UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended August 31, 2011

[ ] 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)

2200 Lucien Way, Suite 201	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 [X] 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 [X]

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

As of October 12, 2011 there were 2,743,699 common shares, no par value, outstanding, excluding 270 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 August 31, 2011 and May 31, 2011	1
		Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three Months Ended August 31, 2011 and 2010	2
		Consolidated Statement of Shareholders’ Equity for the Three Months Ended August 31, 2011	3
		Condensed Consolidated Statements of Cash Flows for the Three Months Ended August 31, 2011 and 2010	4
		Notes to Condensed Consolidated Financial Statements	5

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23

	Item 4T.	Controls and Procedures	30

Part II.		Other Information

	Item 1.	Legal Proceedings	31

	Item 1A.	Risk Factors	31

	Item 6.	Exhibits	32

		Signatures	33

WORKSTREAM INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

As of August 31, 2011 and May 31, 2011

	Notes		August 31, 2011			May 31, 2011
ASSETS:			(Unaudited)
Current assets:
Cash and cash equivalents			$	706,130		$	813,333
Accounts receivable, net of allowances of $581,736 and $571,078 at
August 31, 2011 and May 31, 2011, respectively				1,663,960			1,393,679
Prepaid expenses and other assets				157,210			124,370
Total current assets				2,527,300			2,331,382

Equipment, net				223,174			208,725
Other assets				70,640			43,490
Intangible assets, net		4		940,907			962,338
Goodwill		4		8,606,441			8,606,441

TOTAL ASSETS			$	12,368,462		$	12,152,376

LIABILITIES, REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS’ EQUITY:
Current liabilities:
Accounts payable			$	436,859		$	598,277
Accrued liabilities		5		1,285,773			1,346,537
Accrued compensation				816,885			1,016,923
Current portion of long-term debt, related party				94,000			94,000
Current portion of long-term obligations		6		96,465			135,110
Deferred revenue				1,075,812			1,083,386
Liabilities of discontinued operations				-			102,258
Total current liabilities				3,805,794			4,376,491

Secured note payable and accrued interest, net-related party		2		-			464,301
Long-term debt, related party		3		94,000			118,476
Long-term obligations, less current portion		6		1,065,732			1,059,318
Deferred revenue – long-term				-			26,667
Common stock warrant liability		1		2,847			2,847
Total liabilities				4,968,373			6,048,100

Commitments and Contingencies		7

Preferred shares, Class A series B, no par value, issued and outstanding 481,174 shares as of August 31, 2011				1,382,988			-

SHAREHOLDERS’ EQUITY:		8
Preferred shares, Class A series A, no par value				-			-
Common shares, no par value, issued and outstanding 2,693,598 and 2,517,373 shares as of August 31, 2011 and May 31,2011				140,623,226			140,209,385
Additional paid-in capital				31,239,057			31,061,264
Accumulated deficit		1		(164,829,197	)		(164,160,363	)
Accumulated other comprehensive loss				(1,015,985	)		(1,006,010	)
Total shareholders’ equity				6,017,101			6,104,276

TOTAL LIABILITIES, PREFERRED STOCK AND SHAREHOLDERS’ EQUITY			$	12,368,462		$	12,152,376

See accompanying notes to these condensed consolidated financial statements.

WORKSTREAM INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS & COMPREHENSIVE LOSS

For the Three Months Ended August 31, 2011 and 2010

(Unaudited)

			Three Months Ended
	Notes		August 31, 2011			August 31, 2010
Revenues, net				2,138,096			1,770,905

Cost of revenues (exclusive of amortization				195,573			154,615
and depreciation expense noted below)

Gross profit				1,942,523			1,616,290

Operating expenses:
Selling and marketing				780,383			330,261
General and administrative				510,278			752,093
Research and development				395,862			391,078
Amortization and depreciation				79,145			63,393
Total operating expenses				1,765,668			1,536,825

Business Income				176,855			79,465

Corporate and stock compensation expense:
RSU/Option Expense				177,792			500,679
Public company expense				79,637			9,152
Corporate overhead				597,553			841,301
Total corporate and stock compensation expenses				854,982			1,351,132

Operating Loss				(678,127	)		(1,271,667	)

Other income / (expense):
Interest income and expense, net				5,318			(655,540	)
Gain on extinguishment of debt		2		-			1,192,635
Change in fair value of warrants and derivative		2		-			214,500
Impairment of goodwill		4		-			685,426
Other income and expense, net				285			(393	)
Other income (expense), net				5,603			1,436,628

Income (loss) before income tax expense				(672,524	)		164,961

Income tax expense				(3,676	)		(8,336	)

Net Income (loss) from Continuing Operations			$	(676,200	)	$	156,625

Net Income from Discontinued Operations			$	7,366		$	333,585

Net Income (loss)			$	(668,834	)	$	490,210

Earnings (loss) per share from continuing operations- basic			$	(0.26	)	$	0.38

Earnings (loss) per share from continuing operations- diluted			$	(0.26	)	$	0.36

Earnings per share from discontinued operations- basic			$	0.00		$	0.81

Earnings per share from discontinued operations- diluted			$	0.00		$	0.59

Earnings (loss) per share - basic			$	(0.26	)	$	1.18

Earnings (loss) per share - diluted		10	$	(0.26	)	$	0.87

Weighted average number of common shares
outstanding:
Basic				2,603,172			416,409
Diluted				2,684,845			566,593

Net income (loss)			$	(668,834	)	$	490,210
Comprehensive loss:
Foreign curency translation adjustment				(9,975	)		(7,395	)

COMPREHENSIVE INCOME (LOSS)			$	(678,809	)	$	482,815

See accompanying notes to these condensed consolidated financial statements.

WORKSTREAM INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Unaudited)

							Accumulated
					Additional		Other						Total
	Common Stock				Paid-In		Comprehensive			Accumulated			Shareholders'			Comprehensive
	Shares		Amount		Capital		Loss			Deficit			Equity			Loss
Balance at May 31, 2011		2,517,373	$	140,209,385	$	31,061,264	$	(1,006,010	)	$	(164,160,363	)	$	6,104,276

Restricted stock unit grants and expense		7,023				113,791								113,791
Issuance of perferred shares														-
Issuance of perferred shares for settlement of debt														-
Stock option expense						64,002								64,002
Issuance of common shares for services		18,707		34,054										34,054
Issuance of common shares for compensation		144,565		379,787										379,787
Net loss											(668,834	)		(668,834	)		(668,834	)
Cumulative translation adjustment								(9,975	)					(9,975	)		(9,975	)
Comprehensive loss																$	(678,809	)
Balance at August 31, 2011		2,687,668	$	140,623,226	$	31,239,057	$	(1,015,985	)	$	(164,829,197	)	$	6,017,101

WORKSTREAM INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Three Months Ended August 31, 2011 and 2010

(Unaudited)

	Three Months Ended
	August 31, 2011			August 31, 2010
Cash flows used in operating activities:
Net income / (loss)	$	(668,834	)	$	490,210
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Amortization and depreciation		79,145			63,393
Amortization of deferred financing costs		-			12,195
Leasehold inducement amortization		46			2,889
Allowance for doubtful accounts, net		13,003			60,745
Impairment of goodwill		-			(685,426	)
Stock-based compensation		177,793			241,954
Non-cash compensation of stock purchased by management		-			258,725
Non-cash compensation of stock for services		34,054			-
Non-cash compensation of stock for compensation		379,787			-
Gain on exchange of senior secured notes payable		-			(1,192,635	)
Change in fair value of warrants and derivative		-			(214,500	)
Net change in components of working capital:
Accounts receivable		(283,284	)		(672,910	)
Prepaid expenses and other assets		(59,990	)		82,120
Accounts payable		(263,673	)		(21,570	)
Accrued liabilities		(24,610	)		486,957
Accrued compensation		(200,038	)		5,842
Deferred revenue		(34,240	)		278,638
Net cash used in operating activities		(850,841	)		(803,373	)

Cash flows used in investing activities:
Purchase of equipment		(31,430	)		-
Capitalization of Software Development Costs		(40,734	)		-
Net cash used in investing activities		(72,164	)		-

Cash flows provided by / (used in) financing activities:
Proceeds from issuance of common stock		-			1,250,000
Proceeds from issuance of senior secured note payable, net of issuance costs $90,000		-			660,000
Proceeds from issuance of preferred stock, net of issuance costs of $60,534		939,466			-
Repayment of long-term obligations		(113,689	)		(52,673	)
Net cash provided by financing activities		825,777			1,857,327

Effect of exchange rate changes on cash and cash equivalents		(9,975	)		(7,870	)

Net increase / (decrease) in cash and cash equivalents		(107,203	)		1,046,084
Cash and cash equivalents - beginning of period		813,333			358,529

Cash and cash equivalents - end of period	$	706,130		$	1,404,613


Supplemental schedule of non-cash investing and financing activities:
Exchange of senior secured notes for common stock	$	-		$	22,382,383
Reclass of accrued liabilities to long-term obligations	$	112,313		$	-
Exchange of debt instruments for preferred shares	$	443,522		$	-

Cash paid for interest	$	16,908		$	6,939
Cash paid for taxes	$	5,623		$	-

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 August 31, 2011, the condensed consolidated statements of operations and comprehensive loss for the three months ended August 31, 2011 and 2010, and the condensed consolidated statements of cash flows for the three months ended August 31, 2011 and 2010 are unaudited but include all adjustments that are, in the opinion of management, necessary for a fair presentation of our financial position at such dates and our results of operations and cash flows for the periods then ended in conformity with U.S. generally accepted accounting principles (“US GAAP”). The condensed consolidated balance sheet as of May 31, 2011 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 months ended August 31, 2011 are not necessarily indicative of results that may be expected for the entire fiscal year. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K for the fiscal year ended May 31, 2011.

Description of the Company

Workstream Inc. is a provider of Human Resource Software and Services. Our business primarily provides corporate human resource departments with solutions used for Talent Acquisition and Talent Management.

Our Talent Acquisition solutions includes the Workstream Recruiting Solution; Incentive Advisors, which assists businesses in obtaining hiring tax credits, training grants and other federal, state and local incentives; 6FigureJobs.com is a job board which matches executive level candidates with executive recruiters.

Workstream’s Talent Management solution (TalentCenter) allows businesses to use web based software to better manage human resources. Available solutions include systems to manage performance, development, employee communications and compensation. Increasingly, employers seek automated tools to tie their performance management and professional development strategies to compensation management so that they truly can pay for performance.

Workstream conducts its business primarily in the United States of America and Canada and our target market is employers with more than 1,500 employees.

Management’s Assessment of Liquidity

The Company has incurred substantial losses in recent periods. Losses for the three months ended August 31, 2011 was $668,834 and losses for the years ended May 31, 2011 and 2010 were $162,719 and $26,583,731, respectively. However, since the first quarter of fiscal 2011, the Company has been successful in raising capital through private placements of its common and preferred stock. On August 13, 2010, we exchanged our 2009 Senior Secured Notes for common stock. At the same time we completed a private placement of our common shares for $1,250,000. Furthermore in the third quarter of fiscal 2011, we raised $1,006,000 in additional private placements of our common stock. On July 14, 2011, the Company entered into a Securities Purchase Agreement with First Advantage Offshore Services, Private Limited pursuant to which the Company consummated on July 15, 2011 a private placement of 333,333 shares of its newly formed Class A, Series B Convertible Preferred Shares (the “Series B Shares”) to the Investor for $1,000,000. The Company will use the proceeds from the private placement for working capital and general corporate purposes.

On August 12, 2011, the Company entered into a Securities Purchase Agreement with CCM Master Qualified Fund, Ltd. pursuant to which the Company consummated on August 12, 2011 a private placement of 147,841 shares of its Series B Shares to the Investor for $443,522, the principal and accrued and unpaid interest on the 2010 Note. As a result, we have shareholders’ equity of $6,017,101 as of August 31, 2011.

The Company has made significant reductions in operating expenses beginning in the fourth quarter of fiscal 2008 and continuing through fiscal 2012. These, together with the funding received by the Company in connection with private placements of its common and preferred shares, as well as $750,000 received by the Company in connection with the issuance of its 2010 Note and $900,000 received by the Company under its line of credit with Bridge Bank and an analysis of our current contracts, forecasted new business, our current backlog and current expense level leads management believes that current operations will be sufficient to meet its anticipated working capital and capital expenditure requirements. If this proves insufficient, management will consider additional cost savings measures or 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 2012.

The Company continues to actively pursue financing from multiple sources including but not limited to, additional sales of preferred or common stock for cash, bank financing, and business acquisitions. Potential uses of such capital include but are not limited to continued investments in its core technology, enhancing its sales infrastructure and acquiring companies that provide complimentary products and services to the company’s core suite of products.

Use of Estimates

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

Revenue Recognition

The Company derives revenue from various sources including the following: subscription and hosting fees; licensing of software and related maintenance fees; professional services related to software implementation, customization and training; career transition services; training grants; hiring and job creation credits; and, applicant sourcing.

In general, the Company recognizes revenue when all of the revenue recognition criteria are met, which is typically when:

evidence of an arrangement exists;

services have been provided or goods have been delivered;

the price is fixed or determinable; and

collection is reasonably assured.

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

Subscription and hosting fees and software maintenance fees are billed in advance on a monthly, quarterly or annual basis. Amounts that have been invoiced are recorded in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met. Quarterly and annual payments are deferred and recognized monthly over the service period on a straight-line basis. Set up fees are deferred and recognized monthly on a straight-line basis over the contractual lives of the customer.

Subscription revenues and hosting fees consist of fees from customers accessing our on-demand application service. The Company follows the provisions of ASC 605, Revenue Recognition and ASC605-25, Revenue Recognition with Multiple Deliverables Arrangements. For revenue arrangements with multiple deliverables, the Company allocates the total customer arrangement to the separate units of accounting based on their relative fair values, as determined by the price of the undelivered items when sold separately. Professional services included in an application services arrangement with multiple deliverables are accounted for separately when these services have value to the customer on a standalone basis, and there is objective and reliable evidence of fair value of each undeliverable item of the arrangement. When accounted for separately, revenues are recognized as the services are rendered.

The new revenue guidance contained in ASU 2009-13 modifies the way the Company accounts for certain of its arrangements, by allowing the Company to separate its professional services and corresponding license fees into two separate units of accounting. These two deliverables represent the primary elements in those arrangements and are recognized upon performance or delivery of each service or product, respectively to the end customer. Revenue related to

professional services is recognized as obligations are fulfilled on a proportional performance basis while the license fees may be recognized over a one to five year period. Expenses associated with the delivery of our consulting service are expensed as incurred. These arrangements usually do not contain cancellation or refund-type provisions and may include termination for convenience clauses following a stated period of time or the failure to meet performance level commitments. Multiple element arrangements consisting of multiple products are impacted by the new revenue guidance. Under ASU 2009-13, total consideration for an arrangement is allocated to each product using the hierarchy of VSOE, third party evidence or the relative selling price method and is recognized as each product is delivered to the customer. Consistent with current practice, revenue may be deferred if the arrangement includes any unusual terms including extended payment terms, specified acceptance terms, or holdbacks payable upon final acceptance of the product.

The Company’s arrangements with customers may include provisions of professional services and software licenses. For arrangements that contain multiple deliverables, the selling price hierarchy established in ASU 2009-13 is used to determine the selling price of each deliverable. The selling price hierarchy allows for the use of an estimated selling price (“ESP”) to determine the allocation of arrangement consideration to each deliverable in a multiple-element arrangement in the absence of vendor specific objective evidence (“VSOE”) or third-party evidence (“TPE”). To qualify as a separate unit of accounting, deliverable items must have value to the customer on a standalone basis and, if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control. If the arrangement does not meet all criteria above, the entire amount of the transactions is deferred until all elements are delivered. The Company determines the selling price in multiple-element arrangements using VSOE or TPE if available. VSOE is determined based on the price charged for the same deliverable when sold separately and TPE is established based on the price charged by our competitors or third parties for the same deliverable. If the Company is unable to determine the selling price because VSOE or TPE does not exist, the ESP is used.

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

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

Tax advisory service revenues are generated from transaction fees based on a percentage of the value of the tax credit identified and are recognized in the period that the approval of the underlying eligible employee or program is received from the taxing authority and such credit is reported to the client. Revenue from hourly and fixed fee consulting services is recognized as the services are performed.

For career transition services, the Company recognizes revenue when all of the revenue recognition criteria are met, which is typically when services have been completed.

As described above, the Company defers certain revenues received and recognizes them ratably over the applicable term of service. If the revenue is expected to be recognized within the next twelve months, it is classified as a current liability on

the accompanying consolidated balance sheets. If the revenue is expected to be recognized over a period longer than 12 months, then the portion of revenue expected to be recognized greater than 12 months is classified as a long-term liability.

Warrant Liability

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

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

Lattice Model Inputs:
	August 31, 2011		May 31, 2011

Stock price	$	2.00	$	3.70
Exercise price	$	40.00	$	40.00
Expected volatility		54% - 154%		54% - 154%
Expected dividend yield		0%		0%
Expected term (in years)		1		1.2
Risk-free interest rate		0.04% - 0.18%		0.04% - 0.18%

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 August 31, 2011. The Company uses the market approach to measure fair value for its Level 1 financial assets which includes cash equivalents. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. There were no cash equivalents as of August 31, 2011 or May 31, 2011. The respective carrying value of certain on-balance-sheet financial instruments approximated their fair values due to the short-term nature of these instruments. These instruments include cash, accounts receivable, accounts payable and accrued liabilities.

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

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

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

The Company’s warrants related to the 2008 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 three months ended August 31, 2011:

	Warrant
	Liability

Fair value as of May 31, 2011	$	2,847
Change in fair value of warrants and derivative		-
Fair value as of August 31, 2011	$	2,847

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 accounts for derivative instruments in accordance with FASB ASC 815, Derivatives and Hedging (“ASC 815”), which requires additional disclosures about the Company’s objectives and strategies for using derivative instruments, how the derivative instruments and related hedged items are accounted for , and how the derivative instruments and related hedging items affect the financial statements. The Company does not use derivative instruments to hedge exposure to cash flow, market and foreign currency risk. Terms of convertible debt and equity instruments are reviewed to determine whether or not they contain embedded derivative instruments that are required under ASC 815 to be accounted for separately from the host contract, and recorded on the balance sheet at fair value. The fair value of derivatives liabilities, if any, is required to be revalued at each reporting date, with corresponding changes in fair value recorded current period operating results.

Preferred Stock

The preferred stock has been classified within the mezzanine section between liabilities and equity in its consolidated balance sheets in accordance with ASC 480, Distinguishing Liabilities from Equity because any holder of Series B Preferred may require the Company to redeem all of its Series B Preferred in the event of a triggering event which is outside of the control of the Company.

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. There were no stock options granted during the three months ended August 31, 2011.

	Three Months Ended
	August 31, 2010

Expected volatility	178% - 198%
Expected dividend yield	0%
Expected term (in years)	3.5
Risk-free interest rate	1.47% - 2.0%
Forfeiture rate	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.

Intangible Asset- Customer Relationships

Customer relationships represent relationships that we have with customers of acquired companies which are based upon contractual rights. These customer relationships are initially recorded at their fair value based on the present value of expected future cash flows using the multi-period excess earnings method.

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

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 months ending August 31, 2011 of $40,734. The company began amortizing those costs in the first quarter of fiscal 2012. certain of our internally developed software was placed into service in June 2011.

Accrued Compensation

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

Prepaids and Other Assets

	August 31, 2011		May 31, 2011
Advances	$	19,124	$	19,124
Advances, related parties		30,000		30,000
Prepaid Insurance		9,691		10,760
Software and Maintenance		26,507		22,555
Other		71,888		41,931
	$	157,210	$	124,370

Research and Development Costs

The Company accounts for research and development costs associated with computer software development under the provisions of ASC 985, Software. Costs are expensed as incurred until technological feasibility has been established. Technological feasibility is established upon completion of a working model; thereafter, all software production costs are capitalized and subsequently reported at the lower of unamortized cost or net realizable value. To date, the time period between the establishment of technological feasibility and completion of software development has been short, and as a result, no significant development costs have been incurred during that period. Accordingly, the Company has not capitalized any research and development costs associated with computer software products to be sold, leased, or otherwise marketed.

Research and development costs primarily include salaries and related costs, costs associated with using outside contractors and miscellaneous software support and administrative expenses.

Recent Accounting Pronouncements

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

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

In 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 became effective for us in fiscal 2012 and should be applied prospectively.

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, the activity in Level 3 fair value measurements, and the transfers between Levels 1, 2, and 3. Certain provisions of this update became effective for us in fiscal 2012.

In October 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-13, “Revenue Recognition: Multiple-Deliverable Revenue Arrangements-a consensus of the FASB Emerging Issues Task Force”, which eliminates the use of the residual method for allocating consideration, as well as the criteria that requires objective and reliable evidence of fair value of undelivered elements in order to separate the elements in a multiple-element arrangement. By removing the criterion requiring the use of objective and reliable evidence of fair value in separately accounting for deliverables, the

recognition of revenue will more closely align with certain revenue arrangements. The standard also will replace the term "fair value" in the revenue allocation guidance with "selling price" to clarify that the allocation of revenue is based on entity-specific assumptions rather than assumptions of a marketplace participant. ASU No. 2009-13 is effective for revenue arrangements entered or materially modified in fiscal years beginning on or after June 15, 2010. The Company has determined it has no material impact on the financial condition or results of operations of the Company. ASU No. 2009-13 became effective for us in fiscal 2012.

NOTE 2.

SENIOR SECURED NOTES PAYABLE

On December 11, 2009, the Company entered into an Exchange Agreement (collectively, the “2009 Exchange Agreements”) with each of the Holders of its 2008 Notes 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 $100.00 (a “$100.00 Convertible Note”); and, (iii) a senior secured convertible note that is convertible into the Company's common shares at a conversion price of $40.00 (a “$40.00 Convertible Note,” and together with the Non-Convertible Notes and the $100.00 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, $100.00 Convertible Notes in an aggregate principal amount of $6,650,000, and $40.00 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% increasing to 14.5% upon occurrence of default. Interest on the $100.00 Convertible Notes and the $40.00 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 $100.00 Convertible Notes and the $40.00 Convertible Notes were convertible as registrable securities.

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.

Each of the warrants issued in connection with the 2008 Exchange Transaction that occurred in fiscal 2009 contained anti-dilution protection provisions. As a result of the Company’s issuance of the $40.00 Convertible Notes, the exercise price of the warrants that remain outstanding was adjusted to $40.00 per share from $100.00 per share and the number of common shares issuable upon exercise was proportionately increased by 10,500 to 17,500 in which $995,400 representing the fair

value of this increase was included in the loss on extinguishment of debt in the statement of operations as it was directly related to the exchange of the New Secured Notes.

Furthermore, in accordance with the guidance in ASC 470-20-30, the Payment-in-Kind (“PIK”) interest associated with the $40.00 Convertible Note and $100.00 Convertible Note accrued during each quarter has to be compared to the fair value of the Company’s commons shares at the quarter end, or the commitment date, for potential interest charges derived from beneficial conversion features. During the year ended May 31, 2010, the Company recognized additional interest expense of $137,804 associated with the PIK interest’s beneficial conversion feature.

In January 2010, $148,856 of principal and accrued interest related to the $40.00 Convertible Notes was converted into 3,721 of the Company’s common shares and in February 2010, $88,932 of principal and accrued interest related to the $100.00 Convertible Notes was converted into 889 of the Company’s common shares. In March 2010, $302,203 of principal and accrued interest related to the $40.00 Convertible Notes was converted into 7,555 shares of the Company’s common stock. In April 2010, $274,790 of principal and accrued interest related to the $40.00 Convertible Notes was converted into 6,869 of the Company’s common shares.

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%.

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 2009 Secured 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 1,707,130 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. The 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. Principal and interest is payable upon the maturity date of October 13, 2012. Upon the occurrence of an event of default, as defined in the 2010 Note, the Lending Investor may require the Company to redeem all or a portion of the 2010 Note. Upon a Disposition (as defined in the 2010 Note), the Company has agreed to use the Net Proceeds from such Disposition to redeem the 2010 Note. Under the 2010 Note, the Company is required to comply with various financial and other covenants and restrictions. Material covenants and restrictions include that: the Company and its subsidiaries may not redeem or repurchase any of its capital shares or declare or pay any dividend without the consent of the Lending Investor; subject to certain exceptions, the Company and its subsidiaries may not sell, lease, license, assign, transfer, convey or otherwise dispose of any assets in excess of $250,000 in any twelve-month period without the consent of the Lending Investor; the Company must maintain a minimum cash balance of not less than $250,000; as of the end of each calendar month, the Company’s cash balance plus accounts receivable that are less than 90 days old must be equal to or greater than 200% of the outstanding principal amount, interest due and late charges owing under the 2010 Note; and the Company and its subsidiaries may not have any material weakness in their control environments as reported by the Company’s auditors. 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 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 at an amount equal to the net proceeds up to the maximum amount owed under the note including outstanding principal, unpaid interest and late fees. Under ASC 815, Derivatives and Hedging, embedded put derivatives such as these require bifurcation and separate classification at fair value. The value of the embedded put derivatives were deemed to be nil on May 31, 2011.

Simultaneous and in connection with the 2010 Exchange Agreements and the 2010 Note, we issued 158,069 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 from 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 $12.00 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 extinguishment of debt totaling $1,192,635. The basic gain per common share was $0.66 and the diluted gain per common share was $0.62.

On August 12, 2011, the Company entered into a Securities Purchase Agreement with CCM Master Qualified Fund, Ltd., the holder of the 2010 Note pursuant to which the Company consummated on August 12, 2011 a private placement of 147,841 shares of its Series B Preferred shares to the Investor valued at $443,522, which was equivalent to the carrying value of the principal and accrued and unpaid interest on the 2010 Note. The issuance of the Series B Shares in the private placement was deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act of 1933.

NOTE 3.

LONG-TERM DEBT – RELATED PARTY

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

NOTE 4.

ACQUIRED INTANGIBLE ASSETS AND GOODWILL

Acquired intangible assets consist of the following:

	August 31, 2011					May 31, 2011
				Accumulated					Accumulated
	Cost			Amortization		Cost			Amortization
Customer relationships	$	663,000		$	81,984	$	663,000		$	48,834
Software developed for internal use		388,905			29,014		348,172			-
Intellectual property		1,322,760			1,322,760		1,322,760			1,322,760
		2,374,665		$	1,433,758		2,333,932		$	1,371,594

Less accumulated amortization		(1,433,758	)				(1,371,594	)
Net acquired intangible assets	$	940,907				$	962,338

Amortization expense for intangible assets was $62,164 and $48,834 for the quarter ended August 31, 2011 and zero for quarter ended August 31, 2010, respectively.

Expected future amortization expense for the customer relationships as of August 31, 2011 follows:

	Amount
Year ended May 31:
2012		99,450
2013		132,600
2014		132,600
2015		132,600
2016		83,766

Total	$	581,016

The following represents the detail of the changes in the goodwill account for the years ended May 31, 2011 and 2010:

	Enterprise
	Workforce
	Services

Goodwill at May 31, 2010	$	6,045,900
Purchase of Incentives Advisors	$	1,875,115
Impairment adjustment		685,426
Goodwill at May 31, 2011	$	8,606,441
Activity		-
Goodwill at August 31, 2011	$	8,606,441

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

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

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

NOTE 5.

ACCRUED LIABILITIES

Accrued liabilities consist of the following at August 31, 2011 and May 31, 2011:

	August 31, 2011		May 31, 2011
Legal, audit & professional fees		53,966	$	90,772
Merger costs		80,000		80,000
Consulting fees		92,333		107,958
Sales tax payable		329,961		329,746
Other		729,513		738,061
	$	1,285,773	$	1,346,537

NOTE 6.

OTHER LONG-TERM OBLIGATIONS

The Company entered into various capital lease obligations for equipment to be housed in an outside data center facility. All capital leases are being paid on a monthly and quarterly basis.

On May 10, 2011, Workstream Inc. (the “Company”) entered into a Business Financing Agreement (the “Financing Agreement”) with Bridge Bank, National Association. The Financing Agreement is secured by a lien on all of the assets of the Company and its subsidiaries pursuant to the terms of a Stock Pledge Agreement among the Company, its subsidiaries and the Lending Investor (the “Pledge Agreement”). The credit limit on the Financing Agreement is $3,000,000. Interest on the Financing Agreement accrues at an annual rate of the Prime Rate plus 2% with the Prime Rate having a minimum of 3.25%. From and after the occurrence and during the continuance of any event of default under the Financing Agreement, the interest rate then in effect will be automatically increased by 5% per year. The Financing Agreement has an annual facility fee of $15,000 or .5% of the advance balance. The Financing Agreement has a monthly maintenance fee of .125% of the average monthly balance. The Financing Agreement contains customary covenants of providing monthly financial statements within 30 days, annual audited financials with 180 days, annual board approved budget within 60 days of fiscal year end and a semi-annual accounts receivable audit. The Company must also maintain a minimum asset coverage ratio of 1.5 to 1. The Pledge Agreement sets forth that the Company has granted a security interest in all shares of capital stock, corporations, limited partnership interests and limited liability company interests that the Company now owns or hereafter acquires.

Long-term obligations consist of the following at August 31, 2011 and May 31, 2011:

	August 31, 2011		May 31, 2011
Secured notes payable	$	901,663	$	901,663
Long-term payables		111,684		83,333
Capital lease obligations		148,850		205,111
Leasehold inducements		-		4,321
		1,162,197		1,194,428

Less current portion of:
Senior secured notes payable		-		-
Long-term obligations		96,465		135,110
	$	1,065,732	$	1,059,318

Maturities
Fiscal 2012	$	96,465
Fiscal 2013		1,058,927
Fiscal 2014		6,805
	$	1,162,197

NOTE 7.

COMMITMENTS AND CONTINGENCIES

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

NOTE 8.

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 Class A, Series B Convertible Preferred Shares (the “Series B Shares”). There were 2,693,868 common shares issued and outstanding, including 270 shares being held in escrow, as of August 31, 2011. There were 481,174 Class A, Series B Convertible Preferred Shares outstanding as of August 31, 2011.

The Series B Shares rank senior to the Company’s common shares and the Company’s previously created but unissued Class A, Series A Preferred Shares. The Series B Shares accrue dividends at a rate of 7% per year, payable in additional Series B Shares. The Series B Shares have a liquidation preference and are convertible into common shares at a price of $3.00 per share, subject to adjustments and full-ratchet anti-dilution protection. Additionally, the Series B shares will automatically convert into common shares on the 180th day that the closing price of the common shares equals or is greater than three times the conversion price for such entire 180 day period. In addition, in the event of liquidation, dissolution or winding up of the Company, the holders of Series B shares can require the redemption of such Series B shares. As there are certain events that are considered “deemed liquidation” events, such as a merger or consolidation or similar transaction resulting in a change of control that are outside of the control of the company, the Series B Preferred has been classified in the mezzanine equity section of the Company’s balance sheet.

On July 14, 2011, the Company entered into a Securities Purchase Agreement with First Advantage Offshore Services, Private Limited pursuant to which the Company consummated on July 15, 2011 a private placement of 333,333 shares of its newly formed Class A, Series B Convertible Preferred Shares to the Investor for $1,000,000 net of issuance costs of $60,534. The issuance of the Series B Shares in the private placement was deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act of 1933. Marc Bala, a Director of First Advantage Corporation and a Principal of Symphony Technology Group joined the Company’s Board of Directors upon consummation of the transaction. The Company will use the proceeds from the private placement for working capital and general corporate purposes.

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 April 2011 at the annual shareholders’ meeting. Under the Plan, as amended, the Company is authorized to issue up to 375,000 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.

On June 1, 2006, the Company adopted the provisions of ASC 718, which requires it to recognize expense related to the fair value of stock-based compensation awards. 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 the provisions of ASC 718. Compensation expense for stock option awards is recognized on a straight-line basis over the requisite service period of the award. 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 and comprehensive loss under other operating expenses:

	Three Months Ended
	August 31, 2011		August 31, 2010

Stock compensation expense - options	$	64,001	$	17,450

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, 2010		4,386		$	236.00
Granted		81,346			8.38	$	11.71
Exercised		-			-
Forfeited or expired		(22,621	)		31.35
Balance outstanding - May 31, 2011		63,111			16.07
Granted		-			-	$	-
Exercised		-			-
Forfeited or expired		(453	)		401.01
Balance outstanding - August 31, 2011		62,658		$	13.29				3.9	$	-

Exercisable - August 31, 2011		21,597		$	20.31				3.9	$	-

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 $2.00 on August 31, 2011, the last trading day of the reporting period and the exercise price times the number of shares, that would have been received by the option holders had the option holders exercised their options on August 31, 2011.

There were no options exercised during the three months ended August 31, 2011 and 2010; and therefore, no intrinsic value or cash received from option exercises during the period.

The following table summarizes information about options outstanding August 31, 2011:

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

$7.90 - $99.00		61,021		4.0	$	8.57		20,355		4.0	$	8.62
$100.00 - $299.00		1,114		2.8	$	118.74		719		2.8	$	49.09
$300.00 - $399.00		457		1.4	$	313.98		457		1.4	$	313.98
$400.00 - $599.00		66		0.5	$	516.85		66		0.5	$	516.85

		62,658		3.9	$	13.29		21,597		3.9	$	20.31

As of August 31, 2011, $465,236 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 months ended August 31, 2011 and 2010 due to the uncertainty of realizability.

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

	Three Months Ended
	August 31, 2011		August 31, 2010

Stock compensation expense - RSUs	$	113,791	$	224,505
Stock compensation expense - Restricted Stock Issuances	$	-	$	-
Total	$	113,791	$	224,505

As of August 31, 2011, $888,507 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, 2010		717
Granted		155,298		$	11.83
Vested and issued		(25,437	)
Vested and unissued		(19,010	)
Forfeited or expired		(21,024	)
Outstanding - May 31, 2011		90,544
Granted		-
Vested and issued		(7,023	)
Vested and unissued		(2,120	)
Cancelled		-
Forfeited or expired		-
Outstanding - August 31, 2011		81,401

NOTE 9.

SEGMENT INFORMATION

The Company has two reportable segments: Human Resource Software and Services and Career Transition Services. The revenue for the Human Resource Software and Services consists of revenue generated from Human Resource software, related professional services, tax incentives, applicant sourcing and recruitment research services.

The Company changed its reportable segments during fiscal year 2011. The Company was reporting the segments as Enterprise which included software and professional services and Career Networks which included recruitment research services and career transition services. The Company consolidated management, and began cross-selling the various product lines. Management believes the new segment reporting more accurately represents the present conditions within the Company.

The following tables summarize the Company’s operations by business segment for the three months ended August 31, 2011 and 2010:

	Three Months Ended								Three Months Ended
	August 31, 2011								August 31, 2010
	Human Resource Software and Services		Career Transition Services			Total			Human Resource Software and Services			Career Transition Services			Total
Software	$	947,520	$	-		$	947,520		$	1,160,470		$	-		$	1,160,470
Professional services		67,546		-			67,546			38,595			-			38,595
Tax incentives		536,430		-			536,430			-			-			-
Job board		340,152		-			340,152			343,532			-			343,532
Career transition services		-		246,448			246,448			-			228,308			228,308
Revenue, net		1,891,648		246,448			2,138,096			1,542,597			228,308			1,770,905
Cost of revenues:
Other		186,653		8,920			195,573			149,599			5,016			154,615
Gross profit		1,704,995		237,528			1,942,523			1,392,998			223,292			1,616,290
Expenses		1,445,389		241,134			1,686,523			1,057,307			416,125			1,473,432
Impairment charges - goodwill		-		-			-			(685,426	)		-			(685,426	)
Amortization and depreciation		77,108		2,037			79,145			56,805			6,588			63,393
Business segment income from continuing operations	$	182,498	$	(5,643	)		176,855		$	964,312		$	(199,421	)		764,891

Corporate and stock compensation expense							854,982									1,351,132
Other expense and income tax							1,927									742,866
Net Income (loss) from Continuing Operations						$	(676,200	)							$	156,625
Net Income from Discontinued Operations						$	7,366								$	333,585
Net Income (loss)						$	(668,834	)							$	490,210

NOTE 10.

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
	August 31, 2011			August 31, 2010
Numerator:
Net income (loss) from continuing operations	$	(676,200	)	$	156,625

Net Income from discontinued operations	$	7,366		$	333,585

Net income (loss)	$	(668,834	)	$	490,210

Denominator:
Weighted average shares outstanding-basic		2,603,172			416,409
Potential shares "in-the-money" under stock
option and warrant agreements		81,673			168,874
Less: Shares assumed respurchased under the
treasury stock method		-			(18,690	)

Weighted average shares outstanding-diluted		2,684,845			566,593

Basic net income (loss) per common share from continuing operations	$	(0.26	)	$	0.38
Diluted net income (loss) per common share from continuing operations	$	(0.26	)	$	0.36

Basic net income per common share from discontinued operations	$	0.00		$	0.81
Diluted net income per common share from discontinued operations	$	0.00		$	0.59

Basic net income (loss) per common share	$	(0.26	)	$	1.18
Diluted net income (loss) per common share	$	(0.26	)	$	0.87

Because the Company reported net income from continuing operations and from discontinued operations during the three months ended August31, 2010 as well as from discontinued operations during the three months ended August 31, 2011 the Company included the impact of its common stock equivalents in the computation of dilutive earnings per share for these periods. A net loss from continuing operations was reported during the three months ended August 31, 2011 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 three months ended August 31, 2011:

Total dilutive instruments:
Stock options			62,658
Restricted stock units			-
Escrowed shares			-
Warrants			20,000
Total potential dilutive instruments			82,658

NOTE 11.

DISCONTINUED OPERATIONS

During the fourth quarter of fiscal 2011, the Company decided to discontinue its operations of the Rewards business. This business was not core to our vision of a Human Resources software and technology enabled service business. We had been given notice that the largest rewards customer, as well as others, will not renew its contract with Workstream. Although management was disappointed by the customers’ decision to terminate their agreements, the Rewards service is low margin and working capital intensive. The business is not held for sale.

Results from discontinued operations were as follows:

	Three Months Ended
	August 31, 2011		August 31, 2010

Rewards		26,647		1,966,188
Revenue, net		26,647		1,966,188
Cost of revenues:
Cost of revenues		18,434		1,500,792
Gross profit		8,213		465,396
Expenses		847		131,811
Impairment charges - goodwill		-		-
Amortization and depreciation		-		-
Net Income from Discontinued Operations	$	7,366	$	333,585

Assets and liabilities from discontinued operations consist of $98,433 of accounts payable at August 31, 2010.

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, 2011 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 August 24, 2011 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

Workstream Inc. is a provider of Human Resource Software and Sevices. Our business provides corporate human resource departments with solutions used for Talent Acquistion and Talent Management.

Our Talent Acquisition solutions include the Workstream Recruiting Solution, an applicant tracking system; Incentive Advisors, which assists businesses in obtaining hiring tax credits, cash training grants and other federal, state and local incentives available to businesses; 6FigureJobs.com a job board which matches executive level candidates with executive recruiters.

Workstream’s Talent Management solution (TalentCenter) allows businesses to tie their performance management and professional development strategies to compensation management so that they truly can pay for performance.

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 fiscal 2010. In fiscal 2011 and 2012, 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 and has been discontinued. We will continue to focus on generating revenue growth through sales of our enterprise software solutions.

Revenues

	Three Months Ended August 31
	2011			2010			$ Change			% Change
Revenues:
Software	$	947,520		$	1,160,470		$	(212,950	)		-18.4	%
Professional services	$	67,546		$	38,595			28,951			75.0	%
Tax incentives	$	536,430		$	-			536,430			N/A
Job board	$	340,152		$	343,532			(3,380	)		-1.0	%
Career transition services	$	246,448		$	228,308			18,140			7.9	%
Total revenues	$	2,138,096		$	1,770,905		$	367,191			20.7	%

Percentage of total revenues:
Software		44.3	%		65.5	%
Professional services		3.2	%		2.2	%
Tax incentives		25.1	%		0.0	%
Job board		15.9	%		19.4	%
Career transition services		11.5	%		12.9	%

Fiscal First Quarter 2012 Compared to Fiscal First Quarter 2011: Software revenue decreased primarily due to lower subscriptions as a result of our discontinuing support of old software versions reduced renewals from existing clients. Revenue from new clients in fiscal 2012 was insufficient to offset the decline. Professional services revenues increased due to billable services for new customers. Career transition services revenues increased as hiring activity, especially the hiring of highly compensated executives found on 6FigureJobs.com grew stronger. The tax incentives business was acquired in January 2011. It assists businesses in obtaining hiring tax credits, training grants and other federal, state and local incentives.

Cost of Revenues & Gross Profit

	Three Months Ended August 31
	2011			2010			$ Change			% Change
Cost of revenues:
Software	$	120,823		$	128,941		$	(8,118	)		-6.3	%
Professional services		56,041			18,374			37,667			205.0	%
Tax incentives		6,469			-			6,469			N/A
Job board		3,319			2,284			1,035			45.3	%
Career transition services		8,921			5,016			3,905			77.9	%
	$	195,573		$	154,615		$	40,958			26.5	%


Gross profit	$	1,942,523		$	1,616,290		$	326,233			20.2	%

Gross profit as a percentage of total revenues:
Software		87.2	%		88.9	%
Professional services		17.0	%		52.4	%
Tax incentives		98.8	%		N/A
Job board		99.0	%		99.3	%
Career transition services		96.4	%		97.8	%
Total		90.9	%		91.3	%

Fiscal First Quarter 2012 Compared to Fiscal First Quarter 2011: Software costs of revenues decreased due to decreases in service provider fees. The prior service provider fees were re-negotiated due to the contract expiring in August 2011. We expect to decrease these costs by 50%. Professional services costs increased due to more consulting for new customers, while the Gross Profit decreased due to an increase in non-billable hours being worked. Career transition services cost of revenues directly increased due to the increase in revenue levels. The tax incentives business was acquired in January 2011.

Selling & Marketing Expense

	Three Months Ended August 31
	2011			2010			$ Change		% Change

Selling and marketing	$	780,383		$	330,261		$	450,122		136.3	%

Percentage of total revenues		36.5	%		18.6	%

Fiscal First Quarter 2012 Compared to Fiscal First Quarter 2011: Consulting and employment related expenses increased by approximately $348,000 primarily as a result of the addition of Incentives Advisors employees and higher sales commissions during the first quarter of 2012. We have an increase of space occupancy and other expenses of approximately $37,000 directly related to the addition of the Incentives Advisors office in Arizona. Job Board increased its marketing expenditures by approximately $56,000 in order to drive more traffic to its business components. Bad debt expense was higher by approximately $8,000 for the first quarter of 2011.

General & Administrative Expense

	Three Months Ended August 31
	2011			2010			$ Change			% Change

General and administrative	$	510,278		$	752,093		$	(241,815	)		-32.2	%

Percentage of total revenues		23.9	%		42.5	%

Fiscal First Quarter 2012 Compared to Fiscal First Quarter 2011: Consulting, professional fees and employment related expenses decreased by approximately $211,800 as a result of fewer employees. Space occupancy and telephone expenses decreased by approximately $33,200 due to the re-negotiation of leases. Other expenses were approximately $13,100 higher mainly due to moving costs.

Research & Development Expense

	Three Months Ended August 31
	2011			2010			$ Change		% Change

Research and development	$	395,862		$	391,078		$	4,784		1.2	%

Percentage of total revenues		18.5	%		22.1	%

Fiscal First Quarter 2012 Compared to Fiscal First Quarter 2011: Costs associated with software and computer support increased by approximately $4,800.

Corporate and Stock Compensation Expense

	Three Months Ended August 31
	2011			2010			$ Change			% Change

Corporate and stock compensation expense	$	854,982		$	1,351,132		$	(496,150	)		N/A

Percentage of total revenues		40.0	%		76.3	%

Fiscal First Quarter 2012 Compared to Fiscal First Quarter 2011: Consulting, professional fees and employment related expenses decreased by approximately $139,000 as a result of no bonuses and reduced legal fees. Non-cash stock compensation and RSU expense decreased by approximately $322,900 due to changes in management. Space occupancy and telephone expenses decreased by approximately $50,700 due to the re-negotiation of leases. Other expenses were approximately $16,000 higher mainly due to moving costs.

Impairment of Goodwill

	Three Months Ended August 31
	2011		2010		$ Change			% Change

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

In considering the current and expected future market conditions, the Company determined that the Enterprise goodwill was impaired in accordance with ASC 350, Intangibles – Goodwill and Other, and the Company recorded non-cash, pre-tax goodwill impairment estimate charges of $5,335,760 during the year ended May 31, 2010. The decline in estimated fair value of the Enterprise operating segment resulted from an analysis of the current economic conditions, the Company’s performance to budget and the lower estimated future cash flows. During the first quarter of fiscal year 2011, we had a change in management as well as a conversion of our 2009 Notes to Equity (see Note 2 for further discussion). The Company believed 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 impairment charge 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 August 31
	2011			2010			$ Change		% Change

Amortization and depreciation	$	79,145		$	63,393		$	15,752		24.8	%

Percentage of total revenues		3.7	%		3.6	%

Fiscal First Quarter 2012 Compared to Fiscal First Quarter 2011: Amortization expense increased by nearly $62,100 due to the acquisition of Incentives Advisors and the amortization of related acquired customer relationships plus the amortization of software capitalization costs. Depreciation expense decreased by approximately $46,400 due to fixed assets becoming fully depreciated during fiscal year 2011.

Interest Income & Expense, Net

	Three Months Ended August 31
	2011		2010			$ Change		% Change

Interest income and expense, net	$	5,318	$	(655,540	)	$	660,858		-100.8	%

Fiscal First Quarter 2012 Compared to Fiscal First Quarter 2011: Interest expense decreased by approximately $640,000 due to the exchange of the 2009 Senior Secured Notes for Common Stock in August 2010. Finance costs for the exchange were approximately $12,200 in Fiscal First Quarter 2011.

Change in Fair Value of Warrants & Derivative

	Three Months Ended August 31
	2011		2010		$ Change			% Change
Change in fair value of warrants
and derivative	$	-	$	214,500	$	(214,500	)		N/A

On June 1, 2009, the Company adopted ASC 815, which required it to begin accounting for certain warrants as a liability due primarily to the reset provisions of the warrant in the event of lower priced financing transactions. We recognized amounts of NIL and $214,500 associated with the change in the fair value of the Warrants in the condensed consolidated statement of operations and comprehensive loss for the three months ended August 31, 2011 and 2010, respectively.

Gain on Exchange/Extinguishment of Debt

	Three Months Ended August 31
	2011		2010		$ Change			% Change

Gain on extinguishment of debt	$	-	$	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. On August 12, 2011, the Company entered into a Securities Purchase Agreement with CCM Master Qualified Fund, Ltd.”) pursuant to which the Company consummated on August 12, 2011 a private placement of 147,841 shares of its Series B Shares to the Investor valued at which was equal to $443,522, the carrying value of the principal and accrued and unpaid interest on the 2010 Note. During the same month as the exchange transaction, the same Class A Series B Preferred shares were sold to an unrelated party at $3.00 a share for total proceeds of $1,000,000. Based on this (Level 1) transaction and the fact that the Company is not under financial duress and the note holder was willing to take the same price is seems reasonable that that the fair value of a Class A Series B share as of the date of the CCM transaction was $3.00. As such, the carrying value of the debt was the same as the value of the preferred shares issued resulting in no gain or loss on extinguishment of debt.

Income Taxes

	Three Months Ended August 31
	2011			2010			$ Change		% Change

Income tax expense	$	(3,676	)	$	(8,336	)	$	4,660		-55.9	%

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 $1.02 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. We had two private placements for common stock during the fiscal third quarter of 2011 to infuse capital into the Company. The Company also completed a merger with Incentives Advisors which should increase our working capital in future quarters. The Company has been successful in negotiating and settling large liabilities which has helped increase our working capital over prior quarters. On July 14, 2011, the Company entered into a Securities Purchase Agreement with First Advantage Offshore Services, Private Limited pursuant to which the Company consummated on July 15, 2011 a private placement of 333,333 shares of its newly formed Class A, Series B Convertible Preferred Shares (the “Series B Shares”) to the Investor for $1,000,000. The issuance of the Series B Shares in the private placement was deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act of 1933.

Cash & Cash Equivalents: As of August 31, 2011, we have approximately $706,000 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 71.1 days at August 31, 2011 from 54.2 days at May 31, 2011. The cause for the change days sales outstanding is primarily due to the increase in Incentive Advisors receivables which have a longer collection cycle.

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. Workstream Inc and Second Foundation Inc reached an out of court settlement in fiscal year 2011. Workstream Inc and Sungard Availability Services (Canada) Ltd. Reached an out of court settlement in fiscal year 2011.

Cash Flows: The following is a summary of cash flow activities for the three months ended August 31, 2011 and 2010:

	Three Months Ended August 31
	2011			2010			$ Change			% Change

Cash used in operating activities	$	(850,841	)	$	(803,373	)	$	(47,468	)		5.9	%
Cash used in investing activities		(72,164	)		-			(72,164	)		N/A
Cash provided by / (used in) financing activities		825,777			1,857,327			(1,031,550	)		-55.5	%

Cash Flows From Operating Activities: The change in these cash flows primarily relates to the goodwill impairment reversal and the gain on the extinguishment of debt. We also settled $1,499,818 in accrued liabilities for a $1,124,846 non-cash gain. Without these three transactions, we would have had a net loss instead of net income in the first quarter of fiscal 2011.

Cash Flows From Investing Activities: The changes in these cash flows relate to the capitalization of software of $40,734. The company also invested $31,430 in new equipment and furniture for the office moves for Incentive Advisors in AZ and Workstream headquarters in FL.

Cash Flows From Financing Activities: The decrease in these cash flows primarily relates to a private placement for equity and a new secured note for $2,281,000 and $660,000, respectively in the first quarter of fiscal 2011. In the first quarter of fiscal 2012 a private placement of 333,333 shares of its newly formed Class A, Series B Convertible Preferred Shares (the “Series B Shares”) to the Investor for $1,000,000 offset by $60,534 in legal fees associated with the private placement.

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
	August 31
	2011			2010

Net income / (loss), as reported under US GAAP	$	(668,834	)	$	490,210

Effects of certain transactions:
Interest income and expense, net		(5,318	)		655,540
Income tax expense		3,676			8,336
Amortization and depreciation		79,145			63,393
Stock-based compensation		591,634			500,679
Gain on extinguishment of debt		-			(1,192,635	)
Impairment of goodwill		-			(685,426	)
Change in fair value of warrants and derivative		-			(214,500	)
Other income and expense, net		(285	)		393

EBITDA, as adjusted	$	18		$	(374,010	)

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.

Debt Facility

On May 10, 2011, Workstream Inc. (the “Company”) entered into a Business Financing Agreement (the “Financing Agreement”) with Bridge Bank, National Association. The Financing Agreement is secured by a lien on all of the assets of the Company and its subsidiaries pursuant to the terms of a Stock Pledge Agreement among the Company, its subsidiaries and the Lending Investor (the “Pledge Agreement”). The credit limit on the Financing Agreement is $3,000,000. Interest on the Financing Agreement accrues at an annual rate of the Prime Rate plus 2% with the Prime Rate having a minimum of 3.25%. From and after the occurrence and during the continuance of any event of default under the Financing Agreement, the interest rate then in effect will be automatically increased by 5% per year. The Financing Agreement has an annual facility fee of $15,000 or .5% of the advance balance. The Financing Agreement has a monthly maintenance fee of .125% of the average monthly balance. The Financing Agreement contains customary covenants of providing monthly financial statements within 30 days, annual audited financials within 180 days, annual board approved budget within 60 days of fiscal year end and a semi-annual accounts receivable audit. The Company must also maintain a minimum asset coverage ratio of 1.5 to 1. The Pledge Agreement sets forth that the Company has granted a security interest in all shares of capital stock, corporations, limited partnership interest and limited liability company interests that the Company now owns or hereafter acquires. The Company drew down $500,000 of the line of credit upon closing of which $100,000 was used for working capital and $400,000 was used to reduce the amount outstanding on the 2010 note referenced below. In conjunction with the arrangement of the debt facility the 2010 Note was subordinated to Bridge Bank.

Exchange Agreements

On August 13, 2010, the Company eliminated $22,356,665 in debt through separate Exchange and Share Purchase Agreements and an 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 1,707,130 of the Company’s common shares. The 2008 Warrants were not affected by the transactions effected by the 2010 Exchange Agreements.

Pursuant to the terms of the 2010 Exchange Agreements with certain of the Holders, the Company also consummated a private placement pursuant to which it raised $750,000 through the sale of an aggregate 94,840 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 aggregate63,227 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 was 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 accrued at an annual rate of 12%. On August 12, 2011, the outstanding balance on the note was exchanged for equity in the Company.

The Company also received $1,006,000 in connection with private placements of its common shares. Separately, the Company intends to continue to raise capital from time to time as it pursues its business plan.

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, valuation and impairment analysis for goodwill and intangible assets, 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 has been no significant changes during the three months ended August 31, 2011 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, 2011.

RECENT ACCOUNTING PRONOUNCEMENTS

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

ITEM 4T.

CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to provide reasonable assurance that information required to be disclosed by us in our reports filed or submitted under the Exchange Act is processed, recorded, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Operating Officer, Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

As required by SEC Rule 13a-15(b), our company carried out an evaluation, under the supervision and with the participation of management, including our Chief Operating Officer, Chief Executive Officer and Acting Chief Financial Officer, of the effectiveness of its disclosure controls and procedures as of the end of the period covered by this Quarterly Report. Based on this evaluation, management concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

There were no changes in our internal control over financial reporting that occurred during the three month period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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 7 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, 2011, 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. Losses for the three months ended August 31, 2011 were $668,834 and losses for the years ended May 31, 2011 and 2010 were $162,719 and $26,583,731, respectively. Management believes that current operations will be sufficient to meet its anticipated working capital and capital expenditure requirements. However, 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.

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:	October 14, 2011	By:	/s/ John Long
		John Long Chief Executive Officer (Principal Executive Officer)


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

WORKSTREAM INC 10-Q