WORKSTREAM INC - FORM 10-Q - January 14, 2011

Attached files

file	filename
EX-32.1 - WORKSTREAM INC	fp0002388_ex32-1.htm
EX-31.1 - WORKSTREAM INC	fp0002388_ex31-1.htm
EX-31.2 - WORKSTREAM INC	fp0002388_ex31-2.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended November 30, 2010

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

For the transition period from _____ to _____

Commission File Number: 001-15503

WORKSTREAM INC.

(Exact name of registrant as specified in its charter)

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

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

(407) 475-5500

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No ¨

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

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

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

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

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

WORKSTREAM INC.

TABLE OF CONTENTS

			Page No.
Part I.		Financial Information

	Item 1.	Financial Statements (Unaudited)
		Condensed Consolidated Balance Sheets as of November 30, 2010 and May 31, 2010	1
		Condensed Consolidated Statements of Operations for the Three and Six Months Ended November 30, 2010 and 2009	2
		Consolidated Statement of Stockholders’ Equity for the Six Months Ended November 30, 2010	3
		Condensed Consolidated Statements of Cash Flows for the Six Months Ended November 30, 2010 and 2009	4
		Notes to Condensed Consolidated Financial Statements	5

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20

	Item 4T.	Controls and Procedures	30

Part II.		Other Information

	Item 1.	Legal Proceedings	31

	Item 1A.	Risk Factors	31

	Item 6.	Exhibits	33

		Signatures	34

WORKSTREAM INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

As of November 30, 2010 and May 31, 2010

	Notes	November 30, 2010			May 31, 2010
ASSETS:		(Unaudited)
Current assets:
Cash and cash equivalents		$	375,161		$	358,529
Accounts receivable, net of allowances of $512,224 and $442,195 at
November 30, 2010 and May 31, 2010, respectively			1,832,296			1,606,623
Prepaid expenses and other assets			52,110			161,692
Total current assets			2,259,567			2,126,844

Equipment, net			199,458			295,798
Other assets			43,043			163,817
Intangible assets, net			150,162			-
Goodwill	3		6,731,326			6,045,900

TOTAL ASSETS		$	9,383,556		$	8,632,359

LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT):
Current liabilities:
Accounts payable		$	939,927		$	1,232,019
Accrued liabilities			1,837,481			3,211,124
Accrued compensation			403,562			516,209
Current portion of long-term obligations			172,941			200,469
Deferred revenue			1,272,563			1,456,005
Total current liabilities			4,626,474			6,615,826

Senior secured note payable	2		-			21,718,093
Senior secured note payableand accrued interest, net-related party	2		849,926			-
Long-term obligations, less current portion			65,426			138,858
Deferred revenue – long-term			21,440			7,667
Common stock warrant liability	1		67,100			268,600
Total liabilities			5,630,366			28,749,044

Commitments and Contingencies	4

SHAREHOLDERS’ EQUITY (DEFICIT):	5
Preferred shares, no par value			-			-
Common shares, no par value, issued and outstanding 816,502,956 and 65,666,341 shares as of November 30, 2010 and May 31,2010			136,880,540			114,498,157
Additional paid-in capital			30,760,815			30,313,814
Accumulated deficit	1		(162,913,611	)		(163,997,644	)
Accumulated other comprehensive loss			(974,554	)		(931,012	)
Total shareholders’ equity (deficit)			3,753,190			(20,116,685	)

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)		$	9,383,556		$	8,632,359

See accompanying notes to these condensed consolidated financial statements.

WORKSTREAM INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

For the Three and Six Months Ended November 30, 2010 and 2009

(Unaudited)

		Three Months Ended						Six Months Ended
	Notes	November 30, 2010			November 30, 2009			November 30, 2010			November 30, 2009
Revenues:
Software		$	1,127,931		$	1,739,128		$	2,288,399		$	3,345,455
Professional services			109,839			273,567			148,434			507,905
Rewards			2,032,255			2,096,257			3,998,443			3,520,071
Career networks			574,631			921,167			1,146,471			1,868,433
Revenues, net			3,844,656			5,030,119			7,581,747			9,241,864

Cost of revenues:
Rewards			1,512,777			1,525,358			3,009,271			2,609,033
Other			174,992			206,692			333,905			412,705
Cost of revenues (exclusive of amortization			1,687,769			1,732,050			3,343,176			3,021,738
and depreciation expense noted below)

Gross profit			2,156,887			3,298,069			4,238,571			6,220,126

Operating expenses:
Selling and marketing			433,340			545,513			763,601			1,002,181
General and administrative			1,727,356			1,971,921			3,962,392			3,993,777
Research and development	4		(674,293	)		341,148			(283,215	)		770,287
Amortization and depreciation			47,884			300,924			111,277			582,701
Impairment of goodwill	3		-			-			(685,426	)		-
Total operating expenses			1,534,287			3,159,506			3,868,629			6,348,946

Operating Income (loss)			622,600			138,563			369,942			(128,820	)

Other income / (expense):
Interest income and expense, net			(16,828	)		(887,502	)		(672,367	)		(1,401,577	)
Gain on exchange of senior secured notes payable	2		-			-			1,192,635			-
Change in fair value of warrants and derivative	2		(13,000	)		364,226			201,500			787,693
Other income and expense, net			71			43,620			(321	)		42,018
Other income (expense), net			(29,757	)		(479,656	)		721,447			(571,866	)

Income (loss) before income tax expense			592,843			(341,093	)		1,091,389			(700,686	)

Income tax expense			980			(39	)		(7,356	)		(328	)

NET INCOME (LOSS)		$	593,823		$	(341,132	)	$	1,084,033		$	(701,014	)

Income (loss) per share - basic and diluted		$	0.00		$	(0.01	)	$	0.00		$	(0.01	)

Weighted average number of common shares
outstanding:
Basic			812,298,199			56,997,415			487,666,585			56,995,352
Diluted			853,035,207			56,997,415			540,921,399			56,995,352

See accompanying notes to these condensed consolidated financial statements.

WORKSTREAM INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

(Unaudited)

							Accumulated
					Additional		Other						Total
	Common Stock				Paid-In		Comprehensive			Accumulated			Stockholders'			Comprehensive
	Shares		Amount		Capital		Loss			Deficit			Equity (Deficit)			Income
Balance at May 31, 2010		65,666,341	$	114,498,157	$	30,313,814	$	(931,012	)	$	(163,997,644	)	$	(20,116,685	)

Restricted stock unit grants and restricted common stock issuances		3,391,465				334,277								334,277
Issuance of common shares in connection with 2010 exchange transaction		746,079,445		22,382,383										22,382,383
Stock option expense						85,724								85,724
Issuance of common shares for services		1,365,705				27,000								27,000
Net income											1,084,033			1,084,033			1,084,033
Cumulative translation adjustment								(43,542	)					(43,542	)		(43,542	)
Comprehensive income																$	1,040,491
Balance at November 30, 2010		816,502,956	$	136,880,540	$	30,760,815	$	(974,554	)	$	(162,913,611	)	$	3,753,190

WORKSTREAM INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Six Months Ended November 30, 2010 and 2009

(Unaudited)

	Six Months Ended
	November 30, 2010			November 30, 2009
Cash flows used in operating activities:
Net income / (loss)	$	1,084,033		$	(701,014	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Amortization and depreciation		111,277			582,701
Amortization of deferred financing costs		12,195			-
Leasehold inducement amortization		5,778			4,778
Allowance for doubtful accounts, net		63,063			198,642
Impairment of goodwill		(685,426	)		-
Stock-based compensation		420,001			70,274
Non-cash compensation on stock purchased by management		258,725			-
Non-cash compensation on stock for board member fees		27,000			-
Gain on exchange of senior secured notes payable		(1,192,635	)		-
Non-cash gain on settlements of accrued liabilities		(993,218	)		-
Change in fair value of warrants and derivative		(201,500	)		(787,693	)
Net change in components of working capital:
Accounts receivable		(288,736	)		(1,034,189	)
Prepaid expenses and other assets		103,532			6,977
Accounts payable		(292,092	)		(639,262	)
Accrued liabilities		260,775			2,049,734
Accrued compensation		(112,647	)		149,019
Deferred revenue		(169,669	)		74,043
Net cash used in operating activities		(1,589,544	)		(25,990	)

Cash flows used in investing activities:
Purchase of equipment		-			(106,761	)
Capitalization of Software Development Costs		(150,162	)		-
Net cash used in investing activities		(150,162	)		(106,761	)

Cash flows provided by / (used in) financing activities:
Proceeds from issuance of stock		1,250,000			-
Proceeds from issuance of senior secured note payable, net of issuance costs $90,000		660,000			(135,788	)
Repayment of long-term obligations		(108,614	)		(164,573	)
Net cash provided by / (used in) financing activities		1,801,386			(300,361	)

Effect of exchange rate changes on cash and cash equivalents		(45,048	)		(17,022	)

Net increase / (decrease) in cash and cash equivalents		16,632			(450,134	)
Cash and cash equivalents - beginning of period		358,529			1,643,768

Cash and cash equivalents - end of period	$	375,161		$	1,193,634


Supplemental schedule of non-cash investing and financing activities:
Equipment acquired under capital leases	$	13,431		$	191,298
Cumulative effect of change in accounting principle for warrant classification	$	-		$	876,400
Exchange of senior secured notes for common stock	$	22,382,383		$	-

See accompanying notes to these condensed consolidated financial statements.

WORKSTREAM INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Unaudited Interim Financial Information

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

Description of the Company

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

Management’s Assessment of Liquidity

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

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

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

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

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

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

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

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

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

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

Use of Estimates

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

Warrant Liability

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

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

	November 30, 2010		May 31, 2010		May 31, 2009		August 29, 2008

Stock price	$	0.02	$	0.08	$	0.37	$	0.20
Exercise price	$	0.10	$	0.10	$	0.25	$	0.25
Expected volatility		134% - 224%		77% - 152%		94%-194%		74%-117%
Expected dividend yield		0%		0%		0%		0%
Expected term (in years)		1.7		2.2		3.2		3.9
Risk-free interest rate		0.17% - 0.45%		0.16% - 0.76%		0.14%-1.42%		1.97%-2.60%

Beginning in December 2009, the Company began using a probability-weighted trinomial lattice model to obtain the fair value of the warrants to take into consideration potential anti-dilution scenarios.

Fair Value of Financial Instruments

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

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

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

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

Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available to management as of November 30, 2010. The Company uses the market approach to measure fair value for its Level 1 financial assets which includes cash equivalents. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. There were no cash equivalents as of November 30, 2010 or May 31, 2010. The respective carrying value of certain on-balance-sheet financial instruments approximated their fair values due to the short-term nature of these instruments. These instruments include cash, accounts receivable, accounts payable and accrued liabilities.

The Company’s 2009 Senior Secured Notes were initially valued using multiple, probability-weighted cash flow outcomes at credit-risk adjusted market rates (“Forward Value”). The 2009 Senior Secured Notes with options to convert principal balances into common equity derive their value from a combination of the Forward Value and the fair value of the embedded conversion feature (“ECF”). For purposes of the ECF, management concluded that the Monte Carlo Simulations Method (“MCS”) was the appropriate technique to embody all assumptions market participants would likely consider in estimating the ECF value.

The Company’s 2010 Senior Secured Note was valued using the fair value of the forward cash flows including principal and interest payable through the maturity date, using credit-risk adjusted market rates.

The embedded put derivative on the Company’s 2008 Notes was valued in accordance with ASC 820 using multiple, probability-weighted cash flow outcomes (Level 3 inputs) at credit-risk adjusted market rates (Level 2 inputs). The Company’s warrants related to the Notes were valued using a lattice-based valuation model with the inputs detailed previously under Warrant Liability.

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

	Warrant
	Liability

Fair value as of May 31, 2010	$	268,600
Change in fair value of warrants and derivative		(201,500	)
Fair value as of November 30, 2010	$	67,100

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

Derivative Financial Instruments

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

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

Accounting for Stock-Based Compensation

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

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

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

	Six Months Ended
	November 30, 2010	November 30, 2009

Expected volatility	178% - 200%	169%-171%
Expected dividend yield	0%	0%
Expected term (in years)	3.45	3.45
Risk-free interest rate	1.18% - 2.00%	2.46%-2.71%
Forfeiture rate	30%	30%

The dividend yield was calculated by dividing the current annualized dividend by the option exercise price of each grant. The expected volatility was determined considering the Company’s historical stock prices for the fiscal year the grant occurred and prior fiscal years for a period equal to the expected life of the option. The risk-free rate represents the US Treasury bond rate with maturity equal to the expected life of the option. The expected life of the option was estimated based on the exercise history of previous grants.

Software Developed for Internal Use

In accordance with FASB ASC 350, “Intangibles-Goodwill and Other, Internal-Use Software”, the costs incurred in the preliminary stages of development are expensed as incurred. Once an application has reached the development stage, internal costs are capitalized until the software is substantially complete and ready for its intended use. Internal use software is amortized on a straight-line basis over its estimated useful life, generally five years. Management evaluates the useful lives of these assets on an annual basis and tests for impairments whenever events or changes in circumstances occur that could impact the recoverability of these assets.

The company capitalized internal-use software costs for the three and six months ending November 30, 2010 of $150,162. The company will begin amortizes those costs when the product is placed into service.

Accrued Compensation

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

Comprehensive Income / (Loss)

Comprehensive income / (loss) consists of the following:

	Three Months Ended						Six Months Ended
	November 30, 2010			November 30, 2009			November 30, 2010			November 30, 2009

Net income / (loss)	$	593,823		$	(341,132	)	$	1,084,033		$	(701,014	)
Foreign currency translations (losses), net		(36,147	)		7,184			(43,542	)		(15,532	)

Comprehensive income / (loss)	$	557,676		$	(333,948	)	$	1,040,491		$	(716,546	)

Subsequent Events

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

Recent Accounting Pronouncements

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

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

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

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

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

Employment Agreements

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

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

period of six months following the date of termination, certain benefits for such six-month period and a prorated bonus for the year in which he is terminated.

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

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

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

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

NOTE 2. INVESTOR WARRANTS AND SENIOR SECURED NOTES PAYABLE

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

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

On June 1, 2009, the Company adopted ASC 815-40, which required it to begin accounting for the 2008 Warrants as a liability due primarily to the reset provisions of the warrant in the event of lower priced financing transactions. Therefore, they were reclassified out of equity to a liability classification as of June 1, 2009 via a cumulative effect adjustment.

On December 11, 2009, the Company entered into a separate Exchange Agreement (collectively, the “2009 Exchange Agreements”) with each of the Holders pursuant to which, among other things, each Holder exchanged its existing 2008 Note for: (i) a replacement senior secured non-convertible note (a “Non-Convertible Note”); (ii) a senior secured convertible note that is convertible into the Company's common shares at a conversion price of $0.25 (a “$0.25 Convertible Note”); and, (iii) a senior secured convertible note that is convertible into the Company's common shares at a conversion price of $0.10 (a “$0.10 Convertible Note,” and together with the Non-Convertible Notes and the $0.25 Convertible Notes, collectively, the “2009 Secured Notes”). Pursuant to the terms of the separate 2009 Exchange Agreements, the Company issued Non-Convertible Notes in an aggregate principal amount of $9,500,000, $0.25 Convertible Notes in an aggregate principal amount of $6,650,000, and $0.10 Convertible Notes in an aggregate principal amount of $5,361,337. The aggregate principal amount of all of the 2009 Secured Notes issued pursuant to the 2009 Exchange Agreements was $21,613,516, which was the aggregate amount of principal and accrued interest outstanding under the 2008 Notes on December 11, 2009. This transaction is deemed an extinguishment of debt and new issuance for accounting purposes in accordance with ASC 470-50-40.

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

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

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

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

Secured Notes was reclassified to additional paid-in capital under the presumption that such net premium represented a capital contribution in which the 2009 Secured Notes were being carried at face value.

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

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

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

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

Simultaneous and in connection with the 2010 Exchange Agreements and the 2010 Note, we issued 63,227,072 shares in a private placement of $1,250,000 by the new management team and the 2009 Note holders.

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

NOTE 3. GOODWILL

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

	Enterprise
	Workforce			Career
	Services			Networks			Total

Goodwill at May 31, 2009	$	11,381,660		$	6,347,788		$	17,729,448
Impairment		(5,335,760	)		(6,347,788	)		-
Goodwill at May 31, 2010	$	6,045,900		$	-		$	6,045,900
Impairment adjustment		685,426			-			685,426
Goodwill at November 30, 2010	$	6,731,326		$	-		$	6,731,326

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

During the second quarter of FY2011, the Company performed a Step 1 goodwill impairment test for the Enterprise operating segment. The company felt that the test was warranted based on the loss of the large rewards business customers. The test showed no impairment was necessary.

Inherent in our fair value determinations are certain judgments and estimates, including projections of future cash flows, the discount rate reflecting the risk inherent in future cash flows, the interpretation of current economic indicators and market valuations and our strategic plans with regard to our operations. A change in these underlying assumptions would cause a change in the results of the tests, which could cause the fair value of one or more reporting units to be more or less than their respective carrying amounts. In addition, to the extent that there are significant changes in market conditions or overall economic conditions or our strategic plans change, it is possible that our conclusion regarding goodwill impairment could change, which could have a material adverse effect on our financial position and results of operations. Impairment charges related to reporting units which are not currently impaired may occur in the future if further market deterioration occurs resulting in a revised analysis of fair value.

NOTE 4. COMMITMENTS AND CONTINGENCIES

Litigation

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

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

* * *

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

* * *

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

NOTE 5. CAPITAL STOCK

Classes of Stock

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

Stock Plans and Stock-Based Compensation

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

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

	Three Months Ended				Six Months Ended
	November 30, 2010		November 30, 2009		November 30, 2010		November 30, 2009

Stock compensation expense - options	$	68,274	$	20,180	$	85,724	$	40,397

Stock option activity and related information is summarized as follows:

								Weighted
				Weighted				Average
				Average		Weighted		Remaining	Aggregate
	Number			Exercise		Average		Contractual	Intrinsic
	of Options			Price		Fair Value		Term (in Years)	Value

Balance outstanding - May 31, 2009		1,427,032		$	1.12
Granted		1,224,100			0.30	$	0.26
Exercised		-			-
Forfeited or expired		(900,565	)		1.03
Balance outstanding - May 31, 2010		1,750,567			0.59
Granted		32,538,318			0.02	$	0.04
Exercised		-			-
Forfeited or expired		(8,809,717	)		0.04
Balance outstanding - November 30, 2010		25,479,168		$	0.05			4.6	$ 4,680

Exercisable - November 30, 2010		2,275,914		$	0.23			4.0	$ 390

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

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

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

Range of Exercise Prices	Number of Options Outstanding	Weighted Average Remaining Contractual Life (in Years)	Weighted Average Exercise Price	Number of Options Exercisable	Weighted Average Remaining Contractual Life (in Years)	Weighted Average Exercise Price

$0.02 - $0.99	25,256,668	4.7	$ 0.03	2,053,414	4.4	$ 0.11
$1.00 - $1.99	217,500	0.6	$ 1.38	217,500	0.6	$ 1.38
$2.00 - $2.04	5,000	0.2	$ 2.04	5,000	0.2	$ 2.04
	25,479,168	4.6	$ 0.05	2,275,914	4.0	$ 0.23

As of November 30, 2010, $677,823 of total unrecognized compensation costs related to non-vested stock options is expected to be recognized ratably over the remaining individual vesting periods up to three years. The realized tax benefit from stock options and other share based payments was nil for the three and six months ended November 30, 2010 and 2009 due to the uncertainty of realizability.

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

	Three Months Ended				Six Months Ended
	November 30, 2010		November 30, 2009		November 30, 2010		November 30, 2009

Stock compensation expense - RSUs	$	8,028	$	14,939	$	232,533	$	29,877
Stock compensation expense - Restricted Stock Issuances	$	101,744	$	-	$	101,744	$	-
Total	$	109,772	$	14,939	$	334,277	$	29,877

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

				Weighted
	Number			Average
	of Units			Fair Value

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

NOTE 6. SEGMENT INFORMATION

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

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

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

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

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

The following tables summarize the Company’s operations by business segment for the three and six months ended November 30, 2010 and 2009:

	Three Months Ended								Three Months Ended
	November 30, 2010								November 30, 2009
	Enterprise								Enterprise
	Workforce		Career						Workforce		Career
	Services		Networks			Total			Services		Networks		Total
Software	$	1,127,931	$	-		$	1,127,931		$	1,739,128	$	-	$	1,739,128
Professional services		109,839		-			109,839			273,567		-		273,567
Rewards		2,032,255		-			2,032,255			2,096,257		-		2,096,257
Career services		-		574,631			574,631			-		921,167		921,167
Revenue, net		3,270,025		574,631			3,844,656			4,108,952		921,167		5,030,119
Cost of revenues:
Rewards		1,512,777		-			1,512,777			1,525,358		-		1,525,358
Other		167,170		7,822			174,992			175,520		31,172		206,692
Gross profit		1,590,078		566,809			2,156,887			2,408,074		889,995		3,298,069
Expenses		825,870		660,533			1,486,403			2,091,028		767,554		2,858,582
Impairment charges - goodwill		-		-			-			-		-		-
Amortization and depreciation		43,069		4,815			47,884			293,582		7,342		300,924
Business segment income (loss)	$	721,139	$	(98,539	)		622,600		$	23,464	$	115,099		138,563

Other income (expense) and income tax							(28,777	)						(479,695	)
Net income (loss)						$	593,823						$	(341,132	)

	Six Months Ended									Six Months Ended
	November 30, 2010									November 30, 2009
	Enterprise									Enterprise
	Workforce			Career						Workforce			Career
	Services			Networks			Total			Services			Networks		Total
Software	$	2,288,399		$	-		$	2,288,399		$	3,345,455		$	-	$	3,345,455
Professional services		148,434			-			148,434			507,905			-		507,905
Rewards		3,998,443			-			3,998,443			3,520,071			-		3,520,071
Career services		-			1,146,471			1,146,471			-			1,868,433		1,868,433
Revenue, net		6,435,276			1,146,471			7,581,747			7,373,431			1,868,433		9,241,864
Cost of revenues:
Rewards		3,009,271			-			3,009,271			2,609,033			-		2,609,033
Other		318,783			15,122			333,905			322,558			90,147		412,705
Gross profit		3,107,222			1,131,349			4,238,571			4,441,840			1,778,286		6,220,126
Expenses		3,124,515			1,318,263			4,442,778			4,051,426			1,714,819		5,766,245
Impairment charges - goodwill		(685,426	)		-			(685,426	)		-			-		-
Amortization and depreciation		99,635			11,642			111,277			568,772			13,929		582,701
Business segment income (loss)	$	568,498		$	(198,556	)		369,942		$	(178,358	)	$	49,538		(128,820	)

Other income (expense) and income tax								714,091								(572,194	)
Net income (loss)							$	1,084,033							$	(701,014	)

NOTE 7. NET INCOME / (LOSS) PER SHARE

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

	Three Months Ended						Six Months Ended
	November 30, 2010			November 30, 2009			November 30, 2010			November 30, 2009
Numerator:
Net Income (loss)	$	593,823		$	(341,132	)	$	1,084,033		$	(701,014	)

Denominator:
Weighted average shares outstanding-basic		812,298,199			56,997,415			487,666,585			56,995,352
Potential shares "in-the-money" under stock
option and warrant agreements		60,608,234			-			64,658,234			-
Less: Shares assumed repurchased under the
treasury stock method		(19,871,226	)		-			(11,403,420	)		-

Weighted average shares outstanding-diluted		853,035,207			56,997,415			540,921,399			56,995,352

Basic net income (loss) per common share	$	0.00		$	(0.01	)	$	0.00		$	(0.01	)
Diluted net income (loss) per common share	$	0.00		$	(0.01	)	$	0.00		$	(0.01	)

Because the Company reported net income during the three and six months ended November 30, 2010 the Company included the impact of its common stock equivalents in the computation of dilutive earnings per share for these periods. A net loss was reported during the three and six months ended November 30, 2009 as such the Company excluded the impact of its common stock equivalents in the computation of dilutive earnings per share for these periods, as their effect would be anti-dilutive. The following outstanding instruments were excluded from the above computation as their exercise price was greater than the company’s average stock price for the quarter and six months ended November 30, 2010:

	Three Months Ended		Six Months Ended
	November 30, 2010		November 30, 2010

Stock options		5,130,369		1,080,369
Warrants		6,500,000		6,500,000
		11,630,369		7,580,369

NOTE 8. ECONOMIC DEPENDENCE

The Company had one customer which represented approximately 40% and 25% of net revenue for the six months ended November 30, 2010 and 2009, respectively, and one customer which represented approximately 14% and 12% of accounts receivable at November 30, 2010 and 2009, respectively.

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

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD LOOKING STATEMENTS

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

The following discussion and analysis should be read in conjunction with our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K as filed on September 13, 2010 and in conjunction with our unaudited condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. All figures are in United States dollars, except as otherwise noted.

OVERVIEW

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

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

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

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

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

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

Enterprise Workforce Services

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

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

Career Networks

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

Career Transition Services

Our career transition services provide job search services for displaced employees. We focus on creating professional career marketing materials that displaced employees need in order to immediately begin their new job campaign. This package includes a professionally written résumé, broadcast letter, custom cover letter and references. This assistance is provided to thousands of job seekers each year in the areas of information technology, engineering, finance and marketing.

Applicant Sourcing

6FigureJobs.com, Inc., is an online applicant-sourcing portal where job seeking candidates and companies that are actively hiring and filling positions can interact. The site provides content appropriate for senior executives, directors and other managers, as well as containing job postings that meet their qualifications. We employ screening to create this exclusive community of job seekers. On the candidate side, each job seeker is hand reviewed, to ensure they have recent total compensation of $100,000 per annum, before his or her resume is allowed to reside in the site’s candidate database. On the recruiting side, all job openings must have a minimum aggregate compensation of $100,000. We generate revenue through 6FigureJobs on a subscription basis from employers and recruiters that access our database of job seekers and use our tools to post, track and manage job openings. We also generate revenue by charging companies that advertise on our 6FigureJobs website, which includes charging certain advertisers a fee based on the number of leads delivered or on a cost per lead basis. Launched in early calendar 2009, executives who wish to access additional jobs, or give their resume and profile more exposure than free membership, may subscribe to a premium service for a small monthly fee.

RESULTS OF OPERATIONS

At the end of fiscal 2008 and the first half of fiscal 2009, management restructured the entire Company and decreased its employee base by 35% and reduced its usage of outside consultants as part of its overall plan to reduce costs to better align them with the Company’s current revenues. The Company continued this practice in FY 2010. In FY 2011, the Company continues to analyze expenses to find ways of reducing costs. To monitor our results of operations and financial condition, we review key financial information including net revenues, gross profit, operating income and cash flow from operations. We have deployed numerous analytical dashboards across our business to assist in evaluating current performance against established metrics, budgets and business objectives on an ongoing basis. We continue to seek methods to more efficiently monitor and manage our business performance. Such financial information has been included in the following discussion

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

Revenues

	Three Months Ended November 30												Six Months Ended November 30
	2010			2009			$ Change			% Change			2010			2009			$ Change			% Change
Revenues:
Software	$	1,127,931		$	1,739,128		$	(611,197	)		-35.1	%	$	2,288,399		$	3,345,455		$	(1,057,056	)		-31.6	%
Professional services		109,839			273,567			(163,728	)		-59.8	%		148,434			507,905			(359,471	)		-70.8	%
Rewards		2,032,255			2,096,257			(64,002	)		-3.1	%		3,998,443			3,520,071			478,372			13.6	%
Career networks		574,631			921,167			(346,536	)		-37.6	%		1,146,471			1,868,433			(721,962	)		-38.6	%
Total revenues	$	3,844,656		$	5,030,119		$	(1,185,463	)		-23.6	%	$	7,581,747		$	9,241,864		$	(1,660,117	)		-18.0	%

Percentage of total revenues:
Software		29.3	%		34.6	%								30.2	%		36.2	%
Professional services		2.9	%		5.4	%								2.0	%		5.5	%
Rewards		52.9	%		41.7	%								52.7	%		38.1	%
Career networks		14.9	%		18.3	%								15.1	%		20.2	%

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

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

Cost of Revenues & Gross Profit

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


Gross profit	$	2,156,887		$	3,298,068		$	(1,141,181	)		-34.6	%	$	4,238,571		$	6,220,126		$	(1,981,555	)		-31.9	%

Gross profit as a percentage of total revenues:
Software		89.3	%		92.2	%								89.1	%		92.5	%
Professional services		60.1	%		86.7	%								58.1	%		86.9	%
Rewards		25.4	%		27.1	%								24.6	%		25.8	%
Career networks		98.6	%		96.6	%								98.7	%		95.2	%
Total		56.1	%		65.6	%								55.9	%		67.3	%

Fiscal Second Quarter 2011 Compared to Fiscal Second Quarter 2010: Software costs of revenues decreased due to decreases in service provider fees. Professional services costs increased due to more consulting for new customers. Rewards cost of revenues remained flat due to the stabilization of the shipment of merchandise to clients and related margins decreased quarter over quarter due to a higher volume of low margin merchandise. 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.

First Six Months of Fiscal 2011 Compared to First Six Months of Fiscal 2010: Software costs of revenues remained relatively flat due to service provider fees, but decreased as a percentage of revenues primarily due to 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. 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

	Three Months Ended November 30												Six Months Ended November 30
	2010			2009			$ Change			% Change			2010			2009			$ Change			% Change

Selling and marketing	$	433,340		$	545,513		$	(112,173	)		-20.6	%	$	763,601		$	1,002,181		$	(238,580	)		-23.8	%

Percentage of total revenues		11.3	%		10.8	%								10.1	%		10.8	%

Fiscal Second Quarter 2011 Compared to Fiscal Second Quarter 2010: Consulting and employment related expenses decreased by approximately $112,000 primarily as a result of the restructuring and reduction of headcount during fiscal 2010.

First Six Months of Fiscal 2011 Compared to First Six Months of Fiscal 2010: Consulting and employment related expenses decreased by approximately $211,000 primarily as a result of the restructuring and reduction of headcount during fiscal 2010. The additional decrease was due primarily to less trade shows in the first quarter of fiscal 2011. These decreases were offset by increased administrative expenses.

General & Administrative Expense

	Three Months Ended November 30												Six Months Ended November 30
	2010			2009			$ Change			% Change			2010			2009			$ Change			% Change

General and administrative	$	1,727,356		$	1,971,921		$	(244,565	)		-12.4	%	$	3,962,392		$	3,993,777		$	(31,385	)		-0.8	%

Percentage of total revenues		44.9	%		39.2	%								52.3	%		43.2	%

Fiscal Second Quarter 2011 Compared to Fiscal Second Quarter 2010: Consulting, professional fees and employment related expenses decreased by approximately $197,000 as a result of fewer employees and offset by additional Audit and Tax fees being recorded in the second quarter of Fiscal 2011. Non-cash stock compensation and RSU expense increased by approximately $143,900 due to changes in management resulting in additional options and restricted stock awards being issued to the new management team and the board of directors. Space Occupancy Expenses decreased by approximately $81,000 due to an accrual in 2010 for rent at a closed office. Telephone expense decreased approximately $45,000 due to a settlement of old outstanding bills. Marketing expenses decreased approximately $21,000 due to less trade show costs.

First Six Months of Fiscal 2011 Compared to First Six Months of Fiscal 2010: Consulting, professional fees and employment related expenses decreased by approximately $268,000 as a result of fewer employees. Non-cash stock compensation and RSU expense increased by approximately $608,400 due to changes in management resulting in additional options and restricted stock awards being issued to the new management team and the board of directors. A non-cash compensation adjustment for the difference in the purchase price and the fair value of the private placement from the new management team of $258,725 was recorded in the first quarter of 2011. Space Occupancy Expenses decreased by approximately $72,700 due to an accrual in 2010 for rent at a closed office. Other Expenses decreased by approximately $56,600 due to lower costs for postage, credit card fees, payroll fees and public company expenses. Telephone expense decreased approximately $39,600 due to a settlement of old outstanding bills. Marketing expenses decreased approximately $16,000 due to less trade show costs. Bad Debt decreased approximately $158,600 due to a higher rate of collectability in Fiscal 2011 compared to Fiscal 2010.

Research & Development Expense

	Three Months Ended November 30												Six Months Ended November 30
	2010			2009			$ Change			% Change			2010			2009			$ Change			% Change

Research and development	$	(674,293	)	$	341,148		$	(1,015,441	)		-297.7	%	$	(283,215	)	$	770,287		$	(1,053,502	)		-136.8	%

Percentage of total revenues		-17.5	%		6.8	%								-3.7	%		8.3	%

Fiscal Second Quarter 2011 Compared to Fiscal Second Quarter 2010: Employment related expenses increased by approximately $135,000 as a result of the restructuring and addition in headcount. Costs associated with consultants and outsourcing of R&D activities decreased by approximately $1,047,000 due to a settlement with a vendor on outstanding invoices. We had a non-cash gain of $993,218 as a result of the settlement with Second Foundation.

First Six Months of Fiscal 2011 Compared to First Six Months of Fiscal 2010Employment related expenses increased by approximately $210,500 as a result of the restructuring and addition in headcount. Costs associated with consultants and outsourcing of R&D activities decreased by approximately $1,125,000 due to a settlement with a vendor on outstanding invoices. We had a non-cash gain of $993,218 as a result of the settlement with Second Foundation.

Impairment of Goodwill

	Three Months Ended November 30								Six Months Ended November 30
	2010		2009		$ Change		% Change		2010			2009		$ Change			% Change

Impairment of goodwill	$	-	$	-	$	-		N/A	$	(685,426	)	$	-	$	(685,426	)		N/A

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

Amortization & Depreciation Expense

	Three Months Ended November 30												Six Months Ended November 30
	2010			2009			$ Change			% Change			2010			2009			$ Change			% Change

Amortization and depreciation	$	47,884		$	300,924		$	(253,040	)		-84.1	%	$	111,277		$	582,701		$	(471,424	)		-80.9	%

Percentage of total revenues		1.2	%		6.0	%								1.5	%		6.3	%

Fiscal Second Quarter 2011 Compared to Fiscal Second Quarter 2010: Depreciation expense decreased by approximately $253,000 due to many of our fixed assets becoming fully depreciated during fiscal year 2010.

First Six Months of Fiscal 2011 Compared to First Six Months of Fiscal 2010: Amortization expense decreased by nearly $21,000 due to certain acquired intangible assets becoming fully amortized in prior years. Depreciation expense also decreased by approximately $450,000 due to many of our fixed assets becoming fully depreciated during fiscal year 2010.

Interest Income & Expense, Net

	Three Months Ended November 30											Six Months Ended November 30
	2010			2009			$ Change		% Change			2010			2009			$ Change		% Change

Interest income and expense, net	$	(16,828	)	$	(887,502	)	$	870,674		-98.1	%	$	(672,367	)	$	(1,401,577	)	$	729,210		-52.0	%

Fiscal Second Quarter 2011 Compared to Fiscal Second Quarter 2010: Interest expense decreased by approximately $870,000 due to the exchange of the 2009 Senior Secured Notes for Common Stock in August 2010. The interest recorded in Fiscal Second Quarter 2011 was for the new $750,000 note from the infusion of capital during the exchange transaction.

First Six Months of Fiscal 2011 Compared to First Six Months of Fiscal 2010: Interest expense decreased by approximately $729,000 due to the exchange of the 2009 Senior Secured Notes for Common Stock in August 2010. The interest recorded in Fiscal Second Quarter 2011 was for the new $750,000 note from the infusion of capital during the exchange transaction.

Change in Fair Value of Warrants & Derivative

	Three Months Ended November 30										Six Months Ended November 30
	2010			2009		$ Change			% Change		2010		2009		$ Change			% Change

Change in fair value of warrants and derivative	$	(13,000	)	$	364,226	$	(377,226	)		N/A	$	201,500	$	787,693	$	(586,193	)		N/A

On June 1, 2009, the Company adopted ASC 815, which required it to begin accounting for the New 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 New Warrants was reclassified from equity to a liability classification as of June 1, 2009 via a cumulative effect adjustment. We recognized amounts of ($13,000) and $364,226 associated with the change in the fair value of the New Warrants in the condensed consolidated statement of operations for the three months ended November 30, 2010 and 2009, respectively. We recognized amounts of $201,500 and $815,026 associated with the change in the fair value of the New Warrants in the condensed consolidated statement of operations for the six months ended November 30, 2010 and 2009, respectively. In addition, the change for the six months ended November 30, 2009 includes ($27,333) change in the fair value of an embedded put derivative in the 2008 Senior Secured Note.

Gain on Extinguishment of Debt

	Three Months Ended November 30								Six Months Ended November 30
	2010		2009		$ Change		% Change		2010		2009		$ Change		% Change

Gain on extinguishment of debt	$	-	$	-	$	-		N/A	$	1,192,635	$	-	$	1,192,635		N/A

On August 13, 2010, the Company exchanged its 2009 senior secured notes for common stock. Furthermore, this transaction was combined with a private placement for equity and the issuance of a 2010 Note which resulted in a gain on exchange of debt of $1,192,635. The private placement was additional capital invested in the Company by several of the 2009 Note holders. The 2010 Note was provided by one of the 2009 Note holders as additional working capital for the Company and matures on October 13, 2012.

Income Taxes

	Three Months Ended November 30										Six Months Ended November 30
	2010		2009			$ Change		% Change			2010			2009			$ Change			% Change

Income tax expense	$	980	$	(39	)	$	1,019		-2612.8	%	$	(7,356	)	$	(328	)	$	(7,028	)		2142.7	%

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: Working capital, which represents current assets less current liabilities, was negative $2.37 million. Further improvement of working capital is a component of management’s overall plan to better align the Company’s financial position with its current operational requirements.

Cash & Cash Equivalents: As of November 30, 2010, we have approximately $375,000 in cash, which primarily consists of deposits held with banks.

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 increased to 33.1 days at November 30, 2010 from 27.5 days at May 31, 2010. The cause for the change days sales outstanding is primarily due to an increase in the rewards business revenue and accounts receivable.

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. Workstream Inc and Second Foundation Inc reached an out of court settlement. We settled $1,193,218 in accrued liabilities for $200,000. The adjustment to reduce the liability is recorded in the Statement of Operations and Comprehensive Income (Loss).

Cash Flows: The following is a summary of cash flow activities for the three and six months ended November 30, 2010 and 2009:

	Six Months Ended November 30
	2010			2009			$ Change			% Change

Cash used in operating activities	$	(1,589,544	)	$	(25,990	)	$	(1,563,554	)		6016.0	%
Cash (used in) investing activities		(150,162	)		(106,761	)		(43,401	)		40.7	%
Cash provided/(used in) by financing activities		1,801,386			(300,361	)		2,101,747			-699.7	%

Cash Flows From Operating Activities: The increase in these cash flows primarily relates to the goodwill impairment reversal and the gain on the extinguishment of debt. We also settled $1,193,218 in accrued liabilities for a $993,218 non-cash gain. Without these three transactions, we would have had a net loss instead of net income. The increase is also affected by the increase in accounts receivable.

Cash Flows From Investing Activities: The changes in these cash flows relate to a temporary suspension of purchasing equipment.

Cash Flows From Financing Activities: The increase in these cash flows primarily relates to a private placement for equity and a new secured note for $1,250,000 and $660,000, respectively.

EBITDA: To supplement our condensed 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:

	Three Months Ended						Six Months Ended
	November 30						November 30
	2010			2009			2010			2009

Net income / (loss), as reported under US GAAP	$	593,823		$	(341,132	)	$	1,084,033		$	(701,014	)

Effects of certain transactions:
Interest income and expense, net		16,828			887,502			672,367			1,401,577
Income tax expense		(980	)		39			7,356			328
Amortization and depreciation		47,884			300,924			111,277			582,701
Stock-based compensation		178,046			35,119			420,001			70,274
Gain on exchange of senior secured notes payable		-			-			(1,192,635	)		-
Impairment of goodwill		-			-			(685,426	)		-
Change in fair value of warrants and derivative		13,000			(364,226	)		(201,500	)		(787,693	)
Other income and expense, net		(71	)		(43,620	)		321			(42,018	)

EBITDA, as adjusted	$	848,530		$	474,606		$	215,794		$	524,155

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, gain or loss on asset disposals or impairment, merger and acquisition costs, 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.

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.

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.

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 exchange of the 2009 Notes discussed above eliminates the need for quarterly principal payments and the final payment of principal on the 2009 Notes and accrued interest is in 2012. This allows for the usage of this cash for operations.

CRITICAL ACCOUNTING POLICIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our Condensed Consolidated Financial Statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“US GAAP”). The preparation of these financial statements requires management to make certain estimates, judgments and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements. Management makes estimates and assumptions that affect the value of assets and the reported revenues. The accounting policies that reflect our more significant estimates, judgments and assumptions and which management believes are the most critical to aid in fully understanding and evaluating the Company’s reported financial results include: revenue recognition, allowance for trade receivables, impairment analysis for goodwill, valuation of derivative financial instruments, valuation of deferred taxes, and valuation of compensation expense on share-based awards. In many cases, the accounting treatment of a particular transaction is specifically dictated by U.S. GAAP and does not require management's judgment in its application. There are also areas in which management's judgment in selecting among available alternatives would not produce a materially different result. Management has discussed the development, selection and disclosure of critical accounting policies and estimates with our Board of Directors. Management believes that there have been no significant changes during the six months ended November 30, 2010 to the items that were disclosed as the Company’s critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Form 10-K for the fiscal year ended May 31, 2010.

RECENT ACCOUNTING PRONOUNCEMENTS

See Note 1 of the accompanying condensed consolidated financial statements for information concerning recent accounting pronouncements.

ITEM 4T.

CONTROLS AND PROCEDURES

Disclosure controls are controls and procedures designed to reasonably ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls include controls and procedures designed to reasonably ensure that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of the Company’s financial statements would be prevented or detected. Furthermore, the Company’s controls and procedures could be circumvented by the individual acts of some persons, by collusion or two or more people or by management override of the control. Misstatements due to error or fraud may occur and not be detected on a timely basis.

In the Annual Report on Form 10-K for the fiscal year ended May 31, 2010, we identified no material weaknesses in our internal controls. As of November 30, 2010 under the supervision of and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934. Based upon our evaluation, management concluded that our internal controls over financial reporting were effective as of November 30, 2010. In connection with this evaluation, management identified changes in our internal control over financial reporting that occurred during the most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Michael Mullarkey, our prior Chief Executive Officer and Jerome Kelliher, our prior Chief Financial Officer resigned during the first quarter of FY 2011. The Company has hired John Long as our new Chief Executive Officer and acting Chief Financial Officer and David Kennedy as the Chief Operating Officer.

A material weakness is a control deficiency that results in a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis by employees in the normal course of their assigned functions.

PART II. OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

We are involved in claims, which arise in the ordinary course of business. In the opinion of management, we have made adequate provision for potential liabilities, if any, arising from any such matters. However, litigation is inherently unpredictable, and the costs and other effects of pending or future litigation, governmental investigations, legal and administrative cases and proceedings (whether civil or criminal), settlements, judgments and investigations, claims and changes in any such matters, and developments or assertions by or against us relating to intellectual property rights and intellectual property licenses, could have a material adverse effect on our business, financial condition, operating results or cash flows. Please refer to Note 4 to the accompanying condensed consolidated financial statements for further discussion of litigation that may be material to our business.

ITEM 1A.

RISK FACTORS

In addition to the information set forth under Item 1A of Part I to our Annual Report on Form 10-K for the year ended May 31, 2010, you should carefully consider the following factors, which could have a material adverse effect on our results of operations, financial condition, cash flows, business or the market for our common shares. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our business, financial condition and future results of operations. We cannot assure you that we will successfully address any of these risks or address them on a continuing basis.

We have limited operating funds.

The Company has incurred substantial losses in recent periods. On August 13, 2010, we converted our 2009 Senior Secured Notes to equity. At the same time we had a private placement and issued a 2010 Secured Note. As a result, we have a shareholders’ equity of $3,753,190 as of November 30, 2010. Income for the six months ended November 30, 2010 was $1,084,033 and losses for the years ended May 31, 2010 and 2009 were $26,583,731 and $4,856,356, respectively. Due to significant reductions in operating expenses in the fourth quarter of fiscal 2008 and throughout fiscal 2009 and 2010, together with 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. 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.

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”).

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:

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.

ITEM 6.

EXHIBITS

The following Exhibits are filed as part of this Form 10-Q:

Exhibit No	Exhibit Description
*31.1	Certification of Chief Executive Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes Oxley Act of 2002.
*31.2	Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes Oxley Act of 2002.
*32.1	Certifications of the Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002.

* Filed herewith.

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-Q report or any other report we file or furnish with the SEC.

SIGNATURES

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

	Workstream Inc. (Registrant)
DATE: January 14, 2011	By: /s/ John Long
	John Long Chief Executive Officer (Principal Executive Officer)


DATE: January 14, 2011	By: /s/ John Long
	John Long Acting Chief Financial Officer (Principal Financial Officer)

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