UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington D.C., 20549





---



FORM 10-Q





---



(Mark One)



|S | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934 
|- | ---------------------------------------------------------------------------------
|  |                                                                                  
|  | For the quarterly period ended June 30, 2012                                     
|  |                                                                                  
|£ | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934
|  |                                                                                  
|  | For the transition period                        to                              



Commission file number: 001-15835



US Dataworks, Inc.

(Exact name of registrant as specified in
its charter)



|Nevada                                                                 | 84-1290152                             
|---------------------------------------------------------------------- | ---------------------------------------
|(State or other jurisdiction of
        incorporation or organization) | (I.R.S. employer identification number)



|One Sugar Creek Center Boulevard
        5th Floor
        Sugar Land, Texas | 77478     
|---------------------------------------------------------------------------- | ----------
|(Address of principal executive offices)                                     | (Zip Code)



Registrant’s telephone number: (281)
504-8000



Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

YESxNO ̈



Indicate by check mark whether the registrant
has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted
and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such files).

YesxNo ̈



Indicate by check mark whether the registrant
is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of
“large accelerated filer,” “accelerated filer,” “non-accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.



| | Large accelerated filer                     | £ | Accelerated filer         | £
| | ------------------------------------------- | - | ------------------------- | -
| | Non-accelerated filer                       | £ | Smaller reporting company | S
| | (Do not check if smaller reporting company) |   |                          



Indicate by check mark whether the registrant
is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES ̈NOx



Number of shares of the issuer’s
common stock outstanding as of August 13, 2012: 33,554,045.











US DATAWORKS, INC.



TABLE OF CONTENTS



FORM 10-Q



QUARTERLY PERIOD ENDED JUNE 30, 2012



|                               |                                                                                       | Page
|------------------------------ | ------------------------------------------------------------------------------------- | ----
|                               |                                                                                       |     
|PART I - FINANCIAL INFORMATION |                                                                                       | 4   
|                               |                                                                                       |     
|Item 1.                        | Financial Statements                                                                  |     
|                               |                                                                                       |     
|Item 2.                        | Management’s Discussion and Analysis of Financial Condition and Results of Operations |     
|                               |                                                                                       |     
|Item 3.                        | Quantitative and Qualitative Disclosures About Market Risk                            |     
|                               |                                                                                       |     
|Item 4.                        | Controls and Procedures                                                               |     
|                               |                                                                                       |     
|PART II - OTHER INFORMATION.   |                                                                                       | 21  
|                               |                                                                                       |     
|Item 1.                        | Legal Proceedings                                                                     |     
|                               |                                                                                       |     
|Item 1A.                       | Risk Factors                                                                          |     
|                               |                                                                                       |     
|Item 2.                        | Unregistered Sales of Equity Securitites and Use of Proceeds                          |     
|                               |                                                                                       |     
|Item 3.                        | Defaults Upon Senior Securities                                                       |     
|                               |                                                                                       |     
|Item 4.                        | Mine Safety Disclosures                                                               |     
|                               |                                                                                       |     
|Item 5.                        | Other Information                                                                     |     
|                               |                                                                                       |     
|Item 6.                        | Exhibits                                                                              |     



2







NOTE REGARDING FORWARD LOOKING
STATEMENTS AND CERTAIN TERMS



When used in this Report, 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, our operating expenses, our strategic opportunities,
adequacy of capital resources, our potential professional services contracts and the related benefits, demand for software and
professional services, demand for our solutions, expectations regarding net losses, expectations regarding cash flow and sources
of revenue, statements regarding our growth and profitability, investments in marketing and promotion, fluctuations in our operating
results, our need for future financing, effects of accounting standards on our financial statements, our investment in strategic
partnerships, development of our customer base and our infrastructure, our dependence on our strategic partners, our dependence
on personnel, our employee relations, our disclosure controls and procedures, our ability to respond to rapid technological change,
expansion of our technologies and products, benefits of our products, our competitive position, statements regarding future acquisitions
or investments, our legal proceedings, and our dividend policy.  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 herein, 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 referred to in “Part II - Item 1A. Risk Factors.” These forward-looking
statements speak only as of the date hereof. We expressly disclaim 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.



All references to “US Dataworks,”
the “Company,” “we,” “us,” or “our” means US Dataworks, Inc.



MICRworksTM, ClearingworksTM,
ReturnworksTM, RemitworksTM, ClearPaymentsTM, ClearDepositsTM, ClearReturnsTM, ClearInsightsTM and
PayItFastTM are trademarks of US Dataworks. Other trademarks referenced herein are the property of their respective owners.



3







PART I - FINANCIAL INFORMATION



Item 1.                Financial
Statements



US DATAWORKS, INC.

UNAUDITED CONDENSED BALANCE SHEETS



|                                                                                                                                                                                                                                                            |  | June 30, 2012 |             |   | March 31, 2012 |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ----------- | - | -------------- | -
|                                                                                                                                                                                                                                                            |  | (Unaudited)   |             |   |                |  
|ASSETS                                                                                                                                                                                                                                                      |  |               |             |   |                |  
|                                                                                                                                                                                                                                                            |  |               |             |   |                |  
|Current assets:                                                                                                                                                                                                                                             |  |               |             |   |                |  
|Cash and cash equivalents                                                                                                                                                                                                                                   |  | $             | 79,222      |   |                | $
|Accounts receivable, trade, net of allowance for doubtful accounts at June 30, 2012 and March 31, 2012 of $10,500 and $0, respectively                                                                                                                      |  |               | 530,969     |   |                |  
|Prepaid expenses and other current assets                                                                                                                                                                                                                   |  |               | 110,321     |   |                |  
|Total current assets                                                                                                                                                                                                                                        |  |               | 720,512     |   |                |  
|                                                                                                                                                                                                                                                            |  |               |             |   |                |  
|Property and equipment, net                                                                                                                                                                                                                                 |  |               | 174,338     |   |                |  
|Goodwill                                                                                                                                                                                                                                                    |  |               | 4,020,698   |   |                |  
|Other assets                                                                                                                                                                                                                                                |  |               | 32,110      |   |                |  
|Total assets                                                                                                                                                                                                                                                |  | $             | 4,947,658   |   |                | $
|                                                                                                                                                                                                                                                            |  |               |             |   |                |  
|LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                                                                                                                                                        |  |               |             |   |                |  
|                                                                                                                                                                                                                                                            |  |               |             |   |                |  
|Current liabilities:                                                                                                                                                                                                                                        |  |               |             |   |                |  
|Current portion of long term debt                                                                                                                                                                                                                           |  | $             | 431,800     |   |                | $
|Accounts payable                                                                                                                                                                                                                                            |  |               | 491,800     |   |                |  
|Accrued expenses                                                                                                                                                                                                                                            |  |               | 166,822     |   |                |  
|Accrued interest – related parties                                                                                                                                                                                                                          |  |               | 467,246     |   |                |  
|Deferred revenue                                                                                                                                                                                                                                            |  |               | 526,114     |   |                |  
|Derivative instruments                                                                                                                                                                                                                                      |  |               | 8,488       |   |                |  
|Total current liabilities                                                                                                                                                                                                                                   |  |               | 2,092,270   |   |                |  
|                                                                                                                                                                                                                                                            |  |               |             |   |                |  
|Long term liabilities:                                                                                                                                                                                                                                      |  |               |             |   |                |  
|Notes payable, net of unamortized discount at June 30, 2012 and March 31, 2012 of $7,377 and $2,557, respectively                                                                                                                                           |  |               | 125,876     |   |                |  
|Notes payable – related parties, net of unamortized discount  at June 30, 2012 and March 31, 2012 of  $231,220 and $267,689, respectively                                                                                                                   |  |               | 2,861,025   |   |                |  
|Total long term liabilities                                                                                                                                                                                                                                 |  |               | 2,986,901   |   |                |  
|Total liabilities                                                                                                                                                                                                                                           |  |               | 5,079,171   |   |                |  
|                                                                                                                                                                                                                                                            |  |               |             |   |                |  
|Commitments and contingencies                                                                                                                                                                                                                               |  |               |             |   |                |  
|                                                                                                                                                                                                                                                            |  |               |             |   |                |  
|Stockholders’ 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 $469,085 and $458,802 in arrears as of June 30, 2012 and March 31, 2012, respectively |  |               | 11          |   |                |  
|                                                                                                                                                                                                                                                            |  |               |             |   |                |  
|Common stock, $0.0001 par value, 90,000,000 shares authorized,  33,517,668 and 33,485,835 shares issued and outstanding as of June 30, 2012 and March 31, 2012, respectively                                                                                |  |               | 3,351       |   |                |  
|Additional paid-in-capital                                                                                                                                                                                                                                  |  |               | 66,604,632  |   |                |  
|Accumulated deficit                                                                                                                                                                                                                                         |  |               | (66,739,507 | ) |                |  
|Total stockholders’ equity                                                                                                                                                                                                                                  |  |               | (131,513    | ) |                |  
|                                                                                                                                                                                                                                                            |  |               |             |   |                |  
|Total liabilities and stockholders’ equity                                                                                                                                                                                                                  |  | $             | 4,947,658   |   |                | $



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



4







US DATAWORKS, INC.

UNAUDITED CONDENSED STATEMENTS OF OPERATIONS



|                                            |  | For the Three Months Ended June 30, |           
|------------------------------------------- |  | ----------------------------------- | ----------
|                                            |  | 2012                                |           
|                                            |  |                                     |           
|Revenues:                                   |  |                                     |           
|Software transactional and subscription     |  | $                                   | 649,900   
|Software licensing                          |  |                                     | 2,432     
|Software maintenance                        |  |                                     | 166,918   
|Professional services                       |  |                                     | 392,425   
|Software resale                             |  |                                     | —         
|                                            |  |                                     |           
|Total revenues                              |  |                                     | 1,211,675 
|                                            |  |                                     |           
|Cost of revenues                            |  |                                     | 487,480   
|                                            |  |                                     |           
|Gross profit                                |  |                                     | 724,195   
|                                            |  |                                     |           
|Operating expenses:                         |  |                                     |           
|Research and development                    |  |                                     | 231,613   
|Sales and marketing                         |  |                                     | 278,926   
|General and administrative                  |  |                                     | 558,932   
|Depreciation and amortization               |  |                                     | 18,629    
|Total operating expenses                    |  |                                     | 1,088,100 
|                                            |  |                                     |           
|Net income (loss) from operations           |  |                                     | (363,905  
|                                            |  |                                     |           
|Other expense:                              |  |                                     |           
|Interest expense                            |  |                                     | (21,420   
|Interest expense – related parties          |  |                                     | (149,373  
|Total other expense                         |  |                                     | (170,793  
|                                            |  |                                     |           
|Net income (loss)                           |  | $                                   | (534,698  
|                                            |  |                                     |           
|Basic earnings (loss) per share             |  | $                                   | (0.02     
|                                            |  |                                     |           
|Diluted earnings (loss) per share           |  | $                                   | (0.02     
|                                            |  |                                     |           
|Basic weighted-average shares outstanding   |  |                                     | 33,516,961
|                                            |  |                                     |           
|Diluted weighted-average shares outstanding |  |                                     | 33,516,961



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



5







US DATAWORKS, INC.

UNAUDITED CONDENSED STATEMENTS OF CASH
FLOWS



For the Three Months Ended June 30,



|                                                                                                                                                                                                                                                                              |  | 2012 |           |   | 2011 |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | --------- | - | ---- | -
|Cash flows from operating activities:                                                                                                                                                                                                                                         |  |      |           |   |      |  
|Net loss from operating activities                                                                                                                                                                                                                                            |  | $    | (534,698  | ) |      | $
|Adjustments to reconcile net loss to net cash (used in) provided by operating activities:                                                                                                                                                                                     |  |      |           |   |      |  
|Depreciation and amortization of property and equipment                                                                                                                                                                                                                       |  |      | 18,629    |   |      |  
|Bad debt expense                                                                                                                                                                                                                                                              |  |      | 15,581    |   |      |  
|Amortization of discount on notes payable                                                                                                                                                                                                                                     |  |      | 1,857     |   |      |  
|Amortization of discount on notes payable – related parties                                                                                                                                                                                                                   |  |      | 36,469    |   |      |  
|Amortization of deferred financing costs – related parties                                                                                                                                                                                                                    |  |      | 10,243    |   |      |  
|Stock based compensation                                                                                                                                                                                                                                                      |  |      | 13,287    |   |      |  
|Changes in operating assets and liabilities:                                                                                                                                                                                                                                  |  |      |           |   |      |  
|Accounts receivable                                                                                                                                                                                                                                                           |  |      | (108,888  | ) |      |  
|Prepaid expenses and other current assets                                                                                                                                                                                                                                     |  |      | 90,315    |   |      |  
|Accounts payable                                                                                                                                                                                                                                                              |  |      | 64,905    |   |      |  
|Accrued expenses                                                                                                                                                                                                                                                              |  |      | 28,789    |   |      |  
|Accrued interest – related parties                                                                                                                                                                                                                                            |  |      | 83,654    |   |      |  
|Deferred revenue                                                                                                                                                                                                                                                              |  |      | 101,923   |   |      |  
|                                                                                                                                                                                                                                                                              |  |      |           |   |      |  
|Net cash (used in) provided by operating activities                                                                                                                                                                                                                           |  |      | (177,934  | ) |      |  
|                                                                                                                                                                                                                                                                              |  |      |           |   |      |  
|Cash flows from investing activities:                                                                                                                                                                                                                                         |  |      |           |   |      |  
|Purchase of property and equipment                                                                                                                                                                                                                                            |  |      | (8,580    | ) |      |  
|                                                                                                                                                                                                                                                                              |  |      |           |   |      |  
|Net cash used in investing activities                                                                                                                                                                                                                                         |  |      | (8,580    | ) |      |  
|                                                                                                                                                                                                                                                                              |  |      |           |   |      |  
|Cash flows from financing activities:                                                                                                                                                                                                                                         |  |      |           |   |      |  
|Payments on note payable to bank                                                                                                                                                                                                                                              |  |      | —         |   |      |  
|Payments on asset backed bank loan                                                                                                                                                                                                                                            |  |      | (941,927  | ) |      |  
|Proceeds from asset backed bank loan                                                                                                                                                                                                                                          |  |      | 1,126,503 |   |      |  
|Payment on equipment loan payable                                                                                                                                                                                                                                             |  |      | (825      | ) |      |  
|                                                                                                                                                                                                                                                                              |  |      |           |   |      |  
|Net cash provided by (used in) financing activities                                                                                                                                                                                                                           |  |      | 183,751   |   |      |  
|                                                                                                                                                                                                                                                                              |  |      |           |   |      |  
|Net (decrease) increase in cash and cash equivalents                                                                                                                                                                                                                          |  |      | (2,763    | ) |      |  
|Cash and cash equivalents, beginning of period                                                                                                                                                                                                                                |  |      | 81,985    |   |      |  
|Cash and cash equivalents, end of period                                                                                                                                                                                                                                      |  | $    | 79,222    |   |      | $
|                                                                                                                                                                                                                                                                              |  |      |           |   |      |  
|Supplemental disclosures of cash flow information:                                                                                                                                                                                                                            |  |      |           |   |      |  
|Interest paid                                                                                                                                                                                                                                                                 |  | $    | 57,735    |   |      | $
|Income taxes paid                                                                                                                                                                                                                                                             |  |      | —         |   |      |  
|                                                                                                                                                                                                                                                                              |  |      |           |   |      |  
|Supplemental disclosures of non-cash financing activities:                                                                                                                                                                                                                    |  |      |           |   |      |  
|In conjunction with extension of loan maturity date of certain notes payable the Company issued additional common stock warrants and modified the notes to add a common stock conversion feature. As a result, the following balance sheet accounts were affected as follows: |  |      |           |   |      |  
|Increased derivative warrant instruments                                                                                                                                                                                                                                      |  | $    | 8,488     |   |      |  
|Increased note discount on notes payable                                                                                                                                                                                                                                      |  |      | 6,676     |   |      |  
|Decreased additional paid-in-capital                                                                                                                                                                                                                                          |  |      | (1,812    | ) |      |  



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



6







US DATAWORKS, INC.

NOTES TO UNAUDITED CONDENSED FINANCIAL
STATEMENTS



| | 1. | Organization and Business
| | -- | -------------------------



General



US Dataworks, Inc., a Nevada
corporation, (the “Company”), develops, markets, and supports payment processing software for on-premise customers
and cloud-computing service customers within multiple market segments. Its customer base includes some of the largest financial
institutions as well as credit card companies, government institutions, banker’s banks and high-volume merchants in the United
States. The Company was formerly known as Sonicport, Inc.



| | 2. | Summary of Significant Accounting Policies
| | -- | ------------------------------------------



Interim Financial Statements



The accompanying interim unaudited
condensed financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities
and Exchange Commission (“SEC”).  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 audited financial statements and the notes thereto included in the Company’s Annual Report
on Form 10-K for the fiscal year ended March 31, 2012.  The results of operations for interim periods are not necessarily
indicative of the results for any subsequent quarter or the fiscal year ending March 31, 2013.



Revenue Recognition



The Company recognizes revenues
associated with its software products in accordance with the provisions of the Financial Accounting Standard Board (“FASB”)
Accounting Standards Codification (“ASC”) Topic 985–605, Software Revenue Recognition.



The Company licenses its software
on a transaction or subscription fee basis. 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 that are essential to the functionality of the software are provided in connection with the installation
of the software licensed, revenue is recognized when these services have been provided on the percentage of completion basis. The
Company measures its percentage of completion by the percentage of labor hours incurred to-date to estimated total labor hours
for each contract.



In certain instances, the Company
licenses its software products under non-exclusive, non-transferable license agreements that involve services essential to the
functionality of the software in which case license revenue is recognized when services have been provided on the percentage of
completion basis. 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 established in the agreement, commencing
upon completion of the installation period of the software. In certain instances, the Company enters into arrangements that include
multiple elements, where fees are allocated to the various elements based on vendor specific objective evidence of fair value.



Cash and Cash Equivalents



For 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.



The Company maintains cash deposits
with a major bank that, from time to time, may exceed federally insured limits; however, the Company has not experienced any losses
on deposits.



7







Accounts Receivable and
Allowance for Doubtful Accounts



The Company’s receivables
are recorded when revenue is earned and claims against third parties will be settled in cash.  The carrying value of
the Company’s receivables represents their estimated net realizable value.   The Company extends credit to
customers and other parties in the normal course of business.  The Company regularly reviews outstanding receivables
and provides for estimated losses through an allowance for doubtful accounts.  In evaluating the level of established
reserves, the Company makes judgments regarding its customers’ ability to make required payments, economic events, and other
factors.  As the financial condition of these parties change, circumstances develop or additional information becomes
available, adjustments to the allowance for doubtful accounts may be required.  Provisions for bad debts and recoveries
of accounts previously charged off are adjusted to the allowance account.



Property and Equipment



Property 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 years                                        
|---------------------- | -----------------------------------------------
|Telephone equipment    | 5 to 10 years                                  
|Computer equipment     | 5 years                                        
|Computer software      | 5 years                                        
|Leasehold improvements | Shorter of lease period or useful life of asset



Maintenance and minor replacements are charged to
expense as incurred. Gains and losses on disposals are included in the results of operations.



Impairment of Long-Lived
Assets



The 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.



Goodwill



The goodwill recorded on the
Company’s books is from the acquisition of US Dataworks, Inc. in fiscal year 2002 which remains the Company’s single
reporting unit. ASC Topic 350, Intangibles – Goodwill and Other Intangibles, requires goodwill for each reporting
unit of an entity 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.



ASC Topic 350 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 record an impairment of goodwill for either the
quarter ended June 30, 2012 or the year ended March 31, 2012.



Goodwill is classified
as Level 3 within the fair value hierarchy.



Stock Options



The Company follows the guidance
cited in ASC Topic 718, Compensation – Stock Compensation, to account for its stock options. ASC Topic 718 requires
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. Stock-based compensation expense recognized under ASC Topic 718, which
consists of stock-based compensation expense related to employee and director stock options and stock issuances, for the three
months ended June 30, 2012 and June 30, 2011 were $13,287 and $11,531, respectively.



ASC Topic 718 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. Stock-based compensation expense recognized during the period is based on the value of the portion of
share-based payment awards that is ultimately expected to vest during the period. Compensation expense recognized for all employee
stock options awards granted is recognized over their respective vesting periods unless the vesting period is graded. As stock-based
compensation expense recognized in the Statement of Operations for the three months ended June 30, 2012 and June 30, 2011 is based
on awards ultimately expected to vest, it has been reduced for estimated forfeitures.



8







Upon adoption of ASC Topic 718,
the Company continues to use the Black-Scholes option valuation model, which requires management to make certain assumptions for
estimating the fair value of employee stock options granted at the date of the grant.  There were no stock options granted
during the three months ended June 30, 2012 or June 30, 2011.



As of June 30, 2012, there was
approximately $32,923 of total unrecognized compensation cost related to non-vested share-based compensation arrangements, which
is expected to be recognized over a period of one year.



Derivative Instruments



The Company accounts for warrant
derivative instruments under the provisions of ASC Topic 815 – 40, Derivatives and Hedging - Contracts in Entity’s
Own Stock. The requirements of this ASC Topic can affect the accounting for warrants and many convertible instruments with
provisions that protect holders from a decline in the stock price (or “down-round” provisions). For example, warrants
or convertible instruments with such provisions cannot be recorded in equity. Downward provisions reduce the exercise price
of a warrant or convertible instrument if a company either issues equity shares for a price that is lower than the exercise price
of those instruments or issues new warrants or convertible instruments that have a lower exercise price. The Company evaluated
whether warrants contained provisions that protect holders from declines in the Company’s stock price or otherwise couldresult
in modification of the exercise price and/or shares to be issued under the respective warrant or preferred stock agreements based
on a variable that is not an input to the fairvalue of a “fixed-for-fixed” option as defined under ASC
Topic 815 – 40.



In accordance with ASC Topic
815 – 40, the Company recognized the financial instruments that contain these down round provisions as liabilities at their
respective fair values on each reporting date. ASC Topic 815 – 40 also requires that such instruments be measured at fair
value at each reporting period. See Footnote 5 – Derivative Instruments for disclosure regarding amount of derivative instrument
presented on the balance sheet.



Income and Loss
per Share



The Company calculates income
and loss per share in accordance with ASC Topic 260-10, 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 similar 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.



For
the three months ended June 30, 2012,15,233,127potential common stock equivalents have been
excluded from the computation of diluted earnings per share because the effect would have been anti-dilutive.  For the
three months ended June 30, 2011, 16,041,692 potential common stock equivalents have been excluded from the computation of diluted
earnings per share because the effect would have been anti-dilutive.  Options and warrants typically convert on a one-for-one
basis – see below for details of the conversion of the preferred stock into shares of common stock. The weighted-average
common stock equivalents that were excluded from the computation of diluted loss per share for the three ended June 30, 2012 and
June 30, 2011 are as follows:



|                                                     |  | For the Three Months |          
|---------------------------------------------------- |  | -------------------- | ---------
|                                                     |  | Ended June 30,       |          
|                                                     |  | 2012                 |          
|Options outstanding:                                 |  |                      |          
|Under the Company’s stock option plan                |  |                      | 6,653,669
|Outside the Company’s stock option plan              |  |                      | —        
|Warrants outstanding:                                |  |                      |          
|In conjunction with private placements               |  |                      | 4,762,143
|For services rendered and litigation settlement      |  |                      | 202,222  
|As consideration for note extensions                 |  |                      | 3,505,160
|Convertible Series B preferred stock outstanding (a) |  |                      | 109,933  



| | (a) | The Series B preferred stock is convertible into shares of common stock at a conversion ratio of
one share of Series B preferred stock for one share of common stock.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



Estimates



The preparation of financial
statements in accordance with accounting principles generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. The most
significant estimates relate to the measurement of progress of completion on contracts, determination of allowance for doubtful
accounts, share based compensation, fair value of derivative instrument, and fair value of goodwill impairment assessment. Actual
results could differ from those estimates.



9







Concentrations of Credit
Risk



The Company sells its products
throughout the United States and extends credit to its customers. It also performs ongoing credit evaluations of such customers.
The Company does not obtain collateral to secure its accounts receivable. The Company evaluates its accounts receivable on a regular
basis for collectability and provides for an allowance for potential credit losses as deemed necessary.



Two of the Company’s customers
accounted for 58% and 12%, respectively, of the total net revenues for the three months ended June 30, 2012. Three of the Company’s
customers accounted for 53%, 12% and 10%, respectively, of the total net revenues for the three months ended June 30, 2011.



At June 30, 2012, amounts due
from two of the Company’s customers accounted for 59% ($312,566) and 19% ($100,000), respectively, of accounts receivable.
At June 30, 2011, amounts due from three of the Company’s customers accounted for 51% ($339,008), 15% ($100,000), and 12%
($78,600), respectively, of accounts receivable.



Income Taxes



Deferred income taxes are provided
on a liability method whereby deferred tax assets and liabilities are established for the difference between the financial reporting
and income tax basis of assets and liabilities as well as operating loss and tax credit carryforwards.  Deferred tax
assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or
all of the deferred tax assets will not be realized.



The Company recorded a net loss
of $534,698 for the three months ended June 30, 2012 and has computed the tax provision for the three months ended June 30, 2012
in accordance with the provisions of ASC Topic 740, Income Taxes and ASC Topic 270, Interim Reporting.  The
Company has estimated that its overall effective tax rate for US purposes to be 0% for the three months ended June 30, 2012. Consequently,
the Company recorded zero income tax expense or benefit for the period ended June 30, 2012. The Company’s income tax benefit
on the loss before taxes was offset by an increase in the valuation allowance. At June 30, 2012 and March 31, 2012, a valuation
allowance has been maintained to fully offset net deferred tax assets until it is evident that the deferred tax assets will be
utilized in the future.



At
June 30, 2012, the Company had approximately$30.3million of net operating loss carryforwards
for U.S. purposes.  These loss carryforwards will expire beginning in 2020 through 2030 if not utilized.



The Company records expense
and penalties related to unrecognized tax benefits as income tax expense, and there is no liability accrued for the payment of
interest and penalties as of June 30, 2012 and March 31, 2012, respectively.  The Company recognized no tax benefits
or liabilities for uncertain positions during the three months ended June 30, 2012.



Recently Issued
Accounting Pronouncements



In May 2011, the FASB issued
ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS.
The ASU attempts to clarify the FASB’s intent about the application of existing fair value measurement requirements and changes
certain principles or requirements for measuring fair value or for disclosing information about fair value measurements. The ASU’s
amendments will result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRS and are effective for
the first interim or annual period beginning on or after December 15, 2011. The Company’s adoption of this ASU, effective
January 1, 2012, is presentation and disclosure related and did not have an effect on the Company’s financial statements.



In September 2011, the FASB
issued ASU 2011-08, Intangibles-Goodwill and Other (Topic 350) – Testing Goodwill for Impairment. ASU 2011-08
provides companies with a new option to determine whether or not it is necessary to apply the traditional two-step quantitative
goodwill impairment test in ASC 350, Intangibles – Goodwill and Other. Under ASU 2011-08 companies are no longer required
to calculate the fair value of a reporting unit unless it determines, on the basis of qualitative information, that it is more
likely than not (i.e., greater than 50%) that the fair value of a reporting unit is less than its carrying amount. ASU 2011-08
is effective of periods ending after December 15, 2011. The Company’s adoption of this ASU, effective January 1, 2012, did
not have a material impact on the Company’s financial statements.



10







| | 3. | Property and Equipment
| | -- | ----------------------



Property and equipment
at June 30, 2012 and March 31, 2012 consisted of the following:



|                                                |  | June 30, 2012 |            |   | March 31, 2012 |  
|----------------------------------------------- |  | ------------- | ---------- | - | -------------- | -
|Furniture and fixtures                          |  | $             | 102,631    |   |                | $
|Office and telephone equipment                  |  |               | 198,781    |   |                |  
|Computer equipment                              |  |               | 857,144    |   |                |  
|Computer software                               |  |               | 1,375,260  |   |                |  
|Leasehold improvements                          |  |               | 64,732     |   |                |  
|                                                |  |               | 2,598,548  |   |                |  
|Less: accumulated depreciation and amortization |  |               | (2,424,210 | ) |                |  
|Total                                           |  | $             | 174,338    |   |                | $



Depreciation and amortization
expense for the three months ended June 30, 2012 and June 30, 2011 was $18,629 and $24,629, respectively.



| | 4. | Bank Credit Line and Long-Term Debt
| | -- | -----------------------------------



At June 30, 2012 and March 31,
2012, the Company’s bank credit line and long-term debt consisted of the following:



|                                          |  | June 30, 2012 |           |   | March 31, 2012 |  
|----------------------------------------- |  | ------------- | --------- | - | -------------- | -
|Secured line of credit                    |  | $             | 428,499   |   |                | $
|Notes payable                             |  |               | 125,000   |   |                |  
|Notes payable – related parties           |  |               | 3,092,245 |   |                |  
|Notes payable – equipment                 |  |               | 11,554    |   |                |  
|Unamortized debt discount                 |  |               | (238,597  | ) |                |  
|Total secured notes payable and bank debt |  |               | 3,418,701 |   |                |  
|Less: Current portion of long-term debt   |  |               | (431,800  | ) |                |  
|Long-term debt, net of current portion    |  | $             | 2,986,901 |   |                | $



A/R Line of Credit and Term Loan



Effective as of October 27,
2010, the Company entered into an Amended and Restated Loan and Security Agreement (the “Loan Agreement”) with Silicon
Valley Bank (“SVB”) providing for a senior credit facility (the “Credit Facility”) comprised of an asset-based
accounts receivable line of credit (the “A/R Line of Credit”) and a term loan (The “Term Loan”). The Loan
Agreement amended and restated a previous loan agreement with SVB in its entirety. On February 8, 2011, May 9, 2011, June 7, 2011,
July 7, 2011, September 12, 2011, November 1, 2011 and March 15, 2012, the Company entered into certain amendments to the Loan
Agreement. Additionally, since June 30, 2012, the Company entered into an additional amendment to the Loan Agreement (see Note
11 – Subsequent Events).



The maturity date of the Term
Loan was February 1, 2013. However, with the additional principal payments made by the Company, the Term Loan was fully repaid
in March 2012. Prior thereto, the Term Loan accrued interest at the fixed annual rate of 7.00% and was payable monthly.



The maximum availability under
the A/R Line of Credit is $1,000,000. Subject to certain commitment limits, through June 30, 2011, the Company could borrow up
to eighty percent (80%) of its eligible accounts receivable.  Pursuant to the July 7, 2011 amendment, SVB increased the
borrowing availability up to eighty-five percent (85%) of its eligible accounts receivables.  Also, pursuant to the July
7, 2011 amendment, the maturity date of the A/R Line of Credit was extended to June 28, 2012.  The finance charges and
handling fees that applied to the A/R Line of Credit through June 30, 2011 consisted of (i) a finance charge of 1.25% above SVB’s
prime rate and (ii) a collateral handling fee of either 0.10% per month or 0.25% per month depending on whether the Company’s
adjusted quick ratio was above or below 1.30 (for the quarter ended June 30, 2011, the higher collateral handling fee applied).
These charges apply to the full face amount of the financed receivables.  The effective rate of these charges during
the quarter ended June 30, 2011 was 10.31%.  Pursuant to the July 7, 2011 amendment, (i) the finance charge applicable
to the A/R Line of Credit was increased to 2.20% above SVB’s prime rate but will reduce back to 1.25% above SVB’s prime
rate if the Company’s adjusted quick ratio exceeds 1.00 and (ii) the adjusted quick ratio trigger to reduce the collateral
handling fee was reduced to 1.00. The effective interest rate of these charges for the quarters ended June 30, 2011, September
30, 2011, December 31, 2011, March 31, 2012 and June 30, 2011 were 10.31%, 10.82%, 10.82%, 10.82%, and 10.82%, respectively.



11







Through July 31, 2011, the Loan
Agreement imposed one financial covenant that required the Company to meet certain minimum EBITDA requirements (where “EBITDA”
is defined to include an add-back for equity-based compensation expense) for a trailing three-month period. Beginning in August
2011, the EBITDA covenant was replaced with a minimum liquidity ratio covenant that required the Company to maintain a liquidity
ratio of at least 1.20 at all times but measured at the end of each month. Beginning in September 2011, the Loan Agreement imposed
an additional covenant requiring the Company to maintain a fixed charge coverage ratio (as defined) of at least 1.30 at all times
but tested at the end of each month based on a trailing three-month total.  The Company failed to comply with the EBITDA
covenant for the three months ended June 30, 2011. On August 12, 2011, the Company received a waiver from SVB for the violation.
The Company failed to comply with the EBITDA covenant for the three months ended July 31, 2011. On September 12, 2011, the Company
received a conditional waiver from SVB which was subsequently met.  The Company failed to comply with the fixed charge coverage
ratio covenant originally imposed for the three months ended September 30, 2011. Pursuant to the November 1, 2011 amendment, the
Company received a waiver from SVB for the violation and SVB agreed to move the initial compliance period for the covenant to the
three months ended November 30, 2011.  At December 31, 2011 and through March 31, 2012, the Company was in compliance
with the financial covenants. All financial covenants were eliminated when the Term Loan was paid in full in March 2012.



The July 7, 2011 amendment also
(i) provides that no payments in respect of any subordinated debt can be made without the prior written consent of SVB until the
Term Loan is paid in full, (ii) eliminates all early termination fees and (iii) imposes certain additional reporting requirements.



The March 15, 2012 amendment
(i) imposes a new condition to the Company’s ability to make interest payments on its subordinated debt (other than the One-Year
Notes (defined below)), without the prior written consent of SVB that requires the Company to maintain a fixed charge coverage
ratio (as defined) of 1.10:1.00 measured on a trailing three-month basis beginning February 2012 and (ii) modifies the definition
of fixed charge coverage ratio to add changes in deferred revenue to the EBITDA calculation in the numerator of the ratio. Also,
in connection with the March 15, 2012 amendment, the subordination agreement that establishes the SVB bank debt as being senior
in all rights to the Refinance Notes (defined below) and the One-Year Notes (the “Subordination Agreement”) was amended
to reflect the new subordinated payment condition.



The indebtedness owed under
the Credit Facility is fully secured by a perfected first priority security interest in favor of SVB in all of the Company’s
assets, including its cash, accounts receivable, inventory, equipment, intellectual property rights and contract rights.



On July 11, 2012 but effective
as of June 28, 2012, the Company and SVB entered into another amendment to the Loan Agreement extending the maturity date out to
September 26, 2012 and reducing the availability under the A/R Line of Credit (see Note 11 – Subsequent Events).  The
Company has recently established a factoring facility that will replace the A/R Line of Credit before September 26, 2012 (see Note
11 – Subsequent Events).



Notes Payable



In August 2011, the Company completed a private placement
in which investors received in the aggregate $125,000 in one-year notes (the “One-Year Notes”) and three-year warrants
to purchase a total of 58,138 shares of the Company’s common stock at an exercise price of $0.43 per share (the “Three
Year Warrants”). Included in the One-Year Notes is $25,000 held by a related party. The One-Year Notes accrue interest at
a rate of 12% per annum payable monthly in arrears.  No principal payments are required to be made on the Notes until
the maturity date, which was August 1, 2012.  The One-Year Notes rank junior to the SVB bank debt but senior to all other
Company debt, including the affiliate debt.  The One-Year Notes are secured by a second lien on all of the assets
of the Company which is junior only to the first lien securing the SVB bank debt (and will be junior to the first lien
that will secure the new factoring facility). The Three Year Warrants were valued at $7,111, which represents the original issue
discount to the One-Year- Notes.



In June 2012, the Company and
the holders of the One-Year Notes and the Three-Year Warrants agreed to certain amendments to the One-Year Notes and the Three-Year
Warrants. Specifically, the One-Year Notes were amended to (i) extend the maturity date of the notes out to August 1, 2013 and
(ii) add a right to convert the notes into shares of the Company’s common stock at a conversion price of $0.43 per share,
with such conversion price being subject to reduction in the event of certain dilutive equity issuances by the Company. The Three-Year
Warrants were amended to (i) double the number of shares of the Company’s common stock into which the warrants are exercisable,
(ii) extend the expiration date of the warrants to August 1, 2017 and (iii) add a provision that the exercise price of the warrants
will be subject to reduction in the event of certain dilutive equity issuances by the Company. The unamortized discount on the
One-Year-Notes was $7,377 at June 30, 2012.



Notes Payable – Related Parties



Through a series of negotiated
agreements, the Company has executed and delivered, and is currently indebted under, (i) a promissory note (the “Nicholson
Refinance Note”) payable to John L. Nicholson, an outside director of the Company and (ii) a promissory note (the “Ramey
Refinance Note”) payable to Charles E. Ramey, the Chairman and CEO of the Company.  The original proceeds from
the Nicholson Refinance Note and the Ramey Refinance Note (collectively, the “Refinance Notes”) were used to refinance
certain debt of the Company and for other corporate purposes.



12







The terms of the Refinance Notes
are as follows:



|Refinance Notes |          
|--------------- | ---------
|Nicholson       |          
|$               | 2,295,000



The maturity date on the Refinance
Notes is January 1, 2014. Interest on the Refinance Notes is payable monthly (subject to certain conditions as discussed below)
and no principal payments are required until maturity.  The annual interest rate for the Nicholson Refinance Note is
12% but reduces to 10% if the principal balance drops below $1,905,000.  The annual interest rate for the Ramey Refinance
Note is 10%. As of June 30, 2012, the Company had $466,994 in accrued but unpaid interest on the Refinance Notes. In July 2012,
the Company and the affiliate debt holders entered into a letter agreement regarding the accrued and unpaid interest on the Refinance
Notes (see Note 11 – Subsequent Events).



Pursuant to the March 15, 2012
amendment to the Loan Agreement, all payments on the Refinance Notes (including regular scheduled interest payments) are prohibited
if the Company fails to maintain a fixed charge coverage ratio, as defined, of greater than 1.10: 1.00 measured on a trailing three
month basis beginning February 2012 without the prior written consent of SVB.



The Refinance Notes are secured
by a Security Agreement, dated August 13, 2008, by and between the Company and Messrs. Nicholson and Ramey, pursuant to which the
Company granted Messrs. Nicholson and Ramey a security interest in all its personal property, whether now owned or hereafter acquired,
including but not limited to, all accounts receivable, copyrights, trademarks, licenses, equipment and all proceeds as from such
collateral.  Pursuant to the subordination agreements with SVB and the holders of the One-Year Notes, this security interest
will remain junior to SVB’s security interest under the Credit Facility as long as such facility remains in place and
will be junior to the security interest of the holders of the One-Year Notes until those notes are paid in full. This security
interest will also be junior to the security interest of the provider of the Company’s new factoring facility.



Note Payable – Equipment



In December 2010, the Company
entered into a capital lease agreement with CIT Technology Financing Services, Inc. to lease new telephone equipment for $16,505.
The lease has a $1 purchase option at the end of 60 equal monthly installments of $379.  As of June 30, 2012, the outstanding
balance on this capital lease was $11,554.



Payment Table



Future minimum payments under
our loan agreements and notes payable at June 30, 2012 were as follows:



|Fiscal Year Ended March 31, |  | Amount |          
|--------------------------- |  | ------ | ---------
|2013                        |  | $      | 430,975  
|2014                        |  |        | 3,220,546
|2015                        |  |        | 3,301    
|2016                        |  |        | 2,476    
|2017                        |  |        | —        
|                            |  | $      | 3,657,298



| | 5. | Derivative Instruments
| | -- | ----------------------



In
June 2012, the Company modified the One-Year Notes and the Three-Year Warrants. After the modification, the One-Year Notes are
convertible into shares of the Company’s common stock at any time at the option of the holder at the conversion price of
$0.43 per share. If the Company, at any time or from time to time while any of the One-Year Notes are outstanding, issues (1) any
common stock or common stock equivalent at a price per share that is less than the conversion price or (2) any common stock equivalents
that entitle the holder thereof to acquire shares of common stock at a price per share that is less than the conversion price,
then in each case, except for certain excluded issuances, the applicable conversion price shall be adjusted to equal to that lower
issuance price. Both the One-Year Notes and the Three-Year Warrants, as amended, contain the same price protection. The Company
determined the embedded conversion feature for the One-Year Notes and the Three-Year Warrants to be a derivative liability in accordance
with ASC Topic 815, Derivatives and Hedging and estimated the fair value of the derivative
using Lattice Model with Monte Carlo simulation as of June 28, 2012. Such estimates are to be revalued at each balance sheet date,
with changes in value recorded as unrealized gains or losses in non-operating income (expense) in the Company’s statements
of operations.



13







Activity for derivative instruments
liability during the three months ended June 30, 2012 was as follows:



|                       |  |           |   |  |                 |   |       | Decrease in          |  |   |          | 
|---------------------- |  | --------- | - |  | --------------- | - | ----- | -------------------- |  | - | -------- | 
|                       |  | March 31, |   |  | Activity During |   |       | Fair Value of        |  |   | June 30, | 
|                       |  | 2012      |   |  | Fiscal Year     |   |       | Derivative Liability |  |   | 2012     | 
|Derivative instruments |  | $         | — |  |                 | $ | 8,488 |                      |  | $ | —        | 
|                       |  | $         | — |  |                 | $ | 8,488 |                      |  | $ | —        | 



The fair value of the derivative
instruments is estimated using the Lattice model with the following assumptions as of June 28, 2012:



|                                                                        |  | June 30, 2012 |            
|----------------------------------------------------------------------- |  | ------------- | -----------
|Common stock issuable upon exercise of warrants and conversion of notes |  |               | 406,974    
|Market value of common stock on measurement date                        |  | $             | 0.13-0.15  
|Projected                                                               |  | $             | 0.12-0.43  
|Offering price range (1)                                                |  | $             | 0.12-0.35  
|Risk free interest rate (2)                                             |  |               | 0.31       
|Warrant and convertibles lives in years                                 |  |               | 1.00 – 5.00
|Expected volatility (3)                                                 |  |               | 41% - 49   
|Expected dividend yields (4)                                            |  |               | None       



| | (1) | Represents the estimated offering price range in future offerings as determined by management
| | --- | ---------------------------------------------------------------------------------------------

| | (2) | The risk-free interest rate was determined by management using 1, 3 or 5 year Treasury Bill as
of the respective measurement date.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------

| | (3) | The volatility factor was estimated by management using the historical volatilities of comparable
companies in the industry.
| | --- | ----------------------------------------------------------------------------------------------------------------------------

| | (4) | Management determined the dividend yield to be 0% based upon its expectation that it will not pay
dividends for the foreseeable future.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------



| | 6. | Fair Value Measurement
| | -- | ----------------------



As defined in ASC Topic 820
– 10, Fair Value Measurement and Disclosures, fair value is the price that would be received upon the sale of an asset
or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 –
10 requires disclosure that establishes a framework for measuring fair value and expands disclosure about fair value measurements.
The statement requires fair value measurements be classified and disclosed in one of the following categories:



|Level 1: | Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. The Company considers active markets as those in which transactions for the assets or liabilities occur in sufficient frequency and volume to provide pricing information on an ongoing basis.
|-------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Level 2: | Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability. Substantially all of these inputs are observable in the marketplace throughout the term of the derivative instruments, can be derived from observable data, or supported by observable levels at which transactions are executed in the marketplace.
|-------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Level 3: | Measured based on prices or valuation models that require inputs that are both significant to the fair value measurement and less observable from objective sources (i.e. supported by little or no market activity). The Company’s valuation models are primarily industry standard models.  Level 3 instruments include derivative warrant instruments.  US Dataworks does not have sufficient corroborating evidence to support classifying these assets and liabilities as Level 1 or Level 2.
|-------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



14







As required by ASC Topic 820
– 10, financial assets and liabilities are classified based on the lowest level of input that is significant to the fair
value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires
judgment, and may affect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy
levels. The estimated fair value of the derivative warrant instruments was calculated using the Lattice  model (see Note 5
– Derivative Instruments).



Fair Value on a Recurring
Basis



The following table sets forth,
by level within the fair value hierarchy, the Company’s financial assets and liabilities that were accounted for at fair
value on a recurring basis as of June 30, 2012:



|                       |  | Fair Value Measurements at June 30, 2012 |  
|---------------------- |  | ---------------------------------------- | -
|                       |  | Quoted Prices in                         |  
|                       |  | Active Markets for                       |  
|                       |  | Identical Assets                         |  
|                       |  | (Level 1)                                |  
|Derivative instruments |  | $                                        | —
|Total                  |  | $                                        | —



Fair Value on a Non-Recurring Basis



Certain nonfinancial assets
and liabilities are measured at fair value on a nonrecurring basis in accordance with ASC 820 – 10.  This includes
items such as nonfinancial assets and liabilities initially measured at fair value in a business combination and nonfinancial long-lived
asset groups measured at fair value for an impairment assessment.  In general, nonfinancial assets including goodwill
and property and equipment are measured at fair value when there is an indication of impairment and are recorded at fair value
only when any impairment is recognized.



| | 7. | Commitments and Contingencies
| | -- | -----------------------------



Leases



The
Company leases an office in Sugar Land, Texas under an operating lease agreement that expires on January 31, 2018. Rent expense
for the three months ended June 30, 2012 and June 30, 2011 was $93,387 and $93,461, respectively. This lease was amended on June
2, 2011 to, among other things, extend the term through January 31, 2018 and provide for total rent abatements of approximately$188,000 and a refurbishment allowance of approximately$282,000. As of June 30, 2012,
the Company has used approximately $38,000 of the refurbishment allowance. The Company expenses rent
on a straight line basis over the lease term at $30,708 per month.



Future minimum lease payments under operating leases
at June 30, 2012 were as follows:



|Fiscal Year Ended March 31, |  | Amount |          
|--------------------------- |  | ------ | ---------
|2013                        |  | $      | 187,900  
|2014                        |  |        | 378,932  
|2015                        |  |        | 397,722  
|2016                        |  |        | 416,512  
|2017                        |  |        | 433,736  
|Thereafter                  |  |        | 367,971  
|                            |  | $      | 2,182,773



| | 8. | 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.



15







Convertible Series B Preferred
Stock



The Company has 700,000 shares
authorized, 109,933 shares issued and outstanding, of $0.0001 par value convertible Series B preferred stock. The Series B preferred
stock has a liquidation preference of $3.75 per share and carries a 10% cumulative dividend payable each March 1 and September
1, as and when declared by the Board of Directors. Each share of Series B preferred stock is convertible into one share of common
stock, resulting in an effective conversion price of $3.75 per share. The Company has the right to redeem the Series B preferred
stock at any time after issuance at a redemption price of $4.15 per share, plus any accrued but unpaid dividends.



At June 30, 2012 and March 31,
2012, there were accumulated, undeclared dividends in arrears of $469,085 and $458,802, respectively.



Stock Options



In August 2000, the Company’s
Board of Directors approved the 2000 Stock Option Plan, which has since been amended and/or amended and restated a number
of times(the “2000 Plan”).  As of June 30, 2012, the maximum aggregate number
of shares which may be granted under the 2000 Plan was 10,000,000. Under the 2000 Plan, 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 grant. 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. During the three months ended June 30, 2012, the
Company did not grant any stock options.



The following table summarizes
certain information relative to stock options:



|                            |  | 2000 Stock Option Plan |          
|--------------------------- |  | ---------------------- | ---------
|                            |  | Shares                 |          
|Outstanding, March 31, 2012 |  |                        | 6,691,169
|Granted                     |  |                        | —        
|Forfeited/canceled          |  |                        | (37,500  
|Outstanding, June 30, 2012  |  |                        | 6,653,669
|Exercisable, June 30, 2012  |  |                        | 5,881,168



The weighted-average remaining
lives of the options granted under the 2000 Plan at June 30, 2012 were 4.63 years.



Common Stock Grants



During the three months ended
June 30, 2012, the Company granted 31,833 shares of common stock (at $0.15 per share based on the closing price of the common stock
on the grant date) to its outside directors pursuant to the Company’s Outside Director Compensation Plan. The Company expensed
$4,775 related to these grants during the three months ended June 30, 2012. These grants were made under the 2000 Plan.



Warrants



All warrants outstanding as
of June 30, 2012 have an exercise price of $0.43. The warrants outstanding as of June 30, 2012 expire as of the following dates;
4,651,163 private placement warrants expire November 13, 2012, 116,276 private placement warrants expire August 1, 2017, 200,000
warrants issued for services rendered and litigation settlement expire November 13, 2012, 1,854,141 warrants issued for note extensions
expire June 26, 2014 and 1,612,501 warrants issued for note extensions expire February 29, 2015.



| | 9. | Liquidity
| | -- | ---------



The Company has a history of
experiencing negative cash flow from operations and continues to operate under liquidity constraints. Over the years, the Company
has put a number of debt financings in place to address this ongoing situation. As of June 30, 2012, the Company had approximately
$3.1 million of affiliate debt coming due January 1, 2014 and $125,000 of debt coming due on August 1, 2013. The Company also has
an accounts receivable line of credit that was recently renewed through September 26, 2012. The Company has recently established
a factoring facility that will replace this line of credit before it terminates. As of June 30, 2012, the Company had $467,246
in accrued but unpaid interest on the affiliate debt. Although the Company has had the right to pay the affiliate debt interest
since March 2012, the affiliate debt holders have been willing to defer a portion of the affiliate debt interest in order to accommodate
the liquidity constraints. The affiliate debt holders recently agreed to (i) waive the defaults arising from our inability to keep
current on the affiliate debt interest payments through June 30, 2013 and (ii) agreed not to take any action against the Company
to collect this growing past due interest payment through June 30, 2013. However, there can be no assurance that the Company will
be current on these payments or enter into a similar agreement beyond such date.



16







With respect to the $3.1 million
in principal payments due to the affiliate debt holders on January 1, 2014 and any unpaid interest thereon as of such date as well
as the $125,000 of debt coming due on August 1, 2013, the Company will have to either build enough cash to fund these payments
when they come due or the Company will have to come to an agreement with the holders of such debt to restructure the payment terms
thereof or obtain other adequate sources of debt or equity funding to retire this debt when it comes due.



The Company will need to increase
revenues from transaction and subscription based software license contracts and professional services agreements and software licenses
to achieve and sustain profitability.



The Company has taken a number
of steps to address and improve its liquidity.  These steps include additional rent abatements in fiscal 2013 in connection
with the negotiation of a renewal of the Company’s office lease and deferring interest payments on the affiliate debt, as
needed.  The Company’s management believes the processes put in place will fund its operations through March 31, 2013,
and for a reasonable period of time thereafter.  If the Company’s liquidity does not improve in a meaningful way, the
Company will be forced to take additional steps to address the issue, the primary one being raising additional equity and/or debt
capital.  However, there can be no assurance that the Company would be successful in attempting to raise such capital.





| | 10. | Related Party Transaction
| | --- | -------------------------







Our hosting services agreement involves
a related party transaction in that one of our outside directors is an executive officer with the parent company of our
hosting services provider.







| | 11. | Subsequent Events
| | --- | -----------------



Recent Amendment to the Loan Agreement



On July 11, 2012 but effective
as of June 28, 2012, the Company and SVB entered into that certain Eighth Amendment to Amended and Restated Loan and Security Agreement
pursuant to which the Company and SVB agreed to (i) extend the maturity date of the asset-based accounts receivable line of credit
to September 26, 2012 and (ii) reduce the amount available under the account receivable line of credit from $1,250,000 to $764,000
through August 27, 2012 and $468,750 thereafter until September 26, 2012. The Company paid a $2,000 amendment fee to SVB in connection
with this amendment.



Factoring Facility



On July 13, 2012, the Company
and Porter Capital Corporation (“PCC”) entered into a certain Recourse Receivables Purchase & Security Agreement
pursuant to which PCC has agreed to purchase from the Company certain of its accounts receivable from time to time (the “Factoring
Agreement”).  The Factoring Agreement provides, among other things, that (i) the line of credit will be $1,000,000 measured
as the unpaid face amount of all purchased receivables at any given time; (ii) the initial term of the facility will be one year
with automatic one-year renewals unless the Company elects in advance not to renew; (iii) the advance rate under the facility will
be 85% of the face amount of purchased receivables (the “Advance Amount”), with the remaining 15% being held in reserve
until the purchased receivable is paid in full, (iii) interest will accrue on the Advance Amount until the purchased receivable
is paid in full at an annual rate equal to (a) the greater of prime rate or 5%, plus (b) 1.75%; (iv) additional service fees will
accrue on the full face amount of each purchased receivable until such purchased receivable is paid in full at a rate of 0.90%
for each 30 days, or 0.03% per day; and (v) the Company will owe a minimum term fee if the fees paid to PCC during the initial
or any renewal term do not exceed a specified threshold based on maintaining an average throughput of $150,000 of receivables per
month.  In connection with entering into this factoring facility, the Company agreed to an origination fee of $7,500 when
it first accesses the facility.



Affiliate Debt Holder Letter
Agreement



On July 11, 2012, the Company
and the affiliate debt holders entered into a letter agreement pursuant to which such holders agreed to (i) waive the default under
their notes that has occurred and will continue to occur as a result of the Company’s failure to remain current on the interest
owed on these notes and (ii) agreed not to take any action against the Company for such defaults.  These agreements expire
on June 30, 2013.



Private Placement



In early August 2012, the Company
completed the initial closings of its private placement of units, with each unit consisting of (i) $1,000 in principal amount of
its 12% Senior Subordinated Convertible Notes due August 1, 2014 (the “Two-Year Notes”) and (ii) a five-year warrant
to purchase approximately 465.1 shares of the Company’s common stock at an exercise price of $0.43 per share.  In
connection with these initial closings, Company sold 75 units for a total purchase price of $75,000 to two investors. One of these
investors, who purchased 25 units, is a related party. The investors received in the aggregate $75,000 in Two-Year Notes and five-year
warrants to purchase a total of 34,882 shares of the Company’s common stock at an exercise price of $0.43 per share, with
such exercise price being subject to reduction in the event of certain dilutive equity issuances by the Company.  Holders
of the Two Year Notes have the right to convert the notes into shares of the Company’s common stock at a conversion price
of $0.43 per share, with such conversion price being subject to reduction in the event of certain dilutive equity issuances by
the Company. The Two-Year Notes accrue interest at a rate of 12% per annum payable monthly in arrears.  No principal
payments are required to be made on the Two-Year Notes until the maturity date, which is August 1, 2014.  The Two-Year
Notes will rank junior to the SVB bank debt (and, when accessed, the Company’s factoring facility with PCC) but senior to
all other Company debt, including the affiliate debt.  The Two-Year Notes will be secured by a second lien on all
of the assets of the Company which is junior only to the first lien securing the SVB bank debt (and, when accessed, the
Company’s factoring facility with PCC). The Company is in the process of assessing the value of the warrants, which will
be an Original Issue Discount (OID) to the Two-Year Notes.



17







Item 2.                     Management’s
Discussion and Analysis of Financial Condition and Results of Operations.



The following discussion and
analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed financial
statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and the audited financial statements and
notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2012.



Critical Accounting Policies



The following discussion and
analysis of our unaudited condensed 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 of America. 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 unaudited condensed financial statements (see Note 2 to the Financial Statements
included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2012), the following are critical
accounting policies, which may involve a higher degree of judgment, complexity and estimates.



Revenue Recognition



We recognize revenues associated
with our software products in accordance with the provisions of the Financial Accounting Standard Board (“FASB”)
Accounting Standards Codification (“ASC”) ASC Topic 985–605, Software Revenue Recognition.



We license software on a transactional
or a subscription fee basis. 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.  We also charge an
onboarding fee for implementation services when a customer chooses our cloud based service. If professional services that are essential
to the functionality of the software are provided in connection with the installation of the software licensed, revenue is recognized
when these services have been provided on a percentage of completion basis. In certain instances, we license our software products
under non-exclusive, non-transferable license agreements that involve services essential to the functionality of the software in
which case license revenue is recognized when services have been provided on the percentage of completion basis. 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 established in the agreement, but following any installation period of the software.
In certain instances, we enter into arrangements that include multiple elements, where fees are allocated to the various elements
based on vendor specific objective evidence of fair value.



Goodwill



The goodwill recorded on the
Company’s books is from the acquisition of US Dataworks, Inc. in fiscal year 2002 which remains the Company’s single
reporting unit. ASC Topic No. 350, Intangibles – Goodwill and Other Intangibles, requires goodwill for each reporting
unit of an entity 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.



ASC Topic No. 350 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 record an impairment of goodwill for either the
quarter ended June 30, 2012 or the year ended March 31, 2012. At the most recent testing date of March 31, 2012, the Company had
significant excess fair value over its carrying value of goodwill.



18







Goodwill is classified
as Level 3 within the fair value hierarchy.



Concentrations of Credit
Risk



We sell our products throughout
the United States and extend credit to our customers. We also perform ongoing credit evaluations of such customers. We do not obtain
collateral to secure our accounts receivable. We evaluate our accounts receivable on a regular basis for collectability and provide
for an allowance for potential credit losses as deemed necessary. Historically we have not experienced significant credit losses.



Two of our customers accounted
for 58% and 12%, respectively, of the total net revenues for the three months ended June 30, 2012. Three of our customers accounted
for 53%, 12% and 10%, respectively, of the total net revenues for the three months ended June 30, 2011.



At June 30, 2012, amounts due
from two of our customers accounted for 59% ($312,566) and 19% ($100,000), respectively, of accounts receivable. At June 30, 2011,
amounts due from three of our customers accounted for 51% ($338,698), 15% ($100,000), and 12% ($79,694), respectively, of accounts
receivable.



Results of Operations



The results of operations reflected
in this discussion include our operations for the three months ended June 30, 2012 and June 30, 2011.



Revenue



We generate revenues from (i)
licensing and supporting software with fees due on a transactional or subscription basis, (ii) licensing software with fees due
on the grant of the license and delivery of the software recognizing revenue as percentage of completion over the term of professional
services associated with the license, (iii) providing maintenance, enhancement and support for previously licensed products, (iv)
providing professional services and (v) reselling third party software in connection with our software.



|                                       |  | For the Three Months Ended June 30, |           |  |      |  
|-------------------------------------- |  | ----------------------------------- | --------- |  | ---- | -
|                                       |  | 2012                                |           |  | 2011 |  
|Software transactions and subscription |  | $                                   | 649,900   |  |      | $
|Software licensing                     |  |                                     | 2,432     |  |      |  
|Software maintenance                   |  |                                     | 166,918   |  |      |  
|Professional services                  |  |                                     | 392,425   |  |      |  
|Software resale                        |  |                                     | —         |  |      |  
|Total revenue                          |  | $                                   | 1,211,675 |  |      | $



Total revenue decreased by 23%
for the three months ended June 30, 2012 as compared to the three months ended June 30, 2011. For the three months ended June 30,
2012 as compared to the three months ended June 30, 2011, recurring revenue as a percentage of total revenue held constant and
non-recurring revenue as a percentage of total revenue decreased 23%. Recurring revenue consists of software transaction and subscription
revenue and software maintenance revenue, while non-recurring revenue consist of software licensing revenue, professional services
revenue and software resale revenue.



Software transactional and subscription
revenue decreased 5% for the three months ended June 30, 2012 as compared to the three months ended June 30, 2011 due to the loss
of a customer and fewer transactions processed.



Software license revenue is
recognized ratably over the period that related services are rendered.  Software license revenue decreased 97% for the
three months ended June 30, 2012, as compared to the three months ended June 30, 2011, due to a nonrecurring Clearingworks product
license upgrade recognized on percentage of completion of the associated professional fees that was completed in June 2011.



Software maintenance revenue
increased 18% for the three months ended June 30, 2012 as compared to the three months ended June 30, 2011 due to a new maintenance
contract that began in late June 2011.



Professional services revenue
decreased by 33% for the three months ended June 30, 2012 as compared to the three months ended June 30, 2011 due to the timing
of professional services engagements from a large customer as we were in between the end of one professional services engagement
and the start of a follow-on professional services engagement in addition to a decrease in consulting revenue from a large customer
in the three months ended June 30, 2012 compared to the prior year period.



19







Software resale revenues decreased
100% for the three months ended June 30, 2012 as compared to the three months ended June 30, 2011 related to sale of hardware that
was part of a professional services engagement that occurred in the prior year period.



Cost of Revenues



Cost of revenues includes personnel
costs associated with our software, maintenance, support, training and installation services of our on premise and cloud-computing
offerings.  Cost of revenues also includes the cost of other third party software resold in connection with our software.
Cost of revenues for the three months ended June 30, 2012 decreased by $73,425, or 13%, to $487,480 as compared to $560,905 for
the three months ended June 30, 2011. This decrease was due to a $62,673 decrease in cost of license software expense and a $9,839
decrease in outside services expenses associated with management’s cost reduction actions.



Operating Expenses



Total operating expenses for
the three months ended June 30, 2012 decreased by $51,430, or 5%, to $1,088,100 as compared to $1,139,530 for the three months
ended June 30, 2011.



Research
and development expenses for the three months ended June 30, 2012 decreased by $21,628, or 9%, as compared to the three months
ended June 30, 2011.The decrease was due to the research and development employees working on various consulting projects.



Sales and marketing expenses
for the three months ended June 30, 2012, as compared to the three months ended June 30, 2011, decreased by $24,525, or 8%. The
decrease is due to a decrease of $77,698 in sales and marketing outside services relating to expenses incurred from outside sales
engagement during the three months ended June 30, 2011 (which was terminated during the third quarter of fiscal year 2012), offset
by an increase of $39,126 in personnel expenses and $16,617 in commissions expense incurred in three months June 30, 2012 after
bringing the sales and marketing functions in-house.



General and administrative expenses
for the three months ended June 30, 2012 of $558,932, as compared to the three months ended June 30, 2011 of $558,209, remained
essentially constant.



Depreciation and amortization
expenses for the three months ended June 30, 2012 decreased by $6,000, or 24%, as compared to the three months ended June
30, 2011. This decrease is primarily due to property and equipment items attaining a fully depreciated state during the current
fiscal.



Other Expenses



Other
expenses, including interest expense and financing costs, for the three months ended June 30, 2012increasedby $26,110, or 18%, to $170,793 as compared to $144,683 for the three months ended June 30, 2011. The increase of $26,110 was primarily
due to increased interest expense of $25,215 during the three months ended June 30, 2012 from the interest charges occurring on
the deferred interest balance of the notes payable – related parties.



Net Loss



Net loss for the three months
ended June 30, 2012 increased by $262,503 to a net loss of $534,698 compared to a net loss of $272,195 for the three months ended
June 30, 2011. For details related to these losses, see the preceding discussions related to revenues, cost of revenues, operating
expenses and other income sections above.



Liquidity and Capital Resources



We have a history of experiencing
negative cash flow from operations and continue to operate under liquidity constraints. Over the years, we have put a number of
debt financings in place to address this ongoing situation. As of June 30, 2012, we have approximately $3.1 million of affiliate
debt coming due January 1, 2014 and $125,000 of debt coming due on August 1, 2013. We also have an accounts receivable line of
credit that was recently renewed through September 26, 2012. We have recently established a factoring facility that will replace
this line of credit before it terminates. As of June 30, 2012, we had $467,246 in accrued but unpaid interest on the affiliate
debt. Although we have had the right to pay the affiliate debt interest since March 2012, the affiliate debt holders have been
willing to defer a portion of the affiliate debt interest in order to accommodate the liquidity constraints. The affiliate debt
holders recently agreed to (i) waive the defaults arising from our inability to keep current on the affiliate debt interest payments
through June 30, 2013 and (ii) agreed not to take any action against us to collect this growing past due interest payment through
June 30, 2013. However, there can be no assurance that we will be current on these payments or enter into a similar agreement beyond
such date.



20







With respect to the $3.1 million
in principal payments due to the affiliate debt holders on January 1, 2014 and any unpaid interest thereon as of such date as well
as the $125,000 of debt coming due on August 1, 2013, We will have to either build enough cash to fund these payments when they
come due or we will have to come to an agreement with the holders of such debt to restructure the payment terms thereof or obtain
other adequate sources of debt or equity funding to retire this debt when it comes due.



We will need to increase revenues
from transaction and subscription based software license contracts and professional services agreements and software licenses to
achieve and sustain profitability.



We have taken a number of steps
to address and improve its liquidity.  These steps include additional rent abatements in fiscal 2013 in connection with the
negotiation of a renewal of our office lease and deferring interest payments on the affiliate debt, as needed.  Management
believes the processes put in place will fund its operations through March 31, 2013, and for a reasonable period of time thereafter. 
If our liquidity does not improve in a meaningful way, we will be forced to take additional steps to address the issue, the primary
one being raising additional equity and/or debt capital.  However, there can be no assurance that we would be successful in
attempting to raise such capital.



Cash and cash equivalents at
June 30, 2012 were $79,222 as compared to $81,985 at March 31, 2012.



Cash used by operating activities
for the three months ended June 30, 2012 was $177,934, which consisted of net loss of $534,648, offset by noncash expenses of $96,066
and changes in working capital of $260,698.



Cash used by investing activities
for the three months ended June 30, 2012 was $8,580, representing minimal capital expenditures during the period.



Cash provided by financing activities
for the three months ended June 30, 2012 was $183,751, resulting from increased borrowing, net of payments, from line of credit
of $184,576 for the three months ended June 30, 2012.



Item 3.                     Quantitative and Qualitative
Disclosures about Market Risk



Not applicable.



Item 4.                     Controls and Procedures



Disclosure controls and
procedures. We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e)
under the Securities Exchange Act of 1934, or the Exchange Act, that are designed to ensure that information required to be disclosed
by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time
periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated
to our management, including our Chief Executive Officer and Chief Financial Officer, or persons performing similar functions,
as appropriate, to allow timely decisions regarding required disclosure.  In designing and evaluating our disclosure
controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated,
can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our
disclosure controls and procedures have been designed to meet reasonable assurance standards. Additionally, in designing disclosure
controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship
of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon
certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving
its stated goals under all potential future conditions.



Based on their evaluation as of the end of the period
covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer, or persons performing similar
functions, have concluded that, as of that date, our disclosure controls were effective at the reasonable assurance level.



Changes in internal control
over financial reporting.  There were no changes in our internal control over financial reporting (as defined
in Rule 13a-15(f) under the Exchange Act) identified in connection with management’s evaluation during our last fiscal
quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



PART II - OTHER INFORMATION



Item 1.                                            Legal Proceedings



From time to time, we may become
involved in various legal and other proceedings that are incidental to the conduct of our business. We are currently not involved
in any such legal proceedings.



21







Item 1A.                                         Risk Factors



There have been no material
changes in our risk factors disclosed in our Annual Report on Form 10-K for the year ended March 31, 2012 filed with the SEC
on July 13, 2012 under “Item 1A. Risk Factors.”



Item 2.                Unregistered
Sales of Equity Securities and Use of Proceeds



In
June 2012, the Company and the holders of certain notes and warrants entered into certain amendments to these securities that involved
the issuance of a new set of notes and warrants in exchange for the securities then held by such investors. Warrants to purchase
a total of 58,138 shares of the Company’s common stock were issued in connection with this exchange of securities. The warrants
were issued under the exemption from registration provided by Section 3(a)(9) of the Securities Act of 1933, as amended (the “Securities
Act”), in that the issuance involved an exchange by the Company with its existing security holders where no commission or
other remuneration was paid or given directly or indirectly for soliciting such exchange. In addition, the Company believes that
the issuance of the warrants qualifies forthe exemption from registration provided by Section 4(2) of the Securities Act
of 1933 in that the issuance of such warrants was a transaction by the Company not involving a public offering.  Facts
supporting the applicability of this exemption include that (i) the investors receiving the warrants certified to the Company in
writing that they were “accredited investors” and are sophisticated, knowledgeable and experienced investors, (ii)
the warrants were issued through direct negotiations and did not involve general solicitation, (iii) the investors receiving the
warrants represented to the Company in writing that they were acquiring the warrants and, upon exercise of the warrants, will acquire
the securities underlying the warrants, for their own account and  not with a view to the resale or distribution thereof
and (iv) the investors receiving the warrants agreed in writing that the warrants are not transferrable except in certain limited
circumstances and that the warrants (and the securities underlying the warrants) will be transferred only in strict compliance
with Rule 144.



Item 3.                Defaults
Upon Senior Securities



During the three months ended
June 30, 2012, the Company was in default under the Refinance Notes for its failure to remain current on the interest payments
due thereon. In July 2012, the holders of the Refinance Notes waived this default in writing effective through June 30, 2103.



Item 4.               Mine
Safety Disclosures



Not applicable.



Item 5.               Other
Information



None.



Item 6.               Exhibits



Listed below are the
exhibits required by Item 601 of Regulation S-K.



|Exhibit
        Number |  | Description of Document                                                                                                                                                                                                                                                          
|---------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                       |  |                                                                                                                                                                                                                                                                                  
|10.1                   |  | Eighth Amendment to Amended and Restated Loan and Security Agreement by and between US Dataworks, Inc. and Silicon Valley Bank dated July 11, 2012 (incorporated by reference to Exhibit 10.42 to the Registrant’s Annual Report on Form 10-K for the year ended March 31, 2012).
|                       |  |                                                                                                                                                                                                                                                                                  
|10.2                   |  | Recourse Receivables Purchase & Security Agreement by and between Porter Capital Corporation and US Dataworks, Inc. dated July 13, 2012 (incorporated by reference to Exhibit 10.43 to the Registrant’s Annual Report on Form 10-K for the year ended March 31, 2012).           
|                       |  |                                                                                                                                                                                                                                                                                  
|10.3                   |  | Letter Agreement by and among US Dataworks, Inc., Charles E. Ramey and John L. Nicholson, M.D. dated July 11, 2012 (incorporated by reference to Exhibit 10.44 to the Registrant’s Annual Report on Form 10-K for the year ended March 31, 2012).                                
|                       |  |                                                                                                                                                                                                                                                                                  
|31.1*                  |  | Section 302 Certification of Chief Executive Officer.                                                                                                                                                                                                                            
|                       |  |                                                                                                                                                                                                                                                                                  
|31.2*                  |  | Section 302 Certification of Chief Financial Officer.                                                                                                                                                                                                                            
|                       |  |                                                                                                                                                                                                                                                                                  
|32.1*                  |  | Section 906 Certification of Chief Executive Officer.                                                                                                                                                                                                                            
|                       |  |                                                                                                                                                                                                                                                                                  
|32.2*                  |  | Section 906 Certification of Chief Financial Officer.                                                                                                                                                                                                                            
|                       |  |                                                                                                                                                                                                                                                                                  
|101*                   |  | Interactive Data File                                                                                                                                                                                                                                                            



---

*Filed herewith



22







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
14, 2012

| | US DATAWORKS, INC.
| | ------------------
| |                   
| | By:               
| |                   
| |                   
| |                   



| | By: | /s/ Randall J. Frapart       
| | --- | -----------------------------
| |     | Randall J. Frapart           
| |     | Chief Financial Officer      
| |     | (Principal Financial Officer)



23







EXHIBIT INDEX



|Exhibit
        Number |  | Description of Document                                                                                                                                                                                                                                                          
|---------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                       |  |                                                                                                                                                                                                                                                                                  
|10.1                   |  | Eighth Amendment to Amended and Restated Loan and Security Agreement by and between US Dataworks, Inc. and Silicon Valley Bank dated July 11, 2012 (incorporated by reference to Exhibit 10.42 to the Registrant’s Annual Report on Form 10-K for the year ended March 31, 2012).
|                       |  |                                                                                                                                                                                                                                                                                  
|10.2                   |  | Recourse Receivables Purchase & Security Agreement by and between Porter Capital Corporation and US Dataworks, Inc. dated July 13, 2012 (incorporated by reference to Exhibit 10.43 to the Registrant’s Annual Report on Form 10-K for the year ended March 31, 2012).           
|                       |  |                                                                                                                                                                                                                                                                                  
|10.3                   |  | Letter Agreement by and among US Dataworks, Inc., Charles E. Ramey and John L. Nicholson, M.D. dated July 11, 2012 (incorporated by reference to Exhibit 10.44 to the Registrant’s Annual Report on Form 10-K for the year ended March 31, 2012).                                
|                       |  |                                                                                                                                                                                                                                                                                  
|31.1*                  |  | Section 302 Certification of Chief Executive Officer.                                                                                                                                                                                                                            
|                       |  |                                                                                                                                                                                                                                                                                  
|31.2*                  |  | Section 302 Certification of Chief Financial Officer.                                                                                                                                                                                                                            
|                       |  |                                                                                                                                                                                                                                                                                  
|32.1*                  |  | Section 906 Certification of Chief Executive Officer.                                                                                                                                                                                                                            
|                       |  |                                                                                                                                                                                                                                                                                  
|32.2*                  |  | Section 906 Certification of Chief Financial Officer.                                                                                                                                                                                                                            
|                       |  |                                                                                                                                                                                                                                                                                  
|101*                   |  | Interactive Data File                                                                                                                                                                                                                                                            



---

*Filed herewith



24