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EX-23.1 - WORKSTREAM INCfp0002052_ex23-1.htm
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EX-31.1 - WORKSTREAM INCfp0002052_ex31-1.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-K

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

For the fiscal year ended May 31, 2010

OR

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

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)
 
1-866-953-8800
Registrant’s telephone number, including area code:
None
Securities registered pursuant to Section 12(b) of the Act:
 
Securities registered pursuant to Section 12(g) of the Act:
 
 
Common Stock, no par value
None
(Title of Class)
(Name of exchange on which registered)

Indicate by check mark if registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ¨                      No þ

Indicate by check mark if registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes ¨                      No þ


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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer  ¨     Accelerated filer  ¨     Non-accelerated filer  ¨    Smaller reporting company  þ
 
 
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨                      No þ

The aggregate market value of the voting and non-voting common equity held by non-affiliates as of November 30, 2009 (the last business day of the registrant’s most recently completed second fiscal quarter) was $1,037,363 based on the closing price of such common equity of $0.21 per share on that date.  All executive officers and directors of the registrant and all persons filing a Schedule 13D or a Schedule 13G with the Securities and Exchange Commission in respect to the registrant’s common stock have been deemed, solely for the purpose of the foregoing calculation, to be “affiliates” of the registrant.

The total number of common shares, no par value, outstanding on September 10, 2010 was 811,745,786 excluding 108,304 common shares held in escrow.


DOCUMENTS INCORPORATED BY REFERENCE:  None

 
ii

 
 
WORKSTREAM INC.
 
TABLE OF CONTENTS
 
For the Fiscal Year Ended May 31, 20010

     
Page No.
Part I.
     
 
Item 1.
Business
1
       
 
Item 1A.
Risk Factors
10
       
 
Item 2.
Properties
18
       
 
Item 3.
Legal Proceedings
18
       
       
       
Part II.
     
 
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
19
       
 
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
26
       
 
Item 8.
Financial Statements and Supplementary Data
 
   
Report of Registered Public Accounting Firms
39
   
Consolidated Balance Sheets as of  May 31, 2010 and 2009
40
   
Consolidated Statements of Operations & Comprehensive Loss for the fiscal years ended May 31, 2010 and 2009
41
   
Consolidated Statements of Stockholders’ Deficit for the fiscal years ended May 31, 2010 and 2009
42
   
Consolidated Statements of Cash Flows for the fiscal years ended May 31, 2010 and 2009
43
   
Notes to the Consolidated Financial Statements
44
       
 
Item 9A(T).
Controls and Procedures
72
       
       
Part III.
     
 
Item 10.
Directors, Executive Officers and Corporate Governance
73
       
 
Item 11.
Executive Compensation
74
       
 
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
79
       
 
Item 13.
Certain Relationships and Related Transactions, and Director Independence
80
       
 
Item 14.
Principal Accountant Fees and Services
81
       
Part IV.
     
 
Item 15.
Exhibits
82
       
   
Signatures
86
 
 
iii

 
 
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE STATEMENTS CONTAINED IN THIS REPORT THAT ARE NOT PURELY HISTORICAL ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. FORWARD-LOOKING STATEMENTS INCLUDE, WITHOUT LIMITATION, STATEMENTS CONTAINING THE WORDS "ANTICIPATES," "BELIEVES," "EXPECTS," "INTENDS," "FUTURE," AND WORDS OF SIMILAR IMPORT WHICH EXPRESS MANAGEMENT'S BELIEF, EXPECTATIONS OR INTENTIONS REGARDING OUR FUTURE PERFORMANCE. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT ARE BASED ON INFORMATION AVAILABLE TO US ON THE DATE HEREOF, AND WE HAVE NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM OUR HISTORICAL OPERATING RESULTS AND FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING, WITHOUT LIMITATION, THOSE SET FORTH IN PART I, ITEM 1A, "RISK FACTORS," OF THIS FORM 10-K AND OTHER FACTORS AND UNCERTAINTIES CONTAINED ELSEWHERE IN THIS FORM 10-K AND IN OUR OTHER FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION.
 
PART I
ITEM 1.      BUSINESS
 
OVERVIEW

We were incorporated on May 24, 1996 under the Canada Business Corporation Act under the name CareerBridge Corporation.  In February 1999, we changed our name to E-Cruiter.com Inc., and in November 2001, we changed our name to Workstream Inc. (the “Company”).  In 1997, we began operating an online regional job board, on which applicants posted their resumes and employers posted available positions, focused on the high-technology industry.  In February 1999, we changed our business focus from the job board business to providing on-line recruitment services.  Beginning in 2001, we began to expand our focus further and embarked on a strategy of product design and development, principally through acquired intellectual property, that would allow us to provide a full range of services and web-based software for Human Capital Management (“HCM”).  HCM is the process by which companies recruit, train, compensate, evaluate performance, motivate and retain their employees.  Today, we offer software and service solutions that address the needs of companies to more effectively manage their human capital management function.  We believe that our single provider approach for our clients’ HCM needs is more efficient and effective than traditional methods of human resource management.

We conduct our business and reflect our management reports on a fiscal year basis from June 1 through May 31 each year.

COMPANY SEGMENTS

Workstream is a provider of software and services for HCM.   Workstream has two distinct reporting units: 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 awards and discounts programs. The Career Networks segment offers recruitment research, resume management and career transition services. In addition, Career Networks provides services through a web-site where job-seeking senior executives can search job databases and post their resumes, and companies and recruiters can post position openings and search for qualified senior executive candidates. Workstream conducts its business primarily in the United States of America and Canada.

INDUSTRY BACKGROUND

Our target market includes any organization that needs to manage their human capital function in a more effective and cost efficient manner.  This includes providing solutions for recruitment needs, evaluating performance, compensation planning, development, incenting and retaining employees and benefits administration.  Our target market also includes companies seeking to fulfill those functions through information technology skills and expertise.  We believe that there are several factors that have contributed to companies now placing a higher premium on hiring the right personnel, appropriately compensating and rewarding performance, and making substantial investments in areas such as training and development, incentives and rewards and overall employee satisfaction.  These factors include increased employee turnover, the shortage
 
 
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of knowledgeable workers, and compliance pressures on compensation practices, particularly in North America, all of which increase the demand for our services.

We believe that many organizations are seeking to overhaul their human resources information systems to take advantage of both new technologies and new human capital management concepts, and we anticipate that spending in human capital management will continue to shift away from the client-server human resources services to web-based and hosted services because of their lower recurring cost and lower cost of implementation.

The Value of Human Capital

Over the past two decades, many organizations have implemented software systems that automate best practices and drive efficiency in most departments, including enterprise resource planning systems, and customer relationship management systems. These software applications provide a wide array of benefits that both increase revenue growth and eliminate expenses. Based on our experience, however, we believe that the human resource (HR) departments of many of these organizations have only implemented HR information systems which track basic employee information for payroll and benefits purposes, or the organizations are increasingly dependent on inefficient use of spreadsheets and other manual paper-based processes for management of critical areas such as compensation and performance management.  Although these methods provide some level of automation, they often do little to increase the effectiveness of managing the human capital function because, in spite of the volumes of data and business information that are generated, the critical knowledge within an organization and therefore much of its value, resides with employees.  As a result, many companies have begun to change their view of human capital, not as an expense to be minimized but as an asset whose value should be optimized.  Unfortunately, many organizations have neither systematized best practices for talent management nor have they implemented software applications to support these processes and provide HR professionals with critical analytics and metrics.

We believe that our suite of workforce management solutions directly addresses the major challenges facing employers in effectively managing the human capital function.  Our solutions enable companies to employ sophisticated systems in their talent management processes.  The ability to leverage valuable data generated through these functions allows organizations to identify overall trends that could improve the efficiency and effectiveness of its processes, quickly identify problems that could lead to employee turnover and ensure that the employee workforce is aligned appropriately around the corporate objectives.

Increased Use of On-Demand Applications

Based on our experience, we believe that organizations have become increasingly dissatisfied with traditional enterprise software applications, resulting in the growing adoption of the on-demand model for enterprise software. Historically, organizations have purchased perpetual software licenses and deployed enterprise software applications on-site within their IT environment. This traditional method of purchasing and deploying enterprise software applications has left many organizations questioning whether the benefits of these technologies outweigh the following burdens:

·  
expensive and time consuming implementation;
·  
significant initial capital investment;  
·  
  expensive maintenance; and  
·  
  limited incentives to ensure client success.

Developments in technology have enabled software developers to offer enterprise software applications on an on-demand basis. Leveraging the Internet, multi-tiered architectures, advances in security and open standards for application integration, software vendors can offer software applications to their clients as a service, hosting the software on servers operated by the software vendor. Clients, using an Internet browser, access the applications, which are designed to be easily configured and integrated with a client’s existing applications.

The on-demand model fundamentally changes both the purchasing and deployment of enterprise software from a client perspective. Rather than making large, up-front investments in perpetual licenses, clients purchase limited term subscriptions for on-demand software applications. Further, because only an Internet browser is required to access on-demand software applications, which can be easily configured to meet the buyer’s specific needs, organizations eliminate the expense of ancillary technology and third-party services required to implement, configure and maintain the enterprise application on-site. Finally, the finite duration of subscriptions provides a strong incentive to software vendors to ensure that the software provides the expected benefits to the client and that they receive consistent customer service. The on-
 
 
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demand model also reduces research and development support costs for the software developer. Because only limited versions of the software exist at any one time, the on-demand model relieves the burden of maintaining and upgrading historical versions of the software.

We believe that talent management applications are particularly well-suited to the on-demand model. Talent management applications are generally purchased by an organization’s HR department. Because the HR departments of most organizations have little historical experience making capital expenditures for enterprise software applications, we believe that the on-demand applications are an operating expense model that provides these departments the opportunity to access these software applications on a subscription basis, thus eliminating a major impediment to the adoption of talent management software solutions.
 
STRATEGY

Our objective is to become a leading supplier of comprehensive, adaptive workforce solutions in North America.  While our Career Network services can be used by any size organization, our Enterprise Workforce talent management solutions were primarily configured for larger organizations.  We believe that our products can address the needs of most of the human capital market and manage the entire employee lifecycle and we are able to provide enterprise workforce management solutions and services to companies of 2,500 employees or more.

We believe that our solutions help companies cost-effectively maximize workforce productivity, performance and satisfaction by applying business discipline to key people processes.  Our solutions are built around a suite of easily configurable software applications that automate talent management best practices. We believe that by providing our software applications on an on-demand basis, we can substantially reduce the costs and risks associated with traditional enterprise software application implementations. We also believe that implementing feature-rich and scalable, or easily configurable on a real-time basis, talent management solutions that meet organizations’ specific needs requires a combination of software, services and domain-specific content. Accordingly, we complement our software applications with consulting services, outsourcing services and proprietary content. Together, these components form solutions that enable our clients to improve the quality of their human capital management processes and increase employee productivity and retention and make their talent management programs more cost-effective.  Our solutions include:

·  
management of talent compensation;
·  
evaluation of talent performance and competencies;
·  
talent development and training need identification;
·  
talent succession planning;
·  
talent reward, non-cash incentives and retention services;
·  
talent separation services that encompass pre-termination planning, individual coaching, opportunity research and job marketing campaign development;
·  
benefits enrollment and administration and  tools for employee communications;
·  
automating and monitoring the recruitment process and the provision of links to external service providers, such as companies that specialize in skill testing or personality profiling;
·  
talent acquisition services ranging from job posting outreach to job boards;
·  
hosting a corporate career site; and
·  
talent utilization services with job posting to internal company intranets.

We believe we have developed a strategy that will achieve revenue growth in most economic conditions, and we are focused on achieving profitability through a combination of organic revenue growth, cost management and strategic acquisitions.  Key elements of our strategy for business development are as follows:

·  
Expanding direct sales with vertical focus.  We will continue to emphasize our direct sales efforts into targeted vertical industries, especially those with good current economic outlooks including healthcare, financial services, retail, education and government, pharmaceuticals and biotech, food services and some manufacturing sectors;

·  
Building a wider indirect sales channel for distribution of our products and services.  We will continue to pursue reseller agreements for all of our services with human capital solution providers such as Human Resource Outsourcing companies, Business Processing Outsourcing companies, and Systems Integrators.  In addition, we will continue to pursue OEM channels for our products and services;
 
 
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·  
Expand market opportunities for our products and services. We will continue to identify and leverage additional growth engines for our products and services as well as Education and Government markets. These markets provide new revenue opportunities for our products and services;

·  
Maintaining technological leadership.  We plan to remain at the forefront of web-based human capital solutions by developing and hosting or licensing the latest available technologies taking advantage of the internet and offering our clients a comprehensive and functionally rich human capital management service in a hosted environment;

·  
Cross-selling additional solutions to further penetrate current clients.   We believe that having a “suite” of human capital solutions that address the entire employee life cycle combined with our strong client relationships provides us with a meaningful opportunity to cross-sell additional solutions to our existing clients and to achieve greater penetration within an organization. We expect to continue to create innovative programs designed to provide our sales and account management personnel with strong incentives to maximize the value for each of our clients; and

·  
Pursuing strategic acquisitions.  From time-to-time, we will evaluate acquisition and investment opportunities in complementary businesses, products and/or technologies.  Our objective is to increase our revenue growth, expand our customer base, add new services or new technologies for our existing client base and penetrate new markets.

We believe that our services allow organizations to significantly improve their recruiting, hiring, evaluation, compensation, performance management, retention and outplacement cycles. Our systems automate those human capital management functions and most are accessible with any standard web browser and require no additional software or hardware deployment by clients.

PRINCIPAL SERVICES AND OPERATIONS

Enterprise Workforce Services

Our 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.  Enterprise Workforce Services generated approximately 81% and 74% of our net revenue in fiscal 2010 and 2009, respectively.

TalentCenter
The Workstream TalentCenter provides a unified view of all of our offerings.  It is a role-based talent management portal that provides single sign-on authentication to all licensed applications and services. This streamlined approach facilitates rapid user adoption of our applications and services.  Due to the fact that TalentCenter is a hosted solution, we manage virtually all of the integration and service complexities at a state-of-the-art, world class data center facility.  Through a standard web browser, companies have access to our on-demand applications and can turn on those they need, when they need them.  TalentCenter provides companies the flexibility to start small and grow over time or deploy the entire solution at once.

Performance
Workstream Performance enables organizations to translate business strategy into a fully aligned set of operational goals, provide real-time visibility and reporting on goal status, assess employee performance and gather employee feedback across the organization.  These products supply the tools and information required to manage organizational performance effectively, including: goal setting, alignment, cascading and linkage; self, peer, multi-rater and 360 degree performance assessments; on-demand tracking and reporting of performance against established metrics; and the collaboration and evaluation capabilities necessary to assess results. The solution is also integrated with Workstream Compensation to help support organization's pay-for-performance programs.   Performance applications include:
 
 
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·  
Achievement, for aligning individual performance with top-level business goals, automating the process of managing, monitoring and assessing individual employee performance and integrating performance data into the compensation planning process;
·  
Development, for assessing, developing and mentoring specific competencies and behaviors with self-assessments, 180 degree, 360 degree and multi-rater assessments; and
·  
Employee Surveys, for gathering employee feedback across the entire organization, analyzing and communicating the results.

Compensation
Workstream Compensation is a comprehensive set of products that enable end-to-end management of all types of enterprise compensation, including salary, merit increases, variable pay and stock awards.   As many organizations are beginning to introduce more complex, formula-driven variable pay plans, we feature an advanced variable pay product that provides the flexibility to use formula-based compensation plans and managerial discretion to reward the company's high achievers.  All compensation planning products are designed to provide managers and compensation professionals with the information and online decision support tools necessary to help them make more informed, policy-based pay decisions. The compensation planning products can be implemented separately or together, allowing organizations to achieve the goal of realizing a pay-for-performance philosophy at their own pace.  Compensation applications include:

·  
Focal Planning, for annual salary, basic variable pay and stock evaluation across the enterprise during a pre-determined planning window;
·  
Off Cycle Planning, for evaluating individual employees throughout the year based on “effective” hiring dates or ad hoc needs;
·  
Advanced Variable Pay, for formulaic variable pay plans that are administered throughout the year; and
·  
Total Rewards Statements, a Web-based product for employees to access, view, model and manage all of their corporate-sponsored financial benefits.  

Development
Workstream Development is designed to allow organizations to maximize the value of their current workforce as well as ensuring that there will be strong leadership in the future. A modular solution, Workstream Development combines individual development planning (IDP), a competency-based assessment and development process with integrated succession planning and organizational charting capabilities, all based on the Workstream Competency Dictionary, which includes over 10,000 technical, 60 behavioral competencies, and over 600 behavioral-based interview questions for over 1,500 job titles. 900 of these competencies have been joint-commission certified for specific certification use in healthcare organizations.  Development capabilities include:

·  
Individual Development Plans (IDP) is the creation and management of the entire employee development process. IDP compliance reports ensure that managers and employees are creating and approving the correct IDP’s;
·  
Workstream Development enables “true” competency assessment of both employee competency and behavioral levels. The product supports measurement of skills, knowledge and competencies requiring different scales and tracks employee attributes that may be important for succession planning or resourcing, such as additional education, certifications or licensing;
·  
Competency Definitions provides full competency definitions and assessment scale information in easy to use pop-up windows;
·  
Competency Health and Ranking Reports aggregate competency gaps and rank employees based against specific competency profiles;
·  
Career Development allows employees and their managers to graphically compare their personal portfolio of competencies to job requirements in their career path and identify suitable learning for each competency gap. Employees can address these gaps through classes, e-learning, books, and other developmental materials. Workstream Development includes pre-defined links to numerous courses and development tactics;
·  
Workstream Succession Planning allows incumbents and other managers to easily designate potential successors from queries to the employee database. Managers can indicate whether the incumbents are promotable or transferable; to which positions; when and what development they will need in order to be ready;
·  
Successors can easily be displayed and rank-ordered based on their competency assessments, readiness, availability or other selected fields;
·  
Succession Plan Reports can be created for a specific position, for specific successors, and managing your entire succession plan; and
 
 
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·  
Organizational Charting uses information customers already have to deliver information-rich corporate directories and organizational charts across an intranet site.
 
Recruitment
Workstream Recruitment helps companies automate and manage the entire recruitment process including job requisition, job profile creation, job posting, applicant attraction, screening, and tracking, interview scheduling, offer letter generation and making the hire. Workstream Recruitment also provides companies with an extended network and industry database to help source key hires. The end result is a thoroughly researched and filtered list of qualified prospective candidates.  Recruitment applications include the following:

·  
Candidate Management, for automating and streamlining the recruiting process used to attract, manage, screen and qualify candidates;
·  
Career Site, a custom-designed internal and external career website hosted and maintained by Workstream at our secure data center, used for attracting, routing and tracking job candidates;
·  
Compliance, reporting tools for preparing Equal Employment Opportunity Commission (EEOC) compliance reporting information and evaluating the staffing process including OFCCP compliance; and
·
Document Builder, for automating and streamlining the creation process and management of candidate-facing letters, such as offer letters.

Benefits
Workstream Benefits is an integrated benefits solution that supports both benefits communication and transactions. Featuring flexible, out-of-the-box functionality, Workstream Benefits can be implemented quickly to help companies automate and streamline the entire benefits enrollment, communication and administration process.  Benefit capabilities and applications include:

·  
Benefits Enrollment and Administration is an out-of-the-box application that automates the benefits enrollment and administration process. It supports customers’ full enrollment cycle, including open, new hire and life event processing;
·  
Benefits Communicator helps organizations personalize and communicate benefit information as well as human resources policies and procedures via the web to their employees, in turn reducing the amount of inquiries into customers’ human resources staff supporting this process and
·  
Health Pages is a one-stop source for the information employees need to make educated health care choices during benefits enrollment and year-round. Health Pages gives employees 24/7 access to personalized information on providers and plans specific to customers’ benefits programs and the tools they need to make well-informed decisions. All information comes from our continuously maintained database of more than 500,000 physicians, 6,000 hospitals and 400 health plans.
·  
Total Rewards Statements gives employees one place to view, model and manage all of their corporate-sponsored compensation, financial and health benefits.  Employees are able to grasp the full value of their wealth-related benefits programs and the contributions employers make on their behalf.

Rewards
Workstream Rewards programs enable organizations to increase employee productivity, improve employee satisfaction and drive engagement. These solutions deliver convenience and productivity benefits to the entire workforce and help organizations identify and reward accomplishments and behaviors that drive desired operational results. This product line delivers several offerings using an enterprise class solution.  Rewards applications include:

·  
Discount Programs, for enhancing employee satisfaction and productivity.  This web-based incentive and employee discount platform offers employees savings on computers, movies, entertainment, travel, insurance and professional services from over 200 brand name providers;
·  
Incentive Programs, for motivating performance and driving results across the organization. This web-based incentive solution calculates and distributes thousand of non-cash incentive awards including travel, gift cards and merchandise shipped worldwide, and distributed by points, certificates or categories, to employees for achieving specific results based upon predefined metrics strategically aligned with company goals; and
·  
Recognition Programs, for rewarding years of service or other corporate milestones and outstanding performance achievement. This online recognition program rewards employees for attaining corporate milestones using online certificates with a selection from a non-cash awards catalog offering thousands of items shipped worldwide. The program also provides a company-wide online recognition tool for participants and managers to issue on-the-spot recognition certificates and awards when exceptional performance occurs or goals are achieved.

 
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Career Networks

Our Career Networks segment consists of career transition services, recruitment research and applicant sourcing.  Career Networks generated approximately 19% and 26% of our net revenue in fiscal 2010 and 2009, respectively.

Career Transition Services
Workstream’s career transition services provide a package of outplacement products and services, which are provided through our wholly-owned subsidiary Paula Allen Holdings, Inc., which we acquired in July 2001 and does business under the name of Allen and Associates.

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.

We market our career transition services to individuals seeking employment or other career opportunities in the marketplace.  Career transition services are marketed to individuals predominantly by advertising on the internet as well as in local newspapers throughout North America.  Individuals are charged on average between $795 and $3,000 for our resume development, career consulting and market research services.

Applicant Sourcing
6FigureJobs.com, Inc., which we acquired in October 2001, is an online applicant-sourcing portal where job seeking candidates and companies that are actively hiring and filling positions can interact.  We believe that 6FigureJobs customizes this experience to satisfy the needs of the upper-echelon management candidate and the companies looking to hire them.  The site provides content appropriate for senior executives, directors and other managers, as well as containing job postings that meet their qualifications.  The 6FigureJobs job board has evolved into one of the premier executive job boards.  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.  Starting 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.
 
FOREIGN OPERATIONS

We have operations in Canada and the United States, and, therefore, are subject to the risks typical of an international business, including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility.

Our operations group is headed from Maitland, Florida with a few essential personnel in Canada.  We maintain our servers in the Fusepoint datacenter in Toronto, Canada that provide on-demand application hosting for all the software that is accessed by our clients and our locations in a SAAS environment.  We also have product development resources in Maitland, Florida and Victoria, British Columbia.

Financial information about segments and geographic areas can be found in Note 10 to our consolidated financial statements under Item 8.
 
 
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REVENUE SOURCES

The Enterprise Workforce Services segment derives revenue from various sources including the following: subscription and hosting fees; licensing of software; software maintenance fees; professional services related to software implementation, customization and training; and sale of products and tickets through the Company’s employee discount and rewards software module. Clients enter into contracts which specifically address the products and services acquired, periods covered, and the billings terms.   Contracts that include a software subscription component have a period of at least one year and typically, average three years.  Clients are billed in advance according to the terms of the contract.   In the case of annual or multiple year contracts, we bill our clients in advance monthly, quarterly or annually as deemed necessary when negotiating the contract.  Any billed but unearned revenue is disclosed in the balance sheet as deferred revenue and is recognized as revenue when the service is provided.   Professional services are billed either on a time and material basis or on a fixed fee basis.  Time and material engagements are billed monthly as the professional services hours are incurred.  Fixed fee engagements are billed according to the terms of the contract, and revenue is recognized on a percentage of completion basis.  Revenue from the sale of products and tickets through the discount and rewards software module is billed and recognized when the goods are shipped and title has transferred.

The Career Networks segment derives revenue from career transition, applicant sourcing and recruitment research services.  For career transition services, clients are billed 50% when the assignment starts and the remaining 50% when the assignment is completed, which is generally in approximately ten days.   For recruitment research services and applicant sourcing and exchange, customers are billed and revenue is recognized as services are provided.  Revenue is recognized when the services have been completed.

RESEARCH AND DEVELOPMENT

From fiscal 2002 through fiscal 2005, the Company embarked on a research and development strategy whereby, rather than relying solely on developing software internally, the Company began to obtain new technology applications and intellectual property through the acquisition of companies that had already developed the technology and proven its success in the marketplace.  During late fiscal 2005 through fiscal 2008, the Company incurred significant research and development costs subsequent to the various acquisitions in order to further enhance the technologies developed by the individual entities prior to the acquisitions.  This included a more common look and feel to the various applications user interfaces and reporting, integration between modules.  The increase in costs was primarily due to the addition of internal resources as well as the use of offshore contractors.  In fiscal 2008, much of the effort was focused on specific integration of Workstream TalentCenterV7.0, with particular emphasis on the compensation, performance management and development solutions.  Upon the release of Workstream TalentCenterV7.0 our research and development activities and expense was significantly reduced. Research and development expense was approximately $1.5 million and $3.5 million in fiscal 2010 and fiscal 2009, respectively.  All research and development expense was incurred in the Enterprise Workforce Services segment.

INTELLECTUAL PROPERTY

We rely upon a combination of copyright, trade secret and trademark laws and non-disclosure and other contractual arrangements to protect our proprietary rights. Many of the copyrights and trademarks we hold were obtained in connection with the acquisitions we have made since 2002. Currently, we have eight registered trademarks in Canada and thirteen in the United States.  With the acquisition of Kadiri, we now have four registered trademarks in the European Union and three in Mexico.  Our trademarks include Workstream, E-Cruiter, E-Cruiter Enterprise, E-Cruiting, 6FigureJobs, Kadiri, Kadiri TotalComp, and Decisis.  In addition, we have two service marks for OMNIpartners and OMNIresearch.  We also have copyrights on some of our training manuals and internally developed software programs.

In 1999, we changed our name from “Careerbridge” to “E-Cruiter”.  In 2001, we changed our name to “Workstream”.  We have registered the Workstream trademark in the U.S. and Canada, and such registrations expire in May 2014 and in May 2019, respectively.  The U.S. trademark renews ten years at a time and the Canadian trademark renews fifteen years at a time.

The following registered trademarks, are registered and will expire as follows: E-Cruiter – December 2013, E-Cruiter Enterprise - October 2015, E-Cruiting – January 2014.  These trademarks are renewable for fifteen years at a time.  Our 6FigureJobs and RezLogic trademark registrations expired and renewals have been applied for and are renewable for ten years at a time.
 
 
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Our Kadiri trademarks are registered and expire as follows: United States: Kadiri, Decisis, and Kadiri TotalComp - January 2011.  These trademarks are renewable for ten years at a time.  Canada: Kadiri – March 2018, and Kadiri TotalComp - December 2018. These trademarks are renewable for fifteen years at a time.  European Kadiri – December 2010, and Kadiri TotalComp – December 2010.  These trademarks are renewable for ten years at a time.  Mexico: Kadiri and Kadiri TotalComp – January 2011. These trademarks are renewable for ten years at a time.

In connection with our acquisition of Kadiri, we acquired one U.S. patent issued July 31, 2001 for Automated Process Guidance System and Method Using Knowledge Management System by Kadiri Inc.  In addition, we have three pending patent applications:  (1) a Canadian patent application for Method for Traversing a Flowchart by Kadiri Inc, (2) a European patent application for Method for Traversing a Flowchart by Kadiri Inc, and (3) a U.S. patent application for Automated Process Guidance System and Method by Kadiri Inc.

We believe that the proprietary rights created by these trademarks, service marks and patents are important to our business. The measures we have taken to protect our proprietary rights, however, may not be adequate to deter misappropriation of proprietary information or protect us if misappropriation occurs.  Policing unauthorized use of our technologies and other intellectual property is difficult, particularly because of the global nature of the internet.  We may not be able to detect unauthorized use of our proprietary information and take appropriate steps to enforce our intellectual property rights.

We are not aware of any patent infringement charge or any violation of other proprietary rights claim by any third party relating to use of our products. However, the computer technology market is characterized by frequent and substantial intellectual property litigation.
 
SALES AND MARKETING

We market our services in both the United States and Canada. Target clients for our on-demand software applications range from large global 2000 companies to medium size organizations.  We sell these solutions to both new and existing clients primarily through our direct sales force, which is comprised of mainly field sales personnel.  Target clients for Career Networks range from headhunters and recruitment firms seeking applicant sourcing from the internet job board, advertisers for our job board website, 6FigureJobs.com, outplacement candidates looking to either change positions or find a job and companies that wish to avail themselves of our recruitment research capabilities.

Our marketing strategy focuses on generating qualified sales leads.   The Enterprise Workforce Services segment’s sales cycle for global 2000 companies is approximately six to nine months depending on the size of the potential client and the number of solutions the prospective customer is evaluating.  Career Networks sales cycle is relatively short and of a higher volume nature.
Our marketing initiatives are generally targeted toward specific vertical industries or specific solutions. Our marketing programs primarily consist of:

 
·        participation in conferences, trade shows and industry events;
 
·        direct mail and email campaigns;
 
·        use of webinars;
 
·        distribution of white papers, case studies and thought leadership documents; and
 
·        using our website to provide product and company information.

COMPETITION

The market for HCM services is highly fragmented and competitive with hundreds of companies offering products or services that compete with one or more of the services that we offer.  Our Career Networks segment competes within the United States and Canada with internet recruitment services companies, outplacement services companies and human resource service providers.  We compete for a portion of employer’s recruiting budgets with many types of competitors such as offline recruiting firms, offline advertising, resume processing companies and web-based recruitment companies.  While we do not believe that any of our competitors offer the full suite of services that we provide, there are a number of companies that have products or services that compete with one or more of the services we provide.  Companies that compete with our recruiting systems services include Taleo Corporation, Kenexa/BrassRing and Webhire. Companies such as Monster Worldwide, Execunet and Netshare have products or services that compete with our applicant sourcing and exchange services.  We also compete with vendors of enterprise resource planning software, such as Peoplesoft, Oracle and SAP.  In the area of outplacement services, we compete with companies such as ITS Personal Marketing and Chandler Hill.  Companies such as LifeCare, Next Jump and SparkFly compete with our employee portal. Oracle, SAP, Workscape and
 
 
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Authoria are our main competitors for our benefit products and Siebel, Kronos, Callidus, Softscape, Success Factors and Authoria compete with our compensation and performance product lines.
 
We believe that the primary competitive factors affecting our market include:
·  
product functionality and performance;
·  
 solution breadth and functionality;
·  
  ease of deployment, integration and configuration;
·  
cost of delivery;
·  
integration between applications;
·  
domain expertise;
·  
  industry-specific expertise;
·  
service support, including consulting services;
·  
solution price;
·  
  scalability and reliability;
·  
security and data privacy; and
·  
breadth of customer support.
 
We believe that our principal competitive advantages include:
·  
our complete and integrated suite of HCM applications;
·  
our richness and completeness of product functionality to meet the demanding requirements of global customers;
·  
our career transition service products;
·  
our unique combination of services;
·  
our technology;
·  
our competitive and innovative packet and delivery model;
·  
our performance and reliability as an application service provider;
·  
our applicant sourcing job board website;
·  
our customer service; and
·  
our experienced staff.

Although we believe we compete favorably with respect to such factors, there can be no assurance that we can maintain our position against current and potential competitors.  A number of our competitors have longer operating histories and greater financial, technology and marketing resources, as well as better name recognition than we do.
 
EMPLOYEES

As of May 31, 2010, we had 86 full-time employees.  Our employees are not represented by a collective bargaining organization, and we have never experienced any work stoppage.  We consider our relations with our employees to be good.
 
AVAILABLE INFORMATION
 
Our internet website address is www.workstreaminc.com.  We provide free access to various reports that we file with or furnish to the United States Securities and Exchange Commission through our website, as soon as reasonably practicable after they have been filed or furnished.  These reports include, but are not limited to, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports.  Our SEC reports can be accessed through the investor relations section of our website, or through www.sec.gov.  Information on our website does not constitute part of this 10-K report or any other report we file or furnish with the SEC.   
 
ITEM 1A.   RISK FACTORS
 
You should carefully consider the risk factors set forth as follows and elsewhere in this Annual Report on Form 10-K that pertain to our Company.  The realization of such risks could result in a material adverse effect on our results of operations, financial condition, cash flows, business or the market for our common shares.  We cannot assure you that we will successfully address any of these risks or address them on a continuing basis.
 
 
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We have limited operating funds.

The Company has incurred substantial losses in recent periods and, as a result, has a shareholders’ deficit of $20,116,685 as of May 31, 2010.  Losses for the twelve months ended May 31, 2010 were $26,583,731 and losses for the years ended May 31, 2009 and 2008 were $4,856,356 and $52,616,875, respectively.  Due to significant reductions in operating expenses in the fourth quarter of fiscal 2008 and throughout fiscal 2009 and 2010, together with our recently completed private placement of common shares for an aggregate $1.25 million and the conversion of our senior secured debt to common shares, each as described below, management believes that current operations will be sufficient to meet its anticipated working capital and capital expenditure requirements.  The current operating loss is the result of current economic conditions and is a reflection of the overall health of the economy as a whole.  Based on an analysis of our current contracts, forecasted new business, our current backlog and current expense level along with the refinancing of the Notes, management believes the Company will meet its cash flow needs for fiscal 2011.  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.

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

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

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

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.

Our ability to obtain financing depends on a number of factors, including our ability to generate positive cash flow from operations, the amount of our cash reserves, the amount and terms of our existing debt arrangements, the availability of sufficient collateral and the prospects of our business.  If financing is not available when required or is not available on acceptable terms, it may impair our ability to:
 
 
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·  
fund current operations;
·  
keep up with technological advances;
·  
pursue acquisition opportunities;
·  
develop product enhancements;
·  
make capital expenditures;
·  
respond to business opportunities;
·  
address competitive pressures or adverse industry developments; or
·  
withstand economic or business downturns.
 
Our stock is no longer traded on the NASDAQ Stock Market but instead is traded on the OTC Bulletin Board, which may make it more difficult for investors to sell shares, may potentially lead to future market declines and may increase our costs related to registration statements.

On May 20, 2009, the Company received a notice from the NASDAQ Hearings Panel stating that the Panel had determined to delist the Company’s common stock from The NASDAQ Stock Market due to its failure to regain compliance with NASDAQ Stock Market Listing Rule 5550(b)(1) within the 180 day extension period granted after the initial failure notice in November 2008.  NASDAQ Marketplace Rule 5550(b)(1) required the Company to have a $35 million market capitalization, a minimum $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 Panel indicated that absent a stay by the NASDAQ Listing and Hearing Review Council, the trading of the Company’s common stock on the NASDAQ Stock Market would be suspended at the open of trading on Friday, May 22, 2009.  We did not appeal the decision.   Therefore, the NASDAQ Stock Market suspended the trading of our common stock on May 22, 2009 and delisted our common stock on August 5, 2009.

Since June 3, 2009, our common stock has been dually quoted on the Over-the-Counter Bulletin Board (OTCBB), an electronic quotation service maintained by the Financial Industry Regulatory Authority (FINRA), and the Pink Sheets electronic over-the-counter securities market.  The common shares continue to trade under the symbol “WSTM-OB.”

As a result, an investor may find it more difficult to dispose of our common shares or to obtain accurate quotations as to the market value of our securities, potentially leading to declines in our share price.  This may cause us to have difficulty obtaining future financing.

Additionally, we are now not eligible to use short form registration statements with the respect to the sale of our securities.  This could substantially increase our costs of registering securities in the future, if we are so required in connection with financing transactions.

Our common stock may become subject to certain “Penny Stock” rules which may make it a less attractive investment.

Since the trading price of our common stock is less than $5.00 per share, trading in our common stock would be subject to the requirements of Rule 15g-9 of the Exchange Act if our net tangible assets fall below $2 million or our average revenue falls below $6,000,000 for three years.  Under Rule 15g-9, brokers who recommend penny stocks to persons who are not established customers and accredited investors, as defined in the Exchange Act, must satisfy special sales practice requirements, including requirements that make and individualized written suitability determination for the purchaser and receive the purchaser’s written consent prior to the transaction.  The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 also requires additional disclosures in connection with any trades involving penny stock, including the delivery, prior to any penny stock transaction, of a disclosure schedule explaining the penny stock market and the risks associated with that market.  Such requirements may severely limit the market liquidity of our common stock and the ability of investors in our equity securities to sell their securities in the secondary market.  For all of these reasons, an investment in our equity securities may not be attractive to our potential investors.
 
 
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The price of our common shares historically has been volatile, which may make it more difficult for you to resell our common shares when you want at prices you find attractive.

The market price of our common shares has been highly volatile in the past, and may continue to be volatile in the future. For example, since June 1, 2004, the closing sale price of our common shares as quoted on the NASDAQ Stock Market prior to May 22, 2009 and since such date on the OTCBB has fluctuated between $0.02 and $5.35 per share. The following factors may significantly affect the market price of our common shares:
·  
quarterly variations in our results of operations;
·  
announcement of new products, product enhancements, joint ventures and other alliances by our competitors or us;
·  
 technological innovations by our competitors or us;
·  
general market conditions or market conditions specific to particular industries;
·  
the issuance of new common shares that dilute the ownership of our existing shareholders; and
·  
the operating and stock price performance of other companies that investors may deem comparable to us.

In addition, the stock market in general, and the market prices for internet-related companies in particular, have experienced extreme volatility that often has been unrelated to the operating performance of such companies. These broad market and industry fluctuations may adversely affect the price of our common shares, regardless of our operating performance.

We may issue securities with rights superior to those of our common stock, which could materially limit the ownership rights of existing stockholders.

We may offer debt or equity securities in private and/or public offerings in order to raise working capital and to refinance our debt.  Our Articles of Incorporation authorizes the board of directors to issue an unlimited number of Class A Preferred Shares, the rights and preferences of which may be designated by our board of directors without shareholder approval.  The designation and issuance of Class A Preferred Shares in the future could create additional securities that would have dividend, liquidation and voting preferences prior in right to the outstanding common shares.  The board of directors is also authorized to issue and unlimited number of common shares and has the right to determine the terms and rights of any debt securities without obtaining further approval of the stockholders.  It is likely that any debt securities or preferred stock that we sell would have terms and rights superior to those of our common stock and may be convertible into common stock.  Any sale of securities could adversely affect the interests or voting rights, impede a change of control and result in substantial dilution to the existing holders of our common stock.  Additionally, a sale of securities could adversely affect the market price of our common stock.

We may not become profitable.

Since our inception, we have incurred losses which have been substantial in relation to our operations and, as a result, have a stockholders’ deficit of $20,116,685 as of May 31, 2010.  Losses for the years ended May 31, 2010 and 2009 were $26,583,731 and $4,856,356, respectively.  Revenues for fiscal 2010 and 2009 were approximately $16,500,000 and $21,500,000, respectively.  Our ability to reduce our losses will be adversely affected if revenue grows slower than we anticipate or if operating expenses exceed our expectations. Even if we do achieve profitability, we may not sustain or increase profitability on a quarterly or annual basis.  Failure to achieve or maintain profitability would materially adversely affect the market price of our common shares.  We expect our operating expenses to moderate due to the scalability of our business model.

Current and future economic downturns may adversely affect the demand for our services.

The general level of current economic activity has significantly affected the demand for employment and recruitment services in our Career Networks segment, as well as sales of Enterprise software.  If the general level of economic activity continues to be slow, our clients may not require additional personnel and may delay or cancel plans that involve recruiting new personnel using our services and technology.  Consequently, the time from initial contact with a potential client to the time of sale could increase and the demand for our services could decline, resulting in a loss of revenue harming our business, operating results and financial condition.

We may not be able to grow our client base and revenue because of competition we face.

Our future success will depend to a large extent on our ability to grow and maintain our client base and revenue.  This requires that we offer services that are superior to the services being offered by the competition that we face and that we price our services competitively.  The market for human capital management, or HCM, services is highly fragmented and competitive, with numerous companies offering products or services that compete with one or more of the services that we offer.  We compete for a portion of employers’ human resource budgets with many types of competitors, as employers typically utilize a variety of sources for managing their human capital needs, including:
 
 
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·  
client-server-based software services;
·  
web-based and hosted service providers with a variety of human capital solutions;
·  
traditional offline recruiting firms;
·  
traditional offline advertising, such as print media;
·  
resume processing companies;
·  
web-based recruitment companies; and
·  
Internet job posting companies.

In addition, many employers are developing or may develop their own software to satisfy their recruitment needs.  We also compete with traditional offline and web-based outplacement service companies and human resource, or HR, service providers.  While we do not believe that any of our competitors offer the full suite of services that we provide, there are a number of companies that have products or services that compete with one or more of the services we provide.  For instance, companies that compete with our recruiting systems services include Taleo Corporation, Kenexa/BrassRing and Webhire. Companies such as Monster Worldwide, Execunet and Netshare have products or services that compete with our applicant sourcing and exchange services.  We also compete with vendors of enterprise resource planning software, such as Peoplesoft, Oracle and SAP.  In the area of outplacement services, we compete with companies such as ITS Personal Marketing and Chandler Hill.  Companies such as LifeCare, Next Jump and SparkFly compete with our employee portal. Oracle, SAP, Workscape and Authoria are our main competitors for our benefit products and Siebel, Kronos, Callidus, Softscape, Success Factors and Authoria compete with our compensation and performance product lines.

We expect competition to increase and intensify in the future, with increased price competition developing for our services.  A number of our current and potential competitors have longer operating histories and greater financial, technical and marketing resources and name recognition than we do, which could give them a competitive advantage.  Our competitors may develop products or services that are equal or superior to ours or that achieve greater market acceptance than ours.  It is also possible that new competitors may emerge and rapidly acquire significant market share.  As a result, we may not be able to expand or maintain our market share and our ability to penetrate new markets may be adversely affected.

If we experience client attrition, our operating results will be adversely affected.

Our Enterprise Workforce Services clients generally enter into subscription agreements covering various periods for at least one year and typically for an average of three years.  We have no assurance that these clients will maintain a long-term relationship with us.  If these clients fail to renew or cancel their subscriptions with us, our business, revenues, operating results and financial condition will be adversely affected.  To the extent we experience significant client attrition, we must attract additional clients to maintain revenue.

We may not be able to strengthen and maintain awareness of our brand name.

We believe that our success will depend to a large extent on our ability to successfully develop, strengthen and maintain the recognition and reputation of our Workstream brand name.  In order to strengthen and maintain our Workstream brand recognition and reputation, we will need to increase our investment in our marketing efforts and continue to maintain high standards for actual and perceived quality, usefulness, reliability, security and ease of use of our services.  If we fail to successfully promote and maintain our Workstream brand name, particularly after incurring significant expenses in promoting our Workstream brand name, or encounter legal obstacles which prevent our continued use of our Workstream brand name, our business, operating results and financial condition could be materially adversely affected and the market price of our common shares could decline.  Moreover, even if we continue to provide quality service to our clients, factors outside of our control, including actions by organizations that are mistaken for us and factors generally affecting our industry, could affect our Workstream brand and the perceived quality of our services.

Our failure to enter into strategic relationships with third parties may harm our business.

If we are unable to enter into or maintain certain strategic relationships, our business will suffer.  These relationships generally include those with job posting boards and other on-line recruitment services such as Monster.com, pursuant to which our clients can post their job openings on such boards.  These relationships allow us to expand the services that we provide our clients without our having to spend significant capital resources developing or acquiring such services. Because many of these third parties compete with each other, the existence of a relationship with any particular third party may limit or preclude us from entering into a relationship with that third party’s competitors.  In addition, some of the third parties with which we seek to enter into relationships may view us as a competitor and refuse to do business with us.  Any loss of an existing relationship or failure to establish new relationships may adversely affect our ability to improve our services, offer an attractive service in the new markets that we enter, or expand the distribution of our services.
 
 
14

 
 
Our large shareholders may influence certain decisions regarding the Company.

As of September 13, 2010, as a result of the exchange of our outstanding senior secured notes for common shares, CCM Master Qualified Fund beneficially owns approximately 48% of our common shares, Magnetar Capital Master Fund beneficially owns approximately 23% of our common shares and Talkot Fund and Thomas Akin together beneficially own approximately 12.5 % of our common shares.  Together, our former senior secured note holders control approximately 87.5% of our common shares. To the extent that CCM Master Qualified Fund in particular, and other of our large shareholders in general, continue to own such a substantial portion of our outstanding common shares, even though less than a majority, they will have significant influence over all matters submitted to our shareholders and exercise significant control over our business policies and affairs. Any of our large shareholders may have interests that conflict with or are different from our own and those of our other shareholders. This concentration of voting power could have the effect of delaying, deterring or preventing a change in control or other business combination that some shareholders might consider beneficial.
 
Because we have international operations, we may face special economic and regulatory challenges that we may not be able to meet.

We expect to continue to expand our U.S. and Canadian operations through both organic growth and acquisitions and may spend significant financial and managerial resources to do so.  In addition, we intend to expand our talent management solution offerings on a broader international scale and are presently enhancing our products with further multi-lingual and multi-currency capabilities. Our international operations are now and will be subject to certain risks, including:
·  
changes in regulatory requirements, tariffs and trade barriers;
·  
changes in diplomatic and trade relationships;
·  
potentially adverse tax consequences;
·  
the impact of recessions in economies outside of Canada;
·  
the burden of complying with a variety of foreign laws and regulations, and any unexpected changes therein;
·  
political or economic constraints on international trade or instability; and
·  
fluctuations in currency exchange rates.

We may lose business if we are unable to successfully develop and introduce new products, services and features.

If we are unable to develop and introduce new products, services, or enhancements to, or new features for, existing products or services, in a timely and successful manner, we may lose sales opportunities.  The market for our services is characterized by rapid and significant technological advancements, the introduction of new products and services, changes in client demands and evolving industry standards.  The adoption of new technologies or new industry standards may render our products obsolete and unmarketable.  The process of developing new services or technologies is complex and requires significant continuing efforts.  We may experience difficulties or funding shortages that could delay or prevent the successful development, introduction and sale of enhancements or new products and services.  Moreover, new products, services or features which we introduce may not adequately address the needs of the marketplace or achieve significant market acceptance.

Our business could be adversely affected if we are unable to protect our proprietary technologies.

Our success depends to a significant degree upon the protection of our proprietary technologies and brand names.  The unauthorized reproduction or other misappropriation of our proprietary technologies could provide third parties with access to our technologies without payment.  If this were to occur, our proprietary technologies would lose value and our business, operating results and financial condition could be materially adversely affected.  We rely upon a combination of copyright, trade secret and trademark laws and non-disclosure and other contractual arrangements to protect our proprietary rights.  The measures we have taken to protect our proprietary rights, however, may not be adequate to deter misappropriation of proprietary information or protect us if misappropriation occurs.  Policing unauthorized use of our technologies and other intellectual property is difficult, particularly because of the global nature of the internet.  We may not be able to detect unauthorized use of our proprietary information and take appropriate steps to enforce our intellectual property rights.  If we resort to legal proceedings to enforce our intellectual property rights, the proceedings could be burdensome and expensive and could involve a high degree of risk.
 
 
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Third parties could claim that we infringe upon their proprietary technologies.

Our products, services, content and brand names may be found to infringe valid copyrights, trademarks or other intellectual property rights held by third parties.  In the event of a successful infringement claim against us and our failure or inability to modify our technologies or services, develop non-infringing technology or license the infringed or similar technology, we may not be able to offer our services.  Any claims of infringement, with or without merit, could be time consuming to defend, result in costly litigation, divert management attention, require us to enter into costly royalty or licensing arrangements, modify our technologies or services or prevent us from using important technologies or services, any of which could harm our business, operating results and financial condition.

We may become subject to burdensome government regulation which could increase our costs of doing business, restrict our activities and/or subject us to liability.

Uncertainty and new regulations relating to the internet could increase our costs of doing business, prevent us from providing our services, slow the growth of the internet or subject us to liability, any of which could adversely affect our business, operating results and prospects.  In addition to new laws and regulations being adopted, existing laws may be applied to the Internet.  There are currently few laws and regulations directly governing access to, or commerce on, the Internet.  However, due to the increasing popularity and use of the Internet, the legal and regulatory environment that pertains to the internet is uncertain and continues to change.  New and existing laws may cover issues which include:
·  
user privacy;
·  
pricing controls;
·  
consumer protection;
·  
libel and defamation;
·  
copyright and trademark protection;
·  
characteristics and quality of services;
·  
sales and other taxes; and
·  
other claims based on the nature and control of Internet materials.

The Canadian Federal Government enacted privacy legislation which requires us to appoint an individual responsible for the administration of personal information, to implement policies and practices to protect personal information, to provide access to information and to deal with complaints.  We must obtain individual consents for each collection, use or retention of personal information.  We implemented procedures to comply with this new privacy legislation.  The privacy legislation increases our cost of doing business due to the administrative burden of these laws, restricts our activities in light of the consent requirement and potentially subjects us to monetary liability for breach of these laws.

Computer viruses or software errors may disrupt our operations, subject us to a risk of loss and/or expose us to liability.

Computer viruses may cause our systems to incur delays or other service interruptions.  In addition, the inadvertent transmission of computer viruses or software errors in new services or products not detected until after their release could expose us to a material risk of loss or litigation and possible liability.  Moreover, if a computer virus affecting our system is highly publicized or if errors are detected in our software after it is released, our reputation and brand name could be materially damaged and we could lose clients.

We may experience reduced revenue, loss of clients and harm to our reputation and brand name in the event of system failures.

We may experience reduced revenue, loss of clients and harm to our reputation and brand name in the event of unexpected network interruptions caused by system failures.  Our servers and software must be able to accommodate a high volume of traffic.  If we are unable to add additional software and hardware to accommodate increased demand, we could experience unanticipated system disruptions and slower response times.  Our systems are vulnerable to damage or interruption from earthquakes, floods, fires, power loss, telecommunication failures, terrorist attacks, computer viruses and similar events.   We have centralized all of our application hosting in a secure, state-of-the-art datacenter facility and we have invested substantial funds in procuring the necessary equipment.  While this initiative should enhance our ability to meet performance and security requirements under our customer service level agreements, there is no assurance that this will cover all eventualities.  We have also established redundant systems and implemented disaster recovery procedures, they also may not be sufficient for all situations.  We have occasionally experienced delays in providing our customers access to their data in the past, and we believe these system interruptions could continue to occur from time to time in the future.  Any catastrophic failure at our network operations center could prevent us from serving our clients for a number of days, or possibly weeks, and any failure of our internet service provider may adversely affect our network’s performance.  Most of our system interruptions are due to heavy internet traffic and minor equipment failures which generally result in our customers being unable to access their data for a few seconds or several minutes.  Our clients may become dissatisfied by any system failure that interrupts our ability to provide our services to them or results in slower response times.  Our subscription agreements generally provide that our customers will be able to access their data during certain guaranteed times.  If we fail to meet the service levels specified under our subscription agreements as a result of repeated outages, the customer can terminate its agreement with us.  Our business interruption insurance may not adequately compensate us for any losses that may occur due to any failures in our system or interruptions in our services.
 
 
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Breaches of our network security could be costly.

If unauthorized persons penetrate our network security, they could misappropriate proprietary information or cause interruptions in our services.  We may be required to spend capital and resources to protect against or to alleviate these problems.  In addition, because we host data for our clients, we may be liable to any of those clients that experience losses due to our security failures.  While we have implemented measures to strengthen and improve our intrusion protection system, this is not an absolute guarantee that security breakdowns will not occur.  As a result, a material security breach could have a material adverse effect on our business and the market price of our common shares may decline.

Our business may be adversely affected if internet service providers fail to provide satisfactory service to our clients to enable them to use our services and access job seeker candidates on-line.

Failure of internet service providers or on-line service providers to provide access to the internet to our clients and job seekers would prevent them from accessing our web board, which would cause our business to suffer.  Many of the internet service providers, on-line service providers and other web site operators on which we depend have experienced significant service slowdowns, malfunctions, outages and capacity limitations.  If users experience difficulties using our services due to the fault of third parties, our reputation and brand name could be harmed.

Failure of the internet infrastructure to support current and future user activity may adversely affect our business.

We cannot assure you that the Internet infrastructure will continue to effectively support the demands placed on it as the internet continues to experience increased numbers of users, greater frequency of use and increased bandwidth requirements of users.  In the past, the internet has experienced a variety of outages and other delays.  The internet is also subject to actions of terrorists or hackers who may attempt to disrupt specific web sites or Internet traffic generally.  Any future outages or delays could affect the willingness of employers to use our on-line recruitment offerings and of job seekers to post their resumes on the internet.  If any of these events occur, our business, operating results and financial condition could be materially adversely affected.

We may not expand and upgrade our systems and hardware in a timely manner in order to accommodate growth in our business, which could adversely affect our business.

We must expand and upgrade our systems and network hardware in order to accommodate growth in our business.  While we have recently updated and refreshed our data center capabilities and upgraded the necessary equipment there is no assurance that such changes and upgrades will accommodate growth in our business, our business, financial condition and operating results could be adversely affected.

We depend on our key employees to manage our business effectively, and if we are unable to retain our key employees, our business may be adversely affected.

Our success depends on the efforts, abilities and expertise of our new Board members, our new senior management team and other key employees.  There can be no assurance that we will be able to retain our key employees.  If any of our key employees leave before suitable replacements are found, there could be an adverse effect on our business.  There can be no assurance that suitable replacements could be hired without incurring substantial additional costs, or at all.
 
 
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ITEM 2.   PROPERTIES
 
Our corporate headquarters were located in approximately 25,020 square feet of leased office space in Ottawa, Ontario, Canada.  This facility housed our network operation and information technology groups, certain research and development personnel and customer support.  Our lease for 17,945 square feet of this facility expired in December 2008 with the remaining 7,075 square feet expiring in October 2010.   In April 2009, we exited this facility early and moved our corporate headquarters to Maitland, Florida.  We still maintain a few key personnel in Canada with our registered office located at 340 Albert Street, Suite 1400 Ottawa, Ontario Canada  K1R0A5.
 
In April 2009, we entered into a sublease for approximately 14,300 square feet of office space in Maitland, Florida, which serves as the corporate headquarters for our consolidated operations.  Our finance and human resources department, our internal sales team and lead generation group, and the majority of the employees of the outplacement and recruitment companies reside in this space.  Our sublease for this premise expires in August 2011.
 
Our wholly-owned subsidiary Paula Allen Holdings, Inc. utilizes space in Maitland, Florida; Dallas, Texas and Minneapolis, Minnesota.  In Dallas, we lease approximately 4,192 square feet of office space under a lease expiring on January 31, 2014 and in Minneapolis, we lease approximately 1,523 square feet of office space under a lease expiring on December 31, 2012.
 
ITEM 3.   LEGAL PROCEEDINGS
 
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 would be dismissed without liability on the part of either party to the other party.

* * *

We are involved in various lawsuits, claims, investigations and proceedings that arise in the ordinary course of business.  If the potential loss from an item is considered probable and the amount can be estimated, we accrue a liability for the estimated loss, as provided in ASC 450, Contingencies .  Because of uncertainties related to these matters, accruals are based only on the best information available at the time.  Periodically, we review the status of each significant matter and assess our potential financial exposure.  These matters are inherently unpredictable and are subject to significant uncertainties, some of which are beyond our control.  Should any of the estimates and assumptions utilized to estimate potential losses change or prove to have been incorrect, it could have a material impact on our results of operations, financial position or cash flows.
 
 
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PART II
 
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
MARKET INFORMATION
 
Until May 22, 2009, our no par common shares were traded on the NASDAQ Stock Market (“NASDAQ”) under the symbol “WSTM.”  Commencing May 22, 2009 and June 3, 2009, we began trading under the symbol “WSTM-OB” on the Pink Sheets electronic over-the-counter securities market and quoted on the Over-the-Counter Bulletin Board (OTCBB) in what is commonly referred to as the OTC Bulletin Board, respectively. OTC market quotations reflect interdealer prices, without retail markup, markdown or commission and may not necessarily represent actual transactions.

The following table sets forth the high and low closing sales prices of our common shares during each quarter as reported by NASDAQ or the OTC Bulletin Board, as applicable, for the fiscal years ended May 31, 2010 and 2009:
 
 
Period
High Closing Sales Price
Low Closing Sales Price
2010 Fiscal Year, quarter ended:
   
August 31, 2009
$0.37
$0.18
November 30, 2009
$0.32
$0.21
February 28, 2010
$0.30
$0.20
May 31, 2010
$0.22
$0.08
     
2009 Fiscal Year, quarter ended:
   
August 31, 2008
$0.45
$0.15
November 30, 2008
$0.20
$0.02
February 28, 2009
$0.22
$0.02
May 31, 2009
$0.40
$0.15

On May 20, 2009, the Company received a notice from the NASDAQ Hearings Panel stating that the Panel had determined to delist the Company’s common stock from The NASDAQ Stock Market due to its failure to regain compliance with NASDAQ Stock Market Listing Rule 5550(b)(1)within the 180 day extension period granted after the initial failure notice in November 2008.  NASDAQ Marketplace Rule 5550(b)(1) required the Company to have a $35 million market capitalization, a minimum $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 Panel indicated that absent a stay by the NASDAQ Listing and Hearing Review Council, the trading of the Company’s common stock on the NASDAQ Stock Market would be suspended at the open of trading on Friday, May 22, 2009.  We did not appeal the decision.   Therefore, the NASDAQ Stock Market suspended the trading of our common stock on May 22, 2009 and delisted our common stock on August 5, 2009.The Company’s common shares are now dually quoted on the Over-the-Counter Bulletin Board (OTCBB), an electronic quotation service maintained by the Financial Industry Regulatory Authority (FINRA), and the Pink Sheets electronic over-the-counter securities market.  The common shares continue to trade under the symbol “WSTM-OB.”

On June 1 2009, the Boston Stock Exchange also filed an application with the Securities and Exchange Commission to strike our common stock from listing and registration on the Exchange due to their decision to no longer trade common stock securities.  Prior to the delisting, our common shares were traded under the symbol “ERM.”

HOLDERS
 
On September 10, 2010, there were approximately 217 stockholders of record for our common stock.   This does not reflect persons or entities that hold our common stock in nominee or “street” name through various brokerage firms.

DIVIDENDS
 
We have not paid any dividends on our common shares and do not expect to pay dividends in the foreseeable future.  It is the present policy of our Board of Directors to retain any future earnings to finance the growth and development of our business.  Any future dividends will be declared at the discretion of the Board of Directors and will depend upon several things including approval by our note holders, the financial condition, capital requirements, earnings and liquidity of our Company.  See Management's Discussion and Analysis of Financial Condition and Results of Operations for a discussion of our current capital position.
 
 
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SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
 
Please see the section titled “Equity Compensation Plan Information” under Item 12 in Part III of this Form 10-K.
 
RECENT SALES OF UNREGISTERED SECURITIES
 
There were no sales of unregistered securities in the quarter ended May 31, 2010.

FOREIGN ISSUER LAWS
 
General

There is no law or government decree or regulation in Canada that restricts the export or import of capital, or that affects the remittance of dividends, interest or other payments to a non-resident holder of common shares, other than withholding tax requirements.

There is no limitation imposed by Canadian law or by our articles or other charter documents on the right of a non-resident of Canada to hold or vote our common shares, other than as provided in the Investment Canada Act, as amended, referred to as the Investment Act.

The Investment Act generally prohibits implementation of a reviewable investment by an individual, government or agency thereof, corporation, partnership, trust or joint venture that is not a "Canadian" as defined in the Investment Act, referred to as a non-Canadian, unless, after review, the minister responsible for the Investment Act is satisfied that the investment is likely to be of net benefit to Canada. If an investment by a non-Canadian is not a reviewable investment, it nevertheless requires the filing of a short notice which may be given at any time up to 30 days after the implementation of the investment.

An investment in our common shares by a non-Canadian that is a WTO investor (defined below) would be reviewable under the Investment Act if it were an investment to acquire direct control, through a purchase of our assets or voting interests, and the gross book value of our assets equaled or exceeded $312 million, the threshold established for 2009, as indicated in our financial statements for our fiscal year immediately preceding the implementation of the investment. In subsequent years, such threshold amount may be increased or decreased in accordance with the provisions of the Investment Act. A WTO investor is an investment by an individual or other entity that is a national of, or has the right of permanent residence in, a member of the World Trade Organization, current members of which include the European Community, Germany, Japan, Mexico, the United Kingdom and the United States, or a World Trade Organization (WTO) investor-controlled entity, as defined in the Investment Act.

An investment in our common shares by a non-Canadian, other than a WTO investor, would be subject to review under the Investment Act if it were an investment to acquire our direct control and the value of the assets were $5.0 million or more, as indicated on our financial statements for our fiscal year immediately preceding the implementation of the investment.

A non-Canadian, whether a WTO investor or otherwise, would acquire control in us for the purposes of the Investment Act if he, she or it acquired a majority of our common shares or acquired all or substantially all of the assets used in conjunction with our business. The acquisition of less than a majority, but one-third or more of our common shares, would be presumed to be an acquisition of control in us unless it could be established that we were not controlled in fact by the acquirer through the ownership of common shares.

The Investment Act would not apply to certain transactions in relation to our common shares including:

(a)  
an acquisition of our common shares by any person if the acquisition were made in the ordinary course of that person's business as a trader or dealer in securities;
 
 
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(b)  
an acquisition of control in us in connection with the realization of security granted for a loan or other financial assistance and not for any purpose related to the provisions of the Investment Act; and

(c)  
an acquisition of control in us by reason of an amalgamation, merger, consolidation or corporate reorganization following which the ultimate direct or indirect control in fact in us through the ownership of voting interests, remains unchanged.

Material Canadian Federal Income Tax Considerations

General
The following is a summary of the material Canadian federal income tax considerations generally applicable to a person who acquires our common shares and who, for purposes of the Income Tax Act (Canada) and the Canada-United States Income Tax Convention, 1980, as applicable, and at all relevant times, is a U.S. holder.  Readers are cautioned that this is not a complete technical analysis or listing of all potential tax effects that may be relevant to holders of our common shares.  In particular, this discussion does not deal with the tax consequences applicable to all categories of investors, some of which may be subject to special rules, and does not address the tax consequences under Canadian provincial or territorial tax laws, or tax laws of jurisdictions outside of Canada.  Accordingly, you should consult your own advisor regarding the particular tax consequences to you of an investment in our common shares.  This summary is based on the advice of our Canadian counsel, Perley-Robertson, Hill & McDougall.

For purposes of the Income Tax Act (Canada) and the Canada-United States Income Tax Convention, 1980, a U.S. holder is a person that:
 
·  
is a U.S. individual;
 
·  
through the period during which the person owns our common shares is not resident in Canada and is a resident of the United States;
 
·  
holds our common shares as capital assets, that is generally as investments;
 
·  
deals at arm’s length with us within the meaning of the Income Tax Act (Canada);
 
·  
does not have a permanent establishment or fixed base in Canada, as defined by the Canada-United States Income Tax Convention, 1980; and
 
·  
does not own and is not treated as owning, 10% or more of our outstanding voting shares.

Special rules, which we do not address in this discussion, may apply to a U.S. holder that is (a) an insurer that carries on an insurance business in Canada and elsewhere, (b) a financial institution subject to special provisions of the Income Tax Act (Canada) applicable to income gain or loss arising from mark-to-market property, or (c) a fiscally transparent entity with respect to the recently introduced Fifth Protocol to the Canada-United States Income Tax Convention, 1980 and may be treated differently than an individual.

This discussion is based on the current provisions of the Canada-United States Income Tax Convention, 1980, the Income Tax Act (Canada) and their regulations, all specific proposals to amend the Income Tax Act (Canada) and regulations, all specific proposals to amend the Income Tax Act (Canada) and regulations announced by the Minister of Finance (Canada) before the date of this annual report and counsel’s understanding of the current published administrative practices of Canada Revenue Agency.  This discussion is not exhaustive of all potential Canadian tax consequences to a U.S. holder and does not take into account or anticipate any other changes in law, whether by judicial, governmental or legislative decision or action, nor does it take into account the tax legislation or considerations of any province, territory or foreign jurisdiction.
 
Taxation of Dividends
Dividends paid or credited or deemed to be paid or credited on common shares owned by a U.S. holder will be subject to Canadian withholding tax under the Income Tax Act (Canada) at a rate of 25% on the gross amount of the dividends.  The rate of withholding tax generally is reduced under the Canada-United States Income Tax Convention, 1980 to 15% where the U.S. holder is the beneficial owner of the dividends.  Under the Canada-United States Income Tax Convention, 1980, dividends paid to religious, scientific, literary, educational, charitable and similar tax exempt organizations and pension organizations that are resident and exempt from tax in the United States and that have complied with the administrative procedures specified in the Tax Convention are exempt from this Canadian withholding tax.
 
 
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Taxation of Capital Gains
Gains realized by a U.S. holder on a sale, disposition or deemed disposition of “taxable Canadian property” are taxable under the Income Tax Act (Canada).  Shares of a Canadian corporation qualify as “taxable Canadian property” unless they are listed on a designated stock exchange pursuant to the Income Tax Act (Canada).  The Over-the-Counter Bulletin Board (OTCBB) and the Pink Sheets electronic over-the-counter securities market are not designated stock exchanges, therefore our common shares are currently “taxable Canadian property”.

However, generally gains will be exempt from Canadian tax by the Canada-United States Income Tax Convention, 1980, so long as the value of our common shares at the time of the sale, disposition or deemed disposition is not derived principally from real property situated in Canada, as defined by the Canada-United States Income Tax Convention, 1980.  We have advised that currently our common shares do not derive their value principally from real property situated in Canada; however, the determination as to whether Canadian tax would be applicable on a sale, disposition or deemed disposition of common shares must be made at the time of that sale, disposition or deemed disposition.

Section 116 of the Income Tax Act (Canada) requires that a U.S. holder apply to the Canada Revenue Agency for a clearance certificate either before or within 10 days after a disposition of “taxable Canadian property” even if a treaty exemption applies; failure to comply or the making of false representations exposes the U.S. holder to prosecution.  While delisted, on the disposition of our common shares to another U.S. resident, the U.S. holder will be deemed to dispose of the common shares and will have to comply with Section 116 and all related filings and withholdings, including filing a Canadian tax return.

If relisted on the Nasdaq Stock Market or listed on any other designated stock exchange then our common shares will generally not be taxable Canadian property provided that at no time during the five-year period immediately preceding the sale, disposition or deemed disposition, did the U.S. holder, persons with whom the U.S. holder did not deal at arm’s length, or the U.S. Holder acting together with those persons, own or have an interest in or a right to acquire 25% or more of the issued shares of any class or series of our shares.

If relisted, our common shares will cease to be “taxable Canadian property” and Section 116 will not apply to a disposition by a U.S. holder.

A deemed disposition of common shares will occur on the death of a U.S. holder.

Material United States Federal Income Tax Considerations

General
Subject to the limitations described below, the following discussion describes the material United States federal income tax consequences to a U.S. Holder (as defined below) that is a beneficial owner of the common shares of Workstream Inc. and that holds them as capital assets.  For purposes of this summary, a “U.S. Holder” is a beneficial owner of common shares who or that is for United States federal income tax purposes (i) a citizen or resident of the United States, (ii) a corporation (or other entity treated as a corporation for United States federal tax purposes) created or organized in the United States or under the laws of the United States or of any state or the District of Columbia, (iii) an estate, the income of which is includible in gross income for United States federal income tax purposes regardless of its source, or (iv) a trust, if a court within the United States is able to exercise primary supervision over the administration of the trust and one or more U.S. persons have the authority to control all substantial decisions of the trust.

This summary is for general information purposes only.  It does not purport to be a comprehensive description of all of the tax considerations that may be relevant to owning the common shares.  AS THIS IS A GENERAL SUMMARY, OWNERS OF COMMON SHARES ARE ADVISED TO CONSULT THEIR OWN TAX ADVISERS WITH RESPECT TO THE U.S. FEDERAL, STATE AND LOCAL TAX CONSEQUENCES, AS WELL AS TO NON-U.S. TAX CONSEQUENCES, OF THE ACQUISITION, OWNERSHIP AND DISPOSITION OF COMMON SHARES APPLICABLE TO THEIR PARTICULAR TAX SITUATIONS.
 
This discussion is based on current provisions of the U.S. Internal Revenue Code of 1986, as amended, current and proposed U.S. Treasury regulations promulgated thereunder, and administrative and judicial decisions, as of the date hereof, all of which are subject to change, possibly on a retroactive basis.  This discussion does not address all aspects of United States federal income taxation that may be relevant to any particular holder based on such holder’s individual circumstances.  In particular, this discussion does not address the potential application of the alternative minimum tax or the United States federal income tax consequences to holders that are subject to special treatment, including:
 
 
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·  
broker-dealers, including dealers in securities or currencies;
·  
insurance companies, regulated investment companies or real estate investment trusts;
·  
taxpayers that have elected mark-to-market accounting;
·  
tax-exempt organizations;
·  
financial institutions or “financial services entities”;
·  
taxpayers who hold common shares as part of a straddle, “hedge” or “conversion transaction” with other investments;
·  
holders owning directly, indirectly or by attribution at least 10% of our voting power;
·  
non-resident aliens of the United States;
·  
taxpayers whose functional currency is not the U.S. dollar; and
·  
taxpayers who acquire common shares as compensation.

This discussion does not address any aspect of United States federal gift or estate tax, or state, local or non-United States laws.  Additionally, the discussion does not consider the tax treatment of partnerships or persons who hold common shares through a partnership or other pass-through entity.  Certain material aspects of United States federal income tax relevant to a beneficial owner other than a U.S. Holder (a “Non-U.S. Holder”) also are discussed below.
 
EACH HOLDER OF COMMON SHARES IS ADVISED TO CONSULT SUCH PERSON’S OWN TAX ADVISOR WITH RESPECT TO THE SPECIFIC TAX CONSEQUENCES TO SUCH PERSON OF PURCHASING, HOLDING OR DISPOSING OF COMMON SHARES.
 
Taxation of Dividends Paid on Common Shares
We have never paid cash dividends, and we currently do not intend to pay cash dividends in the foreseeable future.  In the event that we do pay a dividend, and subject to the discussion of the passive foreign investment company, or PFIC, rules below, a U.S. Holder will be required to include in gross income as ordinary income the amount of any distribution paid on our common shares, including any Canadian taxes withheld from the amount paid, on the date the distribution is received to the extent the distribution is paid out of our current or accumulated earnings and profits, as determined for United States federal income tax purposes.  In the case of non-corporate U.S. Holders, dividends may qualify for favorable tax treatment.  Distributions in excess of such earnings and profits will be applied against and will reduce the U.S. Holder’s basis in the common shares and, to the extent in excess of such basis, will be treated as a gain from the sale or exchange of the common shares.
 
Distributions of current or accumulated earnings and profits paid in a currency other than the U.S. dollar to a U.S. Holder will be includible in the income of a U.S. Holder in a U.S. dollar amount calculated by reference to the exchange rate on the date the distribution is received.  A U.S. Holder that receives a distribution in a currency other than the U.S. dollar and converts the non-U.S. currency into U.S. dollars subsequent to its receipt will have foreign exchange gain or loss based on any appreciation or depreciation in the value of the non-U.S. currency against the U.S. dollar, which will generally be U.S. source ordinary income or loss.
 
U.S. Holders will have the option of claiming the amount of any Canadian income taxes withheld at source either as a deduction from gross income or as a dollar-for-dollar credit against their United States federal income tax liability.  Individuals who do not claim itemized deductions, but instead utilize the standard deduction, may not claim a deduction for the amount of any Canadian income taxes withheld, but such individuals may still claim a credit against their United States federal income tax liability.  The amount of foreign income taxes which may be claimed as a credit in any year is subject to complex limitations and restrictions, which must be determined on an individual basis by each shareholder.  The total amount of allowable foreign tax credits in any year cannot exceed the pre-credit U.S. tax liability for the year attributable to foreign source taxable income.
 
A U.S. Holder will be denied a foreign tax credit with respect to Canadian income tax withheld from dividends received on our common shares:
 
·  
if such U.S. Holder has not held the common shares for at least 16 days of the 30-day period beginning on the date which is 15 days before the ex-dividend date; or
 
 
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·  
to the extent such U.S. Holder is under an obligation to make related payments on substantially similar or related property.
 
Any days during which a U.S. Holder has substantially diminished its risk of loss on the common shares are not counted toward meeting the 15-day holding period required by the statute.  In addition, distributions of current or accumulated earnings and profits will be foreign source passive income for United States foreign tax credit purposes and will not qualify for the dividends received deduction otherwise available to corporations.
 
Taxation of the Disposition of Common Shares
Subject to the discussion of the PFIC rules below, upon the sale, exchange or other disposition of our common shares, a U.S. Holder will generally recognize capital gain or loss in an amount equal to the difference between the amount realized on the disposition and such U.S. Holder’s tax basis in the common shares (tax basis is usually the U.S. dollar cost of such common shares).  If the common shares are publicly traded, a disposition of common shares will be considered to occur on the “trade date,” regardless of the U.S. Holder’s method of accounting.  A U.S. Holder that uses the cash method of accounting calculates the U.S. dollar value of the proceeds received on the sale as of the date that the sale settles.  However, a U.S. Holder that uses the accrual method of accounting is required to calculate the value of the proceeds of the sale as of the “trade date” and may therefore realize foreign currency gain or loss, unless such U.S. Holder has elected to use the settlement date to determine its proceeds of sale for purposes of calculating such foreign currency gain or loss.  Capital gain from the sale, exchange or other disposition of the common shares held more than one year is long-term capital gain.  Gain or loss recognized by a U.S. Holder on a sale, exchange or other disposition of common shares generally will be treated as United States source income or loss for United States foreign tax credit purposes.  The deductibility of a capital loss recognized on the sale, exchange or other disposition of common shares is subject to limitations.  In addition, a U.S. Holder that receives non-U.S. currency upon disposition of our common shares and converts the non-U.S. currency into U.S. dollars subsequent to its receipt will have foreign exchange gain or loss based on any appreciation or depreciation in the value of the non-U.S. currency against the U.S. dollar, which will generally be United States source ordinary income or loss.

Passive Foreign Investment Company Considerations
We will be a passive foreign investment company, or PFIC, for United States federal income tax purposes, if 75% or more of our gross income in a taxable year, including the pro rata share of the gross income of any company, U.S. or foreign, in which we are considered to own 25% or more of the shares by value, is passive income.  Alternatively, we will be considered to be a PFIC if 50% or more of our assets in a taxable year, averaged over the year and ordinarily determined based on fair market value and including the pro rata share of the assets of any company in which we are considered to own 25% or more of the shares by value, are held for the production of, or produce, passive income.  Passive income includes amounts derived by reason of the temporary investment of funds raised in our public offerings.
 
If we were a PFIC, and a U.S. Holder did not make a qualifying election either to (i) treat us as a “qualified electing fund” (a “QEF”) (as described below), or (ii) mark our common shares to market (as discussed below), excess distributions by us to a U.S. Holder would be taxed under special rules.  “Excess distributions” are amounts received by a U.S. Holder with respect to shares in a PFIC in any taxable year that exceed 125% of the average distributions received by such U.S. Holder from the PFIC in the shorter of either the three previous years or such U.S. Holder’s holding period for such shares before the present taxable year.  Excess distributions must be allocated ratably to each day that a U.S. Holder has held shares in a PFIC.  A U.S. Holder must include amounts allocated to the current taxable year in its gross income as ordinary income for that year.  Further, a U.S. Holder must pay tax on amounts allocated to each prior PFIC taxable year at the highest rate in effect for that year on ordinary income and the tax is subject to an interest charge at the rate applicable to deficiencies for income tax.  The entire amount of gain that is realized by a U.S. Holder upon the sale or other disposition of our common shares will also be treated as an excess distribution and will be subject to tax as described above.  A. U.S. Holder’s tax basis in our common shares that were acquired from a decedent who was a U.S. Holder would not receive a step-up to fair market value as of the date of the decedent’s death but would instead be equal to the decedent’s basis, if lower.  If we were a PFIC, a U.S. Holder of our common shares will be subject to the PFIC rules as if such holder owned its pro-rata share of any of our direct or indirect subsidiaries which are themselves PFICs.  Accordingly, a U.S. Holder of our common shares will be subject to tax under the PFIC rules with respect to distributions to us by, and dispositions by us of stock of, any direct or indirect PFIC stock held by us, as if such holder received directly its pro-rata share of either the distribution or proceeds from such disposition.
 
 
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The special PFIC rules described above will not apply to a U.S. Holder if the U.S. Holder makes an election to treat us as a “qualified electing fund” in the first taxable year in which the U.S. Holder owns common shares and if we comply with certain reporting requirements.  Instead, a shareholder of a QEF is required for each taxable year to include in income a pro rata share of the ordinary earnings of the qualified electing fund as ordinary income and a pro rata share of the net capital gain of the QEF as long-term capital gain, subject to a separate election to defer payment of taxes, which deferral is subject to an interest charge.  The QEF election is made on a shareholder-by-shareholder basis and can be revoked only with the consent of the U.S. Internal Revenue Service, (“IRS”).  A shareholder makes a QEF election by attaching a completed IRS Form 8621, including the PFIC annual information statement, to a timely filed United States federal income tax return and by filing such form with the IRS Service Center in Philadelphia, Pennsylvania.  Even if a QEF election is not made, a shareholder in a PFIC who is a U.S. person must file a completed IRS Form 8621 every year.  We have agreed to supply U.S. Holders with the information needed to report income and gain pursuant to a QEF election in the event we are classified as a PFIC.
 
A U.S. Holder of PFIC stock which is publicly traded could elect to mark the stock to market annually, recognizing as ordinary income or loss each year an amount equal to the difference as of the close of the taxable year between the fair market value of the PFIC stock and the U.S. Holder’s adjusted tax basis in the PFIC stock.  Losses would be allowed only to the extent of net mark-to-market gain previously included by the U.S. Holder under the election for prior taxable years.  If the mark-to-market election were made, then the rules set forth above would not apply for periods covered by the election.
 
We believe that we were not a PFIC for the fiscal years ending May 31, 2010 and 2009, and we believe that we will not be a PFIC for the fiscal year ending May 31, 2011.  The tests for determining PFIC status, however, are applied annually, and it is difficult to make accurate predictions of future income and assets, which are relevant to this determination.  Accordingly, there can be no assurance that we will not become a PFIC.  U.S. Holders who hold common shares during a period when we are a PFIC will be subject to the foregoing rules, even if we cease to be a PFIC, subject to certain exceptions for U.S. Holders who made a QEF election.  U.S. Holders are strongly urged to consult their tax advisors about the PFIC rules, including the consequences to them of making a mark-to-market or QEF election with respect to common shares in the event that we qualify as a PFIC.
 
Tax Consequences for Non-U.S. Holders of Common Shares
Except as described in “U.S. Information Reporting and Backup Withholding” below, a Non-U.S. Holder who is a beneficial owner of our common shares will not be subject to United States federal income or withholding tax on the payment of dividends on, and the proceeds from the disposition of, our common shares, unless:
 
·  
Such item is effectively connected with the conduct by the Non-U.S. Holder of a trade or business in the United States and, in the case of a resident of a country which has a treaty with the United States, such item is attributable to a permanent establishment or, in the case of an individual, a fixed place of business, in the United States;
 
·  
The Non-U.S. Holder is an individual who holds the common shares as capital assets and is present in the United States for 183 days or more in the taxable year of the disposition and does not qualify for an exemption; or
 
·  
The Non-U.S. Holder is subject to tax pursuant to the provisions of United States tax law applicable to U.S. expatriates.
 
U.S. Information Reporting and Backup Withholding
U.S. Holders generally are subject to information reporting requirements with respect to dividends paid in the United States on common shares.  In addition, U.S. Holders are subject to U.S. backup withholding at a rate of up to 28% on dividends paid in the United States on common shares unless the U.S. Holder provides an IRS Form W-9 or otherwise establishes an exemption.  U.S. Holders are subject to information reporting and backup withholding at a rate of up to 28% on proceeds paid from the sale, exchange, redemption or other disposition of common shares unless the U.S. Holder provides an IRS Form W-9 or otherwise establishes an exemption.
 
Non-U.S. Holders generally are not subject to information reporting or backup withholding with respect to dividends paid on, or proceeds upon the sale, exchange, redemption or other disposition of, common shares, provided that such Non-U.S. Holder provides a taxpayer identification number, certifies to its foreign status, or otherwise establishes an exemption.
 
The amount of any backup withholding will be allowed as a credit against such U.S. Holder’s or Non-U.S. Holder’s United States federal income tax liability and may entitle such holder to a refund, provided that the required information is furnished to the IRS.
 
 
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ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
FORWARD LOOKING STATEMENTS

Certain statements discussed in Item 7 (Management’s Discussion and Analysis of Financial Condition and Results of Operations) and elsewhere in this Form 10-K 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.  The words “estimate,” “project,” “intend,” “believe,” “plan” and similar expressions are intended to identify forward-looking statements.  Our actual results could differ materially from our historical operating results and from those anticipated in these forward-looking statements as a result of certain factors, including, without limitation, those set forth in Part I, Item 1A, "Risk Factors," of this Form 10-K and other factors and uncertainties contained elsewhere in this Form 10-K and in our other filings with the Securities and Exchange Commission.  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 consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.  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.

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

 
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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.

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.  Therefore, fiscal 2010 expenses for consulting fees and employment related expenses such as wages, commissions, bonuses, payroll taxes and health benefits were sharply lower than fiscal 2009 expenses, particularly in comparison to the first and second quarters.

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.

 Revenues

    Fiscal Years Ended May 31  
   
2010
   
2009
   
$ Change
   
% Change
 
Revenues:
                       
Software
  $ 6,011,926     $ 7,657,142     $ (1,645,216 )     -21.5 %
Professional services
    752,251       2,388,063       (1,635,812 )     -68.5 %
Rewards
    6,600,265       5,957,039       643,226       10.8 %
Career networks
    3,160,323       5,541,826       (2,381,503 )     -43.0 %
   Total revenues
  $ 16,524,765     $ 21,544,070     $ (5,019,305 )     -23.3 %
                                 
Percentage of total revenues:
                               
Software
    36.4 %     35.5 %                
Professional services
    4.6 %     11.1 %                
Rewards
    39.9 %     27.7 %                
Career networks
    19.1 %     25.7 %                
 
Fiscal Year 2010 Compared to Fiscal Year 2009: Software revenue decreased primarily due to lower subscriptions as a result of discontinuing support on old software versions and lack of renewals from existing client base.  Professional services revenues decreased due to less consulting for existing customer upgrades or specialization work and no new customers.  We have implemented a new, more targeted approach during the third and fourth quarter of fiscal 2010 in order to attract new customers to coincide with an expected overall economic recovery and anticipated increase in IT spending.  Rewards increased significantly due to better efficiencies by the Company in shipping product and higher utilization of the rewards program by existing customers.  Career Networks revenues decreased primarily due to less employer and recruiter advertising and economic conditions that negatively affected deals in the recruiting and career transition services segment of the business along with less availability of financing for its customers.  Additionally, we spent less on marketing and advertising and as a result received less leads on which to convert to revenues.  We have implemented a more targeted approach and alternative financing terms for our career transition clients and as a result believe that the first quarter of fiscal 2011 revenues will begin to improve over fiscal 2010.
 
 
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Cost of Revenues & Gross Profit

    Fiscal Years Ended May 31  
   
2010
   
2009
   
$ Change
   
% Change
 
Cost of revenues:
                       
Software
  $ 505,700     $ 497,073     $ 8,627       1.7 %
Professional services
    135,749       485,368       (349,619 )     -72.0 %
Rewards
    5,185,203       4,629,585       555,618       12.0 %
Career networks
    126,429       312,400       (185,971 )     -59.5 %
    $ 5,953,081     $ 5,924,426     $ 28,655       0.5 %
Gross profit
  $ 10,571,684     $ 15,619,644     $ (5,047,960 )     -32.3 %
                                 
Gross profit as a percentage of total revenues:
                               
Software
    91.6 %     93.5 %                
Professional services
    82.0 %     79.7 %                
Rewards
    21.4 %     22.3 %                
Career networks
    96.0 %     94.4 %                
Total
    64.0 %     72.5 %                
 
Fiscal Year 2010 Compared to Fiscal Year 2009: Software costs of revenues increased due to increases in service provider fees.  Further, Software margins decreased due to this increase and lower subscription base as a result of discontinuing support on old software versions and lack of renewals from existing client base.  Professional services costs decreased due to less consulting for existing customer upgrades or specialization work as well as reductions in employee related expenses due to a reduction in headcount.  Rewards cost of revenues increased due to the higher volume of revenues while related margins decreased primarily from the lower margin items being ordered during the holiday season.  Gross profit on our rewards business is driven primarily by the mix of products redeemed by the customers and results typically range between 20%-30%.  Career Networks cost of revenues directly decreased due to the reduction in revenue levels.

Selling & Marketing Expense

    Fiscal Years Ended May 31  
   
2010
   
2009
   
$ Change
   
% Change
 
                         
Selling and marketing
  $ 1,880,091     $ 3,836,391     $ (1,956,300 )     -51.0 %
                                 
Percentage of total revenues
    11.4 %     17.8 %                
 
Fiscal Year 2010 Compared to Fiscal Year 2009: Consulting and employment related expenses decreased by approximately $1,518,000 primarily as a result of the restructuring and reduction of headcount at the end of first half of fiscal 2009.   Further, outside professional fees decreased from approximately $67,000 to nil during this period.  The additional decrease was due primarily to less trade shows (and related travel expenses), marketing and advertising programs in fiscal 2010.  Other administrative expenses also declined due to fewer employees and the cancellation and consolidation of contracts.
 
 
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General & Administrative Expense

    Fiscal Years Ended May 31  
   
2010
   
2009
   
$ Change
   
% Change
 
                         
General and administrative
  $ 7,654,941     $ 9,835,143     $ (2,180,202 )     -22.2 %
                                 
Percentage of total revenues
    46.3 %     45.7 %                

Fiscal Year 2010 Compared to Fiscal Year 2009: Consulting and employment related expenses declined by approximately $155,000 as a result of the reduction of employees.  Non-cash stock compensation expense decreased by approximately $17,000 due to the reduction in headcount resulting in a lower amount of options and restricted stock awards outstanding.  Professional fees decreased by approximately $362,000 during this timeframe.  Additionally, we reduced our space occupancy costs, equipment leases and insurance costs approximately $904,000 by changing or eliminating office space in various locations.  Telephone and Software expenses declined approximately $607,000 due to fewer employees and the cancellation and consolidation of contracts.

Research & Development Expense

    Fiscal Years Ended May 31  
   
2010
   
2009
   
$ Change
   
% Change
 
                         
Research and development
  $ 1,519,396     $ 3,478,241     $ (1,958,845 )     -56.3 %
                                 
Percentage of total revenues
    9.2 %     16.1 %                


Fiscal Year 2010 Compared to Fiscal Year 2009: Employment related expenses declined by approximately $764,000 as a result of the restructuring and reduction in headcount.  Costs associated with consultants and outsourcing of R&D activities decreased by approximately $685,000 during this period.  Additionally, we reduced our space occupancy costs by approximately $84,000 by changing or eliminating office space.  Other administrative expenses also declined due to fewer employees and due to the cancellation and consolidation of contracts.

Impairment of Goodwill
 
    Fiscal Years Ended May 31  
   
2010
   
2009
   
$ Change
   
% Change
 
                         
Impairment of goodwill
  $ 11,683,548     $ -     $ 11,683,548       N/A  
 
During fiscal year 2010, the Company determined that there were indicators of impairment for the goodwill associated with its Career Networks and Enterprise operating segments.  Based on this determination, the Company performed an interim impairment test.  In considering the current and expected future market conditions, the Company determined that the Career Network goodwill was impaired in accordance with ASC 350, Intangibles – Goodwill and Other, and the Company recorded non-cash, pre-tax goodwill impairment charges of $6,347,788 during the year ended May 31, 2010.  The decline in estimated fair value of the Career Networks operating segment resulted from an analysis of the current economic conditions, the Company’s performance to budget and the lower estimated future cash flows.  In considering the current and expected future market conditions, the Company determined that the Enterprise goodwill was impaired in accordance with ASC 350, Intangibles – Goodwill and Other, and the Company recorded non-cash, pre-tax goodwill impairment estimate charges of $5,335,760 during the year ended May 31, 2010.  The decline in estimated fair value of the Enterprise operating segment resulted from an analysis of the current economic conditions, the Company’s performance to budget and the lower estimated future cash flows.  The Enterprise operating segment goodwill impairment is an estimate that has 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 3 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 complete the full testing requirements prior to the issuance of the financials.  Any significant adjustment to the impairment estimate will be made in the 1st quarter of fiscal year 2011.

 
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Amortization & Depreciation Expense

    Fiscal Years Ended May 31  
   
2010
   
2009
   
$ Change
   
% Change
 
                         
Amortization and depreciation
  $ 822,903     $ 1,538,795     $ (715,892 )     -46.5 %
                                 
Percentage of total revenues
    5.0 %     7.1 %                

Fiscal Year 2010 Compared to Fiscal Year 2009: Amortization expense decreased by nearly $407,000 due to certain acquired intangible assets becoming fully amortized in prior years.  Without additional business acquisitions, we are not expecting to incur any additional amortization costs during fiscal 2011.  Depreciation expense also decreased by approximately $308,000 due to many of our fixed assets becoming fully depreciated.

Interest Income & Expense, Net

    Fiscal Years Ended May 31  
   
2010
   
2009
   
$ Change
   
% Change
 
                         
Interest income and expense, net
  $ (2,605,578 )   $ (1,466,697 )   $ (1,138,881 )     77.6 %
 
Fiscal Year 2010 Compared to Fiscal Year 2009: Interest expense on the 2008 Senior Secured Notes increased significantly due to the default interest rate increase of 5% caused by the NASDAQ delisting default in May 2009 and the additional interest rate increase of 5% in late August 2009 due to the failure to repay any of the 2008 Senior Secured Notes principal.  The 2008 Senior Secured Notes were outstanding and in default for the full first half of fiscal 2010.  There was also higher interest expense on the outstanding 2009 Senior Secured Notes in comparison to the 2008 Senior Secured Notes during the second half of fiscal 2010 due to a higher principal balance, as well as a higher applicable interest rate (i.e., 9.5% to 7.0%).  Furthermore, the Company recorded additional interest associated with the Payment-in-Kind (“PIK”) interest’s beneficial conversion feature on the new convertible notes.

Change in Fair Value of Warrants & Derivative

    Fiscal Years Ended May 31  
   
2010
   
2009
   
$ Change
   
% Change
 
Change in fair value of warrants
                       
and derivative
  $ 2,074,393     $ (51,127 )   $ 2,125,520       N/A  
 
At May 31, 2009 we had recognized an embedded put derivative liability of $493,693 related to a contingent put reflected in the contractual rights of default of our 2008 senior secured notes.  Due to the Exchange Agreement signed in December 2009, the value of this put derivative was reduced to nil and we recognized a gain on the decrease in the fair value of $493,693 in the consolidated statement of operations in fiscal year 2010.

On June 1, 2009, the Company adopted ASC 815, which required it to begin accounting for its 2008 warrants issued in an exchange transaction on August 29, 2008 (the “2008 Warrants”) as a liability due primarily to the reset provisions of the warrant in the event of lower priced financing transactions.  Therefore, the fair value of the 2008 Warrants was reclassified from equity to a liability classification as of June 1, 2009 via a cumulative effect adjustment.  We recognized a gain of $1,580,700 associated with the change in the fair value of the 2008 Warrants in the consolidated statement of operations in fiscal year 2010.
 
 
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Loss on Extinguishment of Debt

    Fiscal Years Ended May 31  
   
2010
   
2009
   
$ Change
   
% Change
 
                         
Loss on extinguishment of debt
  $ (13,071,440 )   $ (401,791 )   $ (12,669,649 )     N/A  

In a senior secured note exchange on December 11, 2009 (discussed under Liquidity and Capital Resources), the fair value of the 2009 Secured Notes and embedded put derivatives were 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.  Furthermore, as a result of the Company’s issuance of the $0.10 Convertible Notes, the exercise price of $2,800,000 of its 2008 Warrants that remained 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.
 
Income Taxes

    Fiscal Years Ended May 31  
   
2010
   
2009
   
$ Change
   
% Change
 
                         
Income tax expense
  $ (46,819 )   $ 105,067     $ (151,886 )     -144.6 %
 
Income taxes continue to be minimal for all periods presented, primarily due to current operating losses and significant net operating loss carry forwards in various jurisdictions.  Future effective tax rates could be adversely affected by unfavorable changes in tax laws and regulations, limitations on net operating loss deductions, or by adverse rulings in any tax related litigation that may arise.
 
LIQUIDITY AND CAPITAL RESOURCES

Working Capital: As of May 31, 2010, working capital, which represents current assets less current liabilities, was negative $4,500,000 million.  With the refinancing transactions subsequent to May 31, 2010 (discussed below), the Company nearly eliminated its outstanding debt and received the cash it needed to improve working capital to positive levels.  Due to refinancing transactions and significant reduction in operating expenses in the fourth quarter of fiscal year 2008 and throughout fiscal years 2009 and 2010, management believes that current operations will be sufficient to meet its anticipated working capital and capital expenditure requirements in the future.

Cash & Cash Equivalents: As of May 31, 2010, we have approximately $358,000 in cash and cash equivalents, which primarily consists of deposits held with banks.  Cash decreased from May 31, 2009 primarily due to funding for the rewards program.

Accounts Receivable: Days sales outstanding (“DSO”) is based upon a rolling 12 month calculation performed quarterly.  It is calculated as total accounts receivable (less Allen & Associates accounts receivable) divided by average day’s sales, which is calculated as revenues (less Allen & Associated revenues) divided by the total number of days in period.  The DSO ratio decreased to 24.7 days at May 31, 2010 from 59.3 days at May 31, 2009.  The cause for the improvement in DSO is primarily due to an increased focus on cash collections.

Accounts Payable & Accrued Liabilities:  Management is in the process of systematically reducing accounts payable and accrued liabilities as part of its overall plan to better align the Company’s financial position with its current operational requirements.  Further, the Company is in constant negotiations with its vendors, particularly relating to the rewards programs, for increased credit limits and improved payment terms to improve cash flows.

Cash Flows: The following is a summary of cash flow activities for the twelve months ended May 31, 2010 and 2009:

 
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    Fiscal Years Ended May 31  
   
2010
   
2009
   
$ Change
   
% Change
 
                         
Cash used in operating activities
  $ (624,514 )   $ (1,713,972 )   $ 1,089,458       -63.6 %
Cash provided by / (used in) investing activities
    (106,762 )     434,445       (541,207 )     -124.6 %
Cash used in financing activities
    (441,934 )     (499,816 )     57,882       -11.6 %
 
Cash Flows From Operating Activities: The reduction in these cash flows primarily relates to management’s overall plan of better aligning costs with the Company’s revenues and operations.  The reduction primarily centered on reducing consulting and employment related expenses.  Additionally, reductions in our space occupancy costs, insurance costs, telephone, travel and other administrative expenses contributed to the reduction of cash used in operating activities.

Cash Flows From Investing Activities: The changes in these cash flows relate to the acquisition of certain IT equipment associated with providing the Company’s software hosting services.

Cash Flows From Financing Activities: The decrease in these cash flows primarily relates to a decrease in payments for capital lease obligations outstanding during each period that was partially offset by the financing costs incurred in the note exchange and restructuring of the senior secured notes in December 2009.

EBITDA: To supplement our consolidated statements of operations and cash flows, we use non-GAAP measures of EBITDA.  Management believes that EBITDA, as a complement to US GAAP amounts, allows one to meaningfully trend and analyze the performance of the Company’s core cash operations.  The presentation of this non-GAAP measure is not meant to be considered in isolation or as an alternative to net income as an indicator of our performance, or as an alternative to cash flows from operating activities as a measure of liquidity.  EBITDA is calculated as follows:
 
    Fiscal Years Ended  
   
May 31
 
   
2010
   
2009
 
             
Net income / (loss), as reported under US GAAP
  $ (26,583,731 )   $ (4,856,356 )
                 
Effects of certain transactions:
               
Interest income and expense, net
    2,605,578       1,466,697  
Income tax benefit / (expense)
    46,819       (105,067 )
Amortization and depreciation
    822,903       1,538,795  
Stock-based compensation
    161,680       179,194  
Loss on extinguishment of debt
    13,071,440       401,791  
Impairment of goodwill
    11,683,548       -  
Change in fair value of warrants and derivative
    (2,074,393 )     51,127  
Other income and expense, net
    (54,908 )     (27,118 )
                 
EBITDA, as adjusted
  $ (321,064 )   $ (1,350,937 )

EBITDA is a non-GAAP financial measure within the meaning of Regulation G promulgated by the Securities and Exchange Commission.  EBITDA is commonly defined as earnings before interest, taxes, depreciation and amortization.   We believe that EBITDA provides useful information to investors as it excludes transactions not related to the core cash operating business activities including non-cash transactions.  We believe that excluding these transactions allows investors to meaningfully trend and analyze the performance of our core cash operations.  All companies do not calculate EBITDA in the same manner, and EBITDA as presented by Workstream may not be comparable to EBITDA presented by other companies.  Workstream defines EBITDA as earnings or loss from continuing operations before interest, taxes, depreciation and amortization, other income and expense, including effects of foreign currency gains or losses, non-cash stock related compensation, and non-recurring goodwill impairment, if applicable.

Off-Balance Sheet Arrangements: We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

 
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Refinancing of Senior Secured Notes Payable

On December 11, 2009, the Company entered into a separate Exchange Agreement (collectively, the “2009 Exchange Agreements”) with each of the Holders of its senior secured promissory notes pursuant to which, among other things, each Holder exchanged their existing 2008 Notes 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.

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 existing Security Agreement with the Holders, as amended in connection with the exchange transaction.   Interest on the 2009 Secured Notes accrued at an annual rate of 9.5%. Interest on the $0.25 Convertible Notes and the $0.10 Convertible Notes compounded on a quarterly basis and is 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 is payable on a quarterly basis pursuant to an agreed upon schedule.

Upon the occurrence of an event of default, as defined in the 2009 Secured Notes, a Holder could require the Company to redeem all or a portion of such Holder’s 2009 Notes.  Upon a disposition of assets or liquidity event (each as defined in the 2009 Secured Notes), the Company was required to use 100% of the net proceeds to redeem the 2009 Secured Notes.  Each 2009 Secured Note also contained certain financial and other customary covenants with which the Company was required to comply.  Each subsidiary of the Company previously agreed to guarantee the obligations of the Company under the prior secured 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.

Each of the 2008 Warrants issued in connection with a 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 2008 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 proportionally increased by 4,200,000 to 7,000,000.

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.

Pursuant to the terms of the 2010 Exchange Agreements with certain of the Holders, the Company also consummated a private placement pursuant to which it raised $750,000 through the sale of an aggregate 37,936,243 common shares in the Company to certain of the Holders.  Simultaneous with the consummation of the transactions contemplated by the 2010 Exchange Agreements, pursuant to the terms of a Stock Purchase Agreement (the “Stock Purchase Agreement”) between the Company, and affiliates, John Long, David Kennedy and Ezra Schneier (together, the “New Management Team”), the Company completed a private placement pursuant to which it raised an additional $500,000 through the sale of an aggregate 25,290,828 common shares in the Company to the New Management Team (such common shares, together with the common shares purchased under the Exchange Agreements by the Holders, the “Purchased Shares”).  The Company is using the proceeds from the private placements for working capital and general corporate purposes.

The Company and each of the Holders also entered into a Third Amended and Restated Registration Rights Agreement pursuant to which the Company agreed to register for resale under the Securities Act of 1933, upon the request of a majority of the holders of Registrable Securities thereunder, the common shares received in the exchange, the Purchased Shares and the common shares issuable upon exercise of certain warrants.  If the Company fails to comply with the filing and effectiveness deadlines set forth in the Registration Rights Agreement, the Company must pay to the Holder an amount in cash equal to 0.5% of the sum of the aggregate principal amount of the 2009 Secured Notes and the purchase price paid for the Purchased Shares purchased by such Holder under the relevant Exchange Agreement on the date of such failure and each 30 day anniversary thereafter, in an amount not to exceed $1,000,000 in the aggregate.
 
 
34

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

The conversion of the 2009 Notes to equity eliminates the need for quarterly principal payments and the final payment of principal on the 2009 Notes and accrued interest in 2012.  This allows for the usage of this cash for operations.
 
CRITICAL ACCOUNTING POLICIES

We believe that the following critical accounting policies affect our more significant estimates and judgments used in preparation of our consolidated financial statements.  Management makes estimates and assumptions that affect the value of assets and the reported revenues. Changes in assumptions used would impact our financial position and results.  Our significant estimates include the allowance for trade receivables, valuation of goodwill, valuation of derivative financial instruments, valuation of deferred taxes, valuation of stock-based compensation and loss contingencies.  Although we believe that these estimates are reasonable, actual results could differ from those estimates given a change in conditions or assumptions that have been consistently applied.

Management has discussed the selection of critical accounting policies and estimates with our Board of Directors, and the Board of Directors has reviewed our disclosure relating to critical accounting policies and estimates in this annual  report on Form 10-K. The critical accounting policies used by management and the methodology for its estimates and assumptions are as follows:

Revenue Recognition

The Company derives revenue from various sources including the following: subscription and hosting fees; licensing of software and related maintenance fees; professional services related to software implementation, customization and training; sale of products and tickets through the Company’s employee rewards software module; career transition services; recruitment research services; and, applicant sourcing.

In general, the Company recognizes revenue when all of the revenue recognition criteria are met, which is typically when:
·  
evidence of an arrangement exists;
·  
services have been provided or goods have been delivered;
·  
the price is fixed or determinable; and
·  
collection is reasonably assured.

The Company primarily provides various HCM software applications as an on-demand application service and also enters into the sale of license agreements.  Revenue is generated through a variety of contractual arrangements.

Subscription and hosting fees and software maintenance fees are billed in advance on a monthly, quarterly or annual basis.  Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met.  Quarterly and annual payments are deferred and recognized monthly over the service period on a straight-line basis.   Set up fees are deferred and recognized monthly on a straight-line basis over the contractual lives of the customer.
 
 
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Subscription revenues and hosting fees consist of fees from customers accessing our on-demand application service.  The Company follows the provisions of SEC Staff Accounting Bulletin No. 104, Revenue Recognition and ASC605-25, Revenue Recognition with Multiple Deliverables Arrangements.  For revenue arrangements with multiple deliverables, the Company allocates the total customer arrangement to the separate units of accounting based on their relative fair values, as determined by the price of the undelivered items when sold separately.  Professional services included in an application services arrangement with multiple deliverables are accounted for separately when these services have value to the customer on a standalone basis, and there is objective and reliable evidence of fair value of each undeliverable item of the arrangement. When accounted for separately, revenues are recognized as the services are rendered.

License revenues consist of fees earned from the granting of both perpetual and term licenses to use the software products.  The Company recognizes revenue from the sale of software licenses in accordance with ASC985-605, Software Revenue Recognition, when all of the following conditions are met: a signed contract exists; the software has been shipped or electronically delivered; the license fee is fixed or determinable; and the Company believes that the collection of the fees is reasonably assured.  License revenue is recorded upon delivery with an appropriate deferral for maintenance services, if applicable, provided all of the other relevant conditions have been met. The total fee from the arrangement is allocated based on Vendor Specific Objective Evidence ("VSOE") of fair value of each of the undelivered elements. Maintenance agreements are typically priced based on a percentage of the product license fee and are either multi-year or have a one-year term, renewable annually. VSOE of fair value for maintenance is established based on the stated renewal rates. Services provided to customers under maintenance agreements include technical product support and unspecified product upgrades. VSOE of fair value for the professional service element is based on the standard hourly rates the Company charges for services when such services are sold separately.

Source code revenue is generated by sales in small markets that we do not typically target.  The sales are for old versions of specific applications or products that we no longer support or sell.  As such, future earnings are not affected by these sales.  The Company recognizes revenue when all of the revenue recognition criteria are met, which is typically when the services have been completed.

Professional services revenue is generated from implementation of software applications and from customer training, customization and general consulting.  In addition, revenue is generated from technical support not included in the software maintenance.  The majority of professional services revenue is billed based on an hourly rate and recognized on a monthly basis as services are provided.  For certain contracts which involve significant implementation or other services which are essential to the functionality of the software and which are reasonably estimable, the license and implementation services revenue is recognized using contract accounting, as prescribed by ASC605-35, Revenue Recognition of Construction-Type and Certain Production-Type Contracts.  Revenue is recognized over the period of each implementation using the percentage-of-completion method.  Labor hours incurred is used as the measure of progress towards completion, and management believes its estimates to completion are reasonably dependable. A provision for estimated losses on engagements is made in the period in which the losses become probable and can be reasonably estimated.

One of the software applications offered by the Company allows customers to offer rewards, employee recognition and benefits in an effort to promote their employee retention.  The Company generates subscription revenues from the customer.  In addition, the Company generates revenue from the sale of products and tickets to the customers’ employees through a website.  The Company recognizes revenue when all of the revenue recognition criteria are met, which is typically when the goods are shipped and title has transferred.

For career transition services, the Company bills the client 50% when the assignment starts and the remaining 50% when the assignment is completed.  The Company recognizes revenue when all of the revenue recognition criteria are met, which is typically when services have been completed.

For applicant sourcing services, the Company bills its clients in advance on a monthly, quarterly and annual basis.  The Company recognizes revenue when all of the revenue recognition criteria are met, which is typically on a straight-line basis as services have been completed.  Unrecognized revenue is included in deferred revenue.

As described above, the Company defers certain revenues received and recognizes them ratably over the applicable term of service.  If the revenue is expected to be recognized within the following twelve months, it is classified as a current liability on the accompanying consolidated balance sheets.  If the revenue is expected to be recognized over a period longer than 12 months then the portion of revenue expected to be recognized greater than 12 months is classified as a long-term liability.
 
 
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Allowance for Doubtful Accounts

We perform ongoing credit evaluations of our accounts receivable balances.  Based on historical experience, we evaluate the accounts for potential uncollectible amounts based on a specific identification methodology and record a general reserve for all remaining balances.  Based on the age of the receivable, cash collection history and past dilution in the receivables, we make an estimate of our anticipated bad debt.  Based on this analysis, we reserved $442,195 and $928,430 for doubtful accounts at May 31, 2010 and 2009, respectively.  We believe that this estimate is reasonable, but there can be no assurance that our estimate will not change given a change in economic conditions or business conditions within our industry, our individual customer base or our Company.  Any adjustments to this account are reflected in the accompanying statements of operations and comprehensive loss as a general and administrative expense.

Goodwill

We test goodwill for impairment on an annual basis or as needed if circumstances arise that reduce the value of our reporting units below the carrying value.  We compare the fair value of each reporting unit to its carrying amount (including goodwill) for our impairment evaluation.  Our business segments are considered reporting units for goodwill impairment testing.  Goodwill is considered to be impaired if the carrying value of a reporting unit exceeds its fair value.  If goodwill is considered to be impaired, the loss that is recognized is equal to the amount that the carrying value of the reporting unit goodwill exceeds the implied fair value of that goodwill.

During fiscal year 2010, the Company determined that there were indicators of impairment for the goodwill associated with its Career Networks and Enterprise operating segments.  Based on this determination, the Company performed an interim impairment test.  In considering the current and expected future market conditions, the Company determined that the Career Network goodwill was impaired in accordance with ASC 350, Intangibles – Goodwill and Other, and the Company recorded non-cash, pre-tax goodwill impairment charges of $6,347,788 during the year ended May 31, 2010.  The decline in estimated fair value of the Career Networks operating segment resulted from an analysis of the current economic conditions, the Company’s performance to budget and the lower estimated future cash flows.  In considering the current and expected future market conditions, the Company determined that the Enterprise goodwill was impaired in accordance with ASC 350, Intangibles – Goodwill and Other, and the Company recorded non-cash, pre-tax goodwill impairment estimate charges of $5,335,760 during the year ended May 31, 2010.  The decline in estimated fair value of the Enterprise operating segment resulted from an analysis of the current economic conditions, the Company’s performance to budget and the lower estimated future cash flows.  The Enterprise operating segment goodwill impairment is an estimate that has 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 3 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 complete the full testing requirements prior to the issuance of the financials.  Any significant adjustment to the impairment estimate will be made in the 1st quarter of fiscal year 2011. 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.
 
There are judgments and estimates built into our fair value analysis, including future cash flow projections, the discount rate representing innate risk in future cash flows, market valuation, strategic operation plans and our interpretation of current economic indicators.  Changes in any of the underlying assumptions will cause a change in the results, which could lead to the fair value of one or more of the reporting units to be worth less than the current carrying amounts.  In addition to a change in market and economic conditions or our strategic plans, the possibility exists that our conclusions could change which would result in a material negative effect on both our financial position and results of operations.

While management has a plan to return the Company’s business fundamentals to levels that support the book value per common share, there is no assurance that the plan will be successful, or that the market price of the common stock will increase to such levels in the foreseeable future and the Company may have to recognize an impairment of all, or some portion of, its goodwill and other intangible assets. There is no assurance that: (1) valuation multiples will not decline, (2) discount rates will not increase or (3) the earnings, book values or projected earnings and cash flows of the Company’s individual reporting segments will not decline. Accordingly, an impairment charge to goodwill and other intangible assets may be required in the foreseeable future if the book equity value exceeds the estimated fair value of the enterprise or of an individual segment.
 
 
37

 
 
Derivative Financial Instruments

The Company’s Senior Secured Notes contain certain put derivatives reflected in their contractual rights.  Under certain conversion provisions, if the Company fails to provide timely delivery of shares associated with a conversion of the Notes, the Company will be liable for an amount equal to 2% of the conversion amount and the Holder will have the ability to decide to receive the conversion amounts in cash or in shares.  Under certain of the default provisions, the Holder has 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.  Additionally, the Company’s 2008 Senior Secured Notes issued on August 29, 2008 contained a contingent put reflected in the contractual rights of default.  Under these provisions, the Holder had the right to put the 2008 Notes back to the Company for 110% of face value in the event of certain equity-indexed defaults, such as listing failure and non-delivery of common shares usable upon exercise of certain warrants.  This embedded put derivative was recorded at fair value, marked-to-market at each reporting period and classified in the Company’s balance sheet as a separate line item.  When the 2008 Notes were renegotiated into the 2009 Notes, the embedded put derivative of the 2008 Notes was deemed to have no value.  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 related to the Senior Secured Notes were not deemed to have any value at May 31, 2010.  Along with these embedded put derivatives, certain Company issued warrants are recorded at fair value, marked-to-market at each reporting period and classified in the Company’s consolidated balance sheet as a separate line item.

Deferred Taxes

We apply significant judgment in recording deferred tax assets, which primarily are the result of loss carry forwards of companies that we acquired and loss carry forwards internally generated.  In addition, we make certain assumptions about if and when these deferred tax assets will be utilized.  These determinations require estimates of future profits to be forecasted.  The utilization of the Company’s net operating loss carry forwards may be limited in any given year under certain circumstances.  Events which may affect the Company’s ability to utilize these carry forwards include, but are not limited to, future profitability, cumulative stock ownership changes of 50% or more over a three-year period, as defined by Section 382 of the Internal Revenue Code, and the timing of the utilization of the tax benefit carry forwards.  Actual results may differ from amounts estimated.

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.

   
Fiscal Years Ended
 
   
May 31, 2010
   
May 31, 2009
 
             
Expected volatility
    168% - 176 %     161 %
Expected dividend yield
    0 %     0 %
Expected term (in years)
    3.5       3.5  
Risk-free interest rate
    2.2% -2.7 %     3.30 %
Forfeiture rate
    30 %     0 %
 
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.
 
 
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Loss Contingencies

We are involved in various lawsuits, claims, investigations and proceedings that arise in the ordinary course of business.  If the potential loss from an item is considered probable and the amount can be estimated, we accrue a liability for the estimated loss, as provided in ASC 450, Contingencies.  Because of uncertainties related to these matters, accruals are based only on the best information available at the time.  Periodically, we review the status of each significant matter and assess our potential financial exposure.  These matters are inherently unpredictable and are subject to significant uncertainties, some of which are beyond our control.  Should any of the estimates and assumptions utilized to estimate potential losses change or prove to have been incorrect, it could have a material impact on our results of operations, financial position or cash flows.  
 
RECENT ACCOUNTING PRONOUNCEMENTS

See Note 1 in the Consolidated Financial Statements for information concerning recent accounting pronouncements.
 
ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
The Board of Directors and Stockholders
Workstream Inc.
 
We have audited the accompanying consolidated balance sheets of Workstream Inc. and Subsidiaries as of May 31, 2010 and 2009, and the related consolidated statements of operations and comprehensive loss, stockholders’ deficit, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Workstream Inc. and Subsidiaries as of May 31, 2010 and 2009, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

/s/ Cross, Fernandez & Riley, LLP

Orlando, Florida
September 13, 2010

 
39

 
 
WORKSTREAM INC.
 
CONSOLIDATED BALANCE SHEETS
 
                   
                   
                   
   
Notes
   
May 31, 2010
   
May 31, 2009
 
ASSETS:
                 
Current assets:
                 
   Cash and cash equivalents
        $ 358,529     $ 1,643,768  
   Accounts receivable, net of allowances of $442,195 and $928,430 at
    2                  
      May 31, 2010 and May 31, 2009, respectively
            1,606,623       2,746,360  
   Prepaid expenses and other assets
            161,692       146,609  
         Total current assets
            2,126,844       4,536,737  
                         
Equipment, net
    4       295,798       757,050  
Other assets
            163,817       30,990  
Acquired intangible assets, net
    5       -       21,500  
Goodwill
    5       6,045,900       17,729,448  
                         
TOTAL ASSETS
          $ 8,632,359     $ 23,075,725  
                         
LIABILITIES AND SHAREHOLDERS’ DEFICIT:
                       
Current liabilities:
                       
   Accounts payable
          $ 1,232,019     $ 1,856,892  
   Accrued liabilities
    6       3,211,124       2,924,145  
   Accrued compensation
            516,209       526,935  
   Current portion of senior secured notes payable and accrued interest
    1, 3       -       20,158,044  
   Embedded put derivative
    3       -       493,693  
   Current portion of long-term obligations
    7       200,469       199,516  
   Deferred revenue
            1,456,005       2,591,328  
         Total current liabilities
            6,615,826       28,750,553  
                         
Senior secured notes payable and accrued interest
    3       21,718,093       -  
Long-term obligations, less current portion
    7       138,858       124,594  
Deferred revenue – long-term
            7,667       -  
Common stock warrant liability
    3       268,600       -  
         Total liabilities
            28,749,044       28,875,147  
                         
Commitments and Contingencies
    8                  
                         
SHAREHOLDERS’ DEFICIT:
    9                  
   Preferred shares, no par value
            -       -  
   Common shares, no par value issued and outstanding 65,666,341 and 56,993,312 shares as of May 31, 2010 and 2009
            114,498,157       113,668,376  
   Additional paid-in capital
            30,313,814       18,269,589  
   Accumulated deficit
    1       (163,997,644 )     (136,876,313 )
   Accumulated other comprehensive loss
            (931,012 )     (861,074 )
         Total shareholders’ deficit
            (20,116,685 )     (5,799,422 )
                         
TOTAL LIABILITIES AND SHAREHOLDERS’ DEFICIT
          $ 8,632,359     $ 23,075,725  

See accompanying notes to these consolidated financial statements.
 
 
40

 
 
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

         
Fiscal Years Ended
 
   
Notes
   
May 31, 2010
   
May 31, 2009
 
Revenues:
                 
Software
        $ 6,011,926     $ 7,657,142  
Professional services
          752,251       2,388,063  
Rewards
          6,600,265       5,957,039  
Career networks
          3,160,323       5,541,826  
Revenues, net
          16,524,765       21,544,070  
                       
Cost of revenues:
                     
  Rewards
          5,198,618       4,629,585  
  Other
          754,463       1,294,841  
  Cost of revenues (exclusive of amortization
          5,953,081       5,924,426  
   and depreciation expense noted below)
                     
                       
Gross profit
          10,571,684       15,619,644  
                       
Operating expenses:
                     
Selling and marketing
          1,880,091       3,836,391  
General and administrative
          7,654,941       9,835,143  
Research and development
          1,519,396       3,478,241  
Amortization and depreciation
          822,903       1,538,795  
Impairment of goodwill
    5       11,683,548       -  
Total operating expenses
            23,560,879       18,688,570  
                         
Operating loss
            (12,989,195 )     (3,068,926 )
                         
Other income / (expense):
                       
Interest income and expense, net
            (2,605,578 )     (1,466,697 )
Loss on extinguishment of debt
    3, 7       (13,071,440 )     (401,791 )
Change in fair value of warrants and derivative
    3       2,074,393       (51,127 )
Other income and expense, net
            54,908       27,118  
Other expense, net
            (13,547,717 )     (1,892,497 )
                         
Loss before income tax benefit / (expense)
            (26,536,912 )     (4,961,423 )
                         
Income tax benefit / (expense)
            (46,819 )     105,067  
                         
NET LOSS
          $ (26,583,731 )   $ (4,856,356 )
                         
Loss per share - basic and diluted
    12     $ (0.45 )   $ (0.09 )
                         
Weighted average number of common shares
                       
   outstanding:
                       
        Basic
            58,758,625       55,007,730  
        Diluted
            58,758,625       55,007,730  
                         
                         
Net loss
          $ (26,583,731 )   $ (4,856,356 )
Comprehensive loss:
                       
 Foreign curency translation adjustment
            (69,938 )     (61,884 )
                         
COMPREHENSIVE LOSS
          $ (26,653,669 )   $ (4,918,240 )

See accompanying notes to these consolidated financial statements.

 
41

 
 
WORKSTREAM INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT

                     
Accumulated
                   
               
Additional
   
Other
         
Total
       
   
Common Stock
   
Paid-In
   
Comprehensive
   
Accumulated
   
Stockholders'
   
Comprehensive
 
   
Shares
   
Amount
   
Capital
   
Loss
   
Deficit
   
Deficit
   
Loss
 
Balance at May 31, 2008
    52,442,818     $ 112,588,378     $ 18,261,543     $ (799,190 )   $ (132,019,957 )   $ (1,969,226 )      
                                                       
Exercise of warrants
    364,316       -       -       -       -       -        
Issuance of common shares
    3,636,363       600,000       -       -       -       600,000        
Rounding shares
    (7 )     -       -       -       -       -        
Restricted stock unit grants and expense
    549,822       479,998       (384,318 )     -       -       95,680        
Stock option expense
    -       -       137,764       -       -       137,764        
Issuance of warrants
    -       -       254,600       -       -       254,600        
Net loss
    -       -       -       -       (4,856,356 )     (4,856,356 )     (4,856,356 )
Cumulative translation adjustment
    -       -       -       (61,884 )     -       (61,884 )     (61,884 )
Comprehensive loss
                                                  $ (4,918,240 )
Balance at May 31, 2009
    56,993,312     $ 113,668,376     $ 18,269,589     $ (861,074 )   $ (136,876,313 )   $ (5,799,422 )        
                                                         
Exercise of warrants
    957,687       -       22,500       -       -       22,500          
Issuance of common shares
    7,614,232       814,781               -       -       814,781          
Restricted stock unit grants and expense
    101,110       15,000       64,504       -       -       79,504          
Beneficial conversion feature associated with PIK interest
    -       -       137,804       -       -       137,804          
Premium on senior secured notes
    -       -       12,076,040       -       -       12,076,040          
Stock option expense
    -       -       82,176       -       -       82,176          
Cummulative effect of change in accounting principle for warrant classification
    -       -       (338,800 )     -       (537,600 )     (876,400 )        
Net loss
    -       -       -       -       (26,583,731 )     (26,583,731 )     (26,583,731 )
Cumulative translation adjustment
    -       -       -       (69,938 )     -       (69,938 )     (69,938 )
Comprehensive loss
                                                  $ (26,653,669 )
Balance at May 31, 2010
    65,666,341     $ 114,498,157     $ 30,313,814     $ (931,012 )   $ (163,997,644 )   $ (20,116,685 )        
 
See accompanying notes to these consolidated financial statements.
 
 
42

 

 
WORKSTREAM INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS


    Fiscal Years Ended  
   
May 31, 2010
   
May 31, 2009
 
Cash flows used in operating activities:
           
Net loss
  $ (26,583,731 )   $ (4,856,356 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Amortization and depreciation
    822,903       1,538,795  
Leasehold inducement amortization
    5,935       (26,891 )
Allowance for doubtful accounts, net
    553,443       653,826  
Impairment of goodwill
    11,683,548       -  
Stock-based compensation
    161,680       179,194  
Loss on disposal of fixed assets
    -       100,421  
Loss on extingishment of debt
    13,071,440       895,871  
Beneficial conversion fearture associated with PIK interest
    137,804       -  
Change in fair value of warrants and derivative
    (2,074,393 )     (442,953 )
Net change in components of working capital:
               
Accounts receivable
    586,294       371,412