##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION       (Mark One)[X]
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended September 30, 2004[  ]
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period       to
 Commission file number: 001-15835 US Dataworks, Inc.  Nevada
(State or other jurisdiction of
    
    84-1290152
(I.R.S. employer identification number)incorporation or organization)5301 Hollister Road, Suite 250Houston, Texas
    
    77040(Address of principal executive offices)
    
    (Zip Code)
 Issuers telephone number: (713) 934-3855 Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. YES [X] NO
[ ] Number of shares of Common Stock outstanding as of October 31, 2004:
27,562,428 Transitional Small Business Disclosure Format (Check one): YES [ ] NO [X]




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##### Table of Contents



US DATAWORKS, INC. TABLE OF CONTENTS FORM 10-QSB QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004 PagePART I - FINANCIAL INFORMATION
    
    
    1Item 1. Financial Statements
    
    
    1Item 2. Managements Discussion and Analysis or Plan of Operation
    
    
    15Item 3. Controls and Procedures
    
    
    22PART II - OTHER INFORMATION
    
    
    23Item 1. Legal Proceedings
    
    
    23Item 2. Changes in Securities
    
    
    23Item 4.
Submission of Matters to Vote of Security Holders
    
    
    24Item 6. Exhibits
    
    
    24SIGNATURE
    
    
    25Section 302 Certification of CEOSection 302 Certification of CFOSection 906 Certification of CEOSection 906 Certification of CFO




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PART I  FINANCIAL INFORMATION 
 Item 1. Financial Statements US DATAWORKS, INC. BALANCE SHEET
September 30, 2004 (Unaudited) ASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    2,412,191Accounts receivable, net of allowance for doubtful accounts of $0
    
    
    1,443,381Prepaid expenses and other current assets
    
    
    152,007Total current assets
    
    
    4,007,579PROPERTY AND EQUIPMENT, net
    
    
    700,240GOODWILL, net
    
    
    14,133,629OTHER ASSETS
    
    
    18,012TOTAL ASSETS
    
    $
    18,859,460
 The accompanying notes are an integral part of these financial statements. 1




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US DATAWORKS, INC. BALANCE SHEET
September 30, 2004 (Unaudited) LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIESNote payable  related party
    
    $
    39,000Deferred revenue
    
    
    273,119Accounts payable
    
    
    314,983Accrued expenses
    
    
    152,883Accrued costs for litigation settlement
    
    
    1,000,000Total current liabilities
    
    
    1,779,985Deferred revenue
    
    
    50,014Deferred compensation
    
    
    116,100Total liabilities Interest payable
    
    
    1,946,099COMMITMENTSSHAREHOLDERS EQUITYConvertible Series B preferred stock, $0.0001 par value
700,000 shares authorized, 549,667 shares issued and outstanding
$0.75 liquidation preference, dividends of $148,956 in arrears
    
    
    55Common stock, $0.0001 par value
90,000,000 shares authorized and 27,562,428 shares issued and outstanding
    
    
    2,756Additional paid-in capital
    
    
    60,527,314Deferred compensation
    
    
    (91,913
    )Accumulated deficit
    
    
    (43,524,851
    )Total shareholders equity
    
    
    16,913,361TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    18,859,460
 The accompanying notes are an integral part of these financial statements. 2




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US DATAWORKS, INC.
STATEMENTS OF OPERATIONS
For the Three Months and Six Months Ended September 30, 2004 and 2003 For the Three Months Ended
    
    For the Six Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003REVENUESSoftware licensing revenues
    
    $
    153,016
    
    
    $
    565,300
    
    
    $
    500,732
    
    
    $
    712,867Software maintenance revenues
    
    
    298,538
    
    
    
    64,998
    
    
    
    459,929
    
    
    
    114,144Professional service revenues
    
    
    158,280
    
    
    
    328,510
    
    
    
    552,305
    
    
    
    618,560Total revenues
    
    
    609,834
    
    
    
    958,808
    
    
    
    1,512,966
    
    
    
    1,445,571COST OF SALES
    
    
    202,512
    
    
    
    205,542
    
    
    
    518,648
    
    
    
    349,655Gross profit
    
    
    407,322
    
    
    
    753,266
    
    
    
    994,318
    
    
    
    1,095,916OPERATING EXPENSESGeneral and administrative
    
    
    1,493,420
    
    
    
    912,561
    
    
    
    2,963,323
    
    
    
    1,839,274Depreciation and amortization
    
    
    81,646
    
    
    
    68,123
    
    
    
    155,772
    
    
    
    136,631Total operating expense
    
    
    1,575,066
    
    
    
    980,684
    
    
    
    3,119,095
    
    
    
    1,975,905LOSS FROM OPERATIONS
    
    
    (1,167,744
    )
    
    
    (227,418
    )
    
    
    (2,124,777
    )
    
    
    (879,989
    )OTHER INCOME (EXPENSE)Financing costs
    
    
    (97,451
    )
    
    
    (159,783
    )
    
    
    (419,903
    )
    
    
    (1,209,288
    )Interest expense
    
    
    (48,435
    )
    
    
    (630,602
    )
    
    
    (164,956
    )
    
    
    (940,948
    )Interest expense  related parties
    
    
    
    
    
    
    (49,323
    )
    
    
    
    
    
    
    (113,360
    )Loss on extinguishment of debt
    
    
    
    
    
    
    (635,259
    )
    
    
    
    
    
    
    (635,259
    )Loss on extinguishment of debt  related parties
    
    
    
    
    
    
    (1,722,631
    )
    
    
    
    
    
    
    (1,722,631
    )Accrued cost of litigation settlement
    
    
    (1,000,000
    )
    
    
    
    
    
    
    (1,000,000
    )
    
    
    Other income
    
    
    11,228
    
    
    
    
    
    
    
    17,688
    
    
    
    Total other expense
    
    
    (1,134,658
    )
    
    
    (3,197,598
    )
    
    
    (1,567,171
    )
    
    
    (4,621,486
    )LOSS BEFORE PROVISION FOR INCOME TAXES
    
    
    (2,302,402
    )
    
    
    (3,425,016
    )
    
    
    (3,691,948
    )
    
    
    (5,501,475
    )PROVISION FOR INCOME TAXES
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    NET LOSS
    
    $
    (2,302,402
    )
    
    $
    (3,425,016
    )
    
    $
    (3,691,948
    )
    
    $
    (5,501,475
    )BASIC AND DILUTED LOSS PER SHARETotal basic and diluted loss per share
    
    $
    (0.09
    )
    
    $
    (0.21
    )
    
    $
    (0.14
    )
    
    $
    (0.35
    )BASIC AND DILUTED WEIGHTED-AVERAGE SHARES
OUTSTANDING
    
    
    26,852,288
    
    
    
    16,540,417
    
    
    
    26,184,768
    
    
    
    15,870,636
 The accompanying notes are an integral part of these financial statements. 3




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US DATAWORKS, INC. STATEMENTS OF SHAREHOLDERS EQUITY
for the Six Months ended September 30, 2004 Preferred StockConvertible Series B
    
    Common Stock
    
    AdditionalPaid-In
    
    Deferred
    
    AccumulatedShares
    
    Amount
    
    Shares
    
    Amount
    
    Capital
    
    Compensation
    
    Deficit
    
    TotalBalance, March 31, 2004
    
    
    629,666
    
    
    $
    63
    
    
    
    22,997,136
    
    
    $
    2,300
    
    
    $
    55,135,232
    
    
    $
    0
    
    
    $
    (39,832,903
    )
    
    $
    15,304,692Warrants and options issued to third
parties for services rendered
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    45,706
    
    
    
    
    
    
    
    
    
    
    
    45,706Grant of deferred compensation (Note
6)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (116,100
    )
    
    
    
    
    
    
    (116,100
    )Amortization of deferred compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    24,187
    
    
    
    
    
    
    
    24,187Common stock issued forCash
    
    
    
    
    
    
    
    
    
    
    2,888,201
    
    
    
    289
    
    
    
    4,081,211
    
    
    
    
    
    
    
    
    
    
    
    4,081,500Exercise of warrants and options
    
    
    
    
    
    
    
    
    
    
    433,856
    
    
    
    42
    
    
    
    99,532
    
    
    
    
    
    
    
    
    
    
    
    99,574Notes payable conversion
    
    
    
    
    
    
    
    
    
    
    1,090,376
    
    
    
    109
    
    
    
    940,641
    
    
    
    
    
    
    
    
    
    
    
    940,750Conversion of Series B preferred
stock
    
    
    (79,999
    )
    
    
    (8
    )
    
    
    15,998
    
    
    
    2
    
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    Stock issued for equity line of
credit extinguishment (Note 6)
    
    
    
    
    
    
    
    
    
    
    136,861
    
    
    
    14
    
    
    
    224,986
    
    
    
    
    
    
    
    
    
    
    
    225,000Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,691,948
    )
    
    
    (3,691,948
    )Balance, September 30, 2004
    
    
    549,667
    
    
    $
    55
    
    
    
    27,562,428
    
    
    $
    2,756
    
    
    $
    60,527,314
    
    
    $
    (91,913
    )
    
    $
    (43,524,851
    )
    
    $
    16,913,361
 The accompanying notes are an integral part of these financial statements 4




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US DATAWORKS, INC. STATEMENTS OF CASH FLOW
For the Six Months Ended September 30, (Unaudited) 2004
    
    2003Cash flows from operating activitiesNet loss from continuing operations
    
    $
    (3,691,948
    )
    
    $
    (5,501,474
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization of property and equipment
    
    
    155,772
    
    
    
    136,630Accrued cost of litigation settlement
    
    
    1,000,000
    
    
    
    Loss on extinguishment of debt
    
    
    
    
    
    
    635,259Loss on extinguishment of debt  related party
    
    
    
    
    
    
    1,722,631Amortization of note discount and beneficial conversion features on
convertible promissory notes
    
    
    343,824
    
    
    
    620,217Amortization of deferred compensation expense
    
    
    24,187
    
    
    
    Issuance of stock for interest
    
    
    15,750
    
    
    
    77,403Issuance of stock for extinguishment of equity credit line facility
    
    
    225,000
    
    
    
    Issuance of warrants for extension of notes payable due date
    
    
    
    
    
    
    1,084,505Issuance of warrants for settlement of dispute
    
    
    
    
    
    
    262,755Issuance of warrants for services
    
    
    
    
    
    
    96,750Issuance of warrants for stock cancellation agreement
    
    
    
    
    
    
    45,693Issuance of warrants for convertible promissory note conversions
    
    
    
    
    
    
    7,340Issuance of options to third party for services
    
    
    45,706
    
    
    
    (Increase) decrease in
Accounts receivable
    
    
    (214,280
    )
    
    
    (366,612
    )Prepaid expenses and other current assets
    
    
    (35,235
    )
    
    
    (46,003
    )Other assets
    
    
    9,433
    
    
    
    12,129Increase (decrease) in
Deferred revenue
    
    
    162,681
    
    
    
    (195,845
    )Accounts payable
    
    
    (32,665
    )
    
    
    245,676Accrued expenses
    
    
    (282,108
    )
    
    
    (74,947
    )Interest payable
    
    
    (37,251
    )
    
    
    (215
    )Interest payable  related parties
    
    
    
    
    
    
    44,927Notes payable
    
    
    
    
    
    
    (60,600
    )Net cash used in operating activities
    
    
    (2,311,134
    )
    
    
    (1,253,781
    )Cash flows from investing activitiesPurchase of property and equipment
    
    
    (161,139
    )
    
    
    (9,671
    )Net cash used in investing activities
    
    
    (161,139
    )
    
    
    (9,671
    )
 The accompanying notes are an integral part of these financial statements. 5




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US DATAWORKS, INC. STATEMENTS OF CASH FLOW
For the Six Months Ended September 30, (Unaudited) 2004
    
    2003Cash flows from financing activitiesPayments on capital lease obligations
    
    
    
    
    
    
    (3,410
    )Proceeds from notes payable
    
    
    
    
    
    
    10,000Repayment of notes payable
    
    
    
    
    
    
    (109,099
    )Proceeds from convertible promissory notes
    
    
    
    
    
    
    1,615,000Repayment of convertible promissory notes
    
    
    (500,000
    )
    
    
    (50,000
    )Repayment of note payable related to
discontinued
operations
    
    
    
    
    
    
    (151,442
    )Proceeds from stock sale
    
    
    4,650,000
    
    
    
    Stock issuance costs
    
    
    (568,500
    )
    
    
    Proceeds from exercise of employee stock options
    
    
    69,575
    
    
    
    2,875Proceeds from exercise of warrants
    
    
    30,000
    
    
    
    Net cash provided by financing activities
    
    
    3,681,075
    
    
    
    1,313,924Net increase in cash and cash equivalents
    
    
    1,208,802
    
    
    
    50,472Cash and cash equivalents, beginning of period
    
    
    1,203,389
    
    
    
    8,564Cash and cash equivalents, end of period
    
    $
    2,412,191
    
    
    $
    59,036Supplemental disclosures of cash flow informationInterest paid
    
    $
    31,035
    
    
    $
    57,975
 The accompanying notes are an integral part of these financial statements. 6




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US DATAWORKS, INC. NOTES TO UNAUDITED FINANCIAL STATEMENTS 1. Organization and Business US Dataworks, Inc, a Nevada corporation (the Company), develops,
markets, and supports payment processing software for the financial services
industry. Its customer base includes many of the largest financial institutions
as well as credit card companies, government institutions, and high-volume
merchants in the United States. The Company was formerly known as Sonicport,
Inc. 2. Summary of Significant Accounting Policies  Revenue RecognitionThe Company recognizes revenues in accordance with the provisions of the
American Institute of Certified Public Accountants Statement of Position
97-2, Software Revenue Recognition. The Company licenses its software
products under nonexclusive, nontransferable license agreements. These
arrangements do not require significant production, modification, or
customization, therefore, revenue is recognized when a license agreement
has been signed, delivery of the software product has occurred, the related
fee is fixed or determinable, and collectibility is probable. If
professional services were provided in conjunction with the installation of
the software licensed, revenue is recognized when these services have been
provided.For license agreements that include a separately identifiable fee for
contracted maintenance services, such revenues are recognized on a
straight-line basis over the life of the maintenance agreement noted in the
agreement, but following any installation period of the software.Cash and Cash EquivalentsFor the purpose of the statements of cash flows, the Company considers all
highly liquid investments purchased with original maturities of three
months or less to be cash equivalents.Property and EquipmentProperty and equipment are recorded at cost, less accumulated depreciation
and amortization. Depreciation and amortization are provided using the
straight-line method over estimated useful lives as follows: Furniture and fixtures
    
    5 yearsAutomobile
    
    3 yearsTelephone equipment
    
    5 to 10 yearsComputer equipment
    
    5 yearsComputer software
    
    5 yearsLeasehold improvements
    
    Shorter of initial
lease period or
useful life of asset
  Maintenance and minor replacements are charged to expense as incurred.
Gains and losses on disposals are included in the results of operations.Impairment of Long-Lived AssetsThe Company reviews its long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of the assets to future net
cash flows expected to be generated by the assets. If the assets are
considered to be impaired, the impairment to be recognized is measured by
the amount by which the carrying amount exceeds the fair value of the
assets. 7




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GoodwillIn July 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 142 Goodwill and
Other Intangible Assets, which was effective for fiscal years beginning
after December 15, 2001. SFAS 142 prohibits the amortization of goodwill
and intangible assets with indefinite useful lives but requires that these
assets be reviewed for impairment at least annually or on an interim basis
if an event occurs or circumstances change that could indicate that their
value has diminished or been impaired. Other intangible assets will
continue to be amortized over their estimated useful lives. The Company
evaluates the remaining useful lives of these intangibles on an annual
basis to determine whether events or circumstances warrant a revision to
the remaining period of amortization. Pursuant to SFAS No. 142,
amortization of goodwill recorded in business combinations prior to June
30, 2001 ceased to be effective March 31, 2002. Goodwill resulting from
business combinations completed after June 30, 2001 will not be amortized.SFAS No. 142 requires goodwill to be tested annually and between annual
tests if events occur or circumstances change that would more likely than
not reduce the fair value of the entity below its carrying amount. This
impairment test is performed in two steps. The initial step is designed to
identify potential goodwill impairment by comparing an estimate of the fair
value of the entity to its carrying value, including goodwill. If the
carrying value exceeded the fair value, a second step is performed, which
compares the implied fair value of the entitys goodwill with the carrying
amount of that goodwill, to measure the amount of the goodwill impairment,
if any. Based on step one of this test, the Company did not have an
impairment of goodwill to record for the fiscal years ended March 31, 2003
or March 31, 2004.The goodwill recorded on the Companys books is from the acquisition of US
Dataworks, Inc. in fiscal year 2001.Fair Value of Financial InstrumentsThe Company measures its financial assets and liabilities in accordance
with generally accepted accounting principles in the United States. For
certain of the Companys financial instruments, including cash and cash
equivalents, accounts receivable, prepaid expenses and other current
assets, accounts payable, and accrued expenses, the carrying amounts
approximate fair value due to their short maturities. The amounts shown for
notes payable  related parties also approximate fair value because
current interest rates offered to the Company for debt of similar
maturities are substantially the same or the difference is immaterial.Stock OptionsSFAS No. 123, Accounting for Stock-Based Compensation, establishes and
encourages the use of the fair value based method of accounting for
stock-based compensation arrangements under which compensation cost is
determined using the fair value of stock-based compensation determined as
of the date of grant and is recognized over the periods in which the
related services are rendered. The statement also permits companies to
elect to continue using the current intrinsic value accounting method
specified in Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees (APB 25), to account for stock-based
compensation. The Company has elected to use the implicit value based
method and has disclosed the pro forma effect of using the fair value based
method to account for its stock-based compensation.The Company has elected to follow APB 25 and related Interpretations in
accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under SFAS No. 123 requires
the use of option valuation models that were not developed for use in
valuing employee stock options. Under APB 25, because the exercise price
of the Companys employee stock options is greater than or equals the
market price of the underlying stock on the date of grant, no compensation
cost has been recognized during the three or six months ended September 30,
2004 and September 30, 2003 or for the years ended March 31, 2004 and March
31, 2003.Pro forma information regarding net income and earnings per share is
required by SFAS No. 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method 8




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of that Statement. The fair value for these options was estimated at the
date of grant using a Black-Scholes option pricing model.The Black-Scholes option pricing model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option pricing models require the input of
highly subjective assumptions including the expected stock price
volatility. Because the Companys employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect
the fair value estimate, in managements opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its
employee stock options.For purposes of pro forma disclosure, the estimated fair value of the
options is included in expense over the options vesting period or expected
life. The Companys pro forma information for the three and six months
ended September 30, 2004 and 2003 is as follows: For the Three Months Ended
    
    For the Six Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net loss as reported
    
    $
    (2,302,402
    )
    
    $
    (3,425,016
    )
    
    $
    (3,691,948
    )
    
    $
    (5,501,475
    )Add stock-based employee compensation
expense included in net loss as reported,
net of related tax effects
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0Deduct stock-based employee compensation
expense determined under the fair value
based method for all awards, net of
related tax effects
    
    $
    (390,092
    )
    
    $
    (207,756
    )
    
    $
    (677,720
    )
    
    $
    (492,006
    )Net loss; pro forma
    
    $
    (2,692,494
    )
    
    $
    (3,632,772
    )
    
    $
    (4,369,668
    )
    
    $
    (5,993,481
    )Basic and diluted loss per share, as
reported
    
    $
    (0.09
    )
    
    $
    (0.21
    )
    
    $
    (0.14
    )
    
    $
    (0.35
    )Basic and diluted loss per share, pro forma
    
    $
    (0.10
    )
    
    $
    (0.22
    )
    
    $
    (0.17
    )
    
    $
    (0.38
    )
  The fair value of these options was estimated at the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions for the three months ended September 30, 2004 and
2003, and six months ended September 30, 2004
and 2003: dividend yields of 0% expected volatility of 74%, 150%, 74% and
150%, respectively; risk-free interest rates of 2.87%, 2.26%, 2.82% and
2.05%, respectively; and expected lives of 3 years. The per-share weighted
average fair values of stock options granted during the three months ended September 30, 2004 and
2003, and
six months ended September 30, 2004 and 2003 were $0.48, $2.26, $0.51 and
$1.06, respectively.Income TaxesThe Company accounts for income taxes under the asset and liability method,
which requires the recognition of deferred tax assets and liabilities for
the expected future tax consequences of events that have been included in
the financial statements or tax returns. Under this method, deferred income
taxes are recognized for the tax consequences in future years of
differences between the tax bases of assets and liabilities and their
financial reporting amounts at each period-end based on enacted tax laws
and statutory tax rates applicable to the periods in which the differences
are expected to affect taxable income. Valuation allowances are
established, when necessary, to reduce deferred tax assets to the amount
expected to be realized. The provision for income taxes, if applicable,
represents the tax payable for the period and the change during the period
in deferred tax assets and liabilities.Loss per ShareThe Company calculates loss per share in accordance with SFAS No. 128,
Earnings per Share. Basic loss per share is computed by dividing the net
loss by the weighted-average number of common shares outstanding. Diluted
loss per share is computed in a similar manner to basic loss per share
except that the denominator is increased to include the number of
additional common shares that would have been 9




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outstanding if the potential common stock equivalents had been issued and
if the additional common shares were dilutive.The following potential common stock equivalents have been excluded from
the computation of diluted net loss per share for the periods presented
because the effect would have been anti-dilutive (options and warrants
typically convert on a one-for-one basis, see conversion details of the
preferred stock stated below for the common stock shares issuable upon
conversion): For the Six months EndedSeptember 30,2004
    
    2003Options outstanding under the Companys stock option plans
    
    
    3,842,115
    
    
    
    2,209,000Options granted outside the Companys stock option plans
    
    
    1,206,100
    
    
    
    656,000Warrants issued in conjunction with convertible Series B preferred stock
    
    
    0
    
    
    
    26,733Warrants issued in conjunction with private placements
    
    
    4,816,502
    
    
    
    110,000Warrants issued as a financing cost for notes payable
and convertible notes payable
    
    
    2,226,137
    
    
    
    933,124Warrants issued in conjunction with lock-up agreements
    
    
    0
    
    
    
    14,000Warrants issued for services rendered
    
    
    177,800
    
    
    
    367,800Warrants issued as part of the US Dataworks, Inc. acquisition
    
    
    67,200
    
    
    
    67,200Convertible Series A preferred stock (a)
    
    
    0
    
    
    
    370,751Convertible Series B preferred stock (b)
    
    
    109,933
    
    
    
    125,933
 (a) From May through October 2003, in four separate partial conversions,
all outstanding shares of Series A preferred stock were converted pursuant
to their existing terms into 1,994,286 shares of common stock. The Series A
preferred stock was convertible into shares of common stock as determined
by dividing $2.50 by 60% of the average closing bid price of the Companys
common stock for the 10 trading days prior to each conversion. The number
of common stock equivalents attributable to a potential conversion of the
Series A preferred stock has been calculated based upon the number of
common shares actually issued upon their conversion subsequent to September
30, 2003. (b) The Series B preferred stock is convertible into shares of common stock
at a conversion price of $3.75 per share. Reclassifications Certain amounts included in the prior year financial statements have been
reclassified to conform with the current year presentation. Such
reclassification did not have any effect on reported net loss. Estimates The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from
those estimates. Concentrations of Credit Risk The Company sells its products throughout the United States and extends
credit to its customers. It also performs ongoing credit evaluations of
such customers. The Company does not obtain collateral to secure its
accounts receivable. The Company evaluates its accounts receivable on a
regular basis for collectibility and provides for an allowance for
potential credit losses as deemed necessary. Three of our customers accounted for 25%, 22% and 16% of our net revenue
for the three months ended September 30, 2004. Four of our customers
accounted for 31%, 18%, 17% and 16%, respectively, of our net revenue for
the six months ended September 30, 2004. Two customers of the Company
accounted for 52% and 17% of the Companys net sales for the three months
ended September 30, 2003. Three customers of the 10




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##### Table of Contents



Company accounted for 35%, 13% and 19% respectively, of the Companys net
sales for the six months ended September 30, 2003 As of September 30, 2004, amounts due from two strategic resellers and a
significant customer, an entity of the U.S. Federal government, accounted
for 28%, 10% and 36%, respectively, of accounts receivable.  3.
    
    Property and EquipmentProperty and equipment as of September 30, 2004 consisted of the
following: Furniture and fixtures
    
    $
    58,794Automobile
    
    
    15,072Office and telephone equipment
    
    
    81,097Computer equipment
    
    
    328,172Computer software
    
    
    1,211,819Leasehold improvements
    
    
    62,9971,757,951Less accumulated depreciation and amortization
    
    
    (1,057,711
    )TOTAL
    
    $
    700,240
 Depreciation and amortization expense for the three and six months ended
September 30, 2004 and 2003 was $81,646, $68,123, $155,772 and $136,631,
respectively.  4.
    
    Accrued Costs for Litigation SettlementLitigation During the three months ended September 30, 2004, the Company recorded a
non-recurring, non-cash charge of $1,000,000 related to managements
estimates of costs necessary to settle a lawsuit filed by an investor. In
the lawsuit filed December 12, 2003 in the Los Angeles Superior Court, the
investor alleged that the Company made an oral agreement in connection with
the investors conversion of his promissory notes in
April 2000. The plaintiff claimed that the oral agreement granted him the right
to receive additional shares from the Company if he sold certain shares of
the Companys common stock at a price less than $15 per share. The
investor alleged that in March 2000, as partial consideration under the
alleged oral agreement, he converted three promissory notes with an
aggregate principal amount of $725,000 into 77,856 shares of the Companys
common stock. The Company has estimated the probable costs of settling this
litigation. Subsequent to
September 30, 2004, the Company and the investor entered
into a settlement agreement in which the Company agreed to pay
the investor (1) a $748,000 convertible promissory note payable with interest at 10% per
annum in three equal annual installments beginning September 15, 2005, (2)
a warrant to purchase 160,000 shares of the Companys common stock at a
purchase price of $0.75 per share, which warrant expires on November 10,
2006 and (3) reimbursement of the plaintiffs legal fees and expenses. The
note is convertible at anytime, at the holders election, into shares of
the Companys common stock at a per share conversion price of $1.10,
subject to standard antidilution provisions. Using the
Black-Scholes pricing model the Company has determined the
value of the warrants issued in connection with the settlement to be
$126,000. This amount, together with the value of the convertible
promissory note, the value of the plaintiffs legal expense reimbursement
and the companys legal costs incurred in connection with the settlement
approximates the amount of the accrual recorded at September 30, 11




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##### Table of Contents



2004. Accordingly, the Company will not record any further costs or
expenses in connection with the final settlement. 5. Commitments and Contingencies Employment Agreements On April 2, April 2, May 13 and September 26, 2003, the Company entered
into employment agreements with its President and Chief Operating Officer,
Senior Vice President and Chief Technology Officer, Chief Executive Officer
and Chairman of the Board, and Vice President of Business Development and
General Counsel, respectively. Each employment agreement is for a term of
three years. Annual base salaries for these four members of senior
management are $175,000, $165, 000, $200,000 and $150,000, respectively. On August 2, 2004, the Company entered into an employment agreement with its
Vice President Sales  Remittance Processing Division. The employment
agreement is for a term of three years with an annual base salary of $150,000
and, during the first twelve months of the agreement, an advance of future
commissions of $75,000, payable in semi-monthly installments. The advance is
non-recoverable; however, any commissions earned during the first twenty-four
months of the agreement will be reduced by the amount of the advance.  6.
    
    Stockholders EquityPreferred Stock The Company has 10,000,000 authorized shares of $0.0001 par value preferred
stock. The preferred stock may be issued in series, from time to time, with
such designations, rights, preferences, and limitations as the Board of
Directors may determine by resolution.  Convertible Series B Preferred Stock The Company has 700,000 authorized shares of $0.0001 par value convertible
Series B preferred stock. In August and October 2000, the Company issued 509,333 and 133,666 units
respectively, in a private placement for gross proceeds of $382,000 and
$100,250, respectively. Each unit consisted of one share of the Companys
voting convertible Series B preferred stock (the Series B) and a warrant
to purchase one share of the Companys common stock. The Series B has a
liquidation preference of $0.75 per share and carries a 10% cumulative
dividend payable each March 1 and September 1. The Company has the right to
redeem the Series B at any time after issuance at a redemption price of
$0.83 per share, plus any accrued but unpaid dividends. The Series B is
convertible upon issuance into common stock at $3.75 per share. The warrant
entitles the holder to purchase one share of the Companys common stock at
$6.25 per share, which represents 115% of the market value of the Companys
stock at the closing date. In May 2001, an investor in the Series B rescinded its acquisition and
returned to the Company 13,333 shares and warrants for the purchase of
2,667 shares of common stock in exchange for the return of its investment
of $10,000. In August 2004, an investor in the Series B elected to convert his 79,999
shares and accordingly was issued 15,998 shares of the Companys common
stock. At September 30, 2004, there were accumulated, undeclared dividends in
arrears of $148,956 or $0.27 per share.  Common StockFinancing Agreement On June 30, 2003, the Company entered into an agreement with an
institutional investor for an equity line financing of up to $4,000,000.
The Company may sell up to $4,000,000 of its common stock, with a minimum
commitment of $1,500,000, to the institutional investor under the equity
line on trading days on which our closing price per share is $0.50 or more. In May 2004, the Company and the institutional investor agreed to terminate
the equity line financing in consideration of the Company issuing to the
investor $225,000 of unregistered shares of common stock. Based upon the
closing market price of the Companys common stock on the date of the
termination agreement, the Company issued 136,861 common stock to the
investor in May 2004. 12




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##### Table of Contents



Common Stock and WarrantsDuring the three and six months ended September 30, 2004, the Company
completed the following: Sale of Common Stock and Warrants In April 2004, the Company completed a private placement of $4.65 million,
less direct issuance expenses of $568,500, with certain major institutional
investment funds. Under terms of the agreement, the Company issued 2.89
million shares of common stock. In addition, the Company issued warrants to
purchase up to 3.61 million shares of common stock at an exercise price of
$1.61 per share. Conversions of Convertible Promissory Notes In August 2004, four accredited investors elected to convert their notes
totaling $250,000 and were issued 555,556 shares of common stock in
accordance with the terms of the notes In September 2004, the Company exercised its option to convert $575,000 in
aggregate principal amount of convertible notes and $5,750 of accrued
interest at 1% per annum due October 2, 2004 into common stock at a
conversion price of $2.00 per share. Accordingly, as of September 30,
2004, the Company issued the note holder 290,375 shares of common stock. Stock Options In August 1999, the Company implemented its 1999 Stock Option Plan (the
1999 Plan). In August 2000, the Companys Board of Directors approved the
2000 Stock Option Plan (the 2000 Plan), which amends and restates the
1999 Plan. Under the 2000 Plan, the maximum aggregate number of shares
which may be granted is 6,000,000. The exercise price must not be less than
the fair market value on the date of grant of the option. The options vest
in varying increments over varying periods and expire 10 years from the
date of vesting. In the case of incentive stock options granted to any 10%
owners of the Company, the exercise price must not be less than 100% of the
fair market value on the date of grant. Such incentive stock options vest
in varying increments and expire five years from the date of vesting. During the six months ended September 30, 2004 and 2003, the Company
granted 1,968,502 and 2,695,250 stock options, respectively, to certain
employees that may be exercised at prices ranging between $2.95 and $0.55. The following table summarizes certain information relative to stock
options: 2000 Stock Option Plan
    
    Outside of PlanWeighted-Average
    
    
    
    
    
    Weighted-AverageShares
    
    Exercise Price
    
    Shares
    
    Exercise PriceOutstanding, March 31, 2004
    
    
    2,493,750
    
    
    $
    1.95
    
    
    
    694,100
    
    
    $
    3.72Granted
    
    
    1,388,502
    
    
    $
    1.02
    
    
    
    580,000
    
    
    $
    1.49Exercised
    
    
    (40,137
    )
    
    $
    0.55
    
    
    
    0
    
    
    $
    0Forfeited/canceled
    
    
    0
    
    
    
    0
    
    
    
    (68,000
    )
    
    $
    19.78Outstanding, September 30, 2004
    
    
    3,842,115
    
    
    $
    1.63
    
    
    
    1,206,100
    
    
    $
    2.50Exercisable, September 30, 2004
    
    
    1,723,950
    
    
    $
    1.65
    
    
    
    46,100
    
    
    $
    20.41
 13




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##### Table of Contents



The weighted-average remaining life and the weighted-average exercise price
of all of the options outstanding at September 30, 2004 were 9.0 years and
$1.66, respectively. The exercise prices for the options outstanding at
September 30, 2004 ranged from $0.55 to $23, and information relating to
these options is as follows: Weighted-
    
    
    
    
    
    Weighted-Average
    
    Weighted-
    
    AverageRange of
    
    
    
    
    
    Stock
    
    Remaining
    
    Average
    
    Exercise PriceExercise
    
    Stock Options
    
    Options
    
    Contractual
    
    Exercise
    
    of OptionsPrices
    
    Outstanding
    
    Exercisable
    
    Life
    
    Price
    

    Exercisable$0.55 - 2.00
    
    
    3,805,615
    
    
    
    1,233,613
    
    
    9.19 years
    
    $
    0.94
    
    
    $
    0.77$2.01 - 3.00
    
    
    1,050,500
    
    
    
    344,337
    
    
    9.00 years
    
    $
    2.79
    
    
    $
    2.81$3.01- 23.00
    
    
    192,100
    
    
    
    192,100
    
    
    4.91 years
    
    $
    9.74
    
    
    $
    9.745,048,215
    
    
    
    1,770,050
  Details of Issuance On April 2, 2003, the Company entered into employment agreements with Terry
Stepanik and Mario Villarreal, pursuant to which Mr. Stepanik is employed
as President and Chief Operating Officer and Mr. Villarreal as Chief
Technology Officer. Pursuant to these employment agreements, on April 26,
2004, both Mr. Stepanik and Mr. Villarreal were granted options to purchase
290,000 shares of the Companys common stock outside the 2000 Plan at an
exercise price of $1.49 which was the closing market price of the Companys
common stock on the date of grant. Each of these options will vest as to
145,000 shares on March 31, 2005 and the remaining shares will vest on
March 31, 2006. On May 10, 2004, John Reiland, the Companys Chief Financial Officer, was
granted an option to purchase 200,000 shares of the Companys common stock
under the 2000 Plan, at an exercise price of $1.36 per share which was the
closing market price of the Companys common stock on the date of grant.
Mr. Reilands option vests as to 66,666 shares on May 10, 2005, 66,667
shares on May 10, 2006 and the remaining 66,667 shares vest on May 10,
2007. During the six months ended September 30, 2004, the Company issued options
to certain other employees and non-employee directors to purchase a total
of 1,188,502 shares of its common stock under the 2000 Plan, at exercise
prices ranging from $0.90 to $1.32 per share which in each case was the
closing market price of the Companys common stock on the date of grant.
All of the options are exercisable over a ten year life, generally vest
equally over a period of three years, and generally terminate 90 days after
the date the optionee ceases to be an employee or a director of the
Company.  Deferred compensation On April 12, 2004, the Company granted a deferred compensation award to
John Reiland, the Companys Chief Financial Officer, which provides for a
payment equal to the product of 200,000 multiplied by an amount equal to
(a) the Companys average twenty (20) day trailing stock price on the third
anniversary date of his employment (March 17, 2006) less (b) $0.55 (the
Companys stock price on the date of his employment). In no event may the
payment amount exceed $430,000. The payment amount, if any, is cancelable
in the event of Mr. Reilands voluntary termination or termination by the
Company for Cause (as defined). 14




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##### Table of Contents



Item 2.
Managements Discussion and Analysis or Plan of Operation.
The following discussion and analysis of our financial condition and results of
operations should be read with the consolidated financial statements and
related notes included elsewhere in this Quarterly Report on Form 10-QSB. When used in this Quarterly Report on Form 10QSB, the words expects,
anticipates, believes, plans, will and similar expressions are intended
to identify forward-looking statements. These are statements that relate to
future periods and include, but are not limited to, statements regarding our
critical accounting policies, adequacy of cash, expectations regarding net
losses and cash flow, statements regarding our growth and profitability,
investments in marketing and promotion, our need for future financing, our
dependence on personnel and our ability to respond to rapid technological
change. Forward-looking statements are subject to certain risks and
uncertainties that could cause actual results to differ materially from those
projected. These risks and uncertainties include, but are not limited to, those
discussed below, as well as risks related to our ability to develop and timely
introduce products that address market demand, the impact of alternative
technological advances and competitive products, market fluctuations, our
ability to obtain future financing, and the risks set forth below under
Factors That May Affect Our Results. These forward-looking statements speak
only as of the date hereof. We expressly disclaims any obligation or
undertaking to release publicly any updates or revisions to any forward-looking
statements contained herein to reflect any change in our expectations with
regard thereto or any change in events, conditions or circumstances on which
any such statement is based. Critical Accounting Policies The following discussion and analysis of our financial condition and
results of operations is based upon our financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate these estimates, including
those related to revenue recognition and concentration of credit risk. We base
our estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ
from these estimates under different assumptions or conditions. We believe that of the significant accounting policies used in the
preparation of our financial statements (see Note 2 to the Financial
Statements), the following are critical accounting policies, which may involve
a higher degree of judgment, complexity and estimates. Revenue Recognition We recognize revenues in accordance with the provisions of the American
Institute of Certified Public Accountants Statement of Position 97-2,
Software Revenue Recognition. We license our software products under
non-exclusive, non-transferable license agreements. These arrangements do not
require significant production, modification or customization, therefore
revenue is recognized when the license agreement has been signed, delivery of
the software product has occurred, the related fee is fixed or determinable and
collectibility is probable. If professional services are provided in
conjunction with the installation of the software licensed, revenue is
recognized when those services have been provided. For license agreements that include a separately identifiable fee for
contracted maintenance services, such revenues are recognized on a
straight-line basis over the life of the maintenance agreement noted in the
license agreement, but following any installation period of the software. Concentrations of Credit Risk We extend credit to our customers and perform ongoing credit evaluations
of our customers. We do not obtain collateral from our customers to secure our
accounts receivable. We evaluate our accounts receivable on a regular basis for
collectibility and provide for an allowance for potential credit losses as
deemed necessary. 15




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##### Table of Contents



Three of our customers accounted for 25%, 22% and 16% of our net revenue
for the three months ended September 30, 2004. Four of our customers accounted
for 31%, 18%, 17% and 16% of our net revenue for the six months ended September
30, 2004. Two of our customers accounted for 52% and 17% of our net sales
for the three months ended September 30, 2003. Three of our customers
accounted for 35%, 13% and 19% respectively, of our net sales for the six
months ended September 30, 2003. At September 30, 2004, amounts due from two strategic resellers and a
significant customer, an entity of the U.S. Federal government, accounted for
28%, 10% and 36%, respectively, of accounts receivable. Results of Operations The results of operations reflected in this discussion include our
operations for the three and six month periods ended September 30, 2004 and
2003. Revenue Revenues totaled $609,834 for the three months ended September 30, 2004
compared to revenues of $958,808 for the three months ended September 30, 2003,
a decrease of $348,974 or 36%. The decrease in revenue was primarily
attributable to a decrease of $412,284 or 73% in license fees and by a decrease
in service revenue of $170,230 or 52%. The decrease in license fees is
principally due to (a) the initiation of a direct sales effort and the hiring
of five experienced sales representatives in the current quarter, (b) the
transition of our sales effort to a transactional sales model as opposed to a
license fee sales model, and (c) a significant license sale in the quarter
ended September 30, 2003 of a production license of our software product suite
to a large credit card processing company. This customer accounted for 52% of
our total revenue for the second quarter of the prior fiscal year. The decrease
in service revenues in the current quarter as compared to the same period in
the prior year is also the result of fewer license transactions in the current
year and the associated training and installation services. Maintenance
revenues increased $233,540 or 359% in the second quarter of the current fiscal
year compared to the same period in the prior year principally as a result of
transactional revenues increasing to approximately $158,000 in the current
quarter compared to only $10,000 of such revenue in the corresponding period of
the prior year. Revenues totaled $1,512,966 for the six months ended September 30, 2004
compared to revenues of $1,445,571 for the six months ended September 30, 2003,
an increase of $67,395 or 5%. License revenues decreased by $212,135 or 30% and
service revenues decreased by $66,255 or 11%. A lower level of license
transactions in the current six month period as compared to the corresponding
period in the prior year is the significant reason for the decreases.
Maintenance revenues, however, increased $345,785 or 303% for the six months
ended September 30, 2004 compared to the six months ended September 30, 2003
principally as a result of transactional revenues increasing to approximately
$288,000 in the current six month period compared to only $21,000 of such
revenue in the corresponding period of the prior year. Cost of Sales Costs of sales principally include the cost of personnel who perform the
services associated with our software maintenance, support, training and
installation activities. Cost of sales decreased by $3,030 or 1% to $202,512
for the three months ended September 30, 2004 from $205,542 for the three
months ended September 30, 2003. Cost of sales as a percentage of combined
maintenance and services revenues for the current quarter were 44% as compared
to 52% in the prior year. Cost of sales increased by $168,993 or 48% to $518,648 for the six months
ended September 30, 2004 from $349,655 for the three months ended September 30,
2003. Cost of sales as a percentage of combined maintenance and services
revenues for the current six month period were 51% as compared to 48% in the
prior year. 16




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##### Table of Contents



Operating Expenses Total operating expenses increased by $594,382 or 61% to $1,575,066 for
the three months ended September 30, 2004 from $980,684 for the three months
ended September 30, 2003. The increase in operating expenses was principally
attributable to a $431,297 increase in personnel costs primarily due to an
increase in our headcount to 33 at September 30, 2004 compared to 18 at
September 30, 2003. Additionally, marketing and advertising expenses increased
$219,056 in the second quarter compared to the same period in the prior year.
These increases were offset by a $150,622 decrease in legal and accounting
fees. In the prior year period we incurred an unusually high level of capital
restructuring transactions and the associated high level of legal, accounting
and consulting expenses. Total operating expenses increased by $1,143,190 or 58% to $3,119,095 for
the six months ended September 30, 2004 from $1,975,905 for the six months
ended September 30, 2003. The increase in operating expenses for the six month
period was principally attributable to a $1,022,983 increase in personnel costs
primarily due to an increase in our headcount to 33 at September 30, 2004
compared to 18 at September 30, 2003. Additionally, marketing and advertising
expenses increased $594,365 in the six month period ended September 30, 2004
compared to the same period in the prior year. These increases were offset by a
$436,462 decrease in legal and accounting fees. In the prior year period we
incurred an unusually high level of capital restructuring transactions and the
associated high level of legal, accounting and consulting expenses. Other Expenses Other expenses, including interest expense and financing costs, decreased
$2,062,940 or 65% to $1,134,658 for the three months ended September 30, 2004
from $3,197,598 for the three months ended September 30, 2003. The decrease is
principally due to approximately $3,045,000 of non-recurring, non-cash
financing charges incurred in the second quarter of the prior fiscal year
related to the early extinguishment of debt and other capital restructuring
transactions. During the three months ended September 30, 2004, we recorded a
non-recurring, non-cash charge of $1,000,000 related to managements estimates
of costs necessary to settle a lawsuit filed by an investor (see Note
4). Other expenses, including interest expense and financing costs, decreased
$3,054,315 or 66% to $1,567,171 for the six months ended September 30, 2004
from $4,621,486 for the six months ended September 30, 2003. The decrease was
primarily due to the non-recurring, non-cash financing charges incurred in our
capital restructuring transactions in the prior year offset by the estimated
costs of the lawsuit settlement discussed above recorded in the second quarter
of the current fiscal year. Net Loss Net loss decreased by $1,122,614 or 33% to a net loss of $2,302,402 for
the three months ended September 30, 2004 from $3,425,016 for the three months
ended September 30, 2003. Net loss decreased by $1,809,527 or 33% to a net loss of $3,691,948 for
the six months ended September 30, 2004 from $5,501,475 for the six months
ended September 30, 2003. Liquidity and Capital Resources Cash and cash equivalents increased by $1,208,802 to $2,412,191 at
September 30, 2004 from $1,203,389 at March 31, 2004. Cash used for operating
activities was $2,311,134 in the six months ended September 30, 2004 compared
to $1,253,781 in the same period in the prior year. Net loss from continuing
operations reduced cash by $3,691,948 and $5,501,474 in the six months ended
September 30, 2004 and 2003, respectively. Cash used for investing activities of $161,139 and $9,671 in the six
months ended September 30, 2004 and September 30, 2003, respectively, was due
to equipment purchases. 17




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##### Table of Contents



Financing activities provided cash of $3,681,075 in the six months ended
September 30, 2004 compared to $1,313,924 in the six months ended September 30,
2003. Financing activities in the current six month period included the
repayment of $500,000 of convertible promissory notes and the receipt of
$4,650,000, less direct issuance expenses of $568,500, from the sale of 2.89
million shares of our common stock and warrants to purchase up to 3.61 million
shares of our common stock at an exercise price of $1.61 per share. As a result of our recent capital raising transactions and the level of
revenues achieved in the six months ended September 30, 2004 and in the fiscal
year ended March 31, 2004, we believe we currently have adequate resources to
fund our anticipated cash needs through March 31, 2005 and beyond. However, an
adverse business or legal development could require us to raise additional
financing sooner than anticipated. We recognize that we may be required to
raise such additional capital, at times and in amounts, which are uncertain,
especially under current capital market conditions. If we are unable to acquire
additional capital or are required to raise it on terms that are less
satisfactory than we desire, it may have a material adverse effect on our
financial condition. In the event we raise additional equity financings, these
financings may result in dilution to existing shareholders. Off Balance Sheet Arrangements During the year ended March 31, 2004, we guaranteed a bank loan extended
to one of our executive officers in the amount of $150,000 related to the
officers expenses in relocating from California to Houston, Texas. This loan
was fully repaid by the officer and the guarantee was released in May 2004. Factors That May Affect Our Results We have a general history of losses and may not operate profitably in the
future. We have incurred losses for the last three fiscal years. Our net losses
and negative cash flow may continue for the foreseeable future. As of September
30, 2004, our accumulated deficit was $43,524,851. We believe that our planned
growth and profitability will depend in large part on our ability to promote
our brand name, gain clients and expand our relationships with clients for whom
we would provide licensing agreements and system integration. Accordingly, we
intend to invest heavily in marketing, strategic partnership, development of
our client base, and development of our marketing technology and operating
infrastructure. If we are not successful in promoting our brand name and
expanding our client base, it will have a material adverse effect on our
financial condition and our ability to continue to operate our business. If we are unsuccessful in raising additional capital in the future, we may be
unable to continue to operate. We believe we currently have adequate cash to fund anticipated cash needs
through March 31, 2005 and beyond. In April 2004, we raised an additional
$4,650,000 of equity capital in a private placement with major institutional
investors. However, we may need to raise additional capital in the future. Any
equity financing may be dilutive to shareholders, and debt financing, if
available, will increase expenses and may involve restrictive covenants. We may
be required to raise additional capital, at times and in amounts, which are
uncertain, especially under the current capital market conditions. Under these
circumstances, if we are unable to obtain additional capital or are required to
raise it on undesirable terms, it may have a material adverse effect on our
financial condition, which could require us to:  
    
    curtail our operations significantly;  
    
    sell significant assets;  
    
    seek arrangements with strategic partners or other parties that may
require us to relinquish significant rights to products, technologies or
markets; or  
    
    explore other strategic alternatives including our merger or sale. 18




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Our operating results are subject to fluctuations caused by many factors which
could cause us to fail to achieve our revenue or profitability expectations,
which in turn could cause our stock price to decline. Our operating results can vary significantly depending upon a number of
factors, many of which are outside our control. Factors that may affect our
quarterly operating results include:  
    
    market acceptance of and changes in demand for our products and services;  
    
    gain or loss of clients or strategic relationships;  
    
    announcement or introduction of new software, services and products by us or by our competitors;  
    
    our ability to build brand recognition;  
    
    timing of sales to customers;  
    
    price competition;  
    
    our ability to upgrade and develop systems and infrastructure to accommodate growth;  
    
    our ability to attract and integrate new personnel in a timely and effective manner;  
    
    our ability to introduce and market products and services in accordance with market demand;  
    
    changes in governmental regulation;  
    
    reduction in or delay of capital spending by our clients due to the
effects of terrorism, war and political instability; and  
    
    general economic conditions, including economic conditions specific
to the financial services industry. In addition, each quarter we derive a significant portion of our revenue
from agreements signed at the end of the quarter. Our operating results could
suffer if the timing of these agreements is delayed. Depending on the type of
agreements we enter into, we may not be able to recognize revenue under these
agreements in the quarter in which they are signed. Some or all of these
factors could negatively affect demand for our products and services, and our
future operating results. Most of our operating expenses are relatively fixed in the short-term. We
may be unable to adjust spending rapidly to compensate for any unexpected sales
shortfall, which could harm our quarterly operating results. Because of the
emerging nature of the markets in which we compete, we do not have the ability
to predict future operating results with any certainty. Because of the above
factors, you should not rely on period-to-period comparisons of results of
operation as an indication of future performances. Because a small number of customers have historically accounted for and may in
future periods account for substantial portions of our revenue, our revenue
could decline because of delays of customer orders or the failure to retain
customers. We have a small number of customers that account for a significant portion
of our revenue. Our revenue could decline because of a delay in signing
agreements with a single customer or the failure to retain an existing
customer. We may not obtain additional customers. The failure to obtain
additional customers and the failure to retain existing customers will harm our
operating results. If general economic and business conditions do not improve, we may experience
decreased revenue or lower growth rates. 19




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The revenue growth and profitability of our business depends on the
overall demand for computer software and services in the product segments in
which we compete. Because our sales are primarily to major banking and
government customers, our business also depends on general economic and
business conditions. A softening of demand caused by a weakening of the economy
may result in decreased revenue or lower growth rates. As a result, we may not
be able to effectively promote future license revenue growth in our application
business. We may not be able to attract, retain or integrate key personnel, which may
prevent us from successfully operating our business. We may not be able to retain our key personnel or attract other qualified
personnel in the future. Our success will depend upon the continued service of
key management personnel. The loss of services of any of the key members of our
management team or our failure to attract and retain other key personnel could
disrupt operations and have a negative effect on employee productivity and
morale and harm our financial results. We operate in a market that is intensely and increasingly competitive, and if
we are unable to compete successfully, our revenue could decline and we may be
unable to gain market share. The market for financial services software is relatively new and highly
competitive. Our future success will depend on our ability to adapt to rapidly
changing technologies, evolving industry standards, product offerings and
evolving demands of the marketplace. Some of our competitors have:  
    
    longer operating histories;  
    
    larger installed customer bases;  
    
    greater name recognition and longer relationships with clients; and  
    
    significantly greater financial, technical, marketing and public relations resources than us. Our competitors may also be better positioned to address technological and
market developments or may react more favorably to technological changes. We
compete on the basis of a number of factors, including:  
    
    the breadth and quality of services;  
    
    creative design and systems engineering expertise;  
    
    pricing;  
    
    technological innovation; and  
    
    understanding clients strategies and needs. Competitors may develop or offer strategic services that provide
significant technological, creative, performance, price or other advantages
over the services we offer. If we fail to gain market share or lose existing
market share, our financial condition, operating results and business could be
adversely affected and the value of the investment in us could be reduced
significantly. We may not have the financial resources, technical expertise or
marketing, distribution or support capabilities to compete successfully. We may be responsible for maintaining the confidentiality of our clients
sensitive information, and any unauthorized use or disclosure could result in
substantial damages and harm our reputation. The services we provide for our clients may grant us access to
confidential or proprietary client information. Any unauthorized disclosure or
use could result in a claim against us for substantial damages and could harm
our 20




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reputation. Our contractual provisions attempting to limit these damages
may not be enforceable in all instances or may otherwise fail to adequately
protect us from liability for damages. Future sales of our common stock may cause the market price of our common stock
to decline. As of October 31, 2004, there were approximately 27,562,428 shares of
common stock outstanding, of which at least 9,120,139 are restricted securities
under the Securities Act, a minority of which are held by our affiliates. These
restricted securities will be eligible for sale from time to time upon
expiration of applicable holding periods under Rule 144 under the Securities
Act. If these holders sell in the public market, these sales could cause the
market price of our common stock to decline. This also could make it more
difficult for us to raise funds through future offerings of our common stock. If we do not adequately protect our intellectual property, our business may
suffer, we may lose revenue or we may be required to spend significant time and
resources to defend our intellectual property rights. We rely on a combination of patent, trademark, trade secrets,
confidentiality procedures and contractual procedures to protect our
intellectual property rights. If we are unable to adequately protect our
intellectual property, our business may suffer from the piracy of our
technology and the associated loss in revenue. Any patents that we may hold may
not sufficiently protect our intellectual property and may be challenged by
third parties. Our efforts to protect our intellectual property rights, may not
prevent the misappropriation of our intellectual property. These infringement
claims or any future claims could cause us to spend significant time and money
to defend our intellectual property rights, redesign our products or develop or
license a substitute technology. We may be unsuccessful in acquiring or
developing substitute technology and any required license may be unavailable on
commercially reasonable terms, if at all. In the event of litigation to
determine the validity of any third party claims or claims by us against such
third party, such litigation, whether or not determined in our favor, could
result in significant expense and divert the efforts of our technical and
management personnel, regardless of the outcome of such litigation.
Furthermore, other parties may also independently develop similar or competing
products that do not infringe upon our intellectual property rights. 21




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Item 3. Controls and Procedures Evaluation of Disclosure Controls and Procedures We carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and
Chief Financial Officer, of the effectiveness of our disclosure controls and
procedures (as such term is defined in Rules 13a- 15(e) and 15d  15(e) of the
Securities Exchange Act of 1934, as amended (the Exchange Act)) as of the end
of the period covered by this quarterly report. Based on the evaluation, such
officers have concluded that these disclosure controls and procedures are
effective in alerting them on a timely basis to material information relating
to US Dataworks that is required to be included in our periodic filings under
the Exchange Act. There has been no change in our internal control over financial reporting
(as defined in Rules 13a-13(f) and 15d-15(f) of the Exchange Act) that occurred
during the period covered by this quarterly report that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting. 22




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PART II   OTHER INFORMATION 
 Item 1. Legal Proceedings On
December 12, 2003, one of our investors filed a lawsuit in the Los
Angeles Superior Court alleging that in March 2000, as partial
consideration under an alleged oral agreement he converted three promissory
notes with an aggregate principal amount of $725,000 into 77,856 shares of our
common stock. In the lawsuit, the investor alleged that the oral agreement
granted him the right to receive additional shares from us in the event that he
should sell certain shares of our common stock at a price less than $15 per
share. Subsequent to September 30, 2004, we entered into a settlement agreement
with the investor wherein we agreed to give the investor (1) a $748,000
convertible promissory note payable with interest at 10% per annum in three
equal annual installments beginning September 15, 2005 (2) a warrant to
purchase 160,000 shares of our common stock at a purchase price of $0.75 per
share which warrant expires on November 10, 2006, and (3) reimbursement of the
plaintiffs legal fees and expenses. At the holders election, at anytime, any
portion of the unpaid principal and interest of the promissory note may be
converted into shares of our common stock at a per share conversion price of
$1.10, subject to standard antidilution provisions. 
 Item 2. Changes in Securities During the six months ended September 30, 2004, we raised an additional
$4,650,000 less direct issuance expenses of $568,500 in a private placement
with certain major institutional investment funds wherein we sold 2,888,201
shares of our common stock and warrants to purchase an aggregate of 3,610,250
shares of our common stock. The warrants have an exercise price of $1.61 per
share. Of the aggregate 3,610,250 warrants issued, 722,050 will expire if not
previously exercised on January 22, 2005 and the remaining 2,888,200 warrants
will expire on April 20, 2011. In May 2004, we agreed to terminate an equity line financing agreement
entered into in June 2003 with an institutional investor. As a part of the
termination, we issued the investor $225,000 of unregistered shares of our
common stock. Based upon the closing market price of our common shares on the
date of the termination agreement, we issued 136,861 common shares to the
investor in May 2004 (see Note 6). In
August 2004, a holder of the Series B preferred stock elected to
convert his 79,999 shares and accordingly we issued the investor 15,998 shares
of our common stock (see Note 6). In
August 2004, four holders elected to convert their notes
totaling $250,000 and were issued 555,556 shares of our common stock in
accordance with the terms of the notes. In September 2004, we exercised our option to convert $575,000 aggregate
principal amount of convertible notes and $5,750 of accrued interest
due a noteholder on October 2, 2004 into common 23




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stock at a conversion price of $2.00 per share. Accordingly, as of
September 30, 2004 we issued the note holder 290,375 shares of our common
stock. The
issuances disclosed were made to accredited investors and were deemed
to be exempt from registration under the Securities Act in reliance upon
Section 4(2) of the Securities Act or Regulation D promulgated thereunder. Item 4. Submission of Matters to a Vote of Security Holders On September 1, 2004, we held our 2004 Annual Meeting of Stockholders, at
which meeting our Stockholders approved the following (all tabulations reflect
share numbers on a pre-split basis): (a) Election of the following directors: FOR
    
    WITHHELDClass II Directors:Hayden D. Watson
    
    
    19,248,817
    
    
    
    64,282Thomas L. West
    
    
    19,183,786
    
    
    
    129,313
 The terms of directors Joe Abrell, John L. Nicholson, M.D., Charles E.
Ramey and Terry Stepanik continued beyond the 2004 Annual Meeting of
Stockholders. (b) Approve an amendment to our Amended and Restated 2000 Stock Option
Plan to increase the number of shares available for issuance thereunder from
3,200,000 to 6,000,000 shares: FOR
    
    AGAINST
    
    ABSTAIN4,095,558
    
    428,771
    
    796,698
 (c) Approve an amendment to our Amended and Restated 2000 Stock Option
Plan to increase the number of options granted to any non-employee members of
our Board of Directors: FOR
    
    AGAINST
    
    ABSTAIN4,096,132
    
    423,397
    
    801,498
 (d) Ratify the appointment of Ham, Langston & Brezina, LLP as our
independent auditors. FOR
    
    AGAINST
    
    ABSTAIN19,207,383
    
    33,016
    
    72,700
 
 Item 6. Exhibits The exhibits listed below are required by Item 601 of Regulation S-B. ExhibitNumber
    
    Description of Document31.1
    
    Section 302 Certification of Chief Executive Officer.31.2
    
    Section 302 Certification of Chief Financial Officer.32.1
    
    Section 906 Certification of Chief Executive Officer.32.2
    
    Section 906 Certification of Chief Financial Officer.
 24




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SIGNATURE In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized. Dated: November 15, 2004 US DATAWORKS, INC.By
    
    /s/ John S. ReilandJohn S. ReilandChief Financial Officer(Principal Financial and Accounting Officer
and Duly Authorized Officer)
 25




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EXHIBIT INDEX ExhibitNumber
    
    Description of Document31.1
    
    Section 302 Certification of Chief Executive Officer.31.2
    
    Section 302 Certification of Chief Financial Officer.32.1
    
    Section 906 Certification of Chief Executive Officer.32.2
    
    Section 906 Certification of Chief Financial Officer.
 26