UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington
D.C., 20549










FORM
10-Q







(Mark
One)





x
            QUARTERLY REPORT UNDER SECTION
      13 OR 15(d) OF THE SECURITIES   EXCHANGE ACT OF
      1934For
      the quarterly period ended September 30, 2010o
            TRANSITION REPORT UNDER SECTION
      13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF
    1934For the transition period 
                         
        to




Commission
file number: 001-15835




US
Dataworks, Inc.


(Exact
name of registrant as specified in its charter)





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





One Sugar Creek Center Boulevard
              Sugar Land, Texas
            77478(Address of principal executive offices)
            (Zip Code)





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




Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. YES x NO  ̈





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


Yes  ̈     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
            x(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 x





Number of
shares of the issuer’s common stock outstanding as of November 15, 2010:
33,231,008.







US
DATAWORKS, INC.




TABLE OF
CONTENTS




FORM
10-Q





QUARTERLY
PERIOD ENDED SEPTEMBER 30, 2010




PagePART
      I - FINANCIAL INFORMATIONItem
      1.
              Financial
      Statements
              4Item
      2.
              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
              18Item
      3.
              Quantitative
      and Qualitative Disclosures About Market Risk
              22Item
      4.
              Controls
      and Procedures
              22PART
      II - OTHER INFORMATION.Item
      1.
              Legal
      Proceedings
              23Item
      1A.
              Risk
      Factors
              23Item
      2.
              Unregistered
      Sales of Equity Securitites and Use of Proceeds
              23Item
      3.
              Defaults
      Upon Senior Securities
              23Item
      5.
              Other
      Information
              23Item
      6.
              Exhibits
              23







NOTE
REGARDING FORWARD LOOKING STATEMENTS AND CERTAIN TERMS




When used
in this Report, the words “expects,” “anticipates,” “believes,” “plans,” “will”
and similar expressions are intended to identify forward-looking statements.
These are statements that relate to future periods and include, but are not
limited to, statements regarding our critical accounting policies, our operating
expenses, our strategic opportunities, adequacy of capital resources, our
potential professional services contracts and the related benefits, demand for
software and professional services, demand for our solutions, expectations
regarding net losses, expectations regarding cash flow and sources of revenue,
benefits of our relationship with a Managed Service Provider, statements
regarding our growth and profitability, investments in marketing and promotion,
fluctuations in our operating results, our need for future financing, effects of
accounting standards on our financial statements, our investment in strategic
partnerships, development of our customer base and our infrastructure, our
dependence on our strategic partners, our dependence on personnel, our employee
relations, anticipated benefits of our restructuring, our disclosure controls
and procedures, our ability to respond to rapid technological change, expansion
of our technologies and products, benefits of our products, our competitive
position, statements regarding future acquisitions or investments, our legal
proceedings, and our dividend policy.  Forward-looking statements are
subject to certain risks and uncertainties that could cause actual results to
differ materially from those projected. These risks and uncertainties include,
but are not limited to, those discussed herein, as well as risks related to our
ability to develop and timely introduce products that address market demand, the
impact of alternative technological advances and competitive products, market
fluctuations, our ability to obtain future financing, and the risks referred to
in “Item 1A. Risk Factors.” These forward-looking statements speak only as of
the date hereof. We expressly disclaim any obligation or undertaking to release
publicly any updates or revisions to any forward-looking statements contained
herein to reflect any change in our expectations with regard thereto or any
change in events, conditions or circumstances on which any such statement is
based.




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





MICRworksTM,
Clearingworksâ,
ReturnworksTM, and RemitworksTM are trademarks of US Dataworks. Other trademarks
referenced herein are the property of their respective owners.







PART
I - FINANCIAL INFORMATION




Item
1.   Financial Statements




US
DATAWORKS, INC.


UNAUDITED
CONDENSED BALANCE SHEETS




September 30,
                                                      2010
                                                      (Unaudited)
                                                    
                                                    
                                                    March 31, 2010
                                                      (See Note)ASSETSCurrent
      assets:Cash
      and cash equivalents
                                                    
                                                    $
                                                    308,418
                                                    
                                                    
                                                    $
                                                    444,542Accounts
      receivable, trade
                                                    
                                                    
                                                    577,519
                                                    
                                                    
                                                    
                                                    1,059,825Prepaid
      expenses and other current assets
                                                    
                                                    
                                                    108,466
                                                    
                                                    
                                                    
                                                    307,653Total
      current assets
                                                    
                                                    
                                                    994,403
                                                    
                                                    
                                                    
                                                    1,812,020Property
      and equipment, net
                                                    
                                                    
                                                    182,520
                                                    
                                                    
                                                    
                                                    169,796Goodwill
                                                    
                                                    
                                                    4,020,698
                                                    
                                                    
                                                    
                                                    4,020,698Other
      assets
                                                    
                                                    
                                                    80,472
                                                    
                                                    
                                                    
                                                    90,835Total
      assets
                                                    
                                                    $
                                                    5,278,093
                                                    
                                                    
                                                    $
                                                    6,093,349LIABILITIES AND STOCKHOLDERS'
      EQUITYCurrent
      liabilities:Current
      portion of long term debt
                                                    
                                                    $
                                                    569,444
                                                    
                                                    
                                                    $
                                                    350,972Accounts
      payable
                                                    
                                                    
                                                    267,488
                                                    
                                                    
                                                    
                                                    235,077Accrued
      interest – related party
                                                    
                                                    
                                                    30,161
                                                    
                                                    
                                                    
                                                    30,162Accrued
      expenses
                                                    
                                                    
                                                    67,603
                                                    
                                                    
                                                    
                                                    246,558Deferred
      revenue
                                                    
                                                    
                                                    422,531
                                                    
                                                    
                                                    
                                                    181,330Total
      current liabilities
                                                    
                                                    
                                                    1,357,227
                                                    
                                                    
                                                    
                                                    1,044,099Long
      term liabilities:Notes
      payable
                                                    
                                                    
                                                    236,112
                                                    
                                                    
                                                    
                                                    638,889Note
      payable – related party, net of unamortized discount of $477,209 and
      $543,736 respectively
                                                    
                                                    
                                                    2,615,036
                                                    
                                                    
                                                    
                                                    2,548,509Total
      long term liabilities
                                                    
                                                    
                                                    2,851,148
                                                    
                                                    
                                                    
                                                    3,187,398Total
      liabilities
                                                    
                                                    
                                                    4,208,375
                                                    
                                                    
                                                    
                                                    4,231,497Commitments
      and ContingenciesStockholders’
      Equity:Convertible
      Series B preferred stock, $0.0001 par value 700,000 shares authorized,
      109,933 shares issued and outstanding $3.75 liquidation preference,
      dividends of $396,652 and $376,312 in arrears as of September 30, 2010 and
      March 31, 2010, respectively
                                                    
                                                    
                                                    11
                                                    
                                                    
                                                    
                                                    11Common
      stock, $0.0001 par value 90,000,000 shares authorized, 33,189,383 and
      33,103,951 shares issued and outstanding as of September 30, 2010 and
      March 31, 2010, respectively
                                                    
                                                    
                                                    3,319
                                                    
                                                    
                                                    
                                                    3,310Additional
      paid-in-capital
                                                    
                                                    
                                                    66,524,594
                                                    
                                                    
                                                    
                                                    66,369,315Accumulated
      deficit
                                                    
                                                    
                                                    (65,458,206
                                                    )
                                                    
                                                    
                                                    (64,510,784
                                                    )Total
      stockholders’ equity
                                                    
                                                    
                                                    1,069,718
                                                    
                                                    
                                                    
                                                    1,861,852Total
      liabilities and stockholders’ equity
                                                    
                                                    $
                                                    5,278,093
                                                    
                                                    
                                                    $
                                                    6,093,349




Note: The
balance sheet at March 31, 2010 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 unaudited condensed financial
statements.




4




US
DATAWORKS, INC.


UNAUDITED
CONDENSED STATEMENTS OF OPERATIONS




For the Three Months Ended
      September 30,
                            
                            
                            For the Six Months Ended
      September 30,2010
                            
                            
                            2009
                            
                            
                            2010
                            
                            
                            2009Revenues:Software
      transactional and subscription revenues
                            
                            $
                            586,765
                            
                            
                            $
                            518,725
                            
                            
                            $
                            1,085,982
                            
                            
                            $
                            1,039,968Software
      maintenance revenues
                            
                            
                            140,866
                            
                            
                            
                            208,488
                            
                            
                            
                            285,188
                            
                            
                            
                            420,859Professional
      services revenues
                            
                            
                            977,267
                            
                            
                            
                            1,359,976
                            
                            
                            
                            1,700,066
                            
                            
                            
                            2,634,823Total
      revenues
                            
                            
                            1,704,898
                            
                            
                            
                            2,087,189
                            
                            
                            
                            3,071,236
                            
                            
                            
                            4,095,650Cost
      of revenues
                            
                            
                            586,266
                            
                            
                            
                            670,318
                            
                            
                            
                            1,192,523
                            
                            
                            
                            1,346,689Gross
      profit
                            
                            
                            1,118,632
                            
                            
                            
                            1,416,871
                            
                            
                            
                            1,878,713
                            
                            
                            
                            2,748,961Operating
      expenses:Research
      and development
                            
                            
                            252,766
                            
                            
                            
                            217,254
                            
                            
                            
                            495,273
                            
                            
                            
                            430,191Sales
      and marketing
                            
                            
                            210,865
                            
                            
                            
                            237,290
                            
                            
                            
                            482,652
                            
                            
                            
                            499,590General
      and administrative
                            
                            
                            797,685
                            
                            
                            
                            793,496
                            
                            
                            
                            1,542,548
                            
                            
                            
                            1,365,137Depreciation
      and amortization
                            
                            
                            46,322
                            
                            
                            
                            39,018
                            
                            
                            
                            76,119
                            
                            
                            
                            82,664Total
      operating expense
                            
                            
                            1,307,638
                            
                            
                            
                            1,287,058
                            
                            
                            
                            2,596,592
                            
                            
                            
                            2,377,582(Loss)/Income
      from operations
                            
                            
                            (189,006
                            )
                            
                            
                            129,813
                            
                            
                            
                            (717,879
                            )
                            
                            
                            371,379Other
      expense:Financing
      expense – related party
                            
                            
                            (5,181
                            )
                            
                            
                            (55,518
                            )
                            
                            
                            (10,362
                            )
                            
                            
                            (165,119
                            )Interest
      expense
                            
                            
                            43,093
                            
                            
                            
                            (134,066
                            )
                            
                            
                            25,397
                            
                            
                            
                            (266,675
                            )Interest
      expense – related party
                            
                            
                            (123,172
                            )
                            
                            
                            (94,979
                            )
                            
                            
                            (244,576
                            )
                            
                            
                            (118,248
                            )Total
      other expense
                            
                            
                            (85,260
                            )
                            
                            
                            (284,563
                            )
                            
                            
                            (229,541
                            )
                            
                            
                            (550,042
                            )Net
      loss
                            
                            $
                            (274,266
                            )
                            
                            $
                            (154,750
                            )
                            
                            $
                            (947,420
                            )
                            
                            $
                            (178,663
                            )Basic
      and diluted loss per share
                            
                            $
                            (0.01
                            )
                            
                            $
                            (0.00
                            )
                            
                            $
                            (0.03
                            )
                            
                            $
                            (0.01
                            )Basic
      and diluted weighted-average shares outstanding
                            
                            
                            33,188,907
                            
                            
                            
                            32,849,330
                            
                            
                            
                            33,167,132
                            
                            
                            
                            32,815,014





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




5


US
DATAWORKS, INC.




UNAUDITED
CONDENSED STATEMENTS OF CASH FLOW




For
the Six Months Ended September 30,




2010
                
                
                2009Cash
      flows from operating activities:Net
      loss
                
                $
                (947,420
                )
                
                $
                (178,663
                )Adjustments
      to reconcile net loss to net cash provided by operating
      activities:Depreciation
      and amortization of property and equipment
                
                
                76,120
                
                
                
                82,664Amortization
      of note discount on note payable – related party
                
                
                66,527
                
                
                
                93,063Amortization
      of deferred financing costs – related party
                
                
                10,363
                
                
                
                162,248Stock
      based compensation
                
                
                89,286
                
                
                
                118,503Changes
      in operating assets and liabilities:Accounts
      receivable
                
                
                482,306
                
                
                
                (125,645
                )Prepaid
      expenses and other current assets
                
                
                199,187
                
                
                
                (190,916
                )Accounts
      payable
                
                
                32,410
                
                
                
                (63,756
                )Accrued
      expenses
                
                
                (112,955
                )
                
                
                (68,144
                )Accrued
      interest – related party
                
                
                3⁄4
                
                
                
                (14,679
                )Deferred
      revenue
                
                
                241,201
                
                
                
                62,033Net
      cash provided (used) by operating activities
                
                
                137,025
                
                
                
                (123,293
                )Cash
      flows from investing activities:Purchase
      of property and equipment
                
                
                (88,844
                )
                
                
                3⁄4Net
      cash used by investing activities
                
                
                (88,844
                )
                
                
                3⁄4Cash
      flows from financing activities:Payments
      on note payables
                
                
                (184,305
                )
                
                
                (17,638
                )Repayments
      of note payable – related party
                
                
                3⁄4
                
                
                
                (111,105
                )Net
      cash used by financing activities
                
                
                (184,305
                )
                
                
                (128,743
                )Net
      decrease  in cash and cash equivalents
                
                
                (136,124
                )
                
                
                (252,036
                )Cash
      and cash equivalents, beginning of period
                
                
                444,542
                
                
                
                403,863Cash
      and cash equivalents, end of period
                
                $
                308,418
                
                
                $
                151,827Supplemental
      disclosures of cash flow information:Interest
      paid
                
                $
                229,541
                
                
                $
                285,226Federal
      income taxes paid
                
                
                3⁄4
                
                
                
                3⁄4




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




6


US
DATAWORKS, INC.




NOTES
TO UNAUDITED CONDENSED FINANCIAL STATEMENTS





1.
            Organization and
      Business




General




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




2
            Summary of Significant
      Accounting Policies




Interim Financial
Statements




The
accompanying interim unaudited condensed financial statements included herein
have been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission (“SEC”).  The financial statements
reflect all adjustments that are, in the opinion of management, necessary to
fairly present such information.  All such adjustments are of a normal
recurring nature.  Although the Company believes that the disclosures are
adequate to make the information presented not misleading, certain information
and footnote disclosures, including a description of significant accounting
policies normally included in financial statements prepared in accordance with
accounting principles generally accepted in the United States of America (“US
GAAP”), have been condensed or omitted pursuant to such rules and
regulations.




These
financial statements should be read in conjunction with the audited financial
statements and the notes thereto included in the Company’s Annual Report on Form
10-K for the fiscal year ended March 31, 2010.  The results of operations
for interim periods are not necessarily indicative of the results for any
subsequent quarter or the fiscal year ending March 31, 2011.




Revenue
Recognition





The
Company recognizes revenues associated with its software products in accordance
with the provisions of the Financial Accounting Standard Board (“FASB”)
Accounting Standards Codification (“ASC”) Topic No. 985 – 605, “Software Revenue
Recognition”.





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




If
professional services are provided in connection with the installation of the
software licensed, revenue is recognized when these services have been provided.
The Company also recognizes revenue on a percentage 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.




In
certain instances, we license our software products under non-exclusive,
non-transferable license agreements. For agreements that do not require
significant production, modification or customization, revenue is recognized
when the license agreement has been signed, the software product has been
delivered, the related fee is fixed or determinable and collection of such fee
is probable.  For agreements that involve services essential to the
functionality of the software, revenue would be considered professional services
and revenue would be recognized when services have been provided on percentage
of completion basis.




7




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
term, but following any installation period of the software.




In
certain instances, the Company enters into arrangements that include multiple
elements, where fees are allocated to the various elements based on vendor
specific objective evidence of fair value.





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. FASB ASC Topic No. 350, “Intangibles – Goodwill and Other
Intangibles”), requires goodwill for each reporting unit of an entity be
tested for impairment by comparing the fair value of each reporting unit with
its carrying value. Fair value is determined using a combination of the
discounted cash flow, market multiple and market capitalization valuation
approaches. Significant estimates used in the methodologies include estimates of
future cash flows, future short-term and long-term growth rates, weighted
average cost of capital and estimates of market multiples for each reportable
unit. On an ongoing basis, absent any impairment indicators, the Company
performs impairment tests annually during the fourth quarter.





FASB ASC
Topic No. 350 requires goodwill to be tested annually and between annual tests
if events occur or circumstances change that would more likely than not reduce
the fair value of the reportable unit below its carrying amount. The Company did
not record an impairment of goodwill for either the quarter ended September 30,
2010 or the year ended March 31, 2010.





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




Convertible Debt Financing –
Derivative Liabilities





The
Company reviews the terms of its 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. As of September 30, 2010 and
March 31, 2010, the Company did not have any derivative instrument
liabilities.





Stock
Options




The
Company follows the guidance cited in ASC Topic No. 718, “Compensation – Stock
Compensation”, to account for its stock options. ASC Topic No. 718
requires the measurement and recognition of compensation expense for all
share-based payment awards made to employees and directors, including employee
stock options, based on estimated fair values. Stock-based compensation expense
recognized under ASC Topic No. 718, which consists of stock-based compensation
expense related to employee and director stock options and restricted stock
issuances, for the six months ended September 30, 2010 was $72,638 and $101,403
for the six months ended September 30, 2009, which consists of stock-based
compensation expense related to employee and director stock options and
restricted stock issuances.





ASC Topic
No. 718 requires companies to estimate the fair value of share-based payment
awards on the date of grant using an option-pricing model. The value of the
portion of the award that is ultimately expected to vest is recognized as
expense over the requisite service periods in the Company’s statement of
operations. Stock-based compensation expense recognized during the period is
based on the value of the portion of share-based payment awards that is
ultimately expected to vest during the period. Compensation expense recognized
for all employee stock options awards granted is recognized over their
respective vesting periods unless the vesting period is graded. As stock-based
compensation expense recognized in the Statement of Operations for the six
months ended September 30, 2010 and September 30, 2009 is based on awards
ultimately expected to vest, it has been reduced for estimated forfeitures as
explained below.





8


Upon
adoption of ASC Topic No. 718, the Company continued to use the Black-Scholes
option valuation model, which requires management to make certain assumptions
for estimating the fair value of employee stock options granted at the date of
the grant. In determining the compensation cost of the options granted, as
specified by ASC Topic No. 718, the fair value of each option grant has been
estimated on the date of grant using the Black-Scholes pricing model. The
weighted average assumptions used in the calculations for the options granted in
the six months ended September 30, 2009 included a risk-free interest rate of
..9%, expected life of options granted  is ten years, expected volatility is
208%, expected dividend yield of zero, and expected forfeiture rate of 30%.
There were 25,000 options granted during the six months ended September 30,
2010.  There were 800,000 options granted during the six months ended
September 30, 2009. The weighted average assumptions used in the calculations
for the options granted in the six months ended September 30, 2010 included a
risk-free interest rate of 2.35%, expected life of options granted  is ten
years, expected volatility is 117%, expected dividend yield of zero, and
expected forfeiture rate of 30%.





As of
September 30, 2010, there was approximately $19,212 of total unrecognized
compensation cost related to non-vested share-based compensation arrangements,
which is expected to be recognized over a period of two years.





Income and Loss per
Share





The
Company calculates income and loss per share in accordance with FASB ASC Topic
No. 260 – 10, “Earnings Per
Share”. Basic loss per share is computed by dividing the net loss by the
weighted-average number of common shares outstanding. Diluted loss per share is
computed similar to basic loss per share except that the denominator is
increased to include the number of additional common shares that would have been
outstanding if the potential common stock equivalents had been issued and if the
additional common shares were dilutive.





The
following potential common stock equivalents have been excluded from the
computation of diluted net loss per share for the periods presented because the
effect would have been anti-dilutive (options and warrants typically convert on
a one-for-one basis, see conversion details of the preferred stock stated below
for the common stock shares issuable upon conversion). The weighted-average
common stock equivalents as of September 30, 2010 and 2009 are as
follows:





September
      30,2010
                      
                      
                      2009Options
      outstanding under the Company’s stock option plans
                      
                      
                      6,571,832
                      
                      
                      
                      7,745,720Options
      outstanding outside the Company’s stock option plans
                      
                      
                      580,000
                      
                      
                      
                      1,160,000Warrants
      outstanding in conjunction with private placements
                      
                      
                      7,539,364
                      
                      
                      
                      2,888,201Warrants
      outstanding as a financing cost for notes payableand
      convertible notes payable
                      
                      
                      3,599,976
                      
                      
                      
                      2,888,201Warrants
      outstanding for services rendered and litigation
settlement
                      
                      
                      200,000
                      
                      
                      
                      200,000Convertible
      Series B preferred stock outstanding (a)
                      
                      
                      109,933
                      
                      
                      
                      109,933





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




Estimates




The
preparation of financial statements 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.




9


Concentrations of Credit
Risk




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




Three of
our customers accounted for 61%, 10% and 9% of our net revenues for the six
months ended September 30, 2010. Two of our customers accounted for 59% and 12%
of our net revenues for the six months ended September 30, 2009.




At
September 30, 2010, amounts due from four of our customers accounted for 38%,
19%, 13% and 10% of accounts receivable. At September 30, 2009, amounts due from
five of our customers accounted for 36%, 12%, 12%, 12% and 10% of accounts
receivable.




Recent Accounting
Pronouncements




There
have been no additional accounting pronouncements or changes in accounting
pronouncements during the six months ended September 30, 2010, as compared to
the recent accounting pronouncements described in our Annual Report on Form 10-K
for the fiscal year ended March 31, 2010, that are material, or potentially
material, to the Company’s financial statements.




Income
Taxes




Deferred
income taxes are provided on a liability method whereby deferred tax assets and
liabilities are established for the difference between the financial reporting
and income tax basis of assets and liabilities as well as operating loss and tax
credit carryforwards.  Deferred tax assets are reduced by a valuation
allowance when, in the opinion of management, it is more likely than not that
some portion or all of the deferred tax assets will not be realized. At
September 30, 2010 and March 31, 2010, a valuation allowance has been
established to fully offset deferred tax assets.




The
Company has computed the tax provision for the six months ended September 30,
2010 in accordance with the provisions of ASC 740-Income Taxes and ASC
270-Interim
Reporting.  The Company has estimated that its effective tax rate
for US purposes will be 0% for 2010, and consequently, recorded zero income tax
benefit for the six months ended September 30, 2010.




At
September 30, 2010, the Company had approximately $28 million of net operating
loss carryforwards for U.S. purposes.  These loss carryforwards will expire
from 2020 through 2030 if not utilized.




The
Company records expense and penalties related to unrecognized tax benefits as
income tax expense, and there is no liability accrued for the payment of
interest and penalties as of September 30, 2010 and March 31, 2010,
respectively. The Company recognized no benefits for uncertain positions during
the six months ended September 30, 2010, and there are no unrecognized tax
positions that may be recognized in the next twelve months as a result of a
lapse of statute of limitations and settlement of ongoing audits.




3.
            Property and
      Equipment




Property
and equipment as of September 30, 2010 and March 31, 2010 consisted of the
following:





September 30,
                    2010
                  
                  
                  March 31, 2010Furniture
      and fixtures
                  
                  $
                  99,535
                  
                  
                  $
                  99,535Office
      and telephone equipment
                  
                  
                  182,275
                  
                  
                  
                  182,275Computer
      equipment
                  
                  
                  808,037
                  
                  
                  
                  747,631Computer
      software
                  
                  
                  1,299,536
                  
                  
                  
                  1,271,098Leasehold
      improvements
                  
                  
                  64,733
                  
                  
                  
                  64,7332,454,116
                  
                  
                  
                  2,365,272Less
      accumulated depreciation and amortization
                  
                  
                  (2,271,596
                  )
                  
                  
                  (2,195,476
                  )Total
                  
                  $
                  182,520
                  
                  
                  $
                  169,796





10




Depreciation
and amortization expense for the three months ended September 30, 2010 and 2009
was $46,322 and $39,018, respectively.  Depreciation and amortization for
the six months ended September 30, 2010 and 2009 was $76,119 and $82,663,
respectively.




4.
            Bank Credit Line andLong-Term
      Debt




At
September 30, 2010 and March 31, 2010, the Company’s bank credit line and
long-term debt consisted of the following:




September 30,
                    2010
                  
                  
                  March 31, 2010Bank
      credit line
                  
                  $
                  -
                  
                  
                  $
                  -Bank
      term loan
                  
                  
                  805,556
                  
                  
                  
                  972,222Notes
      payable –related party
                  
                  
                  3,092,245
                  
                  
                  
                  3,092,245Notes
      payable –equipment
                  
                  
                  3⁄4
                  
                  
                  
                  17,639Unamortized
      debt discount
                  
                  
                  (477,209
                  )
                  
                  
                  (543,736
                  )Total
      secured notes payable and bank debt
                  
                  
                  3,420,592
                  
                  
                  
                  3,538,370Total
      long-term debt
                  
                  
                  3,420,592
                  
                  
                  
                  3,538,370Less:
      Current portion of long-term debt
                  
                  
                  569,444
                  
                  
                  
                  350,972Bank
      credit line and long-term debt, net of current portion
                  
                  
                  2,851,148
                  
                  
                  
                  3,187,398





Revolving
Bank Credit Line and Term Loan





On
February 9, 2010, the Company entered into a Loan and Security Agreement (the
“Loan Agreement”) with Silicon Valley Bank (“SVB”) and related agreements and
documents providing for a senior credit facility comprised of a revolving line
of credit and a term loan (the “Credit Facility”). Pursuant to the Loan
Agreement, the Company has granted SVB a security interest in all of its assets,
whether now owned or hereafter acquired, including but not limited to, all
accounts receivable, copyrights, trademarks, licenses, equipment and all
proceeds from such collateral. The initial maximum availability under
the revolving line of credit (the “Revolver”) was $250,000 and increased to
$1,000,000 on July 1, 2010. The maturity date of the Revolver was February 8,
2011. The Revolver accrued interest at an annual rate equal to the higher of (i)
1.25% above SVB’s prime rate or (ii) 5.25% and is payable monthly. No principal
payments are due on the Revolver until its maturity date. Subject to the
commitment limits described above, the Company could borrow up to eighty percent
(80%) of its eligible accounts receivable subject to a number of exceptions. The
Company will use the proceeds from the Revolver for general corporate purposes.
As of September 30, 2010, the Company had zero borrowings on the revolving line
of credit. The amount originally borrowed under the term loan (the “Term Loan”)
was $1,000,000 and the amount outstanding was $805,556 at September 30, 2010 and
$972,222 at March 31, 2010. The maturity date of the Term Loan was February 9,
2013. The Term Loan accrued interest at the fixed annual rate of 6.50% and is
payable monthly. Principal payments on the Term Loan were scheduled to be made
in thirty six equal monthly installments. If an event of default occurs and is
continuing, the interest rates on the Revolver and the Term Loan will increase
by 5.00% on an annualized basis.





The
Credit Facility required that the Company comply with financial
covenants for an adjusted quick ratio and a fixed charge coverage ratio, as
defined. As of September 30, 2010, the Company was not in compliance with
its financial covenants and certain other covenants under the Loan
Agreement.  The Company entered into a series of forbearance agreements
with SVB addressing such non-compliance.  Further, SVB has recently waived
the events of default arising out of such non-compliance in connection with
entering into an amended and restated loan agreement with the Company (See “Note
8-Subsequent Events”).





11


Notes
Payable – Related Parties





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





The terms
of the Nicholson Refinance Note are as follows:





·
            Current
      principal balance is $2,295,000.


·
            The
      maturity date is January 1, 2014.


·
            Annual
      interest rate is twelve percent (12%) but will reduce down to ten percent
      (10%) if the principal balance is reduced below
  $1,905,000.


·
            Interest
      is payable monthly.


·
            No
      principal payments required until the maturity
  date.





The terms
of the Ramey Refinance Note are as follows:





·
            Current
      principal balance is $792,245.


·
            The
      maturity date is January 1, 2014.


·
            Annual
      interest rate is ten percent (10%).


·
            Interest
      is payable monthly.


·
            No
      principal payments required until the maturity
  date.





The
Refinance Notes are expressly subject to the terms and provisions of the Amended
and Restated Subordination Agreement among SVB, Messrs. Nicholson and Ramey, and
the Company that was entered into as of October 27, 2010 in connection with
closing the New Credit Facility (the “Subordination Agreement”).  The
Subordination Agreement provides, among other things, that no payments on the
Refinance Notes other than regular scheduled non-default interest payments are
permitted without the consent of SVB unless and until the New Credit Facility is
paid in full and terminated.





The
Refinance Notes were originally issued pursuant to a Note Purchase Agreement
between the Company and Messrs. Nicholson and Ramey dated August 13, 2008 that
remain in effect.  The Refinance Notes are secured by a Security Agreement,
dated August 13, 2008, by and between the Company and Messrs. Nicholson and
Ramey, pursuant to which the Company granted Messrs. Nicholson and Ramey a
security interest in all its personal property, whether now owned or hereafter
acquired, including but not limited to, all accounts receivable, copyrights,
trademarks, licenses, equipment and all proceeds as from such collateral. 
Pursuant to the Subordination Agreement, this security interest will remain
junior to SVB’s security interest under the New Credit Facility as long as such
facility remains in place.





Note
Payable Equipment





In
August 2007, the Company entered into a note payable with an equipment vendor to
purchase new telephone equipment for $105,835. The note bears a 10.68% per
annum interest rate, is secured by the equipment and was due in 36 equal monthly
installments of $3,418. As of March 31, 2010, the outstanding balance on this
note payable was $17,639, and has been paid in full in FY2011.





12


Payment
Table





Future
minimum payments under our loan agreements affected for the subsequent
modifications of our loan agreement with SVB and notes payable at September
30, 2010 were as follows:




Fiscal Year Ended
                              March 31,
                            
                            Amount2011
                            
                            $
                            486,1112012
                            
                            
                            166,6672013
                            
                            
                            152,7782014
                            
                            
                            3,092,245$
                            3,897,801




Expiration of Private Placement
Liability




During
the quarter ended September 30, 2010, the Company recorded a non-cash event when
it released a $66,000 accrual due to the expiration of a liability that arose in
connection with a prior private placement of securities.




5.
            Commitments and
      Contingencies




Leases





The
Company leases an office in Sugar Land, Texas under an operating lease agreement
that expires in July 2012. Rent expense for the three months ended September 30,
2010 and September 30, 2009 was $101,519 and $101,006, respectively.  Rent
expense for the six months ended September 30, 2010 and September 30, 2009 was
$191,059 and $190,321, respectively.





Future
minimum lease payments under operating leases at September 30, 2010 were as
follows:




Fiscal Year Ended
                      March 31,
                    
                    Amount2011
                    
                    $
                    176,1562012
                    
                    
                    355,4442013
                    
                    
                    119,003$
                    650,603





6.
            Stockholders’
      Equity




Preferred
Stock




The
Company has 10,000,000 authorized shares of $0.0001 par value preferred stock.
The preferred stock may be issued in series, from time to time, with such
designations, rights, preferences, and limitations as the Board of Directors may
determine by resolution.




Convertible Series B
Preferred Stock




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




13


At
September 30, 2010, and March 31, 2010, there were accumulated, undeclared
dividends in arrears of $396,652 and $376,312, respectively.




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.  As of
September 30, 2010, the maximum aggregate number of shares which may be granted
under the 2000 Plan was 9,500,000. Under the 2000 Plan, the exercise price must
not be less than the fair market value on the date of grant of the option. The
options vest in varying increments over varying periods and expire 10 years from
the date of grant. In the case of incentive stock options granted to any 10%
owners of the Company, the exercise price must not be less than 100% of the fair
market value on the date of grant. Such incentive stock options vest in varying
increments and expire five years from the date of vesting.





During
the six months ended September 30, 2010, the Company granted 25,000 stock
options.





The
following table summarizes certain information relative to stock
options:




2000 Stock Option Plan
                              
                              
                              Outside of PlanShares
                              
                              
                              Weighted-
                                AverageExercise
                                Price
                              
                              
                              Shares
                              
                              
                              Weighted-Average
                                Exercise PriceOutstanding,
      March 31, 2010
                              
                              
                              7,845,720
                              
                              
                              $
                              0.63
                              
                              
                              
                              1,160,000
                              
                              
                              $
                              1.02Granted
                              
                              
                              25,000
                              
                              
                              $
                              0.19Forfeited/canceled
                              
                              
                              (1,298,888
                              )
                              
                              $
                              0.52
                              
                              
                              
                              (580,000
                              )
                              
                              $
                              1.02Outstanding,
      September 30, 2010
                              
                              
                              6,571,832
                              
                              
                              $
                              0.65
                              
                              
                              
                              580,000
                              
                              
                              $
                              1.02Exercisable,
      September 30, 2010
                              
                              
                              6,008,501
                              
                              
                              $
                              0.71
                              
                              
                              
                              580,000
                              
                              
                              $
                              1.02




The
weighted-average remaining life and the weighted-average exercise price of all
of the options outstanding at September 30, 2010 were 5.50 years and $0.68,
respectively. The exercise prices for the options outstanding at  September
30, 2010 ranged from $0.15 to $6.25 per share, and information relating to these
options is as follows:




Range of
                            Exercise
                            Prices
                          
                          Stock Options
                            Outstanding
                          
                          
                          Stock Options
                            Exercisable
                          
                          Weighted-Average
                            Remaining
                            Contractual Life
                          
                          Weighted-
                            Average
                            Exercise
                            Price
                          
                          
                          Weighted-
                            Average
                            Exercise Price
                            of Options
                            Exercisable$0.15
      – 0.80
                          
                          
                          5,023,998
                          
                          
                          
                          4,588,999
                          
                          6.19
      years
                          
                          $
                          0.49
                          
                          
                          $
                          0.51$0.81
      – 1.35
                          
                          
                          1,714,834
                          
                          
                          
                          1,714,834
                          
                          3.88
      years
                          
                          $
                          0.93
                          
                          
                          $
                          0.93$1.36
      – 6.25
                          
                          
                          413,000
                          
                          
                          
                          413,000
                          
                          3.25
      years
                          
                          $
                          2.13
                          
                          
                          $
                          2.137,151,832
                          
                          
                          
                          6,716,833




Common Stock
Grants





During
the three months ended September 30, 2010, the Company granted 43,807 shares of
common stock (at $0.19 per share based on the closing price of the common stock
on the grant date), to its outside directors pursuant to the Company’s Outside
Director Compensation Plan. The Company expensed $8,323 related to these grants
in the three months ended September 30, 2010 and $16,648 related to these grants
in the six months ended September 30, 2010. These grants were made under the
2000 Plan.





14


During
the six months ended September 30, 2010, the Company granted 41,625 shares of
common stock (at $0.20 per share based on the closing price of the common stock
on the grant date) and 43,807 shares of common stock (at $0.19 per share based
on the closing price of the common stock on the grant date) to its outside
directors pursuant to the Company’s Outside Director Compensation Plan. The
Company expensed $8,325 related to these grants in the three months ended
September 30, 2010 and $16,648 related to these grants in the six months ended
September 30, 2010. These grants were made under the 2000 Plan.




6.
              Fair
      Value Measurements




On April
1, 2008, the Company adopted SFAS No. 157 “Fair Value Measurements”(“SFAS 157”), which is incorporated in ASC Topic No. 820 - 10, “Fair Value Measurements and
Disclosures”. ASC Topic No. 820 - 10, 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. ASC Topic No. 820 – 10
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, ASC Topic No. 820 – 10 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.





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




7.
              Liquidity




While the
Company incurred a moderate increase in its operating expenses to support the
growth of the Company, the Company experienced a decrease in revenues caused by
a timing difference on the start of a consulting agreement. Due to our prior
history of experiencing negative cash flow from operations and the debt
financing that we put in place to cover this historical negative cash flow, as
of September 30, 2010, we have approximately $3.1 million of debt coming due
January 1, 2014 and another $0.8 million of debt callable at the end of the
forbearance period.  In connection with entering into an amended and
restated loan agreement with SVB, the Company repaid $0.4 million of this debt
using its cash on hand and borrowings under a new accounts receivable line of
credit, leaving $0.4 million payable ratably through February 2013. (See “Note
8-Subsequent Events”).  While we expect to be able to fund our operations
and build enough cash to pay off this debt from our cash flow, if that is not
the case, our long term viability will again depend 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
transaction and subscription based software license contracts and professional
services agreements and software licenses to become profitable.




15




8.
            Subsequent
      Event




Effective
as of October 27, 2010, the Company entered into an Amended and Restated Loan
and Security Agreement (the “New Loan Agreement”) with SVB and related
agreements and documents providing for a senior credit facility comprised of an
asset-based accounts receivable line of credit (the “A/R Line of Credit”) and a
term loan (the “New Credit Facility”).  The New Loan Agreement amends and
restates the Loan Agreement (also referred to herein as the “Prior Loan
Agreement”) in its entirety.





In
connection with the closing of the New Loan Agreement, the Company repaid
$402,750 of the outstanding principal amount of the term loan provided by SVB
under the Prior Loan Agreement (the “Prior Term Loan”), leaving a principal
balance of $402,750 on such term loan that is provided under and governed by the
New Loan Agreement (the “Refinanced Term Loan”).  The maturity date of the
Refinanced Term Loan is February 1, 2013.  The Refinanced Term Loan accrues
interest at the fixed annual rate of 7.00% and is payable monthly. 
Principal payments on the Refinanced Term Loan will be made in twenty eight (28)
equal monthly installments beginning on November 1, 2010.  The Company used
its cash on hand and borrowings under the A/R Line of Credit to fund the partial
repayment of the Prior Term Loan.





The
maximum availability under the A/R Line of Credit is $1,000,000.  The
maturity date of the A/R Line of Credit is February 8, 2011.  The following
finance charges and handling fees apply to the A/R Line of Credit:





·
            A
      finance charge equal to 1.25% above SVB’s prime rate will be applied to
      the full face amount of the financed
  receivables.





·
            An
      additional collateral handling fee equal to 0.25% per month will applied
      to the full face amount of the financed receivables.  This collateral
      handling fee will reduce to 0.10% per month if the Company’s “adjusted
      quick ratio” is greater than 1.30 at all times during an applicable
      testing month, with such reduction being effective for the calendar month
      which is two months after such testing month and where the “adjusted quick
      ratio” equals (A) cash on hand plus the amount of all eligible accounts
      divided by (B) current liabilities minus deferred revenue minus the
      portion of subordinated debt that constitutes current
      liabilities.





For
periods where the Company’s adjusted quick ratio is less than 1.30, it will be
subject to the higher collateral handling fee, yielding an indicative annual
interest rate on the A/R Line of Credit of approximately 10.31% based on the
current SVB prime rate.  For periods where the collateral handling fee is
reduced as discussed above, the Company’s indicative annual interest rate on the
A/R Line of Credit would be approximately 8.06% based on the current SVB prime
rate.  The finance charges and collateral handling fees for a particular
financed receivable are due when the advance made on such financed receivable
becomes due (as discussed below).





An
advance for a particular financed receivable under the A/R Line of Credit is
required to be repaid on the earlier to occur of (i) the date on which payment
is received on such financed receivable, (ii) the date on which such financed
receivable is no longer an eligible account, (iii) the date on which any
adjustment is asserted to such financed receivable (but only to the extent of
the adjustment if such financed receivable remains otherwise an eligible
account), (iv) the date on which there is a breach of certain warranties or
representations set forth in the New Loan Agreement related to such financed
receivable, or (v) the maturity date of the A/R Line of Credit.





Subject
to the commitment limits described above, the Company can borrow up to eighty
percent (80%) of its eligible accounts receivable subject to a number of
exceptions that include, but are not limited to, receivables that remain unpaid
more than 90 days from the invoice date and receivables for work performed that
have not yet been invoiced.  Under certain circumstances, SVB can, in its
discretion, decrease the 80% cap, adjust the eligibility criteria to be more
stringent and/or elect not to make an advance on a particular receivable. 
The Company will use the proceeds from the A/R Line of Credit for general
corporate purposes.





16


The New
Credit Facility requires that the Company comply with one financial
covenant.  That covenant requires that the Company meets the following
minimum EBITDA requirements (where “EBITDA” is defined as earnings before
expenses relating to interest, taxes, depreciation and amortization in
accordance with GAAP, plus equity-based compensation expense):





·
            The
      Company’s EBITDA for the month ending August 31, 2010 shall be at least
      one hundred twenty five percent (125%) of the Company’s projected
      performance for such month as outlined in the Company’s business plan
      submitted to SVB (the “Company
Plan”).





·
            For
      the two months ended September 30, 2010, the Company’s EBITDA shall be at
      least seventy five percent (75%) of the Company’s projected performance
      for such two (2) month period as outlined in the Company
    Plan.





·
            As
      of each subsequent month beginning with the month ending October 31, 2010,
      the Company’s EBITDA for the three (3) months ending on such measurement
      date shall be at least seventy five percent (75%) of the Company’s
      projected performance for such three (3) month period as outlined in the
      Company Plan. The indebtedness owed under the New Credit Facility
      will be fully secured by a perfected first priority security interest in
      favor of SVB in all of the Company’s assets, including its cash, accounts
      receivable, inventory, equipment, intellectual property rights and
      contract rights.




Borrowing
under the A/R Line of Credit will be conditioned on (i) all representations and
warranties contained in the New Loan Agreement being true as of the date of the
borrowing request and (ii) no “event of default” having occurred and be
continuing or resulting from the requested advance.  The New Loan Agreement
contains a number of representations and warranties, including, but not limited
to, those pertaining to due organization and existence, collateral, accounts
receivable, litigation, the Company’s financial statements, solvency, regulatory
compliance, investments, taxes and use of proceeds.  The New Loan Agreement
also contains a number of affirmative covenants, including, but not limited to,
those pertaining to due organization and existence, government approvals,
delivery of financial statements and other certificates, reports and other
information, insurance, bank accounts, intellectual property rights, litigation
and audit rights.  The New Loan Agreement also contains a number of
negative covenants, including, but not limited to, those pertaining to
disposition of assets, changes in business and senior management, mergers and
acquisitions, cash dividends, investments, transactions with affiliates,
subordinated debt and regulatory compliance.





The New
Loan Agreement specifies a number of “events of default,” including, but not
limited to, payment defaults, the occurrence of a material adverse change, legal
attachment to collateral, insolvency, cross-defaults with other agreements,
judgments, misrepresentations, and the occurrence or assertion that the New
Credit Facility is not senior to any subordinated debt.  In addition, a
breach of any of the covenants, representations and warranties, or other
provisions of the New Loan Agreement will constitute an event of default, with
some of such breaches having a 10-30 day cure period and other breaches
(including the financial covenant, the negative covenants and affirmative
covenants relating to taxes, insurance, bank accounts and financial statement
and other information delivery requirements) having no cure period.  As
long as an event of default occurs and is continuing, the interest rates on the
A/R Line of Credit and the Refinanced Term Loan will increase by
5.00%.





In
addition, pursuant to the New Loan Agreement, SVB waived the following events of
default under the Prior Loan Agreement: (i) the Company’s violation of Section
6.7(a) of the Prior Loan Agreement for the April 2010, May 2010, June 2010, July
2010 and August 2010 measuring periods, (ii) the Company’s violation of Section
6.7(b) of the Prior Loan Agreement for the May 2010, June 2010, July 2010 and
August 2010 measuring periods, and (iii) the Company’s violations of Section 7.9
and 8.9 of the Prior Loan Agreement and Section 3 of the subordination agreement
(entered into in connection with the Prior Loan Agreement), for making interest
payments to its subordinated creditors during the period in which the events of
default described in clauses (i) and (ii) of this Section 12.13 had occurred and
were continuing, through the effective date of the New Loan
Agreement.





In
consideration of the New Credit Facility, the Company has paid or agreed to pay
the following fees to SVB: (1) an upfront cash fee of $2,500 payable at the
closing plus (2) an early termination fee of $14,027.50 if the New Loan
Agreement is terminated by the Company prior to February 8, 2011 (or if SVB
terminates the New Loan Agreement before such date after the occurrence of an
event of default).




17


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




The
following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the unaudited condensed financial
statements and related notes included elsewhere in this Quarterly Report on Form
10-Q and the audited financial statements and notes thereto included in the
Company’s Annual Report on Form 10-K for the fiscal year ended March 31,
2010.




C$Money
Transaction




During
the quarter ended September 30, 2010, the Company concluded that it would not be
able to record the effects of the transactions contemplated by the Strategic
Alliance Agreement with C$ cMoney, Inc. (“C$Money”) discussed in Item 7 of the
Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2010 in
fiscal 2011 or at any time thereafter.  The Company and C$ Money have since
rescinded the Strategic Alliance Agreement and other agreements entered into in
connection therewith.




Critical
Accounting Policies




The
following discussion and analysis of our unaudited condensed financial condition
and results of operations is based upon our financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate these estimates, including
those related to revenue recognition and concentration of credit risk. We base
our estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.




We
believe that of the significant accounting policies used in the preparation of
our unaudited condensed financial statements (see Note 2 to the Financial
Statements included in the Company’s Annual Report on Form 10-K for the fiscal
year ended March 31, 2010), the following are critical accounting policies,
which may involve a higher degree of judgment, complexity and
estimates.




Revenue
Recognition




The
Company recognizes revenues associated with its software products in accordance
with the provisions of the Financial Accounting Standard Board Accounting
Standards Codification (“ASC”) Topic No. 985 – 605, “Software Revenue
Recognition”.





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




If
professional services are provided in connection with the installation of the
software licensed, revenue is recognized when these services have been provided.
The Company also recognizes 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.




In
certain instances, we license our software products under non-exclusive,
non-transferable license agreements. For agreements that do not require
significant production, modification or customization, revenue is recognized
when the license agreement has been signed, the software product has been
delivered, the related fee is fixed or determinable and collection of such fee
is probable.  For agreements that involve services essential to the
functionality of the software, revenue would be considered professional services
and revenue would be recognized when services have been provided on percentage
of completion basis.




18


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.




In
certain instances, the Company enters into arrangements that include multiple
elements, where fees are allocated to the various elements based on vendor
specific objective evidence of fair value.





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. FASB ASC Topic No. 350, “Intangibles – Goodwill and Other
Intangibles”, requires goodwill for each reporting unit of an entity be
tested for impairment by comparing the fair value of each reporting unit with
its carrying value. Fair value is determined using a combination of the
discounted cash flow, market multiple and market capitalization valuation
approaches. Significant estimates used in the methodologies include estimates of
future cash flows, future short-term and long-term growth rates, weighted
average cost of capital and estimates of market multiples for each reportable
unit. On an ongoing basis, absent any impairment indicators, the Company
performs impairment tests annually during the fourth quarter.





FASB ASC
Topic No. 350 requires goodwill to be tested annually and between annual tests
if events occur or circumstances change that would more likely than not reduce
the fair value of the reportable unit below its carrying amount. The Company did
not record an impairment of goodwill for either the six months ended September
30, 2010 or the year ended March 31, 2010.




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




Concentrations
of Credit Risk




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




Three of
our customers accounted for 61%, 10% and 9% of our net revenues for the six
months ended September 30, 2010. Two of our customers accounted for 59% and 12%
of our net revenues for the six months ended September 30, 2009.




At
September 30, 2010, amounts due from four of our customers accounted for 38%,
19%, 13% and 10% of accounts receivable. At September 30, 2009, amounts due from
five of our customers accounted for 36%, 12%, 12%, 12% and 10% of accounts
receivable




Results
of Operations




The
results of operations reflected in this discussion include our operations for
the three and six month periods ended September 30, 2010 and 2009.




Revenues




For the Three Months Ended
                    September 30,
                  
                  
                  
                  
                  
                  For the Six Months Ended
                    September 30,2010
                  
                  
                  2009
                  
                  
                  Change
                  
                  
                  2010
                  
                  
                  2009
                  
                  
                  ChangeSoftware
      transactional and subscription revenues
                  
                  $
                  586,765
                  
                  
                  $
                  518,725
                  
                  
                  
                  13
                  %
                  
                  $
                  1,085,982
                  
                  
                  $
                  1,039,968
                  
                  
                  
                  4
                  %Software
      maintenance revenues
                  
                  
                  140,866
                  
                  
                  
                  208,488
                  
                  
                  
                  -32
                  %
                  
                  
                  285,188
                  
                  
                  
                  420,859
                  
                  
                  
                  -32
                  %Professional
      service revenues
                  
                  
                  977,267
                  
                  
                  
                  1,359,976
                  
                  
                  
                  -28
                  %
                  
                  
                  1,700,066
                  
                  
                  
                  2,634,823
                  
                  
                  
                  -35
                  %Total
      revenues
                  
                  $
                  1,704,898
                  
                  
                  $
                  2,087,189
                  
                  
                  
                  -18
                  %
                  
                  $
                  3,071,236
                  
                  
                  $
                  4,095,650
                  
                  
                  
                  -25
                  %





19




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




Revenues
decreased for the three and six months ended September 30, 2010, by 18% and 25%,
respectively, as compared to the same periods ended September 30, 2009. 
For the three and six months ended September 30, 2010, (i) professional services
revenue decreased by 28% and 35%, respectively, primarily due to the timing
of the completion of certain professional services contracts and the start of
new contracts, (ii) software maintenance revenues decreased 32% and 32%,
respectively, due to the non-renewal of certain maintenance agreements,
(iii)  software transactional and subscription revenue increased by 13% and
4%, respectively, due to the addition three new customers and increased
transactions of larger customer, all as compared to the same periods ended
September 30, 2009.  We expect our transactional revenue to grow as more of
our current customers, along with new customers, begin to run more of their
business through our software products.





Cost
of Revenues




Costs of
revenues include the cost of other third party software resold in connection
with our software and personnel costs associated with our software, maintenance,
support, training and installation services. Cost of revenues for the three
months ended September 30, 2010 decreased by $84,052, or 13%, to $586,266 as
compared to $670,318 for the prior period.  Cost of revenues for the six
month ended September 30, 2010 decreased by $154,166, or 11.4%, to $1,192,523 as
compared to $1,346,689 for the prior year period. This decrease was primarily
due to a decrease of $22,000 and $70,000 in the cost of third party software
purchased for resale for the three and six months ended September 30, 2010,
respectively, and a decrease of $40,000 and $102,000 in outside consulting labor
costs for the three and six months ended September 30, 2010, respectively, due
to reduction in professional services performed.




Operating
Expenses




Total
operating expenses for the three months ended September 30, 2010, increased by
$20,580, or 2%, to $1,307,638 as compared to $1,287,058 for the prior year
period. Total operating expenses for the six months ended September 30, 2010
increased by $219,010, or 9%, to $2,596,592 as compared to $2,377,582 for the
prior year period.




General
and administrative expenses for the three months ended September 30, 2010
increased by $4,189, or 1%, as compared to prior year period due to an $80,000
increase in payroll due to salary increase, overlap of positions and a severance
payment, partially offset by a $38,000 decrease in bonus and accounting accruals
and a $34,000 decrease in stock-based compensation.  General and
administrative expenses for the six months ended September 30, 2010 increased by
$177,411, or 13%, as compared to the prior year period
primarily attributable to a $101,000 increase in general and administrative
personnel expenses, a $93,000 increase in legal expense associated with the
Company’s delisting issues, a $40,000 increase in outside consultant expense,
partially offset by a $29,000 decrease in stock-based compensation
expense.




Research
and development expenses for the three and six months ended September 30, 2010
increased by $35,512 and $65,082, respectively, as compared to the prior year
periods due to increases in personnel and outside services.  Sales and
marketing expenses for the three and six months ending September 30, 2010
decreased by $26,425 and $16,398, respectively, as compared to prior year
periods due to a decrease in salary expenses.




20


In our
effort to promote our brand name, increase our client base and expand our
relationship with existing clients, we expect our operating expenses in both
research and development and sales and marketing to increase.




Our
depreciation and amortization expense for the three months ended September 30,
2010 increased by $7,304, or 18.7%, as compared to the prior year period due to
the purchase of additional equipment and from the correction of lives of
leasehold improvements.  Depreciation and amortization for the six months
ended September 30, 2010 decreased by $6,545, or 7.9%, due to a number of our
property and equipment items attaining a fully depreciated state during the
fiscal year.




Other
Expenses




Other
expenses, including interest expense and financing costs, for the three months
ended September 30, 2010 decreased by $199,303, or 70%, to $85,260 as compared
to $284,563 for the prior year period.  Other expenses, including interest
expense and financing costs, for the six months ended September 30, 2010
decreased by $320,501, or 58.3%, to $229,541 as compared to $550,042 for the
prior year period. The decrease was primarily due to the effects of the
restructuring of the related party notes on interest expense and the release of
a $60,000 accrual of interest associated with debt.




Net
Loss




Net loss
for the months ended September 30, 2010 increased by $119,516 to a net loss of
$274,266 as compared $154,750 for the prior year period.  Net loss for the
six months ended September 30, 2010 increased by $768,757, to a net loss of
$947,420 as compared to a net loss of $178,663.  For details related to
this loss see the preceding discussions related to revenues, cost of revenues,
operating expenses and other income sections above.




Liquidity
and Capital Resources




While the
Company incurred a moderate increase in its operating expenses to support the
growth of the Company, the Company experienced a decrease in revenues caused by
a timing difference on the start of a consulting agreement. Due to our prior
history of experiencing negative cash flow from operations and the debt
financing that we put in place to cover this historical negative cash flow, as
of September 30, 2010, we have approximately $3.1 million of debt coming due
January 1, 2014 and another $0.8 million of debt callable at the end of the
forbearance period.  In connection with entering into an amended and
restated loan agreement with SVB, the Company repaid $0.4 million of this debt
using its cash on hand and borrowings under a new accounts receivable line of
credit, leaving $0.4 million payable ratably through February 2013. (See “Note
8-Subsequent Events”).




While we
expect to be able to fund our operations and build enough cash to pay off this
debt from our cash flow, if that is not the case, our long term viability will
again depend 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 transaction and subscription based software license
contracts and professional services agreements and software licenses to become
profitable.




Cash and
cash equivalents decreased by $198,829 to $308,418 at September 30, 2010 from
$507,247 at June 30, 2010.  Cash provided by operating activities was
$137,025 for the six months ended September 30, 2010 compared to $123,293 used
by operating activities for the same period in the prior fiscal
year.




Investing
activities used $88,844 in the six months ended September 30, 2010 compared to
no cash used by investing activities for the same period in the prior fiscal
year.




Financing
activities used cash of $184,305 in the six months ended September 30, 2010 as
compared to $128,743 of cash used by financing activities in the six months
ended September 30, 2009.




21


We
believe we currently have adequate capital resources to fund our anticipated
cash needs through March 31, 2011. 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 raise 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 3.   Quantitative and Qualitative
Disclosures About Market Risk




Not
applicable.




Item 4.   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.




As previously disclosed in our Annual Report on Form 10-K for the
fiscal year ended March 31, 2010, management identified a material weakness in
our internal control over financial reporting, which is an integrated component
of our disclosure controls and procedures.  A material weakness is a
deficiency, or a combination of deficiencies, in internal control over financial
reporting such that there is a reasonable possibility that a material
misstatement of the annual or interim will not be prevented or detected on a
timely basis.   Specifically our management concluded that at March
31, 2010, there was a material weakness regarding the calculation of stock
option values based on terms other than those listed.  This material
weakness resulted in errors in the Company’s accounting and disclosures for
shareholders’ equity and share-based compensation expense and resulted in the
restatement of the financial statements for the fiscal years ended March 31,
2007, 2008 and 2009. We have since developed and implemented new procedures to
remediate this material weakness.  Specifically, we have created a new
procedure to quarterly review accounting estimates for all equity
transactions.  These procedures will be documented internal controls and
will be reviewed annually.  These procedures were utilized in connection
with the stock option grants made during the three months ended September 30,
2010, and we believe that as of September 30, 2010, this material weakness no
longer exists.




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. Except for remedial measures
discussed above, 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 may become involved in various legal and other proceedings that are
incidental to the conduct of our business. We are currently not involved in any
such legal proceedings.




Item
1A.  Risk Factors




There
have been no material changes in our risk factors disclosed in our Annual Report
on Form 10-K for the fiscal year ended March 31, 2010 dated as of, and
filed with the SEC on, June 29, 2010 (the “Annual Report”).  For a
discussion of these risk factors, see “Item 1A. Risk Factors”
in the Annual Report.




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





None.





Item 3.          Defaults Upon
Senior Securities





As of
September 30, 2010, the Company was in default under its Credit Facility with
SVB as a result of failing to comply with the financial covenants and certain
other covenants of the Loan Agreement.  The Company entered into a series
of forbearance agreements with SVB addressing such non-compliance. 
Further, SVB has recently waived the events of default arising out of such
non-compliance in connection with entering into an amended and restated loan
agreement with the Company (See “Note 8-Subsequent Events”).





Item
5.         Other Information





None.




Item
6.         Exhibits




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




Exhibit
                  Number
                
                Description of Document10.1
                
                Forbearance
      to Loan and Security Agreement by and between US Dataworks, Inc. and
      Silicon Valley Bank dated September 20, 2010 (incorporated by reference to
      Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed with the
      SEC on September 24, 2010).10.2
                
                Forbearance
      to Loan and Security Agreement by and between US Dataworks, Inc. and
      Silicon Valley Bank dated September 30, 2010 (incorporated by reference to
      Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed with the
      SEC on October 6, 2010).10.3
                
                Amended
      and Restated Loan and Security Agreement by and between US Dataworks, Inc.
      and Silicon Valley Bank dated as of October 27, 2010 (incorporated by
      reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K
      filed with the SEC on November 2, 2010).31.1*
                
                Section
      302 Certification of Chief Executive Officer.31.2*
                
                Section
      302 Certification of Chief Financial Officer or person performing similar
      functions.32.1*
                
                Section
      906 Certification of Chief Executive Officer.32.2*
                
                Section
      906 Certification of Chief Financial Officer or person performing similar
      functions.


________


*Filed
herewith




23


SIGNATURE




In
accordance with the requirements of the Exchange Act, the registrant caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.




Dated: 
November 15, 2010




US
      DATAWORKS, INC.By
              / s/ Charles E. RameyCharles
      E. RameyChief
      Executive Officer(Duly
      Authorized Officer)By:
              /s/ Randall J. FrapartRandall
      J. FrapartChief
      Financial Officer(Principal
      Financial Officer)


24




EXHIBIT
INDEX




Exhibit
                      Number
                    
                    Description of Document10.1
                    
                    Forbearance
      to Loan and Security Agreement by and between US Dataworks, Inc. and
      Silicon Valley Bank dated September 20, 2010 (incorporated by reference to
      Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed with the
      SEC on September 24, 2010).10.2
                    
                    Forbearance
      to Loan and Security Agreement by and between US Dataworks, Inc. and
      Silicon Valley Bank dated September 30, 2010 (incorporated by reference to
      Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed with the
      SEC on October 6, 2010).10.3
                    
                    Amended
      and Restated Loan and Security Agreement by and between US Dataworks, Inc.
      and Silicon Valley Bank dated as of October 27, 2010 (incorporated by
      reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K
      filed with the SEC on November 2, 2010).31.1*
                    
                    Section
      302 Certification of Chief Executive Officer.31.2*
                    
                    Section
      302 Certification of Chief Financial Officer or person performing similar
      functions.32.1*
                    
                    Section
      906 Certification of Chief Executive Officer.32.2*
                    
                    Section
      906 Certification of Chief Financial Officer or person performing similar
      functions.


________


*Filed
herewith




25