UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q


(Mark
One)




[x]
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
the quarterly period ended September 30, 2008





OR





[_]
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For the
transition period from __________________ to __________________





Commission
File Number    0-17304





Cistera Networks,
Inc.


(Exact
name of registrant as specified in its charter)





Nevada
              (State
      or other jurisdiction of incorporation or organization)
            91-1944887
              (I.R.S.
      Employer Identification No.)





6509 Windcrest Drive, Suite
160, Plano,
Texas       75024


(Address
of principal executive
offices)               (Zip
Code)





972-381-4699


(Registrant's
telephone number, including area code)















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




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




Large
      accelerated filer 
            
            Accelerated
      filer 
            
            Non-accelerated
      filer 
            
            Smaller
      reporting company ý







Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes    No X




As of
October 31, 2008, 17,423,310 shares of the registrant’s stock, $0.001 par value
per share, were outstanding.





CISTERA
NETWORKS, INC & SUBSIDIARY




TABLE
OF CONTENTS














PART
I: FINANCIAL INFORMATION




Item
      1.
            Financial
      Statements:Consolidated
      Balance Sheets – September 30, 2008 (unaudited) and March 31, 2008
      (audited)
            2Consolidated
      Statements of Operations – For the three months ended September 30, 2008
      and
              2007
      (unaudited)
            3Consolidated
      Statements of Operations – For the six months ended September 30, 2008
      and
              2007
      (unaudited)
            4Consolidated
      Statement of Stockholders’ Deficit – September 30, 2008 (unaudited)
      and
              March
      31, 2008 (audited)
            5Consolidated
      Statements of Cash Flows – For the six months ended September 30, 2008
      and
              2007
      (unaudited)
            6Notes
      to Consolidated Financial Statements (unaudited)
            8Item
      2.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            16Item
      3.
            Quantitative
      and Qualitative Disclosures About Market Risk
            24Item
      4T.
            Controls
      and Procedures
            24


PART
II: OTHER INFORMATION




Item
      1.
            Legal
      Proceedings
            25Item
      1A.
            Risk
      Factors
            25Item
      2.
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            25Item
      3.
            Defaults
      Upon Senior Securities
            25Item
      4.
            Submission
      of Matters to a Vote of Security Holders
            25Item
      5.
            Other
      Information
            25Item
      6.
            Exhibits
            25SIGNATURE
            26









1


Part
I. FINANCIAL INFORMATION




Item
1. Financial Statements


CISTERA
NETWORKS, INC. & SUBSIDIARY


CONSOLIDATED
BALANCE SHEETS


(Unaudited)


Current
      assets
            
            September
      30, 2008
            
            
            March
      31, 2008Cash
      and cash equivalents
            
            $
            154,728
            
            
            $
            125,007Restricted
      cash
            
            
            -
            
            
            
            50,000Accounts
      receivable, net of allowance for doubtful accounts of $-0-
            
            
            145,851
            
            
            
            264,023Inventory
            
            
            180,049
            
            
            
            187,960Prepaid
      expenses
            
            
            63,617
            
            
            
            46,030Total
      current assets
            
            
            544,245
            
            
            
            673,020Property
      and equipment, net
            
            
            377,129
            
            
            
            355,411Intangible
      assets, net
            
            
            1,887,330
            
            
            
            2,023,218Total
      long-term assets
            
            
            2,264,459
            
            
            
            2,378,629TOTAL
      ASSETS
            
            $
            2,808,704
            
            
            $
            3,051,649Current
      liabilitiesAccounts
      payable
            
            
            373,051
            
            
            
            420,603Related
      party payables
            
            
            76,426
            
            
            
            129,702Accrued
      liquidated damages - outside investors
            
            
            177,024
            
            
            
            629,957Accrued
      liquidated damages - related parties
            
            
            -
            
            
            
            41,485Accrued
      liabilities
            
            
            1,027,316
            
            
            
            1,076,360Deferred
      revenue
            
            
            1,055,150
            
            
            
            971,474Current
      portion of long-term debt, net of discount
            
            
            776,202
            
            
            
            408,204Line
      of credit
            
            
            -
            
            
            
            17,503Total
      current liabilities
            
            
            3,485,169
            
            
            
            3,695,288Convertible
      promissory notes - outside investors, net of discount
            
            
            -
            
            
            
            1,606,300Convertible
      promissory notes - related parties, net of discount
            
            
            -
            
            
            
            59,719Deferred
      revenue
            
            
            95,992
            
            
            
            225,917Other
      long-term liabilities
            
            
            61,578
            
            
            
            285,470Total
      long-term liabilities
            
            
            157,570
            
            
            
            2,177,406Total
      liabilities
            
            
            3,642,739
            
            
            
            5,872,694Commitments
      and Contingencies (Note 4)Stockholders'
      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;
              17,423,410
      and 8,820,192 shares issued and outstanding,respectively
            
            
            17,423
            
            
            
            8,820Additional
      paid-in capital
            
            
            19,264,390
            
            
            
            13,764,517Accumulated
      deficit
            
            
            (20,115,848
            )
            
            
            (16,594,382
            )Total
      stockholders' deficit
            
            
            (834,035
            )
            
            
            (2,821,045
            )TOTAL
      LIABILITIES AND STOCKHOLDERS' DEFICIT
            
            $
            2,808,704
            
            
            $
            3,051,649





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


2


CISTERA
NETWORKS, INC. & SUBSIDIARY


CONSOLIDATED
STATEMENTS OF OPERATIONS


(Unaudited)





Three
      months ended September 30,2008
            
            
            2007RevenuesConvergence
      solutions
            
            $
            1,013,075
            
            
            $
            657,207Professional
      services
            
            
            45,125
            
            
            
            90,542Support
      and maintenance
            
            
            230,303
            
            
            
            146,033Total
      revenues
            
            
            1,288,503
            
            
            
            893,782Cost
      of revenuesConvergence
      solutions
            
            
            276,710
            
            
            
            192,271Professional
      services
            
            
            42,500
            
            
            
            36,301Support
      and maintenance
            
            
            24,250
            
            
            
            20,700Total
      cost of revenues
            
            
            343,460
            
            
            
            249,272Gross
      Profit
            
            
            945,043
            
            
            
            644,510Operating
      expensesSales
      and marketing
            
            
            301,043
            
            
            
            280,412Software
      development
            
            
            226,875
            
            
            
            198,646Engineering
      and support
            
            
            201,969
            
            
            
            129,510General
      and administrative
            
            
            422,105
            
            
            
            319,291Depreciation
      and amortization
            
            
            100,674
            
            
            
            83,937Total
      operating expenses
            
            
            1,252,666
            
            
            
            1,011,796Loss
      from operations
            
            
            (307,623
            )
            
            
            (367,286
            )Other
      income (expense)Interest
      income
            
            
            86
            
            
            
            8,534Interest
      expense
            
            
            (50,117
            )
            
            
            (74,936
            )Amortization
      of discount on convertible notes – outside investors
            
            
            (108,918
            )
            
            
            (371,775
            )Amortization
      of discount on convertible notes – related parties
            
            
            -
            
            
            
            (10,237
            )Charge
      for inducements related to stock issued to convertible note
      holders
            
            
            (131,631
            )
            
            
            (135,825
            )Total
      other income (expense)
            
            
            (290,580
            )
            
            
            (584,239
            )Net
      loss
            
            $
            (598,203
            )
            
            $
            (951,525
            )Basic
      & diluted net loss per share
            
            $
            (0.03
            )
            
            $
            (0.11
            )Weighted
      average shares outstanding – basic and diluted
            
            
            17,274,687
            
            
            
            8,594,469




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


3


CISTERA
NETWORKS, INC. & SUBSIDIARY


CONSOLIDATED
STATEMENTS OF OPERATIONS


(Unaudited)





Six
      months ended September 30,2008
            
            
            2007RevenuesConvergence
      solutions
            
            $
            1,535,468
            
            
            $
            1,119,144Professional
      services
            
            
            105,833
            
            
            
            194,593Support
      and maintenance
            
            
            447,762
            
            
            
            259,832Total
      revenues
            
            
            2,089,063
            
            
            
            1,573,569Cost
      of revenuesConvergence
      solutions
            
            
            409,742
            
            
            
            331,927Professional
      services
            
            
            93,000
            
            
            
            83,176Support
      and maintenance
            
            
            47,434
            
            
            
            41,400Total
      cost of revenues
            
            
            550,176
            
            
            
            456,503Gross
      Profit
            
            
            1,538,887
            
            
            
            1,117,066Operating
      expensesSales
      and marketing
            
            
            580,472
            
            
            
            514,298Software
      development
            
            
            423,333
            
            
            
            350,518Engineering
      and support
            
            
            406,400
            
            
            
            225,717General
      and administrative
            
            
            760,617
            
            
            
            544,005Depreciation
      and amortization
            
            
            198,830
            
            
            
            164,873Total
      operating expenses
            
            
            2,369,652
            
            
            
            1,799,411Loss
      from operations
            
            
            (830,765
            )
            
            
            (682,345
            )Other
      income (expense)Interest
      income
            
            
            168
            
            
            
            18,123Interest
      expense
            
            
            (147,809
            )
            
            
            (148,360
            )Amortization
      of discount on convertible notes – outside investors
            
            
            (1,188,855
            )
            
            
            (732,809
            )Amortization
      of discount on convertible notes – related parties
            
            
            (41,060
            )
            
            
            (19,918
            )Charge
      for inducements related to stock issued to convertible note
      holders
            
            
            (1,324,444
            )
            
            
            (135,825
            )Credit
      (charge) for estimated liquidated damages
            
            
            11,299
            
            
            
            (251,176
            )Total
      other income (expense)
            
            
            (2,690,701
            )
            
            
            (1,269,965
            )Net
      loss
            
            $
            (3,521,466
            )
            
            $
            (1,952,310
            )Basic
      & diluted net loss per share
            
            $
            (0.26
            )
            
            $
            (0.23
            )Weighted
      average shares outstanding – basic and diluted
            
            
            13,369,365
            
            
            
            8,594,469




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




4


CISTERA
NETWORKS, INC. & SUBSIDIARY


CONSOLIDATED
STATEMENT OF STOCKHOLDERS' DEFICIT


(Unaudited)


Preferred
      Stock
            
            
            Common
      Stock
            
            
            Additional
      Paid-in Capital
            
            
            Accumulated
      Deficit
            
            
            Total
      Stockholders’ DeficitShares
            
            
            Amount
            
            
            Shares
            
            
            AmountBalances
      at March 31, 2008
            
            
            -
            
            
            $
            -
            
            
            
            8,820,192
            
            
            $
            8,820
            
            
            $
            13,764,517
            
            
            $
            (16,594,382
            )
            
            $
            (2,821,045
            )Stock
      issued from the
              conversion of convertible
              notes
            
            
            
            
            
            
            
            
            
            
            6,175,857
            
            
            
            6,176
            
            
            
            3,280,940
            
            
            
            
            
            
            
            3,287,116Stock
      issued from the exercise
              of warrants
            
            
            
            
            
            
            
            
            
            
            2,368,584
            
            
            
            2,368
            
            
            
            894,547
            
            
            
            
            
            
            
            896,915Stock
      issued for waiver of
              registration rights payments
            
            
            
            
            
            
            
            
            
            
            58,777
            
            
            
            59
            
            
            
            21,983
            
            
            
            
            
            
            
            22,042Inducement
      charges related to
              conversion of convertible
              notes
      and exercise of warrants
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,302,403
            
            
            
            
            
            
            
            1,302,403Net
      loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (3,521,466
            )
            
            
            (3,521,466
            )Balances
      at September 30, 2008
            
            
            -
            
            
            $
            -
            
            
            
            17,423,410
            
            
            $
            17,423
            
            
            $
            19,264,390
            
            
            $
            (20,115,848
            )
            
            $
            (834,035
            )





















































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


5


CISTERA
NETWORKS, INC. & SUBSIDIARY


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Unaudited)





Six
      months ended September 30,2008
            
            
            2007CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
            
            $
            (3,521,466
            )
            
            $
            (1,952,310
            )Adjustments
      used to reconcile net loss to net cash used in operating
      activities:Charge
      for inducement to convert debt to convertible promissory
    notes
            
            
            1,324,444
            
            
            
            135,825Charge
      (credit) for liquidated damages
            
            
            (11,299
            )
            
            
            251,176Amortization
      of discount on convertible promissory notes – outside
    parties
            
            
            1,188,855
            
            
            
            732,809Amortization
      of discount on convertible promissory notes – related
    parties
            
            
            41,060
            
            
            
            19,918Depreciation
      and amortization
            
            
            198,830
            
            
            
            164,873Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            118,172
            
            
            
            (272,302
            )Inventory
            
            
            (12,488
            )
            
            
            (17,847
            )Prepaid
      expenses
            
            
            (17,587
            )
            
            
            (879
            )Accounts
      payable
            
            
            (100,828
            )
            
            
            (32,539
            )Accrued
      liabilities
            
            
            25,997
            
            
            
            (2,318
            )Deferred
      revenue
            
            
            (46,249
            )
            
            
            317,728Other
      long-tem liabilities
            
            
            45,378
            
            
            
            -Net
      cash used in operating activities
            
            
            (767,181
            )
            
            
            (655,866
            )CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of property and equipment, net
            
            
            (64,261
            )
            
            
            (123,067
            )Net
      cash used in investing activities
            
            
            (64,261
            )
            
            
            (123,067
            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Decrease
      in restricted cash
            
            
            50,000
            
            
            
            -Net
      borrowings (payments) on line of credit
            
            
            (17,503
            )
            
            
            (62,094
            )Net
      proceeds from issuance of convertible promissory notes
            
            
            -
            
            
            
            1,225,000Net
      proceeds from exercise of warrants
            
            
            843,604
            
            
            
            -Payments
      on convertible promissory notes and other loans
            
            
            (14,938
            )
            
            
            (74,215
            )Payments
      on other notes payable and capital lease
            
            
            -
            
            
            
            (2,063
            )Net
      cash provided by financing activities
            
            
            861,163
            
            
            
            1,086,628Net
      increase in cash and cash equivalents
            
            
            29,721
            
            
            
            307,695Cash
      and cash equivalents at beginning of period
            
            
            125,007
            
            
            
            534,871Cash
      and cash equivalents at end of period
            
            $
            154,728
            
            
            $
            842,566




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






6




CISTERA
      NETWORKS, INC. & SUBSIDIARY
              CONSOLIDATED
      STATEMENTS OF CASH FLOWS (continued)
              (Unaudited)Six
      months ended September 302008
            
            
            2007SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Cash
      paid during the year for:Interest
            
            $
            38,982
            
            
            $
            9,910Income
      taxes
            
            
            -
            
            
            
            -SUPPLEMENTAL
      DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:Conversion
      of convertible promissory notes and related accrued interest
      and
              accrued
      liquidated damages to common stock
            
            $
            3,287,116
            
            
            $
            -Conversion
      of accounts payable and other accrued liabilities to
      convertible
              promissory
      notes
            
            
            
            
            
            
            359,885Conversion
      of accrued liabilities to common stock
            
            
            53,312
            
            
            
            -Transfer
      of inventory to equipment
            
            
            20,399
            
            
            
            -Allocation
      of discount on convertible promissory notes to warrants
            
            
            -
            
            
            
            488,054Discount
      related to beneficial conversion feature on convertible
      promissory
              notes
            
            
            -
            
            
            
            815,599OTHER
      NON-CASH TRANSACTIONS:Cumulative effect of change in accounting
      principle:Reclassification
      of Warrants from derivative financial instruments to equity
              securities
      (as valued at inception)
            
            
            -
            
            
            $
            2,730,824Accrued
      liquidated damages at April 1, 2007
            
            
            -
            
            
            
            289,518Reclassification
      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 consolidated financial
statements.


7
 CISTERA
NETWORKS, INC. & SUBSIDIARY
 Notes
to Consolidated Financial Statements
 (Unaudited)


NOTE
1 – BASIS OF PRESENTATION





The
accompanying unaudited consolidated financial statements of Cistera Networks,
Inc. (“Cistera” the “Company” or “we”) and its wholly-owned subsidiary have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission (“SEC”). All significant intercompany transactions and balances have
been eliminated in consolidation. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America (“US GAAP”) have
been condensed or omitted pursuant to such rules and regulations. In the opinion
of management, the unaudited consolidated financial statements have been
prepared on the same basis as the annual audited consolidated financial
statements, and reflect all adjustments, consisting only of normal, recurring
adjustments necessary for a fair presentation in accordance with US GAAP. The
results of operations for interim periods presented are not necessarily
indicative of the operating results for the full year. These unaudited
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company’s
Annual Report on Form 10-KSB for the fiscal year ended March 31, 2008 (the “2008
10-KSB”).





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 2008 10-KSB.





Recently
Issued Accounting Pronouncements




In
February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities—Including an Amendment of FASB
Statement No. 115"(“SFAS 159”).  SFAS 159 permits companies
to measure many financial instruments and certain other items at fair value at
specified election dates. Unrealized gains and losses on these items will be
reported in earnings at each subsequent reporting date. The fair value option
may be applied instrument by instrument (with a few exceptions), is irrevocable
and is applied only to entire instruments and not to portions of instruments.
SFAS 159 is effective for fiscal years beginning after November 15,
2007. We intend to adopt the standard beginning in the first quarter of fiscal
year 2010. We are currently assessing the impact of SFAS 159 on our
financial statements and do not believe it will have a material
impact.






In December 2007, the FASB issued SFAS No. 160,
“Non-Controlling Interests in Consolidated Financial Statements” (“SFAS 160”),
which requires all entities to report non-controlling (minority interests) in
subsidiaries with equity in the consolidated financial statements, but separate
from the parent stockholders' equity. We intend to adopt the standard beginning
in the first quarter of fiscal year 2010. We are currently evaluating the impact
of adopting SFAS 160 on our financial statements and do not believe it will
have a material impact.






In
December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business
Combinations" ("SFAS 141R"), which replaces FASB Statement No. 141.
SFAS 141R establishes principles and requirements for how an acquirer
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, any non-controlling interest in the acquiree
and the goodwill acquired. The Statement also establishes disclosure
requirements that will enable users to evaluate the nature and financial effects
of the business combination. We intend to adopt the standard beginning in the
first quarter of fiscal year 2010. We are currently evaluating the impact of
adopting SFAS 141R on our financial statements and do not believe it will
have a material impact.




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


Balance
Sheet Accounts





Accounts
receivable are comprised of the following:





September
      30, 2008
            
            
            March
      31, 2008Unfactored
      accounts receivable
            
            $
            104,454
            
            
            $
            222,277Receivables
      assigned to factor
            
            
            226,131
            
            
            $
            183,945Advances
      from factor
            
            
            (194,201
            )
            
            
            (157,972
            )Reserve
      balance held by factor
            
            
            9,467
            
            
            
            (64
            )Amounts
      due from factor
            
            
            41,397
            
            
            
            25,909Related
      party
            
            
            -
            
            
            
            15,837Total
      accounts receivable
            
            $
            145,851
            
            
            $
            264,023




Accrued
liabilities are comprised of the following:


September
      30, 2008
            
            
            March
      31, 2008Accrued
      interest
            
            $
            168,766
            
            
            $
            88,375Reserve
      for litigation contingency
            
            
            650,000
            
            
            
            650,000Accrued
      compensation and payroll taxes
            
            
            141,231
            
            
            
            234,029Other
            
            
            67,319
            
            
            
            103,956$
            1,027,316
            
            
            $
            1,076,360





Other
long-term liabilities are comprised of the following:


September
      30, 2008
            
            
            March
      31, 2008Accrued
      interest
            
            $
            -
            
            
            $
            269,270Other
            
            
            61,578
            
            
            
            16,200$
            61,578
            
            
            $
            285,470





Loss
per Share





Basic
earnings (loss) per share is based on the weighted average number of common
shares outstanding.





Diluted
earnings (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.  The Company had approximately 6.6 million and 10.4
million potentially dilutive common stock equivalents (in the form of stock
options and stock purchase warrants) outstanding as of September 30, 2008 and
2007, respectively. These potentially dilutive common stock equivalents have
been excluded from the diluted share calculations for the three months and six
months ended September 30, 2008 and 2007, 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)


Significant
Customers and Concentration of Credit Risk





The
following table shows significant customers as a percentage of accounts
receivable at September 30 and March 31, 2008.  A customer is included
in the table if they comprise greater than 10% of accounts receivable as of
either period.





September
      30,
            
            
            March
      31,2008
            
            
            2008Customer
      A
            
            
            -
      %
            
            
            
            27.9
      %Customer
      B
            
            
            25.1
      %
            
            
            
            0.3
      %Customer
      C
            
            
            -
      %
            
            
            
            13.2
      %Customer
      D
            
            
            -
      %
            
            
            
            19.9
      %





The
following table shows significant customers as a percentage of revenue for the
three and six months ended September 30, 2008 and 2007.  A customer is
included in the table if they comprise 10% for any of the periods in 2008 or
2007.


Three
      months ended September 30,
            
            
            Six
      months ended September 30,2008
            
            
            2007
            
            
            2008
            
            
            2007Customer
      A
            
            
            6.4
      %
            
            
            
            11.1
      %
            
            
            
            9.9
      %
            
            
            
            22.2
      %Customer
      C
            
            
            0.5
      %
            
            
            
            -
      %
            
            
            
            1.3
      %
            
            
            
            12.0
      %Customer
      E
            
            
            41.1
      %
            
            
            
            -
      %
            
            
            
            25.4
      %
            
            
            
            -
      %Customer
      F
            
            
            10.7
      %
            
            
            
            10.9
      %
            
            
            
            11.1
      %
            
            
            
            15.0
      %Customer
      G
            
            
            0.6
      %
            
            
            
            0.6
      %
            
            
            
            1.56
      %
            
            
            
            11.0
      %





Reclassifications





Certain
reclassifications have been made in the fiscal year 2008 financial statements to
conform to the fiscal year 2009 presentation.





NOTE
2 - FINANCIAL CONDITION





The
accompanying consolidated financial statements have been prepared in conformity
with US GAAP (except with regard to omission of certain disclosures within
interim financial statements, as permitted by the SEC), which contemplate our
continuation as a going concern and do not include any adjustments relating to
the recoverability and classification of recorded asset amounts or amounts and
classification of liabilities that might be necessary if we were unable to
continue as a going concern. However, the report of our independent registered
public accounting firm on our consolidated financial statements, as of and for
the year ended March 31, 2008, contains an explanatory paragraph expressing
substantial doubt as to our ability to continue as a going concern. The “going
concern” explanatory paragraph resulted from, among other things, the
substantial losses from operations we have incurred since inception, our
liquidity position and the net loss of $5.3 million for the year ended March 31,
2008, which included non-cash charges of $1.9 million related to amortization of
discounts associated with our sale and issuance of Senior Unsecured Convertible
Promissory Notes in the fiscal years 2007 and 2008 (the “PP2 Notes”) and
negative working capital (current liabilities in excess of current assets) of
$3.0 million as of March 31, 2008.  In addition, we had a net loss of
$3.5 million for the six months ended September 30, 2008, which included
non-cash charges in the amount of $2.5 million related to the amortization of
discounts associated with the PP2 Notes and inducements related to the
conversion of PP2 Notes and exercise of warrants issued with the PP1 Notes (“PP1
Warrants”) and the exercise of warrants issued with the PP2 Notes (“PP2
Warrants”).  Also, as of September 30, 2008, we have negative working
capital (current liabilities in excess of current assets) of $2.9
million.  10
 CISTERA
NETWORKS, INC. & SUBSIDIARY
 Notes
to Consolidated Financial Statements
 (Unaudited)




Accordingly,
as of September 30, 2008, the recoverability of a major portion of the recorded
asset amounts is dependent on our continuing operations, which in turn is
dependent on our ability to maintain our current financing arrangements and our
ability to become profitable in our future operations. These factors raise
substantial doubt about the Company’s ability 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.





The
Company improved its liquidity through the execution of its Short Term
Investment Incentive Plan (the “STIIP”), which it completed in June and July of
2008, and which raised approximately $844,000 in cash from the exercises of
warrants and reduced debt, accrued interest and accrued liquidated damages by
approximately $3.2 million.  While management believes that this
action mitigates the substantial doubt about the Company’s ability to continue
as a going concern, the Company will need to become profitable in the near
future through generating higher revenues or lowering operating costs, or a
combination of the two.  The Company will likely need
to  renegotiate the payment or conversion of the remaining principal
balance due on its PP2 Notes or raise additional capital, or a combination of
the two.  If we raise additional capital, it could be in the form of
equity or debt, or a combination of the two. There can be no assurance that the
Company will be successful in these endeavors or that the cost savings or
required new capital will be sufficient.





NOTE
3 – DEBT





As of
September 30, 2008, the Company had $980,641 of gross principal, accrued
interest of $168,766 and accrued liquidated damages of $177,024 outstanding on
its PP1 Notes and PP2 Notes.  Both the PP1 and PP2 Notes bear interest
at an annual rate of 8%, compounded quarterly.





PP1 Notes and
Warrants





The
outstanding principal and accrued interest 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 PP1 Note holder on any interest compounding
date.





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
PP1 Warrants, the Company may, upon thirty days prior written notice, redeem the
PP1 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.





PP2 Notes and
Warrants





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 issuance of the respective PP2 Note.  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.





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.


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




For the
three months ended September 30, 2008 and 2007, the Company recorded $108,918
and $382,012 respectively, of amortization of debt discounts associated with the
PP2 Notes.  For the six months ended September 30, 2008 and 2007, the
Company recorded $1,229,915 and $752,727 respectively, of amortization of debt
discounts associated with the PP2 Notes.  For the six months ended
September 30, 2008 the total amortization charge included $747,357 for the
write-off of unamortized debt discounts related to the conversion of $2,470,156
in principal of PP2 Notes under the STIIP.





Short Term Investment
Incentive Plan (“STIIP”)





Under the
STIIP, which commenced on June 9, 2008, the Company temporarily modified the
terms of its outstanding PP1 Notes, PP2 Notes, PP1 Warrants and PP2 Warrants.
During the period beginning June 9, 2008 through June 24, 2008 (the “Conversion
Period”), the conversion prices of the PP1 Notes and PP2 Notes, which were $1.00
and $0.75 per share, respectively, were reduced to $0.53 per
share.  In addition, the exercise prices for the PP1 Warrants and the
PP2 Warrants, which were $1.30 and $1.00 per share, respectively, were reduced
to $0.40 per share.  Under the STIIP, certain PP2 Note holders
converted $3,240,290, comprised of $2,470,156 in principal and $770,134 in
accrued interest and liquidated damages into approximately 6.2 million shares of
the Company’s common stock at the reduced conversion price.




Also
under the STIIP, certain PP1 and PP2 Warrant holders exercised approximately 2.3
million PP1 and PP2 Warrants at an exercise price of $0.40 per
share.  All PP1 and PP2 Warrant holders who exercised their warrants
also received three additional warrants (the “Bonus Warrants”) for every ten
warrants exercised.  The Bonus Warrants were exercisable during the
Conversion Period  at an exercise price of $0.30 per share, and if not
exercised on or before such date, the exercise price for such Bonus Warrants was
increased to $0.60 per share.  A total of 507,675 Bonus Warrants were
exercised at $0.30 per share.  The bonus warrants were valued using the
Black-Scholes option pricing model (“Black-Scholes model”) and a charge and a
corresponding credit to additional paid-in capital were recorded for the June
30, 2008 and September 30, 2008 quarters in the amounts of $36,125 and $131,631,
respectively.  The bonus warrants expire on April 6,
2012.  The total cash proceeds received from the exercises of the PP1,
PP2 and Bonus Warrants was $844,000.




The
Company accounted for the reduction in the conversion prices of the PP2 Notes
under the STIIP in accordance with FASB Statement No. 84, “Induced Conversions
of Convertible Debt an amendment of APB Opinion No. 26” (“SFAS
84”).  Accordingly, the Company calculated and recorded an inducement
charge and a corresponding credit to additional paid-in capital in the June 30,
2008 quarter in the amount of $931,893 for the fair value of common stock issued
based on the reduced price in excess of the fair value of the common stock
issuable pursuant to the original conversion price.





The
Company accounted for the reduction in the exercise price of the PP1 and PP2
Warrants exercised under the STIIP in accordance with the guidance in SFAS
123(R), “Share-based payment” (“SFAS 123R”) and FASB Staff Position No. FSP FAS
123(R)-6, “Technical Corrections of FASB Statement No. 123(R)” for a
modification due to a short-term inducement.  Accordingly, the Company
recorded a charge and a corresponding credit to additional paid-in capital in
the June 30, 2008 quarter in the amount of $202,743 for the difference between
the fair value of the PP1 and PP2 Warrants immediately before and after the
modification multiplied by the number of PP1 and PP2 Warrants that were
exercised during the Conversion Period of the STIIP.  The fair value
of the PP1 and PP2 Warrants were calculated using the Black-Scholes model. The
total non-cash charge recorded for the inducement on the PP2 Notes and the
reduction in exercise price on the PP1 and PP2 Warrants was
$1,134,216.


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


Line of
Credit





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 carried an interest rate of
prime plus one half point.  The line of credit was secured with a
deposit guaranty of $50,000.  On September 8, 2008, the Company repaid
the outstanding obligation from the balance of its deposit guaranty and
cancelled this line of credit facility.





Factoring
Facility





The
Company maintains a factoring facility with Allied Capital Partners, L.P.
(“Allied”) for up to $1,500,000 of the Company’s customer accounts
receivable.  The facility allows for an 85.88% advance rate and
initial factoring charges are 1.75% of the total accounts receivable
balance.  Advances made by Allied are collateralized by the Company’s
accounts receivable, chattel paper, general intangibles, supporting obligations,
inventory and proceeds thereof.  The term of the current agreement is
for a period of twelve months with an automatic twelve month renewal
thereafter.  Advances under the factoring facility at September 30,
2008 were $194,201 and are netted against total accounts receivable on the
Consolidated Balance Sheet.





The
Company’s total debt as of September 30, 2008, all of which is current, is as
follows:


PP1
      and PP2 Notes:Principal
            
            $
            980,641Accrued
      interest
            
            
            168,766Accrued
      estimated liquidated damages
            
            
            177,0241,326,431Less:
      unamortized discount
            
            
            (204,439
            )Total
            
            $
            1,121,992





Registration Payment
Arrangements





Effective
April 1, 2007, the Company adopted FASB Staff Position No. EITF 00-19-2
“Accounting for Registration Payment Arrangements” (“FSP EITF 00-19-2”), which
was applicable to the accounting for the liquidated damages on the PP2
Notes.  Upon adoption, 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 (based on the criteria as outlined under EITF 00-19 “Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company’s Own Stock” (“EITF 00-19”)), 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 was 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 of FSP EITF
00-19 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 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 EITF 00-19-2, recorded a contingent liability and related charge to the
consolidated Statement of Operations for estimated liquidated damages related to
this funding through March 31, 2008.  The amount recorded was
$251,176.





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





As of
March 31, 2008, the Company estimated and accrued $671,342 related to liquidated
damages related to the PP2 Notes and concluded that this amount was the maximum
pay-out required.  On June 24, 2008, the Company executed agreements
with certain investors comprising approximately 70% of the original principal
investment of PP2 to convert their outstanding Notes at a reduced price of
$0.53.  On June 30, 2008, the Company executed an agreement with the
institutional investor in the PP2 offering that had the contractual right to
liquidated damages.  In exchange for the waiver from the investor, the
Company issued to the investor 58,777 shares of its common stock. The agreement
terminated any assessment of liquidated damages beyond June 24, 2008. For the
three months ended June 30, 2008, the Company recorded a charge and credit to
additional paid-in capital for the fair value of these shares issued in the
amount of $22,041.


The table
below summarizes the cumulative effect entry recorded as of April 1, 2007 for
the adoption of FSP EITF 00-19-2:





Accumulated
      deficit, April 1, 2007
            
            $
            (10,586,847
            )Adjustments
      for the cumulative effect of the change in accounting
      principle:Contingent
      liability recorded for estimated liquidated damages
            
            
            (289,518
            )Reclassification
      of Warrants from derivative liabilities to equity
    securities
            
            
            (465,597
            )Total
      adjustments
            
            
            (755,115
            )Accumulated
      deficit, April 1, 2007, as adjusted
            
            $
            (11,341,962
            )








NOTE
4 – COMMITMENTS AND 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. The Company is
currently in the process of negotiating definitive settlement agreements. In
accordance with SFAS No. 5, “Accounting for Contingencies” (“SFAS 5”), we
recorded a contingent liability in the amount of $650,000 as of March 31, 2008
related to the outstanding litigation.  As of September 30, 2008, the
Company believes that this amount represents the best estimate of a potential
settlement.




The
Company is a defendant in a breach-of-contract claim filed on behalf of Richard
McDowell, the Company’s former Chief Financial Officer, who was terminated from
the Company on July 14, 2008.  Mr. McDowell is demanding severance
under his employment agreement with the Company.  On August 22, 2008,
the Company through its legal counsel notified Mr. McDowell’s attorney that it
categorically denied Mr. McDowell's claim for severance under the employment
agreement.  On September 23, 2008, the Company received notice that Mr.
McDowell had filed claims against it with the American Arbitration Association
in accordance with the employment agreement.  On October 17, 2008, the
Company through its legal counsel filed an answer with the American Arbitration
Association that categorically denied Mr. McDowell's claims.  The Company
also asserted counterclaims against Mr. McDowell.  The arbitration is in
its early stages and no discovery has taken place and no hearing has been set by
the American Arbitration Association.  The Company plans to vigorously
defend itself and pursue its counterclaims in the arbitration.




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


NOTE
5 - RELATED PARTY TRANSACTIONS





On April
5, 2007, the Company issued PP2 Notes to the Company’s President, CEO and
director, Derek Downs, and the Company’s Chief Technology Officer and director,
Greg Royal for accrued, but unpaid base salary due to each as of this
date.  On June 24, 2008, both individuals converted their PP2 notes
plus accrued interest as part of the STIIP.  Mr. Downs and Mr. Royal
converted $38,940 and $91,871, respectively into 73,471 and 173,341 shares of
our common stock at a conversion price of $0.53.  After this
conversion, the Company no longer had any indebtedness with either Mr. Downs or
Mr. Royal.


15


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





FORWARD-LOOKING
STATEMENTS





This
report contains “forward-looking statements” within the meaning of the Private
Securities Litigation Reform Act of 1995. In many but not all cases you can
identify forward-looking statements by words such as “anticipate,”
“believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,”
“should,” “will” and “would” or the negative of these terms or other similar
expressions.  These forward-looking statements include statements regarding
our expectations, beliefs, or intentions about the future, and are based on
information available to us at this time. We assume no obligation to update any
of these statements and specifically decline any obligation to update or correct
any forward-looking statements to reflect events or circumstances after the date
of such statements or to reflect the occurrence of anticipated or unanticipated
events. Actual events and results could differ materially from our expectations
as a result of many factors, including those identified in this report. We urge
you to review and consider those factors, and those identified from time to time
in our reports and filings with the SEC, for information about risks and
uncertainties that may affect our future results. All forward-looking statements
we make after the date of this filing are also qualified by this cautionary
statement and identified risks. Additional risk factors are discussed in our
Annual Report on Form 10-KSB for the fiscal year ended March 31, 2008 and our
other reports filed with the SEC, to which reference should be
made.





EXECUTIVE SUMMARY AND RECENT
BUSINESS DEVELOPMENTS





For the
quarter ending September 30, 2008, we continued executing against our business
plan and achieved the highest quarterly revenue in our
history.  Recurring revenue from maintenance and support continues to
become a more significant piece of our revenues as our installed base grows, and
our pipeline of opportunities is increasing in both number and project
size.





Our
business model relies upon the leverage of a network of strong reseller partners
to sell our products.  During the quarter, we continued to invest in
building out our internal technical, sales and business development
organizations as required to properly support our channel reseller program -
CollaborNETTM, which was launched in August.  We are pleased at the
commitments we have received from both existing and new partners.  As
a result of the program, we have seen increased joint pipeline planning, joint
marketing programs and commitments to obtain certification for installation
engineers.





We
continued to make good penetration into the public sector markets where our
solutions are increasingly well received as the answer to critical communication
challenges.  We also took early steps to begin to explore
opportunities in the Federal market. We are seeing continued support from
the Cisco Industry Solutions Partner Network (ISPN) program where we enjoy
significant visibility due to our product certification for multiple vertical
markets.





In light
of the clear signs of general economic weakness, we are carefully
monitoring our sales pipeline.  While we expect that
portions of our market will undoubtedly be affected, we believe that the
Company is positioned to endure a challenging economy. We expect that
market segments, such as government, and education will be more resilient due to
continued demand for event alerting and notification solutions for public safety
and campus safety requirements. With the demographics of an aging population,
healthcare is an industry that is continuing to grow.  And because
there are fewer employees to operate facilities, the efficiencies and increased
productivity our products
provide can measurably enhance business operations.





We remain
focused on driving the Company to profitability, and believe our emphasis on
leveraging our reseller partner relationships will lead to the continued
pipeline growth, completed installations and increased average deal size that
will be necessary to achieve that goal.  Our program of certifying
partner installation engineers is a key piece of this effort, as it will allow
us to significantly extend our reach while providing partners with enhanced
customer interaction.  We believe that this focus will continue the
trending of our product mix toward the higher margin convergence solutions,
maintenance and support areas, offsetting the proportionally lower revenue
generated by low margin professional services.


16


RESULTS
OF OPERATIONS





Selected
Consolidated Statements of Operations Data





The
following tables present consolidated statements of operations data for the
three and six months ended September 30, 2008 and 2007 based on the percentage
of revenue for each line item, as well as the dollar and percentage change of
each of the items.





Results
of Operations for the Three Months Ended September 30, 2008


Compared
to the Three Months Ended September 30, 2007





For
      the three months ended September 30,2008
            %
      of revenue
            2007
            %
      of revenueRevenues:Convergence
      solutions
            $        1,013,075
            79%
            $       657,207
            74%Professional
      services
            45,125
            3%
            90,542
            10%Support
      and maintenance
            230,303
            18%
            146,033
            16%Total
      revenues
            1,288,503
            100%
            893,782
            100%Cost
      of revenues:Convergence
      solutions
            276,710
            22%
            192,271
            22%Professional
      services
            42,500
            3%
            36,301
            4%Support
      and maintenance
            24,250
            2%
            20,700
            2%Total
      cost of revenues
            343,460
            27%
            249,272
            28%Gross
      Profit
            945,043
            73%
            644,510
            72%Operating
      expenses:Sales
      and marketing
            301,043
            23%
            280,412
            31%Software
      development
            226,875
            18%
            198,646
            22%Engineering
      and support
            201,969
            15%
            129,510
            14%General
      and administrative
            422,105
            33%
            319,291
            36%Depreciation
      and amortization
            100,674
            8%
            83,937
            10%Total
      operating expenses
            1,252,666
            97%
            1,011,796
            113%Loss
      from operations
            (307,623)
            (24%)
            (367,286)
            (41%)Other
      income (expense)Interest
      income
            86
            -%
            8,534
            1%Interest
      expense
            (50,117)
            (4%)
            (74,936)
            (8%)Amortization
      of discount on convertible notes
            (108,918)
            (8%)
            (382,012)
            (43%)Charge
      for inducements related to stock
              issued
      to convertible note holders
            (131,631)
            (10%)
            (135,825)
            (15%)Total
      other income (expense)
            (290,580)
            (22%)
            (584,239)
            (65%)Net
      loss
            $         (598,203)
            (46%)
            $      (951,525)
            (106%)





17


Revenue





Revenue
for the quarter ended September 30, 2008 increased $394,721 or approximately 44%
from the comparable prior year quarter primarily due to increased revenue from
convergence solutions as a result of larger average project size and higher
support and maintenance revenue generated by our growing installed
based.  Revenue from professional services decreased from the prior
year quarter primarily due to the timing of completion of certain project
service engagements and as a result of a change of certifying reseller partners
to handle installations in lieu of performing them ourselves.  This
strategy is part of the CollaborNETTM initiative and allows our internal
technical and support personnel to support our partner resellers and provide
higher-end and better margin services. As we transition to larger projects, we
expect more installations to be completed by certified partners.





Gross Profit and Gross
Margin





Gross
profit for the quarter ended September 30, 2008 increased $300,533 or
approximately 47% from the comparable prior year quarter primarily due to
increased revenue.  Gross margin also increased in the September 2008
quarter as compared to the September 2007 quarter to 73% from
72%.  This increase was primarily due to increases in the higher
margin revenue categories of convergence solutions and support and maintenance,
offset by lower margins on professional services as a result of the timing of
completion of certain project service engagements.





Operating
Expenses





Operating
expenses, excluding depreciation and amortization increased from $927,859 in the
September 2007 quarter to $1,151,992 in the September 2008 quarter, an increase
of $224,133 or approximately 24%.  The increasewas primarily attributable
to: 1) increased salaries that were applied over the course of fiscal year 2008
for a significant number of employees, who had been receiving much below the
“average market” salaries for similar positions; 2) increased headcount in all
departments; 3) higher payroll taxes as a result of the higher salaries and
increased personnel; and, 4) increased rent and facilities related expenses due
to our new corporate office location.





Interest
Expense





Interest
expense for the September 2008 quarter decreased $24,819 from the September 2007
quarter primarily due to the decrease in accrued interest on the PP2 Notes due
to the decrease in the PP2 Notes as a result of the conversions under the STIIP
in June 2008.  Offsetting the overall interest expense decrease was an
increase in interest on our accounts receivable factoring facility as a result
of higher factorings in the September 2008 quarter as compared to the September
2007 quarter.





Amortization of Debt
Discount





The
amortization of debt discount on our PP2 Notes in the September 2008 quarter
decreased approximately $273,000 from the September 2007 quarter primarily as a
result of the significant amount of PP2 Notes that were converted in June 2008
as part of our “Short Term Investment Incentive Plan” (the
“STIIP”).  As required under GAAP, all unamortized debt discount
outstanding at the date of the conversion was expensed.  See further
discussion of the STIIP under “Liquidity” under this Item.





18


Charge for InducementsRelated to Stock Issued to
Convertible Note Holders





As part
of the STIIP that was completed at the end of the June 2008 quarter, we lowered
the conversion price of our PP2 Notes and the exercise price of both our PP1 and
PP2 Warrants.  As required under GAAP, we recorded a non-cash charge
in the amount of $131,631 related to these inducements for the three months
ended September 30, 2008.  See further discussion of the STIIP under
“Liquidity” under this Item.





During
the quarter ended September 30, 2007, we elected to compensate PP1 investors who
had opted to convert their PP1 Notes into shares of common stock, which remained
unregistered with the SEC as of the date the PP1 Notes became due and payable on
December 13, 2006.  The amount offered to, and accepted by, the
shareholders was $135,825, payable in the form of additional shares of common
stock, and a non-cash charge was recorded during the September 2007
quarter.





19


Results
of Operations for the Six Months Ended September 30, 2008


Compared
to the Six Months Ended September 30, 2007





For
      the six months ended September 30,2008
            %
      of revenue
            2007
            %
      of revenueRevenues:Convergence
      solutions
            $        1,535,468
            74%
            $     1,119,144
            71%Professional
      services
            105,833
            5%
            194,593
            12%Support
      and maintenance
            447,762
            21%
            259,832
            17%Total
      revenues
            2,089,063
            100%
            1,573,569
            100%Cost
      of revenues:Convergence
      solutions
            409,742
            20%
            331,927
            21%Professional
      services
            93,000
            4%
            83,176
            5%Support
      and maintenance
            47,434
            2%
            41,400
            3%Total
      cost of revenues
            550,176
            26%
            456,503
            29%Gross
      Profit
            1,538,887
            74%
            1,117,066
            71%Operating
      expenses:Sales
      and marketing
            580,472
            28%
            514,298
            33%Software
      development
            423,333
            20%
            350,518
            22%Engineering
      and support
            406,400
            20%
            225,717
            14%General
      and administrative
            760,617
            36%
            544,005
            35%Depreciation
      and amortization
            198,830
            10%
            164,873
            10%Total
      operating expenses
            2,369,652
            114%
            1,799,411
            114%Loss
      from operations
            (830,765)
            (40%)
            (682,345)
            (43%)Other
      income (expense)Interest
      income
            168
            -%
            18,123
            1%Interest
      expense
            (147,809)
            (7%)
            (148,360)
            (9%)Amortization
      of discount on convertible notes
            (1,229,915)
            (59%)
            (752,727)
            (48%)Charge
      for inducements related to stock
              issued
      to convertible note holders
            (1,324,444)
            (63%)
            (135,825)
            (9%)Credit
      (charge) for estimated liquidated
              damages
            11,299
            1%
            (251,176)
            (16%)Total
      other income (expense)
            (2,690,701)
            (128%)
            (1,269,965)
            (81%)Net
      loss
            $     (3,521,446)
            (168%)
            $   (1,952,310)
            (124%)





20


Revenue





Revenue
for the six months ended September 30, 2008 increased $515,494 or approximately
33% from the six months ended September 30, 2007 primarily due to increased
revenue from convergence solutions as a result of increased average project size
and increased support and maintenance revenue from our increased installed
base.  Revenue from professional services decreased from the prior
year quarter primarily due to the timing of completion of certain project
service engagements and as a result of a change of certifying reseller partners
to handle installations in lieu of performing them ourselves.  This
strategy is part of the CollaborNETTM initiative and allows our internal
technical and support personnel to support our partner resellers and provide
higher-end and better margin services. As we transition to larger projects, we
expect more installations to be completed by certified partners.





Gross Profit and Gross
Margin





Gross
profit for the six months ended September 30, 2008 increased $421,821 or
approximately 38% from the comparable prior year six-month period primarily due
to increased revenue.  Gross margin also increased in the six months
ended September 30, 2008 as compared to the  prior year six-month
period to 74% from 71%.  This increase was primarily due to increases
in the higher margin revenue categories of convergence solutions and support and
maintenance, offset by lower margins on professional services as a result of the
timing of completion of certain project service engagements.





Operating
Expenses





Operating
expenses, excluding depreciation and amortization increased from $1,634,538 in
the six months ended September 30, 2007 to $2,170,822 in the September 2008
six-month period, an increase of $536,284 or 33%  The increasewas primarily attributable
to: 1) increased salaries that were applied over the course of fiscal year 2008
for a significant number of employees, who had been receiving much below the
“average market” salaries for similar positions; 2) increased headcount in all
departments; 3) higher payroll taxes as a result of the higher salaries and
increased personnel; and, 4) increased rent and facilities related expenses due
to our new corporate office location.





Interest
Expense





Interest
expense for the six months ended September 30, 2008 remained flat as compared to
the six months ended September 30, 2007 due primarily to a decrease in accrued
interest on the PP2 Notes due to the decrease in the PP2 Notes as a result of
the conversions under the STIIP in June 2008  Offsetting this decrease
was an increase in interest on our accounts receivable facility as a result of
higher factorings during the September 2008 six-month period as compared to the
September 2007 six-month period.





Amortization of Debt
Discount





The
amortization of debt discount on our PP2 Notes in the six months ended September
30, 2008 increased approximately $477,000 from the September 2007 six-month
period primarily as a result of the significant amount of PP2 Notes that were
converted in June 2008 under the STIIP.  As required under GAAP, all
unamortized debt discount outstanding at the date of the conversion was
expensed.  See further discussion of the STIIP under “Liquidity” under
this Item.








21


Charge for InducementsRelated to Stock Issued to
Convertible Note Holders





As part
of the STIIP that was completed at the end of the June 2008 quarter, we lowered
the conversion price of our PP2 Notes and the exercise price of both our PP1 and
PP2 Warrants.  As required under GAAP, we recorded


non-cash
charges for the June 2008 and September 2008 quarters in the amounts of
$1,192,813 and $131,631, respectively, related to these
inducements.  See further discussion of the STIIP under “Liquidity”
under this Item.





During
the six months ended September 30, 2007, we elected to compensate PP1 investors
who had opted to convert their PP1 Notes into shares of common stock, which
remained unregistered with the SEC as of the date the PP1 Notes became due and
payable on December 13, 2006.  The amount offered to, and accepted by,
the shareholders was $135,825, payable in the form of additional shares of
common stock, and a non-cash charge was recorded in the September 2007
quarter.





Liquidated
Damages





The
decrease in the charge for liquidated damages from the six months ended
September 30, 2007 was primarily the result of the settlement of future
liquidated damages as of June 24, 2008.  As of June 30, 2008, we
recorded an adjustment to the amount of accrued liquidated damages for PP2 Note
holders who did not convert their notes in the STIIP.  As part of an
agreement dated June 30, 2008 with the investor in the PP2 offering that had the
contractual right to liquidated damages, we issued to the investor 58,777 shares
of our common stock in exchange for a waiver on future liquidated damages after
June 24, 2008. The agreement terminated any assessment of liquidated damages
beyond June 24, 2008.





Liquidity
and Capital Resources





The
unaudited consolidated financial statements contained in this report have been
prepared in conformity with US GAAP (except with regard to omission of certain
disclosures within interim financial statements, as permitted by the SEC), which
contemplate our continuation as a going concern and do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts or amounts and classification of liabilities that might be necessary if
we were unable to continue as a going concern. However, the report of our
independent registered public accounting firm on our consolidated financial
statements, as of and for the year ended March 31, 2008, contains an explanatory
paragraph expressing substantial doubt as to our ability to continue as a going
concern. The “going concern” explanatory paragraph resulted from, among other
things, the substantial losses from operations we have incurred since inception,
our liquidity position and net loss of $5.3 million for the year ended March 31,
2008, which included non-cash charges of $1.9 million related to amortization of
discounts associated with our PP2 Notes and negative working capital (current
liabilities in excess of current assets) of $3.0 million as of March 31,
2008.  In addition, we had a net loss of $3.5 million for the six
months ended September 30, 2008, which included non-cash charges of $2.5 million
related to amortization of discounts associated with the PP2 Notes and
inducements related to the conversion of PP2 Notes and the exercise of the PP1
Warrants and the PP2 Warrants.  Also, as of September 30, 2008, we
have negative working capital (current liabilities in excess of current assets)
of $2.9 million. Accordingly, as of September 30, 2008, the recoverability of a
major portion of the recorded asset amounts is dependent on our continuing
operations, which in turn is dependent on our ability to maintain our current
financing arrangements and our ability to become profitable in our future
operations. These factors raise substantial doubt about the Company’s ability to
continue as a going concern. These consolidated financial statements do not
reflect adjustments that would be necessary if we were unable to continue as a
“going concern.”





Our
primary source of working capital liquidity is a factoring facility we have with
Allied Capital Partners, L.P. (“Allied”), which allows for cash advances of up
to $1,500,000 on our customer accounts receivable, subject to the approval of
Allied of the customer and the type of product or service that is
invoiced.  The facility allows for an 85.88% advance rate and initial
factoring charges are 1.75% of the total accounts receivable
balance.  Advances made by Allied are collateralized by our accounts
receivable, chattel paper, general intangibles, supporting obligations,
inventory and proceeds thereof.  The term of the current agreement is
for a period of twelve months with an automatic twelve month renewal
thereafter.  Advances under the factoring facility at September 30,
2008 were $194,201 and are netted against total accounts receivable on the
Consolidated Balance Sheet.




22




We
improved our liquidity through the execution of the STIIP, which we completed in
June and July of 2008, and which raised approximately $844,000 in cash from the
exercises of PP1, PP2 and Bonus Warrants and reduced debt, accrued interest and
accrued liquidated damages by approximately $3.2 million.  While
management believes that this action mitigates the substantial doubt about the
Company’s ability to continue as a going concern, we will need to become
profitable in the near future though generating higher revenues or lowering
operating costs, or a combination of the two.  We will likely need to
renegotiate the payment or conversion of the remaining principal due on our PP2
Notes or raise additional capital, or a combination of the two. If we need to
raise additional capital it could be in the form of equity or debt, or a
combination of the two. There can be no assurance that we will be successful in
these endeavors or that the cost savings or required new capital will be
sufficient.





Cash and Cash
Flows





Our cash
and cash equivalents at September 30, 2008 were $154,728. For the six months
ended September 30, 2008, net cash used in operations was
$767,181.  The primary use of cash was the loss from operations
incurred for the period of $830,765 adjusted for non-cash charges of $198,830
for depreciation and amortization.  Net cash used in investing
activities of $64,261 related to purchases of computer and lab equipment and
office furniture.  Net cash from financing activities of $861,163 was
primarily the result of the net proceeds raised from the exercise of certain PP1
and PP2 Warrants as part of the STIIP.





ContractualObligations





Our
current material contractual obligations are our current and former corporate
office leases and the principal, accrued interest and accrued liquidated damages
under our PP1 and PP2 Notes.  During the September 2008 quarter, the
sub-lessee on our former corporate office lease ceased its business and has
defaulted on its lease obligation to us.  We are currently in
discussions with the sub-lessee’s parent company seeking payment on the balance
of lease payments of approximately $60,000 and are also pursuing a sub-lessee
for the remaining lease term, which is through November 2009.





The
following amounts are due within the current fiscal year under the PP1 and the
PP2 Notes, all of which is payable within the next seven months:


PP1
      and PP2 Notes:Principal
            
            $
            980,641Accrued
      interest
            
            
            168,766Accrued
      estimated liquidated damages
            
            
            177,0241,326,431Less:
      unamortized discount
            
            
            (204,439
            )Total
            
            $
            1,121,992





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 2008 10-KSB.





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.








23


Item
3. Quantitative and Qualitative Disclosures About Market Risk





As a
smaller reporting company, we are not required to provide this
information.








Item
4(T). Controls and Procedures





Evaluation of Disclosure
Controls and Procedures




Disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under
the Exchange Act) are designed to ensure that information required to be
disclosed in reports filed or submitted under the Exchange Act is recorded,
processed, summarized, and reported within the time periods specified in SEC
rules and forms and that such information is accumulated and communicated to
management, including our Chief Executive Officer, who is also currently our
interim Chief Financial Officer(the “Certifying Officer”), to allow timely
decisions regarding required disclosures.





As of
September 30, 2008, we carried out an analysis, under the supervision and with
the participation of our management, including our Certifying Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures. During the September 2008 quarter, the Certifying Officer determined
that our consolidated financial statements for the fiscal years ended March 31,
2007 and 2006 and the quarterly periods June 30, 2007 and 2006, September 30,
2007 and 2006 and December 31, 2007 and 2006 should not be relied upon and that
the Company would restate its consolidated financial statements for those
respective years and periods.  We completed these restatements during
the period from September to October 2008.  Accordingly, for the
September 2008 quarter, our Certifying Officer concluded that our disclosure
controls and procedures and internal controls over financial reporting were not
effective and identified remediation measures to be implemented during the
fiscal year ended March 31, 2009.





We
estimate that during the second half of fiscal 2009, the Certifying Officer,
along with the Company’s other management personnel 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.
            Financial
      Reporting, including technical accounting surrounding complex accounting
      transactions


2.
            Order
      Entry Accounting & Reporting


3.
            Debt/Equity
      Accounting & Compliance


4.
            Cash
      & Other Working Capital
Management


5.
            Compensation
      Accounting & Administration


6.
            Other
      Assets & Liability Account
Management





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 the our business
and financial reporting requirements, our evaluation and monitoring measures
will also address any additional corrective actions that may be
required.





Inherent Limitations of
Internal Controls





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.








24


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.  The
Company is currently in the process of negotiating definitive settlement
agreements.





The
Company is a defendant in a breach-of-contract claim filed on behalf of Richard
McDowell, the Company’s former Chief Financial Officer, who was terminated from
the Company on July 14, 2008.  Mr. McDowell is demanding severance
under his employment agreement with the Company.  On August 22, 2008,
the Company through its legal counsel notified Mr. McDowell’s attorney that it
categorically denied Mr. McDowell's claim for severance under the employment
agreement.  On September 23, 2008, the Company received notice that Mr.
McDowell had filed claims against it with the American Arbitration Association
in accordance with the employment agreement.  On October 17, 2008, the
Company through its legal counsel filed an answer with the American Arbitration
Association that categorically denied Mr. McDowell's claims.  The Company
also asserted counterclaims against Mr. McDowell.  The arbitration is in
its early stages and no discovery has taken place and no hearing has been set by
the American Arbitration Association.  The Company plans to vigorously
defend itself and pursue its counterclaims in the arbitration.







Item
1A.  Risk Factors





As a
smaller reporting company, we are not required to provide this
information.





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





None.





Item
3.  Defaults Upon Senior Securities





None.





Item
4.  Submission of Matters to a Vote of Security Holders





None.





Item
5.  Other Information





None.





Item
6.  Exhibits





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





32.1              Certification
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


25


SIGNATURE





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: November 10,
      2008
              /s/    Derek
      P. DownsDerek
      P. DownsChief
      Executive Officer and interimChief
      Financial Officer(Principal
      Executive, Financial andAccounting
      Officer)