10-Q 1 fp0002783_10q.htm fp0002783_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 February 28, 2011

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 April 12, 2011 there were 992,094,055 common shares, no par value, outstanding, excluding 108,304 common shares held in escrow.
 
 
 

 
 
WORKSTREAM INC.
 
TABLE OF CONTENTS

     
Page No.
Part I.
 
Financial Information
 
       
 
Item 1.
Financial Statements (Unaudited)
 
   
Condensed Consolidated Balance Sheets as of  February 28, 2011 and May 31, 2011
1
   
Condensed Consolidated Statements of Operations for the Three and Nine Months Ended February 28, 2011 and 2010
2
   
Consolidated Statement of Stockholders’ Equity for the Nine Months Ended February 28, 2011
3
   
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended February 28, 2011 and 2010
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
 
 
 

 
 
WORKSTREAM INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
As of February 28, 2011 and May 31, 2010

   
Notes
   
February 28, 2011
   
May 31, 2010
 
ASSETS:
       
(Unaudited)
       
Current assets:
                 
   Cash and cash equivalents
        $ 538,405     $ 358,529  
   Accounts receivable, net of allowances of $504,818 and $442,195 at
                     
      February 28, 2011 and May 31, 2010, respectively
          1,571,045       1,606,623  
   Prepaid expenses and other assets
          120,412       161,692  
         Total current assets
          2,229,862       2,126,844  
                       
Equipment, net
          233,974       295,798  
Other assets
          43,043       163,817  
Intangible assets, net of accumulated amortization of $22,100
          917,044       -  
Goodwill
    4       8,606,441       6,045,900  
                         
TOTAL ASSETS
          $ 12,030,364     $ 8,632,359  
                         
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT):
                       
Current liabilities:
                       
   Accounts payable
          $ 983,189     $ 1,232,019  
   Accrued liabilities
            1,310,355       3,211,124  
   Accrued compensation
            487,057       516,209  
   Current portion of long-term debt, related party
            94,000       -  
   Current portion of long-term obligations
            195,709       200,469  
   Deferred revenue
            913,050       1,456,005  
         Total current liabilities
            3,983,360       6,615,826  
                         
Senior secured note payable
    2       -       21,718,093  
Senior secured note payable and accrued interest, net-related party
    2       864,377       -  
Long-term debt, related party
    3       141,979       -  
Long-term obligations, less current portion
            159,870       138,858  
Deferred revenue – long-term
            15,947       7,667  
Common stock warrant liability
    1       28,100       268,600  
         Total liabilities
            5,193,633       28,749,044  
                         
Commitments and Contingencies
    5                  
                         
SHAREHOLDERS’ EQUITY (DEFICIT):
    6                  
   Preferred shares, no par value
            -       -  
   Common shares, no par value, issued and outstanding 993,548,251 and 65,666,341 shares as of February 28, 2011 and May 31,2010
            140,084,922       114,498,157  
   Additional paid-in capital
            30,909,196       30,313,814  
   Accumulated deficit
    1       (163,175,561 )     (163,997,644 )
   Accumulated other comprehensive loss
            (981,826 )     (931,012 )
         Total shareholders’ equity (deficit)
            6,836,731       (20,116,685 )
                         
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
          $ 12,030,364     $ 8,632,359  

See accompanying notes to these condensed consolidated financial statements.
 
 
1

 
 
WORKSTREAM INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three and Nine Months Ended February 28, 2011 and 2010
(Unaudited)

         
Three Months Ended
   
Nine Months Ended
 
   
Notes
   
February 28, 2011
   
February 28, 2010
   
February 28, 2011
   
February 28, 2010
 
Revenues:
                             
Software
        $ 1,213,982     $ 1,276,792     $ 3,502,382     $ 4,621,702  
Professional services
          81,339       168,050       229,773       675,955  
Rewards
          1,258,868       1,916,208       5,257,311       5,436,279  
Career networks
          553,477       600,724       1,699,948       2,469,703  
Revenues, net
          3,107,666       3,961,774       10,689,414       13,203,639  
                                       
Cost of revenues:
                                     
  Rewards
          933,122       1,720,239       3,942,393       4,329,272  
  Other
          197,830       176,454       531,735       589,159  
  Cost of revenues (exclusive of amortization
          1,130,952       1,896,693       4,474,128       4,918,431  
   and depreciation expense noted below)
                                     
                                       
Gross profit
          1,976,714       2,065,081       6,215,286       8,285,208  
                                       
Operating expenses:
                                     
Selling and marketing
          564,903       404,760       1,328,504       1,406,941  
General and administrative
          1,323,842       2,150,351       5,286,234       6,144,129  
Research and development
    5       320,851       331,881       37,636       1,102,168  
Amortization and depreciation
            60,977       165,457       172,254       748,158  
Impairment of goodwill
    4       -       6,347,788       (685,426 )     6,347,788  
Total operating expenses
            2,270,573       9,400,237       6,139,202       15,749,184  
                                         
Operating Income (loss)
            (293,859 )     (7,335,156 )     76,084       (7,463,976 )
                                         
Other income / (expense):
                                       
Interest income and expense, net
            (20,766 )     (672,181 )     (693,133 )     (2,073,758 )
Gain(loss) on exchange/extinguishment of debt
    2       -       (13,071,440 )     1,192,635       (13,071,440 )
Change in fair value of warrants and derivative
    2       39,000       443,800       240,500       1,231,493  
Other income and expense, net
            13,675       9,861       13,354       51,879  
Other income (expense), net
            31,909       (13,289,960 )     753,356       (13,861,826 )
                                         
Income (loss) before income tax benefit(expense)
            (261,950 )     (20,625,116 )     829,440       (21,325,802 )
                                         
Income tax benefit(expense)
            -       425       (7,357 )     97  
                                         
NET INCOME (LOSS)
          $ (261,950 )   $ (20,624,691 )   $ 822,083     $ (21,325,705 )
                                         
Income (loss) per share - basic and diluted
          $ (0.00 )   $ (0.36 )   $ 0.00     $ (0.37 )
                                         
Weighted average number of common shares
                                       
   outstanding:
                                       
        Basic
            904,238,753       57,568,176       624,998,070       57,175,404  
        Diluted
            904,238,753       57,568,176       672,143,942       57,175,404  
 
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
    6,782,930               444,604                       444,604        
Issuance of common shares in connection with 2010 exchange transaction
    746,079,445       22,382,383                               22,382,383        
Stock option expense
                    150,778                       150,778        
Issuance of common shares for services
    4,615,705       79,000                               79,000        
Private Placements of Common Shares
    64,437,500       1,006,000                               1,006,000        
Purchase of Incentives Advisors
    105,966,330       2,119,382                               2,119,382        
Net income
                                    822,083       822,083       822,083  
Cumulative translation adjustment
                            (50,814 )             (50,814 )     (50,814 )
Comprehensive income
                                                  $ 771,269  
Balance at February 28, 2011
    993,548,251     $ 140,084,922     $ 30,909,196     $ (981,826 )   $ (163,175,561 )   $ 6,836,731          
 
 
3

 
 
WORKSTREAM INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended February 28, 2011 and 2010
(Unaudited)
 
   
Nine Months Ended
 
   
February 28, 2011
   
February 28, 2010
 
Cash flows used in operating activities:
           
Net income / (loss)
  $ 822,083     $ (21,325,705 )
Adjustments to reconcile net income (loss) to net cash used in operating activities:
               
Amortization and depreciation
    172,115       748,158  
Amortization of deferred financing costs
    12,195       -  
Leasehold inducement amortization
    8,666       3,286  
Allowance for doubtful accounts, net
    137,628       618,224  
Impairment of goodwill
    (685,426 )     6,347,788  
Stock-based compensation
    595,382       124,996  
Non-cash compensation of stock purchased by management
    258,725       -  
Non-cash compensation of stock for board member fees
    54,000       -  
Non-cash compensation of stock for other services
    25,000       -  
Loss on extinguishment of debt
    -       13,071,440  
Interest exchanged for common shares
    -       6,372  
Beneficial conversion feature associated with PIK interest
    -       132,098  
Gain on exchange of senior secured notes payable
    (1,192,635 )     -  
Non-cash gain on settlements of accrued liabilities
    (1,124,846 )     -  
Change in fair value of warrants and derivative
    (240,500 )     (1,231,493 )
Net change in components of working capital:
               
Accounts receivable
    (12,329 )     861,252  
Prepaid expenses and other assets
    80,354       20,792  
Accounts payable
    (335,559 )     (572,082 )
Accrued liabilities
    (10,486 )     2,228,775  
Accrued compensation
    (35,348 )     (90,117 )
Deferred revenue
    (535,675 )     (758,857 )
Net cash provided by / (used in) operating activities
    (2,006,656 )     184,927  
                 
Cash flows used in investing activities:
               
Cash paid for business acquistion net of cash acquired
    (188,368 )     -  
Purchase of equipment
    -       (106,761 )
Capitalization of Software Development Costs
    (276,144 )     -  
Net cash used in investing activities
    (464,512 )     (106,761 )
                 
Cash flows provided by / (used in) financing activities:
               
Proceeds from issuance of stock
    2,256,000       -  
Proceeds from issuance of senior secured note payable, net of issuance costs $90,000
    660,000       (137,360 )
Repayment of non-convertible senior note
    -       (29,250 )
Repayment of long-term obligations
    (203,638 )     (200,402 )
Net cash provided by / (used in) financing activities
    2,712,362       (367,012 )
                 
Effect of exchange rate changes on cash and cash equivalents
    (61,318 )     (102,814 )
                 
Net increase / (decrease) in cash and cash equivalents
    179,876       (391,660 )
Cash and cash equivalents - beginning of period
    358,529       1,643,768  
                 
Cash and cash equivalents - end of period
  $ 538,405     $ 1,252,108  
                 
                 
Supplemental schedule of non-cash investing and financing activities:
               
Equipment acquired under capital leases
  $ 67,972     $ 191,298  
Cumulative effect of change in accounting principle for warrant classification
  $ -     $ 876,400  
Non-cash issuance of common stock in connection with conversion of senior secured notes and accrued interest
  $ -     $ 237,789  
Exchange of senior secured notes for common stock
  $ 22,382,383     $ 33,587,377  
                 
Cash paid for interest
  $ 35,512     $ 26,396  
Cash paid for taxes
  $ 5,623     $ 42,718  

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 February 28, 2011, the condensed consolidated statements of operations for the nine months ended February 28, 2011 and 2010, and the condensed consolidated statements of cash flows for the nine months ended February 28, 2011 and 2010 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 nine months ended February 28, 2011 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.  On January 18, 2011, Workstream acquired Incentives Advisors, LLC (“Incentives Advisors”) through a merger of a wholly-owned subsidiary of Workstream with Incentives Advisors. This combination adds solutions for obtaining hiring tax credits, training grants and other incentives to the Workstream offering.  Incentives Advisors specializes in managing the process of procuring employment-related tax credits and incentives for employers.  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 completed a private placement and incurred $750,000 of indebtedness as evidenced by the issuance of our 2010 Note. As a result, we have shareholders’ equity of $6,836,731 as of February 28, 2011.  Income for the nine months ended February 28, 2011 was $822,083 and losses for the years ended May 31, 2010 and 2009 were $26,583,731 and $4,856,356, respectively.  In addition, Liberty Mutual Insurance Company gave notice during the second quarter of fiscal 2011 that it will not renew its contract with Workstream.   In fiscal 2010, Liberty Mutual comprised 30% of Workstream’s revenue.  Although management was 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.  Due to significant reductions in operating expenses in the fourth quarter of fiscal 2008 and throughout fiscal 2009 and 2010 together with the $2.3 million received by the Company in connection with private placements of its common shares as well as $750,000 received by the Company in connection with the issuance of a senior secured note, 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 fiscal 2011, management believes the Company will meet its cash flow needs for fiscal 2011.  The additional financing received by the Company in 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

 
 
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 determined 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.
 
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 Consolidated Statements of Operations.

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 probability-weighted trinomial lattice-based valuation model with the following key inputs:
 
   
February 28, 2011
   
May 31, 2010
 
             
Stock price
  $ 0.02     $ 0.08  
Exercise price
  $ 0.10     $ 0.10  
Expected volatility
    58% - 165%       77% - 152%  
Expected dividend yield
    0%       0%  
Expected term (in years)
    1.4       2.2  
Risk-free interest rate
    0.13% - 0.25%       0.16% - 0.76%  

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:
 
 
6

 
 
·
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 February 28, 2011.  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 February 28, 2011 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.

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 fair value of the Company’s notes associated with the acquisition of Incentives Advisors approximates the carrying value based upon current rates available to the Company.

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 nine months ended February 28, 2011:
 
   
Warrant
 
   
Liability
 
       
Fair value as of May 31, 2010
  $ 268,600  
Change in fair value of warrants and derivative
    (240,500 )
Fair value as of February 28, 2011
  $ 28,100  

Impairment of goodwill was measured on a nonrecurring basis using the income approach, which utilizes Level 3 inputs in the fair value hierarchy.

 
7

 

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 February 28, 2011.  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 sheets 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 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.
 
 
Nine Months Ended
 
February 28, 2011
 
February 28, 2010
       
Expected volatility
178% - 198%
 
169%-171%
Expected dividend yield
0%
 
0%
Expected term (in years)
3.45
 
3.45
Risk-free interest rate
1.47% - 2.0%
 
2.23%-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.

 
8

 

Intangible Assets- Customer List

In accordance with FASB ASC 350, “Intangibles-Goodwill and Other”, the customer list is amortized over the estimated life of the revenue generated by the customers.  Management has determined the useful life to be five years.  The Company amortizes the value of its customer list on a straight-line basis over its estimated useful life.  Management evaluates the useful lives of this asset on an annual basis and tests for impairments whenever events or changes in circumstances occur that could impact the recoverability of this asset.

For the three and nine months ended, amortization of the customer list was $22,100.

Expected future amortization expense for the customer list as of February 28, 2011 follows:


   
Amount
 
Year ended May 31:
     
2011
    33,150  
2012
    132,600  
2013
    132,600  
2014
    132,600  
2015
    132,600  
2016
    99,450  
         
Total
  $ 663,000  
 
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 nine months ending February 28, 2011 of $125,982 and $276,144, respectively.  The company will begin amortizing 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     Nine Months Ended  
   
February 28, 2011
   
February 28, 2010
   
February 28, 2011
   
February 28, 2010
 
                         
Net income / (loss)
  $ (261,950 )   $ (20,624,691 )   $ 822,083     $ (21,325,705 )
Foreign currency translations (losses), net
    (7,272 )     (43,723 )     (50,814 )     (59,255 )
                                 
Comprehensive income / (loss)
  $ (269,222 )   $ (20,668,414 )   $ 771,269     $ (21,384,960 )

 
9

 

Recent Accounting Pronouncements

In December 2010, the FASB issued ASU No. 2010-28, which updates the guidance in ASC Topic 350, Intangibles – Goodwill &Other. The amendments in ASU 2010-28 affect all entities that have recognized goodwill and have one or more reporting units whose carrying amount for purposes of performing Step 1 of the goodwill impairment test is zero or negative. The amendments in ASU 2010-28 modify Step 1 so that for those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with existing guidance, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The adoption of this guidance is not expected to have a material impact on our financial position or results of operations.

In December 2010, the FASB issued ASU No. 2010-29, which updates the guidance in ASC Topic 805, Business Combinations. The objective of ASU 2010-29 is to address diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. The amendments in ASU 2010-29 specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments affect any public entity as defined by ASC 805 that enters into business combinations that are material on an individual or aggregate basis. This guidance will become effective for us for acquisitions occurring on or after the beginning of our 2012 fiscal year. We do not expect the adoption of this guidance will have a material impact upon our financial position or results of operations.

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 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 February 2010, the FASB issued ASU No. 2010-09, “Subsequent Events”.  Under this amended guidance, SEC filers are no longer required to disclose the date through which subsequent events have been evaluated in originally issued and revised 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.
 
 
10

 

Employment Agreements

In connection with the exchange transactions and private placement of common shares that was consummated on August 13, 2010, the Company entered into employment agreements with a new management team consisting of John Long, David Kennedy and Ezra Schneier.  The Company 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 earns 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 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 earns 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 earns 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 fiscal 2011, the Board fees were paid in common shares instead of cash per the agreement of the Board of Directors.  This resulted in 2,731,410 of common shares valued at $54,000 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.
 
 
11

 
 
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.

William Becker, Senior Vice President, Tax Credit and Incentive Services.  Mr. Becker has entered into a three year employment agreement with the Company and earns an initial base salary of $145,000.  Mr. Becker is also eligible to receive a quarterly bonus for each calendar quarter of up $15,000 based on achieving certain goals, which are to be mutually agreed upon.  Mr. Becker is also eligible to receive annual bonus of 12.5% of the difference between $400,000 and the calendar year 2011 EBITDA.   Such bonus will be payable in cash within 30 days following the accounting and financial closing of the quarterly period.

Shaung Liu, Senior Vice President, Tax Credit and Incentive Services.  Mr. Liu has entered into a three year employment agreement with the Company and earns an initial base salary of $145,000.  Mr. Liu is also eligible to receive a quarterly bonus for each calendar quarter of up $15,000 based on achieving certain goals, which are to be mutually agreed upon.  Mr. Liu is also eligible to receive annual bonus of 12.5% of the difference between $400,000 and the calendar year 2011 EBITDA.   Such bonus will be payable in cash within 30 days following the accounting and financial closing of the quarterly period.

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.

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.
 
 
12

 

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 have required 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 would have been 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 consolidated statements 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 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.

Each of the New Warrants issued in connection with the 2008 Exchange Transaction contained anti-dilution protection provisions.  As a result of the Company’s issuance of the $0.10 Convertible Notes, the exercise price of the New Warrants that remain outstanding was adjusted to $0.10 per share from $0.25 per share and the number of common shares issuable upon exercise was proportionately increased by 4,200,000 to 7,000,000 in which $995,400 representing the fair value of this increase was included in the loss on extinguishment of debt in the statement of operations as it was directly related to the exchange of the New Secured Notes.

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.
 
 
13

 

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.  Principal and 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.  Under the 2010 Note, the Company is required to comply with various financial and other covenants and restrictions.  Material covenants and restrictions include that: the Company and its subsidiaries may not redeem or repurchase any of its capital shares or declare or pay any dividend without the consent of the Lending Investor; subject to certain exceptions, the Company and its subsidiaries may not sell, lease, license, assign, transfer, convey or otherwise dispose of any assets in excess of $250,000 in any twelve-month period without the consent of the Lending Investor; the Company must maintain a minimum cash balance of not less than $250,000; as of the end of each calendar month, the Company’s cash balance plus accounts receivable that are less than 90 days old must be equal to or greater than 200% of the outstanding principal amount, interest due and late charges owing under the 2010 Note; and the Company and its subsidiaries may not have any material weakness in their control environments as reported by the Company’s auditors.  Since issuing the 2010 Note to the Lending Investor, the Company has been in compliance with all such covenants and restrictions under the 2010 Note.   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 at 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 February 28, 2011.

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.

NOTE 3.   LONG-TERM DEBT – RELATED PARTY

On January 18, 2011, the Company acquired Incentives Advisors.  Part of the consideration given was two notes payable to the managing members of Incentives Advisors.  Each note is for $117,500 and accrues interest at the rate of five percent per annum.  Each note is payable in thirty equal monthly installments of principal plus interest starting on March 1, 2011.  The notes may be voluntarily prepaid, in whole or in part prior to the maturity date with premium or penalty.  The only event of default is failure to pay when due any principal or interest due within 10 business days thereafter.  If a default does occur, the note holders have the right to declare the entire unpaid principal balance of the note, together with all accrued and unpaid interest thereon, immediately due and payable.  The notes are subordinated to the Company’s Senior Secured Notes payable.
 
 
14

 

NOTE 4.   GOODWILL

The following represents the detail of the changes in the goodwill account for the nine months ended February 28, 2011:
 
   
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  
Purchase of Incentives Advisors
  $ 1,875,115     $ -       1,875,115  
Impairment adjustment
    685,426       -       685,426  
Goodwill at February 28, 2011
  $ 8,606,441     $ -     $ 8,606,441  
 
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.

Effective as of January 18, 2011, Workstream Inc. acquired Incentives Advisors.  This acquisition was accounted for under the acquisition method per ASC Topic 805, Business Combinations (see Note 10).  We recognized goodwill of $1,875,115 for the excess of the purchase price over the fair value of the acquired assets and liabilities assumed.

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.

 
15

 

NOTE 5.  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.

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 was 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  and Second Foundation  reached an out of court settlement.  We settled the $1,193,218 claim, 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 statements of operations.

* * *

Sungard Availability Services (Canada) Ltd. filed a lawsuit in the Superior Court of Justice in Ontario, Canada. On March 17, 2011, Workstream Inc and Sungard reached an out of court settlement.  We settled the $306,628claim, which we had fully accrued, for $175,000.  The resulting gain of $131,628 is included in general & administrative costs in the accompanying condensed consolidated statements 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 6.   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 993,548,251 common shares issued and outstanding, including 108,304 shares being held in escrow, as of February 28, 2011.  There were no Class A Preferred Shares or Series A Shares outstanding as of February 28, 2011.

 
16

 

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 is seeking shareholder approval to amend the Plan to increase the number of shares authorized to be issued under the plan at its 2011 annual shareholders meeting. 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:
 
   
Three Months Ended
   
Nine Months Ended
 
   
February 28, 2011
   
February 28, 2010
   
February 28, 2011
   
February 28, 2010
 
                         
Stock compensation expense - options
  $ 65,054     $ 22,409     $ 150,778     $ 62,807  

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
    (8,909,822 )     0.08                    
Balance outstanding - February 28, 2011
    25,379,063     $ 0.04          
 4.4
    $
4,680
                                   
Exercisable - February 28, 2011
    3,960,374     $ 0.13          
 4.1
    $
780

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 $0.01 on February 28, 2011, 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 February 28, 2011.

There were no options exercised during the nine months ended February 28, 2011 and 2010; and therefore, no intrinsic value or cash received from option exercises during the period.

 
17

 

The following table summarizes information about options outstanding at February 28, 2011:

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
 
 25,206,563
 
4.4
 
 $0.03
 
 3,787,874
 
4.3
 
 $0.07
 $1.00 - $1.40
 
 172,500
 
0.4
 
 $1.31
 
 172,500
 
0.4
 
 $1.31
                         
   
 25,379,063
 
4.4
 
 $0.04
 
 3,960,374
 
4.1
 
 $0.13

As of February 28, 2011, $609,637 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 nine months ended February 28, 2011 and 2010 due to the uncertainty of realizability.

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
   
Nine Months Ended
 
   
February 28, 2011
   
February 28, 2010
   
February 28, 2011
   
February 28, 2010
 
                         
Stock compensation expense - RSUs
  $ 8,584     $ 32,312     $ 241,116     $ 62,190  
Stock compensation expense - Restricted Stock Issuances
  $ 101,744     $ -     $ 203,488     $ -  
Total
  $ 110,328     $ 32,312     $ 444,604     $ 62,190  

As of February 28, 2011, $1,064,706 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
    (7,603,916 )        
     Cancelled
    (6,782,930 )        
     Forfeited or expired
    (8,376,183 )        
Outstanding - February 28, 2011
    35,242,999          
 
 
18

 
 
NOTE 7.   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.  On January 18, 2011, Workstream acquired Incentives Advisors. This combination adds solutions for obtaining hiring tax credits, training grants and other incentives to the Workstream offering.  Incentives Advisors specializes in managing the process of procuring employment-related tax credits and incentives for employers.  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 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 nine months ended February 28, 2011 and 2010:

   
Three Months Ended
   
Three Months Ended
 
   
February 28, 2011
   
February 28, 2010
 
   
Enterprise
               
Enterprise
             
   
Workforce
   
Career
         
Workforce
   
Career
       
   
Services
   
Networks
   
Total
   
Services
   
Networks
   
Total
 
Software
  $ 1,213,982     $ -     $ 1,213,982     $ 1,276,792     $ -     $ 1,276,792  
Professional services
    81,339       -       81,339       168,050       -       168,050  
Rewards
    1,258,868       -       1,258,868       1,916,208       -       1,916,208  
Career services
    -       553,477       553,477       -       600,724       600,724  
Revenue, net
    2,554,189       553,477       3,107,666       3,361,050       600,724       3,961,774  
Cost of revenues:
                                               
Rewards
    933,122       -       933,122       1,720,239       -       1,720,239  
Other
    185,072       12,758       197,830       157,084       19,370       176,454  
Gross profit
    1,435,995       540,719       1,976,714       1,483,727       581,354       2,065,081  
Expenses
    1,650,992       558,604       2,209,596       2,215,815       671,177       2,886,992  
Impairment charges - goodwill
    -       -       -       -       6,347,788       6,347,788  
Amortization and depreciation
    57,594       3,383       60,977       158,073       7,384       165,457  
Business segment income (loss)
  $ (272,591 )   $ (21,268 )     (293,859 )   $ (890,161 )   $ (6,444,995 )     (7,335,156 )
                                                 
Other income (expense) and income tax
              31,909                       (13,289,535 )
Net loss
                  $ (261,950 )                   $ (20,624,691 )

 
19

 

   
Nine Months Ended
   
Nine Months Ended
 
   
February 28, 2011
   
February 28, 2010
 
   
Enterprise
               
Enterprise
             
   
Workforce
   
Career
         
Workforce
   
Career
       
   
Services
   
Networks
   
Total
   
Services
   
Networks
   
Total
 
Software
  $ 3,502,382     $ -     $ 3,502,382     $ 4,621,702     $ -     $ 4,621,702  
Professional services
    229,773       -       229,773       675,955       -       675,955  
Rewards
    5,257,311       -       5,257,311       5,436,279       -       5,436,279  
Career services
    -       1,699,948       1,699,948       -       2,469,703       2,469,703  
Revenue, net
    8,989,466       1,699,948       10,689,414       10,733,936       2,469,703       13,203,639  
Cost of revenues:
                                               
Rewards
    3,942,393       -       3,942,393       4,329,272       -       4,329,272  
Other
    503,855       27,880       531,735       479,642       109,517       589,159  
Gross profit
    4,543,218       1,672,068       6,215,286       5,925,022       2,360,186       8,285,208  
Expenses
    4,775,507       1,876,867       6,652,374       6,267,242       2,385,996       8,653,238  
Impairment charges - goodwill
    (685,426 )     -       (685,426 )     -       6,347,788       6,347,788  
Amortization and depreciation
    157,229       15,025       172,254       726,845       21,313       748,158  
Business segment income (loss)
  $ 295,908     $ (219,824 )     76,084     $ (1,069,065 )   $ (6,394,911 )     (7,463,976 )
                                                 
Other income (expense) and income tax
              745,999                       (13,861,729 )
Net income (loss)
                  $ 822,083                     $ (21,325,705 )
 
NOTE 8.  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
   
Nine Months Ended
 
   
February 28, 2011
   
February 28, 2010
   
February 28, 2011
   
February 28, 2010
 
Numerator:
                       
Net Income (loss)
  $ (261,950 )   $ (20,624,691 )   $ 822,083     $ (21,325,705 )
                                 
Denominator:
                               
Weighted average shares outstanding-basic
    904,238,753       57,568,176       624,998,070       57,175,404  
Potential shares "in-the-money" under stock
                               
option and warrant agreements
    -       -       61,250,102       -  
Less: Shares assumed repurchased under the
                               
treasury stock method
    -       -       (14,104,230 )     -  
                                 
Weighted average shares outstanding-diluted
    904,238,753       57,568,176       672,143,942       57,175,404  
                                 
Basic net income (loss) per common share
  $ (0.00 )   $ (0.36 )   $ 0.00     $ (0.37 )
Diluted net income (loss) per common share
  $ (0.00 )   $ (0.36 )   $ 0.00     $ (0.37 )
 
Because the Company reported net income during the nine months ended February 28 2011 the Company included the impact of its common stock equivalents in the computation of dilutive earnings per share for this period. A net loss was reported during the three months ended February 28, 2011 and the three and nine months ended February 28, 2010 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 nine months ended February 28, 2011:
 
 
20

 

   
Nine Months Ended
 
   
February 28, 2011
 
       
Stock options
    980,264  
Warrants
    6,500,000  
      7,480,264  

NOTE 9.   ECONOMIC DEPENDENCE

The Company had one customer which represented approximately 34% and 29% of net revenue for the nine months ended February 28, 2011 and 2010, respectively, and one customer which represented approximately 15% of accounts receivable at February 28, 2010.
 
We have been given notice that the above mentioned customer will not renew its contract with Workstream.   Although management was disappointed by such customer’s decision to terminate its agreement, 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.
 
NOTE 10.  BUSINESS COMBINATION

Effective as of January 18, 2011, Workstream Inc. and Incentives Advisors, LLC (“IA”) entered into a Merger Letter Agreement whereby the Company acquired 100% of the assets and liabilities of IA.  This combination adds solutions for obtaining hiring tax credits, training grants and other incentives to the Workstream offering.  Incentives Advisors specializes in managing the process of procuring employment-related tax credits and incentives for employers.

This acquisition has been accounted for in accordance with ASC topic 805, Business Combinations, and accordingly, the consolidated statements of operations include the results of IA since the date of acquisition.  The assets acquired and liabilities assumed are recorded at estimates of fair value as determined by management based on information available.  The excess of the purchase price over the fair value of acquired assets and liabilities assumed is allocated to goodwill.  Goodwill represents the synergies and economics of scale expected to be realized from combining the operations of the Company and IA.  All of the goodwill was assigned to the Company’s Enterprise Workforce Services segment.

The following table summarizes the consideration paid for IA and the amounts of the assets acquired and liabilities assumed recognized at the acquisition date:

Consideration:
     
Cash
  $ 204,000  
105,966,330 common shares of the Company valued at $.02 per share
    2,119,382  
Notes Payable
     235,000  
    $ 2,558,382  
Recognized amounts of identifiable assets acquired and liabilities assumed:
     
Financial assets including accounts receivable of $89,720
  $ 150,476  
Property, plant, and equipment
     9,715  
Identifiable intangible assets – customer list
     663,000  
Financial liabilities
    (139,924 )
Total identifiable net assets
     683,267  
Goodwill
     1,875,115  
     $
2,558,382
 

Acquisition-related costs included in general and administrative expenses in the Company’s income statement for the year ended February 28, 2011 totals $21,100.

The unaudited amounts of IA’s revenue and earnings included in the Company’s consolidated statements of operations for the quarter ended February 28, 2011, and the revenue and earnings of the combined entity had the acquisition date been June 1, 2010, or June 1, 2009, are:
 
 
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Revenue
   
Net income(loss)
   
Earnings/Share
 
Actual from 12/1/2010–2/28/2011
  $ 156,530     $ 11,485     $ 0.00  
Supplemental pro forma for 6/1/2010–2/28/2011
  $ 11,199,923     $ 959,392     $ 0.00  
Supplemental pro forma for 6/1/2009–2/28/2010
  $ 13,422,074     $ (21,454,747 )   $ (0.38 )
Supplemental pro forma for 12/1/2009-2/28/2010
  $ 4,030,951     $ (20,707,283 )   $ (0.36 )
 
These proforma amounts do not purport to show the exact results that would have been obtained if the acquisition had occurred as of the beginning of the periods presented or that may be obtained in the future.
 
 
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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 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.
 
 
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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.

On January 18, 2011, Workstream acquired Incentives Advisors. This combination adds solutions for obtaining hiring tax credits, training grants and other incentives to the Workstream offering.  Incentives Advisors specializes in managing the process of procuring employment-related tax credits and incentives for employers.

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.
 
 
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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 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 February 28     Nine Months Ended February 28  
   
2011
   
2010
   
$ Change
   
% Change
   
2011
   
2010
   
$ Change
   
% Change
 
Revenues:
                                               
Software
  $ 1,213,982     $ 1,276,792     $ (62,810 )     -4.9 %   $ 3,502,382     $ 4,621,702     $ (1,119,320 )     -24.2 %
Professional services
    81,339       168,050       (86,711 )     -51.6 %     229,773       675,955       (446,182 )     -66.0 %
Rewards
    1,258,868       1,916,208       (657,340 )     -34.3 %     5,257,311       5,436,279       (178,968 )     -3.3 %
Career networks
    553,477       600,724       (47,247 )     -7.9 %     1,699,948       2,469,703       (769,755 )     -31.2 %
   Total revenues
  $ 3,107,666     $ 3,961,774     $ (854,108 )     -21.6 %   $ 10,689,414     $ 13,203,639     $ (2,514,225 )     -19.0 %
                                                                 
Percentage of total revenues:
                                                               
Software
    39.1 %     32.2 %                     32.8 %     35.0 %                
Professional services
    2.6 %     4.2 %                     2.1 %     5.1 %                
Rewards
    40.5 %     48.4 %