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EX-32.1 - WORKSTREAM INCfp0001257_ex32-1.htm
EX-31.1 - WORKSTREAM INCfp0001257_ex31-1.htm
EX-31.2 - WORKSTREAM INCfp0001257_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, 2009

OR

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

For the transition period from _____ to _____

Commission File Number: 001-15503

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

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

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

(407) 475-5500
(Registrant’s telephone number, including area code)

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

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

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

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

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

As of January11, 2010 there were 56,993,312 common shares, no par value, outstanding, excluding 108,304 common shares held in escrow.
 
i

 
WORKSTREAM INC.

     
Page No.
Part I.
 
Financial Information
 
       
 
Item 1.
Financial Statements (Unaudited)
 
   
1
   
2
   
3
   
4
       
 
Item 2.
17
       
 
Item 4T.
26
       
Part II.
 
Other Information
 
       
 
Item 1.
27
       
 
Item 1A.
27
       
 
Item 6.
28
       
   
29
 
ii

 
WORKSTREAM INC.
As of November 30, 2009 and May 31, 2009
(Unaudited)
 
   
November 30, 2009
   
May 31, 2009
 
ASSETS:
 
(Unaudited)
       
Current assets:
           
   Cash and cash equivalents
  $ 1,193,634     $ 1,643,768  
   Accounts receivable, net of allowances of $1,133,553 and $928,430 at
               
      November 30, 2009 and May 31, 2009, respectively
    3,581,908       2,746,360  
   Prepaid expenses and other assets
    139,632       146,609  
         Total current assets
    4,915,174       4,536,737  
                 
Equipment, net
    493,365       757,050  
Other assets
    166,778       30,990  
Acquired intangible assets, net
    -       21,500  
Goodwill
    17,729,448       17,729,448  
                 
TOTAL ASSETS
  $ 23,304,765     $ 23,075,725  
                 
LIABILITIES AND SHAREHOLDERS’ DEFICIT:
               
Current liabilities:
               
   Accounts payable
  $ 1,129,681     $ 1,856,892  
   Accrued liabilities
    3,580,850       2,924,145  
   Accrued compensation
    675,954       526,935  
   Current portion of senior secured notes payable and accrued interest
    276,250       20,158,044  
   Embedded put derivative
    -       493,693  
   Current portion of long-term obligations
    220,813       199,516  
   Deferred revenue
    2,519,216       2,591,328  
         Total current liabilities
    8,402,764       28,750,553  
                 
Senior secured notes payable and accrued interest, less current portion
    21,274,823       -  
Long-term obligations, less current portion
    220,716       124,594  
Deferred revenue – long term
    146,156       -  
Common stock warrant liability
    582,400       -  
         Total liabilities
    30,626,859       28,875,147  
                 
Commitments and Contingencies
               
                 
SHAREHOLDERS’ DEFICIT:
               
Preferred shares, no par value
    -       -  
Common shares, no par value
    113,668,376       113,668,376  
   Additional paid-in capital
    18,001,063       18,269,589  
   Accumulated deficit
    (138,114,927 )     (136,876,313 )
   Accumulated other comprehensive loss
    (876,606 )     (861,074 )
         Total shareholders’ deficit
    (7,322,094 )     (5,799,422 )
                 
TOTAL LIABILITIES AND SHAREHOLDERS’ DEFICIT
  $ 23,304,765     $ 23,075,725  

See accompanying notes to these condensed consolidated financial statements.
 
 
WORKSTREAM INC.
For the Three and Six Months Ended November 30, 2009 and 2008
(Unaudited)
 
    Three Months Ended     Six Months Ended  
   
November 30
   
November 30,
 
   
2009
   
2008
   
2009
   
2008
 
Revenues:
                       
Software
  $ 1,739,128     $ 1,838,082     $ 3,345,455     $ 3,631,979  
Professional services
    273,567       509,169       507,905       1,231,140  
Rewards
    2,096,257       1,435,089       3,520,071       2,954,004  
Career networks
    921,167       1,361,983       1,868,433       2,880,086  
Revenues, net
    5,030,119       5,144,323       9,241,864       10,697,209  
                                 
Cost of revenues
    1,732,050       1,499,342       3,021,738       3,101,812  
                                 
Gross profit
    3,298,069       3,644,981       6,220,126       7,595,397  
                                 
Operating expenses:
                               
Selling and marketing
    545,513       1,128,676       1,002,181       2,431,283  
General and administrative
    1,971,921       2,052,077       3,993,777       4,977,563  
Research and development
    341,148       985,159       770,287       2,287,260  
Amortization and depreciation
    300,924       446,092       582,701       926,867  
Total operating expenses
    3,159,506       4,612,004       6,348,946       10,622,973  
                                 
Operating income / (loss)
    138,563       (967,023 )     (128,820 )     (3,027,576 )
                                 
Other income / (expense):
                               
Interest income and expense, net
    (887,502 )     (351,025 )     (1,401,577 )     (347,435 )
Change in fair value of warrants and derivative
    364,226       -       787,693       -  
Other income and expense, net
    43,620       (47,297 )     42,018       (87,721 )
Other expense, net
    (479,656 )     (398,322 )     (571,866 )     (435,156 )
                                 
Loss before income tax benefits / (expense)
    (341,093 )     (1,365,345 )     (700,686 )     (3,462,732 )
                                 
Income tax expense
    (39 )     15,725       (328 )     61,530  
                                 
NET LOSS
  $ (341,132 )   $ (1,349,620 )   $ (701,014 )   $ (3,401,202 )
                                 
Loss per share - basic and diluted
  $ (0.01 )   $ (0.02 )   $ (0.01 )   $ (0.06 )
                                 
 
                               
Weighted average number of common shares outstanding - basic and diluted
    56,997,415       55,120,140       56,995,352       53,766,928  
 
See accompanying notes to these condensed consolidated financial statements.
 
 
WORKSTREAM INC.
For the Six Months Ended November 30, 2009 and 2008
(Unaudited)
 
    Six Months Ended  
    November 30,  
   
2009
   
2008
 
Cash flows used in operating activities:
           
Net loss
  $ (701,014 )   $ (3,401,202 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Amortization and depreciation
    582,701       926,867  
Leasehold inducement amortization
    4,778       (30,497 )
Provision for bad debt
    198,642       465,999  
Stock related compensation
    70,274       132,702  
Change in fair value of warrants and derivative
    (787,693 )     -  
Net change in components of working capital:
               
Accounts receivable
    (1,034,189 )     (314,412 )
Prepaid expenses and other assets
    6,977       187,819  
Accounts payable
    (639,262 )     (723,545 )
Accrued liabilities
    2,049,734       506,520  
Accrued compensation
    149,019       (318,951 )
Deferred revenue
    74,043       173,093  
Net cash used in operating activities
    (25,990 )     (2,395,607 )
                 
Cash flows provided by (used in) investing activities:
               
Purchase of equipment
    (106,761 )     (1,922 )
Proceeds from sale of short-term investments
    -       9,091  
Net cash provided by (used in) investing activities
    (106,761 )     7,169  
                 
Cash flows provided by (used in) financing activities:
               
Payment of costs associated with re-financing of senior secured notes
    (135,788 )     -  
Repayment of long-term obligations
    (164,573 )     (232,748 )
Net cash used in financing activities
    (300,361 )     (232,748 )
                 
Effect of exchange rate changes on cash and cash equivalents
    (17,022 )     69,410  
                 
Net decrease in cash and cash equivalents
    (450,134 )     (2,551,776 )
Cash and cash equivalents - beginning of period
    1,643,768       3,435,337  
                 
Cash and cash equivalents - end of period
  $ 1,193,634     $ 883,561  
                 
                 
Supplemental schedule of non-cash investing and financing activities:
               
Equipment acquired under capital leases
  $ 191,298     $ -  
Cumulative effect of change in accounting principle for warrant classification
  $ 876,400     $ -  
Exchange of warrant liability for senior secured notes payable
  $ -     $ 19,000,000  
Non-cash issuance of common stock in connection with the settlement of class action lawsuits
  $ -     $ 600,000  
 
See accompanying notes to these condensed consolidated financial statements.
 
WORKSTREAM INC.
(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, 2009, the condensed consolidated statements of operations for the three and six months ended November 30, 2009 and 2008, and the condensed consolidated statements of cash flows for the six months ended November 30, 2009 and 2008 are unaudited but include all adjustments (consisting of normal recurring 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, 2009 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, 2009 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, 2009.

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.

Going Concern and Management’s Assessment of Liquidity

The opinion of our independent registered public accounting firm on the audited financial statements as of and for the year ended May 31, 2009 contained an explanatory paragraph regarding substantial doubt about our ability to continue as a going concern.

The Company has incurred substantial losses in recent periods and, as a result, has a shareholders’ deficit of $7,322,094 as of November 30, 2009.  Losses for the six months ended November 30, 2009 were $701,014 and losses for the years ended May 31, 2009 and 2008 were $4,856,356 and $52,616,875, respectively.  The Company's ability to continue as a going concern depends upon its ability to successfully refinance approximately $21.6 million of its senior secured notes payable (the “Notes”), including accrued interest thereon, generate positive cash flows from operations and obtain sufficient additional financing, if necessary.  The Notes went into default on May 22, 2009 due to the Company’s suspension of trading on the NASDAQ Stock Market as a result of its shareholders’ deficit.  Such Notes were restructured on December 11, 2009; please refer to Note 2 to these condensed consolidated financial statements.  The accompanying financial statements have been prepared on a going concern basis, which assumes continuity of operations and realization of assets and liabilities in the ordinary course of business.  The financial statements do not include any adjustments that might result if the Company was forced to discontinue its operations.
 
 
WORKSTREAM INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
Due to significant reductions in operating expenses in the fourth quarter of fiscal 2008 and throughout fiscal 2009, management believes that current operations will be sufficient to meet its anticipated working capital and capital expenditure requirements upon the refinancing of the Notes.  The current operating loss is the result of current economic conditions and is a reflection of the overall health of the economy as a whole.  Based on an analysis of our current contracts, forecasted new business, our current backlog and current expense level along with the refinancing of the Notes, management believes the Company will meet its cash flow needs for fiscal 2010.  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 2010.

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

On June 1, 2009, the Company adopted the guidance on determining whether an instrument (or embedded feature) is indexed to an entity’s own stock (primarily codified in ASC 815, Derivatives and Hedging).  This guidance requires a new 2-step test for determination of whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock. Step 1 is to evaluate the instrument's contingent exercise provisions, if any, and step 2 is to evaluate the instrument's settlement provisions.  The Company evaluated its existing current instruments previously classified as equity immediately prior to such adoption and determined that the warrants issued in conjunction with its Senior Secured Notes Payable are not indexed to the Company’s own stock under the accounting requirements 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, as required.  Subsequent changes to the fair value of the liability after June 1, 2009 will be included in the consolidated statements of operations.  The table below details the effect of the adoption on the Company’s financial statements as of June 1, 2009:
 
   
May 31, 2009
   
Effect of Adoption
   
June 1, 2009
 
                     
Common stock warrant liability
    -       876,400   (1)     876,400  
Additional paid-in capital
    18,269,589       (338,800 ) (2)     17,930,789  
Accumulated deficit
    (136,876,313 )     (537,600 ) (3)     (137,413,913 )

(1)  
Fair value of warrants on May 31, 2009.
(2)  
Fair value of warrants upon issuance on August 29, 2008.
(3)  
Cumulative change in fair value of warrants from August 29, 2008 through May 31, 2009.

The fair value of the warrants was valued using a lattice-based valuation model with the following key inputs:
 
   
August 29, 2008
   
May 31, 2009
   
November 30, 2009
 
                   
Stock Price
  $ 0.20     $ 0.37     $ 0.30  
Exercise Price
  $ 0.25     $ 0.25     $ 0.25  
Expected volatility
    74%-117%       94%-194%       21%-149%  
Expected dividend yield
    0%       0%       0%  
Expected term (in years)
    3.9       3.2       2.7  
Risk-free interest rate
    1.97%-2.60%       0.14%-1.42%       0.08%-0.67%  
 
 
WORKSTREAM INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
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, 2009.  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, 2009.  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 Senior Secured Notes were initially valued using multiple, probability-weighted cash flow outcomes at credit-risk adjusted market rates.  The fair value of the Notes is being accreted to the Face Value including accrued interest of $22,835,685 until August 29, 2010 through interest expense using the effective interest method.  The carrying value of the Notes on November 30, 2009 approximated their fair value, including accrued interest thereon.
 
The embedded put derivative on the Company’s Senior Secured 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 above 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 three months ended November 30, 2009:

   
Embedded
   
Warrant
         
   
Put Derivative
   
Liability
     
Total
 
                     
Fair value as of May 31, 2009
  $ 493,693     $ 876,400   (1)   $ 1,370,093  
Change in fair value of warrants and derivative
    (493,693 )     (294,000 )       (787,693 )
Fair value as of November 30, 2009
  $ -     $ 582,400       $ 582,400  

(1)  
Fair value of warrants as of May 31, 2009 recorded as a liability in the Company’s financial statements upon initial adoption of ASC 815.40 on June 1, 2009.

Further, the Company began applying fair value measurements for all non-financial assets and non-financial liabilities on June 1, 2009.  This application did not have a significant impact on the Company’s results of operations, financial position or cash flows for the three or six months ended November 30, 2009.
 
6

 
WORKSTREAM INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
Derivative Financial Instruments

The Company’s Senior Secured Notes contain a contingent put reflected in the contractual rights of default.  Under these provisions, the Holder has the right to put the Notes back to the Company for 110% of face value in the event of certain equity-indexed defaults, such as listing failure and non-delivery of common shares issuable upon exercise of certain warrants.  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 embedded put derivative and 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
 
2009
 
2008
       
Expected volatility
169%-171%
 
137%
Expected dividend yield
0%
 
0%
Expected term (in years)
3.45
 
3.45
Risk-free interest rate
2.23%-2.71
 
2.90%
Forfeiture rate
30%
 
0%

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

Comprehensive Loss

Comprehensive loss consists of the following:
 
    Three Months ended     Six Months ended  
   
November 30,
   
November 30,
 
   
2009
   
2008
   
2009
   
2008
 
                         
Net loss
  $ (341,132 )   $ (1,349,620 )   $ (701,014 )   $ (3,401,202 )
Foreign currency translations gains (losses), net
    7,184       180,639       (15,532 )     184,551  
                                 
Comprehensive loss
  $ (333,948 )   $ (1,168,981 )   $ (716,546 )   $ (3,216,651 )
 
 
WORKSTREAM INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
Reclassifications

Certain prior period amounts have been reclassified in the accompanying fiscal 2009 condensed consolidated financial statements to conform to the current period presentation.

Subsequent Events

In accordance with ASC 855, Subsequent Events, we evaluated subsequent events through the date and time our condensed consolidated financial statements were issued on January 14, 2010.

Recent Accounting Pronouncements

In September 2009, the FASB ratified ASC Update No. 2009-13, Multiple-Deliverable Revenue Arrangements (“ASC 2009-13”).  ASC 2009-13, amends existing revenue recognition accounting pronouncements that are currently within the scope of FASB Accounting Standards Codification, or ASC, Subtopic 605-25 (previously included within EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables).  This consensus provides for two significant changes to the existing multiple element revenue recognition guidance.  First, this guidance deletes the requirement to have objective and reliable evidence of fair value for undelivered elements in an arrangement and will result in more deliverables being treated as separate units of accounting.  The second change modifies the manner in which the transaction consideration is allocated across the separately identified deliverables.  These changes may result in entities recognizing more revenue up-front, and entities will no longer be able to apply the residual method and defer the fair value of undelivered elements. Upon adoption of these new rules, each separate unit of accounting must have a selling price, which can be based on management’s estimate when there is no other means to determine the fair value of that undelivered item, and the arrangement consideration is allocated based on the elements’ relative selling price.  This accounting guidance is effective no later than fiscal years beginning on or after June 15, 2010 but may be early adopted as of the first quarter of an entity’s fiscal year.  Entities may elect to adopt this accounting guidance either through prospective application to all revenue arrangements entered into or materially modified after the date of adoption or through a retrospective application to all revenue arrangements for all periods presented in the financial statements.  We are currently evaluating the impact of this revised accounting guidance.

In September 2009, the FASB ratified ASC No. 2009-14, Applicability of SOP 97-2 to Certain Arrangements that Include Software Elements (formerly EITF Issue No. 09-3, Certain Revenue Arrangements that Include Software Elements), which amends the existing accounting guidance for how entities account for arrangements that include both hardware and software, which typically resulted in the sale of hardware being accounted for under the software revenue recognition rules.  This accounting guidance changes revenue recognition for tangible products containing software elements and non-software elements.  The tangible element of the product is always outside of the scope of the software revenue recognition rules, and the software elements of tangible products when the software element and non-software elements function together to deliver the product’s essential functionality are outside of the scope of the software rules.  As a result, both the hardware and qualifying related software elements are excluded from the scope of the software revenue guidance and accounted for under the revised multiple-element revenue recognition guidance.  This accounting guidance is effective for all fiscal years beginning on or after June 15, 2010 with early adoption permitted.  Entities must adopt ASC 2009-14 and ASC 2009-13 in the same manner and at the same time.  We are currently evaluating the impact of this revised accounting guidance.

In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles (codified within ASC 105, Generally Accepted Accounting Principles) , which establishes the FASB Accounting Standards Codification as the single source of authoritative U.S. GAAP.  The Codification will supersede all existing non-SEC accounting and reporting standards.  As a result, upon adoption, all references to accounting literature in our SEC filings will conform to the appropriate reference within the Codification.  The adoption of this standard did not have an impact on our financial position, results of operations or cash flows.
 
 
WORKSTREAM INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
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 (“Old Warrants”), for an aggregate $19,147,191 in Face Value of Senior Secured Notes (collectively, the “Notes”) and newly issued warrants indexed to 3,800,000 shares of common stock (“New 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 Notes.

The Notes were secured by a lien on all of our and our subsidiaries’ assets pursuant to the terms of a Security Agreement with each Note Holder.  Interest on the Notes accrued at an annual rate of 7% until August 29, 2009 and then 12% per year thereafter.  The Notes were to mature on August 29, 2010 and all unpaid principal and accrued interest was to be due upon maturity.

The New Warrants were convertible into 3,800,000 shares of common stock at an exercise price of $0.25.  All other material terms of the New Warrants were substantially the same as those contained in the old warrants that were exchanged, including the existence of anti-dilution provisions that provide for a full adjustment of the exercise price and the number of common shares to be issued in the event we, in certain circumstances, issue securities at a price below the exercise price of the New Warrants.  Each New Warrant must be exercised on or prior to August 3, 2012 or it will expire by its terms.

The Notes also contained a contingent put reflected in the contractual rights of default.  Upon the occurrence of an event of default, as defined in the Notes, a Holder could require us to redeem all or a portion of such Holder’s Note at a price equal to 110% of the sum of the principal amount of the Note, accrued and unpaid interest and late fees, if any, to be redeemed. 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.  Each of our subsidiaries delivered a Guaranty pursuant to which it agreed to guarantee our obligations under each Note.

On May 22, 2009, the Company’s stock was 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 Notes and thereby entitled each Holder of the Notes to require the Company to redeem all or a portion of the Holder’s Note at a price equal to 110% of the sum of the principal amount of the Note, accrued and unpaid interest and late fees, if any.  Additionally, as a result of the event of default, the interest rate under each Note was increased by 5% in addition to the contractual rate of interest due.

The Notes and the embedded put derivative were valued in accordance with ASC 820 using multiple, probability-weighted cash flow outcomes at credit-risk adjusted market rates.  The fair value of the Notes was accreted to the Face Value including accrued interest of $22,835,685 until August 29, 2010 through interest expense using the effective interest method.   Interest expense on the Notes was $883,878 and $1,393,029 during the three and six months ended November 30, 2009.  Gains on the decrease in the fair value of $521,026 and $493,693 on the embedded put derivative were recognized in the condensed consolidated statements of operations during the three and six months ended November 30, 2009, respectively.

On June 1, 2009, the Company adopted ASC 815.40 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, they were reclassified out of equity to a liability classification as of June 1, 2009 via a cumulative effect adjustment.  Amounts of $(156,800) and $294,000 associated with the change in the fair value of the New Warrants are recognized in the condensed consolidated statement of operations for the three and six months ended November 30, 2009, respectively.

In August 2009, the Company signed a term sheet with the Holders, whereby the Holders agreed to restructure the Notes. On December 11, 2009, the Company entered into a separate Exchange Agreement (collectively, the “Exchange Agreements”) with each of the Holders of its senior secured promissory notes pursuant to which, among other  things, each Holder exchanged its existing 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 “New Secured Notes”).  Pursuant to the terms of the separate Exchange
 
 
WORKSTREAM INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
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 New Secured Notes issued pursuant to the Exchange Agreements is $21,613,516, which was the aggregate amount of principal and accrued interest outstanding under the Notes on December 11, 2009.

Each New Secured Note continues 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 Investors, as amended in connection with the exchange transaction.   Interest on each New Secured Note accrues at an annual rate of 9.5%.  Interest on the $0.25 Convertible Notes and the $0.10 Convertible Notes compounds on a quarterly basis and is payable, together with principal, on July 31, 2012 (the “Maturity Date”).  Interest on the Non-Convertible Notes compounds on a quarterly basis and is payable on the 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 New Secured Notes, an Investor may require the Company to redeem all or a portion of such Investor’s Notes.  Upon a disposition of assets or liquidity event (each as defined in the New Secured Notes), the Company is required to use 100% of the net proceeds to redeem the New Secured Notes.  Each New Secured Note contains customary covenants with which the Company must comply.  Each subsidiary of the Company previously agreed to guarantee the obligations of the Company under the Notes and has reaffirmed such guarantee with respect to the New Secured Notes by delivering to the Investors a Reaffirmation of Guaranty.  The Company and each of the Investors 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 are convertible as registrable securities.

Each of the New Warrants issued in connection with the 2008 Exchange Transaction contained anti-dilution protection provisions.  As a result of the Company’s issuance of the $0.10 Convertible Notes, the exercise price of the New Warrants that remain outstanding was adjusted to $0.10 per share from $0.25 per share and the number of common shares issuable upon exercise was proportionately increased.

NOTE 3.      COMMITMENTS AND CONTINGENCIES

Litigation

On or about August 10, 2005, a class action lawsuit was filed against the Company, its former Chief Executive Officer and its former Chief Financial Officer in the United States District Court for the Southern District of New York.  The action, instituted on behalf of a purported class of purchasers of the Company’s common shares during the period from January 14, 2005 to and including April 14, 2005 (the class period), alleged, among other things, that management provided the market misleading guidance as to anticipated revenues for the quarter ended February 28, 2005, and failed to correct this guidance on a timely basis. The action claimed violations of Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 promulgated thereunder, as well as Section 20(a) of the Exchange Act, and sought compensatory damages in an unspecified amount as well as the award of reasonable costs and expenses, including counsel and expert fees and costs. The Court certified the case as a class action.

The parties agreed to settle the claims in consideration of the payment of $3 million in cash and $600,000 in the Company’s common shares.  The $3 million was paid for by the Company’s insurance carrier pursuant to the Company’s insurance policies.  The Court held a hearing on June 24, 2008 to consider the fairness of the settlement after notice of the settlement and the hearing had been given to the class.  No opposition to approval of the settlement was presented at the hearing.  On August 13, 2008, the court entered a final judgment in the case, which became final on September 12, 2008.  The $600,000 was accrued for in fiscal 2007 and 3,636,363 shares were issued in fiscal 2009 on September 24, 2008 after the issuance of the final judgment.

* * *

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
 
 
WORKSTREAM INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
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 have now asserted their claims in the State Court Lawsuit.  The Company has denied these allegations.  The parties are proceeding with discovery in this case.  Trial is scheduled for March 7, 2011, with mandatory alternative dispute resolution to be completed by January 7, 2011.

* * *

On June 10, 2009, Franklin Drive, LLC filed a lawsuit in the Superior Court of the State of California against the Company, its former Chief Executive Officer and its former Chief Financial Officer for a dispute regarding the Company’s lease of commercial property located at 5000 Franklin Drive, Pleasanton, California which was for a term commencing on January 1, 2008 and expiring on January 31, 2013.  On or about October 2008, we abandoned the property and ceased making rental payments pursuant to the lease.  Franklin Drive, LLC is claiming termination damages of $1.5 million, but seeking actual settlement at terms considerably less than this amount.  On or about January 8, 2010, the parties entered into an out-of-court, settlement in which the Company has agreed to pay Franklin Drive, LLC a total of $246,000 comprised of an initial payment of $80,000 and twelve equal monthly payments of $13,833.  The full amount of this settlement was accrued in the condensed consolidated balance sheet as of November 30, 2009.

* * *

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 4.      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 56,993,312 common shares issued and outstanding as of November 30, 2009.  There were no Class A Preferred Shares or Series A Shares outstanding as of November 30, 2009.

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 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.   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.
 
 
WORKSTREAM INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
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,
   
November 30,
 
   
2009
   
2008
   
2009
   
2008
 
                         
Stock compensation expense - options
  $ 20,180     $ 24,009     $ 40,397     $ 90,263  

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, 2008
    2,356,548     $ 1.23                    
     Granted
    27,600       0.17     $ 0.09              
     Exercised
    -       -                      
     Forfeited or expired
    (957,116 )     1.37                      
Balance outstanding - May 31, 2009
    1,427,032       1.12                      
     Granted
    906,700       0.31     $ 0.27              
     Exercised
    -       -                      
     Forfeited or expired
    (234,400 )     1.86                      
Balance outstanding - November 30, 2009
    2,099,332     $ 0.75            
                   3.2
    $
         2,386
                                     
Exercisable - November 30, 2009
    1,134,717     $ 1.07            
                      2.3
    $
     352
 
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 $0.21 on November 30, 2009, 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, 2009.

There were no options exercised during the six months ended November, 2009 and 2008; 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, 2009:
 
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
 
                                       
$0.19 - $0.99       1,598,500       3.8     $ 0.52       650,330       3.0     $ 0.76  
$1.00 - $1.99       460,301       1.5       1.34       443,856       1.5       1.34  
$2.00 - $2.99       5,000       1.2       2.04       5,000       1.2       2.04  
$3.00 - $3.25       35,531       0.1       3.25       35,531       0.1       3.25  
          2,099,332       3.2       0.75       1,134,717       2.3       1.07  
 
 
WORKSTREAM INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
As of November 30, 2009, $163,005 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, 2009 and 2008 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.  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
   
November 30,
 
   
2009
   
2008
   
2009
   
2008
 
                         
Stock compensation expense - RSUs
  $ 14,939     $ 15,007     $ 29,877     $ 42,440  

As of November 30, 2009, $65,572 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, 2008
    486,670   (1)      
     Granted
    200,926       $ 0.27  
     Vested and issued
    (549,822 )          
     Forfeited or expired
    (60,000 )          
Outstanding - May 31, 2009
    77,774            
     Granted
    160,000       $ 0.34  
     Vested and issued
    -            
     Forfeited or expired
    -            
Outstanding - November 30, 2009
    237,774   (2)        
                   

(1)  
At May 31, 2008, 486,670 restricted stock units were outstanding including 264,444 that were fully vested, but not issued.
(2)  
At November 30, 2009, 237,774 restricted stock units were outstanding including 46,444 that were fully vested but not issued.
 
 
WORKSTREAM INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
As of November 30, 2009, the Company had outstanding warrants to purchase shares of common stock which were issued in connection with past financing arrangements.  Information related to these warrants is summarized as follows:
 
                      Weighted        
         
Weighted
          Average        
         
Average
   
Weighted
    Remaining     Aggregate
   
Number
   
Exercise
   
Average
    Contractual     Intrinsic
   
of Warrants
   
Price
   
Fair Value
    Term (in Years)     Value
                                 
Balance outstanding - May 31, 2008
    24,337,501     $ 1.70                      
     Granted
    3,800,000       0.25     $ 0.12                
     Exercised
    (1,000,000 )     0.25                        
     Forfeited or expired
    (21,987,501 )     2.28                        
Balance outstanding - May 31, 2009
    5,150,000       0.14                        
     Granted
    -                                
     Exercised
    -                                
     Forfeited or expired
    -                                
Balance outstanding - November 30, 2009
    5,150,000     $ 0.14              
 2.3
    $
 470,000
                                       
Exercisable - November 30, 2009
    5,150,000     $ 0.14              
 2.3
    $
470,000
 
NOTE 5.      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, 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.
 
 
WORKSTREAM INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
The following tables summarize the Company’s operations by business segment for the three and six months ended November 30, 2009 and 2008:
 
    Three Months Ended November 30, 2009     Three Months Ended November 30, 2008  
   
Enterprise
               
Enterprise
             
   
Workforce
   
Career
         
Workforce
   
Career
       
   
Services
   
Networks
   
Total
   
Services
   
Networks
   
Total
 
                                     
Software
  $ 1,739,128     $ -     $ 1,739,128     $ 1,838,082     $ -     $ 1,838,082  
Professional services
    273,567       -       273,567       509,169       -       509,169  
Rewards
    2,096,257       -       2,096,257       1,435,089       -       1,435,089  
Career services
    -       921,167       921,167       -       1,361,983       1,361,983  
Revenue, net
    4,108,952       921,167       5,030,119       3,782,340       1,361,983       5,144,323  
                                                 
Cost of revenues
    1,700,878       31,172       1,732,050       1,426,837       72,505       1,499,342  
Gross profit
    2,408,074       889,995       3,298,069       2,355,503       1,289,478       3,644,981  
Expenses
    2,091,028       767,554       2,858,582       2,541,052       1,624,860       4,165,912  
Amortization and depreciation
    293,582       7,342       300,924       428,131       17,961       446,092  
Business segment income / (loss)
  $ 23,464     $ 115,099       138,563     $ (613,680 )   $ (353,343 )     (967,023 )
                                                 
Other income and expense and income tax
              (479,695 )                     (382,597 )
Net loss
                  $ (341,132 )                   $ (1,349,620 )
 
 
    Six Months Ended November 30, 2009     Six Months Ended November 30, 2008  
   
Enterprise
               
Enterprise
             
   
Workforce
   
Career
         
Workforce
   
Career
       
   
Services
   
Networks
   
Total
   
Services
   
Networks
   
Total
 
                                     
Software
  $ 3,345,455     $ -     $ 3,345,455     $ 3,631,979     $ -     $ 3,631,979  
Professional services
    507,905       -       507,905       1,231,140       -       1,231,140  
Rewards
    3,520,071       -       3,520,071       2,954,004       -       2,954,004  
Career services
    -       1,868,433       1,868,433       -       2,880,086       2,880,086  
Revenue, net
    7,373,431       1,868,433       9,241,864       7,817,123       2,880,086       10,697,209  
                                                 
Cost of revenues
    2,931,591       90,147       3,021,738       2,921,925       179,887       3,101,812  
Gross profit
    4,441,840       1,778,286       6,220,126       4,895,198       2,700,199       7,595,397  
Expenses
    4,051,426       1,714,819       5,766,245       6,263,149       3,432,957       9,696,106  
Amortization and depreciation
    568,772       13,929       582,701       891,634       35,233       926,867  
Business segment income / (loss)
  $ (178,358 )   $ 49,538       (128,820 )   $ (2,259,585 )   $ (767,991 )     (3,027,576 )
                                                 
Other income and expense and income tax
              (572,194 )                     (373,626 )
Net loss
                  $ (701,014 )                   $ (3,401,202 )
 
15

 
WORKSTREAM INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
 
NOTE 6.      NET LOSS PER SHARE

The following is a reconciliation of basic net loss per share to diluted net loss per share:
 
    Three Months Ended     Six Months Ended  
   
November 30,
   
November 30,
 
   
2009
     
2008
   
2009
     
2008
 
Numerator:
                           
Net loss
  $ (341,132 )     $ (1,349,620 )   $ (701,014 )     $ (3,401,202 )
                                     
Denominator:
                                   
Weighted average shares outstanding used
                                   
to compute basic EPS
    56,997,415         55,120,140       56,995,352         53,766,928  
Effect of dilutive securities:
                                   
None
    -         -       -         -  
Weighted average shares outstanding used
                                   
to compute diluted EPS
    56,997,415         55,120,140       56,995,352         53,766,928  
                                     
Basic net loss per common share
  $ (0.01 )     $ (0.02 )   $ (0.01 )     $ (0.06 )
Diluted net loss per common share
  $ (0.01 )     $ (0.02 )   $ (0.01 )     $ (0.06 )
 
Because the Company reported a net loss during the three and six months ended November 30, 2009 and 2008, 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 could potentially dilute earnings per share in the future as of November 30, 2009:
 
Total dilutive instruments:
     
Stock options
    2,099,332  
Restricted stock units
    237,774  
Escrowed shares
    108,304  
Warrants
    5,150,000  
  Total potential dilutive instruments
    7,595,410  
 
On December 11, 2009, the Company issued $5,361,337 of $0.10 Convertible Notes and $6,650,000 off $0.25 Convertible Notes.  The principal of these notes are convertible into a combined 80,213,370 common shares and are potentially dilutive instruments.  Furthermore, these notes accrue interest at 9.5% compounded on a quarterly basis in which the accrued interest is also convertible into common shares at said conversion rates.
 
 
 
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, 2009 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 14, 2009 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.

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

To monitor our results of operations and financial condition, we review key financial information including net revenues, gross profit, operating income and cash flow from operations.  We have deployed numerous analytical dashboards across our business to assist in evaluating current performance against established metrics, budgets and business objectives on an ongoing basis.  We continue to seek methods to more efficiently monitor and manage our business performance.  Such financial information has been included in the following discussion of the Company’s results of operations.
 
 
Revenues
 
      Three Months Ended November 30,       Six Months Ended November 30,  
   
2009
   
2008
     
$ Change
   
% Change
   
2009
   
2008
     
$ Change
   
% Change
 
Revenues:
                                                   
Software
  $ 1,739,128     $ 1,838,082       $ (98,954 )     -5.4 %   $ 3,345,455     $ 3,631,979       $ (286,524 )     -7.9 %
Professional services
    273,567       509,169         (235,602 )     -46.3 %     507,905       1,231,140         (723,235 )     -58.7 %
Rewards
    2,096,257       1,435,089         661,168       46.1 %     3,520,071       2,954,004         566,067       19.2 %
Career networks
    921,167       1,361,983         (440,816 )     -32.4 %     1,868,433       2,880,086         (1,011,653 )     -35.1 %
Total revenues
  $ 5,030,119     $ 5,144,323       $ (114,204 )     -2.2 %   $ 9,241,864     $ 10,697,209       $ (1,455,345 )     -13.6 %
                                                                     
Percentage of total revenues:
                                                                   
Software
    34.6 %     35.7 %                       36.2 %     34.0 %                  
Professional services
    5.4 %     9.9 %                       5.5 %     11.5 %                  
Rewards
    41.7 %     27.9 %                       38.1 %     27.6 %                  
Career networks
    18.3 %     26.5 %                       20.2 %     26.9 %                  
 
Fiscal Second Quarter 2010 Compared to Fiscal Second Quarter 2009: 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 and no new customers.  We will be implementing a new, more targeted approach during the second half of fiscal 2010 in order to attract new customers to coincide with an expected overall economic recovery and anticipated increase in IT spending.  Rewards increased significantly due to better efficiencies by the Company in shipping product and higher utilization of the rewards program by existing customers.  Career Networks revenues decreased primarily due to less employer and recruiter advertising and economic conditions that negatively affected deals in the recruiting and career transition services segment of the business along with less availability of financing for its customers. Additionally, we spent less on marketing and advertising and as a result received less leads on which to convert to revenues.  We have implemented a more targeted approach and alternative financing terms for our career transition clients and as a result believe that the third quarter of fiscal 2010 revenues will begin to improve over the second quarter of fiscal 2010.

First Half Fiscal 2010 Compared to First Half Fiscal 2009: Software revenue decreased primarily due to lower subscriptions as a result of discontinuing support on old software versions and lack of renewals from existing client base.  Professional services revenues decreased due to less consulting for existing customer upgrades or specialization work and no new customers.  We will be implementing a new, more targeted approach during the second half of fiscal 2010 in order to attract new customers to coincide with an expected overall economic recovery and anticipated increase in IT spending.  Rewards increased significantly due to better efficiencies by the Company in shipping product and higher utilization of the rewards program by existing customers.  Career Networks revenues decreased primarily due to less employer and recruiter advertising and economic conditions that negatively affected deals in the recruiting and career transition services segment of the business along with less availability of financing for its customers. Additionally, we spent less on marketing and advertising and as a result received less leads on which to convert to revenues.  We have implemented a more targeted approach and alternative financing terms for our career transition clients and as a result believe that the third quarter of fiscal 2010 revenues will begin to improve over the first half of fiscal 2010.

Cost of Revenues & Gross Profit
 
    Three Months Ended November 30,     Six Months Ended November 30,  
   
2009
   
2008
     
$ Change
   
% Change
   
2009
   
2008
     
$ Change
   
% Change
 
Cost of revenues