and should be classified, recorded and prospectively
accounted for as derivative liabilities until it has registered all underlying
shares to the Warrants or until such time that the RR agreements are no longer
in effect.  The prospective accounting requires that the Warrants be
remeasured at each balance sheet date based on estimated fair value and any
resultant changes in fair value be recorded to the Statement of
Operations.





26


The
Company used the BS model for calculating the fair value of all Warrants issued
based on the following assumptions:





Warrants
      issued in PP1
            
            Warrants
      issued in PP2Expected
      volatility
            128%
            
            100%-104%Expected
      term
            5
      years
            
            5
      yearsRisk-free
      interest rate
            3.58%
      - 4.33%
            
            4.46%
      - 4.65%Expected
      dividend yield
            0%
            
            0%





We
estimated volatility primarily based on historical volatility rates through the
date of each closing of the PP1 and PP2 offerings. The Warrants have a
transferability provision and based on guidance provided in SAB 107 for options
issued with such a provision, we used the full, five-year contractual term as
the expected term in the initial valuation of the Warrants.  For the
risk-free interest rate, we used the five year U.S. Treasury zero coupon rate
for the initial valuation of the Warrants.  Expected volatilities,
expected terms and risk-free interest rates were adjusted as of each quarterly
period commensurate with the remaining contractual lives of the Warrants on such
dates and were used to determine the estimated fair value of the Warrants under
the BS model.





Share-based
compensation





The
Company has concluded that it incorrectly calculated and recorded share-based
compensation expense associated with stock options upon the adoption of SFAS
123R on April 1, 2006.  Specifically, the Company did not calculate
the fair value of employee stock options issued during the period from February
2004 through October 2004 and did not record any related expense in the
Statement of Operations for the year ended March 31, 2007 related to the
unrecognized stock option cost as of April 1, 2006.  The Company has
not issued any additional stock options to employees since October
2004.





27


The table
below summarizes the effect of the restatement adjustments on the Consolidated
Statement of Operations for the year ended March 31, 2007:





As
      previously reported
            
            
            Adjustments
            
            
            As
      restatedRevenuesConvergence
      Solutions
            
            $
            1,401,789
            
            
            
            
            
            $
            1,401,789Professional
      Services
            
            
            218,454
            
            
            
            
            
            
            218,454Support
      and Maintenance
            
            
            312,595
            
            
            
            
            
            
            312,595Total
      revenues
            
            
            1,932,838
            
            
            
            
            
            
            1,932,838Cost
      of revenuesConvergence
      Solutions
            
            
            313,272
            
            
            
            
            
            
            313,272Professional
      Services
            
            
            167,012
            
            
            
            
            
            
            167,012Support
      and Maintenance
            
            
            78,048
            
            
            
            
            
            
            78,048Total
      cost of revenues
            
            
            558,332
            
            
            
            
            
            
            558,332Gross
      Profit
            
            
            1,374,506
            
            
            
            
            
            
            1,374,506Expenses:Sales
      and marketing
            
            
            676,868
            
            
            
            
            
            
            676,868Software
      development
            
            
            510,025
            
            
            
            32,572
            
            
            
            542,597Engineering
      and support
            
            
            209,532
            
            
            
            
            
            
            
            209,532General
      and administrative
            
            
            831,400
            
            
            
            69,128
            
            
            
            900,528Depreciation
      and amortization
            
            
            347,086
            
            
            
            
            
            
            
            347,086Total
      expenses
            
            
            2,574,911
            
            
            
            101,700
            
            
            
            2,676,611Loss
      from operations
            
            
            (1,200,405
            )
            
            
            (101,700
            )
            
            
            (1,302,105
            )Other
      income (expense)Interest
      income
            
            
            714
            
            
            
            
            
            
            
            714Interest
      expense
            
            
            (84,752
            )
            
            
            
            
            
            
            (84,752
            )Amortization
      of discount on convertible notes
            
            
            
            
            
            
            (146,684
            )
            
            
            (146,684
            )Change
      in estimated value of derivative financialinstruments
      - warrants
            
            
            
            
            
            
            (518,511
            )
            
            
            (518,511
            )Total
      other income (expense)
            
            
            (84,038
            )
            
            
            (665,195
            )
            
            
            (749,233
            )Net
      loss
            
            $
            (1,284,443
            )
            
            $
            (766,895
            )
            
            $
            (2,051,338
            )Basic
      & diluted net loss per share
            
            $
            (0.16
            )
            
            $
            (0.09
            )
            
            $
            (0.25
            )Weighted
      average shares outstanding – basic anddiluted
            
            
            8,190,123
            
            
            
            
            
            
            
            8,190,123





28


The table
below summarizes the effect of the restatement adjustments on the Consolidated
Balance Sheet as of March 31, 2007:





As
      previously reported
            
            
            Adjustments
            
            
            As
      restatedCurrent
      assets:Cash
      and cash equivalents
            
            $
            534,871
            
            
            
            
            
            $
            534,871Restricted
      cash
            
            
            -
            
            
            
            
            
            
            -Accounts
      receivable, net
            
            
            314,178
            
            
            
            
            
            
            314,178Related
      party receivables
            
            
            23,927
            
            
            
            
            
            
            23,927Inventory
            
            
            75,743
            
            
            
            
            
            
            75,743Prepaid
      expenses
            
            
            10,143
            
            
            
            
            
            
            10,143Total
      current assets
            
            
            958,862
            
            
            
            
            
            
            958,862Property
      and equipment, net
            
            
            122,046
            
            
            
            
            
            
            122,046Intangible
      assets, net
            
            
            2,294,993
            
            
            
            
            
            
            2,294,993Total
      long-term assets
            
            
            2,417,039
            
            
            
            
            
            
            2,417,039TOTAL
      ASSETS
            
            $
            3,375,901
            
            $
            -
            
            
            $
            3,375,901Current
      liabilities:Accounts
      payable
            
            $
            544,796
            
            
            
            
            
            $
            544,796Related
      party payables
            
            
            24,038
            
            
            
            
            
            
            24,038Accrued
      liabilities
            
            
            598,023
            
            
            
            
            
            
            598,023Deferred
      revenue
            
            
            465,179
            
            
            
            
            
            
            465,179Convertible
      promissory notes
            
            
            144,000
            
            
            
            
            
            
            144,000Line
      of credit and other current debt
            
            
            64,509
            
            
            
            
            
            
            64,509Total
      current liabilities
            
            
            1,840,545
            
            
            
            
            
            
            1,840,545Convertible
      promissory notes
            
            
            1,900,606
            
            
            
            
            
            
            1,900,606Discount
      on convertible promissory notes
            
            
            
            
            
            
            (1,663,211
            )
            
            
            (1,663,211
            )Derivative
      financial instruments, at estimated fairvalue
      – Warrants
            
            
            
            
            
            
            2,265,225
            
            
            
            2,265,225Deferred
      revenue
            
            
            84,968
            
            
            
            
            
            
            
            84,968Total
      long-term liabilities
            
            
            1,985,574
            
            
            
            602,014
            
            
            
            2,587,588Total
      liabilities
            
            
            3,826,119
            
            
            
            602,014
            
            
            
            4,428,133Stockholders’
      deficit:Preferred
      stock
            
            
            -
            
            
            
            
            
            
            
            -Common
      stock
            
            
            8,292
            
            
            
            
            
            
            
            8,292Additional
      paid-in capital
            
            
            8,739,970
            
            
            
            786,353
            
            
            
            9,526,323Accumulated
      deficit
            
            
            (9,198,480
            )
            
            
            (1,388,367
            )
            
            
            (10,586,847
            )Total
      stockholders’ deficit
            
            
            (450,218
            )
            
            
            (602,014
            )
            
            
            (1,052,232
            )TOTAL
      LIABILITIES AND STOCKHOLDERS’DEFICIT
            
            $
            3,375,901
            
            
            $
            -
            
            
            $
            3,375,901





29


The table
below summarizes the effect of the restatement adjustments on the Consolidated
Statement of Cash Flows for the year ended March 31, 2007:





As
      previously reported
            
            
            Adjustments
            
            
            As
      restatedCASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
            
            $
            (1,284,443
            )
            
            $
            (766,895
            )
            
            $
            (2,051,338
            )Adjustments
      used to reconcile net loss to net cash used inoperating
      activities:Amortization
      of discount on convertible promissory notes –outside
      investors
            
            
            -
            
            
            
            146,684
            
            
            
            146,684Charge
      for changes in estimated fair value of derivativefinancial
      instruments - warrants
            
            
            -
            
            
            
            518,511
            
            
            
            518,511Depreciation
      and amortization
            
            
            347,086
            
            
            
            
            
            
            
            347,086Share-based
      compensation
            
            
            -
            
            
            
            101,700
            
            
            
            101,700Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            (125,149
            )
            
            
            
            
            
            
            (125,149
            )Related
      party receivables
            
            
            9,290
            
            
            
            
            
            
            
            9,290Inventory
            
            
            (52,616
            )
            
            
            
            
            
            
            (52,616
            )Prepaid
      expenses
            
            
            31,483
            
            
            
            
            
            
            
            31,483Accounts
      payable
            
            
            (350,181
            )
            
            
            
            
            
            
            (350,181
            )Related
      party payables
            
            
            (35,400
            )
            
            
            
            
            
            
            (35,400
            )Accrued
      interest
            
            
            44,109
            
            
            
            
            
            
            
            44,109Other
      accrued liabilities
            
            
            43,600
            
            
            
            
            
            
            
            43,600Deferred
      revenue
            
            
            320,988
            
            
            
            
            
            
            
            320,988Net
      cash used in operating activities
            
            
            (1,051,233
            )
            
            
            -
            
            
            
            (1,051,233
            )Net
      cash used investing activities
            
            
            (63,619
            )
            
            
            -
            
            
            
            (63,619
            )Net
      cash provided by financing activities
            
            
            1,588,733
            
            
            
            -
            
            
            
            1,588,733Net
      increase (decrease) in cash and cash equivalents
            
            
            473,881
            
            
            
            
            
            
            
            473,881Cash
      and cash equivalents at beginning of year
            
            
            60,990
            
            
            
            
            
            
            
            60,990Cash
      and cash equivalents at end of year
            
            $
            534,871
            
            
            $
            -
            
            
            $
            534,871SUPPLEMENTAL
      DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:Conversion
      of convertible promissory notes and related accruedinterest
      to common stock
            
            $
            21,965
            
            
            $
            -
            
            
            $
            21,965Conversion
      of accounts payable and other accrued liabilities toconvertible
      promissory notes
            
            
            220,606
            
            
            
            
            
            
            
            220,606Conversion
      of other notes payable to common stock
            
            
            32,595
            
            
            
            
            
            
            
            32,595Allocation
      of discount on convertible promissory notes to derivativefinancial
      instruments - warrants
            
            
            -
            
            
            
            1,244,591
            
            
            
            1,244,591Discount
      related to beneficial conversion feature on convertiblepromissory
      notes
            
            $
            -
            
            
            $
            482,934
            
            
            $
            482,934







30


OVERVIEW
OF BUSINESS




We
provide a range of enterprise application servers—named the Cistera
ConvergenceServerTM —for  IP Communications that deliver advanced
application services, like recording, monitoring and reporting for quality
assurance and compliance requirements; and broadcasting across IP phones, cell
phones, overhead speakers and two-way radios for event alerting and notification
requirements.  The solutions are used by organizations of all
sizes—large enterprises, small and mid-sized organizations, both in the
commercial and public sectors.  We offer our solution sets
predominately using a perpetual license and maintenance fee model, with
increasing movement to an annuity pricing structure for hosted application
services delivery (also referred to as Software-as-a-Service or
SaaS).




While we
have hundreds of customers in a diverse range of industries, we have focused our
proactive marketing efforts on healthcare and the public sector, including
federal, state, local government and education.  Our customers have a
range of needs requirements that we believe Cistera is uniquely qualified to
satisfy.  We have customers with requirements to provide public safety
and security, and look to Cistera’s Event Alerting and Notification solutions to
enable them to proactively establish protection for their citizens, members,
students or faculty.  Some customers need to increase customer
satisfaction through increased quality controls, while others have an obligation
need to meet compliance requirements.  These customers leverage
Cistera’s Quality Assurance and Compliance solution to meet these
challenges.




Our
objective is to be a leading provider of IP communications application services
for businesses worldwide.  To address our market opportunity, our
management team is focused on a number of short- and long-term challenges,
including: strengthening and extending our solution offerings; adding new
customers and expanding our sales efforts into the existing Cisco IPC customer
base as well as expanding into the new hosted solutions market; deepening our
relationships with our existing customers, VARs, and SIs; and encouraging the
integration of third-party applications with our enterprise
platform.




In order
to increase our revenues and take advantage of our market opportunity, we will
need to continue to increase Cistera’s visibility and awareness with our channel
partners, while beginning to conduct marketing programs directly to our end
customers to create increased demand for our solutions. We plan to reinvest our
earnings for the foreseeable future in the following ways: hiring additional
personnel, particularly in sales, marketing and engineering; expanding our
domestic and international selling and marketing activities; increasing our
research and development activities to upgrade and extend our solution offerings
and to develop new solutions and technologies; growing our VAR and systems
integration channel; adding to our infrastructure to support our growth; and
expanding our operational and financial systems to manage a growing
business.




FISCAL
YEAR




Our
fiscal year ends on March 31.  References to fiscal 2008 and fiscal
2007, for example, refer to the fiscal years ended March 31, 2008 and 2007,
respectively.




SOURCES
OF REVENUES




We derive
our revenues from three sources: (1) convergence solutions, which are comprised
of software and hardware solutions; (2) professional services revenues,
consisting primarily of installation, configuration, integration, training and
VAR support services; and (3) support and maintenance, which is comprised of
tiered technical support levels.  Convergence solutions revenues
accounted for approximately 73% percent of total revenues during fiscal year
2007 and 65% percent of total revenues during fiscal year
2008.  Professional services revenues accounted for approximately 11%
percent of total revenues during fiscal 2007 and 14% percent of total revenues
during fiscal year 2008.  Revenues for our support and maintenance
services made up approximately 16% percent of total revenues during fiscal 2007
and 21% percent of total revenues in fiscal 2008.




31


Product
revenues are recognized once the software and hardware solution has been shipped
according to the customer order, and is fully installed and operational. Prior
to the adoption of this policy, the Company recognized revenues once orders were
received and shipped. Professional services revenues are recognized once the
services have been completed and the customer has approved the
service.  Support and maintenance revenues are recognized on a monthly
basis over the life of the support contract.  The typical support and
maintenance term is 12 months, although terms range from 12 to 48
months.  Our support and maintenance contracts are non-cancelable,
though customers typically have the right to terminate their contracts for cause
if we fail to perform. We generally invoice our customers in annual or quarterly
installments and typical payment terms provide that our customers pay us within
30 to 45 days of invoice.  Amounts that have been invoiced are
recorded in accounts receivable and in deferred revenue, or in revenue depending
on whether the revenue recognition criteria have been met.  In
general, we collect our billings in advance of the support and maintenance
service period.




Professional
services and other revenues consist of fees associated with consulting and
implementation services and training.  Our consulting and
implementation engagements are typically billed in advance of delivery with
standard rates applied. We also offer a number of classes on implementing, using
and administering our convergence solutions that are billed on a per class
basis.  Our typical professional services payment terms provide that
our customers pay us within 30-45 days of invoice




COST
OF REVENUES AND OPERATING EXPENSES




Cost of
Revenues




Cost of
convergence solutions revenue consists primarily of the purchase cost of
computer equipment that hosts our platform and applications
solutions.  Cost of professional services revenue consists primarily
of employee related expenses from our field engineers and other employees and
contractors that configure, install, and integrate our convergence solutions for
our customers.  The cost of support and maintenance revenues primarily
consists of employee-related costs associated with providing technical support
at various service levels and the costs associated with any required maintenance
provided to our customers’ convergence solutions equipment.  The
company estimates that approximately 85% of salary cost of employees whose
primary role is to provide professional services and support and maintenance is
attributable to the cost of securing those revenues.




To the
extent that our customer base grows, we intend to continue to invest additional
resources in building the channel infrastructure to enable our VARs and SIs to
provide the professional services associated with the standard convergence
solutions installation, configuration and training.  The timing of
these additional expenses could affect our cost of revenues, both in terms of
absolute dollars and as a percentage of revenues, in a particular quarterly
period.  For example, we have increased and plan to further increase
the number of employees who are fully dedicated to supporting and enabling the
reseller and implementation partner channel.




Research and
Development




Research
and development expenses consist primarily of salaries and related expenses, and
allocated overhead.  We have historically focused our research and
development efforts on increasing the functionality and enhancing the
ease-of-use of our convergence platform and applications. Because of our open,
scalable and secure component-based architecture, we are able to provide our
customers with a solution based on a single version of our software application
platform. As a result, we do not have to maintain multiple versions, which
enables us to have relatively low research and development expenses as compared
to traditional enterprise software business models. We expect that in the
future, research and development expenses will increase in absolute dollars as
we support additional IP telephony platforms, extend our solution offerings and
develop new technologies.




Marketing and
Sales




Marketing
and sales expenses are typically one of our largest costs, accounting for
approximately 35% of total revenues for fiscal 2007 and 50% of total revenues in
fiscal 2008. It is expected that the company will increase spending in this
area, as the market for unified communications is beginning to show signs of
momentum.  Marketing and sales expenses consist primarily of salaries
and related expenses for our sales and marketing staff, including
commissions; payments to VARs; marketing programs, which include advertising,
events, corporate communications, public relations, and other brand building and
product marketing expenses, and allocated overhead. Since the beginning of
fiscal 2005, our sales and marketing costs as a percentage of total expenses
have increased as a result of increased market coverage in the U.S., Canada and
the U.K.


32




As our
revenues increase, we plan to continue to invest heavily in marketing and sales
by increasing the number of channel account management personnel in order to add
new customers and increase penetration within our existing customer base,
expanding our domestic and international selling and marketing activities,
building brand awareness and sponsoring additional marketing events. We expect
that in the future, marketing and sales expenses will increase in absolute
dollars and continue to be our largest cost.




General and
Administrative




General
and administrative expenses consist of salaries and related expenses for
executive, finance and accounting, and management information systems personnel,
professional fees, other corporate expenses and allocated overhead. We expect
that in the future, general and administrative expenses will increase in
absolute dollars as we add personnel and incur additional professional fees and
insurance costs related to the growth of our business and our
operations.




We expect
that general and administrative expenses associated with executive compensation
will increase in the future. Although the current executive team has
foregone full salary payment during the initial stages of the business, during
2007 the team began to receive compensation.  We expect that as the
company continues to show increased growth and performance improvement, the
compensation packages will be adjusted to more accurately reflect current market
value.  In addition, we believe that over the next fiscal year the
compensation packages required to attract the senior executives the Company
requires to execute its business plan will increase our total general and
administrative expenses.




CRITICAL
ACCOUNTING POLICIES




Our
consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States (“US GAAP”).  The
preparation of these consolidated financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues, costs and expenses, and related
disclosures.  On an ongoing basis, we evaluate our estimates and
assumptions.  Our actual results may differ from these estimates under
different assumptions or conditions.




We
believe that of our significant accounting policies, which are described in the
notes to our consolidated financial statements, the following accounting
policies involve a greater degree of judgment and complexity. Accordingly, these
are the policies we believe are the most critical to aid in fully understanding
and evaluating our consolidated financial condition and results of
operations.




Revenue
Recognition




We
recognize revenue from software, hardware and services once fully installed and
implemented. This method of revenue reporting does not reflect all orders
received and shipped during the reporting period, but only those orders
received, shipped and completely installed within the reporting
period.




We
recognize revenue according to the American Institute of Certified Public
Accountants’ (“AICPA”) Statement of Position (“SOP”) 97-2 (Software Revenue
Recognition) as defined by paragraphs 07-14 in SOP 97-2 and as amended by SOP
98-9 (Modification of SOP 97-2, Software Revenue Recognition, With Respect to
Certain Transactions).  This SOP provides guidance on when revenue
should be recognized and in what amounts for licensing, selling, leasing or
otherwise marketing computer software (including computer hardware and support
services).




Deferred
revenue represents contracts for certain revenue to be recognized in the future
from support and maintenance contracts as well as product sales and professional
services that have been shipped and billed but not installed.  Support
and maintenance contracts are executed on an annual basis and the revenue from
these contracts is recognized over the life of the contracts.  Of the
total deferred revenue shown as a current liability in the amount of $971,474,
the deferred revenue for products and services was $240,167 as of March 31,
2008.  The remainder of current deferred revenue and the long-term
deferred revenue of $225,917 relates to technical support and maintenance
services.




33




Technical
support services revenue is deferred and recognized ratably over the period
during which the services are to be performed, which is typically from one to
three years.  Advanced services revenue is recognized upon delivery or
completion of performance




We make
sales to distributors and retail partners and recognize revenue based on a
sell-through method using information provided by them.




Accounting for Sales
Commissions




For the
fiscal year 2006 and 2007, the Company did not pay sales commissions except in
select agent arrangements.  Beginning in fiscal 2008, the Company
adopted a sales commission plan that paid commissions at a target rate of 3.75%
of the contract amount.  Commissions payable are accrued in the period
that the customer accepts the product or service from the
Company.  Sales commissions are generally paid on sales meeting the
criteria for sales commission payment in the subsequent accounting
period.




Convertible debt and
warrants





During
the fiscal years 2005 through 2008, the accounting for financial instruments -
convertible debt and detachable warrants - (and the potential derivative
accounting related to these financial instruments) was significant to our
financial statements because the accounting for such instruments requires the
use of management’s significant estimates and assumptions. This accounting
policy is also significant because of the potential fluctuations in the
estimated fair value from period to period, which are recorded as a benefit
(charge) to net loss on the statement of operations. We estimated the fair value
of the PP1 Warrants and PP2 Warrants using the Black-Scholes option pricing
model. This model requires the use of significant estimates and assumptions
related to the estimated term of the financial instruments, the volatility of
the price of our common stock, and interest rates, among other items.
..  Fluctuations in these assumptions may have a significant impact on
the estimated fair value of financial instruments, which, in turn, may have a
significant impact on our reported financial condition and results of
operations.





The
complexity in this accounting area and management’s incorrect application of the
accounting rules at the inception of the recording of the PP1 Warrants and PP2
Warrants required the Company to restate its fiscal year 2007 financial
statements contained in Item 7 of this report. Additionally, our accounting for
these financial instruments is discussed further in Note 3 to our consolidated
financial statements included in Item 7 of this report. As of March 31, 2008,
all PP1 Warrants and PP2 Warrants were classified as equity securities and were
no longer subject to these potential fluctuations in fair value
measurements..





Registration payment
arrangements





On
December 21, 2006, the EITF issued FASB Staff Position No. 00-19-2 (“FSP
00-19-2”).  FSP 00-19-2 was effective immediately for registration
payment arrangements and the financial instruments subject to those arrangements
that were entered into or modified subsequent to the date of issuance of this
FSP. For registration payment arrangements and financial instruments subject to
those arrangements that were entered into prior to the issuance of this FSP, the
FSP was effective for financial statements issued for fiscal years beginning
after December 15, 2006, and interim periods within those fiscal
years.  Effective April 1, 2007, the Company adopted FSP 00-19-2,
which was applicable to the accounting for the liquidated damages on the PP2
Notes.





FSP
00-19-2 requires the Company to account for contingent liquidated damages
separately from the financial instruments to which they relate, which are the
Notes and Warrants issued and sold in the PP1 and PP2
offerings.  Prior to the adoption of FSP-00-19-2, the Company was
accounting for the Warrants as derivative liabilities based on the requirement
of the Company to register all underlying shares to the Notes and the Warrants.
The
Company concluded that with the separate accounting required under FSP 00-19-2
for the liquidated damages, the Warrants by themselves were properly classified
as equity securities (having met all requirements of EITF 00-19 for equity
classification) as of the adoption date.


34





Under FSP
00-19-2, the Company is required to estimate and record a contingent liability
if the likelihood is probable that it will pay liquidated damages in future
periods, calculated in accordance with the SFAS 5, “Accounting for
Contingencies” (“SFAS 5”) and FASB Interpretation No. 14, “Reasonable Estimation
of the Amount of a Loss.”  Further, FSP 00-19-2 requires that “the
financial instrument(s) subject to the registration payment arrangement shall be
recognized and measured in accordance with other applicable GAAP (for example
SFAS 133 and EITF 00-19) without regard to the contingent obligation to transfer
consideration pursuant to the registration payment arrangement.” Accordingly, on
the date of adoption, the Company accounted for the Warrants separately from the
liquidated damages obligations.





Based on
the above requirements, the Company recorded a cumulative effect of an
accounting change entry (i.e., a charge to the beginning balance of the
accumulated deficit) as of April 1, 2007 for the combination of:  1)
the reclassification of the Warrants from derivative liabilities to equity
securities, and 2) a contingent liability for probable future payment of
liquidated damages (based on the Company’s best estimate as of the date of
adoption, which is through March 31, 2008).  The amount of the
contingent liability recorded was approximately $289,000.  Also, as
part of the cumulative effect of an accounting change entry, the Company
reclassified the Warrants from derivative liabilities to equity
securities.  The difference between the Warrants as measured on the
date of adoption and their original recorded value was included in the charge to
the beginning balance of the accumulated deficit.  This amount was
approximately $466,000.  The total of the cumulative effect of this
accounting change was $755,000.





On April
5, 2007, the Company closed the balance of its PP2 offering and, in accordance
with FSP 00-19-2, recorded a contingent liability and related charge to the
consolidated Statement of Operations for estimated liquidated damages related to
this funding through March 31, 2008.





The
Company evaluated the contingent liability for liquidated damages at June 30,
September 30 and December 31, 2007 and concluded that the facts and
circumstances had not changed as to the appropriateness of the March 31, 2008
date.  As of March 31, 2008, the Company was in substantial
discussions with a majority of investors to convert their Notes, exercise their
Warrants and remove the registration requirements of the underlying shares to
the Notes and Warrants.  As a result, as of March 31, 2008, the
Company concluded that it was probable that it would execute an agreement under
these terms and estimated and recorded an additional contingent liability and
related charge for liquidated damages through June 30, 2008.





As of
March 31, 2008, the Company accrued $671,342 related to liquidated
damages related to the PP2 Notes and estimated that this amount was the maximum
payout required. On June
24, 2008, the Company executed agreements with certain investors
comprising approximately 70% of the original principal investment of PP2 to
convert the outstanding Notes at a reduced price of $0.53.  On June
30, 2008, the Company executed an agreement with the institutional investor in
the PP2 offering that had the contractual right to liquidated damages.  In
exchange for the waiver from the investor, the Company issued to the
investor 58,777 shares of its common stock.  The agreement terminated any
assessment of liquidated damages beyond June 24, 2008.





35


The table
below summarizes the cumulative effect entry recorded as of April 1, 2007 for
the adoption of FSP 00-19-2:





Accumulated
      deficit, April 1, 2007 (as restated)
            
            $
            (10,586,847
            )Adjustments
      for the cumulative effect of the change in accounting
      principle:Contingent
      liability recorded for estimated liquidated damages
            
            
            (289,518
            )Reclassification
      of Warrants from derivative liabilities to equity
    securities
            
            
            (465,597
            )Total
      adjustments
            
            
            (755,115
            )Accumulated
      deficit, April 1, 2007, as adjusted
            
            $
            (11,341,962
            )






36


RESULTS
OF OPERATIONS




Overview of Results of
Operations for Fiscal 2008 and Fiscal 2007


For
      the Year Ended March 31,2008
            
            
            % of
      rev
            
            
            2007
            
            
            % of
      revRevenues:
            
            
            
            
            
            
            
            (As
      restated)Convergence
      Solutions
            
            $
            1,871,923
            
            
            
            65%
            
            
            $
            1,401,789
            
            
            
            73%Professional
      Services
            
            
            406,923
            
            
            
            14%
            
            
            
            218,454
            
            
            
            11%Support
      and Maintenance
            
            
            595,769
            
            
            
            21%
            
            
            
            312,595
            
            
            
            16%Total
      Revenues
            
            
            2,874,615
            
            
            
            100%
            
            
            
            1,932,838
            
            
            
            100%Cost
      of Revenues:Convergence
      Solutions
            
            
            520,952
            
            
            
            18%
            
            
            
            313,272
            
            
            
            16%Professional
      Services
            
            
            311,100
            
            
            
            11%
            
            
            
            167,012
            
            
            
            9%Support
      and Maintenance
            
            
            148,750
            
            
            
            5%
            
            
            
            78,048
            
            
            
            4%Total
      Cost of revenues
            
            
            980,802
            
            
            
            34%
            
            
            
            558,332
            
            
            
            29%Gross
      Profit
            
            
            1,893,813
            
            
            
            66%
            
            
            
            1,374,506
            
            
            
            71%Expenses:Sales
      and marketing
            
            
            1,433,888
            
            
            
            50%
            
            
            
            676,868
            
            
            
            35%Software
      development
            
            
            630,411
            
            
            
            22%
            
            
            
            542,597
            
            
            
            28%Engineering
      and support
            
            
            268,754
            
            
            
            9%
            
            
            
            209,532
            
            
            
            11%General
      and administrative
            
            
            1,470,056
            
            
            
            51%
            
            
            
            900,528
            
            
            
            47%Charge
      for litigation contingency
            
            
            650,000
            
            
            
            23%
            
            
            
            -Depreciation
      and amortization
            
            
            353,582
            
            
            
            12%
            
            
            
            347,086
            
            
            
            18%Total
      expenses
            
            
            4,806,691
            
            
            
            167%
            
            
            
            2,676,611
            
            
            
            138%Loss
      from operations
            
            
            (2,912,878
            )
            
            
            (101)%
            
            
            
            (1,302,105
            )
            
            
            (67)%Other
      income (expense)Interest
      income
            
            
            22,626
            
            
            
            1%
            
            
            
            714
            
            
            
            0%Interest
      expense
            
            
            (311,108
            )
            
            
            (11)%
            
            
            
            (84,752
            )
            
            
            (4)%Charge
      for stock issued to convertible note holders
            
            
            (135,825
            )
            
            
            (5)%
            
            
            
            -
            
            
            
            -%Amortization
      of discount on convertible notes
            
            
            (1,532,511
            )
            
            
            (52)%
            
            
            
            (146,684
            )
            
            
            (8)%Change
      in estimated fair value of derivative financial instruments –
      warrants
            
            
            -
            
            
            
            
            
            
            
            (518,511
            )
            
            
            (27)%Charge
      for estimated liquidated damages
            
            
            (381,924
            )
            
            
            (13)%
            
            
            
            -Other
      expense
            
            
            (800
            )
            
            
            -%
            
            
            
            -
            
            
            
            -%Total
      other income (expense)
            
            
            (2,339,542
            )
            
            
            (81)%
            
            
            
            (749,233
            )
            
            
            (39)%Net
      loss
            
            $
            (5,252,420
            )
            
            
            (182)%
            
            
            $
            (2,051,338
            )
            
            
            (106)%Basic
      & diluted net loss per share
            
            $
            (0.61
            )
            
            
            
            
            
            $
            (0.25
            )Weighted
      average shares outstanding – basic and diluted
            
            
            8,644,112
            
            
            
            
            
            
            
            8,190,123




37


The
following discussion should be read in conjunction with the consolidated
statements of financial operations, in their entirety.




Our
revenues have grown from $1,932,838 in fiscal 2007 to $2,874,615 in fiscal 2008,
a growth year-over-year of 48.7% on a recognized revenue basis.




Our gross
profit during the fiscal year 2007 was $1,374,506 or approximately 71% of
revenues, and the operating loss for the same period was
$1,302,105.  Gross profit for fiscal year 2008 was $1,893,813 or
approximately 66% of revenues, and our operating loss for the same period was
$2,912,878.  The Company applied a new method of estimating its cost
of sales that we believe more appropriately associates some costs previously
shown as operating expenses as costs of sales, including employee related costs
related to the installation of convergence solutions as a cost of professional
services revenue, and employee salaries associated with providing support and
maintenance as a cost of the support and maintenance segment of
revenue.




During
the fiscal year 2008, we continued to incur substantial costs and operating
expenses related to the expansion of our business.  We increased our
sales and marketing expenditures by about 112% over the previous year by
augmenting our sales force and bolstering our marketing initiatives in order to
build brand recognition and customer awareness. We added professional staff in
other areas as well, including in field engineering to strengthen our
implementation and support services, as well as software engineers to broaden
and enhance our convergence solutions.  The company’s headquarters
were relocated to a facility that is almost three times the size of the previous
space, in order to provide our developers adequate room for development
laboratories, demonstration rooms for our visiting clients, as well as
additional office and meeting space to allow the company to scale its staff to
meet increasing demand for our convergence solutions.




In
accordance with SFAS No. 5, “Accounting for Contingencies” (“SFAS 5”), as of
March 31, 2008 we have recorded a contingent liability and related charge for
outstanding litigation.  While the Company may prevail in this matter
and disputes damages sought in the case, we have recorded a reserve of $650,000
in accordance with the SFAS 5.




During
both fiscal 2008 and fiscal 2007, the Company recorded significant “Other income
(expense) items in its Statement of Operations.  The amortization of
discount associated with the PP1 and PP2 notes increased significantly from
fiscal 2007 to fiscal 2008 due to the $3.5 million of PP2 Notes issued during
the second half of fiscal 2007.  The charge associated with the
estimated fair value of the PP1 and PP2 Warrants for fiscal 2007 was an expense
of $519,000, and $-0- for fiscal 2008 due to the reclassification of both the
PP1 and PP2 Warrants from derivative liabilities to equity securities as of
April 1, 2007 as a result of a new accounting pronouncement that the Company
adopted on April 1, 2007, as discussed previously under this Item..




LIQUIDITY
AND CAPITAL RESOURCES




From our
start of operations in May 2003 through the end of fiscal 2007, we funded our
operations primarily through the PP1 and PP2 Note offerings—the first in the
third quarter of fiscal 2005 and the second initiated in the third quarter of
fiscal 2007.




At March
31, 2008, we had cash and cash equivalents of $175,007.  Accounts
receivable at March 31, 2008 were $248,186.  Accounts payable, accrued
current liabilities, and related party payables totaled $1,626,665 as of March
31, 2008.




Subsequent
to the fiscal year ended March 31, 2008, the Company completed its Short Term
Investment Incentive Program, wherein the Company extended incentives to PP1 and
PP2 Note holders to 1) convert their notes to equity at a reduced conversion
price, and 2) exercise their warrants at a reduced exercise price. This Program
resulted in the reduction of the Company’s debt by $3,194,953 including accrued
interest, and generated $896,916 in proceeds from the exercise of
warrants.




Equally
significant, subsequent to the year ended March 31, 2008, the Company, in
cooperation with one of its Gold Reseller Partners, has secured its largest
contract to-date for the purchase of joint products and services




38


from a
state in the Midwestern United States, in the initial amount of approximately
$600,000.  Together, these events have substantially improved the
liquidity position of the Company.




Our
future capital requirements will depend on many factors including: our rate of
revenue growth; the expansion of our marketing and sales activities; the timing
and extent of spending to support product development efforts and expansion into
new territories; the timing of introductions of new services and enhancements to
existing services; and the continuing market acceptance of our
services.  To the extent that existing cash and securities and cash
from operations are insufficient to fund our future activities, we will need to
raise additional funds through public or private equity or debt financing.
Although we are currently not a party to any agreement or letter of intent with
respect to potential investments in, or acquisitions of, complementary
businesses, services or technologies, we may enter into these types of
arrangements in the future, which could also require us to seek additional
equity or debt financing.  Additional funds may not be available on
terms favorable to us or at all.  If the Company cannot obtain needed
funds, it may be forced to curtail or cease its activities.




We do not
have any special purpose entities, and other than operating leases for office
space and computer equipment, which are described below, we do not engage in
off-balance sheet financing arrangements. We currently have a secured bank line
of credit with JPMorgan Chase Bank in the amount of $50,000.  In
addition, we have a factoring agreement with Allied Capital Partners, L.P. for
our accounts receivable with a credit line of up to $1,500,000.




ITEM
7:  FINANCIAL STATEMENTS





The
financial statements of the Company are included as a separate
section of this report beginning on page F-1 immediately following the signature
page to this report.







ITEM
8:  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS


ON
ACCOUNTING AND FINANCIAL DISCLOSURE





None.





ITEM
8A(T):  CONTROLS AND PROCEDURES





Evaluation
of Disclosure Controls and Procedures




As of
March 31, 2008, we carried out an initial analysis, under the supervision
and with the participation of our management, including our Chief Executive
Officer (the “Certifying Officer”), of the effectiveness of the design and
operation of our disclosure controls and procedures. Based upon that evaluation,
the Certifying Officer concluded that our disclosure controls and procedures
were not effective as of the end of the period covered by this Annual Report on
Form 10-KSB (“Annual Report”).





The
Certifying Officer also previously determined as of December 31, 2007 that our
financial management team did not have sufficient experience in the preparation
of the narrative disclosures in notes to the interim financial statements to
ensure that the disclosure controls and procedures we maintain (as defined in
Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as
amended (the “Exchange Act”) that are designed to ensure that information
required to be disclosed in Exchange Act reports is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission’s rules and forms, and that such information is accumulated
and communicated to our management, including our Certifying Officers, as
appropriate, to allow timely decisions regarding required disclosure. In an
effort to remediate the insufficiency, we engaged an independent financial
consulting group to provide the personnel resources necessary for technical
accounting and for the recording of complex financial transactions, preparation
of financial statements, and management reporting and disclosure
reporting.  This engagement resulted in a comprehensive review of our
Company’s financials, which resulted in the Company amending its fiscal year
2007 Annual Report and its Form 10-QSB filings for the quarterly periods ended
June 30, 2007 and September 30, 2007.





39


In
connection with the analysis of the effectiveness of our disclosure controls and
procedures as of December 31, 2007, we conducted a search and retained new
financial leadership with the addition of a Chief Financial Officer in March of
2008. As a subsequent event to the filing of this report, the Certifying Officer
noted that the CFO had been terminated, for, among other reasons,  the
inability to provide the necessary technical accounting expertise for the
recording of complex financial transactions, preparation of financial
statements, management reporting and disclosure reporting.  To
remediate the situation, another independent consultant with prior CFO
experience with micro-cap companies was retained to complete the financial
reporting requirements.  While engaged, this financial consultant also
identified the Company’s incorrect accounting for the Company’s PP1 Notes, PP1
Warrants, PP2 Notes, PP2 Warrants and share-based compensation expense related
to stock options issued to employees during the fiscal years 2005 through
2007.  This will result in the Company amending its consolidated
financial statements for the fiscal year ended March 31, 2007 (which have been
restated in this Annual Report filing), amending and restating our Annual Report
for the fiscal year ended March 31, 2007 and our quarterly filings on Form
10-QSB for the periods ended June 30, 2007, September 30, 2007 and December 31,
2007.





We
estimate that during the second half of fiscal 2009, the Certifying Officer,
along with the Company’s other management representatives, will complete
remediation measures that may include engaging an independent consulting firm to
further evaluate, remediate, implement, document and test the internal controls
in these key areas:





1.
            Order
      Entry Accounting & Reporting


2.
            Debt/Equity
      Accounting & Compliance


3.
            Cash
      & Other Working Capital
Management


4.
            Compensation
      Accounting & Administration


5.
            Other
      Assets & Liability Account
Management


6.
            Financial
      Reporting




We will
also monitor our disclosure controls and procedures on a continuing basis to
ensure that information required to be disclosed in the reports we file or
submit under the Exchange Act is accumulated and communicated to our management,
including its principal executive and principal financial officers, as
appropriate, to allow timely decisions regarding required disclosure. In the
future as such controls change in relation to developments in the our business
and financial reporting requirements, our evaluation and monitoring measures
will also address any additional corrective actions that may be
required.





Our
management does not expect that our disclosure control procedures or our
internal control over financial reporting will prevent all errors and fraud. A
control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, have been detected.





Management’s
Annual Report on Internal Control over Financial Reporting.





Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as defined in Exchange Act
Rule 13a-15(f). Our internal control over financial reporting is designed
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles.





Under the
supervision and with the participation of our management, including our Chief
Executive Officer, we conducted an evaluation of the effectiveness of our
internal control over financial reporting based on the framework established by
the Committee of Sponsoring Organizations of the Treadway Commission
(COSO) as set forth in Internal Control - Integrated Framework. Based on
our evaluation under the framework in Internal Control — Integrated Framework,
our management concluded that our internal control over financial reporting was
not effective as of March 31, 2008. An independent financial firm will be
engaged to complete remediation measures that may include further evaluation,
remediation, implementation, documentation and testing of our key internal
controls.





40


The SEC
has extended the requirement date for non-accelerated filers of Section 404(b),
the OUTSIDE AUDITOR'S attestation, from being required for years ending December
15, 2008 or later to December 15, 2009 or later. The Section 404(a) MANAGEMENT
ASSESSMENT, however, is still in effect. This Annual Report does not include an
audit or attestation report of our registered public accounting firm regarding
our internal control over financial reporting. Our management’s report was not
subject to audit or attestation by our registered public accounting firm
pursuant to temporary rules of the SEC that permit us to provide only
management’s report in this annual report.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. It should be noted that any system of controls,
however well designed and operated, can provide only reasonable, and not
absolute, assurance that the objectives of the system will be met. In addition,
the design of any control system is based in part upon certain assumptions about
the likelihood of future events. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.








ITEM
8B:  OTHER INFORMATION





None.




41


PART
III







ITEM
9   DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND


CONTROL
PERSONS AND CORPORATE GOVERNANCE;


COMPLIANCE
WITH SECTION 16(a) OFTHE EXCHANGE ACT





EXECUTIVE
OFFICERS AND DIRECTORS




The
following table sets forth the name, age, and position of each of our executive
officers and directors of the Company as of the period ending March 31,
2008:




Director's Name
            Age
            Position with CompanyDerek
      P. Downs
            40
            Chief
      Executive Officer and DirectorGreg
      T. Royal
            43
            Founder,
      Chief Technology Officer and DirectorCynthia
      A. Garr
            47
            DirectorRichard
      McDowell
            51
            Chief
      Financial Officer





Our
directors hold office until the next annual meeting of shareholders and until
their respective successors have been duly elected and qualified.  Our
officers are elected by the Board of Directors (or “Board’) at the board meeting
held immediately following the shareholders' annual meeting and hold office
until their death or until they either resign or are removed from office. There
are no written or other contracts providing for the election of directors or
term of employment for executive officers, all of whom serve on an at will
basis.




Derek Downshas served as
President since May 31, 2004 and became our Interim CEO for the Company in June
2005.  Effective July 14, 2008, he was appointed Interim Chief
Financial Officer following the termination of employment of our Chief Financial
Officer, Richard McDowell on that date.  Mr. Downs has been a member
of the Board of Directors since October 1, 2004.  Prior to becoming
President and Interim CEO, Mr. Downs served as the Company’s Vice President of
Sales, Marketing and Business Development.   From January 2003 to
May 2003, Mr. Downs held the same position with XBridge Software,
Inc.  From December 2000 to September 2002, Mr. Downs held senior
executive roles in marketing, alliances, product marketing, and business
development at i2 Technologies (NASDAQ:ITWO), a $1 billion supply chain software
company.  Before joining i2 Technologies, he served from December 1999
to December 2000 as VP of Business Development and Strategic Alliances for BSI
Consulting, a midsized technology strategy firm.  From May 1995 to
December 1999, Mr. Downs held the position of Director of Strategic Alliances at
Baan Company, a $1+ billion enterprise software company.  Mr. Downs
graduated from the University of Eastern New Mexico in 1990 with a BBA degree in
Marketing and a BBA degree in Business Administration.




Gregory T. Royal has served as
Executive Vice President and Chief Technology Officer and has been a member of
the Board of Directors since May 2003.  Mr. Royal is the original
founder of XBridge Software, and the inventor of the Convergence ServerTM
technology.  Mr. Royal has over 18 years of IT Sales, Marketing and
Management experience in New Zealand, Australia and the United
States.  He has held Senior Sales and Marketing positions at Sycom
Office Equipment, Eagle Technology, Network General Corp. (NASDAQ:NETG) and
Network Associates Inc (NASDAQ:NETA). Mr. Royal has system certification with
Compaq, IBM, Novell and Hewlett Packard. He also has significant experience in
designing and deploying large-scale IT systems including experience in Banking
and Finance, Government, and Retail and Property Services.  Mr. Royal
graduated from Victoria University in 1986 and holds an MBA from Rushmore
University.




Cynthia A.
Garrhas served
as a member of the Board of Directors since May 2003.  She is one of
the founders of XBridge Software, and has served as its President and as a
Director from its inception in 1999 to the present.  She was also
Director of Sales for Identify Software, a leader in application problem
resolution software, from January 2003 to June 2004.  From January
2000 to August 2001, Ms Garr served as a Regional Sales Manager for Mercury Interactive, the
leading provider of enterprise testing and performance management
solutions.   Ms. Garr was President of U.S. Operations and
Executive Director of Qronus Interactive, a provider of automated testing
solutions software, which was ultimately acquired by Mercury Interactive from
November 1997 to January 2000. She graduated fromBrookhavenCollegein 1985 with a degree in
Business Management.




42




Richard
McDowelljoined
the company in March of 2008 as the Chief Financial Officer.  From
2003 to 2008, Mr. McDowell was the Chief Financial Officer and co-founder of
Enlightened Age Entertainment, Inc., a software development company that
produced web-based applications.  From1995 to 2003, Mr. McDowell was
employed by Blockbuster Inc., where he held a number of executive roles, the
final being Senior Vice President and Treasurer.  From 1983 to 1995,
Mr. McDowell was employed in various capacities by North Broward Hospital
District and held several finance and accounting positions. He began his career
with Coopers and Lybrand and has an undergraduate degree form theUniversityofFloridaand an MBA from theUniversityofMiami.  Mr. McDowell was
terminated as the Company’s Chief Financial Officer on July 14,
2008.




BOARD
COMPOSITION AND COMMITTEES




Our Board
of Directors currently consists of three members, Gregory T. Royal, Cynthia A.
Garr, and Derek P. Downs.  We are planning to expand the number of
members constituting our Board of Directors and will seek persons who are
“independent” within the meaning of the rules and regulations of NASDAQ to fill
vacancies created by any expansion.  Because of our current stage of
development, we do not have any standing audit, nominating or compensation
committees, or any committees performing similar functions.  The Board
meets periodically throughout the year as necessity dictates.  No
current director has any arrangement or understanding whereby they are or will
be selected as a director or nominee.




Audit Committee Financial
Expert




The
Company's Board of Directors does not have an "audit committee financial
expert," within the meaning of such phrase under applicable regulations of the
Securities and Exchange Commission, serving on its audit committee. As there is
no separately designated Audit Committee, the entire Board of Directors serves
as the Audit Committee. The Board of Directors believes that all members of its
Audit Committee are financially literate and experienced in business matters,
and that one or more members of the audit committee are capable of (i)
understanding generally accepted accounting principles ("GAAP") and financial
statements, (ii) assessing the general application of GAAP principles in
connection with our accounting for estimates, accruals and reserves, (iii)
analyzing and evaluating our financial statements, (iv) understanding our
internal controls and procedures for financial reporting; and (v) understanding
audit committee functions, all of which are attributes of an audit committee
financial expert. However, the Board of Directors believes that there is not any
audit committee member who has obtained these attributes through the experience
specified in the SEC's definition of "audit committee financial expert."
Further, like many small companies, it is difficult for the Company to attract
and retain board members who qualify as "audit committee financial experts," and
competition for these individuals is significant. The Board believes that its
current audit committee is able to fulfill its role under SEC regulations
despite not having a designated "audit committee financial expert."




Indebtedness of Directors
and Executive Officer




None of
our directors or our executive officers or their respective associates or
affiliates are indebted to us.




Family
Relationships




There are
no family relationships among our directors or CEO.




Compensation
Committee




The
Company does not maintain a standing Compensation Committee.  Due to
the Company’s small size at this point in time, the Board has not established a
separate compensation committee. All members of the Board (with the
exception of any member about whom a particular compensation decision is being
made) participate in the compensation award process.




43




Nominating
Committee




The
Company does not maintain a standing Nominating Committee and does not have a
Nominating Committee charter.  Due to the Company’s small size at this
point in time, the Board has not established a separate nominating committee and
feels that all directors should have input into nomination decisions. As such,
all members of the Board generally participate in the director nomination
process. Under the rules promulgated by the SEC, the Board of Directors is,
therefore, treated as a “nominating committee.”




The Board
will consider qualified nominees recommended by shareholders. Shareholders
desiring to make such recommendations should submit such recommendations to the
Corporate Secretary, c/o Cistera Networks, Inc., 6509 Windcrest Drive, Suite
160, Plano, Texas 75024.  The Board will evaluate candidates properly
proposed by shareholders in the same manner as all other
candidates.




With
respect to the nominations process, the Board does not operate under a written
charter, but under resolutions adopted by the Board of Directors.  The
Board is responsible for reviewing and interviewing qualified candidates to
serve on the Board, for making recommendations for nominations to fill vacancies
on the Board, and for selecting the nominees for selection by the Company’s
shareholders at each annual meeting.  The Board has not established
specific minimum age, education, experience or skill requirements for potential
directors.  The Board takes into account all factors they consider
appropriate in fulfilling their responsibilities to identify and recommend
individuals as director nominees.  Those factors may include, without
limitation, the following:




•
            
            an
      individual’s business or professional experience, accomplishments,
      education, judgment, understanding of the business and the industry in
      which the Company operates, specific skills and talents, independence,
      time commitments, reputation, general business acumen and personal and
      professional integrity or
character;




•
            
            the
      size and composition of the Board of Directors and the interaction of its
      members, in each case with respect to the needs of the Company and its
      shareholders; and




•
            
            regarding
      any individual who has served as a director of the Company, his or her
      past preparation for, attendance at, and participation in meetings and
      other activities of the Board of Directors or its committees and his or
      her overall contributions to the Board and the
  Company.




The Board
may use multiple sources for identifying and evaluating nominees for directors,
including referrals from the Company’s current directors and management as well
as input from third parties, including executive search firms retained by the
Board.  The Board will obtain background information about candidates,
which may include information from directors’ and officers’ questionnaires and
background and reference checks, and will then interview qualified
candidates.  The Board will then determine, based on the background
information and the information obtained in the interviews, whether to recommend
that a candidate be nominated to the Board of Directors.  We strongly
encourage and, from time to time actively survey, our shareholders to recommend
potential director candidates.




Shareholder Communications
with the Company’s Board of Directors




Any
shareholder wishing to send written communications to the Company’s Board of
Directors may do so by sending them in care of Derek Downs, CEO, at the
Company’s principal executive offices.  All such communications will
be forwarded to the intended recipient(s).




COMPLIANCE
WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934




Section
16(a) of the Exchange Act requires our officers and directors, and persons who
own more than 10% of a registered class of our equity securities, to file
initial  reports of ownership and reports of changes in
ownership with the
SEC.  Such persons are required by SEC  regulation  to furnish us
with copies of all Section  16(a) forms they file.  Based solely on
its review of the copies of such forms received by it and 
representations  from certain  reporting  persons regarding
their  compliance with the relevant filing  requirements,  the
Companybelieves
that all filing requirements applicable to its officers,  directors and
10%  shareholders  were complied with during the fiscal year
ended  March 31,2008, except as set forth below:


44





·
            Derek
      Downs and Greg Royal failed to timely file a Form 4 – Statement of Changes
      in Beneficial Ownership, to report the acquisition of securities in our
      private placement transaction on April 5, 2007 of “Senior Unsecured
      Convertible Notes” (“PP2 Notes”) and warrants (“PP2
      Warrants”).  These filings are expected to be made on or before
      August 22, 2008.





·
            Derek
      Downs, Greg Royal and Cynthia Garr failed to timely file a Form 4 –
      Statement of Changes in Beneficial Ownership, to report the cancellation
      on March 31, 2007 of options to purchase shares of our common
      stock.  These filings are expected to be made on or before
      August 22, 2008.




CODE
OF ETHICS




Due to
the current formative stage of the Company’s development, it has not yet
developed a written code of ethics for its directors or executive
officers.







ITEM
10: EXECUTIVE COMPENSATION





SUMMARY
COMPENSATION TABLE




The
following table sets forth, for our last two fiscal years, certain information
concerning the compensation paid by the Company to our Chief Executive Officer
and our other most highly paid executive officer who received in excess of
$100,000 in compensation during these periods.




SUMMARY
      COMPENSATION TABLE(a)
            (b)
            (c)
            
            (d)
            (e)
            
            (f)
            (g)
            
            (h)
            (i)NonqualifiedYear
            
            
            
            
            
            
            Non-Equity
            
            Deferred
            All
      OtherEnded
            
            
            
            Stock
            
            Option
            Incentive
      Plan
            
            Compensation
            Compen-Name
      and
            March
            Salary
            
            Bonus
            Awards
            
            Awards
            Compensation
            
            Earnings
            sation
            TotalPrincipal
      Position
            31
            ($)
            
            ($)
            ($)
            
            ($)
            ($)
            
            ($)
            ($)
            ($)Derek
      P. Downs
            2008
            $150,000
            (1)
            -
            -
            
            -
            -
            
            -
            82,880
            $233,084CEO/Director
            2007
            $127,500
            
            -
            -
            
            -
            -
            
            -
            -
            $127,500Greg
      T. Royal
            2008
            $136,370
            (2)
            -
            -
            
            -
            
            
            -
            70,979
            $207,349Executive
      V.P./Director
            2007
            $130,500
            
            -
            -
            
            -
            -
            
            -
            -
            $130,500




(1)
            The
      base salary amount for Mr. Downs is $150,000. There was an additional
      bonus of $52,439 provided to offset the tax impact of a stock grant for
      historical accrued salary and additional compensation of $30,441 was
      recognized for prior years’ accrued
salary.






(2)
            The
      base salary amount for Mr. Royal is $150,000.  There was
      additional compensation of $70,979 recognized for prior years’ accrued
      salary.




45


Except as
described below under “Employment Contracts,” there are no compensatory plans or
arrangements with respect to any of our executive officers, which result or will
result from the resignation, retirement or any other termination of such
individual’s employment with us or from a change in control of the Company or a
change in the individual’s responsibilities following a change in
control.  No stock options, stock appreciation rights or other stock
based incentives were awarded to any of our named executive officers during
fiscal 2007 or fiscal 2008.




EMPLOYMENT
CONTRACTS




On March
12, 2008, we entered into an employment agreement with Mr. Richard McDowell, the
Company’s former Chief Financial Officer, pursuant to which we agreed to employ
him as CFO at an annual salary of $145,000.  The initial term of the
agreement is one year, with a self-renewing clause.  If we terminate
our employment relationship with Mr. McDowell (a) without cause, or (b) for any
reason within twelve months of a change in control; or if Mr. McDowell
terminates the agreement with just cause, then Mr. McDowell shall be entitled to
receive two times his then current salary, payable in equal installments over
the course of the immediately following eighteen months.  The amount
of two times his current salary is only earned after completing one year of
service with the Company.  On July 14, 2008, Mr. McDowell’s employment was
terminated.




OUTSTANDING
EQUITY AWARDS AT FISCAL YEAR END




Outstanding
      Equity Awards at Fiscal Year-EndOption
      AwardsName
            Number
      of Securities Underlying Unexercised Options
              (#)
              Exercisable
            Number
      of Securities Underlying Unexercised Options
              (#)
              Unexercisable
            Number
      of Securities Underlying Unexercised Unearned Options
              (#)
            Option
      Exercise Price
              ($)
            Option
      Expiration DateCynthia
      Garr
            41,831(1)
            0
            0
            $0.46
            4/1/2009Gregory
      Royal
            271,174(2)
            0
            0
            $0.46
            5/3/2009







(1)  Prior
to the Company’s acquisition of XBridge, XBridge awarded Ms. Garr options to
purchase shares of 15,426 shares of XBridge Software at an exercise price of
$1.25 per share.  As part of the acquisition of XBridge by the
Company, these options were converted into options to purchase shares of our
common stock, on a basis of 2.71174 shares of our common stock for each share of
XBridge.  This conversion ratio was the same ratio received by all
other XBridge stockholders.




(2)  Prior
to the Company’s acquisition of XBridge, XBridge awarded Mr. Royal options to
purchase shares of 100,000 shares of XBridge Software at an exercise price of
$1.25 per share.  As part of the acquisition of XBridge by the
Company, these options were converted into options to purchase shares of our
common stock, on a basis of 2.71174 shares of our common stock for each share of
XBridge.  This conversion ratio was the same ratio received by all
other XBridge stockholders.




None of
our executive officers exercised options to purchase our common stock during
fiscal 2007 or 2008.




46


DIRECTOR
COMPENSATION




We do not
currently pay our directors a fee for attending scheduled and special meetings
of our Board of Directors.  We intend to reimburse each director for
reasonable travel expenses related to such director’s attendance at Board and
committee meetings.  In the future we expect that we will have to
offer some compensation to attract the caliber of independent board members the
Company is seeking.




ITEM
11:  SECURITY OWNERSHIP OF BENEFICIAL OWNERSAND MANAGEMENT AND RELATED
STOCKHOLER MATTERS





The table
below sets forth, as of August 5, 2008 and exercisable within 60 days, certain
information with respect to the beneficial ownership of our common stock by (i)
each of our directors and executive officers, (ii) each person known to us to be
the beneficial owner of five percent or more of the outstanding shares of our
common stock, and (iii) all of our officers and directors as a
group.  Unless otherwise indicated, the person or entity listed in the
table is the beneficial owner of, and has sole voting and investment power with
respect to, the shares indicated.




Title
      of
            Name
      and Address
            Nature
      and AmountClass
            Of Beneficial Owners
            of Beneficial Ownership
            PercentCommon
            Derek
      P. Downs(1)
            228,670(2)
            1.32%Common
            Cynthia
      A. Garr(1)
            1,330,191(3)
            7.24%Common
            Gregory
      T. Royal(1)
            1,640,279(4)
            8.78%Common
            Kingdon
      Hughes
            1,357,123(5)
            7.38%16475
      Dallas Pkwy, Suite 440Addison,
      TX 75001Common
            Roaring
      Fork Capital Management
            3,664,155(6)
            17.70%5350
      South Roslyn St., Suite 380Greenwood
      Village, CO 80111All
      Officers and Directors as a Group
            
            3,199,140
            15.81%





(1)
            The
      business address for Ms. Garr and Messrs. Downs and Royal is 6509
      Windcrest Drive, Suite 160, Plano, TX,
75024.


(2)
            Includes
      warrants to purchase 30,000 shares of common stock issued  as
      part of the PP2 private placement
offering.


(3)
            Includes
      options to purchase 41,831 shares resulting from the post merger
      conversion of options to purchase shares of XBridge common
      stock.


(4)
            Includes
      options to purchase 271,174 shares resulting from the post merger
      conversion of options to purchase shares of XBridge common stock and
      warrants to purchase 70,779 shares of common stock issued as part of the
      PP2 private placement offering.


(5)
            Includes
      warrants to purchase 189,822 shares of common stock.(6)
            Includes
      convertible promissory notes convertible into 364,133 shares of common
      stock at a conversion price of $0.75.








47


ITEM
12: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS,


AND
DIRECTOR INDEPENDENCE





On April
5, 2007, the Company issued PP2 Notes in the principal amount of $30,000, and
issued PP2 Warrants to purchase 30,000 shares of the Company’s common stock to
Derek Downs, an officer and director of the Company, in connection with the
cancellation of an equal amount of the Company’s outstanding obligations.
 As of March 31, 2008, interest of $7,191 had been accrued on this PP2
Note.




On April
5, 2007, the Company issued PP2 Notes in the principal amount of $70,779, and
issued PP2 Warrants to purchase 70,779 shares of the Company’s common stock to
Gregory Royal, an officer and director of the Company, in connection with the
cancellation of an equal amount of the Company’s outstanding obligations.
 As of March 31, 2008, interest of $16,967 had been accrued on this PP2
Note.




Our Board
of Directors currently consists of three members, Gregory T. Royal, Cynthia A.
Garr, and Derek P. Downs, none of whom are “independent” within the meaning of
the rules and regulations of Nasdaq.  We are planning to expand the
number of members constituting our Board of Directors and will seek persons who
are “independent” to fill vacancies created by any expansion.




ITEM
13: EXHIBITS





The
following exhibits are included as part of this report:





Exhibit
      Number
            Title
      of Document3(ii)
            Bylaws
      (Incorporated by reference from the Company’s Annual Report on Form 10KSB
      for the fiscal year ended March 31, 1996)4.1
            Form
      of Convertible Note Purchase Agreement dated as of December 13, 2004
      (Incorporated by reference from Exhibit 4.1 to the Company’s Current
      Report on Form 8-K filed with the Commission on December 20,
      2004)4.2
            Form
      of Senior Unsecured Convertible Note (Incorporated by reference from
      Exhibit 4.2 to the Company’s Current Report on Form 8-K filed with the
      Commission on December 20, 2004)4.3
            Form
      of Warrant (Incorporated by reference from Exhibit 4.3 to the Company’s
      Current Report on Form 8-K filed with the Commission on December 20,
      2004)4.4
            Registration
      Rights Agreement dated as of December 13, 2004 (Incorporated by reference
      from Exhibit 4.4 to the Company’s Current Report on Form 8-K filed with
      the Commission on December 20, 2004)4.5
            Form
      of Convertible Note Purchase Agreement dated as of April 5, 2007
      (Incorporated by reference from Exhibit 4.1 to the Company’s Current
      Report on Form 8-K filed with the Commission on April 12,
      2007)4.6
            Form
      of Senior Unsecured Convertible Note (Incorporated by reference from
      Exhibit 4.2 to the Company’s Current Report on Form 8-K filed with the
      Commission on April 12, 2007)4.7
            Form
      of Warrant (Incorporated by reference from Exhibit 4.3 to the Company’s
      Current Report on Form 8-K filed with the Commission on April 12,
      2007)4.8
            Registration
      Rights Agreement dated as of April 7, 2005 (Incorporated by reference from
      Exhibit 4.4 to the Company’s Current Report on Form 8-K filed with the
      Commission on April 12, 2007)6.1
            License
      Agreement (incorporated by reference to Exhibit 10.1 to the Company’s
      Annual Report on Form 10-KSB for the fiscal year ended March 31,
      2004)10.1
            Employment
      Agreement between Richard McDowell and Cistera Networks, Inc. dated as of
      March 12, 2008 (Incorporated by reference from Exhibit 10.1 to the
      Company’s Current Report on Form 8-K filed with the Commission on March
      17, 2008)10.2
            Waiver
      Agreement dated as of June 30, 2008, by and between Cistera Networks,
      Inc., and Roaring Fork Capital SBIC, LP. (Incorporated by reference from
      Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the
      Commission on July 3, 2008)31.1
            Certification
      Pursuant to Section 302 of the Sarbanes-Oxley Act of
  2002.32.1
            Certification
      Pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002.





48


ITEM
14: PRINCIPAL ACCOUNTANT FEES & SERVICES





Robison,
Hill & Company (“Robison”) served as our independent registered accounting
firm through September 2007 when the Board of Directors engaged Farmer, Fuqua
and Huff (“Farmer”).  The following table shows the fees that the
Company incurred for audit and other services provided by these firms for the
2008 and 2007 fiscal years:





Service
            
            2008
            
            
            2007Audit
      Fees
            
            $
            33,428
            
            
            $
            42,942Audit-Related
      Fees
            
            
            -
            
            
            
            -Tax
      Fees
            
            
            1,945
            
            
            
            615All
      Other Fees
            
            
            -
            
            
            
            -Total
            
            $
            35,373
            
            
            $
            43,557





Audit Fees. Consists of fees
billed for professional services rendered for the audits of our consolidated
financial statements, reviews of our interim consolidated financial statements
included in quarterly reports, services performed in connection with filings
with the Securities & Exchange Commission and related comfort letters and
other services that are normally provided by an independent registered
accounting firm in connection with statutory and regulatory filings or
engagements.




Tax Fees. Consists of fees
billed for professional services for tax compliance, tax advice and tax
planning. These services include assistance regarding federal, state and local
tax compliance and consultation in connection with various transactions and
acquisitions.




Audit Committee Pre-Approval
of Audit and Permissible Non-Audit Services of Independent
Auditors




As there
is no separately designated Audit Committee, the entire Board of Directors
serves as the Audit Committee.  A function of the Audit Committee is
to pre-approve all audit and non-audit services provided by the independent
auditors. These services may include audit services, audit-related services, tax
services and other services as allowed by law or
regulation.  Pre-approval is generally provided for up to one year and
any pre-approval is detailed as to the particular service or category of
services and is generally subject to a specifically approved
amount.  The independent auditors and management are required to
periodically report to the Audit Committee regarding the extent of services
provided by the independent auditors in accordance with this pre-approval and
the fees incurred to date. The Audit Committee may also pre-approve particular
services on a case-by-case basis.




49





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 its
behalf by the undersigned, thereunto duly authorized.





CISTERA
      NETWORKS, INC.Dated:
      August 15, 2008
            By  /S/     Derek
      P. DownsDerek
      P. DownsChief
      Executive Officer








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





Signatures
            Title
            Date/S/     Derek P.
      Downs
            Chief
      Executive Officer
            August
      15, 2008Derek
      P. Downs
            (Principal
      Executive Officer,Interim
      Principal Financial andAccounting
      Officer)/S/     Cynthia A.
      Garr
            Director
            August
      15, 2008Cynthia
      A. Garr/S/   Gregory T.
      Royal
            Chief
      Technology
            August
      15, 2008Gregory
      T. Royal
            Officer
      and Director








50





Index
      to Financial Statements
            PageReport
      of Independent Registered Public Accountants
            F -
      2Report
      of Independent Registered Public Accountants
            F -
      3Consolidated
      Balance Sheet March 31, 2008
            F -
      4Consolidated
      Statements of Operations for the Years Ended March 31, 2008 and 2007 (as
      restated)
            F -
      5Consolidated
      Statements of Stockholders' Equity for the Years Ended March 31, 2008 and
      2007 (as restated)
            F -
      6Consolidated
      Statements of Cash Flows for the Years Ended March 31, 2008 and 2007 (as
      restated)
            F -
      7Notes
      to Consolidated Financial Statements
            F -
      9


F -
1








REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTANTS





To the
Board of Directors and Shareholders


Cistera
Networks, Inc. & Subsidiary





We have
audited the accompanying consolidated balance sheets of Cistera Networks, Inc.
& Subsidiary as of March 31, 2007 and 2006, and the related consolidated
statements of operations, stockholders’ equity and cash flows for the years
ended March 31, 2007 and 2006.  These consolidated financial
statements are the responsibility of the Company's management.  Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  The
Company is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting.  Our audit included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the company’s
internal control over financial reporting.  Accordingly, we express no
such opinion.  An audit also includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
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 consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Cistera Networks, Inc. as of
March 31, 2007 and 2006, and the results of its operations and its cash flows
for the years ended  March 31, 2007 and 2006 in conformity with
accounting principles generally accepted in the United States of
America.





The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations
and has a net capital deficiency that raise substantial doubt about its ability
to continue as a going concern.  The financial statements do not
include any adjustments that might result from the outcome of this
uncertainty.





/s/ Robison Hill &
  Co.Certified
      Public Accountants


Salt Lake
City, Utah


November
12, 2007, except for Note 3, as to which the date is August 12,
2008


F -
2


REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the
Board of Directors and Shareholders


Cistera
Networks, Inc. and & Subsidiary





We have
audited the accompanying consolidated balance sheet of Cistera Networks, Inc.
& Subsidiary as of March 31, 2008, and the related consolidated statements
of operations, stockholders’ equity and cash flows for the year ended March 31,
2008.  Cistera Networks, Inc.’s management is responsible for these
consolidated financial statements. Our responsibility is to express an opinion
on these consolidated financial statements based on our audits.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. The company
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting.  Our audit included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the company's
internal control over financial reporting.  Accordingly, we express no
such opinion.  An audit also includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements, assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation.  We believe that our audit provide a reasonable basis
for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Cistera Networks, Inc. and
Subsidiary as of March 31, 2008, and the consolidated results of their
operations and their cash flows for the year ended March 31, 2008 in conformity
with accounting principles generally accepted in the United States of
America.





The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern.  As discussed in Note 1
to the financial statements, the Company has suffered recurring losses from
operations and has a net capital deficiency that raises substantial doubt about
its ability to continue as a going concern.  The financial statements
do not include any adjustments that might result from the outcome of this
uncertainty.








/s/ Farmer, Fuqua &
Huff, P.C.


Plano,
Texas


August
12, 2008


F -
3


CISTERA
NETWORKS, INC. & SUBSIDIARY


CONSOLIDATED
BALANCE SHEET





March
      31, 2008Current
      assets:Cash
      and cash equivalents
            
            $
            125,007Restricted
      cash
            
            
            50,000Accounts
      receivable, net of allowance for doubtful accounts $-0-
            
            
            248,186Related
      party receivables
            
            
            15,837Inventory
            
            
            187,960Prepaid
      expenses
            
            
            46,030Total
      current assets
            
            
            673,020Property
      and equipment, net
            
            
            355,411Intangible
      assets, net
            
            
            2,023,218Total
      long-term assets
            
            
            2,378,629TOTAL
      ASSETS
            
            $
            3,051,649Current
      liabilities:Accounts
      payable
            
            $
            420,603Related
      party payables
            
            
            129,702Accrued
      liquidated damages – outside investors
            
            
            629,957Accrued
      liquidated damages – related parties
            
            
            41,485Accrued
      liabilities
            
            
            1,076,360Deferred
      revenue
            
            
            971,474Convertible promissory notes – outside investors, net of
      discount
            
            
            408,204Line
      of credit
            
            
            17,503Total
      current liabilities
            
            
            3,695,288Convertible
      promissory notes – outside investors, net of discount
            
            
            1,606,300Convertible
      promissory notes – related parties, net of discount
            
            
            59,719Deferred
      revenue
            
            
            225,917Other
      long-term liabilities
            
            
            285,470Total
      long-term liabilities
            
            
            2,177,406Total
      liabilities
            
            
            5,872,694Commitments
      and Contingencies (Note 5)Stockholders’
      deficit:Preferred
      stock, $0.001 par value; 1,000,000 shares authorized;-0-
      shares issued and outstanding
            
            
            -Common
      stock, $0.001 par value; 50,000,000 shares authorized;8,820,192
      shares issued and outstanding
            
            
            8,820Additional
      paid-in capital
            
            
            13,764,517Accumulated deficit
            
            
            (16,594,382
            )Total
      stockholders’ deficit
            
            
            (2,821,045
            )TOTAL
      LIABILITIES AND STOCKHOLDERS’DEFICIT
            
            $
            3,051,649





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


F -
4





CISTERA
NETWORKS, INC. & SUBSIDIARY


CONSOLIDATED
STATEMENTS OF OPERATIONS





Years
      ended March 31,2008
            
            
            2007As
      restatedRevenuesConvergence
      Solutions
            
            $
            1,871,923
            
            
            $
            1,401,789Professional
      Services
            
            
            406,923
            
            
            
            218,454Support
      and Maintenance
            
            
            595,769
            
            
            
            312,595Total
      revenues
            
            
            2,874,615
            
            
            
            1,932,838Cost
      of revenuesConvergence
      Solutions
            
            
            520,952
            
            
            
            313,272Professional
      Services
            
            
            311,100
            
            
            
            167,012Support
      and Maintenance
            
            
            148,750
            
            
            
            78,048Total
      cost of revenues
            
            
            980,802
            
            
            
            558,332Gross
      Profit
            
            
            1,893,813
            
            
            
            1,374,506Expenses:Sales
      and marketing
            
            
            1,433,888
            
            
            
            676,868Software
      development
            
            
            630,411
            
            
            
            542,597Engineering
      and support
            
            
            268,754
            
            
            
            209,532General
      and administrative
            
            
            1,470,056
            
            
            
            900,528Charge
      for litigation contingency (Note 5)
            
            
            650,000
            
            
            
            -Depreciation
      and amortization
            
            
            353,582
            
            
            
            347,086Total
      expenses
            
            
            4,806,691
            
            
            
            2,676,611Loss
      from operations
            
            
            (2,912,878
            )
            
            
            (1,302,105
            )Other
      income (expense)Interest
      income
            
            
            22,626
            
            
            
            714Interest
      expense
            
            
            (311,108
            )
            
            
            (84,752
            )Charge
      for stock issued to convertible note holders
            
            
            (135,825
            )
            
            
            -Amortization
      of discount on convertible notes – outside investors
            
            
            (1,492,342
            )
            
            
            (146,684
            )Amortization
      of discount on convertible notes – related parties
            
            
            (40,169
            )
            
            
            -Change
      in estimated fair value of derivative financial instruments -
      warrants
            
            
            -
            
            
            
            (518,511
            )Charge
      for estimated liquidated damages – outside investors
            
            
            (340,439
            )
            
            
            -Charge
      for estimated liquidated damages – related parties
            
            
            (41,485
            )
            
            
            -Other
      expense
            
            
            (800
            )
            
            
            -Total
      other income (expense)
            
            
            (2,339,542
            )
            
            
            (749,233
            )Net
      loss
            
            $
            (5,252,420
            )
            
            $
            (2,051,338
            )Basic
      & diluted net loss per share
            
            $
            (0.61
            )
            
            $
            (0.25
            )Weighted
      average shares outstanding – basic and diluted
            
            
            8,644,112
            
            
            
            8,190,123




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


F -
5


CISTERA
NETWORKS, INC. & SUBSIDIARY


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)





Preferred
      Stock
            
            
            Common
      Stock
            
            
            Additional
      paid-in capital
            
            
            Accumulated
      deficit
            
            
            Total
      stockholders’ equity (deficit)Shares
            
            
            Amount
            
            
            Shares
            
            
            AmountBalances
      at March 31, 2006
            
            
            -
            
            
            $
            -
            
            
            
            8,077,226
            
            
            $
            8,077
            
            
            $
            8,684,405
            
            
            $
            (7,914,037
            )
            
            $
            778,445Cumulative
      effect of the correction of an accounting error(Note
      2)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            201,719
            
            
            
            (621,472
            )
            
            
            (419,753
            )Stock
      issued in connection with exercise of warrants
            
            
            
            
            
            
            
            
            
            
            192,831
            
            
            
            193
            
            
            
            33,622
            
            
            
            
            
            
            
            33,815Stock
      issued for conversion of convertible promissorynotes
            
            
            
            
            
            
            
            
            
            
            21,965
            
            
            
            22
            
            
            
            21,943
            
            
            
            
            
            
            
            21,965Beneficial
      conversion feature of convertible promissorynotes   (Note
      2)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            482,934
            
            
            
            
            
            
            
            482,934Share-based
      compensation expense (Note 2)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            101,700
            
            
            
            
            
            
            
            101,700Net
      loss, as restated (Note 2)
            
            
            
            
            
            
            
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,051,338
            )
            
            
            (2,051,338
            )Balances
      at March 31, 2007, as restated (Note 2)
            
            
            -
            
            
            
            -
            
            
            
            8,292,022
            
            
            
            8,292
            
            
            
            9,526,323
            
            
            
            (10,586,847
            )
            
            
            (1,052,232
            )Cumulative
      effect of change in accounting principle(Note
      3)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,730,824
            
            
            
            (755,115
            )
            
            
            1,975,709Stock
      issued to convertible promissory note holders asinducement
      for debt conversion
            
            
            
            
            
            
            
            
            
            
            134,462
            
            
            
            135
            
            
            
            135,671
            
            
            
            
            
            
            
            135,806Adjustment
      for common stock shares previously notreported
            
            
            
            
            
            
            
            
            
            
            302,447
            
            
            
            302
            
            
            
            (309
            )
            
            
            
            
            
            
            (7
            )Stock
      issued for conversion of convertible promissorynotes
            
            
            -
            
            
            
            -
            
            
            
            91,261
            
            
            
            91
            
            
            
            68,355
            
            
            
            
            
            
            
            68,446Allocation
      of discount on convertible promissory notes towarrants
      (Note 2)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            488,054
            
            
            
            
            
            
            
            488,054Beneficial
      conversion feature of convertible promissorynotes
      (Note 2)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            815,599
            
            
            
            
            
            
            
            815,599Net
      loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (5,252,420
            )
            
            
            (5,252,420
            )Balances
      at March 31, 2008
            
            
            -
            
            
            $
            -
            
            
            
            8,820,192
            
            
            $
            8,820
            
            
            $
            13,764,517
            
            
            $
            (16,594,382
            )
            
            $
            (2,821,045
            )




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




F -
6




CISTERA
NETWORKS, INC. & SUBSIDIARY


CONSOLIDATED
STATEMENTS OF CASH FLOWS





Years
      ended March 312008
            
            
            2007As
      restatedCASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
            
            $
            (5,252,420
            )
            
            $
            (2,051,338
            )Adjustments
      used to reconcile net loss to net cash used in operating
      activities:Charge
      for inducement to convert debt to convertible promissory
    notes
            
            
            135,799
            
            
            
            -Amortization
      of discount on convertible promissory notes – outside
      investors
            
            
            1,492,342
            
            
            
            146,684Amortization
      of discount on convertible promissory notes – related
    parties
            
            
            40,169
            
            
            
            -Charge
      for estimated liquidated damages – outside investors
            
            
            340,439
            
            
            
            -Charge
      for estimated liquidated damages – related parties
            
            
            41,485
            
            
            
            -Charge
      for changes in estimated fair value of derivative financial instruments
      - warrants
            
            
            -
            
            
            
            518,511Depreciation
      and amortization
            
            
            353,582
            
            
            
            347,086Share-based
      compensation
            
            
            -
            
            
            
            101,700Stock
      issued for investor fees
            
            
            10,000
            
            
            
            -Charge
      for litigation contingency
            
            
            650,000
            
            
            
            -Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            75,282
            
            
            
            (125,149
            )Related
      party receivables
            
            
            (1,200
            )
            
            
            9,290Inventory
            
            
            (112,217
            )
            
            
            (52,616
            )Prepaid
      expenses
            
            
            (35,887
            )
            
            
            31,483Accounts
      payable
            
            
            (48,051
            )
            
            
            (350,181
            )Related
      party payables
            
            
            105,664
            
            
            
            (35,400
            )Accrued
      sales commissions
            
            
            167,866
            
            
            
            -Accrued
      interest
            
            
            289,519
            
            
            
            44,109Other
      accrued liabilities
            
            
            (62,427
            )
            
            
            43,600Deferred
      revenue
            
            
            647,244
            
            
            
            320,988Other
      long-tem liabilities
            
            
            16,200
            
            
            
            -Net
      cash used in operating activities
            
            
            (1,146,611
            )
            
            
            (1,051,233
            )CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of property and equipment, net
            
            
            (315,172
            )
            
            
            (63,619
            )Net
      cash used in investing activities
            
            
            (315,172
            )
            
            
            (63,619
            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Increase
      in restricted cash
            
            
            (50,000
            )
            
            
            -Net
      proceeds from issuance of common stock
            
            
            -
            
            
            
            1,220Net
      borrowings (payments) on line of credit
            
            
            (44,591
            )
            
            
            62,094Net
      proceeds from issuance of convertible promissory notes
            
            
            1,220,000
            
            
            
            1,585,000Payments
      on convertible promissory notes
            
            
            (71,075
            )
            
            
            (20,000
            )Payments
      on other notes payable and capital lease
            
            
            (2,415
            )
            
            
            (39,581
            )Net
      cash provided by financing activities
            
            
            1,051,919
            
            
            
            1,588,733Net
      increase (decrease) in cash and cash equivalents
            
            
            (409,864
            )
            
            
            473,881Cash
      and cash equivalents at beginning of year
            
            
            534,871
            
            
            
            60,990Cash
      and cash equivalents at end of year
            
            $
            125,007
            
            
            $
            534,871





The accompanying notes are an integral
part of theseconsolidatedfinancial statements.




F -
7





CISTERA
      NETWORKS, INC. & SUBSIDIARY
              CONSOLIDATED
      STATEMENTS OF CASH FLOWS
              (continued)Years
      ended March 312008
            
            
            2007As
      restatedSUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Cash
      paid during the year for:Interest
            
            $
            17,584
            
            
            $
            35,574Income
      taxes
            
            
            -
            
            
            
            -SUPPLEMENTAL
      DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:Conversion
      of convertible promissory notes and related accrued interest
      tocommon
      stock
            
            $
            68,539
            
            
            $
            21,965Conversion
      of accounts payable and other accrued liabilities to
      convertiblepromissory
      notes
            
            
            363,171
            
            
            
            220,606Conversion
      of other notes payable to common stock
            
            
            -
            
            
            
            32,595Allocation
      of discount on convertible promissory notes to warrants
            
            
            488,054
            
            
            
            -Allocation
      of discount on convertible promissory notes to derivative
      financialinstruments
      – warrants
            
            
            -
            
            
            
            1,244,591Discount
      related to beneficial conversion feature on convertible
      promissoryNotes
            
            
            815,599
            
            
            
            482,934OTHER
      NON-CASH TRANSACTIONS:Cumulative
      effect of change in accounting principle:Reclassification
      of warrants from derivative financial instruments to
      equitySecurities
      (as valued at inception)
            
            $
            2,730,824
            
            
            $
            -Accrue
      liquidated damages at April 1, 2007
            
            
            289,518
            
            
            
            -Reclassification
      of warrants from derivative financial instruments to
      equitysecurities
      (as valued at April 1, 2007)
            
            
            (2,265,227
            )
            
            
            -Cumulative
      effect of change in accounting principle
            
            $
            755,115
            
            
            $
            -








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


F -
8


CISTERA NETWORKS, INC. &
SUBSIDIARY


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS





NOTE 1 - NATURE OF
OPERATIONS AND GOING CONCERN





The
accompanying consolidated financial statements have been prepared in conformity
with accounting principles generally accepted in the United States (“US GAAP”),
which contemplate the Company as a going concern.  However, the
Company has sustained substantial operating losses in recent years and has used
substantial amounts of working capital in its operations.  Realization
of a major portion of the assets reflected on the accompanying balance sheet is
dependent upon continued operations of the Company which, in turn, is dependent
upon the Company's ability to meet its financing requirements and succeed in its
future operations.  Management believes that actions presently being
taken to revise the Company’s operating and financial requirements provide them
with the opportunity for the Company to continue as a going
concern.





These
consolidated financial statements do not reflect adjustments that would be
necessary if the Company were unable to continue as a “going
concern”.  While management believes that the actions already taken or
planned, will mitigate the adverse conditions and events which raise doubt about
the validity of the “going concern” assumption used in preparing these financial
statements, there can be no assurance that these actions will be
successful.





If the
Company were unable to continue as a “going concern,” then substantial
adjustments would be necessary to the carrying values of assets, the reported
amounts of liabilities, the reported revenues and expenses, and the balance
sheet classifications used.





Subsequent
to the fiscal year ended March 31, 2008, the Company completed its Short Term
Investment Incentive Program, wherein the Company extended incentives to PP1 and
PP2 Note holders to 1) convert their notes to equity at a reduced conversion
price, and 2) exercise their warrants at a reduced exercise price. This Program
resulted in the reduction of the Company's debt by $3,194,953 including accrued
interest, and generated $896,916 in proceeds from the exercise of
warrants.  Also, subsequent to the year ended March 31, 2008, the
Company secured its largest contract to-date for the purchase of its Convergence
Solutions from a state in the Midwestern United States, in the initial amount of
approximately $600,000.  Together, management believes that these
events have substantially improved the liquidity position of the
Company.





Organization and Basis of
Presentation





On August
31, 2004, CNH Holdings Company absorbed its wholly-owned subsidiary Corvero
Networks, and began doing business as Cistera Networks, Inc. (“Cistera
Networks,” the “Company” or “we”).  All Corvero products adopted the
Cistera name.





On May
27, 2005, the Company acquired XBridge Software, Inc. through a merger between
XBridge and a Company subsidiary.  XBridge is a wholly-owned
subsidiary of the Company.





On
September 27, 2005, the Company changed its name from CNH Holdings Company to
Cistera Networks, Inc.





Nature of
Operations





Cistera
Networks provides IP network-based application appliances and services that add
features and enhanced functionality to the telecommunications services used by
large enterprises, small and mid-sized organizations, both in the commercial and
public sector.   Our software-based and hardware-based solutions
are delivered on our open-architecture, component-based platform known as the
Cistera ConvergenceServerTM, which allows administrators to centrally manage
advanced applications for IP telephony environments across large single-site and
multi-site private voice/data networks.  Although the origins of the
solution started back in 2000, we began operations in May 2003 as a public
entity under the name of CNH Holdings Company.





F -
9


Our
general business plan is to drive adoption of the Cistera
technology—establishing the Cistera ConvergenceServerTM as the leading platform
for advanced IP-based applications, through the strategic technology
relationships with the IP Telephony equipment providers—Cisco, Nortel, Sylantro
and Avaya, as well as the leading channel resellers—AT&T, Verizon, Bell
Canada, Comstor, BT, etc.  The Company plans to extend our product and
technological leadership in the IP communications industry, and to increase our
market penetration by continuing to expand our sales and distribution channels
and by capitalizing on new market opportunities like two-way radio
interoperability mobile/wireless devices.





NOTE 2 - SUMMARY OF
ACCOUNTING POLICIES





Principles of
Consolidation





The
consolidated financial statements as of March 31, 2008 and for the years ended
March 31, 2008 and 2007 include the accounts of Cistera Networks, Inc. and its
wholly-owned subsidiary XBridge Software, Inc.  XBridge Software, Inc.
was acquired by the Company on May 27, 2005.





The
results of subsidiaries acquired or sold during the year are consolidated from
their effective dates of acquisition through their effective dates of
disposition.





All
significant intercompany balances and transactions have been
eliminated.





Use of
Estimates





Our
consolidated financial statements are prepared in accordance with US
GAAP.  The preparation of these consolidated financial statements
requires us to make estimates and assumptions that affect the reported amounts
of assets, liabilities, revenues, costs and expenses, and related
disclosures.  On an ongoing basis, we evaluate our estimates and
assumptions.  Our actual results may differ from these estimates under
different assumptions or conditions.





Cash and Cash
Equivalents





The
Company considers all highly liquid debt instruments purchased with a maturity
of three months or less to be cash equivalents to the extent the funds are not
being held for investment purposes.  The Company holds a deposit
guaranty as part of a line of credit facility with a financial institution in
the amount of $50,000, and this amount is classified as restricted cash as of
March 31, 2008.  See further discussion in Note 4 to these
consolidated financial statements.





Accounts
Receivable





Accounts
receivable are comprised of the following at March 31, 2008.





Receivables
      Assigned to Factor
            
            $
            757,603Advances
      to (from) Factor
            
            
            (694,808
            )Fees,
      Expenses and Charges to Reserve
            
            
            (36,886
            )Amounts
      Due from Factor
            
            
            25,909Unfactored
      Accounts Receivable
            
            
            222,277Total
      Receivables
            
            $
            248,186





Pursuant
to a factoring agreement with Allied Capital Partners, L.P., effective December
2007, the Company is able to factor up to $1,500,000 of receivables at any one
time at an 85.88% advance rate, with recourse against the Company in the event
of a loss.  The Company’s obligations to Allied are collateralized by
all of the Company’s accounts receivable, chattel paper, general intangibles,
supporting obligations, inventory and proceeds thereof.  The
term of the current agreement is for a period of twelve months with automatic
twelve month renewal thereafter.  For the
year ended March 31, 2008, the factoring charges amounted to 1.75% of the
receivables purchased.


F -
10


Accounts receivable and
concentration of credit risk





The
Company has no significant off-balance sheet concentrations of credit risk such
as foreign exchange contracts, options contracts or other foreign hedging
arrangements.





The
Company is subject to credit risk from accounts receivable with its customers.
The Company’s accounts receivable are due from both governmental and commercial
entities. Credit is extended based on evaluation of the customers’ financial
condition and, generally, collateral is not required. Accounts receivable are
generally due within 30 to 60 days and are stated at amounts due from customers
net of an allowance for doubtful accounts. Accounts outstanding longer than the
contractual payment terms are considered past due.





The
Company assesses potential reserves against its accounts receivable by
considering a number of factors, including the length of time trade accounts
receivable are past due, the Company’s previous loss history, the customers’
current ability to pay their obligations to the Company and economic and
industry conditions.  Based on these factors, the Company has
concluded that an allowance for doubtful accounts as of March 31, 2008 is not
required.





As of
March 31, 2008, the Company receives approximately 23% of its gross revenues
from its top three re-sellers.  This represents a decrease in
concentration of business from the 31% reported for the year ended March 31,
2007.





Inventory





Inventory
consists of equipment that has been purchased but not yet shipped, shipped but
not yet installed,  and equipment that has been returned to the
Company because the customer has cancelled the project or there were problems
with the hardware.  The inventory assets are recorded at the lower of
cost or market. Cost is determined by the first-in, first-out
method.





Accrued liabilities and
Other long-term liabilities are comprised of the following at March 31,
2008:




Accrued
      liabilities
            
            Other
      long-term liabilitiesAccrued
      interest
            
            $
            88,375
            
            Accrued
      interest
            
            $
            269,270Reserve
      for litigation contingency
            
            
            650,000
            
            Other
            
            
            16,200Accrued
      sales commissions
            
            
            167,866Other
            
            
            170,119$
            1,076,360
            
            
            
            $
            285,470





Revenue
recognition




We
recognize revenue when:





·
            persuasive
      evidence of an arrangement exists,·
            delivery
      has occurred or services have been rendered,·
            the
      sales price is fixed or determinable, and·
            collectability
      of the resulting accounts receivable is reasonably
  assured.







F -
11


The
Company recognizes revenue from software, hardware and services once fully
installed and implemented. This method of revenue reporting does not reflect all
orders received and shipped during the reporting period, but only those orders
received, shipped and completely installed within the reporting
period.




The
Company recognizes revenue according to the American Institute of Certified
Public Accountants’ (“AICPA”) Statement of Position (“SOP”) 97-2 (Software
Revenue Recognition) as defined by paragraphs 07-14 in SOP 97-2 and as amended
by SOP 98-9 (Modification of SOP 97-2, Software Revenue Recognition, With
Respect to Certain Transactions).  This SOP provides guidance on when
revenue should be recognized and in what amounts for licensing, selling, leasing
or otherwise marketing computer software (including computer hardware and
support services).




Deferred
revenue represents contracts for certain revenue to be recognized in the future
from support and maintenance contracts as well as product sales and professional
services which have been shipped and billed but not
installed.  Support and maintenance contracts are executed on an
annual basis and the revenue from these contracts is recognized over the life of
the contracts.  Of the total deferred revenue shown as a current
liability in the amount of $971,474, the deferred revenue for products and
services was $543,748 as of March 31, 2008.  The remainder of current
deferred revenue and the long term deferred revenue of $225,917 related to
technical support and maintenance services.




Technical
support services revenue is deferred and recognized ratably over the period
during which the services are to be performed, which is typically from one to
three years. Advanced services revenue is recognized upon delivery or completion
of performance.




We make
sales to distributors and retail partners and recognize revenue based on a
sell-through method using information provided by them.




Accounting for Sales
Commissions




For the
fiscal year 2006 and 2007, the Company did not pay sales commissions except in
select agent arrangements.  Beginning in fiscal 2008, the Company
adopted a sales commission plan that paid commissions at a target rate of 3.75%
of the contract amount.  Commissions payable are accrued in the period
that the customer accepts the product or service from the
Company.  Sales commissions are generally paid on sales meeting the
criteria for sales commission payment in the subsequent accounting
period.




Depreciation and
Amortization





Property
and equipment are recorded at cost and depreciated using straight-line and
accelerated methods over the estimated useful lives of the assets which range
from three to seven years.  Property and equipment consisted of the
following at March 31, 2008:





2008Computer
      Equipment
            
            $
            223,314Trade
      Show Booth & Fixtures
            
            
            15,637Office
      Equipment
            
            
            327,761Leasehold
      Improvements
            
            
            7,372Property
      held under capital leases
            
            
            10,205Less
      accumulated depreciation
            
            
            (228,878
            )Total
            
            $
            355,411





F -
12


Maintenance
and repairs are charged to operations; betterments are
capitalized.  The cost of property sold or otherwise disposed of and
the accumulated depreciation thereon are eliminated from the property and
related accumulated depreciation accounts, and any resulting gain or loss is
credited or charged to income or expense.





Total
depreciation expense for the years ended March 31, 2008 and 2007 was $81,807 and
$36,181, respectively.





Intangible
Assets





The
Company has adopted the Financial Accounting Standards Board (“FASB”) Statement
of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other
Intangible Assets.”  SFAS 142 requires, among other things, that
companies no longer amortize goodwill, but instead test goodwill for impairment
at least annually.  In addition, SFAS 142 requires that the Company
identify reporting units for the purposes of assessing potential future
impairments of goodwill, reassess the useful lives of other existing recognized
intangible assets, and cease amortization of intangible assets with an
indefinite useful life.  An intangible asset with an indefinite useful
life should be tested for impairment in accordance with the guidance in SFAS
142.  Intangible Assets consisted of the following at March 31,
2008:





Intangible
      Asset
            
            
            
            Amortization
      PeriodIntellectual
      Property
            
            $
            2,717,755
            
            10
      YearsSoftware
      Development
            
            
            366,040
            
            4
      YearsLess
      accumulated amortization
            
            
            (1,060,577
            )Total
            
            $
            2,023,218





The
software development costs were acquired in the acquisition of XBridge Software,
Inc. Capitalized software development costs are amortized on a
product-by-product basis over their expected useful life, which is over the term
of the customer license agreement, which is generally four years.  The
annual amortization related to software to be sold is the greater of the amount
computed using (a) the ratio that current gross revenue for a product
compares to the total of current and anticipated future gross revenue for that
product or (b) the straight-line method over the remaining estimated
economic life of the product.





Research
and development expenses consist primarily of salaries and related expenses, and
allocated overhead related to increasing the functionality and enhancing the
ease of use of the convergence platform and applications.





On May
27, 2005, the Company issued 2,000,000 shares of common stock to acquire the
assets and liabilities of XBridge Software, Inc.  The shares were
valued at the market price on the effective date of the acquisition, which was
$2.65 per share.  The Company acquired net assets valued at $782,245
and intellectual property valued at $2,717,755.  The Company has
determined that the intellectual property has a useful life of 10 years, and is
using straight-line amortization.





Total
amortization expense for the years ended March 31, 2008 and 2007 was $271,776
and $311,710, respectively.





The
estimated amortization for the next five years is as follows:





2008
            
            $
            271,7762009
            
            
            271,7762010
            
            
            271,7762011
            
            
            271,7762012
            
            
            271,776Total
            
            $
            1,358,880





F -
13


Long-Lived
Assets





The
Company evaluates the carrying value of long-lived assets, including
identifiable intangible assets with a finite useful life, whenever events or
changes in circumstances indicate the carrying amount may not be fully
recoverable. If that analysis indicates that an impairment has occurred, the
Company measures the impairment based on a comparison of discounted cash flows
or fair values, whichever is more readily determinable, to the carrying value of
the related asset.




Earnings (Loss) per
Share





Basic
earnings (loss) per share has been computed by dividing the net losses earnings
for the period applicable to the common stockholders by the weighted average
number of common shares outstanding during the years.




Diluted
earnings (loss) per share is computed using the weighted average number of
common shares outstanding plus the number of common shares that would be issued
assuming exercise or conversion of all potentially dilutive common
shares.  At March 31, 2008, the total number of potentially dilutive
common stock equivalents was 10,343,689.  At March 31, 2007, the total
number of potentially dilutive common stock equivalents was 6,428,197. These
potentially dilutive common stock equivalents have been excluded from the
diluted share calculations for 2008 and 2007 as they were antidilutive as a
result of the net losses incurred for those years. Accordingly, basic shares
equal diluted shares for all years presented.





Reclassifications





Certain
reclassifications have been made in the 2007 financial statements to conform to
the 2008 presentation.





Stock
Options





Effective
April 1, 2006, the Company adopted the provisions of SFAS No. 123(R).
“Share-based payment” (“SFAS 123R”), applying the modified prospective
method.  SFAS 123R requires all equity-based payments to
employees to be recognized in the Consolidated Statements of Operations at
the fair value of the award on the grant date. Under the modifiedprospective
method, the Company is required to record equity-based compensation expense for
all awards granted after the date of adoption and for the unvested portion of
previously granted awards outstanding as of the date of adoption. The fair
values of all stock options granted by the Company are determined using the
Black-Scholes model (“BS Model”).





Fair Value of Financial
Instruments





The
carrying value of the Company's financial instruments, including accounts
payable and accrued liabilities at March 31, 2008 approximates their fair values
due to the short-term nature of these financial instruments.





Recent Accounting
Pronouncements




In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements
(SFAS 157), which provides guidance on how to measure assets and
liabilities that use fair value. SFAS 157 will apply whenever another
US GAAP standard requires (or permits) measurement of assets or liabilities
at fair value, but does not expand the use of fair value to any new
circumstances. This standard also will require additional disclosures in both
annual and quarterly reports. SFAS 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007. We
intend to adopt the standard beginning in the first quarter of fiscal year 2009.
We are currently evaluating the impact of adopting SFAS 157 on our
financial statements and do not believe it will have a material
impact.




F -
14




In
February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities—Including an Amendment of FASB
Statement No. 115." SFAS 159 permits companies to measure many
financial instruments and certain other items at fair value at specified
election dates. Unrealized gains and losses on these items will be reported in
earnings at each subsequent reporting date. The fair value option may be applied
instrument by instrument (with a few exceptions), is irrevocable and is applied
only to entire instruments and not to portions of instruments. SFAS 159 is
effective for fiscal years beginning after November 15, 2007. We intend to
adopt the standard beginning in the first quarter of fiscal year 2009. We are
currently assessing the impact of SFAS 159 on our financial statements and
do not believe it will have a material impact.




In December 2007, the FASB issued SFAS No. 160,
“Non-Controlling Interests in Consolidated Financial Statements” (“SFAS 160”),
which requires all entities to report non-controlling (minority interests) in
subsidiaries with equity in the consolidated financial statements, but separate
from the parent stockholders' equity. We intend to adopt the standard beginning
in the first quarter of 2009. We are currently evaluating the impact of adopting
SFAS 160 on our financial statements and do not believe it will have a
material impact.




In
December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business
Combinations" ("SFAS 141R"), which replaces FASB Statement No. 141.
SFAS 141R establishes principles and requirements for how an acquirer
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, any non-controlling interest in the acquiree
and the goodwill acquired. The Statement also establishes disclosure
requirements that will enable users to evaluate the nature and financial effects
of the business combination. We intend to adopt the standard beginning in the
first quarter of fiscal year 2010.





NOTE 3 – RESTATEMENT OF
PREVIOUSLY ISSUED CONSOLIDATED FINANCIAL STATEMENTS





The
Company is restating its Consolidated Statements of Operations, Consolidated
Statements of Stockholders’ Equity and Consolidated Statements of Cash Flows for
the year ended March 31, 2007 to reflect: (i) a correction in its
accounting for its Senior Unsecured Convertible Promissory Notes and detachable
warrants issued in private placements during the period from December 2004 to
April 2007 (the “PP1 Notes, “PP1 Warrants,” “PP2 Notes,” and “PP2 Warrants”) and
(ii) share-based compensation related to employee stock options.  The
impact of the restatement is summarized in the table below:
  Adjustments
      to Statements of OperationsConvertible
      Promissory Notes and Warrants
                
                
                Stock
      Compensation Expense
                
                
                TotalYear
      ended March 31, 2007
                
                $
                (665,195
                )
                
                $
                (101,700
                )
                
                $
                (766,895
                )Cumulative
      effect at April 1, 2006
                
                
                (621,472
                )
                
                
                -
                
                
                
                (621,472
                )Total
                
                $
                (1,286,667
                )
                
                $
                (101,700
                )
                
                $
                (1,388,367
                )




Convertible Promissory Notes
and Warrants





The
Company has concluded that its original accounting for the PP1 Notes and PP1
Warrants issued in fiscal year 2005 and the PP2 Notes and PP2 Warrants issued in
fiscal year 2007 and fiscal year 2008 was incorrect and that the necessary
adjustments were material to the fiscal year 2007 consolidated financial
statements.





F -
15


The
Company based its conclusion upon a further review of the documents associated
with the Notes and Warrants and considered the following sources as relevant
guidance in determining the proper accounting treatment for the Notes and
Warrants.





·
            SFAS
      133, Accounting for
      Derivative Instruments and Hedging Activities(“SFAS
      133”),


·
            APB
      Opinion 14, Accounting
      for Convertible Debt and Debt Issued with Stock Purchase Warrants
      (“APB   14”),


·
            Emerging
      Issues Task Force (EITF) Issue 00-19, Accounting for Derivative
      Financial Instruments Indexed to, and Potentially Settled in, a Company’s
      Own Stock(“EITF 00-19”),


·
            EITF
      05-2,The Meaning of
      “Conventional Convertible Debt Instrument”(“EITF
      05-2”),


·
            EITF
      98-5, Accounting for
      Convertible Securities with Beneficial Conversion Features or Contingently
      Adjustable Conversion Ratios (“EITF
  98-5”),


·
            EITF
      00-27, Application of
      Issue No. 98-5 to Certain Convertible Instruments (“EITF
      00-27”),


·
            SEC
      Staff Accounting
      Bulletin No. 107(“SAB 107”)




Conversion feature of the
Notes





The
Company concluded that the Notes meet the definition of “conventional
convertible debt” (as defined in EITF 00-19 and affirmed in EITF
05-2).  EITF 00-19, paragraph 4 states: “The Task Force observed that,
pursuant to paragraphs 11(a) and 12(c) of Statement 133, if an embedded
derivative is indexed to the reporting entity's own stock and would be
classified in stockholders' equity if it was a freestanding derivative, that
embedded derivative is not considered a derivative for purposes of SFAS 133. The
Task Force reached a consensus that for purposes of evaluating under SFAS 133
whether an embedded derivative indexed to a company's own stock would be
classified in stockholders’ equity if freestanding, the requirements of
paragraphs 12–32 of this Issue do not apply if the hybrid contract is a
conventional convertible debt instrument in which the holder may only realize
the value of the conversion option by exercising the option and receiving the
entire proceeds in a fixed number of shares or the equivalent amount of cash (at
the discretion of the issuer).”





Therefore,
the Company has concluded that the conversion feature of the convertible debt
did not meet the definition of a derivative under SFAS 133 and did not require
separate accounting from the debt instrument.





Valuation of Notes and
Warrants and beneficial conversion feature





APB 14
addresses the accounting for convertible debt with a nondetachable (embedded)
conversion feature, the terms of which provide for an initial conversion price
that is greater than the market value at the date of issuance and a conversion
price that does not decrease, except under antidilution protection, but does not
explicitly address situations in which the embedded conversion feature is
“in-the money” at issuance.  The Notes, including any accrued
interest, were exercisable into the Company’s common stock at less than the
closing price of the Company’s stock on the dates of issuance, and the Company
considered this conversion to be an “embedded beneficial conversion
feature.”





EITF 98-5
requires “that embedded beneficial conversion features present in convertible
securities should be valued separately at issuance.” Further, EITF 98-5 states
“that the intrinsic value of the beneficial conversion feature may be greater
than the proceeds allocated to the convertible instrument,” and as such, “that
the amount of the discount assigned to the beneficial conversion feature is
limited to the amount of the proceeds allocated to the convertible instrument.”
EITF 00-27 further states “that the effective conversion price based on the
proceeds received for or allocated to the convertible instrument should be used
to compute the intrinsic value, if any, of the embedded conversion option. As a
result of this consensus, an issuer should first allocate the proceeds received
in a financing
transaction that includes a convertible instrument to the convertible instrument
and any other detachable instruments included in the exchange (such as
detachable warrants) on a relative fair value basis. Then, the Issue 98-5 model
should be applied to the amount allocated to the convertible instrument, and an
effective conversion price should be calculated and used to measure the
intrinsic value, if any, of the embedded conversion
option.”


F -
16





Accordingly,
we calculated the fair value of both the convertible Notes and the Warrants and
allocated the respective relative fair value percentages of each in determining
the initial values of the convertible Notes and the Warrants.  Because
the Warrants were determined to be derivative liabilities (see conclusion in
next section below), the Company recorded them at fair value as calculated under
the Black-Scholes option pricing model (“BS model”).  For Notes and
Warrants issuances where the net cash proceeds were greater than the fair value
of the Warrants, this difference was allocated to the value of the
Notes.  The amount assigned to the Warrants represented a debt
discount on the Notes, which is amortized over the life of the
Notes.  For Notes and Warrants issuances where the net cash proceeds
were less than the fair value of the Warrants, the Warrants were recorded at
fair value and the difference was recorded as a charge to the consolidated
Statement of Operations at inception.  This second situation occurred
with issuance of the PP1 Notes in December 2004 and resulted in a charge to the
Statement of Operations of approximately $230,000; and no value was allocated to
the Notes, with a full debt discount recorded and amortized over the life of the
Notes.





After
determining the recorded value of the Warrants and Notes (if any), we calculated
the beneficial conversion feature of the Notes, which resulted in an additional
debt discount which was amortized over the life of the Notes.





Classification and
accounting for Warrants





We
evaluated the Warrants as a potential free standing derivative under the
criteria in paragraph 11(a) of SFAS 133, which require that a contract
(Warrants) issued by a reporting entity be accounted for as a derivative unless
it is both (1) indexed to its own stock and (2) classified in stockholders’
equity in its statement of financial position. We concluded that the Warrants
were indexed to the Company’s own stock and should be classified in
stockholders’ equity and would qualify for the scope exception contained in this
paragraph.  The Company was required to further review the
requirements for equity classification contained in paragraphs 12-32 of EITF
00-19.  The Company concluded that it had not met criteria (2) above
based on the requirements for equity classification in EITF
00-19.  Specifically, both the PP1 and PP2 Notes contain registration
rights agreements (the “RR agreements”) that stipulate that the Company must
register all “registrable securities” (defined as the “shares of Common Stock
issuable upon conversion of the Notes and the shares of Common Stock issuable
upon exercise of the Warrants”) within a time frame (and this was deemed to be
outside of the control of the Company).  In the event of not filing a
registration statement by a specified date or by not having a registration
effective by a specified date, the Company was obligated to pay liquidated
damages in the amount of 1% of the then current outstanding amount of the Notes
plus accrued interest.  The Company accrued all required liquidated
damages, beginning in FY 2005 with the PP1 Notes. Liquidated damages required
under the RR Agreement for the PP1 Notes ceased on September 25, 2005, which was
the date that the Company filed its initial registration statement for the PP1
Notes and PP1 Warrants.





Accordingly,
the Company concluded that the Warrants did not satisfy the requirement for
equity classification and should be classified, recorded and prospectively
accounted for as derivative liabilities until it has registered all underlying
shares to the Warrants or until such time that the RR agreements are no longer
in effect.  The prospective accounting requires that the Warrants be
remeasured at each balance sheet date based on estimated fair value and any
resultant changes in fair value be recorded to the Statement of
Operations.





The
Company used the BS model for calculating the fair value of all Warrants issued
based on the following assumptions:





Warrants
      issued in PP1
            
            Warrants
      issued in PP2Expected
      volatility
            128%
            
            100%-104%Expected
      term
            5
      years
            
            5
      yearsRisk-free
      interest rate
            3.58%
      - 4.33%
            
            4.46%
      - 4.65%Expected
      dividend yield
            0%
            
            0%




We
estimated volatility primarily based on historical volatility rates through the
date of each closing of the PP1 and PP2 offerings. The Warrants have a
transferability provision and based on guidance provided in SAB 107 for options
issued with such a provision, we used the full, five-year contractual term as
the expected term in the initial valuation of the Warrants.  For the
risk-free interest rate, we used the five year U.S. Treasury zero coupon rate
for the initial valuation of the Warrants.  Expected volatilities,
expected terms and risk-free interest rates were adjusted as of each quarterly
period commensurate with the remaining contractual lives of the Warrants on such
dates and were used to determine the estimated fair value of the Warrants under
the BS model.  F -
17





Share-based
compensation





The
Company has concluded that it incorrectly calculated and recorded share-based
compensation expense associated with stock options upon the adoption of SFAS
123R on April 1, 2006.  Specifically, the Company did not calculate
the fair value of employee stock options issued during the period from February
2004 through October 2004 and did not record any related expense in the
Statement of Operations for the year ended March 31, 2007 related to the
unrecognized stock option cost as of April 1, 2006.  The Company has
not issued any additional stock options to employees since October
2004.





The table
below summarizes the effect of the restatement adjustments on the Consolidated
Statement of Operations for the year ended March 31, 2007:


As
      previously reported
            
            
            Adjustments
            
            
            As
      restatedRevenuesConvergence
      Solutions
            
            $
            1,401,789
            
            
            
            
            
            $
            1,401,789Professional
      Services
            
            
            218,454
            
            
            
            
            
            
            218,454Support
      and Maintenance
            
            
            312,595
            
            
            
            
            
            
            312,595Total
      revenues
            
            
            1,932,838
            
            
            
            
            
            
            1,932,838Cost
      of revenuesConvergence
      Solutions
            
            
            313,272
            
            
            
            
            
            
            313,272Professional
      Services
            
            
            167,012
            
            
            
            
            
            
            167,012Support
      and Maintenance
            
            
            78,048
            
            
            
            
            
            
            78,048Total
      cost of revenues
            
            
            558,332
            
            
            
            
            
            
            558,332Gross
      Profit
            
            
            1,374,506
            
            
            
            
            
            
            1,374,506Expenses:Sales
      and marketing
            
            
            676,868
            
            
            
            
            
            
            676,868Software
      development
            
            
            510,025
            
            
            
            32,572
            
            
            
            542,597Engineering
      and support
            
            
            209,532
            
            
            
            
            
            
            
            209,532General
      and administrative
            
            
            831,400
            
            
            
            69,128
            
            
            
            900,528Depreciation
      and amortization
            
            
            347,086
            
            
            
            
            
            
            
            347,086Total
      expenses
            
            
            2,574,911
            
            
            
            101,700
            
            
            
            2,676,611Loss
      from operations
            
            
            (1,200,405
            )
            
            
            (101,700
            )
            
            
            (1,302,105
            )Other
      income (expense)Interest
      income
            
            
            714
            
            
            
            
            
            
            
            714Interest
      expense
            
            
            (84,752
            )
            
            
            
            
            
            
            (84,752
            )Amortization
      of discount on convertible notes
            
            
            
            
            
            
            (146,684
            )
            
            
            (146,684
            )Change
      in estimated value of derivative financial instruments -
      warrants
            
            
            
            
            
            
            (518,511
            )
            
            
            (518,511
            )Total
      other income (expense)
            
            
            (84,038
            )
            
            
            (665,195
            )
            
            
            (749,233
            )Net
      loss
            
            $
            (1,284,443
            )
            
            $
            (766,895
            )
            
            $
            (2,051,338
            )Basic
      & diluted net loss per share
            
            $
            (0.16
            )
            
            $
            (0.09
            )
            
            $
            (0.25
            )Weighted
      average shares outstanding – basic and diluted
            
            
            8,190,123
            
            
            
            
            
            
            
            8,190,123




F -
18


The table
below summarizes the effect of the restatement adjustments on the Consolidated
Balance Sheet as of March 31, 2007:





As
      previously reported
              
              
              Adjustments
              
              
              As
      restatedCurrent
      assets:Cash
      and cash equivalents
              
              $
              534,871
              
              
              
              
              
              $
              534,871Restricted
      cash
              
              
              -
              
              
              
              
              
              
              -Accounts
      receivable, net
              
              
              314,178
              
              
              
              
              
              
              314,178Related
      party receivables
              
              
              23,927
              
              
              
              
              
              
              23,927Inventory
              
              
              75,743
              
              
              
              
              
              
              75,743Prepaid
      expenses
              
              
              10,143
              
              
              
              
              
              
              10,143Total
      current assets
              
              
              958,862
              
              
              
              
              
              
              958,862Property
      and equipment, net
              
              
              122,046
              
              
              
              
              
              
              122,046Intangible
      assets, net
              
              
              2,294,993
              
              
              
              
              
              
              2,294,993Total
      long-term assets
              
              
              2,417,039
              
              
              
              
              
              
              2,417,039TOTAL
      ASSETS
              
              $
              3,375,901
              
              
              $
              -
              
              
              $
              3,375,901Current
      liabilities:Accounts
      payable
              
              $
              544,796
              
              
              
              
              
              
              $
              544,796Related
      party payables
              
              
              24,038
              
              
              
              
              
              
              
              24,038Accrued
      liabilities
              
              
              598,023
              
              
              
              
              
              
              
              598,023Deferred
      revenue
              
              
              465,179
              
              
              
              
              
              
              
              465,179Convertible
      promissory notes
              
              
              144,000
              
              
              
              
              
              
              
              144,000Line
      of credit and other current debt
              
              
              64,509
              
              
              
              
              
              
              
              64,509Total
      current liabilities
              
              
              1,840,545
              
              
              
              
              
              
              
              1,840,545Convertible
      promissory notes
              
              
              1,900,606
              
              
              
              
              
              
              
              1,900,606Discount
      on convertible promissory notes
              
              
              
              
              
              
              (1,663,211
              )
              
              
              (1,663,211
              )Derivative
      financial instruments, at estimated fair value – Warrants
              
              
              
              
              
              
              2,265,225
              
              
              
              2,265,225Deferred
      revenue
              
              
              84,968
              
              
              
              
              
              
              
              84,968Total
      long-term liabilities
              
              
              1,985,574
              
              
              
              602,014
              
              
              
              2,587,588Total
      liabilities
              
              
              3,826,119
              
              
              
              602,014
              
              
              
              4,428,133Stockholders’
      deficit:Preferred
      stock
              
              
              -
              
              
              
              
              
              
              
              -Common
      stock
              
              
              8,292
              
              
              
              
              
              
              
              8,292Additional
      paid-in capital
              
              
              8,739,970
              
              
              
              786,353
              
              
              
              9,526,323Accumulated
      deficit
              
              
              (9,198,480
              )
              
              
              (1,388,367
              )
              
              
              (10,586,847
              )Total
      stockholders’ deficit
              
              
              (450,218
              )
              
              
              (602,014
              )
              
              
              (1,052,232
              )TOTAL
      LIABILITIES AND STOCKHOLDERS’DEFICIT
              
              $
              3,375,901
              
              
              $
              -
              
              
              $
              3,375,901




F -
19


The table
below summarizes the effect of the restatement adjustments on the Consolidated
Statement of Cash Flows for the year ended March 31, 2007:





As
      previously reported
            
            
            Adjustments
            
            
            As
      restatedCASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
            
            $
            (1,284,443
            )
            
            $
            (766,895
            )
            
            $
            (2,051,338
            )Adjustments
      used to reconcile net loss to net cash used inoperating
      activities:Amortization
      of discount on convertible promissory notes – outside
      investors
            
            
            -
            
            
            
            146,684
            
            
            
            146,684Charge
      for changes in estimated fair value of derivative financial instruments -
      warrants
            
            
            -
            
            
            
            518,511
            
            
            
            518,511Depreciation
      and amortization
            
            
            347,086
            
            
            
            
            
            
            
            347,086Share-based
      compensation
            
            
            -
            
            
            
            101,700
            
            
            
            101,700Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            (125,149
            )
            
            
            
            
            
            
            (125,149
            )Related
      party receivables
            
            
            9,290
            
            
            
            
            
            
            
            9,290Inventory
            
            
            (52,616
            )
            
            
            
            
            
            
            (52,616
            )Prepaid
      expenses
            
            
            31,483
            
            
            
            
            
            
            
            31,483Accounts
      payable
            
            
            (350,181
            )
            
            
            
            
            
            
            (350,181
            )Related
      party payables
            
            
            (35,400
            )
            
            
            
            
            
            
            (35,400
            )Accrued
      interest
            
            
            44,109
            
            
            
            
            
            
            
            44,109Other
      accrued liabilities
            
            
            43,600
            
            
            
            
            
            
            
            43,600Deferred
      revenue
            
            
            320,988
            
            
            
            
            
            
            
            320,988Net
      cash used in operating activities
            
            
            (1,051,233
            )
            
            
            -
            
            
            
            (1,051,233
            )Net
      cash used in investing activities
            
            
            (63,619
            )
            
            
            -
            
            
            
            (63,619
            )Net
      cash provided by financing activities
            
            
            1,588,733
            
            
            
            -
            
            
            
            1,588,733Net
      increase (decrease) in cash and cash equivalents
            
            
            473,881
            
            
            
            
            
            
            
            473,881Cash
      and cash equivalents at beginning of year
            
            
            60,990
            
            
            
            
            
            
            
            60,990Cash
      and cash equivalents at end of year
            
            $
            534,871
            
            
            $
            -
            
            
            $
            534,871SUPPLEMENTAL
      DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:Conversion
      of convertible promissory notes and related accrued interest to common
      stock
            
            $
            21,965
            
            
            $
            -
            
            
            $
            21,965Conversion
      of accounts payable and other accrued liabilities to convertible
      promissory notes
            
            
            220,606
            
            
            
            
            
            
            
            220,606Conversion
      of other notes payable to common stock
            
            
            32,595
            
            
            
            
            
            
            
            32,595Allocation
      of discount on convertible promissory notes to derivative financial
      instruments - warrants
            
            
            -
            
            
            
            1,244,591
            
            
            
            1,244,591Discount
      related to beneficial conversion feature on convertible promissory
      notes
            
            $
            -
            
            
            $
            482,934
            
            
            $
            482,934





F -
20


NOTE 4 -
DEBT





As of
March 31, 2008, the Company had $3,508,577 outstanding under its PP1 Notes and
PP2 Notes.  The Notes bear interest at an annual rate of 8% and were
issued as part of two private placements to accredited investors.





PP1
Notes





On
December 13, 2004, the Company issued and sold an aggregate of $1,146,000 in
principal amount of PP1 Notes, and PP1 Warrants to purchase 1,146,000 shares of
our common stock.  Of the $1,146,000 in principal, the Company
received cash of $1,004,000, and $142,000 in principal amount of the PP1 Notes
was issued in connection with the cancellation of an equal amount of the
Company’s outstanding obligations.





The PP1
Notes bear interest at the rate of 8% per annum, compounded quarterly on each
March 31, June 30, September 30 and December 31 anniversary that they are
outstanding (each, an interest compounding date).  The outstanding
principal and all accrued interest become due and payable on the earlier of (a)
December 13, 2006, or (b) the date on which a change in control of the Company
occurred.





The
outstanding principal and accrued interest are convertible into shares of common
stock at a conversion rate equal to the lesser of (a) $1.30 per share, or (b) a
25% discount to the average closing bid price of the Company’s common stock for
the five days including and immediately preceding the interest compounding date,
provided that in no event shall the conversion price per share be less than
$1.00 per share.  The PP1 Notes may be converted, in whole or in part,
at the option of the PP1 Note holder on any interest compounding date occurring
after the effective date of a registration statement covering the resale of
shares of common stock to be issued upon conversion of the PP1
Notes.





In
addition, if the Company subsequently issues or sells any new securities
convertible, exercisable or exchangeable into shares of our common stock
(“convertible securities”) in a private transaction and receives gross proceeds
of at least $500,000, the PP1 Notes may be converted, in whole or in part at the
option of the note holders, into the convertible securities, upon the same terms
and conditions governing the issuance of the convertible securities in the
private transaction.  The right of the PP1 Note holders to convert
their notes into convertible securities does not apply to any convertible
securities issued by the Company (a) in connection with a merger, acquisition or
consolidation of the Company, (b) in connection with strategic license
agreements and other partnering arrangements so long as such issuances are not
for the purpose of raising capital, (c) in connection with bona fide firm
underwritten public offerings of its securities, (d) pursuant to the Company’s
incentive and stock option plans, (e) as a result of the exercise of options or
warrants or conversion of convertible notes or preferred stock which were
granted or issued as of December 13, 2004.





The
Company may prepay the PP1 Notes in whole or in part, upon thirty days prior
written notice to note holders; provided that partial prepayments may be made
only in increments of $10,000 and, provided further, that the PP1 Note holders
may convert the amount of the proposed prepayment into shares of our common
stock at any time.





The PP1
Warrants have a term of five years and are exercisable at an exercise price of
$1.30 per share.  Subject to an effective registration statement
covering the resale of the shares of common stock issuable upon exercise of the
PP1 Warrants, the Company may, upon thirty days prior written notice, redeem the
PP1 Warrants for $0.10 per share, in whole or in part, if our common stock
closes with a bid price of at least $3.50 for any ten (10) out of fifteen (15)
consecutive trading days.





During
the quarter ended September 30, 2007, the Company elected to compensate PP1 Note
holders who had opted to convert debt into shares of common stock, which
remained unregistered with the SEC as of the date the PP1 Notes became due and
payable on December 13, 2006.  The amount offered to, and accepted by,
the shareholders was $135,825, payable in the form of additional shares of
common stock.  In August 2007, the company recorded a charge and
liability for the impending issuance of this stock.  On January 11,
2008, the Company issued 134,462 shares of common stock at the agreed upon
conversion rate of $1.01, and paid $19 in cash for fractional shares in
settlement of this liability.  At March 31, 2008, there was $72,925 of
principal and $28,071 of interest due on the PP1 Notes.


F -
21


As stated
in Note 3 to the consolidated financial statements, the Company has restated its
consolidated financial statements for the accounting it originally applied in
the initial valuation and recording of the PP1 Notes and PP1 Warrants and
subsequent remeasurement of their carrying values as of April 1,
2006.  See specific accounting treatment in Note 3.





PP2
Notes





On
December 29, 2006 we issued and sold an aggregate of $433,362 in principal
amount of PP2 Notes, and issued PP2 Warrants to purchase 433,571 shares of our
common stock.  Of the $433,362 in principal, we received cash of
$397,500 and $35,862 in principal and interest of PP1 Notes was
converted.  During January through March 2007, the Company received
additional funding from investors in the amount of approximately $1,466,000,
which were formally issued and sold as PP2 Notes on April 5, 2007, when the
Company also issued an additional $1,593,000 in PP2
Notes.  Additionally, the Company issued PP2 Warrants to purchase
3,065,205 shares of our common stock, par value $0.001 per share.  Of
the $3,065,205 in principal, we received cash of $2,416,429, and $648,776 in
principal amount of the PP2 Notes was issued in connection with the cancellation
of an equal amount of the Company’s outstanding obligations.  Included
in the outstanding obligations that were cancelled were $100779 of obligations
to principal officers and directors in the following amounts: Greg Royal $70,779
and Derek Downs $30,000.





The PP2
Notes bear interest at the rate of 8% per annum, compounded quarterly on each
March 31, June 30, September 30 and December 31 anniversary that they are
outstanding (each, an interest compounding date).  The outstanding
principal and all accrued interest become due and payable two years from the
date of the PP2 Notes.  The outstanding principal and accrued interest
are convertible into shares of common stock at a fixed rate of $0.75 per
share.  The PP2 Notes may be converted, in whole or in part, at the
option of the PP2 Note holder on any interest compounding date occurring after
the effective date of a registration statement covering the resale of shares of
common stock to be issued upon conversion of the PP1 Notes.





In
addition, if the Company subsequently issues or sells any new securities
convertible, exercisable or exchangeable into shares of our common stock
(“convertible securities”) in a private transaction and receives gross proceeds
of at least $500,000, the PP2 Notes may be converted, in whole or in part at the
option of the note holders, into the convertible securities, upon the same terms
and conditions governing the issuance of the convertible securities in the
private transaction.  The right of the PP2 Note holders to convert
their notes into convertible securities does not apply to any convertible
securities issued by the Company (a) in connection with a merger, acquisition or
consolidation of the Company, (b) in connection with strategic license
agreements and other partnering arrangements so long as such issuances are not
for the purpose of raising capital, (c) in connection with bona fide firm
underwritten public offerings of its securities, (d) pursuant to the Company’s
incentive and stock option plans, (e) as a result of the exercise of options or
warrants or conversion of convertible notes or preferred stock which were
granted or issued as of December 13, 2004.





The
Company may prepay the PP2 Notes in whole or in part, upon thirty days prior
written notice to note holders; provided that partial prepayments may be made
only in increments of $10,000 and, provided further, that the PP1 Note holders
may convert the amount of the proposed prepayment into shares of our common
stock at any time.





The PP2
Warrants have a term of five years and are exercisable at an exercise price of
$1.00 per share.  Subject to an effective registration statement
covering the resale of the shares of common stock issuable upon exercise of the
PP2 Warrants, the Company may, upon thirty days prior written notice, redeem the
PP2 Warrants for $0.10 per share, in whole or in part, if our common stock
closes with a bid price of at least $3.50 for any ten (10) out of fifteen (15)
consecutive trading days.





As stated
in Note 3 to the consolidated financial statements, the Company has restated its
consolidated financial statements for the accounting it originally applied in
the initial valuation and recording of the PP2 Notes and PP2 Warrants and
subsequent remeasurement of their carrying values as of April 1,
2006.  See specific accounting treatment in Note 3.





F -
22


The
Company’s total debt as of March 31, 2008 is as follows:





Current
            
            
            Long-term
            
            
            TotalLine
      of credit
            
            $
            17,503
            
            
            $
            -
            
            
            $
            17,503PP1
      Notes
            
            
            72,925
            
            
            
            -
            
            
            
            72,925PP2
      Notes – outside investors
            
            
            433,571
            
            
            
            2,901,302
            
            
            
            3,334,873Less:
      discount
            
            
            (98,292
            )
            
            
            (1,295,002
            )
            
            
            (1,393,294
            )Net
      – PP2 Notes – outside investors
            
            
            335,279
            
            
            
            1,606,300
            
            
            
            1,941,579PP2
      Notes – related parties
            
            
            -
            
            
            
            100,779
            
            
            
            100,779Less:
      discount
            
            
            -
            
            
            
            (41,060
            )
            
            
            (41,060
            )Net
      – PP2 Notes – related parties
            
            
            -
            
            
            
            59,719
            
            
            
            59,719$
            425,707
            
            
            $
            1,666,019
            
            
            $
            2,091,726





Registration payment
arrangements





On
December 21, 2006, the EITF issued FASB Staff Position No. 00-19-2 (“FSP
00-19-2”).  FSP 00-19-2 was effective immediately for registration
payment arrangements and the financial instruments subject to those arrangements
that were entered into or modified subsequent to the date of issuance of this
FSP. For registration payment arrangements and financial instruments subject to
those arrangements that were entered into prior to the issuance of this FSP, the
FSP was effective for financial statements issued for fiscal years beginning
after December 15, 2006, and interim periods within those fiscal
years.  Effective April 1, 2007, the Company adopted FSP 00-19-2,
which was applicable to the accounting for the liquidated damages on the PP2
Notes.





FSP
00-19-2 requires the Company to account for contingent liquidated damages
separately from the financial instruments to which they relate, which are the
Notes and Warrants issued and sold in the PP1 and PP2
offerings.  Prior to the adoption of FSP-00-19-2, the Company was
accounting for the Warrants as derivative liabilities based on the requirement
of the Company to register all underlying shares to the Notes and the
Warrants.  The Company concluded that with the separate accounting
required under FSP 00-19-2 for the liquidated damages, the Warrants by
themselves were properly classified as equity securities (having met all
requirements of EITF 00-19 for equity classification) as of the adoption
date.





Under FSP
00-19-2, the Company is required to estimate and record a contingent liability
if the likelihood is probable that it will pay liquidated damages in future
periods, calculated in accordance with the SFAS 5, “Accounting for
Contingencies” (“SFAS 5”) and FASB Interpretation No. 14, “Reasonable Estimation
of the Amount of a Loss.”  Further, FSP 00-19-2 requires that “the
financial instrument(s) subject to the registration payment arrangement shall be
recognized and measured in accordance with other applicable GAAP (for example
SFAS 133 and EITF 00-19) without regard to the contingent obligation to transfer
consideration pursuant to the registration payment arrangement.” Accordingly, on
the date of adoption, the Company accounted for the Warrants separately from the
liquidated damages obligations.





Based on
the above requirements, the Company recorded a cumulative effect of an
accounting change entry (i.e., a charge to the beginning balance of the
accumulated deficit) as of April 1, 2007 for the combination of:  1)
the reclassification of the Warrants from derivative liabilities to equity
securities, and 2) a contingent liability for probable future payment of
liquidated damages (based on the Company’s best estimate as of the date of
adoption, which is through March 31, 2008).  The amount of the
contingent liability recorded was approximately $289,000.  Also, as
part of the cumulative effect of an accounting change entry, the Company
reclassified the Warrants from derivative liabilities to equity
securities.  The difference between the Warrants as measured on the
date of adoption and their original recorded value was included in the charge to
the beginning balance of the Accumulated deficit.  This amount was
approximately $466,000.  The total of the cumulative effect of this
accounting change was $755,000.


F -
23


On April
5, 2007, the Company closed the balance of its PP2 offering and, in accordance
with FSP 00-19-2, recorded a contingent liability and related charge to the
consolidated Statement of Operations for estimated liquidated damages related to
this funding through March 31, 2008.





The
Company evaluated the contingent liability for liquidated damages at June 30,
September 30 and December 31, 2007 and concluded that the facts and
circumstances had not changed as to the appropriateness of the March 31, 2008
date.  As of March 31, 2008, the Company was in substantial
discussions with a majority of investors to convert their Notes, exercise their
Warrants and remove the registration requirements of the underlying shares to
the Notes and Warrants.  As a result, as of March 31, 2008, the
Company concluded that it was probable that it would execute an agreement under
these terms and estimated and recorded an additional contingent liability and
related charge for liquidated damages through June 30, 2008.





As of
March 31, 2008, the Company accrued $671,342 related to liquidated
damages related to the PP2 Notes and estimated that this amount was the maximum
payout required.




On June
24, 2008, the Company executed agreements with certain investors comprising
approximately 70% of the original principal investment of PP2 to convert the
outstanding Notes at a reduced price of $0.53.  On June 30, 2008, the
Company executed an agreement with the institutional investor in the PP2
offering that had the contractual right to liquidated damages.  In exchange
for the waiver from the investor, the Company issued to the investor 58,777
shares of its common stock.  The agreement terminated any assessment of
liquidated damages beyond June 24, 2008.





The table
below summarizes the cumulative effect entry recorded as of April 1, 2007 for
the adoption of FSP 00-19-2:




Accumulated
      deficit, April 1, 2007 (as restated)
              
              $
              (10,586,847
              )Adjustments
      for the cumulative effect of the change in accounting
      principle:Contingent
      liability recorded for estimated liquidated damages
              
              
              (289,518
              )Reclassification
      of Warrants from derivative liabilities to equity
    securities
              
              
              (465,597
              )Total
      adjustments
              
              
              (755,115
              )Accumulated
      deficit, April 1, 2007, as adjusted
              
              $
              (11,341,962
              )




Line of
credit




On May
18, 2007, the Company secured a line of credit with JPMorgan Chase Bank in the
amount of $50,000.  The line of credit carries an interest rate of
prime plus one half point.  The line of credit is secured with a
deposit guarantee of $50,000.  At March 31, 2008, the total amount
outstanding on this line of credit was $17,503.




NOTE 5 – COMMITMENTS AND
CONTINGENCIES





Lease
commitments





The
Company currently leases 9,767 square feet of office space at 6509 Windcrest
Drive, Suite 160, Plano, Texas, 75024 from GKII Plano, L.P..  The
lease payments are $14,479 per month and the lease expires July 13,
2013.  This office space is used as the Corporate
Headquarters.


F -
24


The
minimum future lease payments under this lease for the next five years
are:


April
      1, 2008 - March 31, 2009
            
            $
            129,803April
      1, 2009 - March 31, 2010
            
            
            177,011April
      1, 2010 - March 31, 2011
            
            
            181,894April
      1, 2011 - March 31, 2012
            
            
            186,778April
      1, 2012 - March 31, 2013
            
            
            191,661Total
      minimum future lease payments
            
            $
            867,147





The
Company currently has a lease of 4,264 square feet of office space at 17304
Preston Road, Suite 975, Dallas, Texas with Memshalah Realty, a successor to CMD
Realty Fund.  The Company has subleased the space to First Choice
Funding Group, Ltd. who pays the Company $4,974 per month.  The gross
lease payments are approximately $7,888 per month and the lease expires November
30, 2009.





The
minimum future lease payments (net of the sublease amounts received) under this
lease for the next five years are:


April
      1, 2008 - March 31, 2009
            
            $
            35,675April
      1, 2009 - March 31, 2010
            
            
            24,731April
      1, 2010 - March 31, 2011
            
            
            -April
      1, 2011 - March 31, 2012
            
            
            -April
      1, 2012 - March 31, 2013
            
            
            -Total
      minimum future lease payments
            
            $
            60,406





Litigation





The
Company, and certain of its current and former officers and directors are
defendants in litigation pending in Dallas, Texas, styled KINGDON R. HUGHES VS.
GREGORY T. ROYAL, CYNTHIA A. GARR, JAMES T. MILLER, JR., CHARLES STIDHAM, CNH
HOLDINGS COMPANY D/B/A CISTERA NETWORKS AND XBRIDGE SOFTWARE, INC.; Cause No.
DV05-0600-G; G-134th District Court, Dallas County, Texas.  The
plaintiff has alleged a number of complaints against the defendants, including
breach of fiduciary duty, misappropriation of corporate opportunities, fraud,
fraudulent inducement, breach of contract, tortuous interference with contract,
fraudulent transfer, and shareholder oppression arising in connection with the
license agreement between the Company and XBridge in May 2003 and the
acquisition of XBridge by the Company in May 2005.  The parties held a
mediation conference in April 2006 and have come to an understanding with
respect to the principle elements of a potential settlement.  We are
currently in the process of negotiating definitive settlement agreements. In
accordance with SFAS 5, “Accounting for Contingencies,” we have recorded a
charge for the fiscal year ended March 31, 2008 for a contingent liability
related to outstanding litigation.  While the Company may prevail in
this matter and disputes damages sought in the case, we have nonetheless
recorded a reserve of $650,000 as a potential stock settlement in accordance
with SFAS 5.




NOTE 6 -
INCOME TAXES





As of
March 31, 2008, the Company had net operating loss carryforwards available to
offset future federal income tax of approximately $10.1 million.  Such
carryforwards expire between fiscal year 2009 and fiscal year
2028.  Under the Tax reform Act of 1986, the amount of and the benefit
from net operating losses that can be carried forward may be limited in certain
circumstances.  Events that may cause changes in the Company’s tax
carryovers include, but are not limited to, a cumulative ownership change of
more than 50% over a three-year period.  Therefore, the amount
available to offset future taxable income may be limited.  The Company
carries a deferred tax valuation allowance equal to 100% of total deferred
assets. In recording this allowance, management has considered a number of
factors, but chiefly, the Company’s recent history of sustained operating
losses. Management has concluded that a valuation allowance is required for 100%
of the total deferred tax assets as it is more likely than not that the deferred
tax assets will not be realized.





F -
25





March
      31,Net
      deferred tax assets
            
            2008
            
            
            2007As
      restatedNet
      operating loss carryforwards
            
            $
            4,416,297
            
            
            $
            2,806,509Accrued
      liquidated damages
            
            
            129,854
            
            
            
            -Valuation
      allowance
            
            
            (4,546,151
            )
            
            
            (2,806,509
            )$
            -
            
            
            $
            -





The benefit
for income taxes differs from the amount computed using the U.S. federal
statutory income tax rate as follows:





March
      31,2008
            
            
            2007As
      restatedIncome
      tax benefit at federal statutory rate
            
            $
            1,785,823
            
            
            $
            697,455Less
      Non-deductible itemsCharge
      for stock issued to convertible note holders
            
            
            (46,181
            )
            
            
            -Change
      in estimated fair value of derivative financial
instruments
            
            
            -
            
            
            
            (176,294
            )(46,181
            )
            
            
            (176,294
            )Change
      in valuation allowance
            
            
            (1,739,642
            )
            
            
            (521,161
            )Income
      tax benefit
            
            $
            -
            
            
            $
            -





Effective
April 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes – an interpretation of FASB
Statement No. 109” (“FIN 48”).  FIN 48 prescribes a recognition
threshold and a measurement attribute for the financial statement recognition
and measurement of tax positions taken or expected to be taken in a tax
return.  For those benefits to be recognized, a tax position must be
more-likely-than-not to be sustained upon examination by taxing
authorities.  The adoption of the provisions of FIN 48 did not have a
material impact on the Company’s condensed consolidated financial position and
results of operations.  At April 1, 2007, the Company had no liability
for unrecognized tax benefits and no accrual for the payment of related
interest.




Interest
costs related to unrecognized tax benefits are classified as “Interest Expense,
net” in the accompanying consolidated statements of
operations.  Penalties, if any, would be recognized as a component of
“Selling, general and administrative expenses.”  The Company
recognized $0 of interest expense related to unrecognized tax benefits for the
years ended March 31, 2008 and 2007.  In many cases the Company’s
uncertain tax positions are related to tax years that remain subject to
examination by relevant tax authorities.  With few exceptions, the
Company is generally no longer subject to U.S. federal, state, local or non-U.S.
income tax examinations by tax authorities for years before 2003.  The
following describes the open tax years, by major tax jurisdiction, as of April
1, 2008:




United
States
(a)                                      2003
– Present





(a)
            Includes
      federal as well as state or similar local jurisdictions, as
      applicable.








F -
26


NOTE 7 – STOCKHOLDERS’
EQUITY (DEFICIT)





On July
1, 2006, the Company issued 70,803 shares of stock in connection with the
exercise of warrants issued in the merger of CNH with XBridge at $.46 per
share.  These warrants were exercised to satisfy certain outstanding
notes payable.





On August
31, 2006, the Company issued 4,034 shares of stock upon conversion of certain
outstanding PP1 Notes.  The amount of principal represented by these
shares was $1,000.  The amount of accrued interest represented by
these shares was $3,034 due to the prior conversion of a portion of the
note.  These PP1 Notes converted at $1.00 per share.





On
October 25, 2006, the Company issued 122,028 shares of common stock in
connection with the exercise of options issued in the merger of the Company with
Xbridge at $.01 per share.





On
December 13, 2006, one PP1 Note holder converted the outstanding balance of his
PP1 Note (based on $1.00 per share conversion), and Company issued 17,931 shares
of its common stock in exchange for the conversion of $15,000 of principal and
accrued interest of $2,931 related to these PP1 Notes.  The Company
recorded this conversion transaction on December 13, 2006, but did not
physically issue the shares to the PP1 Note holder until January 23,
2008.  See further discussion under this Item.





During
the quarter ended September 30, 2007, the Company elected to compensate PP1 Note
holders who had opted to convert debt into shares of common stock, which
remained unregistered with the SEC as of the date the PP1 Notes became due and
payable on December 13, 2006.  The amount offered to, and accepted by,
the shareholders was $135,825, payable in the form of additional shares of
common stock.  In August 2007, the company recorded a charge and
liability for the impending issuance of this stock.  On January 11,
2008, the Company issued 134,462 shares of common stock at the agreed upon
conversion rate of $1.01, and paid $19 in cash for fractional shares in
settlement of this liability.  At March 31, 2008, there was $72,925 of
principal and $28,071 of interest outstanding on the PP1 Notes.





During
January and February of 2008, 91,261 shares of common stock were issued upon
conversion of certain PP2 notes.  The amount of principal of these
notes converted was $58,125 and the amount of accrued interest converted was
$9,663.  These notes were converted at $0.75 per share.





NOTE 8 - STOCK OPTIONS AND
STOCK PURCHASE WARRANTS





On
January 9, 2004, our board of directors approved a long-term incentive plan (the
“Plan”), under which we may issue compensation, including stock grants and stock
options.  The Plan allows for the issuance of up to 2,000,000 shares
of the Company’s common stock and has not yet been approved by our
stockholders.




On April
1, 2006, the Company adopted SFAS 123R under the “modified prospective
application.” SFAS 123R requires all equity-based payments to employees to
be recognized in the Consolidated Statements of Operations and Comprehensive
Income at the fair value of the award on the grant date. Under the modified
prospective application, the Company was required to record equity-based
compensation cost for all awards granted after the date of adoption and for the
unvested portion of previously granted awards outstanding as of the date of
adoption. The Company used the BSM model for determining the fair values of all
stock options granted prior to the adoption of SFAS 123R and continues to
use this pricing model for all share-based awards issued or modified on or after
adoption of SFAS 123R.  The Company did not issue any stock
options during the years ended March 31, 2008 and 2007,
respectively.




As
discussed in Note 2 to the consolidated financial statements, the Company
incorrectly calculated and recorded $-0- of share-based compensation for the
year ended March 31, 2007, and, as part of its restatement as of and for the
year ended March 31, 2007, has recorded $101,700. For the year ended March 31,
2008, share-based compensation was $-0-.


F -
27


The
following table sets forth the Company’s stock options outstanding as of March
31, 2008 and 2007 and activity for the years then ended:




WeightedWeighted
            
            
            AverageAverage
            
            
            Remaining
            
            
            AggregateShares
            
            
            Exercise
              Price
            
            
            Contractual
              Term
      (Years)
            
            
            Intrinsic
      ValueOutstanding,
      March 31, 2006
            
            
            2,122,917
            
            
            $
            1.30Granted
            
            
            -
            
            
            
            -Exercised
            
            
            -
            
            
            
            -Forfeited/expired
            
            
            -
            
            
            
            -Outstanding,
      March 31, 2007
            
            
            2,122,917
            
            
            
            1.30Granted
            
            
            -
            
            
            
            -Exercised
            
            
            -
            
            
            
            -
            
            
            
            
            
            
            -Forfeited/expired
            
            
            865,000
            
            
            
            1.17Outstanding,
      March 31, 2008
            
            
            1,257,917
            
            
            $
            1.39
            
            
            
            0.20
            
            
            $
            137,007Vested
      and exercisable at March 31, 2007
            
            
            2,006,667
            
            
            $
            1.30
            
            
            
            1.48Vested
      and exercisable at March 31, 2008
            
            
            1,246,667
            
            
            
            1.39
            
            
            
            0.19
            
            
            $
            137,007




The total
fair value of shares vested during the years ended March 31, 2008 and 2007 was
$107,065 and $19,654, respectively. As of
March 31, 2008, there was $4,463 total unrecognized compensation cost related to
non-vested share-based compensation arrangements granted under the Plans, which
is expected to be recognized over the weighted-average period of six months. The
Company recognizes compensation cost using the straight-line method, as defined
in SFAS 123R, over the vesting term of the option grant.





The
following table sets forth the Company’s investor stock purchase warrants
outstanding as of March 31, 2008 and 2007 and activity for the years then
ended:




SharesOutstanding,
      March 31, 2006
            
            
            1,302,639Granted
            
            
            1,842,690Exercised
            
            
            (70,893
            )Forfeited/expired
            
            
            (51,724
            )Outstanding,
      March 31, 2007
            
            
            3,022,712Granted
            
            
            1,656,088Exercised
            
            
            -Forfeited/expiredOutstanding,
      March 31, 2008
            
            
            4,678,800


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28


NOTE 9 - RELATED PARTY
TRANSACTIONS





As part
of the final closing of PP2 and on April 5, 2007, the Company issued a PP2 Note
in the principal amount of $30,000, and issued warrants to purchase 30,000
shares of the Company’s common stock to Derek Downs, an officer and director of
the Company, in connection with the cancellation of an equal amount of the
Company’s outstanding obligations.  As of March 31, 2008, interest of
$7,191 had been accrued on this PP2 Note.




As part
of the final closing of the PP2 and on April 5, 2007, the Company issued a PP2
Note in the principal amount of $70,779, and issued warrants to purchase 70,779
shares of the Company’s common stock to Gregory Royal, an officer and director
of the Company, in connection with the cancellation of an equal amount of the
Company’s outstanding obligations.  As of March 31, 2008, interest of
$16,967 had been accrued on this PP2 Note.