UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington
D.C., 20549


________________




FORM
10-Q


________________




(Mark
One)





R
            QUARTERLY REPORT UNDER SECTION
      13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
the quarterly period ended December 31, 2008





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





For
the transition
period                      to





Commission
file number: 001-15835





US
Dataworks, Inc.


(Exact
name of small business issuer 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
                Sugar Land,
      Texas
              77478(Address
      of principal executive offices)
              (Zip
      Code)





Issuer’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. YES R
NO £





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
                  R(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 £ NO R





Number of
shares of Common Stock outstanding as of February 4, 2009:
32,730,870













US
DATAWORKS, INC.





TABLE OF
CONTENTS





FORM
10-Q





QUARTERLY
PERIOD ENDED DECEMBER 31, 2008




PagePART
      I — FINANCIAL INFORMATIONItem
      1. Financial Statements
                3Item
      2. Management’s Discussion and Analysis of Financial Condition and Results
      of Operation
                17Item
      4T. Controls and Procedures
                22PART
      II — OTHER INFORMATIONItem
      1. Legal Proceedings
                23Item
      1A. Risk Factors
                23Item
      6. Exhibits
                27




2


PART
I — FINANCIAL INFORMATION





Item
1. Financial Statements





US
DATAWORKS, INC.





BALANCE
SHEETS





Dec
      31,
                  2008
                  (Unaudited)
                
                
                March
      31,
                  2008
                  (See
      note)ASSETSCurrent
      assets:Cash
      and cash equivalents
                
                $
                505,826
                
                
                $
                903,393Accounts
      receivable, trade
                
                
                939,753
                
                
                
                856,261Prepaid
      expenses and other current assets
                
                
                88,153
                
                
                
                145,915Total
      current assets
                
                
                1,533,732
                
                
                
                1,905,569Property
      and equipment, net
                
                
                350,248
                
                
                
                478,687Goodwill,
      net
                
                
                4,020,698
                
                
                
                4,020,698Other
      assets
                
                
                302,523
                
                
                
                357,124Total
      assets
                
                $
                6,207,201
                
                
                $
                6,762,078





Note: The
balance sheet at March 31, 2008 has been derived from the audited financial
statements at that date but does not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements.





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


3


US
DATAWORKS, INC.





BALANCE
SHEETS





Dec
      31,
                  2008
                  (Unaudited)
                
                
                March
      31,
                  2008
                  (See
      note)LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Note
      payable, current
                
                $
                35,279
                
                
                $
                35,279Notes
      payable — related party
                
                
                4,203,500
                
                
                
                —Deferred
      revenue — current
                
                
                339,456
                
                
                
                200,833Accounts
      payable
                
                
                267,648
                
                
                
                271,677Accrued
      expenses
                
                
                172,046
                
                
                
                366,538Interest
      payable — related parties
                
                
                70,902
                
                
                
                18,188Derivative
      — compounded  embedded
                
                
                —
                
                
                
                353,749Derivative
      — warrants
                
                
                —
                
                
                
                267,532Total
      current liabilities
                
                
                5,088,831
                
                
                
                1,513,796Long
      term Note Payable
                
                
                26,459
                
                
                
                52,918Long
      term Note Payable, related party
                
                
                —
                
                
                
                500,000Long
      term convertible promissory note, net unamortized discount of
      $1,995,636
                
                
                —
                
                
                
                2,004,364Total
      long term liabilities
                
                
                26,459
                
                
                
                2,557,282Total
      liabilities
                
                
                5,115,290
                
                
                
                4,071,078Commitments
      and ContingenciesStockholders’
      Equity:Convertible
      Series B preferred stock, $0.0001 par value 700,000 shares authorized,
      109,333 shares issued and outstanding $3.75 liquidation preference,
      dividends of $324,671 in arrears
                
                
                55
                
                
                
                55Common
      stock, $0.0001 par value  90,000,000 shares authorized and
      32,598,517 issued and outstanding
                
                
                3,260
                
                
                
                3,206Additional
      paid—in capital
                
                
                64,997,162
                
                
                
                64,778,977Accumulated
      deficit
                
                
                (63,908,566
                )
                
                
                (62,091,238
                )Total
      stockholders’ equity
                
                
                1,091,911
                
                
                
                2,691,000Total
      liabilities and stockholders’ equity
                
                $
                6,207,201
                
                
                $
                6,762,078





Note: The
balance sheet at March 31, 2008 has been derived from the audited financial
statements at that date but does not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements.





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


4


US
DATAWORKS, INC.


UNAUDITED
CONDENSED STATEMENTS OF OPERATIONS





For
      the Three Months Ended
                  December
      31,
                
                
                For
      the Nine Months Ended
                  December
      31,2008
                
                
                2007
                
                
                2008
                
                
                2007REVENUESSoftware
      licensing revenues
                
                $
                36,508
                
                
                $
                182,911
                
                
                $
                66,508
                
                
                $
                289,833Software
      transactional revenues
                
                
                540,787
                
                
                
                445,654
                
                
                
                1,601,291
                
                
                
                1,225,043Software
      maintenance revenues
                
                
                217,775
                
                
                
                233,010
                
                
                
                666,257
                
                
                
                658,019Professional
      service revenues
                
                
                1,204,941
                
                
                
                669,654
                
                
                
                3,765,741
                
                
                
                1,953,490Total
      revenues
                
                
                2,000,011
                
                
                
                1,531,229
                
                
                
                6,099,797
                
                
                
                4,126,385COST
      OF SALES
                
                
                564,257
                
                
                
                574,230
                
                
                
                1,607,517
                
                
                
                1,469,312Gross
      profit
                
                
                1,435,754
                
                
                
                956,999
                
                
                
                4,492,280
                
                
                
                2,657,073OPERATING
      EXPENSESGeneral
      and administrative
                
                
                1,028,983
                
                
                
                1,375,756
                
                
                
                3,719,426
                
                
                
                4,659,534Depreciation
      and amortization
                
                
                46,745
                
                
                
                48,190
                
                
                
                142,978
                
                
                
                133,003Goodwill
      impairment
                
                
                —
                
                
                
                5,932,184
                
                
                
                —
                
                
                
                5,932,184Total
      operating expense
                
                
                1,075,728
                
                
                
                7,356,130
                
                
                
                3,862,404
                
                
                
                10,724,721OPERATING
      INCOME/(LOSS)
                
                
                360,026
                
                
                
                (6,399,131
                )
                
                
                629,876
                
                
                
                (8,067,648
                )OTHER
      INCOME (EXPENSE)Financing
      costs
                
                
                —
                
                
                
                (86,704
                )
                
                
                (329,692
                )
                
                
                (112,680
                )Interest
      expense
                
                
                (109,601
                )
                
                
                (157,721
                )
                
                
                (2,603,020
                )
                
                
                (170,524
                )Interest
      expense — related party
                
                
                (128,197
                )
                
                
                (14,714
                )
                
                
                (207,026
                )
                
                
                (36,589
                )Loss
      on disposal of assets
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (44,231
                )Gain/(Loss)
      on derivatives
                
                
                —
                
                
                
                1,099,284
                
                
                
                621,281
                
                
                
                1,157,666Other
      income
                
                
                11,622
                
                
                
                7,783
                
                
                
                71,255
                
                
                
                7,783Total
      other income (expense)
                
                
                (226,176
                )
                
                
                847,928
                
                
                
                (2,447,202
                )
                
                
                801,425INCOME/(LOSS)
      BEFORE PROVISION FOR INCOME TAXES
                
                
                133,850
                
                
                
                (5,551,203
                )
                
                
                (1,817,326
                )
                
                
                (7,266,223
                )PROVISION
      FOR INCOME TAXES
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —NET
      INCOME/(LOSS)
                
                $
                133,850
                
                
                $
                (5,551,203
                )
                
                $
                (1,817,326
                )
                
                $
                (7,266,223
                )EARNINGS/(LOSS)
      PER SHAREATTRIBUTABLE
      TO COMMON STOCKBasic
      and diluted earnings/(loss) per share
                
                $
                0.00
                
                
                $
                (0.17
                )
                
                $
                (0.06
                )
                
                $
                (0.23
                )Basic
      and diluted weighted-average shares outstanding
                
                
                32,569,017
                
                
                
                32,062,962
                
                
                
                32,361,717
                
                
                
                31,638,735





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


5


US
DATAWORKS, INC.





UNAUDITED
CONDENSED STATEMENTS OF CASH FLOW





For
the Nine Months Ended December 31,





(Unaudited)





2008
                
                
                2007Cash
      flows from operating activities:-Net
      loss
                
                $
                (1,817,327
                )
                
                $
                (7,266,223
                )Adjustments
      to reconcile net loss to net cash provided by/(used in) operating
      activities:Depreciation
      and amortization of property and equipment
                
                
                142,978
                
                
                
                133,003Amortization
      of note discount on convertible promissory note
                
                
                1,995,636
                
                
                
                83,657Amortization
      of deferred financing costs
                
                
                487,260
                
                
                
                15,489Compensatory
      element of warrants associated with financing costs
                
                
                —
                
                
                
                66,447Gain  on
      disposition of assets
                
                
                —
                
                
                
                44,231Stock
      based compensation
                
                
                218,238
                
                
                
                291,904(Gain)
      on derivatives
                
                
                (621,281
                )
                
                
                (1,157,666
                )Goodwill
      impairment
                
                
                —
                
                
                
                5,932,184Changes
      in operating assets and liabilities:Accounts
      receivable, net
                
                
                (83,492
                )
                
                
                1,207,674Prepaid
      expenses and other current assets
                
                
                57,762
                
                
                
                (44,188
                )Other
      assets
                
                
                —
                
                
                
                (1,777
                )Deferred
      revenue
                
                
                138,623
                
                
                
                (267,334
                )Accounts
      payable
                
                
                (4,029
                )
                
                
                (753,749
                )Accrued
      expenses
                
                
                (194,492
                )
                
                
                (603,771
                )Interest
      payable
                
                
                52,713
                
                
                
                (18,858
                )Net
      cash provided by/(used in) operating activities
                
                
                372,589
                
                
                
                (2,338,977
                )Cash
      flows from investing activities:Purchase
      of property and equipment
                
                
                (14,537
                )
                
                
                (107,280
                )Proceeds
      from sales of fixed assets
                
                
                —
                
                
                
                10,850Net
      cash used in investing activities
                
                
                (14,537
                )
                
                
                (96,430
                )





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


6


US
DATAWORKS, INC.





UNAUDITED
CONDENSED STATEMENTS OF CASH FLOW





For
the Nine Months Ended December 31,





(Unaudited)





2008
                  
                  
                  2007Cash
      flows from financing activities:Proceeds
      from related party note payable
                  
                  
                  3,703,500
                  
                  
                  
                  —Proceeds
      from convertible promissory note
                  
                  
                  —
                  
                  
                  
                  4,000,000Repayment
      of note payable — related party
                  
                  
                  —
                  
                  
                  
                  (39,000
                  )Repayment
      of convertible promissory note
                  
                  
                  (4,000,000
                  )
                  
                  
                  (256,066
                  )Proceeds
      from stock sale
                  
                  
                  —
                  
                  
                  
                  305,000Deferred
      financing costs
                  
                  
                  (432,659
                  )
                  
                  
                  (370,004
                  )Payments
      on  note payable
                  
                  
                  (26,460
                  )
                  
                  
                  (11,760
                  )Net
      cash (used in) /provided by financing activities
                  
                  
                  (755,619
                  )
                  
                  
                  3,628,170Net
      (decrease)/increase in cash and cash equivalents
                  
                  
                  (397,567
                  )
                  
                  
                  1,192,763Cash
      and cash equivalents, beginning of period
                  
                  
                  903,393
                  
                  
                  
                  140,276Cash
      and cash equivalents, end of period
                  
                  $
                  505,826
                  
                  
                  $
                  1,333,039Supplemental
      disclosures of cash flow information:Interest
      paid
                  
                  $
                  366,854
                  
                  
                  $
                  48,918





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


7


US
DATAWORKS, INC.





NOTES
TO UNAUDITED FINANCIAL STATEMENTS





1.
            Organization
      and Business





General





US
Dataworks, Inc. (the “Company”), a Nevada corporation, develops, markets, and
supports payment processing software for the financial services industry. Its
customer base includes many of the largest financial institutions as well as
credit card companies, government institutions, and high-volume merchants in the
United States. The Company was formerly known as Sonicport, Inc.





2.
            Summary
      of Significant Accounting
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. 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 2008 Annual Report.
The results of operations for interim periods are not necessarily indicative of
the results for any subsequent quarter or the entire year ending March 31,
2009.





Revenue
Recognition





The
Company recognizes revenues associated with our software services in accordance
with the provisions of the American Institute of Certified Public Accountants’
Statement of Position 97-2, “Software Revenue Recognition” (“SOP 97-2”). The
Company licenses its software products under nonexclusive, nontransferable
license agreements. These arrangements do not require significant production,
modification, or customization. Therefore, revenue is recognized when such a
license agreement has been signed, delivery of the software product has
occurred, the related fee is fixed or determinable, and collectibility is
probable.





In
certain instances, the Company licenses its software on a transactional fee
basis in lieu of an up-front licensing fee. In these arrangements, the customer
is charged a fee based upon the number of items processed by the software and
the Company recognizes revenue as these transactions occur. The transaction fee
also includes the provision of standard maintenance and support services as well
as product upgrades should such upgrades become available.





If
professional services were provided in conjunction with the installation of the
software licensed, revenue is recognized when these services have been
provided.





In
certain instances, the Company will recognize revenue on a percent of completion
basis for the portion of professional services related to customized customer
projects that have been completed but are not yet deliverable to
customer.





For
license agreements that include a separately identifiable fee for contracted
maintenance services, such maintenance revenues are recognized on a
straight-line basis over the life of the maintenance agreement noted in the
agreement, but following any installation period of the software.




8




Goodwill





The
goodwill recorded on the Company’s books is from the acquisition of US
Dataworks, Inc. in fiscal year 2001, which remains the Company’s single
reporting unit. Statement of Financial Accounting Standards
(“SFAS”) No. 142 “Goodwill and Other Intangible Assets,” 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.





SFAS No.
142 requires goodwill to be tested annually, typically performed during the
fourth quarter, 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 recorded an impairment of goodwill of
$10,112,931 for the year ended March 31, 2008 and does not have an impairment of
goodwill to record for the nine months ended December 31, 2008





Convertible
Debt Financing — Derivative Liabilities





The
Company reviews the terms of convertible debt and equity instruments issued to
determine whether there are embedded derivative instruments, including embedded
conversion options that are required to be bifurcated and accounted for
separately as a derivative financial instrument. In circumstances where the
convertible instrument contains more than one embedded derivative instrument,
including the conversion option, that is required to be bifurcated, the
bifurcated derivative instruments are accounted for as a single, compound
derivative instrument. Also, in connection with the sale of convertible debt and
equity instruments, the Company may issue freestanding options or warrants that
may, depending on their terms, be accounted for as derivative instrument
liabilities, rather than as equity.





In
accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging
Activities,” as amended, the convertible debt holder’s conversion right
provision, interest rate adjustment provision, liquidated damages clause, cash
premium option, and the redemption option (collectively, the debt features)
contained in the terms governing the convertible notes are not clearly and
closely related to the characteristics of the notes. Accordingly, the features
qualify as embedded derivative instruments at issuance and, because they do not
qualify for any scope exception within SFAS 133, they are required by SFAS 133
to be accounted for separately from the debt instrument and recorded as
derivative instrument liabilities.





Stock
Options





The
Company’s financial statements as of and for the three and nine months ended
December  31, 2008 and 2007, reflect the impact of SFAS No. 123R,
“Share-Based Payment (as amended)”. Stock-based compensation expense recognized
under SFAS No. 123R for the three and nine months ended December 31, 2008 was
$32,033 and $218,238 respectively, and $47,860 and $291,904 respectively for the
three and nine months ended December 31, 2007, which consists of stock-based
compensation expense related to employee and director stock options and
restricted stock issuances.




SFAS No.
123R requires companies to estimate the fair value of share-based payment awards
on the date of grant using an option-pricing model. The value of the portion of
the award that is ultimately expected to vest is recognized as expense over the
requisite service periods in the Company’s statement of operations.





For
purposes of pro forma disclosure, the Company expenses the estimated fair value
of the over  the option’s vesting period. The Company’s pro forma
information for the three months and nine months ended December 31, 2008 and
2007 is as follows:





For
      the Three Months
                      Ending Dec 31,
                    
                    
                    For
      the Nine Months
                      Ending Dec 31,2008
                    
                    
                    2007
                    
                    
                    2008
                    
                    
                    2007Net
      Income/(Loss) as reported
                    
                    $
                    133,850
                    
                    
                    $
                    (5,551,203
                    )
                    
                    $
                    (1,817,326
                    )
                    
                    $
                    (7,266,223
                    )Add
      stock-based employee compensation expense included in net loss as
      reported, net of related tax effects
                    
                    $
                    32,033
                    
                    
                    $
                    47,860
                    
                    
                    $
                    218,238
                    
                    
                    $
                    291,904Net
      Income/(loss), pro forma
                    
                    $
                    165,883
                    
                    
                    $
                    (5,503,343
                    )
                    
                    $
                    (1,599,088
                    )
                    
                    $
                    (6,974,319
                    )Basic
      and diluted gain/(loss) per share, as reported
                    
                    $
                    (0.00
                    )
                    
                    $
                    (0.17
                    )
                    
                    $
                    (0.06
                    )
                    
                    $
                    (0.23
                    )Basic
      and diluted gain/(loss) per share, pro forma
                    
                    $
                    (0.00
                    )
                    
                    $
                    (0.17
                    )
                    
                    $
                    (0.06
                    )
                    
                    $
                    (0.22
                    )




9




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 and nine months ended December 31, 2008 is
based on awards ultimately expected to vest, it has been reduced for estimated
forfeitures as per the tables below.





The
Company uses 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. In determining the compensation cost
of the options granted during the three and nine months ended December 31, 2008,
as specified by SFAS No. 123R, the fair value of each option grant has been
estimated on the date of grant using the Black-Scholes pricing model and the
weighted average assumptions used in these calculations are summarized as
follows:





For
      the Three Months Ending
                                    
                                    
                                    For
      the Nine Months EndingDecember
      31,
                                    
                                    
                                    December
      31,2008
                                    
                                    
                                    2007
                                    
                                    
                                    2008
                                    
                                    
                                    2007Risk-free
      Interest Rate
                                    
                                    N/A
                                    
                                    
                                    
                                    4.30
                                    %
                                    
                                    
                                    2.43
                                    %
                                    
                                    
                                    4.56
                                    %Expected
      Life of Options Granted
                                    
                                    N/A
                                    
                                    
                                    3
      years
                                    
                                    
                                    3
      years
                                    
                                    
                                    3
      yearsExpected
      Volatility
                                    
                                    N/A
                                    
                                    
                                    
                                    67
                                    %
                                    
                                    
                                    189
                                    %
                                    
                                    
                                    72
                                    %Expected
      Dividend Yield
                                    
                                    N/A
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    0Expected
      Forfeiture Rate
                                    
                                    N/A
                                    
                                    
                                    
                                    30
                                    %
                                    
                                    
                                    0.0
                                    %
                                    
                                    
                                    30
                                    %


As of
December 31, 2008, there was approximately $104,207 of total unrecognized
compensation cost related to nonvested share-based compensation arrangements,
which is expected to be recognized over a period of 3 years.





Earnings/(Loss) per
Share





The
Company calculates earnings/(loss) per share in accordance with SFAS No. 128,
“Earnings per Share.” Basic earnings/(loss) per share is computed by dividing
the net loss by the weighted-average number of common shares outstanding.
Diluted earnings/(loss) per share is computed in a similar manner to basic
earnings/(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.





The
following potential common stock equivalents have been excluded from the
computation of diluted net earnings/(loss) per share for the periods presented
because the effect would have been anti-dilutive (options and warrants typically
convert on a one-for-one basis, see conversion details of the preferred stock
stated below for the common stock shares issuable upon
conversion):





For
      the Nine Months Ended
                      December
      31,2008
                    
                    
                    2007Options
      outstanding under the Company’s stock option plans
                    
                    
                    7,004,220
                    
                    
                    
                    7,383,349Options
      granted outside the Company’s stock option plans
                    
                    
                    1,160,000
                    
                    
                    
                    1,160,000Warrants
      issued in conjunction with private placements
                    
                    
                    3,538,201
                    
                    
                    
                    5,288,683Warrants
      issued as a financing cost for notes payable and convertible notes
      payable
                    
                    
                    4,651,163
                    
                    
                    
                    6,342,413Warrants
      issued for services rendered and litigation settlement
                    
                    
                    200,000
                    
                    
                    
                    380,769Warrants
      issued as consideration for note extension
                    
                    
                    200,000
                    
                    
                    
                    200,000Convertible
      Series B preferred stock (a)
                    
                    
                    109,933
                    
                    
                    
                    109,933





(a)
            The
      Series B preferred stock is convertible into shares of common stock at a
      conversion price of $3.75 per
share.




10




Estimates





The
preparation of financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.





Concentrations
of Credit Risk





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





Two of
the Company’s customers accounted for 50% and 21%, respectively, of the
Company’s net revenues for the three months ended December 31, 2008. Two
customers accounted for 50% and 21%, respectively, of net revenues for the nine
months ended December 31, 2008. Four of the Company’s customers accounted for
30%, 23%, 15% and 10%, respectively, of the Company’s net revenues for the three
months ended December 31, 2007. Four customers accounted for 27%, 25%, 12% and
11%, respectively, of net revenues for the nine months ended December 31,
2007.





At
December 31, 2008, amounts due from these significant customers accounted for
50% of accounts receivable.





3.
            Property
      and Equipment





Property
and equipment as of December 31, 2008 consisted of the following:





Furniture
      and fixtures
                    
                    $
                    99,534Office
      and telephone equipment
                    
                    
                    182,275Computer
      equipment
                    
                    
                    734,544Computer
      software
                    
                    
                    1,271,098Leasehold
      improvements
                    
                    
                    64,7332,352,184Less
      accumulated depreciation and amortization
                    
                    
                    (2,001,936
                    )Total
                    
                    $
                    350,248





Depreciation
and amortization expense for the three and nine months ended December 31, 2008
and 2007 was $46,745, $48,190, $142,978 and $133,003, respectively.





4.
            Notes
      Payable — Related Parties





In
connection with the redemption of the Senior Secured Convertible Promissory
Notes due November 13, 2010 discussed below, the Company entered into
a Note Purchase Agreement and issued an aggregate of $3,703,500 Senior Secured
Notes due August 13, 2009 (“Refinance Notes”). The Refinance Notes were
purchased by the Company’s Chief Executive Officer and a member of its Board of
Directors (“Holders”). The Refinance Notes bear interest at a rate of 12% per
annum with interest payments due in arrears monthly.




Pursuant
to the Refinance Notes, if the Company fails to pay any amount of principal,
interest, or other amounts when and as due, then the Refinance Notes will bear
an interest rate of 18% until such time as the Company cures this default. In
addition, if the Company is subject to certain events of bankruptcy or
insolvency, the Refinance Notes provide that the Holders may redeem all or a
portion of the Refinance Notes.




The
Refinance Notes are secured by a Security Agreement, dated August 13, 2008, by
and between the Company and the Holders, pursuant to which the Company granted
the Holders a security interest in all its personal property, whether now owned
or hereafter acquired, including but not limited to, all accounts, copyrights,
trademarks, licenses, equipment and all proceeds as from such
collateral.




11




5.
            Convertible
      Promissory Notes




Senior Secured Convertible
promissory notes due November 13, 2010





On
November 13, 2007, the Company secured certain financing from certain
institutional investors (collectively, the “Investors”) in the form of senior
secured convertible notes (the “Notes”) for an aggregate of $4,000,000. The
interest payable on the Notes is equal to the 6-month LIBOR rate plus five
hundred basis points (or 9.7375% at the time of subscription) and is
recalculated as of the first day of each calendar quarter. The Notes may be
converted at any time into shares of the Company’s common stock (“Common Stock”)
at the conversion price of $0.43 per share, which is equal to 110% of the dollar
volume-weighted average price for the Common Stock on November 12, 2007, subject
to anti-dilution provisions; provided, however, the Investor may not
beneficially own more than 4.99% (the “Maximum Percentage”) of outstanding
shares of Common Stock following such conversion. At any time, the Investor may
decrease or increase this Maximum Percentage to any percentage not to exceed
9.99%. In the event of a Fundamental Transaction (as described in the Notes)
where greater than 50% of the Company’s assets or equity is transferred, the
Investors may redeem the note for either 125% of its principal balance or the
value of the Common Stock as converted (such Common Stock as converted under the
Notes, “Conversion Shares”).





In
addition, on each of the 9 month and 18 month anniversary of the closing, the
Investors may request that the Company redeem a portion of the Notes. The Notes
have a maturity date of November 13, 2010. The Notes are secured by the Security
Agreement, dated November 13, 2007, by and between the Company and the Investors
(the “Security Agreement”), pursuant to which the Company granted the Investors
a security interest in all its personal property, whether now owned or hereafter
acquired, including but not limited to, all accounts, copyrights, trademarks,
licenses, equipment and all proceeds as from such collateral.




The
Investors also entered into a Put Agreement (the “Put Agreement”) with the
Company’s Chief Executive Officer, and a member of the Company’s Board of
Directors (collectively, the “Put Grantors”). Pursuant to the Put Agreement,
following August 13, 2008, under certain circumstances the Investors may require
one or more of the Put Grantors to purchase all or a portion of the Note,
including any accrued interest or late charges.





In
consideration for entering into the Put Agreement, the Company is paying the Put
Grantors a fee (the “Put Grantor Fee”) equal to: (i) an initial installment of
two percent (2%) of the outstanding Note principal for initial six months of the
Note’s term; (ii) then, an additional fee equal to two percent (2%) of the
outstanding Note principal for the following twelve months; and, (iii) a final
installment equal to two percent (2%) of the outstanding Note principal for the
remaining 18 months of the Note’s term. The Put Grantor Fee will be shared
equally by the Put Grantors and will accrue immediately upon the start of each
of the time periods described by subsection (i), (ii) and (iii), above. The Put
Grantor Fee is not payable until after the complete satisfaction of the
Note.





In
connection with the issuance of the Notes, the Company has also issued to the
Investors warrants (the “Warrants”) to purchase an aggregate of 4,651,162 shares
of Common Stock (such Common Stock exercisable from the Warrants, “Warrant
Shares”) at the exercise price of $0.43 per share, which is equal to 110% of the
dollar volume-weighted average price for the Common Stock on November 12, 2007,
subject to anti-dilution provisions; provided, however, the Investor may not
beneficially own more than the Maximum Percentage following such exercise. The
Warrant may be exercised at any time until 11:59 p.m., New York time on November
13, 2012.





The
Company is obligated to reserve for issuance upon conversion of the Notes and
exercise of the Warrants shares of Common Stock equal to at least 130% of the
Conversion Shares and Warrant Shares. The Company filed a registration statement
in December 2007 to register the Conversion Shares and Warrant Shares. As of
June 30, 2008, this registration statement has not been declared
effective.




12




In
accordance with SFAS No. 133 “Accounting for Derivative Instruments and Hedging
Activities,” the debt features contained in the terms governing the notes are
not clearly and closely related to the characteristics of the notes.
Accordingly, the debt features qualify as embedded derivative instruments at
issuance and, because they did not qualify for any scope exception within SFAS
133, they were required to be accounted for separately from the debt instrument
and recorded as derivative financial instruments.





At the
date of issuance, the embedded debt feature had an estimated initial fair value
of $960,714, which was recorded as a discount to the convertible notes and
derivative liability on our balance sheet. In subsequent periods, if the price
of the security changes, the embedded derivative financial instrument related to
the debt features will be adjusted to the fair value with the corresponding
charge or credit to other income/(expense). The estimated fair value of the debt
features was determined using the probability weighted averaged discounted cash
flows / Lattice Model with a closing price of $0.43, a conversion price as
defined in the respective note agreement and a period of three years. Concerning
the debt features, the model uses several assumptions including: projected stock
price volatility, annual stock price growth rate, interest rate projections, no
registration default, alternative financing availability, default status, holder
redeeming under default, ownership limitation, warrant exercise reset, fixed
conversion reset and trading volume to determine the estimated fair value of the
derivative liability. Due to the retirement of the debt on August 13, 2008, the
embedded derivative liability was terminated resulting in an other income item
of $359,527.





The
warrants included with this note for purchase of the Company’s common stock had
an initial value of $1,279,549. This amount has been classified as a derivative
financial instrument and recorded as discount to the convertible notes and
derivative liability on our balance sheet in accordance with SFAS No. 133. The
estimated fair value of the warrants at the date of issuance was determined
using the Black-Scholes option-pricing model with a closing price of $0.43, the
respective exercise price of the warrants, a 5 year term, and an 80% volatility
factor relative to the date of issuance. The model uses several assumptions
including: historical stock price volatility, approximate risk-free interest
rate (3.84%), remaining term to maturity, and the closing price of the company’s
common stock to determine the estimated fair value of the derivative liability.
In accordance with the provisions of SFAS No. 133, the Company is required to
adjust the carrying value of the instrument to its fair value at each balance
sheet date and recognize any change since the prior balance sheet date as a
component of other income/ (expense) on its statement of operations. Due to the
retirement of the debt on August 13, 2008, the embedded derivative liability
associated with the warrants was terminated resulting in an other income item of
$220,674.





The
recorded value of the warrants can fluctuate significantly based on fluctuations
in the market value of the underlying securities of the issuer of the warrants,
as well as in the volatility of the stock price during the term used for
observation and the term remaining for the warrants.





In June
2008, the Company received letters from each of the Investors purporting to
be Event of Default Redemption Notices (the “Notices”) pursuant to the Notes.
According to the Notices, the purported Event of Default was the failure of the
registration statement filed by the Company in December 2007 to register
the Conversion Shares and the Warrant Shares to be declared effective by May 12,
2008.




The Company
subsequently informed the Investors that, for reasons described to the
Investors, the Notices were defective and requested that each immediately
withdraw their respective Notice.





On July
15, 2008, the Company gave notice to the Investors of their respective rights of
optional redemption of the Notes on August 13, 2008. In respect thereto,
the Company received optional redemption notices from each of the Investors. On
August 13, 2008, the Company repaid principal of $4,000,000
and $38,808 of interest accrued on the principal from and including
July 1, 2008 through August 12, 2008.





6.
            Accounts
      Receivable Facility





On
September 27, 2006, the Company entered into a Purchase and Sale Agreement with
Catalyst Finance, L.P. (“Catalyst”) for sale of certain of its accounts
receivables. The Company’s borrowing costs under this Agreement range from 1.25%
to 20% of the gross amount of the receivables sold to Catalyst based on the
timing of collection. The maximum funds available under the agreement are all
available accounts receivables as agreed to by Catalyst and the Company. The
agreement allows for Catalyst to request repurchase of an account receivable
under certain conditions. The Agreement was terminated by the Company on August
2, 2007. For the three months ending December 31, 2007, the Company did not sale
any receivables under the agreement. For the nine months ending December 31,
2007, the Company sold $297,105 in receivables under the agreement, which
yielded a loss on the sale of those receivables of $9,674.




13




7.
            Commitments
      and Contingencies





Employment
Agreements





On May 1
and May 15, 2008, the Company accepted the resignation of Messrs. John Figone
and Terry Stepanik, respectively, and as part of the Company’s restructuring, on
June 12, 2008, it entered into a new Employment Agreement (the ‘Agreement”) with
Mr. Mario Villarreal in connection with his promotion to President and Chief
Operating Officer. Under the Agreement Mr. Villarreal will receive an annual
base salary of $185,000 for a term of one year. If Mr. Villarreal is terminated,
other than for cause, death or disability, or resigns within 60 days following a
material reduction in duties or a material reduction in compensation within six
months following a change of control, Mr. Villarreal is entitled to receive a
lump sum payment equal to one-half (0.5) times his annual base salary and any
unpaid base salary and bonus, subject to compliance with certain ongoing
obligations and the delivery of a release to us.





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.





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 has a
liquidation preference of $3.75 per share and carries a 10% cumulative dividend
payable each March 1 and September 1. The Series B is convertible upon issuance
into common stock at $3.75 per share. The Company has the right to redeem the
Series B at any time after issuance at a redemption price of $4.15 per share,
plus any accrued but unpaid dividends.




Stock
Options





In August
1999, the Company implemented its 1999 Stock Option Plan (the “1999 Plan”). In
August 2000, the Company’s Board of Directors approved the 2000 Stock Option
Plan (the “2000 Plan”), which amends and restates the 1999 Plan. In September
2006, shareholders approved an amendment to the Company’s amended and restated
2000 Stock Option Plan to increase the maximum aggregate number of shares
available for issuance thereunder from 6,000,000 to 7,500,000. The exercise
price must not be less than the fair market value on the date of grant of the
option. The options vest in varying increments over varying periods and expire
10 years from the date of vesting. In the case of incentive stock options
granted to any 10% owners of the Company, the exercise price must not be less
than 100% of the fair market value on the date of grant. Such incentive stock
options vest in varying increments and expire five years from the date of
vesting.





During
the nine months ended December 31, 2008 the Company granted 483,335 stock
options to certain employees that may be exercised at prices ranging between
$0.48 and $0.61 per share. During the nine months ended December 31, 2007, the
Company granted 907,000 stock options to certain employees that may be exercised
at prices ranging between $0.48 and $0.61 per share.




14




The
following table summarizes certain information relative to stock
options:





2007
                    
                    
                    Outside of PlanWeighted-Average
                    
                    
                    
                    
                    
                    Weighted-AverageShares
                    
                    
                    Exercise price
                    
                    
                    Shares
                    
                    
                    Exercise priceOutstanding,
      March 31, 2008
                    
                    
                    7,521,349
                    
                    
                    $
                    0.70
                    
                    
                    
                    1,160,000
                    
                    
                    $
                    1.02Granted
                    
                    
                    483,335
                    
                    
                    $
                    0.26
                    
                    
                    
                    0
                    
                    
                    
                    0Exercised
                    
                    
                    0
                    
                    
                    
                    0
                    
                    
                    
                    0
                    
                    
                    
                    0Forfeited/canceled
                    
                    
                    (1,000,464
                    )
                    
                    $
                    0.60
                    
                    
                    
                    0
                    
                    
                    
                    0Outstanding,
      December 31, 2008
                    
                    
                    7,004,220
                    
                    
                    $
                    0.68
                    
                    
                    
                    1,160,000
                    
                    
                    $
                    1.02Exercisable,
      December 31, 2008
                    
                    
                    6,269,058
                    
                    
                    $
                    0.72
                    
                    
                    
                    1,160,000
                    
                    
                    $
                    1.02





The
weighted-average remaining life and the weighted-average exercise price of all
of the options outstanding at December 31, 2008 were 6.61 years and $0.77,
respectively. The exercise prices for the options outstanding at December 31,
2008 ranged from $0.15 to $6.25, and information relating to these options is as
follows:





Weighted-Weighted-
                          
                          
                          
                          
                          AverageAverage
                          
                          Weighted-
                          
                          
                          ExerciseRange
      of
                          
                          
                          Stock
                          
                          
                          Stock
                          
                          Remaining
                          
                          Average
                          
                          
                          Price
      ofExercise
                          
                          
                          Options
                          
                          
                          Options
                          
                          Contractual
                          
                          Exercise
                          
                          
                          OptionsPrices
                          
                          
                          Outstanding
                          
                          
                          Exercisable
                          
                          Life
                          
                          Price
                          
                          
                          Exercisable$0.15
      — 0.80
                          
                          
                          
                          5,718,884
                          
                          
                          
                          4,983,722
                          
                          7.09
      years
                          
                          $
                          0.53
                          
                          
                          $
                          0.55$0.81
      — 1.35
                          
                          
                          
                          1,734,836
                          
                          
                          
                          1,734,836
                          
                          5.62
      years
                          
                          $
                          0.93
                          
                          
                          $
                          0.93$1.36
      — 6.25
                          
                          
                          
                          710,500
                          
                          
                          
                          710,500
                          
                          5.13
      years
                          
                          $
                          1.88
                          
                          
                          $
                          1.888,164,220
                          
                          
                          
                          7,429,058





Warrants





The company issued a
convertible promissory note with interest at 10% annum in September 2004 with a
principal payment due date of Sept 2005.  In September 2005 this note
was amended and the principal payment due date was extended to September
2006.In consideration of this amendment, the Company issued the holder a
common stock purchase warrant to purchase up to 650,000 shares of the Company’s
common stock at an exercise price of $0.59 per share. The warrant expired on
September 15, 2008 without being exercised.





On June
16, 2005, the Company entered into a Securities Purchase Agreement with an
institutional investor (the “Debenture Agreement”) for the sale of a convertible
debenture with a principal amount of $770,000 and an original issue discount of
$70,000 for gross proceeds of $700,000. This convertible note was paid in full
in March 2007. In connection with the Debenture Agreement, the Company issued
Long Term warrants to the institutional investor. The Long Term Warrants allow
the institutional investor to purchase an aggregate of 471,154 shares of the
Company’s common stock with an exercise price of $0.572 per share exercisable at
anytime through June 16, 2008. In June 2008, the warrants associated with this
note expired without being exercised.





Restricted
Stock





During
the three and nine months ended December 31, 2008, the Company completed the
following:





During
the three months ended December 31, 2008, the Company granted 50,000 shares of
restricted common stock at $0.22 per share based on the closing price of the
common stock on the grant date, to the President and Chief Operating Officer
pursuant to his employment agreement, and 80,000 shares valued at $0.22 per
share based on the closing price of the common stock on the grant date, to an
independent member of the Board of Directors associated with his service as a
member of the Company’s Executive Committee.





The
company expensed $4,875 related to these grants during the three months ended
December 31, 2008. The shares are granted under the 2000 Plan.





During
the nine months ended December 31, 2008, the Company granted 50,000 shares of
restricted common stock at $0.12 per share and  50,000 shares of
restricted common stock at $0.22, based on the closing price of the common stock
on the respective grant dates, to the President and Chief Operating Officer
pursuant to his employment agreement, and 55,555 shares valued at $0.12 per
share and 80,000 shares valued at $0.22, based on the closing price of the
common stock on the respective grant dates, to an independent member of the
Board of Directors associated with his service as a member of the Company’s
Executive Committee.




15




The
Company expensed $7,514 related to these grants during the nine months ended
December 31, 2008. The shares are granted under the 2000 Plan.





9.
              Fair Value
      Measurements







The
Company adopted Statement of Financial Accounting Standards No. 157 “Fair
Value Measurements” (“SFAS 157”) on April 1, 2008.  SFAS 157, among
other things, defines fair value, establishes a consistent framework for
measuring fair value and expands disclosure for each major asset and liability
category measured at fair value on either a recurring or nonrecurring
basis.  SFAS 157 clarifies that fair value is an exit price,
representing the amount that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market
participants.  As such, fair value is a market-based measurement that
should be determined based on assumptions that market participants would use in
pricing an asset or liability.  As a basis for considering such
assumptions, SFAS 157 establishes a three-tier fair value hierarchy, which
prioritizes the inputs used in measuring fair value as follows:





Level
      1.
              
              Observable
      inputs such as quoted prices in active markets for identical assets or
      liabilities;Level
      2.
              
              Inputs,
      other than quoted prices included within Level 1, that are observable
      either directly or indirectly; andLevel
      3.
              
              Unobservable
      inputs in which there is little or no market data, which require the
      reporting entity to develop its own
assumptions.





As of
December 31, 2008, the Company had no assets or liabilities that were marked to
fair value under SFAS 157.





10.
              Liquidity




The
Company has incurred significant losses and negative cash flows from operations
for the last two fiscal years. The Company has obtained its required cash
resources through the sale of debt and equity securities. The Company may not
operate profitably in the future and may be required to continue the sale of
debt and equity securities to finance our operations.





The
Company has specific plans to address its financial situation as
follows:





·
            The Company believes that the
      demand for its software and professional services will continue to expand
      as the United States market adopts the new payment processing
      opportunities available under changing regulations such as the Check
      Clearing Act for the 21stCentury, and NACHA’s back office
      conversion, which allows the conversion of paper checks in the back
      offices of retail merchants and government. Increased demand for the
      Company’s solutions, including its recently introduced Clearingworks
      product, has led to increased cash flows from up-front license fees,
      transaction-based contract fees and increases in professional services
      revenues.





·
            The Company has entered into a
      strategic alliance with one of the largest merchant service providers
      (MSP), that will allow this MSP to sell Clearingworks as part of its ARC
      and back office conversion
services.





·
            The Company has undertaken a
      staff restructuring in an effort to reduce its salary and benefit expense
      in the coming year.





·
            The Company has renewed its
      professional service contract with a major credit card company and with an
      arm of the federal government for an additional
    year.





·
            The Company has entered into an
      agreement with a major business process outsourcer (BPO), which will
      enable it to significantly increase its transactional revenues in the
      coming fiscal year as more billers outsource their work to
      BPO’s




16




·
            The
      Company has entered into an agreement with a major U.S. Federal Government
      entity to standardize its payment systems on Clearingworks 3.0, to process
      all of its paper and electronic checks and to provide additional
      professional services.





Furthermore,
on July 23, 2008, the Company received notice from the staff of NYSE Alternext
US indicating that it was not in compliance with certain continued listing
standards of the AMEX Company Guide in that the Company’s stockholders’ equity
is less than $4,000,000 and it had losses from continuing operations and net
losses in three of its four most recent fiscal years (Section 1003(a)(ii)) and
because the Company’s stockholders’ equity is less than $6,000,000 and it had
losses from continuing operations and net losses in its five most recent fiscal
years (Section 1003(a)(iii)).  On August 27, 2008, the Company
submitted to NYSE Alternext US a Plan advising NYSE Alternext US of action it
had taken, or will take, to bring it in compliance with Sections 1003(a)(ii) and
1003(a)(iii) of the AMEX Company Guide within a maximum of 18 months from July
23, 2008.  The Company’s Plan was accepted by NYSE Alternext US on
October 9, 2008 subject to periodic review by NYSE Alternext
US.   If the Company does not show sufficient progress consistent
with the Plan, the Exchange Staff will review the circumstances and may
immediately commence delisting proceedings. In the event that the Company’s
common stock is delisted from NYSE Alternext US, its market value and liquidity
could be materially adversely affected.


There can
be no assurance that the Company’s planned activities will be successful or that
it will ultimately attain profitability. The Company’s long term viability
depends on its ability to obtain adequate sources of debt or equity funding to
fund the continuation of its business operations and to ultimately achieve
adequate profitability and cash flows to sustain its operations. The Company
will need to increase revenues from software licenses, transaction-based
software license contracts and professional services agreements to become
profitable.





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 with the unaudited condensed financial statements and
related notes included elsewhere in this Quarterly Report on Form
10-Q.





When used
in this Quarterly Report on Form 10-Q, 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 strategic opportunities, adequacy of capital resources,
our ability to increase our professional services contracts and the related
benefits, demand for software and professional services, demand for our
solutions, expectations regarding cash flow, revenues, sources of revenue and
operating expenses, benefits of our relationship with an MSP and our agreement
with the U.S. Federal Government, benefits of our restructuring, statements
regarding our growth and profitability, investments in marketing and promotion,
and operating infrastructure, fluctuations in our operating results, our need
for future financing, concentration of and dependence on customers, our ability
to defend against the assertions and demands made by former noteholders, our
dependence on our strategic partners, our dependence on personnel, our
disclosure controls and procedures, our ability to respond to rapid
technological change, statements regarding future acquisitions or investments,
expansion of our technologies and products and our legal proceedings.
Forward-looking statements are subject to certain risks and uncertainties that
could cause actual results to differ materially from those projected. These
risks and uncertainties include, but are not limited to, those discussed below,
as well as risks related to our ability to develop and timely introduce products
that address market demand, the impact of alternative technological advances and
competitive products, market fluctuations, our ability to obtain future
financing, our ability to continue to comply with other continued listing
standards of AMEX and our ability to effect a reverse stock split, and the risks
set forth below under “Factors That May Affect Our Results.” These
forward-looking statements speak only as of the date hereof. We expressly
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,” “we,” “us,” or “our” means US Dataworks,
Inc.





MICRworkstm,
Clearingworks®, Returnworkstm, Remitworkstm, and Clearinghouse Least Cost
Routing/Best Fit Clearing sm , are
trademarks of US Dataworks. Other trademarks referenced herein are the property
of their respective owners.





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. 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.




17




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), 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 American Institute of Certified Public Accountants’ Statement
of Position (SOP) 97-2, “Software Revenue Recognition”. We license our software
products under nonexclusive, nontransferable license agreements. These
arrangements do not require significant production, modification, or
customization. Therefore, revenue is recognized when the license agreement has
been signed, delivery of the software product has occurred, the related fee is
fixed or determinable, and collectibility is probable.





In
certain instances, we license our software on a transactional fee basis in lieu
of an up-front licensing fee. In these arrangements, the customer is charged a
fee based upon the number of items processed by the software and we recognize
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 are provided in conjunction with the installation of the
software licensed, revenue is recognized when these services have been
provided.





In
certain instances, the Company will recognize revenue on a percent of completion
basis for the portion of professional services related to customized customer
projects that have been completed but are not yet deliverable to
customer.





For
license agreements that include a separately identifiable fee for contracted
maintenance services, such license revenues are recognized on a straight-line
basis over the life of the maintenance agreement noted in the license agreement,
but following any installation period of the software.





Goodwill





The
goodwill recorded on our books is from the acquisition of US Dataworks, Inc. in
fiscal year 2001, which remains our single reporting unit. Statement of
Financial Accounting Standards (SFAS) No. 142 “Goodwill and Other
Intangible Assets,” requires goodwill for each reporting unit of an entity to be
tested for impairment by comparing the fair value of each reporting unit with
its carrying value. Fair value is determined using a combination of the
discounted cash flow, market multiple and market capitalization valuation
approaches. Significant estimates used in the methodologies include estimates of
future cash flows, future short-term and long-term growth rates, weighted
average cost of capital and estimates of market multiples for each reportable
unit. On an ongoing basis, absent any impairment indicators, we perform
impairment tests annually during the fourth quarter.





SFAS No.
142 requires goodwill to be tested annually, typically performed during the
fourth quarter, 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. We recorded an impairment of goodwill of $10,112,931
for the year ended March 31, 2008 and no impairment for the nine months ended
December 31, 2008.





Estimates





The
preparation of financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.





Concentrations
of Credit Risk





We extend
credit to our customers and perform ongoing credit evaluations of our customers.
We do not obtain collateral from our customers to secure our accounts
receivable. We evaluate our accounts receivable on a regular basis for
collectibility and provide for an allowance for potential credit losses as
deemed necessary.




18




Two of
our customers accounted for 50% and 21%, respectively, of our net revenues for
the three months ended December 31, 2008. Two customers accounted for 50% and
21%, respectively, of net revenues for the nine months ended December 31, 2008.
Four of our customers accounted for 30%, 23%, 15% and 10%, respectively, of our
net revenues for the three months ended December 31, 2007. Four customers
accounted for 27%, 25%, 12% and 11%, respectively, of net revenues for the nine
months ended December 31, 2007.





At
December 31, 2008, amounts due from these significant customers accounted for
50% of accounts receivable.





Results
of Operations





The
results of operations reflected in this discussion include our operations for
the three and nine month periods ended December 31, 2008 and 2007.





Revenues





We
generate revenues from (a) licensing software with fees due at the initial term
of the license, (b) licensing and supporting software with fees due on a
transactional basis, (c) providing maintenance, enhancement and support for
previously licensed products and (d) providing professional
services.





Three
      Months
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        Nine
      MonthsEnded
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        EndedDecember
      31,
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        December
      31,2008
                                                        
                                                        
                                                        2007
                                                        
                                                        
                                                        Change
                                                        
                                                        
                                                        2008
                                                        
                                                        
                                                        2007
                                                        
                                                        
                                                        Change(In
      000’s)
                                                        
                                                        
                                                        (In
      000’s)Software
      licensing revenues
                                                        
                                                        $
                                                        37
                                                        
                                                        
                                                        $
                                                        183
                                                        
                                                        
                                                        
                                                        -80
                                                        %
                                                        
                                                        $
                                                        67
                                                        
                                                        
                                                        $
                                                        290
                                                        
                                                        
                                                        
                                                        -77
                                                        %Software
      transactional revenues
                                                        
                                                        
                                                        541
                                                        
                                                        
                                                        
                                                        445
                                                        
                                                        
                                                        
                                                        21
                                                        %
                                                        
                                                        
                                                        1,601
                                                        
                                                        
                                                        
                                                        1,225
                                                        
                                                        
                                                        
                                                        31
                                                        %Software
      maintenance revenues
                                                        
                                                        
                                                        218
                                                        
                                                        
                                                        
                                                        233
                                                        
                                                        
                                                        
                                                        -6
                                                        %
                                                        
                                                        
                                                        666
                                                        
                                                        
                                                        
                                                        658
                                                        
                                                        
                                                        
                                                        1
                                                        %Professional
      service revenues
                                                        
                                                        
                                                        1,204
                                                        
                                                        
                                                        
                                                        670
                                                        
                                                        
                                                        
                                                        80
                                                        %
                                                        
                                                        
                                                        3,766
                                                        
                                                        
                                                        
                                                        1,953
                                                        
                                                        
                                                        
                                                        93
                                                        %Total
      revenues
                                                        
                                                        $
                                                        2,000
                                                        
                                                        
                                                        $
                                                        1,531
                                                        
                                                        
                                                        
                                                        31
                                                        %
                                                        
                                                        $
                                                        6,100
                                                        
                                                        
                                                        $
                                                        4,126
                                                        
                                                        
                                                        
                                                        48
                                                        %





Revenues
increased in the three and nine months ended December 31, 2008 by 31% and 48%,
respectively, as compared to the same periods ended December 31, 2007. For the
three months ended December 31, 2008, transactional and professional services
revenue increased by 21% and 80%, respectively, offset by a decrease in
licensing and maintenance revenue by 80% and 6%, respectively, as compared to
the same periods ended December 31, 2007. For the nine months ended December 31,
2008 transactional, maintenance and professional services revenue increased by
31%, 1% and 93%, respectively, offset by a 77% decrease in licensing revenue as
compared to the same periods ended December 31, 2008.





The
decrease in licensing revenues for the three and nine months ended December 31,
2008, compared to the same periods last year, was primarily due to the
significant license revenues recorded in the first quarter of fiscal 2007
associated with the resale of third party software to a significant customer as
compared to the reduction of software resale in the current period.





The
increase in transactional revenues for the three and nine months ended December
31, 2008, compared to the same periods last year, was principally due to an
increase in the number of customers subject to transactional pricing combined
with an increase in trans actions processed by our current
customers.





The
decrease in maintenance revenues for the three months ended December 31, 2008,
compared to the same period last year, was primarily attributable to fewer
customers renewing their annual maintenance agreement in the current period.
However, the slight increase in maintenance revenues for the nine months ended
December 31, 2008, as compared to the prior year period, was due to the annual
maintenance renewal related to the integrated license, maintenance and services
agreement we entered into with a significant customer in the first fiscal
quarter of 2007. This annual maintenance agreement renews in May of every year.
We do not anticipate significant ongoing growth in annual maintenance
fees.




19




The
increase in professional service revenues for the three and nine months ended
December 31, 2008, compared to the same periods last year, was primarily due to
our professional services contract with major credit card company that was
signed in February 2008.




Cost
of Sales





Costs of
sales principally include personnel costs associated with our software
maintenance, support, training and installation activities as well as the cost
of the Accuity EPICWareTM software and other third party software frequently
resold in conjunction with licenses of our software.




Cost of
sales decreased by $9,973, or 1.7%, from $574,230 for the three months ended
December 31, 2007 to $564,257 for the three months ended December 31, 2008. This
slight decrease was due primarily to a reduction in third-party software resale
costs as a result of some of our customers chosing not to renew their annual
Epicware licenses. This decrease was partially offset by a reduction of labor
costs associated with our professional and maintenance services due to a
decreased number of personnel required to perform the maintenance services. Cost
of sales increased by $138,205, or 9.4%, from $1,469,312 for the nine months
ended December 31, 2007 to $1,607,517 for the nine months ended December 31,
2008. This increase was principally the result of an increase in labor costs
associated with the additional resources required for the professional service
activities in the first six months of fiscal year 2009 related to the contract
with a major credit card provider, offset by decreases in the costs of software
purchased for resale and decreases in labor cost associated with maintenance
activities, as compared to the same period last year.




Operating
Expenses





Total
operating expenses decreased by $6,280,402, or 85.4%, from $7,356,130 for the
three months ended December 31, 2007 to $1,075,729 for the three months ended
December 31, 2008. This decrease was related to the one-time charge to goodwill
impairment that we booked in December 2007.





Total
operating expenses decreased by $6,862,317, or 64.0%, from $10,724,721 for the
nine months ended December 31, 2007 to $3,862,405 for the nine months ended
December 31, 2008. This decrease was related to the one-time charge to goodwill
impairment that we booked in December 2007.





Due to
our reduction in staff associated with our restructuring efforts, our headcount
at December 31, 2008 was 35 compared to 44 at December 31, 2007. This reduction
in staff has resulted in close to a $800,000 reduction in operating
expenses.





Other
Expenses(Income)





Other
expenses, including interest expense and financing costs, increased $1,074,104,
or 127.0%, from an income of $847,928 for the three months ended December 31,
2007 to a loss of $(226,176) for the three months ended December 31, 2008. This
increase in expenses was primarily related to a gain in the prior year period,
on the derivatives associated with the warrants issued in conjunction with the
senior secured convertible notes of November 2007 (Notes). Due to the
extinguishment of the debt related to the Notes, there is no gain on derivatives
in the current three month period.




Other
expenses, including interest expense and financing costs, increased $3,248,627,
or 405.0%, from an income of $801,425 for the nine months ended December 31,
2007 to a loss of $(2,447,202) for the nine months ended December 31, 2008. This
increase, for the nine month period ending December 31, 2008 is related to a
gain in the prior year period on the derivatives associated with the warrants
issued in conjunction with the senior secured convertible notes (Notes) of
November 2007, as compared to the gain on derivatives in the current nine month
period, and with the manner in which the eventual payoff of the Notes are
required to be reported under FASB No. 133.





At the
initial recording of the Notes on to our books, a value must be determined for
each portion of the Notes, the compounded embedded derivatives and the warrants.
Once determined, this value is netted against the total value of the Notes and
the remaining amount is identified as a Discount on Note Payable, and is
amortized over the life of the loan utilizing an effective interest method
calculation for determining the value of the units each quarter. This discount
is written off to interest expense after the effective method calculation is
performed each quarter. At inception of the Notes in November 2007 the Discount
on Note Payable was $2,240,263. This discount would have been $0.00 if the Notes
were held until November 2010, and all interest expense would have been
amortized over that time period.




20




The Notes
were paid in full on August 13, 2008, resulting in an accounting treatment
consistent with FASB No. 133 guidelines. At the time the Notes are paid off the
derivatives no longer have value associated with the Notes, and the Discount on
Note Payable must be immediately expensed. At the time the Notes were paid in
August 2008, $1,747,791 remained on the Discount on Note Payable. This amount
was charged to interest expense in the quarter ended September 30, 2008 and
accounts for the bulk of the increase in other income (expenses) for the nine
months ended December 31, 2008 as compared to the same period last
year.





Net
Gain/(Loss)





Net loss
decreased $5,685,052, or 102.0%, from $(5,551,203) for the three months ended
December 31, 2007 to a net gain of $133,850 for the three months ended December
31, 2008. For details related to this loss see the preceding discussions related
to our costs of sales, operating expenses and other expenses sections
above.





Net loss
decreased by $5,448,897, or 75.0%, from $7,266,223 for the nine months ended
December 31, 2007 to a net loss of $1,817,326 for the nine months ended December
31, 2008. For details related to this loss see the preceding discussions related
to our costs of sales, operating expenses and other expenses sections
above.





Liquidity
and Capital Resources





We have
incurred significant losses and negative cash flows from operations for the last
three fiscal years. We have obtained our required cash resources through the
sale of debt and equity securities. We may not operate profitably in the future
and may be required to continue the sale of debt and equity securities to
finance our operations.





We have
specific plans to address our financial situation as follows:





·
            We believe that the demand for
      our software and professional services will continue to expand as the
      United States market adopts the new payment processing opportunities
      available under changing regulations such as the Check Clearing Act for
      the 21stCentury, and NACHA’s back office
      conversion, which allows the conversion of paper checks in the back
      offices of retail merchants and government. Increased demand for our
      solutions, including our recently introduced Clearingworks product, has
      led to increased cash flows from up-front license fees, transaction-based
      contract fees and increases in professional services revenues. We expect
      demand for its product and services to continue to increase in the coming
      year.





·
            We have entered into a strategic
      alliance with one of the largest merchant service providers (MSP), which
      will allow this MSP to sell Clearingworks as part of its ARC and back
      office conversion services. Though no exact dollar amounts have been
      forecast at the time, we expect that this alliance will positively affect
      our profitability.





·
            We have undertaken a staff
      restructuring that we expect will significantly reduce our salary and
      benefit expense in the coming year while still maintaining our customer
      service levels. To date, this restructuring has reduced our expenses by
      approximately $800,000.





·
            We have renewed our professional
      service contract with a major credit card company and with an arm of the
      federal government for an additional year that, in aggregate, could
      provide up to $3,000,000 in revenue in the coming fiscal
      year.





·
            We have entered into an agreement
      with a major business process outsourcer (BPO), which will enable us to
      significantly increase our transactional revenues in the coming fiscal
      year as more billers outsource their work to
  BPO’s.





·
            We have entered into an agreement
      with a major U.S. Federal Government entity to standardize its payment
      systems on Clearingworks 3.0, to process all of its paper and electronic
      checks and to provide additional professional services. We expect this
      alliance to positively affect our
  profitability.







21




Furthermore,
on July 23, 2008, we received notice from the staff of NYSE Alternext US
indicating that we were not in compliance with certain continued listing
standards of the AMEX Company Guide in that our stockholders’ equity is less
than $4,000,000 and we had losses from continuing operations and net losses in
three of our four most recent fiscal years (Section 1003(a)(ii)) and because our
stockholders’s equity is less
than $6,000,000 and we had losses from continuing operations and net losses in
our five most recent fiscal years (Section 1003(a)(iii)). On August 27, 2008, we
submitted to NYSE Alternext US a Plan advising NYSE Alternext US of action we
have taken, or will take, to bring us in compliance with Sections 1003(a)(ii)
and 1003(a)(iii) of the AMEX Company Guide within a maximum of 18 months from
July 23, 2008. Our Plan was accepted by NYSE Alternext US on October 9, 2008
subject to periodic review by NYSE Alternext US. If we do not show sufficient
progress consistent with the Plan, the Exchange Staff will review the
circumstances and may immediately commence delisting proceedings. In the event
that our common stock is delisted from NYSE Alternext US, our market value and
liquidity could be materially adversely affected.




There can
be no assurance that our planned activities will be successful or that we will
ultimately attain profitability. Our long term viability depends on our ability
to obtain adequate sources of debt or equity funding to fund the continuation of
our business operations and to ultimately achieve adequate profitability and
cash flows to sustain our operations. We will need to increase revenues from
software licenses, transaction based software license contracts and professional
services agreements to become profitable.





Cash and
cash equivalents decreased by $397,567 from $903,393 at March 31, 2008 to
$505,826 at December 31, 2008. Cash provided by operating activities was
$372,590 in the nine months ended December 31, 2008 compared to cash used in
operating activities of $2,338,997 in the same nine month period in the prior
year.





Cash used
in investing activities of $14,538 and $96,430 in the nine months ended December
31, 2008 and December 31, 2007, respectively, was due primarily to equipment
purchases.





Cash used
in financing activities for the nine months ended December 31, 2008, was
$755,619 compared to cash provided of $3,628,170 in the nine months ended
December 31, 2007. Financing activities in the current nine month period
included: proceeds of $3,703,500 from the issuance of related party loans,
offset by the repayment of $4,000,000 of convertible promissory notes, $432,659
in deferred financing costs and $26,460 on repayment of notes
payable.





As a
result of our recent capital raising transactions, our increased level of
transactional revenues achieved in fiscal 2008, and the expected increase in
revenues from recently received purchase orders and contemplated contracts, we
believe we currently have adequate capital resources to fund our anticipated
cash needs through December 31, 2009. However, an adverse business or legal
development could require us to raise additional financing sooner than
anticipated. We recognize that we may be required to raise such additional
capital, at times and in amounts, which are uncertain, especially under the
current capital market conditions. If we are unable to acquire additional
capital or are required to raise it on terms that are less satisfactory than we
desire, it may have a material adverse effect on our financial condition. In the
event we raise additional equity, these financings may result in dilution to
existing shareholders.





Item 4(T).   Controls and
Procedures





(a) 
Evaluation
of 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 and procedures were effective at the reasonable assurance
level.





(b) 
Changes in
internal control over financial reporting. There was no change 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.




22




PART II - OTHER INFORMATION





Item 1.   Legal Proceedings




From time
to time, we are involved in various legal and other proceedings that are
incidental to the conduct of our business. We do not believe that these
proceedings, if adversely determined, would have a material effect on our
financial condition, results of operations or cash flows.





Item
1A. Risk Factors





We
have a general history of losses and may not operate profitably in the
future.




We have
incurred losses for the last two fiscal years. Our net losses and negative cash
flow may continue for the foreseeable future. As of December 31, 2008, our
accumulated deficit was $(63,908,564). We believe that our planned growth and
profitability will depend in large part on our ability to promote our brand
name, gain clients and expand our relationships with clients for whom we would
provide licensing agreements and system integration. Accordingly, we intend to
invest heavily in marketing, strategic partnership, development of our client
base and development of our marketing technology and operating infrastructure.
If we are not successful in promoting our brand name and expanding our client
base, it will have a material adverse effect on our financial condition and our
ability to continue to operate our business.





Our ability to continue as a going
concern may be contingent upon our ability to secure capital from prospective
investors or lenders.





The
accompanying consolidated financial statements have been prepared assuming we
will continue on a going concern basis, which contemplates the realization of
assets and the satisfaction of liabilities in the normal course of business. We
believe we currently have adequate cash to fund anticipated cash needs through
December 31, 2008. However, we may need to raise additional capital in the
future. Any equity financing may be dilutive to shareholders, and debt
financing, if available, will increase expenses and may involve restrictive
covenants. We may be required to raise additional capital, at times and in
amounts that are uncertain, especially under the current capital market
conditions. These factors raise substantial doubt about our ability to continue
as a going concern. Under these circumstances, if we are unable to obtain
additional capital or are required to raise it on undesirable terms, it may have
a material adverse effect on our financial condition, which could require us
to:


•
              curtail our operations
      significantly;
 
 •
              sell significant
      assets;
  •
              seek arrangements with strategic
      partners or other parties that may require us to relinquish significant
      rights to products, technologies or markets;
  or
 
 •
              explore other strategic
      alternatives including a merger or sale of US
      Dataworks.


Our
financial statements do not include any adjustments relating to the
recoverability and classification of recorded assets or liabilities that might
be necessary should we be unable to continue as a going concern.





Our operating results are subject to
fluctuations caused by many factors that could cause us to fail to achieve our
revenue or profitability expectations, which in turn could cause our stock
price to decline.





Our
operating results can vary significantly depending upon a number of factors,
many of which are outside our control. Factors that may affect our quarterly
operating results include:




•
              market acceptance of and changes
      in demand for our products and
services;







23


•
              gain or loss of clients or
      strategic relationships;
 
 •
              announcement or introduction of
      new software, services and products by us or by our
      competitors;
 
 •
              our ability to build brand
      recognition;
 
 •
              timing of sales to
      customers;
  •
              price
      competition;
 
 •
              our ability to upgrade and
      develop systems and infrastructure to accommodate
      growth;
 
 •
              our ability to attract and
      integrate new personnel in a timely and effective
      manner;
 
 •
              our ability to introduce and
      market products and services in accordance with market
      demand;
 
 •
                changes
      in governmental regulation;
 
 •
              reduction in or delay of capital
      spending by our clients due to the effects of terrorism, war and political
      instability; and
 
 •
              general economic conditions,
      including economic conditions specific to the financial services
      industry.




In
addition, each quarter we derive a significant portion of our revenue from
agreements signed at the end of the quarter. Our operating results could suffer
if the timing of these agreements is delayed. Depending on the type of
agreements we enter into, we may not be able to recognize revenue under these
agreements in the quarter in which they are signed. Some of all of these factors
could negatively affect demand for our products and services, and our future
operating results.





Most of
our operating expenses are relatively fixed in the short-term. We may be unable
to adjust spending rapidly to compensate for any unexpected sales shortfall,
which could harm our quarterly operating results. Because of the emerging nature
of the markets in which we compete, we do not have the ability to predict future
operating results with any certainty. Because of the above factors, you should
not rely on period-to-period comparisons of results of operation as an
indication of future performances.





We may not be able to maintain our
relationships with strategic partners, which may cause our cash flow to
decline.





We may
not be able to maintain our relationships with strategic partners, such as
Computer Sciences Corporation. These strategic relationships are a core
component of our sales and distribution strategy. The loss of a strategic
partner could harm our financial results.





Because a small number of customers
have historically accounted for and may in future periods account for
substantial portions of our revenue, our revenue could decline because of delays of
customer orders or the failure to retain customers.





We have a
small number of customers that account for a significant portion of our revenue.
Our revenue could decline because of a delay in signing agreements with a single
customer or the failure to retain an existing customer. In addition, we may not
obtain additional customers. The failure to obtain additional customers or the
failure to retain existing customers will harm our operating
results.





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





The
revenue growth and profitability of our business depends on the overall demand
for computer software and services in the product segments in which we compete.
Because our sales are primarily to major banking and government customers, our
business also depends on general economic and business conditions. Recently,
concerns over inflation, energy costs, geopolitical issues, the availability and
cost of credit, the U.S. mortgage market and a declining real estate market in
the U.S. have contributed to increased volatility and diminished expectations
for the global economy and expectations for slower global economic growth going
forward. These factors, combined with declining business and consumer confidence
and increased unemployment, have precipitated an economic slowdown and fears of
a possible recession. If the economic climate in the U.S. continues to
deteriorate, customers or potential customers could reduce or delay their
technology investments, which may result in decreased revenue or lower growth
rates. As a result, we may not be able to effectively promote future license
revenue growth in our application business.




24




We may not be able to attract, retain
or integrate key personnel, which may prevent us from successfully
operating our business.





We may
not be able to retain our key personnel or attract other qualified personnel in
the future. Our success will depend upon the continued service of key management
personnel. The loss of services of any of the key members of our management team
or our failure to attract and retain other key personnel could disrupt
operations and have a negative effect on employee productivity and morale and
harm our financial results.





We operate in a market that is
intensely and increasingly competitive, and if we are unable to compete
successfully, our revenue could decline and we may be unable to gain market
share.





The
market for financial services software highly competitive. Our future success
will depend on our ability to adapt to rapidly changing technologies, evolving
industry standards, product offerings and evolving demands of the
marketplace.





Some of
our competitors have:




•
              longer
      operating histories;


•
              larger
      installed customer bases;


•
              greater
      name recognition and longer relationships with clients;
  and


•
            significantly
      greater financial, technical, marketing and public relations resources
      than US Dataworks.





Our
competitors may also be better positioned to address technological and market
developments or may react more favorably to technological changes. We compete on
the basis of a number of factors, including:





•
              the
      breadth and quality of services;


•
              creative
      design and systems engineering expertise;


•
              pricing;


•
              technological
      innovation; and


•
            understanding
      clients’ strategies and needs.




Competitors
may develop or offer strategic services that provide significant technological,
creative, performance, price or other advantages over the services we offer. If
we fail to gain market share or lose existing market share, our financial
condition, operating results and business could be adversely affected and the
value of the investment in us could be reduced significantly. We may not have
the financial resources, technical expertise or marketing, distribution or
support capabilities to compete successfully.





We may be responsible for maintaining
the confidentiality of our client’s sensitive information, and any
unauthorized use or disclosure could result in substantial damages and harm our
reputation.





The
services we provide for our clients may grant us access to confidential or
proprietary client information. Any unauthorized disclosure or use could result
in a claim against us for substantial damages and could harm our reputation. Our
contractual provisions attempting to limit these damages may not be enforceable
in all instances or may otherwise fail to adequately protect us from liability
for damages.




25




If we do not adequately protect our
intellectual property, our business may suffer, we may lose revenue or we may
be required to spend significant time and resources to defend our intellectual
property rights.





We rely
on a combination of patent, trademark, trade secrets, confidentiality procedures
and contractual procedures to protect our intellectual property rights. If we
are unable to adequately protect our intellectual property, our business may
suffer from the piracy of our technology and the associated loss in revenue. Any
patents that we may hold may not sufficiently protect our intellectual property
and may be challenged by third parties. Our efforts to protect our intellectual
property rights, may not prevent the misappropriation of our intellectual
property. These infringement claims or any future claims could cause us to spend
significant time and money to defend our intellectual property rights, redesign
our products or develop or license a substitute technology. We may be
unsuccessful in acquiring or developing substitute technology and any required
license may be unavailable on commercially reasonable terms, if at all. In the
event of litigation to determine the validity of any third party claims or
claims by us against such third party, such litigation, whether or not
determined in our favor, could result in significant expense and divert the
efforts of our technical and management personnel, regardless of the outcome of
such litigation. Furthermore, other parties may also independently develop
similar or competing products that do not infringe upon our intellectual
property rights.





We may be unable to consummate future
potential acquisitions or investments or successfully integrate acquired
businesses or investments or foreign operations with our business, which may disrupt
our business, divert management’s attention and slow our ability to
expand the range of our technologies and products.





We intend
to continue to expand the range of our technologies and products, and we may
acquire or make investments in additional complementary businesses, technologies
or products, if appropriate opportunities arise. We may be unable to identify
suitable acquisition or investment candidates at reasonable prices or on
reasonable terms, or consummate future acquisitions or investments, each of
which could slow our growth strategy. We have no prior history or experience in
investing in or acquiring and integrating complementary businesses and therefore
may have difficulties completing such transactions or realizing the benefits of
such transactions, or they may have a negative effect on our business. Such
investments or acquisitions could require us to devote a substantial amount of
time and resources and could place a significant strain on our management and
personnel. To finance any acquisitions, we may choose to issue shares of our
common stock, which would dilute your interest in us. Any future acquisitions by
us also could result in significant write-offs or the incurrence of debt and
contingent liabilities, any of which could harm our operating
results.





Our
Senior Secured Convertible Notes contains operating and financial covenants that
may restrict our business and financing activities.





We issued
$4,000,000 in senior secured convertible notes on November 13, 2007. The notes
are secured by a pledge of all of our assets, including our intellectual
property, and contains a variety of operational covenants, including limitations
on our ability to incur liens or additional debt, make dispositions, pay
dividends, redeem our stock, make certain investments and engage in certain
merger, consolidation or asset sale transactions, among other restrictions. Any
future debt financing we enter into may involve similar or more onerous
covenants that restrict our operations. Our borrowings under the notes or any
future debt financing we do will need to be repaid, which creates additional
financial risk for our company, particularly if our business, or prevailing
financial market conditions, are not conducive to paying-off or refinancing our
outstanding debt obligations. Furthermore, any breach of the covenants in the
notes could cause a default under the notes. If there were an event of default
under the notes that is not waived, the noteholders could cause all amounts
outstanding with respect to the notes to be due and payable immediately. Neither
our assets and cash flow nor those of our put grantors may be sufficient to
fully repay borrowings under the notes if accelerated upon an event of default.
If, as or when required, we are unable to repay, refinance or restructure the
notes, and if our put grantors are unable to repay the notes, the noteholders
could institute foreclosure proceedings against the assets securing borrowings
under the notes. On August 13, 2008, we repaid principal of $4,000,000 and
accrued interest of $38,807.50. There is a dispute with the noteholders
regarding whether a redemption premium, penalty interest or other amounts are
owed to the noteholders. We cannot assure you regarding the outcome of the
dispute or that additional amounts will not be payable under these notes, as
noted above.




26




We
have received notice from NYSE Alternext US, formerly the AMEX, notifying us of
our failure to satisfy several continued listing rules or standards, which
could result us being subject to delisting procedures





Our
common stock is listed on NYSE Alternext USunder the symbol “UDW.”
All companies listed on NYSE Alternext US are required to comply with certain
continued listing standards, including maintaining stockholders’ equity at
required levels, share price requirements and other rules and regulations of
NYSE Alternext US . On July 23, 2008, we received notice from the staff of NYSE
Alternext USindicating that we were
not in compliance with certain continued listing standards of the AMEX Company
Guide in that our stockholders’ equity is less than $4,000,000 and we had losses
from continuing operations and net losses in three of our four most recent
fiscal years (Section 1003(a)(ii)) and because our stockholders’ equity is less
than $6,000,000 and we had losses from continuing operations and net losses in
our five most recent fiscal years (Section 1003(a)(iii)). In addition, NYSE
Alternext US advised us that, in accordance with Section 1003(f)(v) of the AMEX
Company Guide, we must effect a reverse stock split to address its low stock
price. Failure to effect a reverse split within a reasonable amount of time
could result in suspension or delisting of our common stock. On August 27, 2008
we submitted to NYSE Alternext US a Plan advising NYSE Alternext US of action we
have taken, or will take, to bring us in compliance with Sections 1003(a)(ii)
and 1003(a)(iii) of the AMEX Company Guide within a maximum of 18 months from
July 23, 2008. Our Plan was accepted by NYSE Alternext US on October 9, 2008
subject to periodic review by NYSE Alternext US. If we do not show sufficient
progress consistent with the Plan, the Exchange Staff will review the
circumstances and may immediately commence delisting proceedings. In the event
that our common stock is delisted from NYSE Alternext US, our market value
and liquidity could be materially adversely affected.





Item
6. Exhibits





The
exhibits listed below are required by Item 601 of Regulation S-K.




ExhibitNumber
                
                Description
      of Document31.1
                
                Section
      302 Certification of Chief Executive Officer.31.2
                
                Section
      302 Certification of Chief Accounting Officer.32.1
                
                Section
      906 Certification of Chief Executive Officer.32.2
                
                Section
      906 Certification of Chief Accounting
Officer.




27


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:
February 17, 2009





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




28


EXHIBIT
INDEX





Exhibit
                    Number
                  
                  Description of Document31.1
                  
                  Section
      302 Certification of Chief Executive Officer.31.2
                  
                  Section
      302 Certification of Chief Accounting Officer.32.1
                  
                  Section
      906 Certification of Chief Executive Officer.32.2
                  
                  Section
      906 Certification of Chief Accounting
Officer.




29