10-Q 1 fp0002388_10q.htm fp0002388_10q.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q

(Mark One)
þ  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended November 30, 2010

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: 001-15503

WORKSTREAM INC.
(Exact name of registrant as specified in its charter)

Canada
N/A
(State or other jurisdiction of
(I.R.S. Employer Identification No.)
incorporation or organization)
 

485 N. Keller Road, Suite 500
32751
Maitland, Florida
(Zip Code)
(Address of principal executive offices)
 

(407) 475-5500
(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 þ       No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ¨  No ¨

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

Large accelerated filer  ¨
Accelerated filer  ¨
 
Non-accelerated filer  ¨
(Do not check if a smaller reporting company)
Smaller reporting company  þ

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

As of January 12, 2011 there were 816,502,956 common shares, no par value, outstanding, excluding 108,304 common shares held in escrow.
 
 
i

 
 
WORKSTREAM INC.
TABLE OF CONTENTS
 
     
Page No.
Part I.
 
Financial Information
 
       
 
Item 1.
Financial Statements (Unaudited)
 
   
Condensed Consolidated Balance Sheets as of  November 30, 2010 and May 31, 2010
 
1
   
Condensed Consolidated Statements of Operations for the Three and Six Months Ended November 30, 2010 and 2009
2
   
Consolidated Statement of Stockholders’ Equity for the Six Months Ended November 30, 2010
3
   
Condensed Consolidated Statements of Cash Flows for the Six Months Ended November 30, 2010 and 2009
4
   
Notes to Condensed Consolidated Financial Statements
5
       
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
20
       
 
Item 4T.
Controls and Procedures
30
       
Part II.
 
Other Information
 
       
 
Item 1.
Legal Proceedings
31
       
 
Item 1A.
Risk Factors
31
       
 
Item 6.
Exhibits
33
       
   
Signatures
34
       

 
ii

 
 
WORKSTREAM INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
As of November 30, 2010 and May 31, 2010
 
   
Notes
   
November 30, 2010
   
May 31, 2010
 
ASSETS:
       
(Unaudited)
       
Current assets:
                 
   Cash and cash equivalents
        $ 375,161     $ 358,529  
   Accounts receivable, net of allowances of $512,224 and $442,195 at
                     
      November 30, 2010 and May 31, 2010, respectively
          1,832,296       1,606,623  
   Prepaid expenses and other assets
          52,110       161,692  
         Total current assets
          2,259,567       2,126,844  
                       
Equipment, net
          199,458       295,798  
Other assets
          43,043       163,817  
Intangible assets, net
          150,162       -  
Goodwill
   3       6,731,326       6,045,900  
                         
TOTAL ASSETS
          $ 9,383,556     $ 8,632,359  
                         
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT):
                       
Current liabilities:
                       
   Accounts payable
          $ 939,927     $ 1,232,019  
   Accrued liabilities
            1,837,481       3,211,124  
   Accrued compensation
            403,562       516,209  
   Current portion of long-term obligations
            172,941       200,469  
   Deferred revenue
            1,272,563       1,456,005  
         Total current liabilities
            4,626,474       6,615,826  
                         
Senior secured note payable
   2       -       21,718,093  
Senior secured note payableand accrued interest, net-related party
   2       849,926       -  
Long-term obligations, less current portion
            65,426       138,858  
Deferred revenue – long-term
            21,440       7,667  
Common stock warrant liability
   1       67,100       268,600  
         Total liabilities
            5,630,366       28,749,044  
                         
Commitments and Contingencies
   4                  
                         
SHAREHOLDERS’ EQUITY (DEFICIT):
   5                  
   Preferred shares, no par value
            -       -  
Common shares, no par value, issued and outstanding 816,502,956 and 65,666,341
shares as of November 30, 2010 and May 31,2010
      136,880,540       114,498,157  
   Additional paid-in capital
            30,760,815       30,313,814  
   Accumulated deficit
   1       (162,913,611 )     (163,997,644 )
   Accumulated other comprehensive loss
            (974,554 )     (931,012 )
         Total shareholders’ equity (deficit)
            3,753,190       (20,116,685 )
                         
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
          $ 9,383,556     $ 8,632,359  
 
See accompanying notes to these condensed consolidated financial statements.
 
 
1

 
 
WORKSTREAM INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three and Six Months Ended November 30, 2010 and 2009
(Unaudited)

         
Three Months Ended
   
Six Months Ended
 
   
Notes
   
November 30, 2010
   
November 30, 2009
   
November 30, 2010
   
November 30, 2009
 
Revenues:
                             
Software
        $ 1,127,931     $ 1,739,128     $ 2,288,399     $ 3,345,455  
Professional services
          109,839       273,567       148,434       507,905  
Rewards
          2,032,255       2,096,257       3,998,443       3,520,071  
Career networks
          574,631       921,167       1,146,471       1,868,433  
Revenues, net
          3,844,656       5,030,119       7,581,747       9,241,864  
                                       
Cost of revenues:
                                     
Rewards
          1,512,777       1,525,358       3,009,271       2,609,033  
Other
          174,992       206,692       333,905       412,705  
Cost of revenues (exclusive of amortization
          1,687,769       1,732,050       3,343,176       3,021,738  
and depreciation expense noted below)
                                     
                                       
Gross profit
          2,156,887       3,298,069       4,238,571       6,220,126  
                                       
Operating expenses:
                                     
Selling and marketing
          433,340       545,513       763,601       1,002,181  
General and administrative
          1,727,356       1,971,921       3,962,392       3,993,777  
Research and development
   4       (674,293 )     341,148       (283,215 )     770,287  
Amortization and depreciation
            47,884       300,924       111,277       582,701  
Impairment of goodwill
   3       -       -       (685,426 )     -  
Total operating expenses
            1,534,287       3,159,506       3,868,629       6,348,946  
                                         
Operating Income (loss)
            622,600       138,563       369,942       (128,820 )
                                         
Other income / (expense):
                                       
Interest income and expense, net
            (16,828 )     (887,502 )     (672,367 )     (1,401,577 )
Gain on exchange of senior secured notes payable
   2       -       -       1,192,635       -  
Change in fair value of warrants and derivative
   2       (13,000 )     364,226       201,500       787,693  
Other income and expense, net
            71       43,620       (321 )     42,018  
Other income (expense), net
            (29,757 )     (479,656 )     721,447       (571,866 )
                                         
Income (loss) before income tax expense
            592,843       (341,093 )     1,091,389       (700,686 )
                                         
Income tax expense
            980       (39 )     (7,356 )     (328 )
                                         
NET INCOME (LOSS)
          $ 593,823     $ (341,132 )   $ 1,084,033     $ (701,014 )
                                         
Income (loss) per share - basic and diluted
          $ 0.00     $ (0.01 )   $ 0.00     $ (0.01 )
                                         
Weighted average number of common shares
                                       
   outstanding:
                                       
        Basic
            812,298,199       56,997,415       487,666,585       56,995,352  
        Diluted
            853,035,207       56,997,415       540,921,399       56,995,352  

See accompanying notes to these condensed consolidated financial statements.

 
2

 


WORKSTREAM INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
(Unaudited)
 
                     
Accumulated
                   
               
Additional
   
Other
         
Total
       
   
Common Stock
   
Paid-In
   
Comprehensive
   
Accumulated
   
Stockholders'
   
Comprehensive
 
   
Shares
   
Amount
   
Capital
   
Loss
   
Deficit
   
Equity (Deficit)
   
Income
 
Balance at May 31, 2010
    65,666,341     $ 114,498,157     $ 30,313,814     $ (931,012 )   $ (163,997,644 )   $ (20,116,685 )      
                                                       
Restricted stock unit grants and restricted common stock issuances
    3,391,465               334,277                       334,277        
Issuance of common shares in connection with 2010 exchange transaction
    746,079,445       22,382,383                               22,382,383        
Stock option expense
                    85,724                       85,724        
Issuance of common shares for services
    1,365,705               27,000                       27,000        
Net income
                                    1,084,033       1,084,033       1,084,033  
Cumulative translation adjustment
                            (43,542 )             (43,542 )     (43,542 )
Comprehensive income
                                                  $ 1,040,491  
Balance at November 30, 2010
    816,502,956     $ 136,880,540     $ 30,760,815     $ (974,554 )   $ (162,913,611 )   $ 3,753,190          
 
3

 
 
WORKSTREAM INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended November 30, 2010 and 2009
(Unaudited)
 
   
Six Months Ended
 
   
November 30, 2010
   
November 30, 2009
 
Cash flows used in operating activities:
           
Net income / (loss)
  $ 1,084,033     $ (701,014 )
Adjustments to reconcile net income (loss) to net cash used in operating activities:
               
Amortization and depreciation
    111,277       582,701  
Amortization of deferred financing costs
    12,195       -  
Leasehold inducement amortization
    5,778       4,778  
Allowance for doubtful accounts, net
    63,063       198,642  
Impairment of goodwill
    (685,426 )     -  
Stock-based compensation
    420,001       70,274  
Non-cash compensation on stock purchased by management
    258,725       -  
Non-cash compensation on stock for board member fees
    27,000       -  
Gain on exchange of senior secured notes payable
    (1,192,635 )     -  
Non-cash gain on settlements of accrued liabilities
    (993,218 )     -  
Change in fair value of warrants and derivative
    (201,500 )     (787,693 )
Net change in components of working capital:
               
Accounts receivable
    (288,736 )     (1,034,189 )
Prepaid expenses and other assets
    103,532       6,977  
Accounts payable
    (292,092 )     (639,262 )
Accrued liabilities
    260,775       2,049,734  
Accrued compensation
    (112,647 )     149,019  
Deferred revenue
    (169,669 )     74,043  
Net cash used in operating activities
    (1,589,544 )     (25,990 )
                 
Cash flows used in investing activities:
               
Purchase of equipment
    -       (106,761 )
Capitalization of Software Development Costs
    (150,162 )     -  
Net cash used in investing activities
    (150,162 )     (106,761 )
                 
Cash flows provided by / (used in) financing activities:
               
Proceeds from issuance of stock
    1,250,000       -  
Proceeds from issuance of senior secured note payable, net of issuance costs $90,000
    660,000       (135,788 )
Repayment of long-term obligations
    (108,614 )     (164,573 )
Net cash provided by / (used in) financing activities
    1,801,386       (300,361 )
                 
Effect of exchange rate changes on cash and cash equivalents
    (45,048 )     (17,022 )
                 
Net increase / (decrease) in cash and cash equivalents
    16,632       (450,134 )
Cash and cash equivalents - beginning of period
    358,529       1,643,768  
                 
Cash and cash equivalents - end of period
  $ 375,161     $ 1,193,634  
                 
                 
Supplemental schedule of non-cash investing and financing activities:
               
Equipment acquired under capital leases
  $ 13,431     $ 191,298  
Cumulative effect of change in accounting principle for warrant classification
  $ -     $ 876,400  
Exchange of senior secured notes for common stock
  $ 22,382,383     $ -  
 
See accompanying notes to these condensed consolidated financial statements.
 
 
4

 
 
WORKSTREAM INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE  1.     THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Unaudited Interim Financial Information

The accompanying condensed consolidated balance sheet as of November 30, 2010, the condensed consolidated statements of operations for the six months ended November 30, 2010 and 2009, and the condensed consolidated statements of cash flows for the six months ended November 30, 2010 and 2009 are unaudited but include all adjustments that are, in the opinion of management, necessary for a fair presentation of our financial position at such dates and our results of operations and cash flows for the periods then ended in conformity with U.S. generally accepted accounting principles (“US GAAP”).  The condensed consolidated balance sheet as of May 31, 2010 has been derived from the audited consolidated financial statements at that date but, in accordance with the rules and regulations of the United States Securities and Exchange Commission (“SEC”), does not include all of the information and notes required by US GAAP for complete financial statements.  Operating results for the three and six months ended November 30, 2010 are not necessarily indicative of results that may be expected for the entire fiscal year.  These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K for the fiscal year ended May 31, 2010.

Description of the Company

Workstream Inc. (“Workstream” or the “Company”) is a provider of services and software for Human Capital Management (“HCM”).  HCM is the process by which companies recruit, train, evaluate, motivate and retain their employees.  Workstream offers software and services that address the needs of companies to more effectively manage their human capital management function.  Workstream has two distinct reportable segments: Enterprise Workforce Services and Career Networks.  The Enterprise Workforce Services segment offers a suite of HCM software solutions, which includes performance management, compensation management, development, recruitment, benefits administration and enrollment, succession planning, and employee reward programs.  The Career Networks segment offers recruitment research, resume management, and career transition services.  In addition, Career Networks provides services through a web-site where job-seeking senior executives can search job databases and post their resumes, and companies and recruiters can post position openings and search for qualified senior executive candidates.  Workstream conducts its business primarily in the United States of America and Canada.

Management’s Assessment of Liquidity

The Company has incurred substantial losses in recent periods.  On August 13, 2010, we exchanged our 2009 Senior Secured Notes for common stock.  At the same time we had a private placement and issued a 2010 Note. As a result, we have shareholders’ equity of $3,753,190 as of November 30, 2010.  Income for the six months ended November 30, 2010 was $1,084,033 and losses for the years ended May 31, 2010 and 2009 were $26,583,731 and $4,856,356, respectively.  Due to significant reductions in operating expenses in the fourth quarter of fiscal 2008 and throughout fiscal 2009 and 2010 together with the $1.25 million received by the Company in connection with its private placement of common shares on August 13, 2010 and $750,000 received by the Company in connection with the issuance of a senior secured note by the Company on August 13, 2010, management believes that current operations will be sufficient to meet its anticipated working capital and capital expenditure requirements.  Based on an analysis of our current contracts, forecasted new business, our current backlog and current expense level along with the conversion and exchange of our senior secured notes and accrued interest to common stock and additional financing received in the first quarter of fiscal 2011, management believes the Company will meet its cash flow needs for fiscal 2011.  The additional financing received by the Company in the first quarter of fiscal 2011 resulted in additional cash used for operating activities.  The Company continues to actively pursue financing from multiple sources including but not limited to, additional sales of common stock for cash, bank financing, and business acquisitions.  If these measures fall short, management will consider additional cost savings measures, including cutting back product development initiatives, further reducing operating expenditures as well as seeking additional financing, if deemed necessary.  We recognize that there are no assurances that the Company will be successful in meeting its cash flow requirements, however, management is confident that, if necessary, there are other alternatives available to fund operations and meet cash requirements during fiscal 2011.
 
 
5

 
 
On August 13, 2010, the Company entered into separate 2010 Exchange and Share Purchase Agreements and a 2010 Exchange Agreement (collectively, the “Exchange Agreements”) with each of the holders of its senior secured promissory notes (collectively, the “Investors”) pursuant to which, among other things, the Investors exchanged their existing senior secured non-convertible notes and senior secured convertible notes (collectively, the “Notes”) (the aggregate principal amount of all the Notes, together with accrued but unpaid interest and penalties, was $22,356,665) for a total of 682,852,374 of the Company’s common shares (the “Exchange Shares”).  The issuance of the Exchange Shares was deemed to be exempt from registration pursuant to Section 3(a)(9) of the Securities Act of 1933.

Pursuant to the terms of the Exchange Agreements with certain of the Investors, the Company consummated a private placement pursuant to which it raised $750,000 through the sale of an aggregate 37,936,243 common shares in the Company to certain of the Investors.  Simultaneous with the consummation of the transactions contemplated by the Exchange Agreements, pursuant to the terms of a Stock Purchase Agreement (the “Stock Purchase Agreement”) between the Company, an affiliate of John Long and David Kennedy and Ezra Schneier (together, the “New Management Team”), the Company completed a private placement pursuant to which it raised an additional $500,000 through the sale of an aggregate 25,290,828 common shares in the Company to the New Management Team (such common shares, together with the common shares purchased under the Exchange Agreements by the Investors, the “Purchased Shares”).  The issuance of the Purchased Shares was deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act of 1933.  The Company will use the proceeds from the private placements for working capital and general corporate purposes.

Simultaneous with the consummation of the transactions contemplated by the Exchange Agreements, the Company received an additional $750,000 from one of the Investors (the “Lending Investor”) in exchange for a senior secured note (the “2010 Note”).  The 2010 Note is secured by a lien on all of the assets of the Company and its subsidiaries pursuant to the terms of a Security Agreement among the Company, its subsidiaries and the Lending Investor (the “Security Agreement”).  Interest on the 2010 Note accrues at an annual rate of 12%.  From and after the occurrence and during the continuance of any event of default under the 2010 Note, the interest rate then in effect will be automatically increased to 15% per year.  Interest is payable at maturity of the 2010 Note, which is October 13, 2012.  Upon the occurrence of an event of default, as defined in the 2010 Note, the Lending Investor may require the Company to redeem all or a portion of the 2010 Note.  Upon a Disposition (as defined in the 2010 Note), the Company has agreed to use the Net Proceeds from such Disposition to redeem the 2010 Note.  The 2010 Note contains customary covenants with which the Company must comply.  Each subsidiary of the Company delivered a Guaranty pursuant to which it agreed to guarantee the obligations of the Company under the 2010 Note (the “Guaranty”).

The new board of directors has agreed to accept common shares in lieu of cash for the board fees.  Additionally, for each quarter following the first quarter board fees will be paid in common shares instead of cash unless otherwise decided by the board of directors.

The Company continues to look for ways to reduce expenses.  The new management team is analyzing all expenditures for potential reduction in the coming months.

We believe that these recent transactions provide suitable liquidity to fund ongoing operations. Separately, the Company intends to continue to raise capital from time to time as it pursues its business plan.

Potential uses of such capital include but are not limited to continued investments in its core technology, enhancing its sales infrastructure and acquiring companies that provide complimentary products and services to the company’s core suite of products.

Liberty Mutual Insurance Company has given notice that they will not renew their contract with Workstream.   In Fiscal Year 2010 Liberty comprised 30% of Workstream’s revenue.  Although we are disappointed by Liberty Mutual’s decision, the Rewards service is low margin and working capital intensive.  It is not core to our vision of a Human Resources software and technology enabled service business.   We will continue to focus on generating revenue growth through sales of our enterprise software solutions.

On December 17, 2010, Workstream Inc. completed a private placement sale (the “Private Placement”) of 40,312,500 common shares to certain accredited investors (the “Investors”) pursuant to the terms of  Subscription Agreements with each Investor.  The aggregate proceeds from the Private Placement were $645,000.  The Company intends to use the proceeds from the Private Placement for working capital.
 
 
6

 
 
Use of Estimates

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions affecting the amounts reported in the consolidated financial statements and the accompanying notes.  Changes in these estimates and assumptions may have a material impact on the financial statements and accompanying notes.
 
Warrant Liability

The Company follows the guidance primarily codified in ASC 815, Derivatives and Hedging on determining whether an instrument (or embedded feature) is indexed to an entity’s own stock.  For instruments that meet the requirements for liability classification, the changes in fair value are included in the Statement of Operations and Comprehensive Income (Loss).

Warrants issued in conjunction with the 2008 Senior Secured Notes Payable are classified as liabilities.  The fair value of the warrants was valued using a lattice-based valuation model with the following key inputs:

   
November 30, 2010
   
May 31, 2010
   
May 31, 2009
   
August 29, 2008
 
                         
Stock price
  $ 0.02     $ 0.08     $ 0.37     $ 0.20  
Exercise price
  $ 0.10     $ 0.10     $ 0.25     $ 0.25  
Expected volatility
    134% - 224%       77% - 152%       94%-194%       74%-117%  
Expected dividend yield
    0%       0%       0%       0%  
Expected term (in years)
    1.7       2.2       3.2       3.9  
Risk-free interest rate
    0.17% - 0.45%       0.16% - 0.76%       0.14%-1.42%       1.97%-2.60%  
 
Beginning in December 2009, the Company began using a probability-weighted trinomial lattice model to obtain the fair value of the warrants to take into consideration potential anti-dilution scenarios.

Fair Value of Financial Instruments

The Company performs fair value measurements in accordance with the guidance provided by ASC 820, Fair Value Measurements and Disclosures.  ASC 820 defines fair value, establishes a framework for measuring fair value under GAAP and expands disclosures about fair value measurements.  ASC 820 defines fair value as the exchange price that would be paid by an external party for an asset or liability (exit price) and emphasizes that fair value is a market-based measurement, not an entity-specific measurement.   ASC 820 also establishes a fair value hierarchy which requires an entity to classify the inputs used in measuring fair value for assets and liabilities as follows:

·
Level 1 – Inputs are unadjusted quoted market prices in active markets for identical assets or liabilities available at the measurement date;

·
Level 2 – Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other than quoted prices that are observable and inputs that are corroborated by observable market data; and

·
Level 3 – Inputs are unobservable inputs that are supported by little or no market activity, therefore requiring an entity to develop its own assumptions about the assumptions that market participants would use in pricing the asset or liability based on the best available information.

Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available to management as of November 30, 2010.  The Company uses the market approach to measure fair value for its Level 1 financial assets which includes cash equivalents.  The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.  There were no cash equivalents as of November 30, 2010 or May 31, 2010.  The respective carrying value of certain on-balance-sheet financial instruments approximated their fair values due to the short-term nature of these instruments.  These instruments include cash, accounts receivable, accounts payable and accrued liabilities.
 
 
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The Company’s 2009 Senior Secured Notes were initially valued using multiple, probability-weighted cash flow outcomes at credit-risk adjusted market rates (“Forward Value”).  The 2009 Senior Secured Notes with options to convert principal balances into common equity derive their value from a combination of the Forward Value and the fair value of the embedded conversion feature (“ECF”).  For purposes of the ECF, management concluded that the Monte Carlo Simulations Method (“MCS”) was the appropriate technique to embody all assumptions market participants would likely consider in estimating the ECF value.

The Company’s 2010 Senior Secured Note was valued using the fair value of the forward cash flows including principal and interest payable through the maturity date, using credit-risk adjusted market rates.
 
The embedded put derivative on the Company’s 2008 Notes was valued in accordance with ASC 820 using multiple, probability-weighted cash flow outcomes (Level 3 inputs) at credit-risk adjusted market rates (Level 2 inputs).  The Company’s warrants related to the Notes were valued using a lattice-based valuation model with the inputs detailed previously under Warrant Liability.

The following table details the change in the fair value of our financial instruments using significant unobservable inputs (Level 3) during the six months ended November 30, 2010:

   
Warrant
 
   
Liability
 
       
Fair value as of May 31, 2010
  $ 268,600  
Change in fair value of warrants and derivative
    (201,500 )
Fair value as of November 30, 2010
  $ 67,100  
 
Impairment of goodwill was measured on a nonrecurring basis using the income approach, which utilizes Level 3 inputs in the fair value hierarchy.
 
Derivative Financial Instruments

The Company’s 2009 Senior Secured Notes, that were exchanged for common stock on August 13, 2010, contained certain put derivatives reflected in their contractual rights.  Under certain conversion provisions, if the Company failed to provide timely delivery of shares associated with a conversion of the Notes, the Company would be liable for an amount equal to 2% of the conversion amount and the Holder would have the ability to decide to receive the conversion amounts in cash or in shares.  Under certain of the default provisions, the Holder had the right to put the Notes back to the Company in the event of certain equity-indexed defaults, such as non-delivery of common shares issuable upon exercise of certain warrants.

The Company’s 2010 Note contains a contingent put reflected in the contractual rights of default.  Upon the occurrence of an event of default, as defined in the 2010 Note, the Holder could require us to redeem all or a portion of such Holder’s 2010 Note at a price equal to 100% of the sum of the principal amount of the 2010 Note, accrued and unpaid interest and late fees, if any, to be redeemed. Upon the occurrence of a disposition or liquidity event, as defined in the 2010 Note, the Holder could require us to redeem all of a portion of such Holder’s 2010 Note as an amount equal to the net proceeds up to the maximum amount owed under the note including outstanding principal, unpaid interest and late fees.  Under ASC 815, Derivatives and Hedging, the risks of equity associated with the conversion provision and certain default provisions are inconsistent with the risks of the debt host and, therefore, embedded derivatives such as these require bifurcation and separate classification at fair value.  The embedded put derivatives are accounted for as a single, compound derivative in accordance with ASC 815-15-25.  The embedded derivatives were not deemed to have any value at August 13, 2010 or November 30, 2010.  Along with these embedded put derivatives, certain Company issued warrants are recorded at fair value, marked-to-market at each reporting period and classified in the Company’s condensed consolidated balance sheet as a separate line item.

Accounting for Stock-Based Compensation

Stock-based compensation expense for all stock-based compensation awards granted on or subsequent to June 1, 2006 is based on the grant date fair value estimated in accordance with ASC 718, Compensation – Stock Compensation.  Compensation expense for stock option awards is recognized on a straight-line basis over the requisite service period of the
 
 
8

 
 
award.  We utilize the Black-Scholes option-pricing model to value our stock option grants.  As required, we also estimate forfeitures in calculating the expense related to stock-based compensation, and it requires us to reflect cash flows resulting from excess tax benefits related to those options as a cash inflow from financing activities rather than as a reduction of taxes paid.

The assumptions in the following table were used to calculate the fair-value of share-based payment awards using the Black-Scholes option pricing model, which values options based on the stock price at the grant date, the expected life of the option, the estimated volatility of the stock, expected dividend payments, and the risk-free interest rate over the expected life of the option.

 
Six Months Ended
 
November 30, 2010
 
November 30, 2009
       
Expected volatility
178% - 200%
 
169%-171%
Expected dividend yield
0%
 
0%
Expected term (in years)
3.45
 
3.45
Risk-free interest rate
1.18% - 2.00%
 
2.46%-2.71%
Forfeiture rate
30%
 
30%
 
The dividend yield was calculated by dividing the current annualized dividend by the option exercise price of each grant.  The expected volatility was determined considering the Company’s historical stock prices for the fiscal year the grant occurred and prior fiscal years for a period equal to the expected life of the option.  The risk-free rate represents the US Treasury bond rate with maturity equal to the expected life of the option.  The expected life of the option was estimated based on the exercise history of previous grants.
 
Software Developed for Internal Use

In accordance with FASB ASC 350, “Intangibles-Goodwill and Other, Internal-Use Software”, the costs incurred in the preliminary stages of development are expensed as incurred.  Once an application has reached the development stage, internal costs are capitalized until the software is substantially complete and ready for its intended use.  Internal use software is amortized on a straight-line basis over its estimated useful life, generally five years.  Management evaluates the useful lives of these assets on an annual basis and tests for impairments whenever events or changes in circumstances occur that could impact the recoverability of these assets.
 
The company capitalized internal-use software costs for the three and six months ending November 30, 2010 of $150,162.  The company will begin amortizes those costs when the product is placed into service.
 
Accrued Compensation

Included in accrued compensation is $150,000 payable due to a related party.

Comprehensive Income / (Loss)

Comprehensive income / (loss) consists of the following:
 
      Three Months Ended       Six Months Ended  
   
November 30, 2010
   
November 30, 2009
   
November 30, 2010
   
November 30, 2009
 
                         
Net income / (loss)
  $ 593,823     $ (341,132 )   $ 1,084,033     $ (701,014 )
Foreign currency translations (losses), net
    (36,147 )     7,184       (43,542 )     (15,532 )
                                 
Comprehensive income / (loss)
  $ 557,676     $ (333,948 )   $ 1,040,491     $ (716,546 )

Subsequent Events

In accordance with ASC 855, Subsequent Events, no material events have occurred subsequent to November 30, 2010 that requires recognition in these financial statements. 

On December 17, 2010, Workstream Inc. completed a private placement sale (the “Private Placement”) of 40,312,500 common shares to certain accredited investors (the “Investors”) pursuant to the terms of Subscription Agreements with each Investor.  The aggregate proceeds from the Private Placement were $645,000.  The Company intends to use the proceeds from the Private Placement for working capital.  The common shares were offered and sold pursuant to an exemption from registration under Section 4(2) of the Securities Act of 1933.

 
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Recent Accounting Pronouncements

In July 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2010-20,  Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (Topic 310)—Receivables  (ASU 2010-20) .  ASU 2010-20 enhances the disclosure requirements about the credit quality and related allowance for credit losses of financing receivables. We will adopt ASU 2010-20 in our third quarter of fiscal 2011, except for certain of the provisions of this update that will be effective in our fourth quarter of fiscal 2011. We are currently evaluating the impact of the pending adoption of ASU 2010-20 on our consolidated financial statements.

In April 2010, the FASB issued Accounting Standards Update No. 2010-17,  Revenue Recognition—Milestone Method (Topic 605) — Revenue Recognition  (ASU 2010-17). ASU 2010-17 provides guidance on defining the milestone and determining when the use of the milestone method of revenue recognition for research or development transactions is appropriate. It provides criteria for evaluating if the milestone is substantive and clarifies that a vendor can recognize consideration that is contingent upon achievement of a milestone as revenue in the period in which the milestone is achieved, if the milestone meets all the criteria to be considered substantive. ASU 2010-17 is effective for us in our first quarter of fiscal 2012 and should be applied prospectively. Early adoption is permitted. If we were to adopt ASU 2010-17 prior to the first quarter of fiscal 2012, we must apply it retrospectively to the beginning of the fiscal year of adoption and to all interim periods presented. We are currently evaluating the impact of the pending adoption of ASU 2010-17 on our consolidated financial statements.

In January 2010, the FASB issued Accounting Standards Update No. 2010-06, Improving Disclosures about Fair Value Measurements (Topic 820) — Fair Value Measurements and Disclosures (ASU 2010-06), to add additional disclosures about the different classes of assets and liabilities measured at fair value, the valuation techniques and inputs used, and the activity in Level 3 fair value measurements. Certain provisions of this update will be effective for us in fiscal 2012 and we are currently evaluating the impact of the pending adoption of ASU 2010-06 on our consolidated financial statements.

In September 2009, the FASB issued Accounting Standards Update 2009-13, “Revenue Recognition (Topic 605)—Multiple Deliverable Revenue Arrangements” (“ASU 2009-13’), which addresses the accounting for multiple-deliverable arrangements to enable vendors to account for products or services (deliverables) separately rather than as a combined unit. The new guidance will be effective prospectively for revenue arrangements entered into or materially modified beginning in fiscal years on or after June 15, 2010.

In September 2009, the FASB issued Accounting Standards Update 2009-14, “Software (Topic 985)—Certain Revenue Arrangements That Include Software Elements” (“ASU 2009-14’), which addresses the accounting for revenue transactions involving software. ASU 2009-14 amends ASC 985-605 to exclude from its scope tangible products that contain both software and non-software components that function together to deliver a product’s essential functionality. The new guidance will be effective prospectively for revenue arrangements entered into or materially modified beginning in fiscal years on or after June 15, 2010.

Employment Agreements

In connection with the exchange transactions and private placement of common shares that was consummated on August 13, 2010, we entered into employment agreements with a new management team consisting of John Long, David Kennedy and Ezra Schneier.  We also entered into an employment agreement with Michael Mullarkey, our former Chairman of the Board, Chief Executive Officer and President.  Mr. Mullarkey subsequently resigned effective as of August 25, 2010.  Below is a summary of the employment agreements with our new management team.

John Long, Chief Executive Officer.  Pursuant to the terms of Mr. Long’s employment agreement, Mr. Long will earn an initial base salary of $250,000.  Upon entering into the employment agreement, Mr. Long received 20,348,798 Restricted Stock Units (“RSUs”) and options to purchase 10,174,399 common shares exercisable at a price of $0.01977 per share.  Such RSUs and options vest in equal quarterly installments beginning on the three month anniversary of the date of grant; provided, however, that upon a “change of control” (as defined in the employment agreement), all unvested RSUs and options shall automatically vest.  Mr. Long is also eligible to receive an annual bonus for each fiscal year of up 100% of his base salary based on achieving certain goals, which are to be mutually agreed upon, including a prorated bonus for the fiscal year ending May 31, 2011.  Such bonus will be payable in cash unless the Board of Directors or the Compensation Committee of the Board determines, in its sole discretion to pay up to, but not more than, 50% of such bonus in fully vested RSUs.  In the event that Mr. Long is terminated without “cause” or resigns for “good reason” (as such terms are defined in the employment agreement), Mr. Long will be entitled to severance equal to his then current salary for a
 
 
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period of six months following the date of termination, certain benefits for such six-month period and a prorated bonus for the year in which he is terminated.

David Kennedy, Chief Operating Officer.  Mr. Kennedy will earn an initial base salary of $125,000.  Upon entering into the employment agreement, Mr. Kennedy received 10,174,399 RSUs and options to purchase 5,087,200 common shares exercisable at a price of $0.01977 per share.  Such RSUs and options vest in equal quarterly installments beginning on the three month anniversary of the date of grant; provided, however, that upon a “change of control” (as defined in the employment agreement), all unvested RSUs and options shall automatically vest.  Mr. Kennedy is also eligible to receive an annual bonus for each fiscal year of up 100% of his base salary based on achieving certain goals, which are to be mutually agreed upon, including a prorated bonus for the fiscal year ending May 31, 2011.  Such bonus will be payable in cash unless the Board of Directors or the Compensation Committee of the Board determines, in its sole discretion to pay up to, but not more than, 50% of such bonus in fully vested RSUs.  In the event that Mr. Kennedy is terminated without “cause” or resigns for “good reason” (as such terms are defined in the employment agreement), Mr. Kennedy will be entitled to severance equal to his then current salary for a period of six months following the date of termination, certain benefits for such six-month period and a prorated bonus for the year in which he is terminated.

Ezra Schneier, Corporate Development Officer.  Mr. Schneier will earn an initial base salary of $125,000.  Upon entering into the employment agreement, Mr. Schneier received 10,174,399 RSUs and options to purchase 5,087,200 common shares exercisable at a price of $0.01977 per share.  Such RSUs and options vest in equal quarterly installments beginning on the three month anniversary of the date of grant; provided, however, that upon a “change of control” (as defined in the employment agreement), all unvested RSUs and options shall automatically vest.  Mr. Schneier is also eligible to receive an annual bonus for each fiscal year of up 100% of his base salary based on achieving certain goals, which are to be mutually agreed upon, including a prorated bonus for the fiscal year ending May 31, 2011.  Such bonus will be payable in cash unless the Board of Directors or the Compensation Committee of the Board determines, in its sole discretion to pay up to, but not more than, 50% of such bonus in fully vested RSUs.  In the event that Mr. Schneier is terminated without “cause” or resigns for “good reason” (as such terms are defined in the employment agreement), Mr. Schneier will be entitled to severance equal to his then current salary for a period of six months following the date of termination, certain benefits for such six-month period and a prorated bonus for the year in which he is terminated.

In connection with the consummation of the transactions contemplated by the Exchange Agreements on August 13, 2010, Thomas Danis and Mitch Tuchman resigned as members of the Board of Directors of the Company.  The Board of Directors appointed in their place Denis Sutton and John Long.  Effective as of August 14, 2010, Mr. Mullarkey and Michael Gerrior resigned as members of the Board of Directors and Jeffrey Moss (Chairman) and Biju Kulathakal was appointed in their place.  Upon their appointment to the Board of Directors, each new member other than Mr. Long was granted 265,000 RSUs and options to purchase 1,350,000 common shares pursuant to the terms of the Company’s 2002 Amended and Restated Stock Option Plan with an exercise price of $0.0293.  The RSUs and options are exercisable on the one year anniversary of the date of their grant.  In addition, each non-employee director will be entitled to receive a cash Board Fee equal to $3,000 per calendar month (or $36,000 per year), payable on a quarterly basis within 10 days of the end of each such quarter.  For the first quarter of fiscal 2011, the Board fees were paid in common shares instead of cash per the agreement of the Board of Directors.  This resulted in 1,365,705 of common shares valued at $27,000 being issued to the Board of Directors.  Additionally, for each quarter following the first quarter board fees will be paid in common shares instead of cash unless otherwise decided by the board of directors.

On October 28, 2010, the Board of Directors revised the management team’s employment agreements to replace the Restricted Stock Units granted under their employment agreements with Rule 144 common shares that will be issued in accordance with the vesting terms of the original Restricted Stock Units.
 
NOTE 2.   INVESTOR WARRANTS AND SENIOR SECURED NOTES PAYABLE

On August 29, 2008, we entered into exchange agreements that provided for the exchange of the aggregate $19,000,000 Special Warrants and Additional Warrants indexed to 3,800,000 shares of common stock, issued August 3, 2007 (the “2007 Warrants”), for an aggregate $19,147,191 in face value of Senior Secured Notes (collectively, the “2008 Notes”) and newly issued warrants indexed to 3,800,000 shares of common stock (the “2008 Warrants”) (the “2008 Exchange Transaction”).  Financing costs of $147,191 incurred by the holders of the Notes (“Holders”) are included in the face value of the 2008 Notes.

 
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On May 22, 2009, the Company’s common shares were suspended from trading on the NASDAQ Stock Market due to its inability to maintain a minimum of $2.5 million in stockholders’ equity or $500,000 of net income from continuing operations for the most recently completed fiscal year or two of the three most recently completed fiscal years.  The suspension constituted an event of default under the 2008 Notes and thereby entitled each Holder to require the Company to redeem all or a portion of the Holder’s 2008 Note at a price equal to 110% of the sum of the principal amount of the 2008 Note, accrued and unpaid interest and late fees, if any.  Additionally, as a result of the event of default, the interest rate under each 2008 Note was increased by 5% in addition to the contractual rate of interest due.

On June 1, 2009, the Company adopted ASC 815-40, which required it to begin accounting for the 2008 Warrants as a liability due primarily to the reset provisions of the warrant in the event of lower priced financing transactions.  Therefore, they were reclassified out of equity to a liability classification as of June 1, 2009 via a cumulative effect adjustment.
 
On December 11, 2009, the Company entered into a separate Exchange Agreement (collectively, the “2009 Exchange Agreements”) with each of the Holders pursuant to which, among other  things, each Holder exchanged its existing 2008 Note for: (i) a replacement senior secured non-convertible note (a “Non-Convertible Note”); (ii) a senior secured convertible note that is convertible into the Company's common shares at a conversion price of $0.25 (a “$0.25 Convertible Note”); and, (iii) a senior secured convertible note that is convertible into the Company's common shares at a conversion price of $0.10 (a “$0.10 Convertible Note,” and together with the Non-Convertible Notes and the $0.25 Convertible Notes, collectively, the “2009 Secured Notes”).  Pursuant to the terms of the separate 2009 Exchange Agreements, the Company issued Non-Convertible Notes in an aggregate principal amount of $9,500,000, $0.25 Convertible Notes in an aggregate principal amount of $6,650,000, and $0.10 Convertible Notes in an aggregate principal amount of $5,361,337.  The aggregate principal amount of all of the 2009 Secured Notes issued pursuant to the 2009 Exchange Agreements was $21,613,516, which was the aggregate amount of principal and accrued interest outstanding under the 2008 Notes on December 11, 2009.  This transaction is deemed an extinguishment of debt and new issuance for accounting purposes in accordance with ASC 470-50-40.

Each 2009 Secured Note continued to be secured by a lien on all of the assets of the Company and its subsidiaries pursuant to the terms of the then existing Security Agreement with the Holders.   Interest on the 2009 Secured Note accrued at an annual rate of 9.5%.  The annual rate of interest increases to 14.5% upon occurrence of default.  Interest on the $0.25 Convertible Notes and the $0.10 Convertible Notes compound on a quarterly basis and was to be payable, together with principal, on July 31, 2012 (the “Original Maturity Date”).  Interest on the Non-Convertible Notes compounded on a quarterly basis and was to be payable on the Original Maturity Date, while part of the principal was to be payable on a quarterly basis pursuant to an agreed upon schedule.

Upon the occurrence of an event of default, as defined in the 2009 Secured Notes, a Holder could require the Company to redeem all or a portion of such Holder’s 2009 Notes.  Upon a disposition of assets or liquidity event (each as defined in the 2009 Secured Notes), the Company was required to use 100% of the net proceeds to redeem the 2009 Secured Notes.  Each 2009 Secured Note also contained certain financial and other customary covenants with which the Company was required to comply.  Each subsidiary of the Company previously agreed to guarantee the obligations of the Company under the 2008 Notes and reaffirmed such guarantee with respect to the 2009 Secured Notes by delivering to the Holders a Reaffirmation of Guaranty.  The Company and each of the Holders also entered into a Second Amended and Restated Registration Rights Agreement principally in order to include the common shares of the Company into which the $0.25 Convertible Notes and the $0.10 Convertible Notes were convertible as registrable securities.

On May 31, 2010, the Company defaulted on the 2009 Secured Notes when the quarterly principal payment was not made and the Company fell out of compliance with certain covenants.  Upon default, the interest rate on the 2009 Secured Notes increased by 5%.

The Company’s 2009 Secured Notes and embedded put derivatives were valued in accordance with ASC 820 using multiple, probability-weighted cash flow outcomes at credit-risk adjusted market rates (“Forward Value”).  The Senior Secured Notes with options to convert principal balances into common equity derive their value from a combination of the Forward Value and the fair value of the embedded conversion feature (“ECF”).  For purposes of the ECF, management concluded that the Monte Carlo Simulations Method (“MCS”) was the appropriate technique to embody all assumptions market participants would likely consider in estimating the ECF value.  The fair value of the 2009 Secured Notes and embedded put derivatives was estimated to be $33,587,376 on the date of the exchange, which resulted in a loss on extinguishment of debt of $12,076,040 included in the statement of operations for the period ending May 31, 2010.  Further, in accordance with ASC 470-20-25 and ASC 470-50-40, the net premium of $12,076,040 associated with the 2009
 
 
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Secured Notes was reclassified to additional paid-in capital under the presumption that such net premium represented a capital contribution in which the 2009 Secured Notes were being carried at face value.

In January 2010, $148,856 of principal and accrued interest related to the $0.10 Convertible Notes was converted into 1,488,570 of the Company’s common shares and in February 2010, $88,932 of principal and accrued interest related to the $0.25 Convertible Notes was converted into 355,727 of the Company’s common shares.  In March 2010, $302,203 of principal and accrued interest related to the $.10 Convertible Notes was converted into 3,022,033 shares of the Company’s common stock.  In April 2010, $274,790 of principal and accrued interest related to the $.10 Convertible Notes was converted into 2,747,902 of the Company’s common shares.

On August 13, 2010, the Company entered into separate 2010 Exchange and Share Purchase Agreements and a 2010 Exchange Agreement (collectively, the “2010 Exchange Agreements”) with each of the Holders pursuant to which, among other things, the Holders exchanged their existing 2009 Secured Notes (the aggregate principal amount of all the Notes, together with accrued but unpaid interest and penalties, was $22,356,665) for a total of 682,852,374 of the Company’s common shares.  The 2008 Warrants were not affected by the transactions effected by the 2010 Exchange Agreements.

Simultaneous and in connection with the consummation of the transactions contemplated by the 2010 Exchange Agreements, the Company received an additional $750,000 from one Holder (the “Lending Investor”) in exchange for a senior secured note (the “2010 Note”).  The 2010 Note is secured by a lien on all of the assets of the Company and its subsidiaries pursuant to the terms of a Security Agreement among the Company, its subsidiaries and the Lending Investor (the “Security Agreement”).  Interest on the 2010 Note accrues at an annual rate of 12%.  From and after the occurrence and during the continuance of any event of default under the 2010 Note, the interest rate then in effect will be automatically increased to 15% per year.  Interest is payable upon the maturity date of October 13, 2012.  Upon the occurrence of an event of default, as defined in the 2010 Note, the Lending Investor may require the Company to redeem all or a portion of the 2010 Note.  Upon a Disposition (as defined in the 2010 Note), the Company has agreed to use the Net Proceeds from such Disposition to redeem the 2010 Note.  The 2010 Note contains customary covenants with which the Company must comply.  Each subsidiary of the Company delivered a Guaranty pursuant to which it agreed to guarantee the obligations of the Company under the 2010 Note.   On August 13, 2010, the 2010 Note had a fair value of $835,743.  The Company’s 2010 Note was valued using the fair value of the forward cash flows including principal and interest payable at the maturity date using the credit-risk adjusted market rates.  This value is being accreted to the face value of the 2010 Note, including accrued interest through the maturity date using the effective interest method.

The 2010 Note also contained a contingent put reflected in the contractual rights of default.  Upon the occurrence of an event of default, as defined in the 2010 Note, the Holder could require us to redeem all or a portion of such Holder’s 2010 Note at a price equal to 100% of the sum of the principal amount of the 2010 Note, accrued and unpaid interest and late fees, if any, to be redeemed. Upon the occurrence of a disposition or liquidity event, as defined in the 2010 Note, the Holder could require us to redeem all of a portion of such Holder’s 2010 Note as an amount equal to the net proceeds up to the maximum amount owed under the note including outstanding principal, unpaid interest and late fees.  Under ASC 815, Derivatives and Hedging, the risks of equity are inconsistent with the risks of the debt host and, therefore, embedded put derivatives such as these require bifurcation and separate classification at fair value.  The value of the embedded put derivatives where deemed to be nil on August 13, 2010 and November 30, 2010.
 
Simultaneous and in connection with the 2010 Exchange Agreements and the 2010 Note, we issued 63,227,072 shares in a private placement of $1,250,000 by the new management team and the 2009 Note holders.

The 2010 exchange transaction met the requirements of and was accounted for under ASC 470-60, Debt: Troubled Debt Restructuring By Debtor.  The Company has performed an evaluation and determined that certain prescribed indicators provided by ASC 470 guidance were met to provide evidence that the Company was having financial difficulty.  In addition, the Company determined that creditor granted a concession to the Company since the fair value of the stock and 2010 Note issued to the investors was less than the carrying value of the 2009 Secured Notes and the cash received in the private placement and the 2010 Note.  The fair value of the stock issued in the exchange and the private placement was determined to be $0.03 per share considering guidance of ASC 820, Fair Value Measurements and Disclosures.  The excess of the carrying value of the 2009 Secured Notes, less issuance costs, plus cash received in the exchange over the fair value of the common stock and debt issued in the exchange was recorded as a gain on exchange of debt totaling $1,192,635.  The basic and diluted gain per common share was $0.00.

 
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NOTE 3.   GOODWILL

The following represents the detail of the changes in the goodwill account for the six months ended November 30, 2010:

   
Enterprise
             
   
Workforce
   
Career
       
   
Services
   
Networks
   
Total
 
                   
Goodwill at May 31, 2009
  $ 11,381,660     $ 6,347,788     $ 17,729,448  
Impairment
    (5,335,760 )     (6,347,788 )     -  
Goodwill at May 31, 2010
  $ 6,045,900     $ -     $ 6,045,900  
Impairment adjustment
    685,426       -       685,426  
Goodwill at November 30, 2010
  $ 6,731,326     $ -     $ 6,731,326  
 
During the fourth quarter of fiscal 2010, the Company determined that indicators of impairment existed for the goodwill associated with its Enterprise Workforce operating segment.  Based on this determination, the Company performed an impairment test.  In considering the current and expected future market conditions, the Company determined that the Enterprise Workforce goodwill was impaired in accordance with ASC 350, Intangibles – Goodwill and Other, and the Company recorded non-cash, pre-tax goodwill impairment charges of $5,335,760 during the fiscal year ended May 31, 2010. The Enterprise operating segment goodwill impairment was an estimate that had not yet been finalized.  During the 1st quarter of fiscal year 2011, we had a change in management and well as a conversion of our 2009 Notes to Equity (see Note 2 for further discussion).  The Company felt that these transactions could have impacted the impairment test.  This delayed the impairment test and the Company was unable to fully complete Step 2 of its goodwill impairment testing prior to the issuance of the financials for fiscal year 2010.  Upon finalization of Step 2, a significant adjustment to the impairment estimate was made in the 1st quarter of fiscal year 2011 totaling $685,426 resulting in a partial reversal of the estimated impairment made in the fourth quarter of fiscal 2010.  The Company’s impairment test is based on a discounted cash flow method.  The discounted cash flows analysis is an income method to valuation wherein the total fair value of the business entity is calculated by discounting projected future cash flows back to the date of valuation.

During the second quarter of FY2011, the Company performed a Step 1 goodwill impairment test for the Enterprise operating segment.  The company felt that the test was warranted based on the loss of the large rewards business customers.  The test showed no impairment was necessary.
 
Inherent in our fair value determinations are certain judgments and estimates, including projections of future cash flows, the discount rate reflecting the risk inherent in future cash flows, the interpretation of current economic indicators and market valuations and our strategic plans with regard to our operations.  A change in these underlying assumptions would cause a change in the results of the tests, which could cause the fair value of one or more reporting units to be more or less than their respective carrying amounts.  In addition, to the extent that there are significant changes in market conditions or overall economic conditions or our strategic plans change, it is possible that our conclusion regarding goodwill impairment could change, which could have a material adverse effect on our financial position and results of operations.  Impairment charges related to reporting units which are not currently impaired may occur in the future if further market deterioration occurs resulting in a revised analysis of fair value.
 
NOTE 4.   COMMITMENTS AND CONTINGENCIES

Litigation

On February 12, 2008, Workstream, Workstream Merger Sub Inc., Empagio Acquisition LLC (“Empagio”) and SMB Capital Corporation entered into an Agreement and Plan of Merger pursuant to which Empagio would merge with and into Workstream, subject to the terms and conditions of the Merger Agreement, which was approved by the Boards of Directors of both the companies. Upon the completion of the Merger, the equity interests in Empagio would be converted into up to 177,397,332 shares of Workstream Inc. common stock, representing approximately 75% of the Company’s outstanding common stock on a diluted basis following the Merger.
 
 
14

 
 
On June 24, 2008, the Company filed a lawsuit in the Superior Court of the State of Delaware in and for New Castle County (the “State Court Lawsuit”) against Empagio Acquisition, LLC (“Empagio”) and SMB Capital Corporation (“SMB”) to obtain the $5 million termination fee required to be paid by Empagio and SMB pursuant to Section 7.02 of the Agreement and Plan of Merger dated as of February 12, 2008 among the Company, Workstream Merger Sub Inc., Empagio and SMB, which agreement was terminated by the Company on June 13, 2008.  On June 25, 2008, Empagio and SMB filed a lawsuit against the Company in the United States District Court for the District of Delaware (the “Federal Lawsuit”) alleging entitlement to a $3 million termination fee pursuant to the Agreement and Plan of Merger.  On July 29, 2008, Empagio and SMB filed a notice of voluntary dismissal of their Federal Lawsuit based on an understanding that Empagio and SMB would make their claim as part of the Company’s State Court Lawsuit.  In accordance with the voluntary notice of dismissal of the Federal Lawsuit, Empagio and SMB asserted their claims in the State Court Lawsuit.  A Stipulation of Dismissal has since been filed with the Superior Court pursuant to which the State Court Lawsuit would be dismissed without liability on the part of either party to the other party.

* * *

Second Foundation Inc filed a lawsuit in the circuit Court of the Ninth Judicial Circuit in Orange County, Florida.  On December 1, 2010, Workstream Inc and Second Foundation Inc reached an out of court settlement.  We settled $1,193,218, which we had fully accrued, for $200,000.  The resulting gain of $993,218 is included in Research & development costs in the accompanying condensed consolidated statement of operations.

* * *

The Company is subject to other legal proceedings and claims which arise in the ordinary course of business.  The Company does not believe that the resolution of such actions will materially affect the Company’s business, results of operations, financial condition or cash flows.
 
NOTE 5.   CAPITAL STOCK

Classes of Stock

The authorized share capital consists of an unlimited number of no par value common shares, an unlimited number of no par value Class A Preferred Shares (the “Class A Preferred Shares”), and an unlimited number of no par value Series A Convertible Preferred Shares (the “Series A Shares”).  There were 816,611,260 common shares issued and outstanding, including 108,304 shares being held in escrow, as of November 30, 2010.  There were no Class A Preferred Shares or Series A Shares outstanding as of November 30, 2010.

Stock Plans and Stock-Based Compensation

The Company grants stock options to employees, directors and consultants under the 2002 Amended and Restated Stock Option Plan (the “Plan”), which was most recently amended in November 2007 at the annual shareholders’ meeting. Under the Plan, as amended, the Company is authorized to issue up to 11,000,000 shares of common stock upon the exercise of stock options or restricted stock unit grants.  The Company has granted options that exceed the amount authorized by the Plan.  The Company intends to request shareholder approval to amend the Plan to be sufficient to issue the granted shares.  The Company intends to request the shareholder approval prior to the end of fiscal 2011.  The Restricted Stock Unit options granted to the management team in August 2010 have been converted to Restricted Stock through a Board Resolution until such time as the Plan has been amended to a sufficient numbers of shares to accommodate the original grant.  The Audit Committee of the Board of Directors administers the Plan.  Under the terms of the Plan, the exercise price of any stock options granted shall not be lower than the market price of the common stock on the date of the grant.   The new board of directors and management team were granted stock options at a grant price below the market price on the date of grant.  Options to purchase shares of common stock generally vest ratably over a period of three years and expire five years from the date of grant.

The assumptions used to calculate the fair-value of share-based payment awards are found in Note 1 under Accounting for Stock-Based Compensation.  The Company recognized the following for stock-based compensation expense resulting from stock options in the consolidated statements of operations under general and administrative expenses:

 
15

 

   
Three Months Ended
   
Six Months Ended
 
   
November 30, 2010
   
November 30, 2009
   
November 30, 2010
   
November 30, 2009
 
                         
Stock compensation expense - options
  $ 68,274     $ 20,180     $ 85,724     $ 40,397  

Stock option activity and related information is summarized as follows:
 
                   
Weighted
   
         
Weighted
       
Average
   
         
Average
   
Weighted
 
Remaining
 
Aggregate
   
Number
   
Exercise
   
Average
 
Contractual
 
Intrinsic
   
of Options
   
Price
   
Fair Value
 
Term (in Years)
 
Value
                         
Balance outstanding - May 31, 2009
    1,427,032     $ 1.12              
     Granted
    1,224,100       0.30     $ 0.26        
     Exercised
    -       -                
     Forfeited or expired
    (900,565 )     1.03                
Balance outstanding - May 31, 2010
    1,750,567       0.59                
     Granted
    32,538,318       0.02     $ 0.04        
     Exercised
    -       -                
     Forfeited or expired
    (8,809,717 )     0.04                
Balance outstanding - November 30, 2010
    25,479,168     $ 0.05          
                      4.6
 
 $        4,680
                               
Exercisable - November 30, 2010
    2,275,914     $ 0.23          
                      4.0
 
 $           390

The aggregate intrinsic value in the table above represents total intrinsic value (of options in the money), which is the difference between the Company’s closing stock price of $0.02 on November 30, 2010, the last trading day of the reporting period and the exercise price times the number of shares, that would have been received by the option holders had the option holders exercised their options on November 30, 2010.

There were no options exercised during the six months ended November 30, 2010 and 2009; and therefore, no intrinsic value or cash received from option exercises during the period.

The following table summarizes information about options outstanding at November 30, 2010:

Range of Exercise Prices
Number of Options Outstanding
Weighted Average Remaining Contractual Life
(in Years)
Weighted Average Exercise Price
Number of Options Exercisable
Weighted Average Remaining Contractual Life
(in Years)
Weighted Average Exercise Price
                         
 $0.02 - $0.99
 
         25,256,668
 
4.7
 
 $                 0.03
 
           2,053,414
 
4.4
 
 $                 0.11
 $1.00 - $1.99
 
              217,500
 
0.6
 
 $                 1.38
 
              217,500
 
0.6
 
 $                 1.38
 $2.00 - $2.04
 
                  5,000
 
0.2
 
 $                 2.04
 
                  5,000
 
0.2
 
 $                 2.04
   
         25,479,168
 
4.6
 
 $                 0.05
 
           2,275,914
 
4.0
 
 $                 0.23
 
As of November 30, 2010, $677,823 of total unrecognized compensation costs related to non-vested stock options is expected to be recognized ratably over the remaining individual vesting periods up to three years.  The realized tax benefit from stock options and other share based payments was nil for the three and six months ended November 30, 2010 and 2009 due to the uncertainty of realizability.
 
 
16

 
 
The Company grants restricted stock units (“RSUs”) to certain management and members of the Board of Directors.  Each restricted stock unit represents one share of common stock and vests ratably over three years.  The Company will then issue common stock for the vested restricted stock units upon exercise by the grantee.  During the vesting period, the restricted stock units cannot be transferred, and the grantee has no voting rights.  The cost of the awards, determined as the fair value of the shares on the grant date, is expensed ratably over the vesting period.  On October 28, 2010, the Board of Directors revised the management team’s employment agreements.  This revision substitutes Restricted Stock in lieu of the Restricted Stock Units in their employment agreements until such time that the Stock Option Plan has authorized shares sufficient enough in quantity to allow for the issuance of the Restricted Stock Units as originally granted. The stock-based compensation expense associated with the restricted stock units included in general and administrative expenses on the consolidated statements of operations and in additional paid-in capital on the consolidated balance sheets is as follows:

   
Three Months Ended
   
Six Months Ended
 
   
November 30, 2010
   
November 30, 2009
   
November 30, 2010
   
November 30, 2009
 
                         
Stock compensation expense - RSUs
  $ 8,028     $ 14,939     $ 232,533     $ 29,877  
Stock compensation expense - Restricted Stock Issuances
  $ 101,744     $ -     $ 101,744     $ -  
Total
  $ 109,772     $ 14,939     $ 334,277     $ 29,877  

As of November 30, 2010, $1,175,033 of total unrecognized compensation costs related to non-vested restricted stock unit grants is expected to be recognized ratably over the remaining individual vesting periods up to three years.

         
Weighted
 
   
Number
   
Average
 
   
of Units
   
Fair Value
 
             
Outstanding - May 31, 2009
    77,774        
     Granted
    310,000     $ 0.32  
     Vested and issued
    (101,110 )        
     Forfeited or expired
    -          
Outstanding - May 31, 2010
    286,664          
     Granted
    57,719,364     $ 0.03  
     Vested and issued/unissued
    (7,587,249 )        
     Cancelled
    (3,391,465 )        
     Forfeited or expired
    (8,376,183 )        
Outstanding - November 30, 2010
    38,651,131          

NOTE 6.   SEGMENT INFORMATION

The Company has two reportable segments: Enterprise Workforce Services and Career Networks.  Enterprise Workforce Services consists of revenue generated from HCM software and related professional services.  In addition, Enterprise Workforce Services generates revenue from the sale of various products through the rewards modules of the HCM software.  Career Networks primarily consists of revenue from career transition, applicant sourcing and recruitment research services.

The Company evaluates the performance in each segment based on profit or loss from operations.  There are no inter-segment sales.  Corporate operating expenses are allocated to the segments primarily based on revenue.

The Company’s segments are distinct business units that offer different products and services.  Each is managed separately and each has a different client base that requires a different approach to the sales and marketing process.

The Company does not allocate other income and expense items such as interest income and expense, change in fair value of warrants and derivative, gain (loss) on extinguishment of debt and other income and expense, as well as income tax expense in the profit and loss presentation for its segments.  The Company deems these costs to be corporate costs that
 
 
17

 
 
would not necessarily be a part of the individual segments ordinary course of business or does not record these assets by segment.

The following tables summarize the Company’s operations by business segment for the three and six months ended November 30, 2010 and 2009:
 
   
Three Months Ended
   
Three Months Ended
 
   
November 30, 2010
   
November 30, 2009
 
   
Enterprise
               
Enterprise
             
   
Workforce
   
Career
         
Workforce
   
Career
       
   
Services
   
Networks
   
Total
   
Services
   
Networks
   
Total
 
Software
  $ 1,127,931     $ -     $ 1,127,931     $ 1,739,128     $ -     $ 1,739,128  
Professional services
    109,839       -       109,839       273,567       -       273,567  
Rewards
    2,032,255       -       2,032,255       2,096,257       -       2,096,257  
Career services
    -       574,631       574,631       -       921,167       921,167  
Revenue, net
    3,270,025       574,631       3,844,656       4,108,952       921,167       5,030,119  
Cost of revenues:
                                               
Rewards
    1,512,777       -       1,512,777       1,525,358       -       1,525,358  
Other
    167,170       7,822       174,992       175,520       31,172       206,692  
Gross profit
    1,590,078       566,809       2,156,887       2,408,074       889,995       3,298,069  
Expenses
    825,870       660,533       1,486,403       2,091,028       767,554       2,858,582  
Impairment charges - goodwill
    -       -       -       -       -       -  
Amortization and depreciation
    43,069       4,815       47,884       293,582       7,342       300,924  
Business segment income (loss)
  $ 721,139     $ (98,539 )     622,600     $ 23,464     $ 115,099       138,563  
                                                 
Other income (expense) and income tax
              (28,777 )                     (479,695 )
Net income (loss)
                  $ 593,823                     $ (341,132 )
 
   
Six Months Ended
   
Six Months Ended
 
   
November 30, 2010
   
November 30, 2009
 
   
Enterprise
               
Enterprise
             
   
Workforce
   
Career
         
Workforce
   
Career
       
   
Services
   
Networks
   
Total
   
Services
   
Networks
   
Total
 
Software
  $ 2,288,399     $ -     $ 2,288,399     $ 3,345,455     $ -     $ 3,345,455  
Professional services
    148,434       -       148,434       507,905       -       507,905  
Rewards
    3,998,443       -       3,998,443       3,520,071       -       3,520,071  
Career services
    -       1,146,471       1,146,471       -       1,868,433       1,868,433  
Revenue, net
    6,435,276       1,146,471       7,581,747       7,373,431       1,868,433       9,241,864  
Cost of revenues:
                                               
Rewards
    3,009,271       -       3,009,271       2,609,033       -       2,609,033  
Other
    318,783       15,122       333,905       322,558       90,147       412,705  
Gross profit
    3,107,222       1,131,349       4,238,571       4,441,840       1,778,286       6,220,126  
Expenses
    3,124,515       1,318,263       4,442,778       4,051,426       1,714,819       5,766,245  
Impairment charges - goodwill
    (685,426 )     -       (685,426 )     -       -       -  
Amortization and depreciation
    99,635       11,642       111,277       568,772       13,929       582,701  
Business segment income (loss)
  $ 568,498     $ (198,556 )     369,942     $ (178,358 )   $ 49,538       (128,820 )
                                                 
Other income (expense) and income tax
              714,091                       (572,194 )
Net income (loss)
                  $ 1,084,033                     $ (701,014 )
 
 
18

 
 
NOTE 7.   NET INCOME / (LOSS) PER SHARE

The following is a reconciliation of basic net income / (loss) per share to diluted net income / (loss) per share:

   
Three Months Ended
   
Six Months Ended
 
   
November 30, 2010
   
November 30, 2009
   
November 30, 2010
   
November 30, 2009
 
Numerator:
                       
Net Income (loss)
  $ 593,823     $ (341,132 )   $ 1,084,033     $ (701,014 )
                                 
Denominator:
                               
Weighted average shares outstanding-basic
    812,298,199       56,997,415       487,666,585       56,995,352  
Potential shares "in-the-money" under stock
                               
option and warrant agreements
    60,608,234       -       64,658,234       -  
Less: Shares assumed repurchased under the
                               
treasury stock method
    (19,871,226 )     -       (11,403,420 )     -  
                                 
Weighted average shares outstanding-diluted
    853,035,207       56,997,415       540,921,399       56,995,352  
                                 
Basic net income (loss) per common share
  $ 0.00     $ (0.01 )   $ 0.00     $ (0.01 )
Diluted net income (loss) per common share
  $ 0.00     $ (0.01 )   $ 0.00     $ (0.01 )
 
Because the Company reported net income during the three and six months ended November 30, 2010 the Company included the impact of its common stock equivalents in the computation of dilutive earnings per share for these periods. A net loss was reported during the three and six months ended November 30, 2009 as such the Company excluded the impact of its common stock equivalents in the computation of dilutive earnings per share for these periods, as their effect would be anti-dilutive.  The following outstanding instruments were excluded from the above computation as their exercise price was greater than the company’s average stock price for the quarter and six months ended November 30, 2010:
 
   
Three Months Ended
   
Six Months Ended
 
   
November 30, 2010
   
November 30, 2010
 
             
Stock options
    5,130,369       1,080,369  
Warrants
    6,500,000       6,500,000  
      11,630,369       7,580,369  
 
NOTE 8.   ECONOMIC DEPENDENCE

The Company had one customer which represented approximately 40% and 25% of net revenue for the six months ended November 30, 2010 and 2009, respectively, and one customer which represented approximately 14% and 12% of accounts receivable at November 30, 2010 and 2009, respectively.
 
We have been given notice that the above mentioned customer will not renew their contract with Workstream.   Although we are disappointed by their decision, the Rewards service is low margin and working capital intensive.  It is not core to our vision of a Human Resources software and technology enabled service business.   We will continue to focus on generating revenue growth through sales of our enterprise software solutions.

 
19

 
 
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
FORWARD LOOKING STATEMENTS

Certain statements discussed in Item 2 (Management’s Discussion and Analysis of Financial Condition and Results of Operations) and elsewhere in this Form 10-Q constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  Such forward-looking statements concerning management’s expectations, strategic objectives, business prospects, anticipated economic performance and financial condition and other similar matters involve known and unknown risks, uncertainties and other important factors that could cause the actual results, performance or achievements of results to differ materially from any future results, performance or achievements discussed or implied by such forward-looking statements. Such risks, uncertainties and other important factors are described in Items 1A (Risk Factors) and 7 (Management’s Discussion and Analysis of Financial Condition and Results of Operations) of the Company’s Form 10-K for the fiscal year ended May 31, 2010 and in Item 1A of Part II hereunder.  The words “estimate,” “project,” “intend,” “believe,” “plan” and similar expressions are intended to identify forward-looking statements.  Forward-looking statements speak only as of the date of the document in which they are made.  The Company disclaims any obligation or undertaking to provide any updates or revisions to any forward-looking statement to reflect any change in the Company’s expectations or any change in events, conditions or circumstances on which the forward-looking statement is based.
 
The following discussion and analysis should be read in conjunction with our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K as filed on September 13, 2010 and in conjunction with our unaudited condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q.  All figures are in United States dollars, except as otherwise noted.

OVERVIEW

We are a provider of services and web-based software applications for Human Capital Management (“HCM”).  HCM is the process by which companies recruit, train, compensate, evaluate performance, motivate, develop and retain their employees.  We offer software and services that address the needs of companies to more effectively manage their HCM functions.  We believe that our broad array of HCM solutions provide a “one-stop-shopping” approach for our clients’ human resource needs and is more efficient and effective than traditional methods of human resource management.

Our business changed beginning in fiscal 2002.  During fiscal 2002, we completed the acquisitions of Paula Allen Holdings, OMNIpartners, 6FigureJobs.com, RezLogic, ResumeXpress and Tech Engine.  During fiscal 2003, we completed the acquisitions of Icarian, PureCarbon and Xylo.  During fiscal 2004, we completed the acquisitions of Perform, Peopleview and Kadiri.  During fiscal 2005, we completed the acquisitions of Peoplebonus, Bravanta, HRSoft and ProAct.  During fiscal 2006, we acquired Exxceed, Inc.  These acquisitions have enabled us to expand and enhance our HCM software, increase our service offerings and increase our revenue streams.  Subsequent to the acquisitions, we have concentrated on integrating the acquired entities and technologies, expanding the reach of the existing business and identifying other potential acquisition targets.  When we complete an acquisition, we combine the business of the acquired entity into the Company’s existing operations and expect that this will significantly reduce the administrative expenses associated with the business prior to the acquisition.  The acquired business is not maintained as a standalone business operation.  Therefore, we do not separately account for the acquired business, including its profitability.  Rather, it is included in one of our two distinct business segments and is evaluated as part of the entire segment.

Over the past three years, we have expended significant resources on further integration of the acquired software applications.  We have enhanced product functionality, user interface and reporting capabilities.  We have further integrated many of the talent management solutions and provide a portal based platform for our customers who may elect to contract for a single solution or multiple applications.

In the last half of fiscal 2008, we initiated objectives that were a part of a strategy to align expenses with revenues of the business.  Our overall strategic objective is still to be the premier provider of talent management solutions in the HCM space.  We completed our development of our seamless integration between our core applications of Compensation, Performance, and Development.  We are capitalizing on the sales and marketing expenditures and continue to maintain
 
 
20

 
 
momentum of selling to new customers and retaining existing customers.  We believe that sound execution of these initiatives will result in revenue growth and the ability to take advantage of the scalable nature of our business model.

We have two distinct operating segments, which are the Enterprise Workforce Services and Career Networks segments.

Enterprise Workforce Services

The Enterprise Workforce Services segment primarily consists of HCM software, professional services and additional products sold as part of rewards programs.  Specifically, our Enterprise Workforce segment offers a complete suite of on-demand HCM software solutions, which address performance, compensation, development, recruitment, benefits and rewards. Workstream provides on-demand compensation; performance and talent management solutions and services that help companies manage the entire employee lifecycle - from recruitment to retirement.  We offer software and services that focus on talent management and address the needs of companies to more effectively manage their Human Capital Management (HCM) functions.  Talent Management is the process by which companies recruit, train, evaluate, motivate, develop and retain their employees.  We believe that our integrated TalentCenter Solution Suite, which brings together our entire modular stand-alone applications on a common platform, is more efficient and effective than traditional methods of human resource management. Access to our TalentCenter Solution Suite is offered on a monthly subscription basis under our web-based Software-as-a-Service (“SaaS”) delivery model designed to help companies build high performing workforces, while controlling costs.

All of our large Rewards business customers have given notice that they will not renew their contract with Workstream. Although we are disappointed by the decision of our customers, the Rewards service is low margin and working capital intensive.  It is not core to our vision of a Human Resources software and technology enabled service business. We will continue to focus on generating revenue growth through sales of our enterprise software solutions.

Career Networks

The Career Networks segment consists of career transition and applicant sourcing services.

Career Transition Services
Our career transition services provide job search services for displaced employees.  We focus on creating professional career marketing materials that displaced employees need in order to immediately begin their new job campaign. This package includes a professionally written résumé, broadcast letter, custom cover letter and references.  This assistance is provided to thousands of job seekers each year in the areas of information technology, engineering, finance and marketing.
 
Applicant Sourcing
6FigureJobs.com, Inc., is an online applicant-sourcing portal where job seeking candidates and companies that are actively hiring and filling positions can interact.  The site provides content appropriate for senior executives, directors and other managers, as well as containing job postings that meet their qualifications.  We employ screening to create this exclusive community of job seekers.  On the candidate side, each job seeker is hand reviewed, to ensure they have recent total compensation of $100,000 per annum, before his or her resume is allowed to reside in the site’s candidate database.  On the recruiting side, all job openings must have a minimum aggregate compensation of $100,000.  We generate revenue through 6FigureJobs on a subscription basis from employers and recruiters that access our database of job seekers and use our tools to post, track and manage job openings.  We also generate revenue by charging companies that advertise on our 6FigureJobs website, which includes charging certain advertisers a fee based on the number of leads delivered or on a cost per lead basis.  Launched in early calendar 2009, executives who wish to access additional jobs, or give their resume and profile more exposure than free membership, may subscribe to a premium service for a small monthly fee.

RESULTS OF OPERATIONS

At the end of fiscal 2008 and the first half of fiscal 2009, management restructured the entire Company and decreased its employee base by 35% and reduced its usage of outside consultants as part of its overall plan to reduce costs to better align them with the Company’s current revenues.  The Company continued this practice in FY 2010.  In FY 2011, the Company continues to analyze expenses to find ways of reducing costs.  To monitor our results of operations and financial condition, we review key financial information including net revenues, gross profit, operating income and cash flow from operations.  We have deployed numerous analytical dashboards across our business to assist in evaluating current performance against established metrics, budgets and business objectives on an ongoing basis.  We continue to seek methods to more efficiently monitor and manage our business performance.  Such financial information has been included in the following discussion
 
 
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of the Company’s results of operations.  All of our large Rewards business customers have given notice that they will not renew their contract with Workstream. Although we are disappointed by the decision of our customers, the Rewards service is low margin and working capital intensive.  It is not core to our vision of a Human Resources software and technology enabled service business. We will continue to focus on generating revenue growth through sales of our enterprise software solutions.

Revenues
 
    Three Months Ended November 30     Six Months Ended November 30  
   
2010
   
2009
   
$ Change
   
% Change
   
2010
   
2009
   
$ Change
   
% Change
 
Revenues:
                                               
Software
  $ 1,127,931     $ 1,739,128     $ (611,197 )     -35.1 %   $ 2,288,399     $ 3,345,455     $ (1,057,056 )     -31.6 %
Professional services
    109,839       273,567       (163,728 )     -59.8 %     148,434       507,905       (359,471 )     -70.8 %
Rewards
    2,032,255       2,096,257       (64,002 )     -3.1 %     3,998,443       3,520,071       478,372       13.6 %
Career networks
    574,631       921,167       (346,536 )     -37.6 %     1,146,471       1,868,433       (721,962 )     -38.6 %
   Total revenues
  $ 3,844,656     $ 5,030,119     $ (1,185,463 )     -23.6 %   $ 7,581,747     $ 9,241,864     $ (1,660,117 )     -18.0 %
                                                                 
Percentage of total revenues:
                                                         
Software
    29.3 %     34.6 %                     30.2 %     36.2 %                
Professional services
    2.9 %     5.4 %                     2.0 %     5.5 %                
Rewards
    52.9 %     41.7 %                     52.7 %     38.1 %                
Career networks
    14.9 %     18.3 %                     15.1 %     20.2 %                
 
Fiscal Second Quarter 2011 Compared to Fiscal Second Quarter 2010: Software revenue is comprised of hosting, license and maintenance fees.  Software revenue decreased primarily due to lower subscriptions as a result of discontinuing support on old software versions and lack of renewals from existing client base.  Professional services revenues decreased due to less consulting for existing customer upgrades or specialization work.  We have implemented a new, more targeted approach during the first quarter of fiscal 2011 in order to attract new customers to coincide with an expected overall economic recovery and anticipated increase in IT spending.  Rewards remained relatively flat from quarter to quarter due to the stabilization of the shipment of merchandise to clients.  Career Networks revenues decreased primarily due to less employer and recruiter advertising and economic conditions that negatively affected deals in the recruiting and career transition services segment of the business along with less availability of financing for its customers. Additionally, we spent less on marketing and advertising and as a result received less leads on which to convert to revenues.  We have implemented a more targeted approach and alternative financing terms for our career transition clients and as a result believe that the third quarter of fiscal 2011 revenues will begin to improve over the second quarter of fiscal 2011.

First Six Months of Fiscal 2011 Compared to First Six Months of Fiscal 2010: Software revenue is comprised of hosting, license and maintenance fees.  Software revenue decreased primarily due to lower subscriptions as a result of discontinuing support on old software versions and lack of renewals from existing client base.  Professional services revenues decreased due to less consulting for existing customer upgrades or specialization work.  We have implemented a new, more targeted approach during the first quarter of fiscal 2011 in order to attract new customers to coincide with an expected overall economic recovery and anticipated increase in IT spending.  Rewards increased due to better efficiencies by the Company in shipping product and higher utilization of the rewards program by existing customers.  Career Networks revenues decreased primarily due to less employer and recruiter advertising and economic conditions that negatively affected deals in the recruiting and career transition services segment of the business along with less availability of financing for its customers. Additionally, we spent less on marketing and advertising and as a result received less leads on which to convert to revenues.  We have implemented a more targeted approach for our career transition clients and as a result believe that the third quarter of fiscal 2011 revenues will begin to improve over the first and second quarters of fiscal 2011.

 
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Cost of Revenues & Gross Profit
 
      Three Months Ended November 30       Six Months Ended November 30  
   
2010
   
2009
   
$ Change
   
% Change
   
2010
   
2009
   
$ Change
   
% Change
 
Cost of revenues:
                                               
Software
  $ 120,163     $ 135,940     $ (15,777 )     -11.6 %   $ 249,104     $ 252,495     $ (3,391 )     -1.3 %
Professional services
    43,819       36,337       7,482       20.6 %     62,193       66,350       (4,157 )     -6.3 %
Rewards
    1,515,965       1,528,602       (12,637 )     -0.8 %     3,016,757       2,612,747       404,010       15.5 %
Career networks
    7,822       31,172       (23,350 )     -74.9 %     15,122       90,146       (75,024 )     -83.2 %
    $ 1,687,769     $ 1,732,051     $ (44,282 )     -2.6 %   $ 3,343,176     $ 3,021,738     $ 321,438       10.6 %
                                                                 
                                                                 
Gross profit
  $ 2,156,887     $ 3,298,068