##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington D.C., 20549
 
 FORM 10-QSB
 
  þ
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2006
 o
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period                      to
 Commission file number: 001-15835
 US Dataworks, Inc.
  Nevada
    
    84-1290152(State or other jurisdiction of
    
    (I.R.S. employer identification number)incorporation or organization)
 5301 Hollister Road, Suite 250Houston, Texas
    
    77040(Address of principal executive offices)
    
    (Zip Code)
  þ o
 o þ
  o þ




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US DATAWORKS, INC.
 TABLE OF CONTENTS
   PagePART I  FINANCIAL INFORMATION
    
    
    1Item 1. Financial Statements
    
    
    1Item 2. Managements Discussion and Analysis or Plan of Operation
    
    
    16Item 3. Controls and Procedures
    
    
    24PART II  OTHER INFORMATION
    
    
    25Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    25Item 4. Submission of Matters to a Vote of Security Holders
    
    
    25Item 6. Exhibits
    
    
    25SIGNATURE
    
    
    26Section 302 Certification of CEOSection 302 Certification of CAOSection 906 Certification of CEOSection 906 Certification of CAO




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 US DATAWORKS, INC.
 BALANCE SHEET
 September 30, 2006
 (Unaudited)
 ASSETSCurrent assets:Cash and cash equivalents
    
    $
    134,646Accounts receivable, trade
    
    
    2,100,519Accounts
receivable, factored
    
    
    244,280Prepaid expenses and other current assets
    
    
    197,558Total current assets
    
    
    2,677,003Property and equipment, net
    
    
    457,106Goodwill, net
    
    
    14,133,629Other assets
    
    
    30,334Total assets
    
    $
    17,298,072
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US DATAWORKS, INC.
 BALANCE SHEET
 September 30, 2006
 (Unaudited)
 LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Current portion of convertible promissory notes, net of unamortized discount of $203,030
    
    $
    463,703Note payable  related party
    
    
    539,000Deferred
revenue  current
    
    
    744,383Accounts payable
    
    
    461,637Accrued expenses
    
    
    216,534Interest payable
    
    
    1,128Derivative  compounded embedded within note
    
    
    68,453Derivative  warrants
    
    
    77,464Total current liabilities
    
    
    2,572,302Total liabilities payable
    
    
    2,572,302Commitments and ContingenciesStockholders Equity:Convertible Series B preferred stock, $0.0001 par value
700,000 shares authorized, 549,667 shares issued and outstanding $0.75 liquidation
preference, dividends of $231,446 in arrears
    
    
    55Common stock, $0.0001 par value
90,000,000 shares authorized and 30,725,050 shares issued and outstanding
    
    
    3,073Additional paid-in capital
    
    
    63,509,143Accumulated deficit
    
    
    (48,786,501
    )Total stockholders equity
    
    
    14,725,770Total liabilities and stockholders equity
    
    $
    17,298,072
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US DATAWORKS, INC.
 For the Three Months Ended
    
    
    For the Six Months EndedSeptember 30,
    
    
    September 30,As Restated
    
    
    
    
    
    
    As Restated2006
    
    
    2005
    
    
    2006
    
    
    2005REVENUESSoftware licensing revenues
    
    $
    135,728
    
    
    $
    1,451,800
    
    
    $
    514,983
    
    
    $
    1,750,920Software transactional revenues
    
    
    291,724
    
    
    
    231,361
    
    
    
    605,720
    
    
    
    412,604Software maintenance revenues
    
    
    102,783
    
    
    
    134,566
    
    
    
    206,549
    
    
    
    226,892Professional service revenues
    
    
    1,291,438
    
    
    
    914,566
    
    
    
    1,709,510
    
    
    
    1,422,216Total revenues
    
    
    1,821,673
    
    
    
    2,732,293
    
    
    
    3,036,762
    
    
    
    3,812,632COST OF SALES
    
    
    497,428
    
    
    
    405,355
    
    
    
    1,019,728
    
    
    
    782,856Gross profit
    
    
    1,324,245
    
    
    
    2,326,938
    
    
    
    2,017,034
    
    
    
    3,029,776OPERATING EXPENSESGeneral and administrative
    
    
    1,768,850
    
    
    
    1,351,247
    
    
    
    3,531,798
    
    
    
    2,905,522Depreciation and amortization
    
    
    34,581
    
    
    
    89,957
    
    
    
    67,641
    
    
    
    178,482Total operating expense
    
    
    1,803,431
    
    
    
    1,441,204
    
    
    
    3,599,439
    
    
    
    3,084,004INCOME (LOSS) FROM OPERATIONS
    
    
    (479,186
    )
    
    
    885,734
    
    
    
    (1,582,405
    )
    
    
    (54,228
    )OTHER INCOME (EXPENSE)Interest expense
    
    
    (78,606
    )
    
    
    (91,046
    )
    
    
    (170,778
    )
    
    
    (144,651
    )Loss on extinguishment of debt
    
    
    
    
    
    
    (206,000
    )
    
    
    
    
    
    
    (206,000
    )Gain/Loss on derivatives
    
    
    257,383
    
    
    
    210,827
    
    
    
    (156,071
    )
    
    
    419,096Litigation settlement
    
    
    222,600
    
    
    
    
    
    
    
    222,600
    
    
    
    Other income
    
    
    2,016
    
    
    
    9,419
    
    
    
    10,491
    
    
    
    16,218Total other income (expense)
    
    
    403,393
    
    
    
    (76,800
    )
    
    
    (93,758
    )
    
    
    84,663INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES
    
    
    (75,793
    )
    
    
    808,934
    
    
    
    (1,676,163
    )
    
    
    30,435PROVISION FOR INCOME TAXES
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    NET INCOME (LOSS)
    
    $
    (75,793
    )
    
    $
    808,934
    
    
    $
    (1,676,163
    )
    
    $
    30,435Basic and diluted earnings (loss) per share
    
    $
    (0.00
    )
    
    $
    0.03
    
    
    $
    (0.06
    )
    
    $
    (0.00
    )Basic weighted-average shares outstanding
    
    
    30,560,591
    
    
    
    30,037,020
    
    
    
    30,415,806
    
    
    
    29,369,865Diluted weighted-average shares outstanding
    
    
    30,560,591
    
    
    
    30,076,243
    
    
    
    30,415,806
    
    
    
    29,409,088
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US DATAWORKS, INC.
 STATEMENTS OF CASH FLOW
 For the Six Months Ended September 30,
 (Unaudited)
 As Restated2006
    
    
    2005Cash flows from operating activities:-Net
(loss)/income from operations
    
    $
    (1,676,163
    )
    
    $
    30,435Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization of property and equipment
    
    
    67,641
    
    
    
    178,482Amortization of note discount on convertible promissory note
    
    
    132,819
    
    
    
    102,914Amortization of deferred compensation expense
    
    
    
    
    
    
    (9,302
    )Loss on extinguishment of debt
    
    
    
    
    
    
    206,000Gain on disposition of automobile
    
    
    (3,394
    )
    
    
    Stock based compensation
    
    
    390,572
    
    
    
    Gain /
(Loss) on derivatives
    
    
    156,071
    
    
    
    (419,096
    )Issuance of warrants for services
    
    
    
    
    
    
    26,456Issuance of options to third party for services
    
    
    
    
    
    
    22,853Changes in operating assets and liabilities:Accounts
receivable, trade
    
    
    (608,831
    )
    
    
    (88,121
    )Accounts
receivable, factored
    
    
    (244,280
    )
    
    
    Costs & estimated earnings in excess of billings on uncompleted contracts
    
    
    238,000
    
    
    
    (880,800
    )Prepaid expenses and other current assets
    
    
    (31,044
    )
    
    
    (240,694
    )Other assets
    
    
    12,890
    
    
    
    Deferred revenue
    
    
    527,629
    
    
    
    (236,827
    )Accounts payable
    
    
    230,225
    
    
    
    (75,516
    )Accrued expenses
    
    
    (246,004
    )
    
    
    (63,039
    )Interest payable
    
    
    (40,544
    )
    
    
    (38,410
    )Net cash used in operating activities
    
    
    (1,094,413
    )
    
    
    (1,484,665
    )Cash flows from investing activities:Purchase of property and equipment
    
    
    (57,246
    )
    
    
    (72,318
    )Proceeds from sales of fixed assets
    
    
    8,000
    
    
    
    Net cash used in investing activities
    
    
    (49,246
    )
    
    
    (72,318
    )
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US DATAWORKS, INC.
 STATEMENTS OF CASH FLOW
 For the Six Months Ended September 30,
 (Unaudited)
 As Restated2006
    
    
    2005Cash flows from financing activities:Proceeds
from related party note payable
    
    
    500,000
    
    
    
    Proceeds from convertible promissory note
    
    
    
    
    
    
    700,000Repayment of convertible promissory note
    
    
    (512,133
    )
    
    
    Proceeds from stock sale
    
    
    
    
    
    
    600,000Stock issuance costs
    
    
    
    
    
    
    (14,550
    )Net cash
(used in)/provided by financing activities
    
    
    (12,133
    )
    
    
    1,285,450Net Decrease in cash and cash equivalents
    
    
    (1,155,792
    )
    
    
    (271,533
    )Cash and cash equivalents, beginning of period
    
    
    1,290,438
    
    
    
    1,525,386Cash and cash equivalents, end of period
    
    $
    134,646
    
    
    $
    1,253,853Supplemental disclosures of cash flow informationInterest paid
    
    $
    78,504
    
    
    $
    76,820
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US DATAWORKS, INC.
 NOTES TO UNAUDITED FINANCIAL STATEMENTS
 1.
    
    Organization and BusinessGeneralUS Dataworks, Inc. (the Company), a Nevada corporation, develops, markets, and supports
payment processing software for the financial services industry. Its customer base includes many
of the largest financial institutions as well as credit card companies, government institutions,
and high-volume merchants in the United States. The Company was formerly known as Sonicport,
Inc.2.
    
    Summary of Significant Accounting PoliciesINTERIM FINANCIAL STATEMENTSThe unaudited condensed financial statements included herein
have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission. The financial
statements reflect all adjustments that are, in the opinion of
management, necessary to fairly present such information. All such
adjustments are of a normal recurring nature. Although the Company
believes that the disclosures are adequate to make the information
presented not misleading, certain information and footnote
disclosures, including a description of significant accounting
policies normally included in financial statements prepared in
accordance with accounting principles generally accepted in the
United States of America (US GAAP), have been condensed or omitted
pursuant to such rules and regulations.These financial statements should be read in conjunction
with the financial statements and the notes thereto included in the
Company's 2006 Annual Report. The results of operations for interim
periods are not necessarily indicative of the results for any
subsequent quarter or the entire fiscal year ending March 31, 2007.Revenue RecognitionThe Company recognizes revenues in accordance with the provisions of the American Institute of
Certified Public Accountants Statement of Position 97-2, Software Revenue Recognition. The
Company licenses its software products under nonexclusive, nontransferable license agreements.
These arrangements do not require significant production, modification, or customization,
therefore, revenue is recognized when such a license agreement has been signed, delivery of the
software product has occurred, the related fee is fixed or determinable, and collectibility is
probable.In certain instances, the Company licenses its software on a transactional fee basis in lieu of
an up-front licensing fee. In these arrangements, the customer is charged a fee based upon the
number of items processed by the software and the Company recognizes revenue as these
transactions occur. The transaction fee also includes the provision of standard maintenance and
support services as well as product upgrades should such upgrades become available.If professional services were provided in conjunction with the installation of the software
licensed, revenue is recognized when these services have been provided.For license agreements that include a separately identifiable fee for contracted maintenance
services, such maintenance revenues are recognized on a straight-line basis over the life of the
maintenance agreement noted in the agreement, but following any installation period of the
software.GoodwillEffective January 1, 2002, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 142 Goodwill and Other Intangible Assets, which establishes new accounting and
reporting requirements for goodwill and other intangible assets. Under SFAS No. 142, all
goodwill amortization ceased effective January 1, 2002.The goodwill recorded on the Companys books is from the acquisition of US Dataworks, Inc. in
fiscal year 2001 which remains the Companys single reporting unit. SFAS No. 142 requires
goodwill for each reporting
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unit of an entity to be tested for impairment by comparing the fair value of each reporting unit
with its carrying value. Fair value is determined using a combination of the discounted cash
flow, market multiple and market capitalization valuation approaches. Significant estimates used
in the methodologies include estimates of future cash flows, future short-term and long-term
growth rates, weighted average cost of capital and estimates of market multiples for each
reportable unit. On an ongoing basis, absent any impairment indicators, the Company performs
impairment tests annually during the fourth quarter.SFAS No. 142 requires goodwill to be tested annually and between annual tests if events occur or
circumstances change that would more likely than not reduce the fair value of the reportable
unit below its carrying amount. The Company did not have an impairment of goodwill to record for
the years ended March 31, 2006 or March 31, 2005.Convertible Debt Financing  Derivative LiabilitiesThe Company reviews the terms of convertible debt and equity instruments issued to determine
whether there are embedded derivative instruments, including embedded conversion options, that
are required to be bifurcated and accounted for separately as a derivative financial instrument.
In circumstances where the convertible instrument contains more than one embedded derivative
instrument, including the conversion option, that is required to be bifurcated , the bifurcated
derivative instruments are accounted for as a single, compound derivative instrument. Also, in
connection with the sale of convertible debt and equity instruments, the Company may issue
freestanding options or warrants that may, depending on their terms, be accounted for as
derivative instrument liabilities, rather than as equity.In accordance with Statement of Financial Accounting Standards No. 133, Accounting for
Derivative Instruments and Hedging Activities, as amended (SFAS 133), the convertible
debt holders conversion right provision, interest rate adjustment provision, liquidated
damages clause, cash premium option, and the redemption option (collectively, the debt
features) contained in the terms governing the convertible notes are not clearly and
closely related to the characteristics of the notes. Accordingly, the features qualify as
embedded derivative instruments at issuance and, because they do not qualify for any scope
exception within SFAS 133, they are required by SFAS 133 to be accounted for separately
from the debt instrument and recorded as derivative instrument liabilitiesStock OptionsEffective April 1, 2006, the Company adopted the Statement of Financial Accounting Standards No.
123 (revised 2004), Share-Based Payment (SFAS 123R), which require the measurement and
recognition of compensation expense for all share-based payment awards made to employees and
directors, including employee stock options, based on estimated fair values. The Company adopted
SFAS 123R using the modified prospective transition method, which requires the application of
the accounting standard as of April 1, 2006, the first day of the Companys fiscal year 2007.
The Companys Financial Statements as of and for the three months ended September 30, 2006
reflect the impact of SFAS 123R. In accordance with the modified prospective transition method,
the Companys Financial Statements for prior periods have not been restated to
reflect, and do not include, the impact of SFAS 123R. Stock-based compensation expense
recognized under SFAS 123R for the three months and six months ended September 30, 2006 was
$128,516, and $390,572 respectively, which consists of stock-based compensation expense related
to employee and director stock options and restricted stock issuances.SFAS 123R requires companies to estimate the fair value of share-based payment awards on the
date of grant using an option-pricing model. The value of the portion of the award that is
ultimately expected to vest is recognized as expense over the requisite service periods in the
companys Statement of Operations. Prior to the adoption of SFAS 123R, the Company accounted for
stock-based awards to employees and directors using the intrinsic value method in accordance
with APB 25 as allowed under Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation, (SFAS 123). Under the intrinsic value method, no stock-based
compensation expense had been recognized in the Companys Statement of Operations prior to
January 1, 2006 because the exercise price of the Companys stock options granted to employees
and directors
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was equal to or greater than the fair market value of the underlying stock at the date of grant.
The Companys pro forma information for the three and six month periods ended September 30,
2005 is as follows:
 For the Three Months
    
    For the Six Months EndingEnding Sept 30, 2005
    
    Sept 30, 2005As Restated
    
    As RestatedNet income as reported
    
    $
    808,934
    
    
    $
    30,435Stock-based employee compensation
expense determined under the fair
value based method for all
awards, net of related tax
effects
    
    $
    (257,957
    )
    
    $
    (527,557
    )Net income (loss); pro forma
    
    $
    550,977
    
    
    $
    (497,122
    )Basic and diluted earnings (loss)
per share, as reported
    
    $
    0.03
    
    
    $
    (0.00
    )Basic and diluted earnings (loss)
per share, pro forma
    
    $
    0.02
    
    
    $
    (0.02
    )
 The fair value of these options was estimated at the date of grant using the Black-Scholes
option pricing model with the following weighted-average assumptions for the three and six month
period ended September 30, 2005: dividend yields of 0%; expected volatility of 89%, risk-free
interest rates of 3.69%, and expected lives of 3 years. For the three and six months ended
September 30, 2005 there were 1,158,400 and 1,161,900 respectively of stock options granted.Stock-based compensation expense recognized during the period is based on the value of the
portion of share-based payment awards that is ultimately expected to vest during the period.
Compensation expense recognized for all employee stock options awards granted is recognized over
their respective vesting periods unless the vesting period is graded. As stock-based
compensation expense recognized in the Statement of Operations for the three and six months
ended September 30, 2006 is based on awards ultimately expected to vest, it has been reduced for
estimated forfeitures.Upon adoption of SFAS 123R 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 during the three and six months ended September 30, 2006, as specified by
SFAS 123R, the fair value of each option grant has been estimated on the date of grant using the
Black-Scholes pricing model and the weighted average assumptions used in these calculations are
summarized as follows:
 For the Three Months Ending
    
    For the Six Months EndingSeptember 30, 2006
    
    September 30, 2006Risk-free Interest Rate
    
    
    4.93
    %
    
    
    4.95
    %Expected
Life of Options Granted
    
    3 years
    
    3 yearsExpected Volatility
    
    
    84
    %
    
    
    86
    %Expected Dividend Yield
    
    
    0
    
    
    
    0Expected forfeiture rate
    
    
    30
    %
    
    
    30
    %
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As of September 30, 2006, there was approximately $455,702 of total unrecognized compensation
cost related to nonvested share-based compensation arrangements, which is expected to be
recognized over a period of 3 years.Loss per ShareThe Company calculates loss per share in accordance with SFAS No. 128, Earnings per Share.
Basic loss per share is computed by dividing the net loss by the weighted-average number of
common shares outstanding. Diluted loss per share is computed in a similar manner to basic loss
per share except that the denominator is increased to include the number of additional common
            shares that would have been outstanding if the potential common stock equivalents had been
issued and if the additional common shares were dilutive.
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):
 For the Six Months EndedSeptember 30,2006
    
    2005Options outstanding under the Companys stock option plans
    
    
    6,444,349
    
    
    
    4,088,683Options granted outside the Companys stock option plans
    
    
    1,160,000
    
    
    
    1,160,000Warrants issued in conjunction with private placements
    
    
    5,839,933
    
    
    
    5,597,859Warrants issued as a financing cost for notes payable
and convertible notes payable
    
    
    2,083,783
    
    
    
    2,122,283Warrants issued for services rendered and litigation settlement
    
    
    360,769
    
    
    
    360,769Warrants issued as part of the US Dataworks, Inc. acquisition
    
    
    -0-
    
    
    
    67,200Convertible Series B preferred stock (a)
    
    
    109,933
    
    
    
    109,933
 
 (a)
    
    The Series B preferred stock is convertible into shares of common stock at a conversion
price of $3.75 per share. EstimatesThe preparation of financial statements requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from those estimates.Concentrations of Credit RiskThe Company sells its products throughout the United States and extends credit to its customers.
It also performs ongoing credit evaluations of such customers. The Company does not obtain
collateral to secure its accounts receivable. The Company evaluates its accounts receivable on a
regular basis for collectibility and provides for an allowance for potential credit losses as
deemed necessary.Three of the Companys customers, accounted for 42%, 17% and 11%, respectively, of the Companys
net revenues for the three months ended September 30, 2006. Two customers accounted for 34% and
20%, respectively, of net revenue for the six months ended September 30, 2006. Two customers
accounted for 75% and 12% of net revenues for the three months ended September 30, 2005. Three
customers accounted for 54%, 18% and 11%, respectively, of net revenue for the six months ended
September 30, 2005.At September 30, 2006, amounts due from significant customers accounted for 71% of accounts
receivable.
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3.
    
    Restatement of Quarterly InformationThe Company concluded that it was necessary to restate its financial results for the interim
period ended September 30, 2005, to reflect additional non-operating gains and losses related
to certain features included is the Companys debt that require derivative treatment.The Company had previously classified the value of its conversion features and warrants to
purchase common stock as debt discounts. After further review, the Company has determined that
these instruments should have been recorded as derivative liabilities and therefore, the fair
value of each instrument must be recorded as a derivative liability on the Companys balance
sheet. Changes in the fair values of these instruments will result in adjustments to the amount
of the recorded derivative liabilities and the corresponding gain or loss will be recorded in
the Companys statement of operations. At the date of the conversion of each respective
instrument or portion thereof (or exercise of the options or warrants or portion thereof, as the
case may be), the corresponding derivative liability will be reclassified as equity.
 STATEMENTS OF OPERATIONS
 For Quarter ending September 30, 2005
 As PreviouslyReported
    
    
    Adjustments
    
    
    As RestatedRevenue
    
    $
    2,732,293
    
    
    $
    
    
    
    $
    2,732,293Income from operations
    
    
    885,734
    
    
    
    
    
    
    
    885,734Other income (expense):Financing costs
    
    
    (76,658
    )
    
    
    76,658
    
    
    
    Interest expense
    
    
    (27,605
    )
    
    
    (63,441
    )
    
    
    (91,046
    )Loss on extinguishment of debt
    
    
    
    
    
    
    (206,000
    )
    
    
    (206,000
    )Gain/Loss on derivatives
    
    
    
    
    
    
    210,827
    
    
    
    210,827Other income (expense)
    
    
    9,419
    
    
    
    
    
    
    
    9,419Net income
    
    $
    790,890
    
    
    $
    18,044
    
    
    $
    808,934Net income per common share; basic and diluted
    
    $
    0.03
    
    
    $
    
    
    
    $
    0.03
 BALANCE SHEET
 As PreviouslyReported
    
    Adjustments
    
    As RestatedTotal Assets
    
    $
    18,147,023
    
    
    $
    
    
    
    $
    18,147,023Total liabilities
    
    $
    1,511,610
    
    
    $
    376,838
    
    
    $
    1,888,448Stockholders Equity
    
    $
    16,635,413
    
    
    $
    (376,838
    )
    
    $
    16,258,575
 4.
    
    Property and EquipmentProperty and equipment as of September 30, 2006 consisted of the following:
 Furniture and fixtures
    
    $
    77,559Office and telephone equipment
    
    
    92,795Computer equipment
    
    
    593,700
 10




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##### Table of Contents



Computer software
    
    
    1,271,098Leasehold improvements
    
    
    62,9972,098,149Less accumulated depreciation and amortization
    
    
    (1,641,044
    )Total
    
    $
    457,105
 Depreciation and amortization expense for the three and six months ended September 30, 2006 and
2005 was $34,581, $67,643, $89,957 and $178,482, respectively.5.
    
    Notes Payable  Related PartiesOn September 26, 2006, the Company entered into a note payable with its Chief Executive Officer
for $500,000. The note bears an 8.75% per annum interest rate, is unsecured and is due
September 25, 2007. As of September 30, 2006, the outstanding balance on the note payable is
$500,000.6.
    
    Convertible Promissory NotesConvertible promissory notes at September 30, 2006 consisted of the following:
 Convertible promissory note, interest at 10% per
annum, unsecured, $256,066 due September 15, 2007
    
    $
    256,066Convertible promissory note issued June 16, 2005 with $70,000 Original
Issue Discount, due in 15 equal monthly installments beginning April 15, 2006,
net of unamortized discount of $203,031
    
    
    207,636463,702Less current portion
    
    
    (463,702
    )Long-term portion
    
    $
    -0-
 Convertible promissory note with interest at 10% per annumThis note is an amendment and restatement of a note in the same principal amount originally
dated September 15, 2004. The original note was issued effective September 15, 2004 in
connection with the November 2004 settlement of a lawsuit brought by an investor in December
2003. The amended note is convertible at anytime, at the holders election, into shares of the
Companys common stock at a per share conversion price of $1.10, subject to standard
antidilution provisions.The amended note is effective September 15, 2005 and extended a principal payment of $256,067
originally due September 15, 2005 for one year. In consideration of this amendment, the Company
issued the holder a common stock purchase warrant to purchase up to 650,000 shares of the
Companys common stock at an exercise price of $0.59 per share. The warrant will expire on
September 15, 2008.The changes to this debt caused the accounting treatment to be an extinguishment of the old debt
and issuance of new debt instead of being treated as modification of debt. Therefore, the
excess of the fair value of the note and warrants over the carrying amount of the debt is
$206,000 and has been recorded as a loss on extinguishment for the year ended March 31, 2006.In connection with the November 2004 settlement, the Company also issued a warrant to purchase
160,000 shares of the Companys common stock at a purchase price of $0.75 per share, which
warrant will expire on November 10, 2006.
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Using the Black-Scholes pricing model the Company has determined the value of the warrants
issued in connection with the settlement to be $126,000. This amount, together with the value of
the convertible promissory note, the value of the plaintiffs legal expense reimbursement and
the Companys legal costs incurred in connection with the settlement totaled $924,200 and has
been recorded as Investor litigation settlement expense for the year ended March 31, 2005.Convertible promissory note issued June 16, 2005 with $70,000 Original Issue DiscountOn June 16, 2005, the Company entered into a Securities Purchase Agreement with an institutional
investor (the Debenture Agreement) for the sale of a convertible debenture with a principal
amount of $770,000 and an original issue discount of $70,000 for gross proceeds of $700,000.
The debenture is convertible at anytime at the discretion of the holder at a price per share of
$0.572 into 1,346,154 shares of the Companys common stock. The convertible debenture is to be
repaid in 15 monthly installments of $51,333.33 beginning April 15, 2006. The Company may also
elect, upon proper notice, to pay any monthly installment in shares of the Companys common
stock based on a conversion price equal to the lesser of (i) the then applicable conversion
price, or (ii) 90% of the volume weighted average price of the Companys common stock for the 10
trading days immediately preceding the payment; provided, that, such conversion price must be at
least equal to the conversion floor of $0.23, or such monthly installment must be paid in cash.
This convertible debenture was amended on March 9, 2006, pursuant to which the Company must,
within 25 calendar days prior to each monthly payment, deliver 89,744 shares of its common stock
to the holders, which represents the monthly installment amount divided by the then conversion
price with the first monthly payment becoming due on April 17, 2006. In connection with the
Debenture Agreement, the Company issued two groups of warrants, Short Term Warrants and Long
Term Warrants to the institutional investor. The Short Term Warrants allow the institutional
investor to purchase an aggregate of 407,926 shares of the Companys common stock with an
exercise price of $0.572 per share exercisable for a period of 180 days at any time after the
later of (i) the effective date of the registration statement (as described below) or (ii)
December 16, 2005. The Long Term Warrants allow the institutional investor to purchase an
aggregate of 471,154 shares of the Companys common stock with an exercise price of $0.572 per
share exercisable at anytime from December 16, 2005 through December 16, 2008; provided,
however, the institutional investor will not be permitted to exercise a warrant to the extent
that the number of shares of the Companys common stock beneficially owned by such institutional
investor taken together with the number of shares to be issued upon exercise of the warrant
equals or exceeds 4.999% of the Companys then issued and outstanding shares of common stock.
The warrants also contain trading market restrictions that preclude
the Company from issuing shares of common stock upon exercise thereof if such issuance, when aggregated with other
issuances of the Companys common stock pursuant to the warrants, would exceed 19.999% of the
Companys then issued and outstanding shares of common stock, unless the Company has previously
obtained the required shareholder approval. Pursuant to a Registration Rights Agreement dated
June 16, 2005 between the Company and the institutional investor, the Company agreed to file a
registration statement for the resale of the shares of the Companys common stock that may be
issued to the institutional investor upon the conversion of the convertible debenture and the
exercise of the Short Term Warrants and the Long Term Warrants. The registration statement
covering these securities was effective on September 1, 2005.In accordance with Statement of Financial Accounting Standards No. 133 Accounting for
Derivative Instruments and Hedging Activities (SFAS 133), the debt features contained in the
terms governing the notes are not clearly and closely related to the characteristics of the
notes. Accordingly, the debt features qualify as embedded derivative instruments at issuance
and, because they did not qualify for any scope exception within SFAS 133, they were required to
be accounted for separately from the debt instrument and recorded as derivative financial
instruments.At the date of issuance, the embedded debt feature had an estimated initial fair value of
$449,089, which was recorded as a discount to the convertible notes and derivative liability on
our balance sheet. In subsequent periods, if the price of the security changes, the embedded
derivative financial instrument related to the debt features will be adjusted to the fair value
with the corresponding charge or credit to other income/(expense). The estimated fair value of
the debt features was determined using the probability weighted averaged expected cash flows /
Lattice Model with a closing price of $0.65, a conversion price as defined in the respective
note
agreement and a period of two years. Concerning the debt features, the model uses several
assumptions
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including: historical stock price volatility, approximate risk-free interest rate
(3.5%), remaining term to maturity, and the closing price of the companys common stock to
determine the estimated fair value of the derivative liability. For the quarter ended September
30, 2006, due in part to a decrease in the market value of the Companys common stock , the
Company recorded an other income item on the statement of operations for the change in fair
value of the embedded debt feature of approximately $257,821. At September 30, 2006, the
estimated fair value of the embedded debt feature was approximately $68,453.The recorded value of the embedded debt feature related to this debt can fluctuate significantly
based on fluctuations in the fair value of the Companys common stock.The warrants included with this note for purchase of the Companys common stock had an initial
value of $271,940. This amount has been classified as a derivative financial instrument and
recorded as a liability on our consolidated balance sheet in accordance with SFAS 133. The
estimated fair value of the warrants at the date of issuance was determined using the
Black-Scholes option-pricing model with a closing price of $1.14, the respective exercise price
of the warrants, a 2 year term, and a 90% volatility factor relative to the date of issuance.
The model uses several assumptions including: historical stock price volatility, approximate
risk-free interest rate (3.50%), remaining term to maturity, and the closing price of the
companys common stock to determine the estimated fair value of the derivative liability. In
accordance with the provisions of SFAS 133, the Company is required to adjust the carrying value
of the instrument to its fair value at each balance sheet date and recognize any change since
the prior balance sheet date as a component of other income/ (expense) on its statement of
operations. The warrant derivative liability at September 30, 2006, decreased to a fair value
of $77,464, due in part to a decrease in the market value of the companys common stock, which
resulted in an other income item of $111,057.The recorded value of the warrants can fluctuate significantly based on fluctuations in the
market value of the underlying securities of the issuer of the warrants, as well as in the
volatility of the stock price during the term used for observation and the term remaining for
the warrants.Due to changes in value upon the conversion of this debt when shares were issued for required
principal payments, additional losses were incurred amounting to $111,495. This loss is the
result of differences in the settlement method and the assumptions that were used in the
original derivative valuation.7.
    
    Accounts Receivable FacilityOn September 27, 2006, the Company entered into a
Purchase and Sale Agreement with Catalyst Finance, L.P.
(Catalyst) for sale of certain of its accounts
receivables. The Companys borrowing costs under this Agreement
range from 1.25% to 20% of the gross amount of the receivables sold
to Catalyst based on the timing of collection. The maximum funds
available under the agreement is all available accounts receivables as
agreed to by Catalyst and the Company. The agreement allows for
Catalyst to request repurchase of an account receivable under certain
conditions. For the three and nine months period ended
September 30, 2006, the financial institution has not requested
repurchase of an account receivable. To date the Company has sold
$305,350 in receivables under the agreement which yielded a loss on
the sale of these receivables of $61,070. The Agreement will continue
in effect until terminated by either party.8.
    
    Commitments and ContingenciesEmployment AgreementsOn April 3, 2006, the Company entered into an employment agreement with each of its President,
Payment Products Division and Vice Chairman, Sr. Vice President and Chief Technology Officer,
and Vice President of Business Development and General Counsel, for a term of three years with
automatic renewal for successive one-year terms unless either party gives timely notice of
non-renewal.Annual base salary for the President, Payment Products Division and Vice Chairman of the Company
is $190,000 and pursuant to the terms of the agreement he is entitled to receive an option to
purchase 550,000 shares of the Companys common stock. This option vests over a 3 year period
with 150,000 shares vesting on April 3, 2006 and 200,000 shares vesting on each of April 3,
2007 and 2008. In addition the President, Payment Products Division and Vice Chairman is
entitled to receive a bonus of $48,125 for year end 2006.Annual base salary for the Senior Vice President and Chief Technology Officer of the Company is
$185,000 and pursuant to the terms of the agreement he is entitled to receive 200,000 shares of
restricted common stock. The restricted shares vest over a 3 year period with 25,000 shares
vesting on April 3, 2006 and 87,500 shares vesting on each of April 3, 2007 and 2008. The Senior
Vice President and Chief Technology Officer is also eligible to receive a quarterly bonus of
equal to 3.5% of the increase in the Companys revenue from fiscal year quarter to fiscal year
quarter and to receive a bonus of $78,750 for fiscal year 2006.Annual base salary for the Vice President of Business Development and General Counsel of the
Company is $175,000, and pursuant to the terms of the agreement he is entitled to receive an
option to purchase 700,000
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##### Table of Contents



shares of the Companys common stock. This option vests over a 3
year period with 300,000 shares vesting on April 3, 2006 and 200,000 shares vesting on each of
April 3, 2007 and, 2008. The Vice President of Business Development and General Counsel is also
eligible to receive a quarterly bonus based upon the Companys future acquisitions or mergers.On May 23, 2006, the Company entered into an employment agreement with its Chairman of the Board
and Chief Executive Officer. The agreement has a 2 year term with automatic renewal for
successive one year terms unless either party gives timely notice of non-renewal. His annual
base salary is $220,000 and he is entitled to receive 100,000 shares of restricted common stock
that vest immediately and is entitled to receive an option to purchase 600,000 shares of the
Companys common stock. This option vests as to 300,000 shares on each of May 22, 2007 and
2008.LitigationIn June 2005, two of our former employees initiated arbitration against the Company
alleging wrongful termination and sought severance pay. Arbitration was held on March 28, 2006
and on June 19, 2006, the arbitration ruled that each employee was entitled to $90,000 in
severance pay, as well as costs and interest. These amounts were included in accrued
liabilities at March 31, 2006. On August 25, 2006 all severance pay, as well as costs and
interest due each employee was paid. These amounts were removed from accrued liabilities at
September 30, 2006.9.
    
    Stockholders EquityPreferred StockThe Company has 10,000,000 authorized shares of $0.0001 par value preferred stock. The preferred
stock may be issued in series, from time to time, with such designations, rights, preferences,
and limitations as the Board of Directors may determine by resolution.Convertible Series B Preferred StockThe Company has 700,000 authorized shares of $0.0001 par value convertible Series B preferred
stock.In August and October 2000, the Company issued 509,333 and 133,666 units respectively, in a
private placement for gross proceeds of $382,000 and $100,250, respectively. Each unit consisted
of one share of the Companys voting convertible Series B preferred stock (the Series B) and a
warrant, exercisable through October 2003, to purchase one share of the Companys common stock.
The Series B has a liquidation preference of $0.75 per share and carries a 10% cumulative
dividend payable each March 1 and September 1. The Company has the right to redeem the Series B
at any time after issuance at a redemption price of $0.83 per share, plus any accrued but unpaid
dividends. The Series B is convertible upon issuance into shares of the Companys common stock
at $3.75 per share. The warrant entitles the holder to purchase one share of the Companys
common stock at $6.25 per share, which represents 115% of the market value of the Companys
common stock at the closing date.In May 2001, an investor in the Series B rescinded its acquisition and returned to the Company
13,333 shares of Series B and warrants for the purchase of 2,667 shares of common stock in
exchange for the return of its investment of $10,000.In August 2004, an investor in the Series B elected to convert his 79,999 shares and accordingly
was issued 15,998 shares of the Companys common stock.At September 30, 2006, there were accumulated, undeclared dividends in arrears of $231,446 or
$0.42 per share.
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Common Stock and WarrantsDuring the three and six months ended September 30, 2006, the Company completed the following:Non-Cash FinancingIn the quarter ended June 30, 2006, the Company issued 303,116 shares of common stock with a
value of $154,000 to pay down debt associated with the convertible promissory note issued June
16, 2005.In the quarter ended September 30, 2006, the Company issued 287,173 shares of common stock with
a value of $154,000 to pay down debt associated with the convertible promissory note issued June
16, 2005.During the three and six months ended September 30, 2005, the Company completed the following:Sale of Common Stock and WarrantsEffective June 16, 2005, the Company entered into definitive agreements with nine accredited
investors for the sale of 1,258,654 shares of the Companys common stock for gross proceeds of
$600,000. The agreements also provide that the Company will issue warrants, exercisable over a
three year period, to purchase up to 314,664 shares of the Companys common stock at an exercise
price of $0.715 per share and an additional 314,664 shares of the Companys common stock at an
exercise price of $0.812 per share. In July 2005, upon receipt of approval of the American
Stock Exchange for issuance of the shares of the Companys common stock, the agreements were
completed and the investors were issued the shares of the Companys common stock and warrants.Stock OptionsIn August 1999, the Company implemented its 1999 Stock Option Plan (the 1999 Plan). In August
2000, the Companys Board of Directors approved the 2000 Stock Option Plan (the 2000 Plan),
which amends and restates the 1999 Plan. In September 2006, shareholders approved an amendment
to the Companys amended and restated 2000 Stock Option Plan to increase the maximum aggregate
number of shares available for issuance thereunder from 6,000,000 to 7,500,000. Under the 200
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 vesting. In the case of incentive stock options granted to any 10% owners of the
Company, the exercise price must not be less than 100% of the fair market value on the date of
grant. Such incentive stock options vest in varying increments and expire five years from the
date of vesting.During the six months ended September 30, 2006 the Company granted 3,098,500 stock options to
certain employees that may be exercised at prices ranging between $0.46 and $0.82. During the
six months ended September 30, 2005, the Company granted 1,161,900 stock options to certain
employees that may be exercised at prices ranging from $0.44 to $0.65.The following table summarizes certain information relative to stock options:
 2000 Stock Option Plan
    
    Outside of PlanWeighted-Average
    
    
    
    
    
    Weighted-AverageShares
    
    Exercise Price
    
    Shares
    
    Exercise PriceOutstanding, March 31, 2006
    
    
    3,499,115
    
    
    $
    0.92
    
    
    
    1,160,000
    
    
    $
    1.02Granted
    
    
    3,098,500
    
    
    $
    0.58
    
    
    
    
    
    
    
    Exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Forfeited/canceled
    
    
    153,266
    
    
    $
    1.43
    
    
    
    
    
    
    
    Outstanding, September 30, 2006
    
    
    6,444,349
    
    
    $
    0.74
    
    
    
    1,160,000
    
    
    $
    1.02Exercisable, September 30, 2006
    
    
    3,795,849
    
    
    $
    0.84
    
    
    
    1,160,000
    
    
    $
    1.02
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The weighted-average remaining life and the weighted-average exercise price of all of the
options outstanding at September 30, 2006 were 8.4 years and $0.78, respectively. The exercise
prices for the options outstanding at September 30, 2006 ranged from $0.44 to $6.25, and
information relating to these options is as follows:
 Range of
    
    
    
    
    
    
    
    
    
    Weighted-Average
    
    Weighted-
    
    Weighted-AverageExercise
    
    Stock Options
    
    Stock Options
    
    Remaining
    
    Average
    
    Exercise Price ofPrices
    
    Outstanding
    
    Exercisable
    
    Contractual Life
    
    Exercise Price
    
    Options Exercisable$0.44  0.80
    
    
    5,022,513
    
    
    
    2,749,013
    
    
    8.76 years
    
    $
    0.56
    
    
    $
    0.55$0.81  1.35
    
    
    1,837,836
    
    
    
    1,462,836
    
    
    7.81 years
    
    $
    0.93
    
    
    $
    0.96$1.36  6.25
    
    
    744,000
    
    
    
    744,000
    
    
    7.35 years
    
    $
    1.96
    
    
    $
    1.967,604,349
    
    
    
    4,955,849
 Restricted Stock
  
 Item 2. Managements Discussion and Analysis or Plan of Operation.
   Critical Accounting Policies
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Revenue Recognition
     Concentrations of Credit Risk
    Results of Operations
  Revenues
  17




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##### Table of Contents



Three Months Ended September 30
    
    
    Nine Months Ended September 30(in thousands)

    
    
(in thousands)2006
    
    
    2005
    
    
    Change
    
    
    2006
    
    
    2005
    
    
    ChangeSoftware licensing revenues
    
    $
    136
    
    
    $
    1,452
    
    
    
    -91
    %
    
    $
    515
    
    
    $
    1,751
    
    
    
    -7
    %Software transactional revenues
    
    
    292
    
    
    
    231
    
    
    
    26
    %
    
    
    606
    
    
    
    413
    
    
    
    47
    %Software maintenance revenues
    
    
    103
    
    
    
    135
    
    
    
    -24
    %
    
    
    207
    
    
    
    227
    
    
    
    -9
    %Professional service revenues
    
    
    1,291
    
    
    
    915
    
    
    
    41
    %
    
    
    1,710
    
    
    
    1,422
    
    
    
    20
    %Total revenues
    
    $
    1,822
    
    
    $
    2,733
    
    
    
    -33
    %
    
    $
    3,038
    
    
    $
    3,813
    
    
    
    20
    %
     Cost of Sales
  Operating Expenses
  18




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##### Table of Contents



Other Income (Expenses)
  Net Income (Loss)
   Liquidity and Capital Resources
   
    
    We entered into a month-to-month professional services contract with an existing
major financial services customer in September 2006, which we anticipate will generate
revenue sufficient to significantly reduce the negative cash flows from our operations
for fiscal 2007.
    
    Additionally, we believe that the demand for our software and professional services
will continue to expand as the United States market adopts the new payment processing
opportunities available under changing regulations such as the Check Clearing Act for
the 21st Century and NACHAs back office conversion, which allows the
conversion of paper checks in the back offices of retail merchants and government. We
believe that increased demand for our solutions, including our recently introduced
Clearingworks product, will lead to increased cash flows from up-front license fees,
transaction based contract fees and increases in professional services revenues.
    
    We have entered into a strategic alliance with one of the largest merchant service
providers, or MSP, which will allow this MSP to sell Clearingworks as part of its ARC
and back office conversion services. We expect this alliance to positively affect our
profitability.
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##### Table of Contents



Factors That May Affect Our Results
 We have a general history of losses and may not operate profitably in the future.
  Our ability to continue as a going concern may be contingent upon our ability to secure capital
from prospective investors or lenders.
  20




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##### Table of Contents




    
    curtail our operations significantly;
    
    sell significant assets;
    
    seek arrangements with strategic partners or other parties that may require us to
relinquish significant rights to products, technologies or markets; or
    
    explore other strategic alternatives including a merger or sale of US Dataworks.
  Our operating results are subject to fluctuations caused by many factors that could cause us to
fail to achieve our revenue or profitability expectations, which in turn could cause our stock
price to decline.
  
    
    market acceptance of and changes in demand for our products and services;
    
    gain or loss of clients or strategic relationships;
    
    announcement or introduction of new software, services and products by us or by our competitors;
    
    our ability to build brand recognition;
    
    timing of sales to customers;
    
    price competition;
    
    our ability to upgrade and develop systems and infrastructure to accommodate growth;
    
    our ability to attract and integrate new personnel in a timely and effective manner;
    
    our ability to introduce and market products and services in accordance with market demand;
    
    changes in governmental regulation;
    
    reduction in or delay of capital spending by our clients due to the effects of
terrorism, war and political instability; and
    
    general economic conditions, including economic conditions specific to the financial
services industry.
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##### Table of Contents



We may not be able to maintain our relationships with strategic partners, which may cause our cash
flow to decline.
  Because a small number of customers have historically accounted for and, may in future periods
account for, substantial portions of our revenue, our revenue could decline because of delays of
customer orders or the failure to retain customers.
  If general economic and business conditions do not improve, we may experience decreased revenue or
lower growth rates.
  We may not be able to attract, retain or integrate key personnel, which may prevent us from
successfully operating our business.
  We operate in a market that is intensely and increasingly competitive, and if we are unable to
compete successfully, our revenue could decline and we may be unable to gain market share.
   
    
    longer operating histories;
    
    larger installed customer bases;
    
    greater name recognition and longer relationships with clients; and
    
    significantly greater financial, technical, marketing and public relations resources than US Dataworks.
  
    
    the breadth and quality of services;
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##### Table of Contents




    
    creative design and systems engineering expertise;
    
    pricing;
    
    technological innovation; and
    
    understanding clients strategies and needs.
  We may be responsible for maintaining the confidentiality of our clients sensitive information,
and any unauthorized use or disclosure could result in substantial damages and harm our reputation.
  If we do not adequately protect our intellectual property, our business may suffer, we may lose
revenue or we may be required to spend significant time and resources to defend our intellectual
property rights.
  We may be unable to consummate future potential acquisitions or investments or successfully
integrate acquired businesses or investments or foreign operations with our business, which may
disrupt our business, divert managements attention and slow our ability to expand the range of our
technologies and products.
  23




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Item 3. Controls and Procedures
 Evaluation of disclosure controls and procedures
  Changes in internal control over financial reporting
 24




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PART II  OTHER INFORMATION
 Item 3. Legal Proceedings
   
 Item 4. Submission of Matters to a Vote of Security Holders
 s
  For
    
    Withheld
    
    AbstainJoe Abrell
    
    
    25,760,412
    
    
    
    457,486
    
    
    
    0John Nicholson
    
    
    25,281,642
    
    
    
    936,256
    
    
    
    0
 For
    
    Against
    
    AbstainApprove amendment to Companys
amended and restated 2000 Stock
Option Plan
    
    
    5,459,311
    
    
    
    2,552,473
    
    
    
    292,934
 For
    
    Against
    
    AbstainRatification of Ham, Langston &
Brezina
    
    
    25,926,329
    
    
    
    218,952
    
    
    
    1,749,837
  
 Item 6. Exhibits
  ExhibitNumber
    
    Description of Document31.1
    
    Section 302 Certification of Chief Executive Officer.31.2
    
    Section 302 Certification of Chief Accounting Officer.32.1
    
    Section 906 Certification of Chief Executive Officer.32.2
    
    Section 906 Certification of Chief Accounting Officer.
 25




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##### Table of Contents



SIGNATURE
   US DATAWORKS, INC.By
    
    / s/ John T. McLaughlinJohn T. McLaughlinChief Accounting Officer(Principal Financial and Accounting Officerand Duly Authorized Officer)
 26




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##### Table of Contents



ExhibitNumber
    
    Description of Document31.1
    
    Section 302 Certification of Chief Executive Officer.31.2
    
    Section 302 Certification of Chief Accounting Officer.32.1
    
    Section 906 Certification of Chief Executive Officer.32.2
    
    Section 906 Certification of Chief Accounting Officer.
 27