UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C.  20549





Form
10-QSB/A


(Amendment
No. 2)





(Mark
One)


[X]   QUARTERLY
REPORT UNDER SECTION 13 OR 15(d) OF THE


SECURITIES
EXCHANGE ACT OF 1934





For the
quarterly period ended:June
30, 2007





[  ]   TRANSITION
REPORT UNDER SECTION 13 OR 15(d) OF THE


EXCHANGE
ACT





For the
transition period from ________ to ________


Commission
file number0-17304





CISTERA NETWORKS,
INC.


(Exact
name of small business issuer as


specified
in its charter)





Nevada
            91-1944887(State
      or other jurisdiction
            (IRS
      Employerof
      incorporation or organization)
            Identification
      No.)





6509 Windcrest Drive, Suite
160, Plano, Texas  75024


(Address
of principal executive offices)





(972)
381-4699


Issuer's
telephone number





Check
whether the issuer  (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 is a shell company (as defined by Rule
12b-2 of the Exchange Act). Yes    No
X





At August
14, 2007, the issuer had 8,292,002 shares of its common stock
outstanding.





Transitional
Small Business Disclosure Format (check one): Yes    No
X













CISTERA NETWORKS, INC &
SUBSIDIARY




TABLE OF
CONTENTS









Explanatory
      Note
            2







PART
I: FINANCIAL INFORMATION




Item
      1.
            Financial
      Statements:Consolidated
      Balance Sheets – June 30, 2007 (unaudited) (as restated) and March 31,
      2007
              (audited)
            3Consolidated
      Statements of Operations – For the three months ended June 30, 2007
      and
              2006
      (unaudited) (as restated)
            5Consolidated
      Statement of Stockholders’ Equity (Deficit) – June 30, 2007
      (unaudited)
              (as
      restated) and March 31, 2007 (audited)
            6Consolidated
      Statements of Cash Flows – For the three months ended June 30, 2007
      and
              2006
      (unaudited) (as restated)
            7Notes
      to Consolidated Financial Statements (unaudited)
            9Item
      2.
            Management’s
      Discussion and Analysis or Plan of Operation
            24Item
      3.
            Controls
      and Procedures
            34







PART
II: OTHER INFORMATION




Item
      1.
            Legal
      Proceedings
            36Item
      2.
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            36Item
      3.
            Defaults
      Upon Senior Securities
            36Item
      4.
            Submission
      of Matters to a Vote of Security Holders
            36Item
      5.
            Other
      Information
            36Item
      6.
            Exhibits
            37SIGNATURE
            
            38





1





EXPLANATORY NOTE





This
Amendment No. 2 to the Quarterly Report on Form 10-QSB/A (the “Report”) for the
quarterly period ended June 30, 2007 includes a restatement of our consolidated
financial statements for the quarterly periods ended June 30, 2007 and 2006 (and
related disclosures), initially filed on August 14, 2007 and amended on November
20, 2007.





The
Company has restated its Consolidated Balance Sheet as of June 30, 2007, its
Consolidated Statement of Stockholders’ Equity (Deficit) for the three months
ended June 30, 2007 and its Consolidated Statements of Operations and Cash
Flows for the three months ended June 30, 2007 and 2006 (as contained in
this Report) to correct its accounting for its Senior Unsecured Convertible
Promissory Notes and detachable warrants issued in private placements during the
period from December 2004 to April 2007 (the “PP1 Notes,” “PP1 Warrants,” “PP2
Notes” and “PP2 Warrants”).  Also, the Company has restated the
aforementioned financial statements as of June 30, 2007 and for the three months
ended June 30, 2007 to correct its accounting for registration payment
arrangements associated with the aforementioned securities.  The Company
concluded that its original accounting for the PP1 Notes and PP1 Warrants issued
in fiscal year 2005 and the PP2 Notes and PP2 Warrants issued in fiscal years
2007 and 2008, including the associated registration payments was incorrect, and
that the necessary adjustments were material to the consolidated financial
statements as of and for the three months ended June 30, 2007 and
2006.  Additionally, the Company has restated its Consolidated
Statements of Operations and Cash Flows for the three months ended June 30, 2006
for share-based compensation related to employee stock options.





Except
for the foregoing amended information, this Form 10−QSB/A continues to speak as
of the date of the original filing, and the Company has not updated the
disclosures contained herein to reflect events that occurred at a later date.
Other events occurring after the filing of the original filing or other
disclosures necessary to reflect subsequent events will be addressed in any
reports filed with the SEC subsequent to the date of this filing.





A further
discussion of the restatement of the consolidated financial statements for these
fiscal quarters is contained under “Part I, Item 2 – Management’s Discussion and
Analysis or Plan of Operation” and in Note 2 to the unaudited consolidated
financial statements of this Report.





2





PART
I. FINANCIAL INFORMATION





Item
1.  Financial Statements





CISTERA NETWORKS, INC. &
SUBSIDIARY


CONSOLIDATED BALANCE
SHEETS


(Unaudited)





June
      30, 2007
            
            
            March
      31, 2007As
      restatedCurrent
      Assets:Cash
            
            $
            1,137,826
            
            
            $
            534,871Accounts
      receivable
            
            
            630,381
            
            
            
            314,178Other
      receivable
            
            
            14,821
            
            
            
            23,927Inventory
            
            
            65,303
            
            
            
            75,743Prepaid
      expenses
            
            
            8,575
            
            
            
            10,143Total
      Current Assets
            
            
            1,856,906
            
            
            
            958,862Fixed
      Assets:Computer
      equipment
            
            
            152,090
            
            
            
            123,035Trade
      show booth & fixtures
            
            
            10,641
            
            
            
            10,641Office
      equipment
            
            
            169,788
            
            
            
            129,064Property
      held under capital leases
            
            
            10,205
            
            
            
            10,205Less
      Accumulated depreciation
            
            
            (163,891
            )
            
            
            (150,899
            )Net
      Fixed Assets
            
            
            178,833
            
            
            
            122,046Intangible
      Assets:Intellectual
      property
            
            
            2,717,755
            
            
            
            2,717,755Software
      development
            
            
            366,040
            
            
            
            366,040Less
      Amortization
            
            
            (856,745
            )
            
            
            (788,802
            )Net
      Intangible Assets
            
            
            2,227,050
            
            
            
            2,294,993Total
      Assets
            
            $
            4,262,789
            
            
            $
            3,375,901




























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





3





CISTERA NETWORKS, INC. &
SUBSIDIARY


CONSOLIDATED BALANCE SHEETS
(continued)


(Unaudited)











June
      30, 2007
            
            
            March
      31, 2007As
      restatedCurrent
      Liabilities:Accounts
      payable
            
            $
            368,051
            
            
            $
            544,796Accrued
      liabilities
            
            
            360,005
            
            
            
            598,023Accrued
      liquidated damages- outside investors
            
            
            525,115
            
            
            
            -Accrued
      liquidated damages – related parties
            
            
            15,579
            
            
            
            -Related
      party payables
            
            
            13,038
            
            
            
            24,038Line
      of credit
            
            
            -
            
            
            
            62,094Convertible
      promissory notes
            
            
            94,000
            
            
            
            144,000Current
      portion of long-term debt
            
            
            1,408
            
            
            
            2,415Current
      portion of deferred revenue
            
            
            654,996
            
            
            
            465,179Total
      Current Liabilities
            
            
            2,032,192
            
            
            
            1,840,545Long-Term
      LiabilitiesConvertible
      promissory notes – outside investors, net of discount
            
            
            860,110
            
            
            
            237,395Convertible
      promissory notes – related parties, net of discount
            
            
            29,230
            
            
            
            -Derivative
      financial instruments - warrants
            
            
            -
            
            
            
            2,265,225Deferred
      revenue
            
            
            114,912
            
            
            
            84,968Total
      Long-Term Liabilities
            
            
            1,004,252
            
            
            
            2,587,588Total
      Liabilities
            
            
            3,036,444
            
            
            
            4,428,133Stockholders’
      Equity (Deficit):Preferred
      Stock, $0.001 par value; 1,000,000 shares authorized;
              -0-
      shares issued and outstanding
            
            
            -
            
            
            
            -Common
      Stock, $0.001 par value; 50,000,000 shares authorized;
              8,292,022
      shares issued and outstanding
            
            
            8,292
            
            
            
            8,292Additional
      Paid-In Capital
            
            
            13,560,800
            
            
            
            9,526,323Accumulated
      Deficit
            
            
            (12,342,747
            )
            
            
            (10,586,847
            )Total
      Stockholders’ Equity (Deficit)
            
            
            1,226,345
            
            
            
            (1,052,232
            )Total
      Liabilities and Stockholders’ Equity (Deficit)
            
            $
            4,262,789
            
            
            $
            3,375,901

























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





4





CISTERA NETWORKS, INC.&
SUBSIDIARY


CONSOLIDATED STATEMENTS OF
OPERATIONS


(Unaudited)





Three
      months ended
              June
      30,2007
            
            
            2006As
      restated
            
            
            As
      restatedRevenues
            
            $
            679,787
            
            
            $
            494,737Cost
      of goods sold
            
            
            139,656
            
            
            
            27,974Gross
      Profit
            
            
            540,131
            
            
            
            466,763Operating
      expenses:Sales
      and marketing
            
            
            176,092
            
            
            
            56,520Research
      and development
            
            
            129,035
            
            
            
            128,094Software
      consulting
            
            
            300,006
            
            
            
            267,755General
      and administrative
            
            
            250,057
            
            
            
            303,243Total
      Expenses
            
            
            855,190
            
            
            
            755,612Loss
      from operations
            
            
            (315,059
            )
            
            
            (288,849
            )Other
      Income (Expense)Interest
      income
            
            
            9,589
            
            
            
            15Interest
      expense
            
            
            (73,424
            )
            
            
            (17,434
            )Amortization
      of discount on convertible notes – outside investors
            
            
            (361,034
            )
            
            
            (27,257
            )Amortization
      of discount on convertible notes – related parties
            
            
            (9,681
            )
            
            
            -Charge
      for estimated liquidated damages
            
            
            (251,176
            )
            
            
            -Charge
      for change in estimated fair value of derivative financial
              instruments
      – Warrants
            
            
            -
            
            
            
            (63,629
            )Total
      Other Income (Expense)
            
            
            (685,726
            )
            
            
            (108,305
            )Net
      Loss
            
            $
            (1,000,785
            )
            
            $
            (397,154
            )Basic
      & diluted net loss per share
            
            $
            (0.12
            )
            
            $
            (0.05
            )Weighted
      Average Shares outstanding – basic & diluted
            
            
            8,292,022
            
            
            
            8,077,226


























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





5





CISTERA NETWORKS, INC. &
SUBSIDIARY


CONSOLIDATED STATEMENT OF
STOCKHOLDERS'EQUITY (DEFICIT)


For the
Three Months Ended June 30, 2007


(Unaudited)





Preferred
      Stock
            
            
            Common
      Stock
            
            
            Additional
              Paid-in
              Capital
            
            
            Accumulated
              Deficit
            
            
            Total
              Stockholders’
              Equity
      (Deficit)Shares
            
            
            Amount
            
            
            Shares
            
            
            AmountBalances
      at March 31, 2007
            
            
            -
            
            
            $
            -
            
            
            
            8,292,022
            
            
            $
            8,292
            
            
            $
            9,526,323
            
            
            $
            (10,586,847
            )
            
            $
            (1,052,232
            )Cumulative
      effect of the change
              in
      an accounting principle
              (Note
      2)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,730,824
            
            
            
            (755,115
            )
            
            
            1,975,709Allocation
      of discount on
              convertiblepromissory
              notes to warrants(Note
      2)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            488,054
            
            
            
            
            
            
            
            488,054Beneficial
      conversion feature of
              convertible
      promissory notes
              (Note
      2)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            815,599
            
            
            
            
            
            
            
            815,599Net
      loss, as restated
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (1,000,785
            )
            
            
            (1,000,785
            )Balances
      at June 30, 2007, as restated
            
            
            -
            
            
            $
            -
            
            
            
            8,292,022
            
            
            $
            8,292
            
            
            $
            13,560,800
            
            
            $
            (12,342,747
            )
            
            $
            1,226,345





















































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








6





CISTERA NETWORKS, INC. &
SUBSIDIARY


CONSOLIDATED STATEMENTS OF
CASH FLOWS


(Unaudited)


Three
      months ended
              June
      30,2007
            
            
            2006As
      restated
            
            
            As
      restatedCASH
      FLOWS FROM OPERATING ACTIVITIESNet
      loss
            
            $
            (1,000,785
            )
            
            $
            (397,154
            )Adjustments
      used to reconcile net loss to net cash used in operating
      activities:Charge
      for estimated liquidated damages
            
            
            251,176
            
            
            
            -Amortization
      of discount on convertible promissory notes
            
            
            370,715
            
            
            
            27,257Charge
      for change in estimated fair value of derivative financial
              instruments
      - Warrants
            
            
            -
            
            
            
            63,629Share-based
      compensation
            
            
            -
            
            
            
            25,425Depreciation
      and amortization
            
            
            80,935
            
            
            
            112,573Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            (307,097
            )
            
            
            36,265Inventory
            
            
            10,440
            
            
            
            (550
            )Prepaid
      expenses
            
            
            1,568
            
            
            
            (95,088
            )Accounts
      payable
            
            
            (100,812
            )
            
            
            (186,837
            )Accrued
      liabilities
            
            
            45,934
            
            
            
            250,994Deferred
      income
            
            
            219,761
            
            
            
            29,957Net
      cash used in operating activities
            
            
            (428,165
            )
            
            
            (133,529
            )CASH
      FLOWS FROM INVESTING ACTIVITIESPurchase
      of equipment
            
            
            (69,779
            )
            
            
            (2,598
            )Net
      cash used in investing activities
            
            
            (69,779
            )
            
            
            (2,598
            )CASH
      FLOWS FROM FINANCING ACTIVITIESNet
      proceeds from issuance of convertible promissory notes
            
            
            1,225,000
            
            
            
            154,000Payments
      on capital lease
            
            
            (1,007
            )
            
            
            (832
            )Net
      payments on line of credit
            
            
            (62,094
            )
            
            
            -Payments
      on loans
            
            
            (61,000
            )
            
            
            (12,500
            )Net
      cash provided by financing activities
            
            
            1,100,899
            
            
            
            140,668Net
      increase in cash and cash equivalents
            
            
            602,955
            
            
            
            4,541Cash
      and cash equivalents at beginning of period
            
            
            534,871
            
            
            
            60,990Cash
      and cash equivalents at end of period
            
            $
            1,137,826
            
            
            $
            65,531





























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





7





CISTERA NETWORKS, INC. &
SUBSIDIARY


CONSOLIDATED STATEMENTS OF
CASH FLOWS (continued)


(Unaudited)





Three
      months ended
              June
      30,2007
            
            
            2006As
      restated
            
            
            As
      restatedSUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Cash
      paid during the year for:Interest
            
            $
            9,798
            
            
            $
            658Income
      taxes
            
            
            -
            
            
            
            -SUPPLEMENTAL
      DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:Conversion
      of accounts payable and other accrued liabilities to
              convertible
      promissory notes
            
            $
            359,885
            
            
            $
            -Allocation
      of discount on convertible promissory notes to warrants
            
            
            488,054
            
            
            
            -Discount
      related to beneficial conversion feature on convertible
              promissory
      notes
            
            
            815,599
            
            
            
            -OTHER
      NON-CASH TRANSACTIONS:Cumulative effect of
      change in accounting principle:Reclassification
      of Warrants from derivative financial
              Instruments
      to equity securities (as valued at inception)
            
            $
            2,730,824
            
            
            $
            -Accrued
      liquidated damages at April 1, 2007
            
            
            289,518
            
            
            
            -Reclassification
      of Warrants from derivative financial
              instruments
      to Equity securities (as valued at April 1, 2007)
            
            
            (2,265,227
            )
            
            
            -Cumulative
      effect of change in accounting principle
            
            $
            755,115
            
            
            $
            -



































The
accompanying notes are an integral part of these financial
statements





8
 CISTERA NETWORKS, INC. &
SUBSIDIARY
 Notes to
Consolidated Financial Statements
 (Unaudited)





NOTE 1 - BASIS OF
PRESENTATION AND GOING CONCERN





The
accompanying consolidated financial statements have been prepared in conformity
with accounting principles generally accepted in the United States (“US GAAP”),
which contemplate the Company as a going concern.  However, the
Company has sustained substantial operating losses in recent years and has used
substantial amounts of working capital in its operations.  Realization
of a major portion of the assets reflected on the accompanying balance sheet is
dependent upon continued operations of the Company which, in turn, is dependent
upon the Company's ability to meet its financing requirements and succeed in its
future operations.  Management believes that actions presently being
taken to revise the Company’s operating and financial requirements provide them
with the opportunity for the Company to continue as a going
concern.





These
consolidated financial statements do not reflect adjustments that would be
necessary if the Company were unable to continue as a “going
concern.”  While management believes that the actions already taken or
planned, will mitigate the adverse conditions and events which raise doubt about
the validity of the “going concern” assumption used in preparing these financial
statements, there can be no assurance that these actions will be
successful.





If the
Company were unable to continue as a “going concern,” then substantial
adjustments would be necessary to the carrying values of assets, the reported
amounts of its liabilities, the reported revenues and expenses, and the balance
sheet classifications used.





Interim
Reporting





The
unaudited financial statements as of June 30, 2007, and for the three-month
period then ended reflect, in the opinion of management, all adjustments (which
include only normal recurring adjustments) necessary to fairly state the
financial position and results of operations for the three
months.  Operating results for interim periods are not necessarily
indicative of the results that can be expected for full years.  These
consolidated financial statements should be read in connection with the
consolidated financial statements and notes thereto included in the Company’s
Annual Report on Form 10-KSB/A for the fiscal year ended March 31, 2007, as
amended.





Significant Accounting
Policies





The
Company prepares its financial statements in accordance with US GAAP. The
accounting policies most fundamental to understanding our financial statements
are those relating to recognition of revenue, our use of estimates and the
accounting for convertible debt and warrants. For a detailed discussion on the
application of these accounting policies, see Note 2 to our audited consolidated
financial statements contained in our Annual Report on Form 10-KSB/A for the
fiscal year ended March 31, 2007, as amended.





Loss per
Share





Basic
loss per share has been computed by dividing the net loss for the respective
period applicable to the common stockholders by the weighted average number of
common shares outstanding for the respective period.





Diluted
loss per share is computed using the weighted average number of common shares
outstanding plus the number of common shares that would be issued assuming
exercise or conversion of all potentially dilutive common stock
equivalents.  At June 30, 2007, the total number of potentially
dilutive common stock equivalents was 10,123,893.  At June 30, 2006,
the total number of potentially dilutive common stock equivalents was 3,088,598.
These potentially dilutive common stock equivalents have been excluded from the
diluted share calculations for the three months ended June 30, 2007 and 2006,
respectively, as they were antidilutive as a result of the net losses incurred
for those periods. Accordingly, basic shares equal diluted shares for all
periods presented.








9
 CISTERA NETWORKS, INC. &
SUBSIDIARY
 Notes to
Consolidated Financial Statements
 (Unaudited)





Reclassifications





Certain
reclassifications have been made in the fiscal year 2007 financial statements to
conform to the fiscal year 2008 presentation.





Stock
Options





See Note
2 to these unaudited consolidated financial statements for discussion of the
Company’s restatement related to share-based compensation for the fiscal quarter
ended June 30, 2006.





Recent Accounting
Pronouncements





In
September 2006, the FASB issued Statement of Financial Accounting Standard No.
157 (“SFAS 157”), “Fair Value Measurements,” which defines fair value,
establishes a framework for measuring fair value in generally accepted
accounting principles, and expands disclosures about fair value measurements.
The Company will be required to adopt SFAS 157 effective for the fiscal year
beginning April 1, 2008. Management is currently evaluating the potential impact
of adopting SFAS 157 on the Company’s financial statements.





NOTE 2 – RESTATEMENT OF
PREVIOUSLY ISSUED CONSOLIDATED FINANCIAL STATEMENTS





The
Company has restated its Consolidated Balance Sheet as of June 30, 2007, its
Consolidated Statement of Stockholders’ Equity (Deficit) for the three months
ended June 30, 2007 and its Consolidated Statements of Operations and Cash
Flows for the three months ended June 30, 2007 and 2006 to correct its
accounting for its Senior Unsecured Convertible Promissory Notes and detachable
warrants issued in private placements during the period from December 2004 to
April 2007 (the “PP1 Notes,” “PP1 Warrants,” “PP2 Notes” and “PP2
Warrants”).





In
addition, the Company has restated its Consolidated Balance Sheet as of June 30,
2007 and its Consolidated Statements of Operations, Stockholders’ Equity
(Deficit) and Cash Flows for the three months ended June 30, 2007 to reflect a
correction in its accounting for registration payment arrangements (associated
with the aforementioned securities) as required under FASB Staff Position No.
00-19-2, “Accounting for Registration Payment Arrangements” (“FSP
00-19-2”).  FSP 00-19-2 was effective April 1, 2007 for the Company,
and the Company incorrectly accounted for its registration payment arrangements
as of the effective date (which required the recording of a cumulative effect of
a change in accounting principle) and for the three months ended June 30,
2007.





Additionally,
the Company has restated its Consolidated Statements of Operations and Cash
Flows for the three months ended June 30, 2006 for share-based compensation
related to employee stock options.








10
 CISTERA NETWORKS, INC. &
SUBSIDIARY
 Notes to
Consolidated Financial Statements
 (Unaudited)





The
impact of the restatement on the Consolidated Statements of Operations for the
three months ended


June 30,
2007 and 2006 is summarized in the table below:





Adjustments
      to Consolidated Statements of Operations:
              Income
      (Expense)Convertible
              Promissory
              Notes
      and
              Warrants
            
            
            Registration
              Payment
              arrangements
            
            
            Share-based
              compensation
            
            
            TotalThree
      months ended June 30, 2007
            
            $
            (370,715
            )
            
            $
            (166,465
            )
            
            $
            -
            
            
            $
            (537,180
            )Three
      months ended June 30, 2006
            
            $
            (90,886
            )
            
            $
            -
            
            
            $
            (25,425
            )
            
            $
            (116,311
            )





The
Company has concluded that its original accounting for the PP1 Notes and PP1
Warrants issued in fiscal year 2005 and the PP2 Notes and PP2 Warrants issued in
fiscal years 2007 and 2008 was incorrect and that the necessary adjustments were
material for the fiscal year 2007 and 2006 consolidated financial
statements.





The
Company based its conclusion upon a further review of the documents associated
with the Notes and Warrants and considered the following sources as relevant
guidance in determining the proper accounting treatment for the Notes and
Warrants:





·
            SFAS
      133, Accounting for
      Derivative Instruments and Hedging Activities(“SFAS
      133”),


·
            APB
      Opinion 14, Accounting
      for Convertible Debt and Debt Issued with Stock Purchase Warrants
      (“APB   14”),


·
            Emerging
      Issues Task Force (EITF) Issue 00-19, Accounting for Derivative
      Financial Instruments Indexed to, and Potentially Settled in, a Company’s
      Own Stock(“EITF 00-19”),


·
            EITF
      05-2,The Meaning of
      “Conventional Convertible Debt Instrument”(“EITF
      05-2”),


·
            EITF
      98-5, Accounting for
      Convertible Securities with Beneficial Conversion Features or Contingently
      Adjustable Conversion Ratios (“EITF
  98-5”),


·
            EITF
      00-27, Application of
      Issue No. 98-5 to Certain Convertible Instruments (“EITF 00-27”),
      and


·
            SEC
      Staff Accounting
      Bulletin No. 107(“SAB
107”).





Conversion feature of the
Notes





The
Company concluded that the Notes meet the definition of “conventional
convertible debt” (as defined in EITF 00-19 and affirmed in EITF
05-2).  EITF 00-19, paragraph 4 states: “The Task Force observed that,
pursuant to paragraphs 11(a) and 12(c) of Statement 133, if an embedded
derivative is indexed to the reporting entity's own stock and would be
classified in stockholders' equity if it was a freestanding derivative, that
embedded derivative is not considered a derivative for purposes of SFAS 133. The
Task Force reached a consensus that for purposes of evaluating under SFAS 133
whether an embedded derivative indexed to a company's own stock would be
classified in stockholders’ equity if freestanding, the requirements of
paragraphs 12–32 of this Issue do not apply if the hybrid contract is a
conventional convertible debt instrument in which the holder may only realize
the value of the conversion option by exercising the option and receiving the
entire proceeds in a fixed number of shares or the equivalent amount of cash (at
the discretion of the issuer).”





Therefore,
the Company has concluded that the conversion feature of the convertible debt
did not meet the definition of a derivative under SFAS 133 and did not require
separate accounting from the debt instrument.








11
 CISTERA NETWORKS, INC. &
SUBSIDIARY
 Notes to
Consolidated Financial Statements
 (Unaudited)





Valuation of Notes and
Warrants and beneficial conversion feature





APB 14
addresses the accounting for convertible debt with a nondetachable (embedded)
conversion feature, the terms of which provide for an initial conversion price
that is greater than the market value at the date of issuance and a conversion
price that does not decrease, except under antidilution protection, but does not
explicitly address situations in which the embedded conversion feature is
“in-the money” at issuance.  The Notes, including any accrued
interest, were exercisable into the Company’s common stock at less than the
closing price of the Company’s stock on the dates of issuance, and the Company
considered this conversion to be an “embedded beneficial conversion
feature.”





EITF 98-5
requires “that embedded beneficial conversion features present in convertible
securities should be valued separately at issuance.” Further, EITF 98-5 states
“that the intrinsic value of the beneficial conversion feature may be greater
than the proceeds allocated to the convertible instrument,” and as such, “that
the amount of the discount assigned to the beneficial conversion feature is
limited to the amount of the proceeds allocated to the convertible instrument.”
EITF 00-27 further states “that the effective conversion price based on the
proceeds received for or allocated to the convertible instrument should be used
to compute the intrinsic value, if any, of the embedded conversion option. As a
result of this consensus, an issuer should first allocate the proceeds received
in a financing transaction that includes a convertible instrument to the
convertible instrument and any other detachable instruments included in the
exchange (such as detachable warrants) on a relative fair value basis. Then, the
Issue 98-5 model should be applied to the amount allocated to the convertible
instrument, and an effective conversion price should be calculated and used to
measure the intrinsic value, if any, of the embedded conversion
option.”





Accordingly,
we calculated the fair value of both the convertible Notes and the Warrants and
allocated the respective relative fair value percentages of each in determining
the initial values of the convertible Notes and the Warrants.  Because
the Warrants were determined to be derivative liabilities (see conclusion in
next section below and in Note 2 to the consolidated financial statements), the
Company recorded them at fair value as calculated under the Black-Scholes option
pricing model (“BS model”).  For Notes and Warrants issuances where
the net cash proceeds were greater than the fair value of the Warrants, this
difference was allocated to the value of the Notes.  The amount
assigned to the Warrants represented a debt discount on the Notes, which is
amortized over the life of the Notes.  For Notes and Warrants
issuances where the net cash proceeds were less than the fair value of the
Warrants, the Warrants were recorded at fair value and the difference was
recorded as a charge to the consolidated Statement of Operations at
inception.  This second situation occurred with the issuance of the
PP1 Notes in December 2004 and resulted in a charge to the Statement of
Operations of approximately $230,000; no value was allocated to the Notes, with
a full debt discount recorded and amortized over the life of the
Notes.





After
determining the recorded value of the Warrants and Notes (if any), we calculated
the beneficial conversion feature of the Notes, which resulted in an additional
debt discount which was amortized over the life of the Notes.








12
 CISTERA NETWORKS, INC. &
SUBSIDIARY
 Notes to
Consolidated Financial Statements
 (Unaudited)





Classification and
accounting for Warrants





We
evaluated the Warrants as a potential free standing derivative under the
criteria in paragraph 11(a) of SFAS 133, which require that a contract
(Warrants) issued by a reporting entity be accounted for as a derivative unless
it is both (1) indexed to its own stock and (2) classified in stockholders’
equity in its statement of financial position. We concluded that the Warrants
were indexed to the Company’s own stock and should be classified in
stockholders’ equity and would qualify for the scope exception contained in this
paragraph.  The Company was required to further review the
requirements for equity classification contained in paragraphs 12-32 of EITF
00-19.  The Company concluded that it had not met criteria (2) above
based on the requirements for equity classification in EITF
00-19.  Specifically, both the PP1 and PP2 Notes contain registration
rights agreements (the “RR agreements”) that stipulate that the Company must
register all “registrable securities” (defined as the “shares of Common Stock
issuable upon conversion of the Notes and the shares of Common Stock issuable
upon exercise of the Warrants”) within a time frame (and this was deemed to be
outside of the control of the Company).  In the event of not filing a
registration statement by a specified date or by not having a registration
effective by a specified date, the Company was obligated to pay liquidated
damages in the amount of 1% of the then current outstanding amount of the Notes
plus accrued interest.  The Company accrued all required liquidated
damages, beginning in FY 2005 with the PP1 Notes. Liquidated damages required
under the RR Agreement for the PP1 Notes ceased on September 25, 2005, which was
the date that the Company filed its initial registration statement for the PP1
Notes and PP1 Warrants.





Accordingly,
the Company concluded that the Warrants did not satisfy the requirement for
equity classification and should be classified, recorded and prospectively
accounted for as derivative liabilities until it has registered all underlying
shares to the Warrants or until such time that the RR agreements are no longer
in effect.  The prospective accounting requires that the Warrants be
remeasured at each balance sheet date based on estimated fair value and any
resultant changes in fair value be recorded to the Statement of
Operations.





The
Company used the BS model for calculating the fair value of all Warrants issued
based on the following assumptions:





Warrants
      issued in PP1
            
            Warrants
      issued in PP2Expected
      volatility
            128%
            
            100%-104%Expected
      term
            5
      years
            
            5
      yearsRisk-free
      interest rate
            3.58%
      - 4.33%
            
            4.46%
      - 4.65%Expected
      dividend yield
            0%
            
            0%





We
estimated volatility primarily based on historical volatility rates through the
date of each closing of the PP1 and PP2 offerings. The Warrants have a
transferability provision and based on guidance provided in SAB 107 for options
issued with such a provision, we used the full, five-year contractual term as
the expected term in the initial valuation of the Warrants.  For the
risk-free interest rate, we used the five year U.S. Treasury zero coupon rate
for the initial valuation of the Warrants.  Expected volatilities,
expected terms and risk-free interest rates were adjusted as of each quarterly
period commensurate with the remaining contractual lives of the Warrants on such
dates and were used to determine the estimated fair value of the Warrants under
the BS model.





Registration Payment
Arrangements





On
December 21, 2006, the EITF issued FASB Staff Position No. 00-19-2 (“FSP
00-19-2”).  FSP 00-19-2 was effective immediately for registration
payment arrangements and the financial instruments subject to those arrangements
that were entered into or modified subsequent to the date of issuance of this
FSP. For registration payment arrangements and financial instruments subject to
those arrangements that were entered into prior to the issuance of this FSP, the
FSP was effective for financial statements issued for fiscal years beginning
after December 15, 2006, and interim periods within those fiscal
years.  Effective April 1, 2007, the Company adopted FSP 00-19-2,
which was applicable to the accounting for the liquidated damages on the PP2
Notes.





13
 CISTERA NETWORKS, INC. &
SUBSIDIARY
 Notes to
Consolidated Financial Statements
 (Unaudited)





FSP
00-19-2 requires the Company to account for contingent liquidated damages
separately from the financial instruments to which they relate, which were the
Notes and Warrants issued and sold in the PP1 and PP2
offerings.  Prior to the adoption of FSP-00-19-2, the Company
accounted for the Warrants as derivative liabilities based on the requirement of
the Company to register all underlying shares to the Notes and the
Warrants.  The Company concluded that with the separate accounting
required under FSP 00-19-2 for the liquidated damages, the Warrants by
themselves were properly classified as equity securities (having met all
requirements of EITF 00-19 for equity classification) as of the adoption
date.





Under FSP
00-19-2, the Company is required to estimate and record a contingent liability
if the likelihood is probable that it will pay liquidated damages in future
periods, calculated in accordance with SFAS 5, “Accounting for Contingencies”
(“SFAS 5”) and FASB Interpretation No. 14, “Reasonable Estimation of the Amount
of a Loss.”  Further, FSP 00-19-2 requires that “the financial
instrument(s) subject to the registration payment arrangement shall be
recognized and measured in accordance with other applicable GAAP (for example
SFAS 133 and EITF 00-19) without regard to the contingent obligation to transfer
consideration pursuant to the registration payment arrangement.” Accordingly, on
the date of adoption, the Company accounted for the Warrants separately from the
liquidated damages obligations.





Based on
the above requirements, the Company recorded a cumulative effect of an
accounting change entry (i.e., a charge to the beginning balance of the
accumulated deficit) as of April 1, 2007 for the combination of:  1)
the reclassification of the Warrants from derivative liabilities to equity
securities, and 2) a contingent liability for probable future payment of
liquidated damages (based on the Company’s best estimate as of the date of
adoption, which is through March 31, 2008).  The amount of the
contingent liability recorded was approximately $289,000.  The
difference between the Warrants as measured on the date of adoption and their
original recorded value was approximately $466,000, and, as stated above, was
included in the charge to the beginning balance of the accumulated
deficit.  The total of the cumulative effect of this accounting change
was $755,000.





On April
5, 2007, the Company closed the balance of its PP2 offering and, in accordance
with FSP 00-19-2, recorded a contingent liability and related charge to the
consolidated Statement of Operations for the three months ended June 30, 2007 in
the amount of $251,176 for the estimated liquidated damages related to this
funding through March 31, 2008.  At June 30, 2007, the total liability
for estimated liquidated damages was $540,176.





Share-based
compensation





The
Company concluded that it incorrectly calculated and recorded share-based
compensation expense associated with stock options upon the adoption of
Statement of Financial Accounting Standards No. 123 (revised) (“SFAS 123R”),
“Share-Based Payment,” on April 1, 2006.  Specifically, the Company
did not calculate the fair value of employee stock options issued during the
period from February 2004 through October 2004 and did not record any related
expense in the Statement of Operations for the fiscal year ended March 31, 2007,
or for the respective quarterly periods for that fiscal year, related to the
unrecognized stock option cost as of April 1, 2006.  The Company has
not issued any additional stock options to employees since October
2004.








14
 CISTERA NETWORKS, INC. &
SUBSIDIARY
 Notes to
Consolidated Financial Statements
 (Unaudited)





The table
below summarizes the effect of the restatement adjustments on the Consolidated
Statements of Operations:





For
      the three months ended June 30, 2007
            
            
            For
      the three months ended June 30, 2006As
      previously
              reported
            
            
            Adjustments
            
            
            As
      restated
            
            
            As
      previously
              reported
            
            
            Adjustments
            
            
            As
      restatedGross
      profit
            
            $
            540,131
            
            
            $
            -
            
            
            $
            540,131
            
            
            $
            466,763
            
            
            $
            -
            
            
            $
            466,763Operating
      expenses
            
            
            855,190
            
            
            
            -
            
            
            
            855,190
            
            
            
            730,187
            
            
            
            25,425
            
            
            
            755,612Loss
      from operations
            
            
            (315,059
            )
            
            
            -
            
            
            
            (315,059
            )
            
            
            (263,424
            )
            
            
            (25,425
            )
            
            
            (288,849
            )Other
      income (expense)Interest
      expense, net
            
            
            (148,546
            )
            
            
            84,711
            
            
            
            (63,835
            )
            
            
            (17,419
            )
            
            
            -
            
            
            
            (17,419
            )Amortization
      of discount on
              convertible
      notes
            
            
            -
            
            
            
            (370,715
            )
            
            
            (370,715
            )
            
            
            
            
            
            
            (27,257
            )
            
            
            (27,257
            )Charge
      for estimated liquidated
              damages
            
            
            -
            
            
            
            (251,176
            )
            
            
            (251,176
            )
            
            
            -
            
            
            
            -
            
            
            
            -Charge
      for change in estimated
              value
      of derivative financial
              instruments - Warrants
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (63,629
            )
            
            
            (63,629
            )Net
      loss
            
            $
            (463,605
            )
            
            $
            (537,180
            )
            
            $
            (1,000,785
            )
            
            $
            (280,843
            )
            
            $
            (116,311
            )
            
            $
            (397,154
            )Basic
      & diluted net loss per share
            
            $
            (0.06
            )
            
            $
            (0.06
            )
            
            $
            (0.12
            )
            
            $
            (0.03
            )
            
            $
            (0.01
            )
            
            $
            (0.05
            )Weighted
      average shares outstanding: basic and diluted
            
            
            8,292,022
            
            
            
            
            
            
            
            8,292,022
            
            
            
            8,077,226
            
            
            
            
            
            
            
            8,077,226








15
 CISTERA NETWORKS, INC. &
SUBSIDIARY
 Notes to
Consolidated Financial Statements
 (Unaudited)





The table
below summarizes the effect of the restatement adjustments on the Consolidated
Balance Sheet as of June 30, 2007:


As
      previously
              reported
            
            
            Adjustments
            
            
            As
      restatedCurrent
      liabilities:Accounts
      and related party payables
            
            $
            381,089
            
            
            $
            -
            
            
            $
            381,089Accrued
      liquidated damages
            
            
            -
            
            
            
            540,694
            
            
            
            540,694Accrued
      liabilities
            
            
            444,716
            
            
            
            (84,711
            )
            
            
            360,005Deferred
      revenue
            
            
            654,996
            
            
            
            
            
            
            
            654,996Current
      portion of long-term debt, net of discount
            
            
            95,408
            
            
            
            
            
            
            
            95,408Total
      current liabilities
            
            
            1,576,209
            
            
            
            455,983
            
            
            
            2,032,192Convertible
      promissory notes, net of discount
            
            
            3,485,491
            
            
            
            (2,596,151
            )
            
            
            889,340Deferred
      revenue
            
            
            114,912
            
            
            
            
            
            
            
            114,912Total
      long-term liabilities
            
            
            3,600,403
            
            
            
            (2,596,151
            )
            
            
            1,004,252Total
      liabilities
            
            
            5,176,612
            
            
            
            (2,140,168
            )
            
            
            3,036,444Stockholders’
      equity (deficit):Preferred
      stock
            
            
            -
            
            
            
            
            
            
            
            -Common
      stock
            
            
            8,292
            
            
            
            
            
            
            
            8,292Additional
      paid-in capital
            
            
            8,739,970
            
            
            
            4,820,830
            
            
            
            13,560,800Cumulative
      effect of adoption of FSP 00-19-2
            
            
            -
            
            
            
            (755,115
            )
            
            
            (755,115
            )Accumulated deficit
            
            
            (9,662,085
            )
            
            
            (1,925,547
            )
            
            
            (11,587,632
            )Total
      stockholders’ equity (deficit)
            
            
            (913,823
            )
            
            
            2,140,168
            
            
            
            1,226,345TOTAL
      LIABILITIES AND STOCKHOLDERS’
              EQUITY
      (DEFICIT)
            
            $
            4,262,789
            
            
            $
            -
            
            
            $
            4,262,789








16
 CISTERA NETWORKS, INC. &
SUBSIDIARY
 Notes to
Consolidated Financial Statements
 (Unaudited)





The table
below summarizes the effect of the restatement adjustments as well as the
correction in errors in the reporting of components of cash flows from
operations and cash flows from financing activities on the Consolidated
Statement of Cash Flows for the three months ended June 30,
2007:


As
      previously
              reported
            
            
            Adjustments
            
            
            As
      restatedCASH
      FLOWS FROM OPERATING ACTIVITIESNet
      loss
            
            $
            (463,605
            )
            
            $
            (537,180
            )
            
            $
            (1,000,785
            )Adjustments
      used to reconcile net loss to net cash used in
              operating
      activities:Charge
      for estimated liquidated damages
            
            
            -
            
            
            
            251,176
            
            
            
            251,176Amortization
      of discount on convertible promissory notes
            
            
            -
            
            
            
            370,715
            
            
            
            370,715Depreciation
      and amortization
            
            
            80,936
            
            
            
            (1
            )
            
            
            80,935Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            (307,094
            )
            
            
            (3
            )
            
            
            (307,097
            )Inventory
            
            
            10,440
            
            
            
            
            
            
            
            10,440Prepaid
      expenses
            
            
            1,568
            
            
            
            
            
            
            
            1,568Accounts
      payable
            
            
            (176,745
            )
            
            
            75,933
            
            
            
            (100,812
            )Accrued
      interest
            
            
            -
            
            
            
            (24,090
            )
            
            
            (24,090
            )Other
      accrued liabilities
            
            
            (153,307
            )
            
            
            223,331
            
            
            
            70,024Deferred
      revenue
            
            
            219,758
            
            
            
            3
            
            
            
            219,761Net
      cash used in operating activities
            
            
            (788,049
            )
            
            
            359,884
            
            
            
            (428,165
            )Net
      cash used in investing activities
            
            
            (69,780
            )
            
            
            1
            
            
            
            (69,779
            )CASH
      FLOWS FROM FINANCING ACTIVITIESNet
      proceeds from issuance of convertible promissory notes
            
            
            1,584,885
            
            
            
            (359,885
            )
            
            
            1,225,000Payments
      on convertible promissory notes and other loans
            
            
            (61,000
            )
            
            
            
            
            
            
            (61,000
            )Net
      payments on line of credit
            
            
            (62,094
            )
            
            
            
            
            
            
            (62,094
            )Payments
      on capital lease
            
            
            (1,007
            )
            
            
            
            
            
            
            (1,007
            )Net
      cash provided by financing activities
            
            
            1,460,784
            
            
            
            (359,885
            )
            
            
            1,100,899Net
      increase in cash and cash equivalents
            
            
            602,955
            
            
            
            
            
            
            
            602,955Cash
      and cash equivalents at beginning of year
            
            
            534,871
            
            
            
            
            
            
            
            534,871Cash
      and cash equivalents at end of year
            
            $
            1,137,826
            
            
            $
            -
            
            
            $
            1,137,826





The table
below summarizes the effect of the restatement adjustments on the Consolidated
Statement of Cash Flows for the three months ended June 30,
2006.  There was no impact on cash flows from investing or financing
activities.





As
      previously
              reported
            
            
            Adjustments
            
            
            As
      restatedCASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
            
            $
            (280,843
            )
            
            $
            (116,311
            )
            
            $
            (397,154
            )Adjustments
      used to reconcile net loss to net cash used in
              operating
      activities
            
            
            147,314
            
            
            
            -
            
            
            
            147,314Amortization
      of discount on convertible promissory notes
            
            
            -
            
            
            
            27,257
            
            
            
            27,257Charge
      for change in estimated fair value of derivative
              financial
      instruments - Warrants
            
            
            -
            
            
            
            63,629
            
            
            
            63,629Share-based
      compensation
            
            
            -
            
            
            
            25,425
            
            
            
            25,425Net
      cash used in operating activities
            
            $
            (133,529
            )
            
            $
            -
            
            
            $
            (133,529
            )


17
 CISTERA NETWORKS, INC. &
SUBSIDIARY
 Notes to
Consolidated Financial Statements
 (Unaudited)





NOTE 3 - CONCENTRATION OF
RISK





As of
June 30, 2007, the Company received approximately 33% of its gross revenues from
its top three re-sellers.  This represents some decrease in
concentration of business from the 38% reported for the quarter ended June 30,
2006.  The loss of these re-sellers would adversely impact the
business of the Company.





NOTE 4 - LEASE
COMMITMENT





As of
June 30, 2007, the Company currently leases approximately 4,264 square feet of
office space at 17304 Preston Road, Suite 975, Dallas, Texas from Memshalah
Realty, a successor to CMD Realty Fund.  The lease payments are
approximately $7,626 per month and the lease expires November 30,
2009.  As of June 30, 2007, this office space was used as the
corporate headquarters.





The
minimum future lease payments under this lease for the next five years
are:





April
      1, 2007 - March 31, 2008
            
            $
            92,225April
      1, 2008 - March 31, 2009
            
            
            94,357April
      1, 2009 - March 31, 2010
            
            
            63,852April
      1, 2010 - March 31, 2011
            
            
            -April
      1, 2011 - March 31, 2012
            
            
            -Total
      minimum future lease payments
            
            $
            250,434





NOTE5- LINESOF
CREDIT





On
September 21, 2006, the Company entered into a factoring agreement with Allied
Capital Partners, L.P., whereby Allied Capital provides a revolving line of
credit to the Company up to $750,000 that is secured by the Company’s accounts
receivable.  At March 31, 2007, the total amount outstanding on this
line of credit was $62,094 and at June 30, 2007 the total amount outstanding was
$-0-.





On May
18, 2007, the Company secured a line of credit with JPMorgan Chase Bank in the
amount of $50,000.  The line of credit carries an interest rate of
prime plus one half-point.  The line of credit is secured with a
deposit guarantee of $50,000.





NOTE 6 - RELATED PARTY
TRANSACTIONS





On May
31, 2004, the Company received a loan of $55,755 from one of its executive
officers.  The note carries an interest rate of 8%.  At June
30, 2007, the total amount of principal and interest due on this note was
$25,860.





Effective
May 27, 2005, we acquired XBridge through a merger transaction in exchange for
4,150,000 shares of our common stock (which after the cancellation of the
2,150,000 originally issued to XBridge resulted in the issuance of only
2,000,000 new shares) and the elimination of approximately $1.86 million of
inter-company payables owed to XBridge.  Prior to entering into the
agreement governing the merger, (a) Ms. Cynthia Garr, the Company's Executive
Vice President, acting Chief Financial Officer and a director, was also the
President and a director of XBridge, (b) Mr. Gregory Royal, the Company's Chief
Technology Officer and a director, was also a Vice President and a director of
XBridge, (c) Mr. Derek Downs, the Company's acting Chief Executive Officer and a
director, was also a consultant to XBridge.







18
 CISTERA NETWORKS, INC. &
SUBSIDIARY
 Notes to
Consolidated Financial Statements
 (Unaudited)





At the
time of the merger, Ms. Garr owned 451,000 shares of XBridge common stock and
held options to purchase another 15,426 shares, and Mr. Royal owned 375,000
shares of XBridge common stock and held options to purchase another 100,000
shares.  At an exchange ratio of 2.71174 shares of our common stock
for each share of XBridge stock outstanding, post merger, (1) Ms. Garr owned
1,222,997 shares of our common stock and held options to purchase another 41,831
shares; (2) Mr. Royal owned 1,016,904 shares of our common stock and held
options to purchase an additional 271,174 shares.  Ms. Garr's options
expire April 1, 2009, and Mr. Royal’s options expire May 3, 2009. With regard to
these stock options and all other outstanding options to purchase XBridge shares
at the time, the original provisions for the XBridge stock options were applied
in a carry-forward manner to the options to purchase shares of our
stock.





On March
31, 2006, the Company received a loan of $6,400 from one of its executive
officers.  The note carries an interest rate of 8% and was due March
31, 2007.  At June 30, 2007, the total amount of principal and
interest due on this note was $-0-.





On June
30, 2006, the Company received a short term loan of $16,434 from one of its
executive officers.  At March 31 and at June 30, 2007, the balance of
the loan was $-0-.





Pursuant
to an employment agreement dated January 1, 2005, the Company agreed to pay
$125,000 per year to Derek Downs, an officer and director of the
Company.  This agreement was mutually terminated by the parties,
effective March 31, 2007.





Pursuant
to an employment agreement dated January 1, 2005, the Company agreed to pay
$125,000 per year to Cynthia Garr, an officer and director of the
Company.  This agreement was mutually terminated by the parties,
effective April 1, 2006.





Pursuant
to an employment agreement dated October 1, 2004, the Company agreed to pay
$130,000 per year to Gregory Royal, an officer and director of the
Company.  This agreement was mutually terminated by the parties,
effective March 31, 2007.





On April
5, 2007, the Company issued a PP2 Note of $30,000, and issued PP2 Warrants to
purchase 30,000 shares of the Company’s common stock to Derek Downs, an officer
and director of the Company, in connection with the cancellation of an equal
amount of the Company’s outstanding obligations. As of June 30, 2007, interest
of $1,293 had been accrued on this PP2 Note.





On April
5, 2007, the Company issued a PP2 Note in the principal amount of $70,779, and
issued PP2 Warrants to purchase 70,779 shares of the Company’s common stock to
Gregory Royal, an officer and director of the Company, in connection with the
cancellation of an equal amount of the Company’s outstanding obligations. As of
June 30, 2007, interest of $3,052 had been accrued on this PP2
Note.





NOTE 7 -
ACQUISITIONS





On May 5,
2003, the Company, Corvero Networks, Inc., a Florida corporation and our wholly
owned subsidiary (Corvero), and XBridge Software, Inc., a Delaware corporation,
entered into a license agreement pursuant to which Corvero agreed to license
from XBridge Software, Inc. all rights, title, and interest of XBridge in and to
certain technologies and intellectual properties (the “XBridge
Technology”).  The exclusive license was worldwide in scope and had a
term of twenty years, and included, but was not limited to, the right to make
alternations and/or derivative works and to license, sublicense, cross-license
or otherwise transfer the XBridge Technology for commercial purposes, and all
rights to derivative works would be the Company’s sole and exclusive
property.  This license did not, however, give the Company the right
to transfer or resell the XBridge Technology without the consent of
XBridge.  CNH Holdings Company, through multiple subsequent amendments
to the licensing agreement, ultimately issued an aggregate of 2,000,000 shares
of its common stock to XBridge.








19
 CISTERA NETWORKS, INC. &
SUBSIDIARY
 Notes to
Consolidated Financial Statements
 (Unaudited)





On August
31, 2004, CNH Holdings Company absorbed its wholly-owned subsidiary Corvero
Networks, Inc., and began operating as Cistera Networks.  As of that
date, all of Corvero's rights under the License Agreement dated May 5, 2003
passed to Cistera Networks, Inc.





Effective
May 27, 2005, we acquired XBridge through a merger transaction in exchange for
4,150,000 shares of our common stock (which after the cancellation of the
2,150,000 originally issued to XBridge resulted in the issuance of only
2,000,000 new shares) and the elimination of approximately $1.86 million of
inter-company payables owed to XBridge. Through this acquisition, the Company
acquired net assets valued at $782,245 and intellectual property valued at
$2,717,755.  Of this amount, $2,134,821 was allocated to goodwill and
has subsequently been expensed.





NOTE 8 - CONVERTIBLE
DEBT





PP1
Notes





Effective
December 13, 2004, the Company issued and sold an aggregate of $1,146,000 in
principal amount of PP1 Notes, and issued PP1 Warrants to purchase 1,146,000
shares of our common stock, par value $0.001 per share.  Of the
$1,146,000 in PP1 Notes, $1,004,000 in principal amount were issued for cash,
and $142,000 in principal amount were issued in connection with the cancellation
of an equal amount of the Company’s outstanding obligations.  At
December 31, 2005, a number of PP1 Note holders opted to convert their debt as
provided in their note agreements.  The total number of shares issued
due to this conversion was 946,392.  The amount of principal and
accrued interest represented by these shares was $859,000 and $87,392,
respectively.  At March 31, 2006, three PP1 Note holders opted to
convert their debt as provided in their note agreements.  The total
number of shares issued due to this conversion was 67,785.  The amount
of principal represented by these shares was $57,000.  The amount of
accrued interest represented by these shares was $10,785.  These PP1
Notes converted at $1.00 per share.  The total amount of principal and
interest due at December 13, 2006 was $196,088.  At August 31, 2006,
one PP1 Note holder who had previously converted most of his outstanding debt
opted to convert the outstanding balance.  The total number of shares
issued due to this conversion was 4,034.  The remaining amount of
principal represented by these shares was $1,000.  The amount of
interest earned on his original note represented by these shares was
$3,034.  At December 13, 2006, one PP1 Note holder opted to convert
their outstanding balance.  There were 17,931 shares issued at $1.00
per share to convert principal of $15,000 and accrued interest of
$2,931.  At December 13, 2006, two PP1 Note holders opted to convert
their outstanding balance to a  second private placement, which was
the first closing of the PP2 Note purchase agreements.  The total
amount converted was $56,071.





During
the three months ended June 30, 2007, the Company paid $50,000 of principal and
accrued interest of $9,770 on the PP1 Notes.  At June 30, 2007,
there was $94,000 of principal and $24,121 of interest due on the
PP1 Notes.





The PP1
Notes bear interest at the rate of 8% per annum, compounded quarterly on each
March 31, June 30, September 30 and December 31 that the PP1 Notes are
outstanding (each, an interest compounding date).  The outstanding
principal on the PP1 Notes and all accrued interest become due and payable on
the earlier of (a) December 9, 2006, or (b) the date on which a change in
control of the Company occurs.





The
outstanding principal and accrued interest on the PP1 Notes are convertible into
shares of common stock at a conversion rate equal to the lesser of (a) $1.30 per
share, or (b) a 25% discount to the average closing bid price of the Company’s
common stock for the five days including and immediately preceding the interest
compounding date, provided that in no event shall the conversion price per share
be less than $1.00 per share.  The PP1 Notes may be converted, in
whole or in part, at the option of the note holder on any interest compounding
date occurring after the effective date of a registration statement covering the
resale of shares of common stock to be issued upon conversion of the PP1
Notes.








20
 CISTERA NETWORKS, INC. &
SUBSIDIARY
 Notes to
Consolidated Financial Statements
 (Unaudited)





In
addition, if the Company subsequently issues or sells any new securities
convertible, exercisable or exchangeable into shares of our common stock
(“convertible securities”) in a private transaction and receives gross proceeds
of at least $500,000, the PP1 Notes may be converted, in whole or in part at the
option of the PP1 Note holders, into the convertible securities, upon the same
terms and conditions governing the issuance of the convertible securities in the
private transaction.  The right of the PP1 Note holders to convert the
PP1 Notes into convertible securities does not apply to any convertible
securities issued by the Company (a) in connection with a merger, acquisition or
consolidation of the Company, (b) in connection with strategic license
agreements and other partnering arrangements so long as such issuances are not
for the purpose of raising capital, (c) in connection with bona fide firm
underwritten public offerings of its securities, (d) pursuant to the Company’s
incentive and stock option plans, (e) as a result of the exercise of options or
warrants or conversion of convertible notes or preferred stock which were
granted or issued as of December 13, 2004.





The
Company may prepay the PP1 Notes in whole or in part, upon thirty days prior
written notice to PP1 Note holders; provided that partial prepayments may be
made only in increments of $10,000 and, provided further, that the PP1 Note
holders may convert the amount of the proposed prepayment into shares of our
common stock, regardless of the period of time that the PP1 Notes have then been
outstanding.





The PP1
Warrants have a term of five years and are exercisable at an exercise price of
$1.30 per share.  Subject to an effective registration statement
covering the resale of the shares of common stock issuable upon exercise of the
Warrants, the Company may, upon thirty days prior written notice, redeem the
warrants for $0.10 per share, in whole or in part, if our common stock closes
with a bid price of at least $3.50 for any ten (10) out of fifteen (15)
consecutive trading days.





Both the
PP1 Notes and Warrants carried registration rights and required the payment of
liquidated damages for failure to file a registration statement by June 22,
2005.  The Company did not meet this filing date and began accruing
liquidated damages at a rate of 1% per month on the total of the principal and
accrued interest of the PP1 Notes.  On August 24, 2005, the Company
filed its initial registration statement covering all of the PP1 Notes and
Warrants and ceased accruing liquidated damages as of this date.





PP2
Notes





On
December 29, 2006 the Company completed the first closing of its PP2 Notes
offering and issued and sold an aggregate of $433,362 in principal amount of PP2
Notes, and issued PP2 Warrants to purchase 433,571 shares of our common
stock.  Of the $433,362 in principal, the Company received cash of
$397,500 and $35,862 in principal and interest of PP1 Notes was
converted.  During January through March 2007, the Company received
additional funding from investors in the amount of approximately $1,466,000,
which were formally issued and sold as PP2 Notes on April 5, 2007, when the
Company also issued an additional $1,593,000 in PP2
Notes.  Additionally, the Company issued PP2 Warrants to purchase
3,065,205 shares of our common stock, par value $0.001 per share.  Of
the $3,065,205 in principal, the Company received cash of $2,416,429, and
$648,776 in principal amount of the PP2 Notes was issued in connection with the
cancellation of an equal amount of the Company’s outstanding
obligations.  Included in the outstanding obligations that were
cancelled were $100,779 of obligations to principal officers and directors in
the following amounts: Greg Royal $70,779 and Derek Downs $30,000.





The PP2
Notes bear interest at the rate of 8% per annum, compounded quarterly on each
March 31, June 30, September 30 and December 31 anniversary that they are
outstanding (each, an interest compounding date).  The outstanding
principal and all accrued interest become due and payable two years from the
date of the PP2 Notes.  The outstanding principal and accrued interest
are convertible into shares of common stock at a fixed rate of $0.75 per
share.  The PP2 Notes may be converted, in whole or in part, at the
option of the PP2 Note holder on any interest compounding date occurring after
the effective date of a registration statement covering the resale of shares of
common stock to be issued upon conversion of the PP2 Notes.








21
 CISTERA NETWORKS, INC. &
SUBSIDIARY
 Notes to
Consolidated Financial Statements
 (Unaudited)





In
addition, if the Company subsequently issues or sells any new securities
convertible, exercisable or exchangeable into shares of our common stock
(“convertible securities”) in a private transaction and receives gross proceeds
of at least $500,000, the PP2 Notes may be converted, in whole or in part at the
option of the note holders, into the convertible securities, upon the same terms
and conditions governing the issuance of the convertible securities in the
private transaction.  The right of the PP2 Note holders to convert
their notes into convertible securities does not apply to any convertible
securities issued by the Company (a) in connection with a merger, acquisition or
consolidation of the Company, (b) in connection with strategic license
agreements and other partnering arrangements so long as such issuances are not
for the purpose of raising capital, (c) in connection with bona fide firm
underwritten public offerings of its securities, (d) pursuant to the Company’s
incentive and stock option plans, (e) as a result of the exercise of options or
warrants or conversion of convertible notes or preferred stock which were
granted or issued as of December 13, 2004.





The
Company may prepay the PP2 Notes in whole or in part, upon thirty days prior
written notice to note holders; provided that partial prepayments may be made
only in increments of $10,000 and, provided further, that the PP2 Note holders
may convert the amount of the proposed prepayment into shares of our common
stock at any time.





The PP2
Warrants have a term of five years and are exercisable at an exercise price of
$1.00 per share.  Subject to an effective registration statement
covering the resale of the shares of common stock issuable upon exercise of the
PP2 Warrants, the Company may, upon thirty days prior written notice, redeem the
PP2 Warrants for $0.10 per share, in whole or in part, if our common stock
closes with a bid price of at least $3.50 for any ten (10) out of fifteen (15)
consecutive trading days.





Both the
PP2 Notes and Warrants carry registration rights and require the payment of
liquidated damages for failure to file a registration statement by April 20,
2007 and to have an effective registration statement by November 30,
2007.  The Company did not meet the April 20, 2007 filing date and
began accruing liquidated damages as of this date at a rate of 1% on the total
of the principal and accrued interest of the PP2 Notes.





Restatement





As stated
in Note 2 to the consolidated financial statements, the Company has restated its
consolidated financial statements for: 1) the accounting it originally applied
in the initial valuation and recording of the PP1 Notes and Warrants and the PP2
Notes and Warrants and subsequent remeasurement of their carrying values, and 2)
the accounting for liquidated damages related to the PP2 Notes and Warrants as
of April 1, 2007 upon the adoption of FSP 00-19-2.  See specific
accounting treatment in Note 2.





NOTE 9 -
CONTINGENCIES





The
Company, and certain of its current and former officers and directors are
defendants in litigation pending in Dallas, Texas, styled KINGDON R. HUGHES VS. GREGORY T.
ROYAL, CYNTHIA A. GARR, JAMES T. MILLER, JR., CHARLES STIDHAM, CNH HOLDINGS
COMPANY D/B/A CISTERA NETWORKS AND XBRIDGE SOFTWARE, INC.;Cause No.
DV05-0600-G; G-134th District Court, Dallas County, Texas.  The
plaintiff has alleged a number of complaints against the defendants, including
breach of fiduciary duty, misappropriation of corporate opportunities, fraud,
fraudulent inducement, breach of contract, tortuous interference with contract,
fraudulent transfer, and shareholder oppression arising in connection with the
license agreement between the Company and XBridge in May 2003 and the
acquisition of XBridge by the Company in May 2005.  The parties held a
mediation conference in April 2006 and have come to an understanding with
respect to the principal elements of a potential settlement.  We are
currently in the process of negotiating definitive settlement
agreements.








22
 CISTERA NETWORKS, INC. &
SUBSIDIARY
 Notes to
Consolidated Financial Statements
 (Unaudited)





The
Company is a defendant in litigation pending in Dallas, Texas, styled
Collaborative Search Partners, Inc. vs. XBridge Software, Inc., and Cistera
Networks, Inc., Cause No. 07-03189; J191st District Court, Dallas County,
Texas.  The plaintiff has alleged a number of complaints against the
defendants, including breach of contract, promissory estoppel, and quantum
meruitt arising in connection with two separate employment search
agreements.  In May 2007, the parties came to an understanding with
respect to the principal elements of a potential settlement, and a Rule 11
letter agreement has been filed with the Court, however, a definitive settlement
agreement is still being negotiated among the parties.  The Rule 11
letter agreement provides for payment by the defendants of $44,000 to the
plaintiff over a period of six months, and in the event the defendants fail to
make such payments, a default judgment may be rendered against the
defendants.





NOTE 10 – INCOME
TAXES





Effective
April 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes – an interpretation of FASB
Statement No. 109” (“FIN 48”). FIN 48 prescribes a recognition threshold and a
measurement attribute for the financial statement recognition and measurement of
tax positions taken or expected to be taken in a tax return. For those benefits
to be recognized, a tax position must be more-likely-than-not to be sustained
upon examination by taxing authorities. The adoption of the provisions of FIN 48
did not have a material impact on the Company’s consolidated financial position
or results of operations. At April 1, 2007, the Company had no liability for
unrecognized tax benefits and no accrual for the payment of related
interest.





Interest
costs related to unrecognized tax benefits are classified as “Interest expense,
net” in the accompanying consolidated statements of operations. Penalties, if
any, would be recognized as a component of “Selling, general and administrative
expenses”. The Company recognized $-0- of interest expense related to
unrecognized tax benefits for the quarter ended June 30, 2007.  In
many cases the Company’s uncertain tax positions are related to tax years that
remain subject to examination by relevant tax authorities. With few exceptions,
the Company is generally no longer subject to U.S. federal, state, local or
non-U.S. income tax examinations by tax authorities for years before 2003. The
following describes the open tax years, by major tax jurisdiction, as of April
1, 2007:





United
      States (a)
            
            2003
      – Present





(a)
Includes federal as well as state or similar local jurisdictions, as
applicable.




















23





ITEM
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION





The
following discussion and analysis of the Company's financial condition and
results of operations should be read in conjunction with the Company's unaudited
consolidated financial statements and related notes that appear in this filing.
In addition to historical consolidated financial information, the following
discussion contains forward-looking information as defined in Section 21E of the
Securities Exchange Act of 1934.





Forward
Looking Statements:





Forward-looking
statements include statements concerning plans, objectives, goals, strategies,
future events or performance and underlying assumptions and other statements,
which are other than statements of historical facts.  Certain
statements in this Form 10-QSB/A are forward-looking statements. Words such as
“expects,” “believes,” “anticipates,” “may,” “intends,” “projects,” “estimates”
and similar expressions are intended to identify forward-looking
statements.  The Company’s expectations, beliefs and projections are
expressed in good faith and are believed by the Company to have a reasonable
basis, including without limitation, management’s examination of historical
operating trends, data contained in the Company’s records and other data
available from third parties, but there can be no assurance that management’s
expectation, beliefs or projections will be achieved or
accomplished.  However, forward-looking statements are subject to
risks and uncertainties that could cause actual results to differ materially
from those projected.  Such risks and uncertainties include, but are
not limited to, limited operating history, historical operating losses and the
uncertainty of the Company’s profitability in the future, the need to raise
additional capital to sustain operations and implement its future business plan,
and other factors that may be beyond the Company’s control  These
factors include changes in regulations or legislation, adverse determination
with respect to litigation or other claims, ability to recruit and retain
employees, and increases in operating costs.  Factors that could cause
or contribute to these differences have been included throughout the public
filings from the Company.  The Company has no obligation to publicly
update or revise these forward-looking statements to reflect the occurrence of
future events or circumstances.





OVERVIEW





We
provide IP network-based application appliances and services that add features
and enhanced functionality to the telecommunications services used by large
enterprises, small and mid-sized organizations, both in the commercial and
public sector.  Our software- and hardware-based solutions are
delivered on our open-architecture, component-based platform known as the
Cistera ConvergenceServer, which allows administrators to centrally manage
advanced applications for IP telephony environments across large single-site and
multi-site private voice/data networks. Because our solutions improve
productivity and efficiencies for customers using IP telephony systems, we
believe that our convergence solutions complement the efforts of IP telephony
solution providers to increase the overall return on investment and value
contribution associated with IP telephony systems.  This has allowed
us to establish cooperative relationships with IP telephony solution providers,
as well as large value added resellers (VARs) and systems integrators (SIs)
focused on delivering IP telephony systems and services.





Currently,
we offer new customers a robust IP-based applications platform pre-loaded with a
variety of packaged applications (we refer to them as application
engines).  We market our software and hardware solutions through a VAR
channel, and in some cases directly to Fortune 500 customers.  To
ensure growth scalability, our VAR channel is being trained to deliver
professional services for standard installations, which we believe will allow us
to focus on advanced professional services for complex
installations.





Our
objective is to be the leading provider of IP communications application
platforms and advanced IP-based applications for businesses
worldwide.  To address our market opportunity, our management team is
focused on a number of short and long-term challenges including: strengthening
and extending our solution offerings; adding new customers and expanding our
sales efforts into new territories; deepening our relationships with our
existing customers, VARs, and SIs; and encouraging the development of
third-party applications on our platform.








24





In order
to increase our revenues and take advantage of our market opportunity, we will
need to add substantial numbers of customer installations. We plan to reinvest
our earnings for the foreseeable future in the following ways: hiring additional
personnel, particularly in sales and engineering; expanding our domestic and
international selling and marketing activities; increasing our research and
development activities to upgrade and extend our solution offerings and to
develop new solutions and technologies; growing our VAR and systems
implementation channel; adding to our infrastructure to support our growth; and
expanding our operational and financial systems to manage a growing
business.





RESTATEMENT
OF PREVIOUSLY ISSUED CONSOLIDATED FINANCIAL STATEMENTS





The
Company has restated its Consolidated Balance Sheet as of June 30, 2007, its
Consolidated Statement of Stockholders’ Equity (Deficit) for the three months
ended June 30, 2007 and its Consolidated Statements of Operations and Cash
Flows for the three months ended June 30, 2007 and 2006 to correct its
accounting for its Senior Unsecured Convertible Promissory Notes and detachable
warrants issued in private placements during the period from December 2004 to
April 2007 (the “PP1 Notes,” “PP1 Warrants,” “PP2 Notes” and “PP2
Warrants”).





In
addition, the Company has restated its Consolidated Balance Sheet as of June 30,
2007 and its Consolidated Statements of Operations, Stockholders’ Equity
(Deficit) and Cash Flows for the three months ended June 30, 2007 to reflect a
correction in its accounting for registration payment arrangements (associated
with the aforementioned securities) as required under FASB Staff Position No.
00-19-2, “Accounting for Registration Payment Arrangements” (“FSP
00-19-2”).  FSP 00-19-2 was effective April 1, 2007 for the Company,
and the Company incorrectly accounted for its registration payment arrangements
as of the effective date (which required the recording of a cumulative effect of
a change in accounting principle) and for the three months ended June 30,
2007.





Additionally,
the Company has restated its Consolidated Statements of Operations and Cash
Flows for the three months ended June 30, 2006 for share-based compensation
related to employee stock options.





The
impact of the restatement on the Consolidated Statements of Operations for the
three months ended


June 30,
2007 and 2006 is summarized in the table below:





Adjustments
      to Consolidated Statements of Operations:
              Income
      (Expense)Convertible
              Promissory
              Notes
      and
              Warrants
            
            
            Registration
              Payment
              arrangements
            
            
            Share-based
              compensation
            
            
            TotalThree
      months ended June 30, 2007
            
            $
            (370,715
            )
            
            $
            (166,465
            )
            
            $
            -
            
            
            $
            (537,180
            )Three
      months ended June 30, 2006
            
            $
            (90,886
            )
            
            $
            -
            
            
            $
            (25,425
            )
            
            $
            (116,311
            )





The
Company has concluded that its original accounting for the PP1 Notes and PP1
Warrants issued in fiscal year 2005 and the PP2 Notes and PP2 Warrants issued in
fiscal years 2007 and 2008 was incorrect and that the necessary adjustments were
material for the fiscal year 2007 and 2006 consolidated financial
statements.





The
Company based its conclusion upon a further review of the documents associated
with the Notes and Warrants and considered the following sources as relevant
guidance in determining the proper accounting treatment for the Notes and
Warrants:





·
            SFAS
      133, Accounting for
      Derivative Instruments and Hedging Activities(“SFAS
      133”),


·
            APB
      Opinion 14, Accounting
      for Convertible Debt and Debt Issued with Stock Purchase Warrants
      (“APB   14”),


·
            Emerging
      Issues Task Force (EITF) Issue 00-19, Accounting for Derivative
      Financial Instruments Indexed to, and Potentially Settled in, a Company’s
      Own Stock(“EITF 00-19”),


·
            EITF
      05-2,The Meaning of
      “Conventional Convertible Debt Instrument”(“EITF
      05-2”),





25





·
            EITF
      98-5, Accounting for
      Convertible Securities with Beneficial Conversion Features or Contingently
      Adjustable Conversion Ratios (“EITF
  98-5”),


·
            EITF
      00-27, Application of
      Issue No. 98-5 to Certain Convertible Instruments (“EITF 00-27”),
      and


·
            SEC
      Staff Accounting
      Bulletin No. 107(“SAB
107”).





Conversion feature of the
Notes





The
Company concluded that the Notes meet the definition of “conventional
convertible debt” (as defined in EITF 00-19 and affirmed in EITF
05-2).  EITF 00-19, paragraph 4 states: “The Task Force observed that,
pursuant to paragraphs 11(a) and 12(c) of Statement 133, if an embedded
derivative is indexed to the reporting entity's own stock and would be
classified in stockholders' equity if it was a freestanding derivative, that
embedded derivative is not considered a derivative for purposes of SFAS 133. The
Task Force reached a consensus that for purposes of evaluating under SFAS 133
whether an embedded derivative indexed to a company's own stock would be
classified in stockholders’ equity if freestanding, the requirements of
paragraphs 12–32 of this Issue do not apply if the hybrid contract is a
conventional convertible debt instrument in which the holder may only realize
the value of the conversion option by exercising the option and receiving the
entire proceeds in a fixed number of shares or the equivalent amount of cash (at
the discretion of the issuer).”





Therefore,
the Company has concluded that the conversion feature of the convertible debt
did not meet the definition of a derivative under SFAS 133 and did not require
separate accounting from the debt instrument.





Valuation of Notes and
Warrants and beneficial conversion feature





APB 14
addresses the accounting for convertible debt with a nondetachable (embedded)
conversion feature, the terms of which provide for an initial conversion price
that is greater than the market value at the date of issuance and a conversion
price that does not decrease, except under antidilution protection, but does not
explicitly address situations in which the embedded conversion feature is
“in-the money” at issuance.  The Notes, including any accrued
interest, were exercisable into the Company’s common stock at less than the
closing price of the Company’s stock on the dates of issuance, and the Company
considered this conversion to be an “embedded beneficial conversion
feature.”





EITF 98-5
requires “that embedded beneficial conversion features present in convertible
securities should be valued separately at issuance.” Further, EITF 98-5 states
“that the intrinsic value of the beneficial conversion feature may be greater
than the proceeds allocated to the convertible instrument,” and as such, “that
the amount of the discount assigned to the beneficial conversion feature is
limited to the amount of the proceeds allocated to the convertible instrument.”
EITF 00-27 further states “that the effective conversion price based on the
proceeds received for or allocated to the convertible instrument should be used
to compute the intrinsic value, if any, of the embedded conversion option. As a
result of this consensus, an issuer should first allocate the proceeds received
in a financing transaction that includes a convertible instrument to the
convertible instrument and any other detachable instruments included in the
exchange (such as detachable warrants) on a relative fair value basis. Then, the
Issue 98-5 model should be applied to the amount allocated to the convertible
instrument, and an effective conversion price should be calculated and used to
measure the intrinsic value, if any, of the embedded conversion
option.”





Accordingly,
we calculated the fair value of both the convertible Notes and the Warrants and
allocated the respective relative fair value percentages of each in determining
the initial values of the convertible Notes and the Warrants.  Because
the Warrants were determined to be derivative liabilities (see conclusion in
next section below and in Note 2 to the consolidated financial statements), the
Company recorded them at fair value as calculated under the Black-Scholes option
pricing model (“BS model”).  For Notes and Warrants issuances where
the net cash proceeds were greater than the fair value of the Warrants, this
difference was allocated to the value of the Notes.  The amount
assigned to the Warrants represented a debt discount on the Notes, which is
amortized over the life of the Notes.  For Notes and Warrants
issuances where the net cash proceeds were less than the fair value of the
Warrants, the Warrants were recorded at fair value and the difference was
recorded as a charge to the consolidated Statement of Operations at
inception.  This second situation occurred with the issuance of the
PP1 Notes in December 2004 and resulted in a charge to the Statement of
Operations of approximately $230,000; no value was allocated to the Notes, with
a full debt discount recorded and amortized over the life of the
Notes.





26





After
determining the recorded value of the Warrants and Notes (if any), we calculated
the beneficial conversion feature of the Notes, which resulted in an additional
debt discount which was amortized over the life of the Notes.





Classification and
accounting for Warrants





We
evaluated the Warrants as a potential free standing derivative under the
criteria in paragraph 11(a) of SFAS 133, which require that a contract
(Warrants) issued by a reporting entity be accounted for as a derivative unless
it is both (1) indexed to its own stock and (2) classified in stockholders’
equity in its statement of financial position. We concluded that the Warrants
were indexed to the Company’s own stock and should be classified in
stockholders’ equity and would qualify for the scope exception contained in this
paragraph.  The Company was required to further review the
requirements for equity classification contained in paragraphs 12-32 of EITF
00-19.  The Company concluded that it had not met criteria (2) above
based on the requirements for equity classification in EITF
00-19.  Specifically, both the PP1 and PP2 Notes contain registration
rights agreements (the “RR agreements”) that stipulate that the Company must
register all “registrable securities” (defined as the “shares of Common Stock
issuable upon conversion of the Notes and the shares of Common Stock issuable
upon exercise of the Warrants”) within a time frame (and this was deemed to be
outside of the control of the Company).  In the event of not filing a
registration statement by a specified date or by not having a registration
effective by a specified date, the Company was obligated to pay liquidated
damages in the amount of 1% of the then current outstanding amount of the Notes
plus accrued interest.  The Company accrued all required liquidated
damages, beginning in FY 2005 with the PP1 Notes. Liquidated damages required
under the RR Agreement for the PP1 Notes ceased on September 25, 2005, which was
the date that the Company filed its initial registration statement for the PP1
Notes and PP1 Warrants.





Accordingly,
the Company concluded that the Warrants did not satisfy the requirement for
equity classification and should be classified, recorded and prospectively
accounted for as derivative liabilities until it has registered all underlying
shares to the Warrants or until such time that the RR agreements are no longer
in effect.  The prospective accounting requires that the Warrants be
remeasured at each balance sheet date based on estimated fair value and any
resultant changes in fair value be recorded to the Statement of
Operations.





The
Company used the BS model for calculating the fair value of all Warrants issued
based on the following assumptions:





Warrants
      issued in PP1
            
            Warrants
      issued in PP2Expected
      volatility
            128%
            
            100%-104%Expected
      term
            5
      years
            
            5
      yearsRisk-free
      interest rate
            3.58%
      - 4.33%
            
            4.46%
      - 4.65%Expected
      dividend yield
            0%
            
            0%





We
estimated volatility primarily based on historical volatility rates through the
date of each closing of the PP1 and PP2 offerings. The Warrants have a
transferability provision and based on guidance provided in SAB 107 for options
issued with such a provision, we used the full, five-year contractual term as
the expected term in the initial valuation of the Warrants.  For the
risk-free interest rate, we used the five year U.S. Treasury zero coupon rate
for the initial valuation of the Warrants.  Expected volatilities,
expected terms and risk-free interest rates were adjusted as of each quarterly
period commensurate with the remaining contractual lives of the Warrants on such
dates and were used to determine the estimated fair value of the Warrants under
the BS model.





Registration Payment
Arrangements





On
December 21, 2006, the EITF issued FSP 00-19-2.  FSP 00-19-2 was
effective immediately for registration payment arrangements and the financial
instruments subject to those arrangements that were entered into or modified
subsequent to the date of issuance of this FSP. For registration payment
arrangements and financial instruments subject to those arrangements that were
entered into prior to the issuance of this FSP, the FSP was effective for
financial statements issued for fiscal years beginning after December 15, 2006,
and interim periods within those fiscal years.  Effective April 1,
2007, the Company adopted FSP 00-19-2, which was applicable to the accounting
for the liquidated damages on the PP2 Notes.





27





FSP
00-19-2 requires the Company to account for contingent liquidated damages
separately from the financial instruments to which they relate, which were the
Notes and Warrants issued and sold in the PP1 and PP2
offerings.  Prior to the adoption of FSP-00-19-2, the Company
accounted for the Warrants as derivative liabilities based on the requirement of
the Company to register all underlying shares to the Notes and the
Warrants.  The Company concluded that with the separate accounting
required under FSP 00-19-2 for the liquidated damages, the Warrants by
themselves were properly classified as equity securities (having met all
requirements of EITF 00-19 for equity classification) as of the adoption
date.





Under FSP
00-19-2, the Company is required to estimate and record a contingent liability
if the likelihood is probable that it will pay liquidated damages in future
periods, calculated in accordance with SFAS 5, “Accounting for Contingencies”
(“SFAS 5”) and FASB Interpretation No. 14, “Reasonable Estimation of the Amount
of a Loss.”  Further, FSP 00-19-2 requires that “the financial
instrument(s) subject to the registration payment arrangement shall be
recognized and measured in accordance with other applicable GAAP (for example
SFAS 133 and EITF 00-19) without regard to the contingent obligation to transfer
consideration pursuant to the registration payment arrangement.” Accordingly, on
the date of adoption, the Company accounted for the Warrants separately from the
liquidated damages obligations.





Based on
the above requirements, the Company recorded a cumulative effect of an
accounting change entry (i.e., a charge to the beginning balance of the
accumulated deficit) as of April 1, 2007 for the combination of:  1)
the reclassification of the Warrants from derivative liabilities to equity
securities, and 2) a contingent liability for probable future payment of
liquidated damages (based on the Company’s best estimate as of the date of
adoption, which is through March 31, 2008).  The amount of the
contingent liability recorded was approximately $289,000.  The
difference between the Warrants as measured on the date of adoption and their
original recorded value was approximately $466,000, and, as stated above, was
included in the charge to the beginning balance of the accumulated
deficit.  The total of the cumulative effect of this accounting change
was $755,000.





On April
5, 2007, the Company closed the balance of its PP2 offering and, in accordance
with FSP 00-19-2, recorded a contingent liability and related charge to the
consolidated Statement of Operations for the three months ended June 30, 2007 in
the amount of $251,176 for the estimated liquidated damages related to this
funding through March 31, 2008.  At June 30, 2007, the total liability
for estimated liquidated damages was $540,176.





Share-based
compensation





The
Company concluded that it incorrectly calculated and recorded share-based
compensation expense associated with stock options upon the adoption of SFAS
123R on April 1, 2006.  Specifically, the Company did not calculate
the fair value of employee stock options issued during the period from February
2004 through October 2004 and did not record any related expense in the
Statement of Operations for the fiscal year ended March 31, 2007, or for the
respective quarterly periods for that year, related to the unrecognized stock
option cost as of April 1, 2006.  The Company has not issued any
additional stock options to employees since October 2004.








28





The table
below summarizes the effect of the restatement adjustments on the Consolidated
Statements of Operations:





For
      the three months ended June 30, 2007
            
            
            For
      the three months ended June 30, 2006As
      previously
              reported
            
            
            Adjustments
            
            
            As
      restated
            
            
            As
      previously
              reported
            
            
            Adjustments
            
            
            As
      restatedGross
      profit
            
            $
            540,131
            
            
            $
            -
            
            
            $
            540,131
            
            
            $
            466,763
            
            
            $
            -
            
            
            $
            466,763Operating
      expenses
            
            
            855,190
            
            
            
            -
            
            
            
            855,190
            
            
            
            730,187
            
            
            
            25,425
            
            
            
            755,612Loss
      from operations
            
            
            (315,059
            )
            
            
            -
            
            
            
            (315,059
            )
            
            
            (263,424
            )
            
            
            (25,425
            )
            
            
            (288,849
            )Other
      income (expense)Interest
      expense, net
            
            
            (148,546
            )
            
            
            84,711
            
            
            
            (63,835
            )
            
            
            (17,419
            )
            
            
            -
            
            
            
            (17,419
            )Amortization
      of discount on
              convertible
      notes
            
            
            -
            
            
            
            (370,715
            )
            
            
            (370,715
            )
            
            
            
            
            
            
            (27,257
            )
            
            
            (27,257
            )Charge
      for estimated liquidated
              damages
            
            
            -
            
            
            
            (251,176
            )
            
            
            (251,176
            )
            
            
            -
            
            
            
            -
            
            
            
            -Charge
      for change in estimated
              fair
      value of derivative
              financialinstruments
      -
              Warrants
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (63,629
            )
            
            
            (63,629
            )Net
      loss
            
            $
            (463,605
            )
            
            $
            (537,180
            )
            
            $
            (1,000,785
            )
            
            $
            (280,843
            )
            
            $
            (116,311
            )
            
            $
            (397,154
            )Basic
      & diluted net loss per share
            
            $
            (0.06
            )
            
            $
            (0.06
            )
            
            $
            (0.12
            )
            
            $
            (0.03
            )
            
            $
            (0.01
            )
            
            $
            (0.05
            )Weighted
      average shares
              outstanding:
      basic and diluted
            
            
            8,292,022
            
            
            
            
            
            
            
            8,292,022
            
            
            
            8,077,226
            
            
            
            
            
            
            
            8,077,226








29





The table
below summarizes the effect of the restatement adjustments on the Consolidated
Balance Sheet as of June 30, 2007:


As
      previously
              reported
            
            
            Adjustments
            
            
            As
      restatedCurrent
      liabilities:Accounts
      and related party payables
            
            $
            381,089
            
            
            $
            -
            
            
            $
            381,089Accrued
      liquidated damages
            
            
            -
            
            
            
            540,694
            
            
            
            540,694Accrued
      liabilities
            
            
            444,716
            
            
            
            (84,711
            )
            
            
            360,005Deferred
      revenue
            
            
            654,996
            
            
            
            
            
            
            
            654,996Current
      portion of long-term debt, net of discount
            
            
            95,408
            
            
            
            
            
            
            
            95,408Total
      current liabilities
            
            
            1,576,209
            
            
            
            455,983
            
            
            
            2,032,192Convertible
      promissory notes, net of discount
            
            
            3,485,491
            
            
            
            (2,596,151
            )
            
            
            889,340Deferred
      revenue
            
            
            114,912
            
            
            
            
            
            
            
            114,912Total
      long-term liabilities
            
            
            3,600,403
            
            
            
            (2,596,151
            )
            
            
            1,004,252Total
      liabilities
            
            
            5,176,612
            
            
            
            (2,140,168
            )
            
            
            3,036,444Stockholders’
      equity (deficit):Preferred
      stock
            
            
            -
            
            
            
            
            
            
            
            -Common
      stock
            
            
            8,292
            
            
            
            
            
            
            
            8,292Additional
      paid-in capital
            
            
            8,739,970
            
            
            
            4,820,830
            
            
            
            13,560,800Cumulative
      effect of adoption of FSP 00-19-2
            
            
            -
            
            
            
            (755,115
            )
            
            
            (755,115
            )Accumulated deficit
            
            
            (9,662,085
            )
            
            
            (1,925,547
            )
            
            
            (11,587,632
            )Total
      stockholders’ equity (deficit)
            
            
            (913,823
            )
            
            
            2,140,168
            
            
            
            1,226,345TOTAL
      LIABILITIES AND STOCKHOLDERS’
              EQUITY
      (DEFICIT)
            
            $
            4,262,789
            
            
            $
            -
            
            
            $
            4,262,789








30





The table
below summarizes the effect of the restatement adjustments as well as the
correction in errors in the reporting of components of cash flows from
operations and cash flows from financing activities on the Consolidated
Statement of Cash Flows for the three months ended June 30, 2007:


As
      previously
              reported
            
            
            Adjustments
            
            
            As
      restatedCASH
      FLOWS FROM OPERATING ACTIVITIESNet
      loss
            
            $
            (463,605
            )
            
            $
            (537,180
            )
            
            $
            (1,000,785
            )Adjustments
      used to reconcile net loss to net cash used in
              operating
      activities:Charge
      for estimated liquidated damages
            
            
            -
            
            
            
            251,176
            
            
            
            251,176Amortization
      of discount on convertible promissory notes
            
            
            -
            
            
            
            370,715
            
            
            
            370,715Depreciation
      and amortization
            
            
            80,936
            
            
            
            (1
            )
            
            
            80,935Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            (307,097
            )
            
            
            
            
            
            
            (307,097
            )Inventory
            
            
            10,440
            
            
            
            
            
            
            
            10,440Prepaid
      expenses
            
            
            1,568
            
            
            
            
            
            
            
            1,568Accounts
      payable
            
            
            (176,745
            )
            
            
            75,933
            
            
            
            (100,812
            )Accrued
      interest
            
            
            -
            
            
            
            (24,090
            )
            
            
            (24,090
            )Other
      accrued liabilities
            
            
            (153,307
            )
            
            
            223,331
            
            
            
            70,024Deferred
      revenue
            
            
            219,761
            
            
            
            
            
            
            
            219,761Net
      cash used in operating activities
            
            
            (788,049
            )
            
            
            359,884
            
            
            
            (428,165
            )Net
      cash used in investing activities
            
            
            (69,780
            )
            
            
            1
            
            
            
            (69,779
            )CASH
      FLOWS FROM FINANCING ACTIVITIESNet
      proceeds from issuance of convertible promissory notes
            
            
            1,584,885
            
            
            
            (359,885
            )
            
            
            1,225,000Payments
      on convertible promissory notes and other loans
            
            
            (61,000
            )
            
            
            
            
            
            
            (61,000
            )Net
      payments on line of credit
            
            
            (62,094
            )
            
            
            
            
            
            
            (62,094
            )Payments
      on capital lease
            
            
            (1,007
            )
            
            
            
            
            
            
            (1,007
            )Net
      cash provided by financing activities
            
            
            1,460,784
            
            
            
            (359,885
            )
            
            
            1,100,899Net
      increase in cash and cash equivalents
            
            
            602,955
            
            
            
            
            
            
            
            602,955Cash
      and cash equivalents at beginning of year
            
            
            534,871
            
            
            
            
            
            
            
            534,871Cash
      and cash equivalents at end of year
            
            $
            1,137,826
            
            
            $
            -
            
            
            $
            1,137,826





The table
below summarizes the effect of the restatement adjustments on the Consolidated
Statement of Cash Flows for the three months ended June 30,
2006.  There was no impact on cash flows from investing or financing
activities.





As
      previously
              reported
            
            
            Adjustments
            
            
            As
      restatedCASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
            
            $
            (280,843
            )
            
            $
            (116,311
            )
            
            $
            (397,154
            )Adjustments
      used to reconcile net loss to net cash used in
              operating
      activities:
            
            
            147,314
            
            
            
            -
            
            
            
            147,314Amortization
      of discount on convertible promissory notes
            
            
            -
            
            
            
            27,257
            
            
            
            27,257Charge
      for change in estimated fair value of derivative
              financial
      instruments - warrants
            
            
            -
            
            
            
            63,629
            
            
            
            63,629Share-based
      compensation
            
            
            -
            
            
            
            25,425
            
            
            
            25,425Net
      cash used in operating activities
            
            $
            (133,529
            )
            
            $
            -
            
            
            $
            (133,529
            )





31





QUARTER
SUMMARY





The
Company’s sales continue to show diversification across
industries.  Sales for the quarter ended June 30, 2007 were
distributed among six primary vertical markets in the following percentages:
financial services 35.2%, healthcare 5.9%, government 15.6%, education 15.9%,
manufacturing 8.4%, management and retail 18.8%.  The Company has
continued to reduce dependency on any single reseller as it has continued to
expand its VAR relationships.





RESULTS
OF OPERATIONS





The
following discussion should be read in conjunction with the consolidated
statements of operations included in this Report, in their
entirety.





OVERVIEW
OF RESULTS OF OPERATIONS FOR FIRST QUARTER FISCAL 2008, ENDED JUNE 30,
2007





The
Company recognized $679,787 in revenue for the quarter, a 55.8% increase over
the previous quarter of $436,350, and a 37.3% increase over the same period last
year of $494,737.  The Company received over $1 million dollars in
orders for the quarter, booking (shipping the system(s) and invoicing the
customer) revenues for the quarter of $925,000.  The Company only
recognized revenues of $679,787 for the quarter, because we only recognize
revenue from projects that have been fully implemented.  Revenues for
a number of the projects that were near full completion at the end of the
quarter have not yet been recognized.





With the
recent capital infusion from a private placement of convertible notes and
warrants to purchase common stock, the Company added a number of resources in
the sales, pre-sales and channel management roles as well as in
engineering.  These new resources are dedicated to further enabling
the VAR channel to market, sell and deliver the Company’s
solutions.  During the quarter, the Company initiated efforts to
review current channel partner performance and establish a scorecard system for
each reseller partner.  This will allow the Company to better
determine the allocation of resources to partner sales and marketing
efforts.  The plan also includes coordinated sales and technical
training, demonstration kit development, and joint marketing
programs.





Gross
profit during the quarter was $540,131, or 79.5% of revenues.  Gross
profit for the previous quarter was $309,000 or 71% of revenues, and for the
same period in fiscal year 2007, it was $467,000 or 94% of
revenues.


The
Company’s software revenue results in higher margins than hardware
revenue.  Because a substantial portion of the Company's revenues are
derived from software, gross margins are positively
impacted.  Management expects that as sales continue to ramp up,
margins will remain above 75 percent.





Sales and
marketing costs for this quarter totaled $176,092 and represented 25.9% of
revenues, as compared to $56,520 and 11.4% of revenues for the same quarter last
year. On an annual basis, we expect marketing and sales costs to continue to
track higher and will represent a substantial percentage of total revenues in
the future as we seek to add and manage more customers, increase sales and
marketing programs to enable our VAR channel, build brand awareness and increase
the number of web-based seminars and sponsored events.  As the Company
develops support for additional platforms, we anticipate that the Company will
increase visibility through participation in future industry
events.  While we also anticipate that the Company will continue to
leverage some of the marketing programs funded by large technology and VAR
partners, the Company’s participation will be reflected in increased sales and
marketing costs





The
Company's revenues were insufficient to support operations and the Company
sustained a net loss in this period.





LIQUIDITY
AND CAPITAL RESOURCES





For the
three months ended June 30, 2007, the Company used $428,165 of cash from
operating activities, used cash of $69,779 from investing activities and
generated net cash of $1,100,899 from financing activities.  The
Company generated cash of $1,225,000 from the issuance of the PP2 Notes offering
that closed in April 2007.








32





At June
30, 2007, the Company had cash, cash equivalents and short-term marketable
securities of $1,137,826, as compared to $65,531 at June 30, 2006.





From the
start of operations in May 2003 through the end of the current quarter,
operations have been funded primarily through sales, financing obtained from
private investors, and from the PP1 and PP2 private placements.





The
Company does not have any special purpose entities, and other than operating
leases for office space and computer equipment, which are described below, and
the Company does not engage in off-balance sheet financing arrangements. The
Company does have a bank line of credit with Chase bank for $50,000 and has a
funding agreement with Allied Capital Group whereby Allied Capital will provide
a revolving credit line secured by Accounts Receivable.  As of June
30, 2007, the maximum borrowing amount on the revolving credit line under the
Allied Capital agreement was increased to $750,000, and  the
outstanding balance on this line of credit was $-0-.  These agreements
enable the Company to smooth its cash-flow cycles and to expand its capability
to fund manufacturing credit requirements.





Future
capital requirements will depend on many factors including: rate of revenue
growth; the expansion of marketing and sales activities; the timing and extent
of spending to support product development efforts and expansion into new
territories; the timing of introductions of new services and enhancements to
existing services; and the continuing market acceptance of the Company's
products and services.  To the extent that existing cash and
securities and cash from operations are insufficient to fund future activities,
the Company will need to raise additional funds through public or private equity
or debt financing.  Although the Company is currently not a party to
any agreement or letter of intent with respect to potential investments in, or
acquisitions of, complementary businesses, services or technologies, the Company
may enter into these types of arrangements in the future, which could also
require additional equity or debt financing. Additional funds, however, may not
be available on terms favorable to the Company or at all.





Critical
Accounting Policies




We
prepare our financial statements in accordance with US GAAP. The accounting
policies most fundamental to understanding our financial statements are those
relating to recognition of revenue, our use of estimates and the accounting for
convertible debt and warrants. For a detailed discussion on the application of
these accounting policies, see Note 2 to our audited consolidated financial
statements contained in our 2007 10-KSB/A.





Recently Issued Accounting
Pronouncements





We
discuss the potential impact of recent accounting pronouncements in Note 1 to
the unaudited consolidated financial statements contained in this
Report.








33





ITEM
3.  Controls and Procedures




As of
June 30, 2007, we carried out an evaluation, under the supervision and with the
participation of the Company's management, chief executive and chief financial
officers, of the effectiveness of the Company's disclosure controls and
procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as
amended (the "Exchange Act").  Based upon the evaluation, the
Company's chief executive and chief financial officers concluded that, as of the
end of the period, our disclosure controls and procedures were effective in
timely alerting them to material information required to be included in the
reports that we file and submit pursuant to the Exchange Act.




During
the second quarter of fiscal year 2008, the Company’s chief executive officer
(and its “Certifying Officer” for the fiscal year ended March 31, 2008)
determined that our financial management team did not have sufficient experience
in the preparation of the narrative disclosures in notes to the interim
financial statements and that our disclosure controls and procedures (as defined
in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as
amended (the “Exchange Act”)), were not effective in ensuring that information
is recorded, processed, summarized and communicated to our Certifying Officers,
and reported within the time periods specified in the Securities and Exchange
Commission’s rules and forms.  In an effort to remediate this
deficiency, we engaged an independent financial consulting group to provide the
personnel resources necessary for technical accounting and for the recording of
complex financial transactions, preparation of financial statements, and
management reporting and disclosure reporting.  This engagement
resulted in a comprehensive review of our financial statements and disclosure
controls, whereby we became aware of errors made in applying the Company’s new
deferred revenue recognition policy adopted in the third quarter of fiscal year
2007.  On November 9, 2007, we determined that we needed to restate
our financial statements for the fiscal year ended March 31, 2007, which were
included in our Annual Report on Form 10-KSB for the fiscal year ended March 31,
2007 (“2007 10-KSB”), originally filed with the Commission on June 29,
2007.  Also, we concluded that our Form 10-QSB filings for the
quarterly periods ended June 30, 2007 (“June 2007 10-QSB”) and September 30,
2007 (“September 2007 10-QSB”) should be restated.  We amended and
refiled the 2007 10-KSB and the June 2007 10-QSB during the fiscal quarter ended
December 31, 2007, and amended and refiled the September 2007 10-QSB during the
fiscal quarter ended March 31, 2008.




As a
result of these restatements, we conducted a search and retained new financial
leadership with the addition of a Chief Financial Officer in March of
2008.  On July 14, 2008, the CFO was terminated, for, among other
reasons, the inability to provide the necessary technical accounting expertise
for the recording of complex financial transactions, preparation of financial
statements, management reporting and disclosure reporting.  To
remediate the situation, an independent consultant with prior CFO experience
with micro-cap companies was retained to complete the financial reporting
requirements.  While engaged, this financial consultant identified the
Company’s incorrect accounting for the Company’s PP1 Notes, PP1 Warrants, PP2
Notes, PP2 Warrants and share-based compensation expense related to stock
options issued to employees during the fiscal years 2005 through
2007.  This resulted in the Company further amending its consolidated
financial statements for the fiscal year ended March 31, 2007 and restating its
consolidated financial statements for the fiscal year ended March 31, 2006.
Further, we have amended our consolidated financial statements for the three
months ended June 30, 2007 and restated our consolidated financial statements
for the three months ended June 30, 2006, both of which are included in this
Report.  Further and as a result of the impact of these errors, the
Company expects to restate and refile its Form 10-QSB filings for the periods
ended September 30, 2007 and December 31, 2007 within a reasonably practical
time period.




We
estimate that during the second half of fiscal 2009, the Certifying Officer,
along with the Company’s other management representatives, will complete
remediation measures that may include engaging an independent consulting firm to
further evaluate, remediate, implement, document and test the internal controls
in these key areas:





1.
            Order
      Entry Accounting & Reporting


2.
            Debt/Equity
      Accounting & Compliance


3.
            Cash
      & Other Working Capital
Management


4.
            Compensation
      Accounting & Administration


5.
            Other
      Assets & Liability Account
Management


6.
            Financial
      Reporting





34





We will
also monitor our disclosure controls and procedures on a continuing basis to
ensure that information required to be disclosed in the reports we file or
submit under the Exchange Act is accumulated and communicated to our management,
including its principal executive and principal financial officers, as
appropriate, to allow timely decisions regarding required disclosure. In the
future as such controls change in relation to developments in our business and
financial reporting requirements, our evaluation and monitoring measures will
also address any additional corrective actions that may be
required.





Our
management does not expect that our disclosure control procedures or our
internal control over financial reporting will prevent all errors and fraud. A
control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, have been detected.








35





PART
II - OTHER INFORMATION





ITEM
1.  Legal Proceedings





The
Company, and certain of its current and former officers and directors are
defendants in litigation pending in Dallas, Texas, styled KINGDON R. HUGHES VS. GREGORY T.
ROYAL, CYNTHIA A. GARR, JAMES T. MILLER, JR., CHARLES STIDHAM, CNH HOLDINGS
COMPANY D/B/A CISTERA NETWORKS AND XBRIDGE SOFTWARE, INC.;Cause No.
DV05-0600-G; G-134th District Court, Dallas County, Texas.  The
plaintiff has alleged a number of complaints against the defendants, including
breach of fiduciary duty, misappropriation of corporate opportunities, fraud,
fraudulent inducement, breach of contract, tortuous interference with contract,
fraudulent transfer, and shareholder oppression arising in connection with the
license agreement between the Company and XBridge in May 2003 and the
acquisition of XBridge by the Company in May 2005.  The parties held a
mediation conference in April 2006 and have come to an understanding with
respect to the principal elements of a potential settlement.  We are
currently in the process of negotiating definitive settlement
agreements.





The
Company is a defendant in litigation pending in Dallas, Texas, styled
Collaborative Search Partners, Inc. vs. XBridge Software, Inc., and Cistera
Networks, Inc., Cause No. 07-03189; J191st District Court, Dallas County,
Texas.  The plaintiff has alleged a number of complaints against the
defendants, including breach of contract, promissory estoppel, and quantum
meruitt arising in connection with two separate employment search
agreements.  In May 2007, the parties came to an understanding with
respect to the principal elements of a potential settlement, and a Rule 11
letter agreement has been filed with the Court, however, a definitive settlement
agreement is still being negotiated among the parties.  The Rule 11
letter agreement provides for payment by the defendants of $44,000 to the
plaintiff over a period of six months, and in the event the defendants fail to
make such payments, a default judgment may be rendered against the
defendants.





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





Effective
April 5, 2007, the Company issued and sold an aggregate of $3,625,754 in
principal amount of Senior Unsecured Convertible Promissory Notes (the “PP2
Notes”), and issued warrants to purchase 3,625,754 shares of our common stock,
par value $0.001 per share (the “PP2 Warrants”).  Of the $3,625,754.00
in PP2 Notes, $2,815,000 in principal amount were issued for cash, and $810,754
in principal amount were issued in connection with the cancellation of an equal
amount of the Company's outstanding obligations.  The PP2 Warrants
have a term of five years and are exercisable at an exercise price of $1.00 per
share.  Subject to an effective registration statement covering the
resale of the shares of common stock issuable upon exercise of the PP2 Warrants,
the Company may, upon thirty days prior written notice, redeem 1,815,000 PP2
Warrants for $0.10 per share, in whole or in part, if our common stock closes
with a bid price of at least $3.50 for any ten (10) out of fifteen (15)
consecutive trading days.  An additional 1,000,000 Warrants may be
redeemed under the same terms if the above conditions are met plus the daily
volume for the 20 consecutive trading days preceding the notice of redemption on
the OTCBB or the principal exchange where the common stock is traded is in
excess of 100,000 shares.  The structure of the PP2 Note purchase
agreement and the issuance of the PP2 Notes warrants were determined through
arm-length negotiations between us and the other parties involved and no
material relationship existed between us and the other parties at that
time.





ITEM
3.  Defaults Upon Senior Securities





None.





ITEM
4.  Submission Of Matters To A Vote Of Securities Holders





None.




ITEM
5.  Other Information





None.








36





ITEM
6.  Exhibits





The
following documents are filed herewith or have been included as exhibits to
previous filings with the Commission and are incorporated herein by this
reference:





Exhibit
      No.
            Exhibit





4.1
            Form
      of Convertible Note Purchase Agreement dated as of December 13, 2004
      (Incorporated by reference from Exhibit 4.1 to the Company’s Current
      Report on Form 8-K filed with the Commission on December 20,
      2004)





4.2
            Form
      of Senior Unsecured Convertible Note (Incorporated by reference from
      Exhibit 4.2 to the Company’s Current Report on Form 8-K filed with the
      Commission on December 20, 2004)





4.3
            Form
      of Warrant (Incorporated by reference from Exhibit 4.3 to the Company’s
      Current Report on Form 8-K filed with the Commission on December 20,
      2004)





4.4
            Registration
      Rights Agreement dated as of December 13, 2004 (Incorporated by reference
      from Exhibit 4.4 to the Company’s Current Report on Form 8-K filed with
      the Commission on December 20,
2004)





4.5
            Form
      of Convertible Note Purchase Agreement dated as of April 5, 2007
      (Incorporated by reference from Exhibit 4.1 to the Company’s Current
      Report on Form 8-K filed with the Commission on April 12,
      2007)





4.6
            Form
      of Senior Unsecured Convertible Note (Incorporated by reference from
      Exhibit 4.2 to the Company’s Current Report on Form 8-K filed with the
      Commission on April 12, 2007)





4.7
            Form
      of Warrant (Incorporated by reference from Exhibit 4.3 to the Company’s
      Current Report on Form 8-K filed with the Commission on April 12,
      2007)





4.8
            Registration
      Rights Agreement dated as of April 7, 2005 (Incorporated by reference from
      Exhibit 4.4 to the Company’s Current Report on Form 8-K filed with the
      Commission on April 12, 2007





6.1
            License
      Agreement (incorporated by reference to Exhibit 10.1 to the Company’s
      Annual Report on Form 10-KSB for the fiscal year ended March 31,
      2004)





10.1
            Employment
      Agreement by and between Derek Downs and Cistera Networks, Inc. dated as
      of January 1, 2005 (Incorporated by reference from Exhibit 10.1 to the
      Company’s Registration Statement on Form SB-2 filed with the Commission on
      May 23, 2007)





10.2
            Employment
      Agreement by and between Cynthia Garr and Cistera Networks, Inc. dated as
      of January 1, 2005 (Incorporated by reference from Exhibit 10.2 to the
      Company’s Registration Statement on Form SB-2 filed with the Commission on
      May 23, 2007)





10.3
            Employment
      Agreement between Gregory Royal and Cistera Networks Canada, Inc. dated as
      of October 1, 2004(Incorporated by reference from Exhibit 10.3 to the
      Company’s Registration Statement on Form SB-2 filed with the Commission on
      May 23, 2007)





31.1
            Certification
      Pursuant to Section 302 of the Sarbanes-Oxley Act of
  2002





32.1
            Certification
      Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
      The Sarbanes-Oxley Act of 2002








37





SIGNATURES





Pursuant
to the requirements of the Exchange Act of 1934, the registrant caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.





CISTERA
      NETWORKS, INC.Date: October 3, 2008
            /s/    Derek
      P. DownsDerek
      P. DownsChief
      Executive Officer and interimChief
      Financial Officer(Principal
      Executive, Financial andAccounting
      Officer)









38