##### Table of Contents



UNITED STATES SECURITIES
AND EXCHANGE COMMISSION    FORM 10-QSB   (Mark One) [X]
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934
  For the quarterly period ended June 30, 2004
 [  ]
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934For the transition
period _________  to
 Commission file number: 001-15835 US Dataworks, Inc.  Nevada
(State or other jurisdiction of
incorporation or organization)
    
    84-1290152
(I.R.S. employer identification number)
 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 July 31, 2004: 26,652,780 Transitional Small Business Disclosure Format (Check one): YES [  ]   NO [X]




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US DATAWORKS, INC. TABLE OF CONTENTS FORM 10-QSB QUARTERLY PERIOD ENDED JUNE 30, 2004 PagePART I  FINANCIAL INFORMATION
    
    
    1Item 1. Financial Statements
    
    
    1Item 2. Managements Discussion and Analysis or Plan of Operation
    
    
    16Item 3. Controls and Procedures
    
    
    23PART II  OTHER INFORMATION
    
    
    24Item 1. Legal Proceedings
    
    
    24Item 2 Changes in Securities.
    
    
    24Item 6. Exhibits and Reports on Form 8-K
    
    
    24SIGNATURE
    
    
    25Additional Compensation AgreementSection 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
June 30, 2004(Unaudited) ASSETS CURRENT ASSETSCash and cash equivalents
    
    $
    3,588,117Accounts receivable, net of allowance for doubtful accounts of $0
    
    
    1,381,150Prepaid expenses and other current assets
    
    
    228,880Total current assets
    
    
    5,198,147PROPERTY AND EQUIPMENT, net
    
    
    653,020GOODWILL, net
    
    
    14,133,629OTHER ASSETS
    
    
    17,445TOTAL ASSETS
    
    $
    20,002,241
 The accompanying notes are an integral part of these financial statements. 1




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US DATAWORKS, INC. BALANCE SHEET
June 30, 2004 (Unaudited) LIABILITIES AND SHAREHOLDERS EQUITY CURRENT LIABILITIESNote payable  related party
    
    $
    39,000Current portion of convertible promissory notes, net of unamortized
discount of $143,750
    
    
    681,250Deferred revenue
    
    
    62,045Accounts payable
    
    
    350,441Accrued expenses
    
    
    304,674Interest payable
    
    
    3,613Total current liabilities
    
    
    1,441,023Deferred revenue
    
    
    66,667Deferred compensation
    
    
    202,100Total liabilities Interest payable
    
    
    1,709,790COMMITMENTSSHAREHOLDERS EQUITYConvertible Series B preferred stock, $0.0001 par value
700,000 shares authorized, 629,666 shares issued and outstanding
$0.75 liquidation preference, dividends of $158,767 in arrears
    
    
    63Common stock, $0.0001 par value
90,000,000 shares authorized and 26,377,227 shares issued and outstanding
    
    
    2,638Additional paid-in capital
    
    
    59,693,248Deferred compensation
    
    
    (181,048
    )Accumulated deficit
    
    
    (41,222,450
    )Total shareholders equity
    
    
    18,292,451TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    20,002,241
 The accompanying notes are an integral part of these financial statements. 2




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US DATAWORKS, INC. STATEMENTS OF OPERATIONS(Unaudited) For the Three Months Ended June 30, 2004
    
    2003REVENUESSoftware licensing revenues
    
    
    347,716
    
    
    $
    147,567Software maintenance revenues
    
    
    161,391
    
    
    
    49,146Professional service revenues
    
    
    394,025
    
    
    
    290,050Total revenues
    
    
    903,132
    
    
    
    486,763Cost of sales
    
    
    316,136
    
    
    
    144,112Gross profit
    
    
    586,996
    
    
    
    342,651OPERATING EXPENSESGeneral and administrative
    
    
    1,469,905
    
    
    
    926,713Depreciation and amortization
    
    
    74,126
    
    
    
    68,507Total operating expense
    
    
    1,544,031
    
    
    
    995,220LOSS FROM OPERATIONS
    
    
    (957,035
    )
    
    
    (652,569
    )OTHER INCOME (EXPENSE)Financing costs
    
    
    (322,451
    )
    
    
    (1,049,505
    )Interest expense
    
    
    (116,521
    )
    
    
    (310,347
    )Interest expense  related parties
    
    
    
    
    
    
    (64,037
    )Other income
    
    
    6,460
    
    
    
    Total other expense
    
    
    (432,512
    )
    
    
    (1,423,889
    )LOSS BEFORE PROVISION FOR INCOME TAXES
    
    
    (1,389,547
    )
    
    
    (2,076,458
    )PROVISION FOR INCOME TAXES
    
    
    
    
    
    
    NET LOSS
    
    $
    (1,389,547
    )
    
    $
    (2,076,458
    )BASIC AND DILUTED LOSS PER SHARETotal basic and diluted loss per share
    
    $
    (0.05
    )
    
    $
    (0.17
    )BASIC AND DILUTED WEIGHTED-AVERAGE SHARES
OUTSTANDING
    
    
    25,509,912
    
    
    
    12,168,348
 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 Three Months ended June 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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    34,279
    
    
    
    
    
    
    
    
    
    
    
    34,279Grant of
deferred compensation (Note 6)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (202,100
    )
    
    
    
    
    
    
    (202,100
    )Amortization of deferred compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    21,052
    
    
    
    
    
    
    
    21,052Common stock issued forCash
    
    
    
    
    
    
    
    
    
    
    2,888,201
    
    
    
    289
    
    
    
    4,091,211
    
    
    
    
    
    
    
    
    
    
    
    4,091,500Exercise of warrants and options
    
    
    
    
    
    
    
    
    
    
    110,583
    
    
    
    11
    
    
    
    97,564
    
    
    
    
    
    
    
    
    
    
    
    97,575Notes payable conversion
    
    
    
    
    
    
    
    
    
    
    244,446
    
    
    
    24
    
    
    
    109,976
    
    
    
    
    
    
    
    
    
    
    
    110,000Stock issued for equity line of
credit extinguishment (Note 6)
    
    
    
    
    
    
    
    
    
    
    136,861
    
    
    
    14
    
    
    
    224,986
    
    
    
    
    
    
    
    
    
    
    
    225,000Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,389,547
    )
    
    
    (1,389,547
    )Balance, June 30, 2004
    
    
    629,666
    
    
    $
    63
    
    
    
    26,377,227
    
    
    $
    2,638
    
    
    $
    59,693,248
    
    
    $
    (181,048
    )
    
    $
    (41,222,450
    )
    
    $
    18,292,451
 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 Three Months Ended June 30, (Unaudited) 2004
    
    2003Cash flows from operating activitiesNet loss from continuing operations
    
    $
    (1,389,547
    )
    
    $
    (2,076,458
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization of property and equipment
    
    
    74,127
    
    
    
    68,507Amortization of note discount and beneficial conversion features on
convertible promissory notes
    
    
    200,074
    
    
    
    263,113Amortization of deferred compensation expense
    
    
    21,052
    
    
    
    Issuance of stock for interest
    
    
    10,000
    
    
    
    27,645Issuance 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
    
    
    
    
    
    
    12,479Issuance of options to third party for services
    
    
    34,279
    
    
    
    (Increase) decrease inAccounts receivable
    
    
    (152,049
    )
    
    
    261,453Prepaid expenses and other current assets
    
    
    (112,108
    )
    
    
    (116,565
    )Other assets
    
    
    10,000
    
    
    
    Increase (decrease) inDeferred revenue
    
    
    (31,740
    )
    
    
    (204,513
    )Accounts payable
    
    
    2,793
    
    
    
    719,592Accrued expenses
    
    
    (130,316
    )
    
    
    (135,152
    )Interest payable
    
    
    (33,638
    )
    
    
    (3,118
    )Interest payable  related parties
    
    
    
    
    
    
    40,479Net cash used in operating activities
    
    
    (1,272,073
    )
    
    
    (58,033
    )Cash flows from investing activitiesPurchase of property and equipment
    
    
    (32,274
    )
    
    
    Net cash used in investing activities
    
    
    (32,274
    )
    
    
    
 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 Three Months Ended June 30, (unaudited) 2004
    
    2003Cash flows from financing activitiesPayments on capital lease obligations
    
    
    
    
    
    
    (3,688
    )Proceeds from notes payable
    
    
    
    
    
    
    10,000Repayment of notes payable
    
    
    
    
    
    
    (97,389
    )Proceeds from convertible promissory notes
    
    
    
    
    
    
    300,000Repayment of convertible promissory notes
    
    
    (500,000
    )
    
    
    (10,000
    )Repayment of note payable related to
discontinued
operations
    
    
    
    
    
    
    (81,442
    )Proceeds from stock sale
    
    
    4,650,000
    
    
    
    Stock issuance costs
    
    
    (558,500
    )
    
    
    Proceeds from exercise of employee stock options
    
    
    67,575
    
    
    
    Proceeds from exercise of warrants
    
    
    30,000
    
    
    
    Net cash provided by financing activities
    
    
    3,689,075
    
    
    
    117,481Net increase in cash and cash equivalents
    
    
    2,384,728
    
    
    
    59,448Cash and cash equivalents, beginning of period
    
    
    1,203,389
    
    
    
    8,564Cash and cash equivalents, end of period
    
    $
    3,588,117
    
    
    $
    68,012Supplemental disclosures of cash flow information
Interest paid
    
    $
    28,898
    
    
    $
    20,024
 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. It also has a strategic alliance with BancTec,
Inc. and Computer Sciences Corporation to license the Companys software and
Thomson Financial Publishing, a unit of Thomson Corporation, to incorporate its
EPICWare database into the Companys products. 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 yearsTelephone equipment
    
    5 to 10 yearsComputer equipment
    
    5 yearsComputer software
    
    5 yearsLeasehold improvements
    
    Shorter of initiallease period oruseful 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 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. 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 Bulletin (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, 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 Accounting Principles Board No. 25,
Accounting for Stock Issued to Employees (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 months ended June
30, 2004 and June 30, 2003 or for the years ended March 31, 2004 and March
31, 2003.Proforma 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 of
that Statement. The fair value for these options was estimated at the date
of grant using a Black-Scholes option pricing model. 8




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The Black-Scholes option valuation 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 valuation
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 proforma disclosure, the estimated fair value of the
options is included in expense over the options vesting period or expected
life. The Companys proforma information for the three months ended June
30, 2004 and 2003 is as follows: 2004
    
    2003Net loss as reported
    
    $
    (1,389,547
    )
    
    $
    (2,076,458
    )Add stock-based employee compensation expense included
in net loss as reported, net of related tax effects
    
    
    0
    
    
    
    0Deduct stock-based employee compensation expense
determined under the fair value based method for all awards,
net of related tax effects
    
    
    (287,627
    )
    
    
    (284,250
    )Net loss, pro forma
    
    $
    (1,677,174
    )
    
    $
    (2,360,708
    )Basic and diluted loss per share, as reported
    
    $
    (0.05
    )
    
    $
    (0.17
    )Basic and diluted loss per share, pro forma
    
    $
    (0.07
    )
    
    $
    (0.19
    )
  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 June 30, 2004 and 2003: dividend
yields of 0% and 0%, respectively; expected volatility of 75% and 150%,
respectively; risk-free interest rates of 2.75% and 1.91%, respectively;
and expected lives of 3 and 3 years, respectively. The per-share weighted
average fair values of stock options granted during the three months ended
June 30, 2004 and 2003 were $0.73 and $0.34, 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 outstanding if the potential
common stock equivalents had been issued and if the additional common
shares were dilutive. 9




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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): Three Months Ended June 30,2004
    
    2003Options outstanding under the Companys stock option plans
    
    
    2,667,250
    
    
    
    1,662,000Options granted outside the Companys stock option plans
    
    
    1,260,100
    
    
    
    124,350Warrants issued in conjunction with convertible Series B preferred stock
    
    
    0
    
    
    
    125,934Warrants issued in conjunction with private placements
    
    
    4,896,502
    
    
    
    106,300Warrants issued as a financing cost for notes payable
and convertible notes payable
    
    
    2,241,137
    
    
    
    369,504Warrants issued in conjunction with lock-up agreements
    
    
    0
    
    
    
    145,952Warrants issued for services rendered
    
    
    337,800
    
    
    
    358,400Warrants issued as part of the April 2001 acquisition
    
    
    67,200
    
    
    
    67,200Convertible Series A preferred stock (a)
    
    
    0
    
    
    
    1,994,286Convertible Series B preferred stock (b)
    
    
    167,911
    
    
    
    167,911
 (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 June 30,
2003. (b) The Series B preferred stock is convertible into shares of common stock
at a conversion price of $3.75 per share.  ReclassificationsCertain 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.EstimatesThe 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 RiskThe 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.Four of our customers accounted for 35%, 23%, 19% and 12% of our net
revenue for the three months ended June 30, 2004. Three of our customers
accounted for 26%, 22% and 12%, respectively, of our net revenue for the
three months ended June 30, 2003. Additionally, our strategic resellers
accounted for 47% and 26% respectively, of our net revenue for the three
months ended June 30, 2004 and 2003, respectively.As of June 30, 2004, amounts due from our strategic resellers and a
significant customer, an entity of the U.S. Federal government, accounted
for 24% and 49%, respectively, of accounts receivable. 10




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3. Property and Equipment  Property and equipment as of June 30, 2004 consisted of the following: Furniture and fixtures
    
    $
    51,606Office and telephone equipment
    
    
    81,097Computer equipment
    
    
    206,116Computer software
    
    
    1,227,269Leasehold improvements
    
    
    62,9971,629,085Less accumulated depreciation and amortization
    
    
    (976,065
    )TOTAL
    
    $
    653,020
  Depreciation and amortization expense for the three months ended June 30,
2004 and 2003 was $74,127 and $68,507, respectively. 4. Convertible Promissory Notes  Convertible promissory notes at June 30, 2004 consisted of the following: Convertible Promissory Notes: Convertible promissory notes, interest at 10% per annum,
unsecured, due August 4, 2004
    
    
    250,000Convertible debentures, interest at 1% per annum, unsecured, due
October 2, 2004, net of unamortized discount of $143,750
    
    
    431,250$
    681,250
 Convertible Note Due August 4, 2004  On June 30, 2003, the Company agreed to sell to five accredited investors
an aggregate of 1,111,112 shares of its common stock for an aggregate
purchase price of $500,000 pursuant to a Securities Purchase Agreement.
The investors purchased these shares from the Company on July 9, 2003. In
connection with this agreement, the Company issued warrants to purchase an
aggregate of 150,000 shares of its common stock with an exercise price of
$1.34 per share. On August 4, 2003, the five accredited investors agreed
to surrender their common stock in exchange for convertible promissory
notes totaling $500,000, due August 4, 2004, with interest at 10% per
annum, and warrants to purchase an additional 10,000 shares of common stock
with an exercise price of $1.34 per share. The warrants may be exercised
at any time after August 4, 2003. The promissory notes are convertible into
common stock at $0.45 per share. On September 15, 2003, one of the
investors elected to convert his promissory note for $250,000 into common
stock and was issued 555,556 shares of common stock prior to September 30,
2003. Subsequent to June 30, 2004, the other four accredited investors
elected to convert their notes and were issued 555,556 shares of common
stock. The non-cash expense of this stock repurchase of $45,693 has been
recorded as financing costs during the fiscal year ended March 31, 2004. Convertible Debentures Due October 2, 2004  In October 2003, the Company sold 1,825,000 shares of common stock for an
aggregate purchase price of $3,650,000, and sold $575,000 aggregate
principal amount of 1% Convertible Debentures (the Debentures). In
connection with the sale of the common stock and Debentures, the Company
also issued warrants to purchase 1,056,250 shares of common stock (the
Warrants, and collectively, with the common stock and Debentures, the
Securities) in a private placement to 11 institutional investors. The
maturity date of the Debentures is October 2, 2004. The sale of the
Securities resulted in gross proceeds to the Company, prior to the exercise
of the Warrants, of approximately $4.2 million. The Debentures are
convertible into common 11




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stock at a conversion price of $2.00 per share (the Conversion Price),
subject to standard anti-dilution adjustments. The Warrants are fully
vested and exercisable at any time until October 2, 2006 at an exercise
price of $2.00 per share (the Exercise Price), subject to standard
anti-dilution adjustments. In accordance with generally accepted accounting
principles, the Company allocates the proceeds received from debt or
convertible debt with detachable warrants using the relative fair value of
the individual elements at the time of issuance. Using the Black-Scholes
valuation model the Company has determined the value of the warrants issued
in connection with the Debentures to be $185,195. This amount, which has
been allocated to the warrants, is accounted for as a debt discount and
will be recognized as additional interest expense in the statement of
operations during the period from the date of issuance to the stated
maturity date. During the three month period ended June 30, 2004, the
Company recognized $46,299 in interest expense related to the accretion of
the debt discount attributable to the warrants issued in connection with
the Debentures.  In accordance with generally accepted accounting principles, in the event
the conversion price is less than the Companys stock price on the date of
issuance, the difference is considered to be a beneficial conversion
feature and is amortized as additional expense over the period from the
date of issuance to the stated redemption date. The Company has calculated
the beneficial conversion feature of the Debentures to be $389,805. During
the three month period ended June 30, 2004, the Company recognized $97,451
in financing costs related to the accretion of the debt discount
attributable to the beneficial conversion feature issued in connection with
the Debentures. 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, $150,000, $200,000 and $150,000, respectively. Litigation  On December 12, 2003, an individual investor filed a lawsuit against the
Company in Los Angeles Superior Court alleging breach of an oral agreement
between the plaintiff and a former director of the Company. In the
complaint, the plaintiff alleges that the oral agreement granted him the
right to receive additional shares from the Company in the event that he
should sell certain shares of the Companys common stock at a price less
than $15 per share. The plaintiff alleges 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. He is seeking unspecified damages.
The Company intends to dispute this claim and defend this action
vigorously. 6. Stockholders Equity Preferred 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 its 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 12




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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 13,333 shares and warrants for the purchase of 2,667 shares of
common stock to the Company in exchange for the return of its investment of
$10,000.At June 3, 2004, there were accumulated, undeclared dividends in arrears of
$158,767 or $0.25 per share. Common Stock Financing 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 shares on the date of the
termination agreement, the Company issued 136,861 common shares to the
investor in May 2004. Common Stock and Warrants During the three months ended June 30, 2004, the Company completed the
following:  Sale of Common Stock and WarrantsIn April 2004, the Company completed a private placement of $4.65 million,
less direct issuance expenses of $558,500, 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. 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 3,200,000. 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 three months ended June 30, 2004 and 2003, the Company granted
790,000 and 1,749,250 stock options, respectively, to certain employees
that may be exercised at prices ranging between $1.49 and $0.55.The following table summarizes certain information relative to stock
options: 13




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##### Table of Contents



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
    
    
    $
    3.68Granted
    
    
    210,000
    
    
    $
    1.36
    
    
    
    580,000
    
    
    $
    1.49Exercised
    
    
    (36,500
    )
    
    $
    0.55
    
    
    
    (19,000
    )
    
    $
    2.50Forfeited/canceled
    
    
    0
    
    
    
    0
    
    
    
    (14,000
    )
    
    $
    21.92Outstanding, June 30, 2004
    
    
    2,667,250
    
    
    $
    1.92
    
    
    
    1,260,100
    
    
    $
    2.51Exercisable, June 30, 2004
    
    
    1,484,087
    
    
    $
    1.49
    
    
    
    100,100
    
    
    $
    19.77
  The weighted-average remaining life and the weighted-average exercise price
of all of the options outstanding at June 30, 2004 were 8.8 years and
$2.11, respectively. The exercise prices for the options outstanding at
June 30, 2004 ranged from $0.55 to $50, and information relating to these
options is as follows: Weighted-Average
    
    
    
    
    
    Weighted-AverageRange of Exercise
    
    Stock Options
    
    Stock Options
    
    Remaining
    
    Weighted-Average
    
    Exercise Price ofPrices
    
    Outstanding
    
    Exercisable
    
    Contractual Life
    
    Exercise Price
    
    Options Exercisable$0.55 - 2.00
    
    
    2,630,750
    
    
    
    1,213,250
    
    
    9.12 years
    
    $
    0.93
    
    
    $
    0.76$2.01 - 3.00
    
    
    1,055,500
    
    
    
    129,837
    
    
    9.21 years
    
    $
    2.79
    
    
    $
    2.87$3.01- 50.00
    
    
    241,100
    
    
    
    241,100
    
    
    4.15 years
    
    $
    12.01
    
    
    $
    12.013,927,350
    
    
    
    1,584,187
 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 three months ended June 30, 2003, the Company issued options to
certain other employees and non-employee directors to purchase a total of
10,000 shares of our common stock under the 2000 Plan, at an exercise price
of $1.32 per share which in all cases was the closing market price of our
common stock on the date of grant. All of the options are exercisable over
a ten year life, generally vest over a period of three years, and generally
terminate 90 days after the date the optionee ceases to be an employee or a
director. 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 14




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cancelable in the event of Mr. Reilands voluntary termination or
termination by the Company for Cause (as defined).7.
    Subsequent EventsConversions of Convertible Promissory NotesIn August of 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. 15




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##### Table of Contents



Item 2. Managements Discussion and Analysis 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. US Dataworks 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 receivables. We evaluate our accounts receivable on a regular basis
for collectibility and provide for an allowance for potential credit losses as
deemed necessary. 16




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##### Table of Contents



Four of our customers accounted for 35%, 23%, 19% and 12% of our net
revenue for the three months ended June 30, 2004. Three of our customers
accounted for 26%, 22% and 12%, respectively, of our net revenue for the three
months ended June 30, 2003. Additionally, our strategic resellers accounted for
47% and 26% respectively of our net revenue for the three months ended June 30,
2004 and 2003, respectively. At June 30, 2004, amounts due from our strategic resellers and a
significant customer, an entity of the U.S. Federal government, accounted for
24% and 49%, respectively, of accounts receivable. Results of Operations The results of operations reflected in this discussion include the
operations of US Dataworks for the three months ended June 30, 2004 and 2003. Revenue Revenues increased by $416,369 or 86% from $486,763 in the three months
ended June 30, 2003 to $903,132 in the three months ended June 30, 2004. The
increase in revenue was primarily attributable to an increase of $200,149 or
136% in software licensing revenues, $112,245 or 228% in maintenance revenues
and $103,975 or 36% in service revenues. Cost of Revenue Cost of revenue principally includes the cost of personnel who perform the
services associated with our software maintenance and installation revenue
activities, and the cost of third party software that is used by our software
to convert electronic data into acceptable formats utilized by the nations
banking system. Total cost of revenue increased by $172,024 or 119% from
$144,112 in the three months ended June 30, 2003 to $316,136 in the three
months ended June 30, 2004. The increase was principally due to the increase in
labor costs associated with the increased maintenance and service revenues for
the period. Operating Expenses Total operating expenses increased by $548,811 or 55% from $995,220 in the
three months ended June 30, 2003 to $1,544,031 in the three months ended June
30, 2004. The increase in operating expenses was attributable to a $554,113
increase in personnel related costs principally due to the increase in our
headcount from 13 at June 30, 2003 to 22 at June 30, 2004. Additionally, a
$291,238 increase in marketing and advertising expenses in the three months
ended June 30, 2004 was largely offset by a $285,840 decrease in legal and
accounting fees. In the prior year during the three months ended June 30, 2003
we incurred an unusually high level of capital restructuring transactions and
the associated high level of legal, accounting and consulting expenses. Other Expenses Total other expenses, including interest expense and financing costs,
decreased $991,377 or 70% from $1,423,889 in the three months ended June 30,
2003 to $432,512 in the three months ended June 30, 2004 primarily due to
unusually high level of capital restructuring transactions incurred in the
prior period. Net Loss Net loss decreased by $686,911 or 33% from a net loss of $2,076,458 in the
three months ended June 30, 2003 to $1,389,547 in the three months ended June
30, 2004. 17




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Liquidity and Capital Resources Cash and Cash Equivalents We have incurred significant losses and negative cash flows from
operations for the last two fiscal years. We have obtained our required cash
resources through the sale of debt and equity securities. We may not operate
profitably in the future and may be required to continue the sale of debt and
equity securities to finance our operations. Cash and cash equivalents increased by $2,384,728 to $3,588,117 at June
30, 2004 from $1,203,389 at March 31, 2004. Cash used for operating activities
was $1,272,073 in the three months ended June 30, 2004 compared to $58,033 for
the three months ended June 30, 2003. Cash used for investing activities for the three months ended June 30,
2004 consisted of the purchase of property and equipment totaling $32,274.
There were no investing activities in the three months ended June 30, 2003. Financing activities provided cash of $3,689,075 the three months ended
June 30, 2004 and included $4,091,500 of net proceeds from stock sales and
$97,575 of proceeds from the exercise of options and warrants, offset by a
$500,000 repayment of debt. Financing activities provided cash of $117,481 in the three months ended
June 30, 2003 and included the issuance of $310,000 in convertible promissory
notes and notes payable offset by $188,831 repayments of notes payable,
convertible promissory notes and a note payable related to discontinued
operations and a $3,688 repayment of capital lease obligations. In April 2004, we raised an additional $4,650,000 in a private placement
wherein we sold 2,888,201 shares of common stock and warrants to purchase an
aggregate of 3,610,250 warrants. As a result of our recent capital raising transactions and our increased
level of revenues achieved in the three months ended June 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 the 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. 18




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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 June 30,
2004, our accumulated deficit was $41,222,450. We believe that our planned
growth and profitability will depend in large part on our ability to promote
our brand name and 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 $4.65
million 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 a merger or sale of US
Dataworks. 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
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; 19




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##### Table of Contents




    
    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 of 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. We may not be able to maintain our relationships with strategic partners, which
may cause our cash flow to decline. We may not be able to maintain our relationships with strategic partners.
These strategic relationships are a core component of our sales and
distribution strategy. The loss of a strategic partner could harm our financial
results. 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. 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. 20




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##### Table of Contents



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 Dataworks. 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 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 July 31, 2004, there were approximately 26,652,780 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 21




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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. 22




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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. 23




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PART I   OTHER INFORMATION 
 Item 1. Legal Proceedings On December 12, 2003, an individual investor filed a lawsuit against US
Dataworks in Los Angeles Superior Court alleging breach of an oral agreement
between the plaintiff and a former director of US Dataworks. In the complaint,
the plaintiff alleges that the oral agreement granted him the right to receive
additional shares from US Dataworks in the event that he should sell certain
shares of our common stock at a price less than $15 per share. The plaintiff
alleges 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 our common stock. He is seeking
unspecified damages. We intend to dispute this claim and defend this action
vigorously. 
 Item 2. Changes in Securities During the three months ended June 30, 2004, we raised an additional
$4,650,000, less direct issuance expenses of $558,500, in a private placement
with certain major institutional investment funds wherein we sold 2,888,201
shares of common stock and warrants to purchase an aggregate of 3,610,250
shares. 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 2,888,201 warrants will expire
on April 20, 2011. The issuances disclosed in this Item 2 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 6. Exhibits and Reports on Form 8-K  (a)
    
    Exhibits. The exhibits listed below are required by Item 601 of Regulation S-B. ExhibitNumber
    
    Description of Document10.1
    
    Additional Compensation Agreement
made and effective as of April 12, 2004, by and between the
Company and John S. Reiland31.1
    
    Section 302 Certification of Chief Executive Officer31.2
    
    Section 302 Certification of Chief Financial Officer32.1
    
    Section 906 Certification of Chief Executive Officer32.2
    
    Section 906 Certification of Chief Financial Officer
  (b)
    
    Reports on Form 8-K. The Company has filed a Current Report on Form 8-K on May 20, 2004
reporting the sale of common stock and warrants to certain accredited
investors. The Company has furnished a Current Report on Form 8-K on May 20, 2004
announcing its financial results for the quarter and year ended March 31, 2004. The Company has furnished a Current Report on Form 8-K on June 7, 2004
reporting a conference call. 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: August 16, 2004 US DATAWORKS, INC.By
    
    /s/ John S. ReilandJohn S. ReilandChief Financial Officer(Principal Financial and AccountingOfficer and Duly Authorized Officer)
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EXHIBIT INDEX ExhibitNumber
    
    Description of Document10.1
    
    Additional Compensation Agreement
made and effective as of April 12, 2004, by and between the
Company and John S. Reiland31.1
    
    Section 302 Certification of Chief Executive Officer31.2
    
    Section 302 Certification of Chief Financial Officer32.1
    
    Section 906 Certification of Chief Executive Officer32.2
    
    Section 906 Certification of Chief Financial Officer
 26