##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington D.C., 20549
 
 FORM 10-QSB
 
  þ
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended December 31, 2007
 o
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For 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)
 One Sugar Creek Center Boulevard 
Sugar Land, Texas
(Address of principal executive offices)
    
    77478
(Zip Code)
  þ o
 o þ
  o þ




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US DATAWORKS, INC.
 TABLE OF CONTENTS
   PagePART I  FINANCIAL INFORMATION
    
    
    1Item 1. Financial Statements
    
    
    1Item 2. Managements Discussion and Analysis or Plan of Operation
    
    
    18Item 3. Controls and Procedures
    
    
    27PART II  OTHER INFORMATION
    
    
    28Item 6. Exhibits
    
    
    29Registration Rights AgreementSecurity AgreementPut AgreementPut Grantor Fee AgreementCertification of CEO Pursuant to Section 302Certification of CAO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CAO Pursuant to Section 906




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 US DATAWORKS, INC.
 BALANCE SHEET
 December 31, 2007
(Unaudited)
 ASSETSCurrent assets:Cash and cash equivalents
    
    $
    1,333,039Accounts receivable, trade
    
    
    972,355Prepaid expenses and other current assets
    
    
    176,100Total current assets
    
    
    2,481,494Property and equipment, net
    
    
    518,659Goodwill, net
    
    
    8,201,445Other assets
    
    
    386,622Total assets
    
    $
    11,588,220
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US DATAWORKS, INC.
 BALANCE SHEET
 December 31, 2007
 (Unaudited)
 LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Note payable
    
    
    35,279Deferred revenue
    
    
    376,561Accounts payable
    
    
    166,361Accrued expenses
    
    
    396,124Derivative  Compound embedded within note
    
    
    647,399Derivative  warrants
    
    
    510,453Total current liabilities
    
    
    2,132,177Long Term Note Payable
    
    
    58,798Long Term Note Payable  Related Party
    
    
    500,000Long Term Convertible Promissory Note, net unamortized discount of $2,156,606
    
    
    1,843,394Total liabilities
    
    
    4,534,369Commitments and ContingenciesStockholders Equity:Convertible Series B preferred stock, $0.0001 par value
700,000 shares authorized, 109,933 shares issued and outstanding $3.75
liquidation preference, dividends of $283,313 in arrears
    
    
    55Common stock, $0.0001 par value
90,000,000 shares authorized and 32,062,962 shares issued and outstanding
    
    
    3,206Additional paid-in capital
    
    
    64,733,161Accumulated deficit
    
    
    (57,682,571
    )Total shareholders equity
    
    
    7,053,851Total liabilities and stockholders equity
    
    $
    11,588,220
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STATEMENTS OF OPERATIONS
 For the Three Months Ended
    
    
    For the Nine Months EndedDecember 31,
    
    
    December 31,2007
    
    
    2006
    
    
    2007
    
    
    2006REVENUESSoftware licensing revenues
    
    $
    182,911
    
    
    $
    94,175
    
    
    $
    289,833
    
    
    $
    609,158Software transactional revenues
    
    
    445,654
    
    
    
    532,868
    
    
    
    1,225,043
    
    
    
    1,138,588Software maintenance revenues
    
    
    233,010
    
    
    
    109,128
    
    
    
    658,019
    
    
    
    315,677Professional service revenues
    
    
    669,654
    
    
    
    983,716
    
    
    
    1,953,490
    
    
    
    2,693,226Total revenues
    
    
    1,531,229
    
    
    
    1,719,887
    
    
    
    4,126,385
    
    
    
    4,756,649COST OF SALES
    
    
    574,230
    
    
    
    540,127
    
    
    
    1,469,312
    
    
    
    1,559,854Gross profit
    
    
    956,999
    
    
    
    1,179,760
    
    
    
    2,657,073
    
    
    
    3,196,795OPERATING EXPENSESGeneral and administrative
    
    
    1,375,756
    
    
    
    1,364,879
    
    
    
    4,659,534
    
    
    
    4,896,677Depreciation and amortization
    
    
    48,190
    
    
    
    37,605
    
    
    
    133,003
    
    
    
    105,246Goodwill Impairment
    
    
    5,932,184
    
    
    
    
    
    
    
    5,932,184
    
    
    
    Total operating expense
    
    
    7,356,130
    
    
    
    1,402,484
    
    
    
    10,724,721
    
    
    
    5,001,923LOSS FROM OPERATIONS
    
    
    (6,399,131
    )
    
    
    (222,724
    )
    
    
    (8,067,648
    )
    
    
    (1,805,128
    )OTHER INCOME (EXPENSE)Financing costs
    
    
    (86,704
    )
    
    
    
    
    
    
    (112,680
    )
    
    
    Interest expense
    
    
    (157,721
    )
    
    
    (49,641
    )
    
    
    (170,524
    )
    
    
    (220,418
    )Interest expense  related party
    
    
    (14,714
    )
    
    
    (10,938
    )
    
    
    (36,589
    )
    
    
    (10,938
    )Loss on disposal of assets
    
    
    
    
    
    
    
    
    
    
    (44,231
    )
    
    
    Gain/(Loss) on derivatives
    
    
    1,099,284
    
    
    
    (37,889
    )
    
    
    1,157,666
    
    
    
    (193,960
    )Contingent
liabilities gain
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    222,600Other income
    
    
    7,783
    
    
    
    
    
    
    
    7,783
    
    
    
    10,491Total other income (expense)
    
    
    847,928
    
    
    
    (98,468
    )
    
    
    801,425
    
    
    
    (192,225
    )LOSS BEFORE PROVISION FOR INCOME TAXES
    
    
    (5,551,203
    )
    
    
    (321,192
    )
    
    
    (7,266,223
    )
    
    
    (1,997,353
    )PROVISION FOR INCOME TAXES
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    NET LOSS
    
    $
    (5,551,203
    )
    
    $
    (321,192
    )
    
    $
    (7,266,223
    )
    
    $
    (1,997,353
    )NET LOSS ATTRIBUTABLE TO COMMON STOCKBasic and diluted loss per share
    
    $
    (0.17
    )
    
    $
    (0.01
    )
    
    $
    (0.23
    )
    
    $
    (0.07
    )Basic and diluted weighted-average shares outstanding
    
    
    32,062,962
    
    
    
    31,003,828
    
    
    
    31,638,735
    
    
    
    30,612,526
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US DATAWORKS, INC.
 STATEMENTS OF CASH FLOW
 For the Nine Months Ended December 31,
 (Unaudited)
 2007
    
    
    2006Cash flows from operating activities:-Net (loss)/income from operations
    
    $
    (7,266,223
    )
    
    $
    (1,997,953
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization of property and equipment
    
    
    133,003
    
    
    
    105,247Amortization of note discount on convertible promissory note
    
    
    83,657
    
    
    
    176,058Amortization of deferred financing costs
    
    
    15,489
    
    
    
    Compensatory element of warrants associated with financing costs
    
    
    66,447
    
    
    
    Gain / (Loss) on disposition of assets
    
    
    44,231
    
    
    
    (3,394
    )Stock based compensation
    
    
    291,904
    
    
    
    517,639(Gain) / Loss on derivatives
    
    
    (1,157,666
    )
    
    
    193,960Goodwill Impairment
    
    
    5,932,184
    
    
    
    Changes in operating assets and liabilities:Accounts receivable, net
    
    
    1,207,674
    
    
    
    (1,099,833
    )Costs and estimated earnings in excess of billings on uncompleted contracts
    
    
    
    
    
    
    238,000Prepaid expenses and other current assets
    
    
    (44,188
    )
    
    
    (941
    )Other assets
    
    
    (1,777
    )
    
    
    12,890Deferred revenue
    
    
    (267,334
    )
    
    
    554,769Accounts payable
    
    
    (753,749
    )
    
    
    571,705Accrued expenses
    
    
    (603,771
    )
    
    
    (282,413
    )Interest payable
    
    
    (18,858
    )
    
    
    (32,434
    )Net cash used in operating activities
    
    
    (2,338,977
    )
    
    
    (1,046,700
    )Cash flows from investing activities:Purchase of property and equipment
    
    
    (107,280
    )
    
    
    (157,098
    )Proceeds from sales of fixed assets
    
    
    10,850
    
    
    
    8,000Net cash used in investing activities
    
    
    (96,430
    )
    
    
    (149,098
    )
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US DATAWORKS, INC.
 STATEMENTS OF CASH FLOW
 For the Nine Months Ended December 31,
 (Unaudited)
 2007
    
    
    2006Cash flows from financing activities:Proceeds from related party note payable
    
    
    
    
    
    
    500,000Proceeds from convertible promissory note
    
    
    4,000,000
    
    
    
    Repayment of note payable  related party
    
    
    (39,000
    )Repayment of convertible promissory note
    
    
    (256,066
    )
    
    
    (512,133
    )Proceeds from stock sale
    
    
    305,000
    
    
    
    Deferred financing costs
    
    
    (370,004
    )
    
    
    Payments on equipment note payable
    
    
    (11,760
    )
    
    
    Net cash (used in) /provided by financing activities
    
    
    3,628,170
    
    
    
    (12,133
    )Net
increase/(decrease) in cash and cash equivalents
    
    
    1,192,763
    
    
    
    (1,207,931
    )Cash and cash equivalents, beginning of period
    
    
    140,276
    
    
    
    1,290,438Cash and cash equivalents, end of period
    
    $
    1,333,039
    
    
    $
    82,507Supplemental disclosures of cash flow informationInterest paid
    
    $
    48,918
    
    
    $
    87,733
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US DATAWORKS, INC.
 NOTES TO UNAUDITED FINANCIAL STATEMENTS
 1.
    
    Organization and BusinessGeneralUS Dataworks, Inc. (the Company), a Nevada corporation, 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 PoliciesINTERIM FINANCIAL STATEMENTSThe unaudited condensed financial statements included herein have been prepared by the Company
pursuant to the rules and regulations of the Securities and Exchange Commission. The financial
statements reflect all adjustments that are, in the opinion of management, necessary to fairly
present such information. All such adjustments are of a normal recurring nature. Although the
Company believes that the disclosures are adequate to make the information presented not
misleading, certain information and footnote disclosures, including a description of significant
accounting policies normally included in financial statements prepared in accordance with
accounting principles generally accepted in the United States of America (US GAAP), have been
condensed or omitted pursuant to such rules and regulations.These financial statements should be read in conjunction with the financial statements and the
notes thereto included in the Companys 2007 Annual Report. The results of operations for
interim periods are not necessarily indicative of the results for any subsequent quarter or the
entire year ending March 31, 2008.Revenue RecognitionThe Company recognizes revenues associated with our software services in accordance with the
provisions of the American Institute of Certified Public Accountants Statement of Position
97-2, Software Revenue Recognition (SOP 97-2). 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
such a license agreement has been signed, delivery of the software product has occurred, the
related fee is fixed or determinable, and collectibility is probable.In certain instances, the Company licenses its software on a transactional fee basis in lieu of
an up-front licensing fee. In these arrangements, the customer is charged a fee based upon the
number of items processed by the software and the Company recognizes revenue as these
transactions occur. The transaction fee also includes the provision of standard maintenance and
support services as well as product upgrades should such upgrades become available.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 maintenance 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.The Company recognizes revenues associated with the resale of ATMs in accordance with the
provisions of the Statement of Financial Accounting Standards (SFAS) No. 48. The Companys
sale price is fixed and determinable at the date of sale and it has no obligation to directly
bring about the resale of the product. In addition, the buyers obligation to pay the Company is
not contingent upon release of the product and its sale
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price is not adjusted if the product is lost or damaged. The buyer has economic substance apart
from the Company and it can reasonably estimate the amount of returns at the time of sale.
Therefore revenue is recognized at the time of sale.GoodwillEffective January 1, 2002, the Company adopted Statement of Financial Accounting Standards No.
142 Goodwill and Other Intangible Assets (SFAS No. 142), which establishes new accounting
and reporting requirements for goodwill and other intangible assets. Under SFAS No. 142, all
goodwill amortization ceased effective January 1, 2002.The goodwill recorded on the Companys books is from the acquisition of US Dataworks, Inc. in
fiscal year 2001, which remains the Companys single reporting unit. SFAS No. 142 requires
goodwill for each reporting unit of an entity to be tested for impairment by comparing the fair
value of each reporting unit with its carrying value. Fair value is determined using a
combination of the discounted cash flow, market multiple and market capitalization valuation
approaches. Significant estimates used in the methodologies include estimates of future cash
flows, future short-term and long-term growth rates, weighted average cost of capital and
estimates of market multiples for each reportable unit. On an ongoing basis, absent any
impairment indicators, the Company performs impairment tests annually during the fourth quarter.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 reportable
unit below its carrying amount. The Company did not have an impairment of goodwill to record for
the years ended March 31, 2007 or March 31, 2006.Convertible Debt Financing  Derivative LiabilitiesThe Company reviews the terms of convertible debt and equity instruments issued to determine
whether there are embedded derivative instruments, including embedded conversion options that
are required to be bifurcated and accounted for separately as a derivative financial instrument.
In circumstances where the convertible instrument contains more than one embedded derivative
instrument, including the conversion option, that is required to be bifurcated, the bifurcated
derivative instruments are accounted for as a single, compound derivative instrument. Also, in
connection with the sale of convertible debt and equity instruments, the Company may issue
freestanding options or warrants that may, depending on their terms, be accounted for as
derivative instrument liabilities, rather than as equity.
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In accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities,
as amended, the convertible debt holders conversion right provision, interest rate adjustment
provision, liquidated damages clause, cash premium option, and the redemption option
(collectively, the debt features) contained in the terms governing the convertible notes are not
clearly and closely related to the characteristics of the notes. Accordingly, the features
qualify as embedded derivative instruments at issuance and, because they do not qualify for any
scope exception within SFAS 133, they are required by SFAS 133 to be accounted for separately
from the debt instrument and recorded as derivative instrument liabilities.Stock OptionsEffective April 1, 2006, the Company adopted the Statement of Financial Accounting Standards No.
123 (revised 2004), Share-Based Payment (SFAS 123R), which require the measurement and
recognition of compensation expense for all share-based payment awards made to employees and
directors, including employee stock options, based on estimated fair values. The Company adopted
SFAS 123R using the modified prospective transition method, which requires the application of
the accounting standard as of April 1, 2006, the first day of the Companys fiscal year 2007.
The Companys Financial Statements as of and for the three months ended December 31, 2006
reflect the impact of SFAS 123R. In accordance with the modified prospective transition method,
the Companys Financial Statements for prior periods have not been restated to reflect, and do
not include, the impact of SFAS 123R. Stock-based compensation expense recognized under SFAS
123R for the three months and nine months ended December 31, 2007 was $47,860 and $291,904
respectively, which consists of stock-based compensation expense related to employee and
director stock options and restricted stock issuances.SFAS 123R requires companies to estimate the fair value of share-based payment awards on the
date of grant using an option-pricing model. The value of the portion of the award that is
ultimately expected to vest is recognized as expense over the requisite service periods in the
companys Statement of Operations. Prior to the adoption of SFAS 123R, the Company accounted for
stock-based awards to employees and directors using the intrinsic value method in accordance
with APB 25 as allowed under Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation, (SFAS 123). Under the intrinsic value method, no stock-based
compensation expense had been recognized in the Companys Statement of Operations prior to
January 1, 2006 because the exercise price of the Companys stock options granted to employees
and directors was equal to or greater than the fair market value of the underlying stock at the
date of grant.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 and six months ended December 31, 2007 and 2006 is as follows:
 For the Three Months
    
    For the Nine MonthsEnding Dec 31,
    
    Ending Dec 31,2007
    
    2006
    
    2007
    
    2006Net Loss as reported
    
    $
    (5,551,203
    )
    
    $
    (321,192
    )
    
    $
    (7,266,223
    )
    
    $
    (1,997,353
    )Add stock-based
employee compensation
expense included in
net loss as reported,
net of related tax
effects
    
    $
    47,860
    
    
    $
    127,067
    
    
    $
    291,904
    
    
    $
    517,639Net (loss);
pro forma
    
    $
    (5,503,343
    )
    
    $
    (194,125
    )
    
    $
    (6,974,319
    )
    
    $
    (1,479,714
    )Basic and diluted
(loss) per
share, as reported
    
    $
    (0.17
    )
    
    $
    (0.01
    )
    
    $
    (0.23
    )
    
    $
    (0.07
    )Basic and diluted
(loss) per
share, pro forma
    
    $
    (0.17
    )
    
    $
    (0.01
    )
    
    $
    (0.22
    )
    
    $
    (0.05
    )
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For the Three Months Ending
    
    For the Nine Months EndingDecember 31,
    
    December 31,2007
    
    2006
    
    2007
    
    2006Risk-free Interest Rate
    
    
    4.30
    %
    
    
    4.93
    %
    
    
    4.56
    %
    
    
    4.89
    %Expected Life of
Options Granted
    
    3 years
    
    
    3 years
    
    
    3 years
    
    
    3 yearsExpected Volatility
    
    
    67
    %
    
    
    84
    %
    
    
    72
    %
    
    
    82
    %Expected Dividend Yield
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0Expected Forfeiture
Rate
    
    
    30
    %
    
    
    30
    %
    
    
    30
    %
    
    
    30
    %
 .
 Loss per Share
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For the Nine Months EndedDecember 31,2007
    
    2006Options outstanding under the Companys stock option plans
    
    
    7,383,349
    
    
    
    6,460,349Options granted outside the Companys stock option plans
    
    
    1,160,000
    
    
    
    1,160,000Warrants issued in conjunction with private placements
    
    
    5,288,683
    
    
    
    19,738,683Warrants issued as a financing cost for notes payable
and convertible notes payable
    
    
    6,342,413
    
    
    
    1,783,650Warrants issued for services rendered and litigation
settlement
    
    
    380,769
    
    
    
    200,769Warrants issued as consideration for note extension
    
    
    200,000
    
    
    
    -0-Convertible Series B preferred stock (a)
    
    
    109,933
    
    
    
    109,933
 
 (a)
    
    The Series B preferred stock is convertible into shares of common stock at a conversion
price of $3.75 per share. 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 the Companys customers accounted for 30%, 23%, 15% and 10%, respectively, of the
Companys net revenues for the three months ended December 31, 2007. Four customers accounted
for 27%, 25%, 12% and 11%, respectively, of net revenues for the nine months ended December 31,
2007. Four of the Companys customers accounted for 20%, 17%, 17% and 12%, respectively, of the
Companys net revenues for the three months ended December 31, 2006. Three customers accounted
for 29%, 19% and 12%, respectively, of net revenues for the nine months ended December 31, 2006.At December 31, 2007, amounts due from these significant customers accounted for 76% of accounts
receivable.3.
    
    Property and EquipmentProperty and equipment as of December 31, 2007 consisted of the following:
 Furniture and fixtures
    
    $
    99,535Office and telephone equipment
    
    
    182,275Computer equipment
    
    
    711,725Computer software
    
    
    1,271,098Leasehold improvements
    
    
    64,7332,329,366Less accumulated depreciation and amortization
    
    
    (1,810,707
    )Total
    
    $
    518,659
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Depreciation and amortization expense for the three and nine months ended December 31, 2007 and
2006 was $48,190, $133,003, $37,605 and $105,247, respectively.4.
    
    Goodwill ImpairmentSFAS No. 142 states that if a significant event or circumstances change that would more likely
than not reduce the fair value of the reportable unit below its
carrying amount, then the fair value
of the reportable unit should be reviewed. The Company has determined that two significant
events occurred in the quarter ending December 31, 2007 that,
when taken together, placed enough
downward pressure on the market value of the Companys common stock to require a review of the fair value of
the reportable unit. First, in November, 2007 the Company issued convertible notes in the amount of
$4,000,000 which increased the Companys debt significantly and the market price of the
Companys common stock began to fall. Secondly, in December 2007, the Company announced the
termination of its Resale Agreement with Hyundai and entered into a Settlement and Release
Agreement terminating the Purchase Agreement. This announcement continued the downward pressure
on the market value of the Companys common stock.The Company used the net book value, defined as total assets less total
liabilities, to compute the carrying value of the reportable unit. The carrying value was then
compared to the Companys market value as of December 31, 2007 based on the market
capitalization of its common stock. This analysis determined that an impairment of $5,932,184
occurred and the goodwill was written down as of December 31, 2007, accordingly. The Company
will continue to perform impairment testing annually during the fourth quarter unless any events
indicating the presence of impairment factors arise.5.
    
    Notes Payable  Related PartiesOn September 26, 2006, the Company entered into a note payable with its Chief Executive Officer
for $500,000. The note bears an 8.75% per annum interest rate, is unsecured and was due
September 25, 2007. On September 25, 2007, the Company entered into a new note payable agreement
that supersedes and supplants the September 2006 note. As of September 30, 2007 the outstanding
balance on this note payable is $500,000. The principal, together with any unpaid accrued
interest on the new note payable, shall be due and payable in full on demand on the earlier of:
(i) the full and complete satisfaction of certain senior secured convertible notes (the
November Notes) issued by the Company to certain investors on November 13, 2007 and (ii)
ninety-one (91) days following the expiration of the term of the November Notes (such date
described in (i) and (ii) hereinafter the Demand Date), unless such date is extended by the
mutual agreement of the parties.Notes PayableIn August 2007 the Company entered into a note payable with an equipment vendor to purchase new
telephone equipment for $105,835. The note bears a 10.68% per annum interest rate, is secured by
the equipment and is due in 36 equal monthly installments.6.
    
    Convertible Promissory NotesConvertible promissory notes at December 31, 2007 consisted of the following:
 Senior Secured Convertible promissory notes, interest at 6-month Libor plus 500
Basis points, determined quarterly, (currently 9.7375%), $4,000,000, due November
13, 2010, net of unamortized discount of $2,156,606
    
    $
    1,843,394Less current portion
    
    
    ( 
    )Long-term portion
    
    $
    1,843,394
 Convertible promissory note with interest at 10% per annumThis note is an amendment and restatement of a note in the same principal amount originally
dated September 15, 2004. The original note was issued effective September 15, 2004 in
connection with the November 2004 settlement of a lawsuit brought by an investor in December
2003. The amended 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.The amended note became effective September 15, 2005 and extended a principal payment of
$256,067, originally due September 15, 2005, for one year. In consideration of this amendment,
the Company issued the holder a common stock purchase warrant to purchase up to 650,000 shares
of the Companys common stock at an exercise price of $0.59 per share. The warrant will expire
on September 15, 2008.The changes to this debt caused the accounting treatment to be an extinguishment of the old debt
and issuance of new debt instead of being treated as modification of debt. Therefore, the excess
of the fair value of the note and warrants over the carrying amount of the debt is $206,000 and
has been recorded as a loss on extinguishment for the year ended March 31, 2006.
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In connection with the November 2004 settlement, the Company also issued a warrant to purchase
160,000 shares of the Companys common stock at a purchase price of $0.75 per share, which
expired on November 10, 2006.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 totaled $924,200 and has
been recorded as Investor litigation settlement expense for the year ended March 31, 2005.On September 14, 2007, the Company reached an agreement with the note holder to extend the terms
of the note for an additional 90 days in exchange for warrants to purchase up to 200,000 shares
of the Companys common stock dependent upon when the note is paid. On September 14, 2007, the
Company issued the holder a warrant to purchase 66,666 shares of the Companys common stock, on
October 15, 2007 the Company issued the holder a warrant to purchase 66,666 shares of the
Companys common stock, and on November 15, 2007 the Company issued the holder the final warrant
to purchase 66,667 shares of the Companys common stock.Using the Black-Scholes pricing model the Company has determined the value of the warrants
issued on September 14, 2007 in connection with the note extension to be $13,141, the warrants
issued on October 15, 2007 in connection with the note extension to be $16,478 and the warrants
issued on November 15, 2007 in connection with the extension to be $14,918.This convertible note was paid in full on December 3, 2007.Convertible promissory note issued June 16, 2005 with $70,000 Original Issue DiscountOn June 16, 2005, the Company entered into a Securities Purchase Agreement with an institutional
investor (the Debenture Agreement) for the sale of a convertible debenture with a principal
amount of $770,000 and an original issue discount of $70,000 for gross proceeds of $700,000. The
debenture is convertible at anytime at the discretion of the holder at a price per share of
$0.572 into 1,346,154 shares of the Companys common stock. The convertible debenture is to be
repaid in 15 monthly installments of $51,333.33 beginning April 15, 2006. The Company may also
elect, upon proper notice, to pay any monthly installment in shares of the Companys common
stock based on a conversion price equal to the lesser of (i) the then applicable conversion
price, or (ii) 90% of the volume weighted average price of the Companys common stock for the 10
trading days immediately preceding the payment; provided, that, such conversion price must be at
least equal to the conversion floor of $0.23, or such monthly installment must be paid in cash.
This convertible debenture was amended on March 9, 2006, pursuant to which the Company must,
within 25 calendar days prior to each monthly payment, deliver 89,744 shares of its common stock
to the holders, which represents the monthly installment amount divided by the then conversion
price with the first monthly payment becoming due on April 17, 2006. In connection with the
Debenture Agreement, the Company issued two groups of warrants, Short Term Warrants and Long
Term Warrants to the institutional investor. The Short Term Warrants allow the institutional
investor to purchase an aggregate of 407,926 shares of the Companys common stock with an
exercise price of $0.572 per share exercisable for a period of 180 days at any time after the
later of (i) the effective date of the registration statement (as described below) or (ii)
December 16, 2005. The Long Term Warrants allow the institutional investor to purchase an
aggregate of 471,154 shares of the Companys common stock with an exercise price of $0.572 per
share exercisable at anytime from December 16, 2005 through December 16, 2008; provided,
however, the institutional investor will not be permitted to exercise a warrant to the extent
that the number of shares of the Companys common stock beneficially owned by such institutional
investor taken together with the number of shares to be issued upon exercise of the warrant
equals or exceeds 4.999% of the Companys then issued and outstanding shares of common stock.
The warrants also contain trading market restrictions that preclude the Company from issuing shares of common stock upon exercise thereof if such issuance, when aggregated with other
issuances of the Companys common stock pursuant to the warrants, would exceed 19.999% of the
Companys then issued and outstanding shares of common stock, unless the Company has previously
obtained the required shareholder approval. Pursuant to a Registration Rights Agreement dated
June 16, 2005 between the Company and the institutional investor, The Company agreed to file a
registration statement for the resale of the shares of the Companys common stock that may be
issued to
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the institutional investor upon the conversion of the convertible debenture and the exercise of
the Short Term Warrants and the Long Term Warrants. The registration statement covering these
securities was effective on September 1, 2005.In accordance with SFAS No. 133 Accounting for Derivative Instruments and Hedging Activities,
the debt features contained in the terms governing the notes are not clearly and closely related
to the characteristics of the notes. Accordingly, the debt features qualify as embedded
derivative instruments at issuance and, because they did not qualify for any scope exception
within SFAS 133, they were required to be accounted for separately from the debt instrument and
recorded as derivative financial instruments.At the date of issuance, the embedded debt feature had an estimated initial fair value of
$449,089, which was recorded as a discount to the convertible notes and derivative liability on
our balance sheet. In subsequent periods, if the price of the security changes, the embedded
derivative financial instrument related to the debt features will be adjusted to the fair value
with the corresponding charge or credit to other income/(expense). The estimated fair value of
the debt features was determined using the probability weighted averaged expected cash flows /
Lattice Model with a closing price of $0.65, a conversion price as defined in the respective
note agreement and a period of two years. Concerning the debt features, the model uses several
assumptions including: historical stock price volatility, approximate risk-free interest rate
(3.5%), remaining term to maturity, and the closing price of the companys common stock to
determine the estimated fair value of the derivative liability. This convertible note was paid
in full in March 2007 and as such has been removed from the Companys financial statements for
fiscal year 2008.The warrants included with this note for purchase of the Companys common stock had an initial
value of $271,940. This amount has been classified as a derivative financial instrument and
recorded as a liability on our consolidated balance sheet in accordance with SFAS 133. The
estimated fair value of the warrants at the date of issuance was determined using the
Black-Scholes option-pricing model with a closing price of $1.14, the respective exercise price
of the warrants, a 2 year term, and a 90% volatility factor relative to the date of issuance.
The model uses several assumptions including: historical stock price volatility, approximate
risk-free interest rate (3.50%), remaining term to maturity, and the closing price of the
companys common stock to determine the estimated fair value of the derivative liability. In
accordance with the provisions of SFAS 133, the Company is required to adjust the carrying value
of the instrument to its fair value at each balance sheet date and recognize any change since
the prior balance sheet date as a component of other income/ (expense) on its statement of
operations. The warrant derivative liability at December 31, 2007, decreased to a fair value of
$469, due in part to a decrease in the market value of the companys common stock, which
resulted in an other income item of $16,404.The recorded value of the warrants can fluctuate significantly based on fluctuations in the
market value of the underlying securities of the issuer of the warrants, as well as in the
volatility of the stock price during the term used for observation and the term remaining for
the warrants.Senior Secured Convertible promissory notes due November 13, 2010On November 13, 2007, the Company secured certain financing from certain institutional investors
(collectively, the Investors) in the form of senior secured convertible notes (the Notes)
for an aggregate of $4.0 million. The interest payable on the Notes is equal to the 6-month
LIBOR rate plus five hundred basis points (or 9.7375% at the time of subscription) and is
re-calculated as of the first day of each calendar quarter. The Notes may be converted at any
time into shares of the Companys common stock (Common Stock) at the conversion price of $0.43
per share, which is equal to 110% of the dollar volume-weighted average price for the Common
Stock on November 12, 2007, subject to anti-dilution provisions; provided, however, the Investor
may not beneficially own more than 4.99% (the Maximum Percentage) of outstanding shares of
Common Stock following such conversion. At any time, the Investor may decrease or increase this
Maximum Percentage to any percentage not to exceed 9.99%. In the event of a Fundamental
Transaction (as described in the Notes) where greater than 50% of the Companys assets or equity
is transferred, the Investors may redeem the note for either 125% of its principal balance or
the value of the Common Stock as converted (such Common Stock as converted under the Notes,
Conversion Shares).
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In addition, on each of the 9 month and 18 month anniversary of the closing, the Investors may
request that the Company redeem a portion of the Notes. The Notes have a maturity date of
November 13, 2010. The Notes are secured by the Security Agreement, dated November 13, 2007, by
and between the Company and the Investors (the Security Agreement), pursuant to which the
Company granted the Investors a security interest in all its personal property, whether now
owned or hereafter acquired, including but not limited to, all accounts, copyrights, trademarks,
licenses, equipment and all proceeds as from such collateral.The Investors also entered into a Put Agreement (the Put Agreement) with the Companys Chief
Executive Officer, and a member of the Companys Board of Directors (collectively, the
Guarantors). Pursuant to the Put Agreement, following August 13, 2008, under certain
circumstances the Investors may require one or more of the Guarantors to purchase all or a
portion of the Note, including any accrued interest or late charges.In consideration for this guarantee, the Company is paying the Guarantors a fee (the
Guarantors Fee) equal to: (i) an initial installment of two percent (2%) of the outstanding
Note principal for initial six months of the Notes term; (ii) then, an additional fee equal to
two percent (2%) of the outstanding Note principal for the following twelve months; and, (iii) a
final installment equal to two percent (2%) of the outstanding Note principal for the remaining
18 months of the Notes term. The Guarantor Fee will be shared equally by the Guarantors and
will accrue immediately upon the start of each of the time periods described by subsection (i),
(ii) and (iii), above. The Guarantors Fee would not be payable until after the complete
satisfaction of the Note.In connection with the issuance of the Notes, the Company has also issued to the Investors
warrants (the Warrants) to purchase an aggregate of 4,651,162 shares of Common Stock (such
Common Stock exercisable from the Warrants, Warrant Shares) at the exercise price of $0.43 per
share, which is equal to 110% of the dollar volume-weighted average price for the Common Stock
on November 12, 2007, subject to anti-dilution provisions; provided, however, the Investor may
not beneficially own more than the Maximum Percentage following such exercise. The Warrant may
be exercised at any time until 11:59 p.m., New York time on November 13, 2012.The Company is obligated to reserve for issuance upon conversion of the Notes and exercise of
the Warrants shares of Common Stock equal to at least 130% of the Conversion Shares and Warrant
Shares. The Company filed a registration statement in December 2007 to register the Conversion
Shares and Warrant Shares.In accordance with SFAS No. 133 Accounting for Derivative Instruments and Hedging
Activities, the debt features contained in the terms governing the notes are not clearly and
closely related to the characteristics of the notes. Accordingly, the debt features qualify as
embedded derivative instruments at issuance and, because they did not qualify for any scope
exception within SFAS 133, they were required to be accounted for separately from the debt
instrument and recorded as derivative financial instruments.At the date of issuance, the embedded debt feature had an estimated initial fair value of
$960,714 which was recorded as a discount to the convertible notes and derivative liability on
our balance sheet. In subsequent periods, if the price of the security changes, the embedded
derivative financial instrument related to the debt features will be adjusted to the fair value
with the corresponding charge or credit to other income/(expense). The estimated fair value of
the debt features was determined using the probability weighted averaged discounted cash flows /
Lattice Model with a closing price of $0.43, a conversion price as defined in the respective
note agreement and a period of three years. Concerning the debt features, the model uses several
assumptions including: projected stock price volatility, annual stock price growth rate,
interest rate projections, no registration default, alternative financing availability, default
status, holder redeeming under default, ownership limitation, warrant exercise reset, fixed
conversion reset and trading volume to determine the estimated fair value of the derivative
liability. The derivative liability at December 31, 2007, decreased to a fair value of $647,399,
due in part to a decrease in the market value of the companys common stock, which resulted in
an other income item of $313,315.The warrants included with this note for purchase of the Companys common stock had an initial
value of $1,279,549. This amount has been classified as a derivative financial instrument and
recorded as discount to the convertible notes and derivative liability on our balance sheet in
accordance with SFAS 133. The estimated fair value of the warrants at the date of issuance was
determined using the Black-Scholes option-pricing model with a closing price of $0.43, the
respective exercise price of the warrants, a 5 year term, and an 80% volatility factor
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relative to the date of issuance. The model uses several assumptions including: historical stock
price volatility, approximate risk-free interest rate (3.84%), remaining term to maturity, and
the closing price of the companys common stock to determine the estimated fair value of the
derivative liability. In accordance with the provisions of SFAS 133, the Company is required to
adjust the carrying value of the instrument to its fair value at each balance sheet date and
recognize any change since the prior balance sheet date as a component of other income/
(expense) on its statement of operations. The warrant derivative liability at December 31, 2007,
decreased to a fair value of $509,984, due in part to a decrease in the market value of the
companys common stock, which resulted in an other income item of $769,565.The recorded value of the warrants can fluctuate significantly based on fluctuations in the
market value of the underlying securities of the issuer of the warrants, as well as in the
volatility of the stock price during the term used for observation and the term remaining for
the warrants.7.
    
    Accounts Receivable FacilityOn September 27, 2006, the Company entered into a Purchase and Sale Agreement with Catalyst
Finance, L.P. (Catalyst) for sale of certain of its accounts receivables. The Companys
borrowing costs under this Agreement range from 1.25% to 20% of the gross amount of the
receivables sold to Catalyst based on the timing of collection. The maximum funds available
under the agreement is all available accounts receivables as agreed to by Catalyst and the
Company. The agreement allows for Catalyst to request repurchase of an account receivable under
certain conditions. For the three and nine months period ended December 31, 2007, the financial
institution has not requested repurchase of an account receivable. For the three months ending
December 31, 2007, the Company did not sale any receivables under the agreement. For the nine
months ending December 31, 2007, the Company has sold $297,105 in receivables under the
agreement, which yielded a loss on the sale of these receivables of $9,674. The Agreement was
terminated by the Company on August 2, 2007.On August 10, 2007, the Company entered into a Loan and Security Agreement (the Loan
Agreement) with Silicon Valley Bank (SVB), pursuant to which SVB will advance funds to the
Company for certain of its accounts receivables up to $2 million. Under the terms of the Loan
Agreement, the Company will receive an advance of up to 80% of the subject account receivable
(the Advance) and pay a finance charge to SVB equal to prime plus 1.5% to 3.0%, based on the
Companys assets to liabilities ratio, while the Advance is outstanding. The Company is
obligated to repay the Advance upon receipt of payment for the subject account receivable. For
the three and nine months ending December 31, 2007, the Company has sold $423,729 in receivables
under the agreement, which yielded a loss on the sale of these receivables of $5,144. The
Agreement was terminated on November 9, 2007.8.
    
    Commitments and ContingenciesEmployment AgreementsOn April 3, 2006, the Company entered into an employment agreement with each of its President,
Payment Products Division and Vice Chairman, Sr. Vice President and Chief Technology Officer,
and Vice President of Business Development and General Counsel, for a term of three years with
automatic renewal for successive one-year terms unless either party gives timely notice of
non-renewal.Annual base salary for the President, Payment Products Division and Vice Chairman of the Company
is $190,000 and pursuant to the terms of the agreement he is entitled to receive an option to
purchase 550,000 shares of the Companys common stock. This option vests over a 3 year period
with 150,000 shares vesting on April 3, 2006 and 200,000 shares vesting on each of April 3, 2007
and 2008. In addition the President, Payment Products Division and Vice Chairman is entitled to
receive a bonus of $48,125 for year end 2006.Annual base salary for the Senior Vice President and Chief Technology Officer of the Company is
$185,000 and pursuant to the terms of the agreement he is entitled to receive 200,000 shares of
restricted common stock.The restricted shares vest over a 3 year period with 25,000 shares vesting on April 3, 2006 and
87,500 shares vesting on each of April 3, 2007 and 2008. The Senior Vice President and Chief
Technology Officer is also
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eligible to receive a quarterly bonus of equal to 3.5% of the increase in the Companys revenue
from fiscal year quarter to fiscal year quarter and to receive a bonus of $78,750 for fiscal
year 2006.Annual base salary for the Vice President of Business Development and General Counsel of the
Company is $175,000, and pursuant to the terms of the agreement he is entitled to receive an
option to purchase 700,000 shares of the Companys common stock. This option vests over a 3 year
period with 300,000 shares vesting on April 3, 2006 and 200,000 shares vesting on each of April
3, 2007 and, 2008. The Vice President of Business Development and General Counsel is also
eligible to receive a quarterly bonus based upon the Companys future acquisitions or mergers.On May 23, 2006, the Company entered into an employment agreement with its Chairman of the Board
and Chief Executive Officer. The agreement has a 2 year term with automatic renewal for
successive one year terms unless either party gives timely notice of non-renewal. His annual
base salary is $220,000 and he is entitled to receive 100,000 shares of restricted common stock
that vest immediately and is entitled to receive an option to purchase 600,000 shares of the
Companys common stock. This option vests as to 300,000 shares on each of May 22, 2007 and 2008.9.
    
    Stockholders EquityPreferred StockThe 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 StockThe Company has 700,000 authorized shares of $0.0001 par value convertible Series B preferred
stock.In August and October 2000, the Company issued 101,867 and 26,733 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, exercisable through October 2003, to purchase one share of the Companys common stock.
The Series B has a liquidation preference of $3.75 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 $4.15 per share, plus any accrued but unpaid
dividends. The Series B is convertible upon issuance into shares of the Companys 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
common stock at the closing date.In May 2001, an investor in the Series B rescinded its acquisition and returned to the
Company 2,667 shares of Series B and warrants for the purchase of 533 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 16,000 shares and
accordingly was issued 3,200 shares of the Companys common stock.At December 31, 2007, there were accumulated, undeclared dividends in arrears of $283,313 or
$2.58 per share.Common Stock and WarrantsDuring the three and nine months ended December 31, 2007, the Company completed the following:On August 31, 2007, the Company entered into a stock purchase agreement ( the Purchase
Agreement), with certain employees and directors of the Company, pursuant to which the Company
agreed to issue to those certain employees and directors an aggregate of 762,500 shares of the
Companys common stock, $0.0001 par value (the Common Stock), for an aggregate purchase price
of $305,000.
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On September 14, 2007 the Company reached agreement with a current note holder to extend the
terms of the convertible promissory note dated September 15, 2005 for an additional 90 days in
exchange for the granting of up to 200,000 warrants dependent upon when the note is paid.
66,666 warrants were issued on the agreement date with another 66,666 to be issued if the note
is not paid by October 15, 2007 and the final 66,667 warrants issued if the note is note paid by
November 15, 2007. All 200,000 warrants were issued in the three and nine months ended December
31, 2007.On November 13, 2007, in connection with the $4,000,000 senior secured convertible note issued
to a group of institutional investors, the Company issued 4,651,162 warrants.Non-Cash Financing and Investing ActivitiesIn August 2007 the Company entered into a note payable with an equipment vendor to purchase new
telephone equipment for $105,835.During the three and nine months ended December 31, 2006, the Company completed the
following:In the quarter ended June 30, 2006, the Company issued 303,116 shares of common stock with a
value of $154,000 to pay down debt associated with the convertible promissory note issued June
16, 2005.In the quarter ended September 30, 2006, the Company issued 287,173 shares of common stock with
a value of $154,000 to pay down debt associated with the convertible promissory note issued June
16, 2005.In the quarter ended December 31, 2006, the Company issued 314,253 shares of common stock with a
value of $154,000 to pay down debt associated with the convertible promissory note issued
June 16, 2005.In the nine months ended December 31, 2006, the Company issued 904,542 shares of common stock
with a value of $462,000 to pay down debt associated with the convertible promissory note issued
June 16, 2005.Sale of Common Stock and WarrantsOn December 29, 2006, the Company entered into a stock purchase agreement (the Purchase
Agreement), with Hyundai Syscomm Corp., a California corporation (Hyundai), pursuant to which
the Company agreed to issue to Hyundai an aggregate of 6,100,000 shares of the Companys common
stock, $0.0001 par value (the Common Stock), for an aggregate purchase price of $1,500,000
(Purchase Shares). In connection with the Purchase Agreement, and subject to shareholder
approval, the Company also agreed to issue to Hyundai a warrant (the Warrant) to purchase up
to an aggregate of 14,300,000 shares of Common Stock (the Warrant Shares); provided, however,
in no event shall the aggregate of Hyundais Warrant Shares and Purchased Shares exceed 39.9% of
the Companys total outstanding shares. Under no condition will Warrant Shares become issuable
hereunder unless and until the Company secures the necessary vote from its shareholders in favor
of the issuance of this Warrant. The Warrant will vest as to one million shares of Common Stock
for each $1 million in gross profits allocated to Hyundai under the Resale Agreement. At
Hyundais option, it may elect to apply its allocation of gross profits to the payment of the
exercise price of the exercise of any of the Warrant Shares. The exercise price will be $0.01
per share and it will have term of 10 years. The Purchase Shares and Warrant are being held in
escrow pending the Closing. The Closing, initially set for December 29, 2006, is expected to
occur in March 2007.The Company and Hyundai have decided not to pursue the business venture set forth in the Resale
Agreement at this time and, on December 13, 2007, the Company and Hyundai entered into a
Settlement and Release Agreement terminating the Purchase Agreement (the Termination
Agreement). Pursuant to the Termination Agreement, the Purchased Shares, which were held in
escrow, will be returned to the Company and Hyundai is no longer obligated to pay the purchase
price of $1,500,000 and the Warrant Shares will not be issued to Hyundai. The parties also
agreed to a mutual release of all claims, known or unknown, with the exception of claims in
connection with confidentiality agreements, that each party may now or in the future have
against the other party, aside from claims in connection with certain confidentiality
agreements.
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Stock OptionsIn 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. In September 2006, shareholders approved an amendment
to the Companys amended and restated 2000 Stock Option Plan to increase the maximum aggregate
number of shares available for issuance thereunder from 6,000,000 to 7,500,000. 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 nine months ended December 31, 2007 the Company granted 907,000 stock options to
certain employees that may be exercised at prices ranging between $0.48 and $0.61 per share.
During the nine months ended December 31, 2006, the Company granted 3,114,500 stock options to
certain employees that may be exercised at prices ranging between $0.46 and $0.82 per share.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, 2007
    
    
    6,565,349
    
    
    $
    0.74
    
    
    
    1,160,000
    
    
    $
    1.02Granted
    
    
    907,000
    
    
    $
    0.50
    
    
    
    0
    
    
    
    0Exercised
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0Forfeited/canceled
    
    
    89,000
    
    
    $
    0.82
    
    
    
    0
    
    
    
    0Outstanding, December 31, 2007
    
    
    7,383,349
    
    
    $
    0.71
    
    
    
    1,160,000
    
    
    $
    1.02Exercisable, December 31, 2007
    
    
    5,803,686
    
    
    $
    0.69
    
    
    
    1,160,000
    
    
    $
    1.02
  Weighted-Weighted-
    
    
    
    
    
    AverageAverage
    
    Weighted-
    
    ExerciseRange of
    
    Stock
    
    Stock
    
    Remaining
    
    Average
    
    Price ofExercise
    
    Options
    
    Options
    
    Contractual
    
    Exercise
    
    OptionsPrices
    
    Outstanding
    
    Exercisable
    
    Life
    
    Price
    
    Exercisable$0.43  0.80
    
    
    6,011,513
    
    
    
    4,431,850
    
    
    7.85 years
    
    $
    0.55
    
    
    $
    0.47$0.81  1.35
    
    
    1,787,836
    
    
    
    1,787,836
    
    
    6.60 years
    
    $
    0.93
    
    
    $
    0.93$1.36  6.25
    
    
    744,000
    
    
    
    744,000
    
    
    6.10 years
    
    $
    1.96
    
    
    $
    1.968,543,349
    
    
    
    6,963,686
 Restricted Stock
   
 Item 2. Managements Discussion and Analysis or Plan of Operation.
 18




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Critical Accounting Policies
   Revenue Recognition
   19




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Goodwill
    Goodwill Impairment
   Estimates
 20




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Concentrations of Credit Risk
    Results of Operations
  Revenues
  Three Months
    
    
    
    
    
    
    Nine MonthsEnded
    
    
    
    
    
    
    EndedDecember 31,
    
    
    
    
    
    
    December 31,2007
    
    
    2006
    
    
    Change
    
    
    2007
    
    
    2006
    
    
    Change(In 000s)
    
    
    
    
    
    
    (In 000s)Software licensing revenues
    
    $
    183
    
    
    $
    94
    
    
    
    94
    %
    
    $
    290
    
    
    $
    609
    
    
    
    -52
    %Software transactional revenues
    
    
    445
    
    
    
    533
    
    
    
    -16
    %
    
    
    1,225
    
    
    
    1,139
    
    
    
    8
    %Software maintenance revenues
    
    
    233
    
    
    
    109
    
    
    
    113
    %
    
    
    658
    
    
    
    316
    
    
    
    108
    %Professional service revenues
    
    
    670
    
    
    
    984
    
    
    
    -32
    %
    
    
    1,953
    
    
    
    2,693
    
    
    
    -27
    %Total revenues
    
    $
    1,531
    
    
    $
    1,720
    
    
    
    -11
    %
    
    $
    4,126
    
    
    $
    4,757
    
    
    
    -13
    %
   21




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Cost of Sales
  Operating Expenses
    Other Expenses/(Income)
  Net Loss
  22




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Liquidity and Capital Resources
   
    
    We expect to receive additional purchase orders under our professional services
contracts with our existing customers and renew our contract with the federal
government, which is anticipated to generate revenue sufficient to significantly reduce
the negative cash flows from our operations.
    
    We believe that the demand for our software and professional services will continue
to expand as the United States market adopts the new payment processing opportunities
available under changing regulations, such as the Check Clearing Act for the
21st Century and NACHAs back office conversion, which allows the conversion
of paper checks in the back offices of retail merchants and government. We believe that
increased demand for our solutions, including our recently introduced Clearingworks
product, will lead to increased cash flows from up-front license fees, transaction based
contract fees and increases in professional services revenues.
    
    We have entered into a strategic alliance with one of the largest MSPs, which will
allow this MSP to sell Clearingworks as part of its ARC and back office conversion
services. We expect this alliance to positively affect our profitability.
    
    Our recent capital raise of $4,000,000, along with our current customer base and
potential new customers in the coming year, should provide us with sufficient liquidity
and capital to maintain effective operations until December 31, 2008.
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Factors That May Affect Our Results
 We have a history of losses and may not operate profitably in the future.
  Our ability to continue as a going concern may be contingent upon our ability to secure capital
from prospective investors or lenders.
  
    
    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 that could cause us to
fail to achieve our revenue or profitability expectations, which in turn could cause our stock
price to decline.
  
    
    market acceptance of and changes in demand for our products and services;
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##### Table of Contents




    
    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.
   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.
  If general economic and business conditions do not improve, we may experience decreased revenue or
lower growth rates.
  25




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We may not be able to attract, retain or integrate key personnel, which may prevent us from
successfully operating our business.
  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.
   
    
    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.
  
    
    the breadth and quality of services;
    
    creative design and systems engineering expertise;
    
    pricing;
    
    technological innovation; and
    
    understanding clients strategies and needs.
  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.
  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.
  26




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##### Table of Contents



We may be unable to consummate future potential acquisitions or investments or successfully
integrate acquired businesses or investments or foreign operations with our business, which may
disrupt our business, divert managements attention and slow our ability to expand the range of our
technologies and products.
  
 Item 3A(T). Controls and Procedures
 Evaluation of disclosure controls and procedures
  Changes in internal control over financial reporting
 27




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##### Table of Contents



PART II  OTHER INFORMATION
 Item 1. Legal Proceedings
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 provided, however,
    28




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##### Table of Contents



Item 6. Exhibits
 ExhibitNumber
    
    Description of Document4.1
    
    
    Rights Agreement, dated July 24, 2003, by and between the
Registrant and Corporate Stock Transfer (incorporated by
reference to Exhibit 4.1 to the Registrants Current Report on
Form 8-K, filed with the Securities and Exchange Commission on
January 5, 2007).4.2
    
    
    Amendment No. 2 to Rights Agreement, dated November 13, 2007, by
and between the Registrant and American Stock Transfer & Trust.
(incorporated by reference to Exhibit 4.2 to the Registrants on
Form 8-K filed with the Securities and Exchange Commission on
November 14, 2007).4.3
    
    
    Securities Purchase Agreement, dated November 13, 2007, by and
among the Registrant and the signatories thereto. (incorporated
by reference to Exhibit 99.1 to the Registrants Registration
Statement on Form S-3 filed with the Securities and Exchange
Commission on December 13, 2007).4.4
    
    
    Registration Rights Agreement, dated as of November 13, 2007, by
and among the Registrant and Highbridge International LLC,
Castlerigg Master Investments Ltd., and Cranshire Capital, L.P.4.5
    
    
    Form of Senior Secured Convertible Promissory Note (incorporated
by reference to Exhibit 99.2 to the Registrants Registration
Statement on Form S-3 as filed with the Securities and Exchange
Commission on December 13, 2007).4.6
    
    
    Form of Common Stock Purchase Warrant (incorporated by reference
to Exhibit 99.3 to the Registrants Registration Statement on
Form S-3 as filed with the Securities and Exchange Commission on
December 13, 2007).10.1
    
    
    Amendment Agreement, dated as of December 28, 2006, by and
between the Registrant and Crescent International Ltd.
(incorporated by reference to Exhibit 10.1 to the Registrants
Current Report on Form 8-K filed with the Securities and
Exchange Commission on December 29, 2006).10.2
    
    
    Settlement and Release Agreement, dated December 13, 2007, by
and among the Registrant, Hyundai Syscomm Corp. and John J.
Figone. (incorporated by reference to Exhibit 10.1 to the
Registrants Current Report on Form 8-K filed with the
Securities and Exchange Commission on December 19, 2007).
 29




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##### Table of Contents



ExhibitNumber
    
    Description of Document10.3
    
    
    Security Agreement, dated as of November 13, 2007, by and
between the Registrant and the Bank of New York.10.4
    
    
    Put Agreement, dated as of November 13, 2007, by and among the
Registrant and Charles E. Ramey, John L. Nicholson, Highbridge
International LLC, Castlerigg Master Investments Ltd., and
Cranshire Capital, L.P.10.5
    
    
    Put Grantor Fee Agreement, dated as of November 13, 2007, by and
between the Registrant and Charles E. Ramey and John Nicholson.31.1
    
    
    Section 302 Certification of Chief Executive Officer.31.2
    
    
    Section 302 Certification of Chief Accounting Officer.32.1
    
    
    Section 906 Certification of Chief Executive Officer.32.2
    
    
    Section 906 Certification of Chief Accounting Officer.
 30




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##### Table of Contents



SIGNATURE
   US DATAWORKS, INC.By
    /s/ John T. McLaughlinJohn T. McLaughlinChief Accounting Officer
(Principal Financial and Accounting Officer
and Duly Authorized Officer) 31




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##### Table of Contents



ExhibitNumber
    
    Description of Document4.1
    
    
    Rights Agreement, dated July 24, 2003, by and between
the Registrant and Corporate Stock Transfer.
(incorporated by reference to Exhibit 4.1 to the
Registants Current Report on Form 8-K filed with the
Securities and Exchange Commission on January 5,
2007).4.2
    
    
    Amendment No. 2 to Rights Agreement, dated November
13, 2007, by and between the Registrant and American
Stock Transfer & Trust. (incorporated by reference to
Exhibit 4.2 to the Registrants Current Report on
Form 8-K filed with the Securities and Exchange
Commission on November 14, 2007).4.3
    
    
    Securities Purchase Agreement, dated November 13,
2007, by and among the Registrant and the signatories
thereto. (incorporated by reference to Exhibit 99.1
to the Registrants Registration Statement on Form
S-3 filed with the Securities and Exchange Commission
on December 13, 2007).4.4
    
    
    Registration Rights Agreement, dated as of November 13, 2007, by and
among the Registrant and Highbridge International LLC, Castlerigg
Master Investments Ltd., and Cranshire Capital, L.P.4.5
    
    
    Form of Senior Secured Convertible Promissory Note
(incorporated by reference to Exhibit 99.2 to the
Registrants Registration Statement on Form S-3 as
filed with the Securities and Exchange Commission on
December 13, 2007).4.6
    
    
    Form of Common Stock Purchase Warrant (incorporated by reference to
Exhibit 99.3 to the Registrants Registration Statement on Form S-3
as filed with the Securities and Exchange Commission on December 13,
2007).10.1
    
    
    Amendment Agreement, dated as of December 28, 2006,
by and between the Registrant and Crescent
International Ltd. (incorporated by reference to
Exhibit 10.1 to the Registrants Current Report on
Form 8-K filed with the Securities and Exchange
Commission on December 29, 2006).10.2
    
    
    Settlement and Release Agreement, dated December 13,
2007, by and among the Registrant, Hyundai Syscomm
Corp. and John J. Figone. (incorporated by reference
to Exhibit 10.1 to the Registrants Current Report on
Form 8-K filed with the Securities and Exchange
Commission on December 19, 2007).10.3
    
    
    Security Agreement, dated as of November 13, 2007, by
and between the Registrant and the Bank of New York.10.4
    
    
    Put Agreement, dated as of November 13, 2007, by and
among the Registrant and Charles E. Ramey, John L.
Nicholson, Highbridge International LLC, Castlerigg
Master Investments Ltd., and Cranshire Capital, L.P.10.5
    
    
    Put Grantor Fee Agreement, dated as of November 13,
2007, by and between the Registrant and Charles E.
Ramey and John Nicholson.31.1
    
    
    Section 302 Certification of Chief Executive Officer.31.2
    
    
    Section 302 Certification of Chief Accounting Officer.32.1
    
    
    Section 906 Certification of Chief Executive Officer.32.2
    
    
    Section 906 Certification of Chief Accounting Officer.
 32