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ShiftPixy, Inc. – ‘S-1’ on 3/27/20

On:  Friday, 3/27/20, at 6:51pm ET   ·   As of:  3/30/20   ·   Accession #:  1104659-20-39721   ·   File #:  333-237457

Previous ‘S-1’:  None   ·   Next:  ‘S-1/A’ on 5/19/20   ·   Latest:  ‘S-1/A’ on 2/12/24   ·   18 References:   By:  ShiftPixy, Inc. – Latest ‘S-1/A’ on 2/12/24 By:  ShiftPixy, Inc. – ‘S-1’ on 1/29/24 By:  ShiftPixy, Inc. – ‘S-1’ on 12/21/23 By:  ShiftPixy, Inc. – ‘10-K’ on 12/14/23 for 8/31/23 By:  ShiftPixy, Inc. – ‘S-1/A’ on 6/30/23 By:  ShiftPixy, Inc. – ‘S-1/A’ on 6/7/23 By:  ShiftPixy, Inc. – ‘S-1’ on 5/23/23 By:  ShiftPixy, Inc. – ‘10-K/A’ on 2/9/23 for 8/31/22 By:  ShiftPixy, Inc. – ‘10-K/A’ on 2/3/23 for 8/31/22 By:  ShiftPixy, Inc. – ‘10-K/A’ on 12/14/22 for 8/31/22 By:  ShiftPixy, Inc. – ‘10-K’ on 12/13/22 for 8/31/22 By:  ShiftPixy, Inc. – ‘10-K/A’ on 2/28/22 for 8/31/21 By:  ShiftPixy, Inc. – ‘10-K’ on 12/3/21 for 8/31/21 By:  ShiftPixy, Inc. – ‘10-K’ on 11/30/20 for 8/31/20 By:  ShiftPixy, Inc. – ‘S-1/A’ on 10/8/20 By:  ShiftPixy, Inc. – ‘S-1/A’ on 10/7/20 By:  ShiftPixy, Inc. – ‘S-1/A’ on 8/18/20 By:  SEC – ‘UPLOAD’ on 4/8/20 

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  As Of               Filer                 Filing    For·On·As Docs:Size             Issuer                      Filing Agent

 3/30/20  ShiftPixy, Inc.                   S-1         3/27/20  126:12M                                    Toppan Merrill/FA

Document/Exhibit                   Description                      Pages   Size 

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100: R25         Summary of significant accounting policies          HTML     59K  
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                Default) (Details Narrative)                                     
39: R32         Stockholders' Equity (Details)                      HTML     46K 
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109: R40         Subsequent Events (Details Narrative)               HTML    114K  
97: R41         Consolidated Balance Sheets                         HTML    118K 
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110: R44         Consolidated Statements of Stockholders' Equity     HTML     76K  
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15: R46         Nature of Operations                                HTML     39K 
65: R47         Summary of significant accounting policies          HTML    207K 
108: R48         Going Concern                                       HTML     50K  
99: R49         Accounts Receivable                                 HTML     36K 
84: R50         Fixed Assets                                        HTML     52K 
120: R51         Workers Compensation                                HTML     68K  
43: R52         Accrued Payroll and Related Liabilities             HTML     39K 
24: R53         Senior Secured Convertible Notes Payable (In        HTML    205K 
                Default)                                                         
83: R54         Stockholders' Equity                                HTML     72K 
119: R55         Share based Compensation                            HTML    154K  
42: R56         Related Parties                                     HTML     55K 
23: R57         Income Taxes                                        HTML     74K 
82: R58         Commitment and contingencies                        HTML     70K 
121: R59         Subsequent Events                                   HTML     47K  
69: R60         Reverse Stock Split                                 HTML     34K 
22: R61         Summary of significant accounting policies          HTML    255K 
                (Policies)                                                       
96: R62         Summary of significant accounting policies          HTML     89K 
                (Tables)                                                         
107: R63         Fixed Assets (Tables)                               HTML     52K  
66: R64         Workers Compensation (Tables)                       HTML     66K 
19: R65         Accrued Payroll and Related Liabilities (Tables)    HTML     39K 
93: R66         Senior Secured Convertible Notes Payable (In        HTML    130K 
                Default) (Tables)                                                
104: R67         Stockholders' Equity (Tables)                       HTML     65K  
71: R68         Share based compensation (Tables)                   HTML    151K 
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76: R73         Summary of significant accounting policies          HTML     37K 
                (Details)                                                        
31: R74         Summary of significant accounting policies          HTML     55K 
                (Details 1)                                                      
55: R75         Summary of significant accounting policies          HTML     39K 
                (Details 3)                                                      
115: R76         Summary of significant accounting policies          HTML     44K  
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81: R77         Summary of significant accounting policies          HTML     58K 
                (Details 4)                                                      
33: R78         Summary of significant accounting policies          HTML     75K 
                (Details Narrative)                                              
45: R79         Going Concern (Details Narrative)                   HTML     75K 
27: R80         Fixed Assets (Details)                              HTML     44K 
51: R81         Fixed Assets (Details 1)                            HTML     38K 
112: R82         Fixed Assets (Details 2)                            HTML     42K  
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74: R106        Income Taxes (Details 2)                            HTML     44K 
117: R107        Income Taxes (Details Narrative)                    HTML     46K  
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72: R111        Subsequent Events (Details Narrative)               HTML     84K 
103: R112        Reverse Stock Split (Details)                       HTML     38K  
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As filed with the Securities and Exchange Commission on March 27, 2020

Registration No. 333-

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

ShiftPixy, Inc.

(Exact name of registrant as specified in its charter)

1 Venture, Suite 150

Irvine, CA 92618

(888) 798-9100

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

Scott Absher

Chief Executive Officer

1 Venture, Suite 150

Irvine, CA 92618

(888) 798-9100

(Name, address, including zip code, and telephone number, including area code, of agent for service)

Copies to:

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box. ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act. ¨

CALCULATION OF REGISTRATION FEE

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to Section 8(a), may determine.

The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any state or other jurisdiction where the offer or sale is not permitted. 

Shares of Common Stock 

We are offering           shares of our common stock, par value $0.0001 per share.

We are also offering to each purchaser, if any, whose purchase of shares of common stock in this offering would otherwise result in the purchaser, together with its affiliates and certain related parties, beneficially owning more than 4.99% of our outstanding common stock immediately following the consummation of this offering, the opportunity to purchase, if the purchaser so chooses, pre-funded warrants, in lieu of shares of common stock that would otherwise result in the purchaser's beneficial ownership exceeding 4.99% (or at the election of the purchaser, 9.99%) of our outstanding common stock. Each pre-funded warrant will be immediately exercisable for one share of our common stock and may be exercised at any time until all of the pre-funded warrants are exercised in full. The purchase price of each pre-funded warrant will equal the price per share at which the shares of common stock are being sold to the public in this offering, minus $0.001, and the exercise price of each pre-funded warrant will be $0.001 per share. This offering also relates to the shares of common stock issuable upon exercise of any pre-funded warrants sold in this offering. For each pre-funded warrant we sell, the number of shares of common stock we are offering will be decreased on a one-for-one basis

Our common stock is listed on The Nasdaq Capital Market (“Nasdaq”), under the symbol “PIXY.” On March      , 2020, the last reported sale price of our common stock was $            per share.

The final public offering price of the shares of common stock in this offering, including the price of any pre-funded warrant, will be determined through negotiation between us and the lead underwriter in the offering and the recent market price used throughout this prospectus will not be indicative of the final offering price. There is no established public trading market for the pre-funded warrants, and we do not expect a market to develop. In addition, we do not intend to apply for a listing of the pre-funded warrants on any national securities exchange.

The offering is being underwritten on a firm commitment basis. We have granted the underwriters an option to buy up to an additional                          shares of common stock from us to cover over-allotments. The underwriters may exercise this option at any time and from time to time during the 45-day period from the date of this prospectus.

We are an “emerging growth company,” as defined in Section 2(a) of the Securities Act of 1933, as amended (the “Securities Act”), and, as such, have elected to comply with certain reduced public disclosure requirements for this prospectus and future filings. This prospectus complies with the requirements that apply to an issuer that is an emerging growth company. See “Prospectus Summary — Implications of Being an Emerging Growth Company.”

Investing in our securities involves a high degree of risk. See “Risk Factors” beginning on page 11 of this prospectus to read about factors you should consider before investing in our securities.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

We have granted the underwriters a 45-day option from the date of this prospectus to purchase approximately      additional shares of our common stock. If the underwriters exercise the option in full, the underwriting discounts and commissions payable by us will be $       , and the total proceeds to us, before expenses will be $ .

The underwriters expect to deliver the shares of common stock and any pre-funded warrants to the purchasers on or about               , 2020.

Sole Book-Running Manager

A.G.P.

The date of this prospectus is                 , 2020

TABLE OF CONTENTS 

You should rely only on the information contained in this prospectus or in any free writing prospectus that we may provide to you in connection with this offering. Neither we nor any of the underwriters has authorized anyone to provide you with information different from, or in addition to, that contained in this prospectus or any such free writing prospectus. If anyone provides you with different or inconsistent information, you should not rely on it. We can provide no assurance as to the reliability of any other information that others may give you. Neither we nor any of the underwriters is making an offer to sell or seeking offers to buy these securities in any jurisdiction where or to any person to whom the offer or sale is not permitted. The information in this prospectus is accurate only as of the date on the front cover of this prospectus, and the information in any free writing prospectus that we may provide you in connection with this offering is accurate only as of the date of such free writing prospectus. Our business, financial condition, results of operations and prospects may have changed since those dates.

Unless otherwise indicated, information contained in this prospectus concerning our industry, competitive position and the markets in which we operate is based on information from independent industry and research organizations, other third-party sources and management estimates. Management estimates are derived from publicly available information released by independent industry analysts and other third-party sources, as well as data from our internal research, and are based on assumptions we made upon reviewing such data and our experience in, and knowledge of, such industry and markets, which we believe to be reasonable. In addition, projections, assumptions and estimates of the future performance of the industry in which we operate and our future performance are necessarily subject to uncertainty and risk due to a variety of factors, including those described in “Risk Factors” on page 11, “Cautionary Note Regarding Forward-Looking Statements” on page 30 and elsewhere in this prospectus. These and other factors could cause results to differ materially from those expressed in the estimates made by the independent parties and by us.

PROSPECTUS SUMMARY

This summary highlights information contained in greater detail elsewhere and does not contain all of the information that you should consider before deciding to invest in our common stock. You should read the entire prospectus carefully, including the “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and the related notes included in this prospectus, before making an investment decision. Unless otherwise indicated in this prospectus or the context otherwise requires, all references to “we,” “us,” and “our” refer to ShiftPixy, Inc.

Company Overview

Our current business, and the primary source of our revenues to date, has been under a traditional staffing services business model. Our initial market focus is to use this traditional approach, coupled with developed technology, to address an underserved market containing predominately lower wage employees with high turnover in light industrial, services, and food and hospitality. We provide human resources, employment compliance, insurance, payroll, and operational employment services solutions for our business clients (“clients” or “operators”) and shift work or gig opportunities for worksite employees (“WSEs” or “shifters”). As consideration for providing these services, we receive administrative or processing fees as a percentage of a client’s gross payroll, process and file payroll taxes and payroll tax returns, provide workers’ compensation insurance, and provide employee benefits. We have built a substantial business on a recurring revenue model since our inception in 2015. For the fiscal year ended August 31, 2019, we processed over $350 million of payroll billings. Our business has significantly grown for each year since inception and we expect to continue our high degree of growth. However, we have experienced losses to date as we have invested in both our technology solutions as well as the back-office operations required to service a large employee base under a traditional staffing model.

We are currently focused on clients in the restaurant and hospitality industries, traditionally market segments with high employee turnover and low pay rates. We believe that our focus on these industries will be better served by our Human Resources Information System (“HRIS”) technology platform which provides payroll and human resources tracking for our clients and will result in lower operating costs, improved customer experience and revenue growth acceleration. All of our clients enter into service agreements with us or our wholly-owned subsidiary, ReThink Human Capital Management, Inc.

Our revenues for the year ended August 31, 2019 primarily consist of administrative fees calculated as a percentage of gross payroll processed, payroll taxes due on WSEs billed to the client and remitted to the applicable taxation authority, and workers’ compensation premiums billed to the client for which we facilitate workers’ compensation coverage. Our costs of revenues consist of accrued and paid payroll taxes and our costs to provide the workers’ compensation coverage including premiums and loss reserves. A significant portion of our assets and liabilities is for our workers’ compensation reserves. Our cash balances related to these reserves are carried as assets and our estimates of projected workers’ compensation claims are carried as liabilities. Since 2019, we have provided a self-funded workers’ compensation policy for up to $500,000 and purchase reinsurance for claims in excess of $500,000. As of November 30, 2019, we have workers’ compensation related assets in excess of our projected workers’ compensation losses. We actively monitor and manage our clients and WSEs’ workers’ compensation claims which we believe allows us to provide a lower cost workers’ compensation option for our clients than they would otherwise be able to purchase on their own.

As of August 31, 2019, we had 246 clients with over 13,000 WSEs and processed payroll of over $350 million during our fiscal year ending August 31, 2019, an increase of nearly 60% for our year ending August 31, 2018. Of these WSEs, approximately 60% represent workers in the restaurant industry. In addition, as of August 31, 2019, there were an additional 12,000 inactive WSEs in our HRIS technology platform who are available for gig opportunities. In January 2020, in connection with an asset purchase agreement, we assigned client contracts representing approximately 70% of our billable clients which comprised approximately 88% of our quarterly revenue as of November 30, 2019 and certain operating assets for $19.1 million in cash of which $9.6 million was received at closing and $9.5 million is due over the next four years, commencing in April 2020, subject to certain conditions, including the performance of the assigned contracts. For the month ended January 31, 2020, we added nine clients, billed 56 clients in total (all related to the food service industry), billed approximately 3,900 total WSEs and retained approximately 30,000 unbilled WSEs in our HRIS platform for an annualized growth rate of over 100% for both clients and WSEs since November 30, 2019. We have also entered into an agreement with a large customer with multiple locations representing approximately 1,000 additional WSEs. These new WSEs were added to our HRIS platform through our new automated onboarding process which was placed into service in November 2019. We believe there is significant business interest in our HRIS platform and scheduling tools for multi-location client opportunities.

Our Services

Our core business is to provide regular payroll processing services to clients under an employer administration services (“EAS”) model in addition to individual services, such as payroll tax compliance, workers’ compensation insurance, and employee HR compliance management. In addition, in November, 2019, we launched our employee onboarding and scheduling functions to our customers in the mobile application. We expect to complete the full commercial launch of our mobile application software later this year which will provide additional services including “white label” food delivery functionality.

Our core EAS services are typically provided to our clients for one-year renewable terms. Through November 30, 2019, we have not had any material revenues or billings generated within our HRIS from additional services. We expect that our future service offerings, including technology-based services provided through our HRIS system and mobile application, will provide for additional revenue streams and support cost reductions for existing and future clients. We expect that our future services will be offered through “a la carte” pricing via customizable on-line contracts.

The new market trend towards flexible, temporary or freelance jobs, often involving connecting with clients or customers through an online platform (the “Gig Economy”) has created legal issues regarding the classification of workers as independent contractors or employees. In addition, the rising trend of predictive scheduling creates logistical issues for our clients regarding worker’s schedules. We provide solutions to businesses struggling with these compliance issue primarily by absorbing our clients’ workers, who we refer to as WSEs but are also referred to as “shift workers,” “shifters,” “gig workers,” or “assigned employees.” WSEs are included under our corporate employee umbrella and we handle certain employment-related compliance responsibilities for our clients as part of our services. This arrangement benefits WSEs by providing additional work opportunities through access to our clients. WSEs further benefit from employee status benefits through our benefit plan offerings, including minimum essential health insurance coverage plans and 401(k) plans, as well as enjoying the protections of workers’ compensation coverage.

Competition

We have two primary sources of competition. Competitors to our gig business model include businesses such as ShiftGig, Instawork, Snag, Jobletics and other comparable businesses that seek to arrange short-term work assignments for both employees and independent contractors. Competitors to our HRIS system include businesses such as Kelly Services, ManpowerGroup, and Barrett Business Services which provide human resource software solutions. We believe our service offering competes effectively based on our strategy of combining an ecosystem of employment services with the individualized ability to link trained workers to specific shift-work opportunities.

Recent Developments

Reverse Stock Split

On November 13, 2019, our board of directors authorized a one-for-forty (1:40) reverse split of our issued and outstanding common stock that became effective on December 16, 2019 (the “Reverse Stock Split”). As a result of the Reverse Stock Split, each forty (40) shares of our issued and outstanding common stock were automatically combined and converted into one issued and outstanding share of common stock. The Reverse Stock Split affected all issued and outstanding shares of our common stock, as well as common stock underlying stock options, preferred stock and warrants outstanding immediately prior to the effectiveness of the Reverse Stock Split. The Reverse Stock Split did not decrease the number of our authorized shares of common stock, alter the par value of common stock, which remains at $0.0001 per share, nor modify any voting rights or other terms of our capital stock. Unless otherwise indicated, all information set forth in this prospectus gives effect to the Reverse Stock Split.

Vensure Asset Transfer

As previously reported, on January 3, 2020, effective January 1, 2020, we entered into an asset purchase agreement with Shiftable HR Acquisition, LLC, part of Vensure Employer Services, Inc. (“Vensure”), that assigned client contracts representing approximately 70% of our billable clients which comprised approximately 88% of our quarterly revenue as of November 30, 2019 and certain operating assets in exchange for up to approximately $19.1 million of consideration (the “Vensure Asset Transfer”). We received $9.6 million upon closing and expect to receive additional proceeds of approximately $2.4 million per year, payable monthly, for the next four years if certain transaction conditions are met, including the performance of the assigned client contracts. This transaction required us to relinquish our service rights to certain clients but allowed us to retain the clients’ WSE information in our HRIS platform which now represents approximately 30,000 potential gig employees. We also retained all of our intellectual property rights, including our HRIS and our mobile application technology, and 47 clients with approximately 2,400 billable WSEs.

Convertible Note Settlements

Between December 5, 2019 and March 24, 2020, we entered into a series of settlements, agreed upon note conversions, note exchanges, and principal repayments (the “Convertible Note Settlements”) for (i) our 8% Senior Secured Convertible Notes we issued on June 4, 2018 (the “June 2018 Notes”), (ii) certain of our 8% Senior Secured Convertible Notes we issued pursuant to a Limited Settlement Agreement and Mutual Release, dated December 20, 2018, with certain holders of the June 2018 Notes (the “December 2018 Notes”), (iii) certain of our Convertible Notes issued on March 12, 2019 (the “March 2019 Notes”) and, together with the June 2018 Notes and the December 2018 Notes, the “Senior Convertible Notes”) and (iv) all of our warrants issued in connection with the March 2019 Notes (the “March 2019 Warrants”) that previously included full-ratchet anti-dilution price protection. Pursuant to the Convertible Note Settlements, we issued an adjustment of 302,271 shares of common stock for conversions and 123,358 shares of common stock for inducements and cashless warrant exercises for the Senior Convertible Notes and to extinguish the remaining March 2019 Notes and March 2019 Warrants with full-ratchet anti-dilution protection. On December 5, 2019, we exchanged $2,445,000 of the March 2019 Notes and $222,000 of the June 2018 Notes for new Senior Convertible Notes in an aggregate principal amount of $2,934,000 (the “December 2019 Exchange Notes” and, together with the June 2018 Notes, the December 2018 Notes and the March 2019 Notes, the “Senior Convertible Notes”). On March 23, 2020 and March 24, 2020, we (i) further amended the December 2019 Exchange Notes to fix the conversion price at $9.20 per share of common stock, (ii) exchanged $830,000 of the March 2019 Notes with full-ratchet anti-dilution price protection for $997,000 of amended March 2019 Notes with a fixed conversion price at $9.20 per share of common stock and (iii) amended, cancelled or exercised for shares of common stock via cashless exercise all March 2019 Warrants which previously included full-ratchet anti-dilution price protection and issued new warrants to purchase 423,669 shares of common stock at an exercise price of $10.17 per share. Pursuant to the Convertible Note Settlements, we also paid cash of approximately $2,600,000 to satisfy all default claims and litigation relating to our Senior Convertible Notes and as repayment of all remaining principal on our June 2018 Notes and December 2018 Notes. The remaining gross principal balances of the Senior Convertible Notes as of March 24, 2020 represent $995,000 of the amended March 2019 Notes, convertible at $9.20 per share, and $1,828,550 of the amended December 2019 Exchange Notes, convertible at $9.20 per share, which amortize in cash or shares or common stock beginning April 1, 2020 at 12.5% of the current principal balance. Also in March 2020, the holder of the amended December 2019 Exchange Notes converted the scheduled April 2020 and July 2020 amortization payments into shares of common stock at $9.20 per share. For further discussion of the Senior Convertible Notes, see “Description of Our Capital Stock – Debt and Equity Offerings.”

Risks Associated with Our Business and this Offering

Our business and our ability to implement our business strategy are subject to numerous risks, as more fully described in the section of this prospectus entitled “Risk Factors”. You should read these risks before you invest in our securities. We may be unable, for many reasons, including those that are beyond our control, to implement our business strategy. In particular, risks associated with our business include:

Implications of Being an Emerging Growth Company

We qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). An emerging growth company may take advantage of certain reduced disclosure and other requirements that are otherwise generally applicable to public companies. As a result, the information that we provide to shareholders may be different than the information you may receive from other public companies in which you hold equity. For example, so long as we are an emerging growth company:

We may take advantage of these reduced disclosure and other requirements until the last day of our fiscal year following the fifth anniversary of the completion of our initial public offering (“IPO”), or such earlier time that we are no longer an emerging growth company. For example, if certain events occur before the end of such five-year period, including if we have more than $1.07 billion in annual revenue, have more than $700 million in market value of our common stock held by non-affiliates or issue more than $1.0 billion of non-convertible debt over a three-year period, we will cease to be an emerging growth company.

As mentioned above, the JOBS Act permits us, as an emerging growth company, to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. We have elected not to opt out of the extended transition period which means that when an accounting standard is issued or revised, and it has different application dates for public or private companies, as an emerging growth company, we can adopt the new or revised standard at the time private companies adopt the new or revised standard. This may make it difficult or impossible because of the potential differences in accounting standards used to compare our financial statements with the financial statements of a public company that is not an emerging growth company or the financial statements of an emerging growth company that has opted out of using the extended transition period.

Our Corporate Information

We were incorporated under the laws of the State of Wyoming on June 3, 2015. Our principal executive office is located at 1 Venture, Suite 150, Irvine, CA 92618, and our telephone number is (888) 798-9100. Our website address is www.shiftpixy.com. Our website does not form a part of this prospectus and listing of our website address is for informational purposes only.

THE OFFERING

Unless otherwise indicated, all information contained in this prospectus assumes no exercise by the underwriter of its over-allotment option, assumes no sale of any pre-funded warrants in this offering, excludes exercise of the warrants to be issued to the underwriters and accounts for Reverse Stock Split that became effective on December 16, 2019. The number of shares of our common stock that are and will be outstanding immediately before and after this offering as shown above is based on 1,321,804 shares outstanding as of March 24, 2020. The number of shares outstanding as of March 24, 2020, as used throughout this prospectus, unless otherwise indicated, excludes:

UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION

The following unaudited pro forma condensed consolidated financial information are presented to illustrate the Vensure Asset Transfer whereby we assigned client contracts representing approximately 70% of our billable clients which comprised approximately 88% of our quarterly revenue as of November 30, 2019 and certain operating assets in exchange for up to approximately $19.1 million of total consideration, if certain conditions are met. The following unaudited pro forma condensed consolidated financial information should be read together with the related notes and the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein. The unaudited pro forma condensed consolidated financial statements, and the data derived therefrom, included in this prospectus were prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). All per share and shares outstanding are adjusted to reflect our Reverse Stock Split.

Unaudited Pro Forma Condensed Consolidated Statement of Operations

Three Months Ended November 30, 2019

See notes to the unaudited pro forma condensed consolidated financial information.

Unaudited Pro Forma Condensed Consolidated Statement of Operations

Fiscal Year Ended August 31, 2019

Unaudited Pro Forma Condensed Consolidated Statement of Operations
Fiscal Year Ended August 31, 2018  

See notes to the unaudited pro forma condensed consolidated financial information.

Unaudited Pro Forma Condensed Consolidated Balance Sheet

November 30, 2019

See notes to the unaudited pro forma condensed consolidated financial information.

Notes to Pro Forma Condensed Consolidated Financial Information

RISK FACTORS

An investment in our common stock involves a high degree of risk. You should carefully consider the following risks and all of the other information contained in this prospectus before deciding whether to invest in our common stock, including the risks and uncertainties described below and under the caption “Risk Factors” in our most recently filed Annual Report on Form 10-K and Quarterly Report on Form 10-Q filed with the SEC, in each case as these risk factors are amended or supplemented by subsequent Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q. The risks set forth below are those which we believe are the material risks that we face. The occurrence of any of such risks may materially and adversely affect our business, financial condition, results of operations and future prospects. In such an event, the market price of our common stock could decline, and you could lose part or all of your investment.

Risks Related to this Offering and Ownership of Our Common Stock

Purchasers in the offering will suffer immediate dilution.

If you purchase common stock in this offering, the value of your shares based on our actual book value will immediately be less than the offering price you paid. This reduction in the value of your equity is known as dilution. At the public offering price of $           per share, purchasers of common stock in this offering will experience immediate dilution of approximately $           per share. Based upon the pro forma as adjusted net tangible book value of our common stock at $                  , your shares may be worth less per share than the price you paid in the offering. See “Dilution.” The net tangible book value of our common stock as used in this prospectus has been adjusted for (i) the Vensure Asset Transfer and (ii) the Convertible Note Settlements.

If the options, warrants and convertible securities we previously granted are exercised, additional dilution will occur. As of March 24, 2020, options to purchase 43,415 shares of common stock at a weighted-average exercise price of $99.56 per share were outstanding, warrants to purchase up to 526,349 shares of common stock at a weighted-average exercise price of $17.92 per share were outstanding, Senior Convertible Notes convertible into 307,078 shares of common stock at $9.20 per share were outstanding and options to purchase 657,845 shares of preferred stock, convertible into 657,845 shares of common stock, with a conversion price of $0.0001 per share were outstanding.

Furthermore, if we raise additional funding by issuing additional equity securities, the newly-issued shares will further dilute your percentage ownership of our shares and may also reduce the value of your investment. The discussion above assumes no sale of pre-funded warrants, which, if sold, would reduce the number of shares of common stock that we are offering on a one-for-one basis until such warrants are exercised.

We have a significant number of outstanding warrants, some of which contain full-ratchet anti-dilution protection, which may cause significant dilution to our shareholders, have a material adverse impact on the market price of our common stock and make it more difficult for us to raise funds through future equity offerings.

As of March 24, 2020, we had 1,321,804 shares of common stock outstanding. In addition, as of that date we had outstanding warrants to acquire up to 526,349 shares of common stock. The issuance of shares of common stock upon the exercise of warrants would dilute the percentage ownership interest of all shareholders, might dilute the book value per share of our common stock and would increase the number of our publicly traded shares, which could depress the market price of our common stock.

Historically, certain of our outstanding warrants contain full-ratchet anti-dilution provisions which, subject to limited exceptions, would reduce the exercise price of the warrants (and increase the number of shares issuable) in the event that we in the future issue common stock, or securities convertible into or exercisable to purchase common stock, at a price per share lower than the exercise price then in effect, to such lower price. On June 4, 2018, in connection with the issuance of June 2018 Notes, we issued warrants (the “June 2018 Warrants”) which are exercisable for 25,104 shares of common stock at an exercise price of $10.17 per share contain a price protection anti-dilution provision. At the assumed offering price of $                          , the closing price of our common stock as reported on Nasdaq on                        , 2020, the anti-dilution provision in the June 2018 Warrants will be triggered in connection with this offering and will result in the June 2018 Warrants becoming exercisable into 30,256 shares of common stock at an exercise price of $                           per share. In addition, on March 12, 2019, in connection with the issuance of March 2019 Notes, we issued the March 2019 Warrants, which were exercisable for 74,390 shares of common stock at an exercise price of $70.00 per share and contain a full-ratchet anti-dilution provision. As of March 24, 2020, all such warrants were either cancelled, exercised or exchanged for warrants without such a full-ratchet anti-dilution provision.

In addition to the dilutive effects described above, the perceived risk of dilution as a result of the significant number of outstanding warrants may cause our common shareholders to be more inclined to sell their shares, which would contribute to a downward movement in the price of our common stock. Moreover, the perceived risk of dilution and the resulting downward pressure on our common stock price could encourage investors to engage in short sales of our common stock, which could further contribute to price declines in our common stock. The fact that our shareholders and warrant holders can sell substantial amounts of our common stock in the public market, whether or not sales have occurred or are occurring, as well as the existence of full-ratchet anti-dilution provisions in our warrants, could make it more difficult for us to raise additional funds through the sale of equity or equity-related securities in the future at a time and price that we deem reasonable or appropriate, or at all.

We have warrants and convertible notes, including the Senior Convertible Notes, that may be converted into shares of our common stock in the future, which would dilute your ownership interest.

On June 4, 2018, December 20, 2018, and March 12, 2019 we issued the June 2018 Notes, the December 2018 Notes and the March 2019 Notes, respectively, to certain institutional investors pursuant to which, at any time while there is an outstanding balance, the notes may be converted for shares of our common stock, at the option of the holders, at a conversion price for the principal and interest, subject to adjustment from down round price protection. As of March 24, 2020, the Senior Convertible Notes, if converted at the applicable discount price, would be convertible into approximately 307,078 shares of common stock. We also have warrants outstanding to purchase up to 526,349 shares of common stock, which may be exercised for up to five years from their issuance date. These warrants may also include the requirement for us to reduce the exercise price if a future financing is entered into at a price per share below the warrant exercise price. Further, any additional financing that we secure may require the granting of rights, preferences or privileges senior to those of our common stock and which result in additional dilution of the existing ownership of our common shareholders.

The agreements governing our Senior Convertible Notes contain a mandatory default amount when an event of default occurs.

The indentures governing our Senior Convertible Notes contain mandatory default amounts when an event of default occurs. These notes accrue default interest at an annual rate of 18%, include a conversion feature that provides for a default conversion rate at a 15% discount to market price, and provide for mandatory redemption for up to 130% of the remaining principal balance.

Our common stock is closely held by our founders which may limit a minority shareholder from influencing corporate governance.

Approximately 50% of our issued and outstanding common stock is held by our founders, Scott Absher, our Chief Executive Officer, and Steven Holmes. In addition, these individuals have options to purchase preferred shares which in turn may be converted into additional common stock in the future. Individual shareholders with a minority stake may have limited influence over shareholder matters.

We have received a delisting notice from Nasdaq and may not be able to maintain our Nasdaq market presence.

On June 6, 2019 we received a notice from the regulations department of Nasdaq for (i) failure to maintain our share price at $1.00 per share for a thirty day period as required under Nasdaq Listing Rule 5550(a)(2) and (ii) failure to comply with the Minimum Market Value of Listed Securities of $35,000,000 as registered under Nasdaq Listing Rule 5550(b)(2). The notice provided for a six month cure period. On December 4, 2019 we received a de-listing notice that would result in us being delisted from Nasdaq on December 13, 2019 unless we filed for a hearing by December 11, 2019. We filed for a hearing date which was scheduled for January 23, 2020. On February 4, 2020, we received a letter from the Hearings Advisor of the Nasdaq Office of General Counsel, which notified that us that we have until April 15, 2020 to issue a public disclosure that we have either a) $2.5 million in shareholder equity or b) a market value of listed securities is equal to or greater than $35 million. We also need to disclose that we have 500,000 publicly held shares by April 15, 2020. The letter also noted that the issue of our share price closing below $1.00 per share is now moot. While we believe we are taking steps to address the listing requirements, we may not be successful in maintaining our Nasdaq listing which may result in our being listed on another exchange, or listed on the OTC Markets or in the “pink sheets.” Such a downgrading in our listing market may limit our ability to make a market in our common stock and which may impact purchases or sales of our securities.

There is no public market for the pre-funded warrants being offered in this offering.

There is no established public trading market for the pre-funded warrants being offered in this offering, and we do not expect a market to develop. In addition, we do not intend to apply to list the pre-funded warrants on any securities exchange or nationally recognized trading system, including Nasdaq. Without an active market, the liquidity of the pre-funded warrants will be limited.

Our board of directors and our shareholders recently approved an amendment to our Articles of Incorporation to add conversion rights to our preferred stock that would be dilutive to the purchasers and current holders of our common stock.

Our board of directors and our shareholders recently approved an amendment to the rights of our preferred stock to provide for its conversion into our common stock on a one-for-one basis which will not take effect until at least 20 days after we file an Information Statement regarding such shareholder approval with the SEC. The purchase price for such preferred stock was set at $0.0001 per share of preferred stock. The conversion of the preferred stock to common stock will have an immediate dilutive effect on our then current shareholders. The aggregate dilution our shareholders will incur will depend on the number of shares of preferred stock that are converted into common stock.

Our share price may be volatile, which could subject us to securities class action litigation and prevent you from being able to sell your shares at or above the offering price.

Our stock could be subject to wide fluctuation in response to many risk factors listed in this section and others beyond our control, including:

Furthermore, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance of those companies. These broad market and industry fluctuations, as well as general economic, political, and market conditions such as recessions, interest rate changes or international currency fluctuations, may negatively impact the market price of shares of our common stock. In addition, such fluctuations could subject us to securities class action litigation, which could result in substantial costs and divert our management’s attention from other business concerns, which could seriously harm our business. If the market price of shares of our common stock after this offering does not exceed the IPO price, you may not realize any return on your investment in us and may lose some or all of your investment.

If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.

The trading market for our common stock is impacted by the research and reports that securities or industry analysts publish about us or our business. We do not have any control over these analysts. We cannot assure that analysts will continue to cover us or provide favorable coverage. If one or more of the analysts who cover us downgrade our stock or change their opinion of our stock, our share price would likely decline. If one or more of these analysts cease coverage of us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which could cause our stock price or trading volume to decline.

We have broad discretion in the use of the net proceeds from this offering and may not use them effectively.

We currently intend to allocate the net proceeds that we will receive from this offering as described in this prospectus under the “Use of Proceeds” section of this prospectus. However, our management will have broad discretion in the actual application of the net proceeds, and we may elect to allocate proceeds differently from that described herein if we believe it would be in our best interest to do so. Our shareholders may not agree with the manner in which our management chooses to allocate and spend the net proceeds. The failure by our management to apply these funds effectively could have a material adverse effect on our business. Pending their use, we may invest the net proceeds from this offering in a manner that does not produce income or that loses value.

Future sales, or the possibility of future sales, of a substantial number of shares of our common stock could adversely affect the price of the shares and dilute shareholders.

Future sales of a substantial number of shares of our common stock, or the perception that such sales will occur, could cause a decline in the market price of our common stock. This is particularly true if we sell our stock at a discount. In addition, in connection with this offering, our directors and executive officers entered into lock-up agreements. If, after the end of such lock-up agreements, these shareholders sell substantial amounts of shares of our common stock in the public market, or the market perceives that such sales may occur, the market price of our common stock and our ability to raise capital through an issue of equity securities in the future could be adversely affected.

In addition, in the future, we may issue additional shares of common stock or other equity or debt securities convertible into common stock in connection with a financing, acquisition, litigation settlement, employee arrangements or otherwise. Any such issuance could result in substantial dilution to our existing shareholders and could cause our common share price to decline.

Holders of pre-funded warrants purchased in this offering will have no rights as common shareholders until such holders exercise their pre-funded warrants and acquire our common stock.

Until holders of pre-funded warrants acquire shares of our common stock upon exercise of the pre-funded warrants, holders of pre-funded warrants will have no rights with respect to the shares of our common stock underlying such pre-funded warrants. Upon exercise of the pre-funded warrants, the holders will be entitled to exercise the rights of a common shareholder only as to matters for which the record date occurs after the exercise date.

We have not paid cash dividends in the past and do not expect to pay dividends in the future. Any return on investment may be limited to the value of our common stock, which may decrease in value.

We have never paid cash dividends on our common stock and do not anticipate doing so in the foreseeable future. The payment of dividends on our common stock will depend on earnings, financial condition and other business and economic factors affecting us at such time as our board of directors may consider relevant. If we do not pay dividends, our common stock may be less valuable because a return on your investment will only occur if our stock price appreciates.

We are an “emerging growth company” as that term is used in the JOBS Act, and we intend to continue to take advantage of reduced disclosure and governance requirements applicable to emerging growth companies, which could result in our common stock being less attractive to investors and adversely affect the market price of our common stock or make it more difficult to raise capital as and when we need it.

We are an “emerging growth company” as that term is used in the JOBS Act, and we intend to continue to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved, and exemptions from any rules that the Public Company Accounting Oversight Board may adopt requiring mandatory audit firm rotation or a supplement to the auditor’s report on the financial statements. We currently take advantage of some, but not all, of the reduced regulatory and reporting requirements that are available to us under the JOBS Act, and intend to continue to do so as long as we qualify as an “emerging growth company.” For example, so long as we qualify as an “emerging growth company,” we may elect not to provide you with certain information, including certain financial information and certain information regarding compensation of our executive officers, that we would have otherwise been required to provide in filings we make with the SEC, which may make it more difficult for investors and securities analysts to evaluate us.

We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile. We may take advantage of these reporting exemptions until we are no longer an emerging growth company, which in certain circumstances could be for up to five years. See “Prospectus Summary — Implications of Being an Emerging Growth Company.”

Because of the exemptions from various reporting requirements provided to us as an “emerging growth company,” we may be less attractive to investors and it may be difficult for us to raise additional capital as and when we need it. Investors may be unable to compare our business with other companies in our industry if they believe that our financial accounting is not as transparent as other companies in our industry. If we are unable to raise additional capital as and when we need it, our business, results of operations, financial condition and cash flows, and future prospects may be materially and adversely affected.

Risks Relating to Our Business

We have limited operating history, which makes it difficult for us to evaluate our future business prospects and make decisions based on those estimates of our future performance.

We are an emerging business and are in the process of developing our products and services. We have been in business since July 2015. Although we have processed gross billings of over $350 million for the fiscal year ended August 31, 2019 it is still difficult, if not impossible, to forecast our future results based upon our limited historical operating data. Because of the related uncertainties, we may be hindered in our ability to anticipate and timely adapt to increases or decreases in sales, revenues or expenses. If we make poor budgetary decisions as a result of unreliable data, our gross billings in the future may decline, which may result in a decline in our stock price.

There is uncertainty regarding our ability to implement our business plan and to grow our business to a greater extent than we can with our existing financial resources without additional financing. Except from the proceeds of our initial public offering and our recent private placements of senior secured convertible notes to institutional investors raising $13 million of gross proceeds ($11.9 million net of costs), we have no binding agreements, commitments or understandings to secure additional financing at this time. We have no binding agreements, commitments or understandings to acquire any other businesses or assets. Our long-term future growth and success is dependent upon our ability to generate cash from operating activities. There is no assurance that we will be able to generate sufficient cash from operations, to borrow additional funds or to raise additional equity capital. Our inability to obtain additional cash could have a material adverse effect on our ability to fully implement our business plan as described herein and grow our business to a greater extent than we can with our existing financial resources.

We have incurred net losses in recent periods and require additional financing. If financing is not available, we may be required to further downsize or discontinue operations.

As of November 30, 2019, we had cash of $0.1 million and a working capital deficiency of $17.6 million. During the year ended August 31, 2019, we used approximately $2.1 million of cash in operations and an additional $1.2 million on capitalized software and fixed asset purchases. During the quarter ended November 30, 2019, we used approximately $1.5 million of cash in operations. On January 3, 2020 we received $9.6 million in connection with the Vensure Asset Transfer, and expect to receive approximately $0.2 million per month for four years thereafter. After taxes and payments of outstanding obligations, we retained $3.5 million for current operations as of These conditions raise substantial doubt as to our ability to continue as going concern and our independent registered public accounting firm has included an explanatory paragraph regarding going concern qualification in its audit report for the year ended August 31, 2019. Management has prepared a liquidity plan to address the going concern issue and while we believe that these liquidity plan measures will be adequate to satisfy our liquidity requirements for at least the next twelve months, there is no assurance that the liquidity plan will be successfully implemented. Failure to successfully implement the liquidity plan may have a material adverse effect on our business, results of operations and financial condition, and may adversely affect our ability to continue as a going concern. If we do not become consistently profitable, our accumulated deficit will grow larger and our cash balances will decline further, and we will require additional financing to continue operations. Any such financing may not be accessible on acceptable terms, if at all. If we cannot generate sufficient cash or obtain additional financing, we may be required to downsize our business further or discontinue our operations altogether.

Our success depends on adoption of our products and services by our various types of customers, and if these potential customers do not accept and acquire our products and services then our revenue will be severely limited.

The major customer groups to whom we believe our products and services will appeal, both employers and employees, particularly related to shift work, may not embrace our products and services. Acceptance of our products and services will depend on several factors, including: cost, ease of use, familiarity of use, convenience, timeliness, strategic partnerships, and reliability. If we fail to adequately meet our customers’ needs and expectations, our product offerings may not be competitive and our ability to commence or continue generating revenues could be reduced. We also cannot be sure that our business model will gain wide acceptance among all targeted customer groups. If the market fails to continue to develop, or develops more slowly than we expect, our ability to continue generating revenues could be reduced.

We assume the obligation to make wage, tax, and regulatory payments for our WSEs, and, as a result, are exposed to client credit risks.

Under the Contract Service Agreement, we become a co-employer of WSEs and assume the obligations to pay their salaries, wages and related benefits costs and payroll taxes. We assume such obligations as an agent, not as a principal, of the client. Our obligations include responsibility for:

If a client does not pay us, our ultimate liability for WSE payroll and benefits costs could have a material adverse effect on our financial condition or results of operations.

If we are unable to effectively manage growth and maintain low operating costs, our results of operations and financial condition may be adversely affected.

We have experienced rapid growth since our inception, and our plans contemplate significant expansion of our business. If we are unable to manage our growth effectively, including having geographically dispersed offices and employees or to anticipate and manage our future growth accurately, our business may be adversely affected. If we are unable to manage our expansion and growth effectively, we may be unable to keep our operating costs low or effectively meet the requirements of an ever-growing, geographically dispersed client base. Our business relies on data systems, billing systems and financial reporting and control systems, procedures and controls. Our success in managing our expansion and growth in a cost-effective manner will require us to upgrade and improve these systems, procedures and controls. If we are unable to adapt our systems and put adequate controls in place in a timely manner, our business may be adversely affected. In addition, our growth may place significant demands on our management, and our overall operational and financial resources. A failure on our part to meet any of the foregoing challenges inherent in our growth strategy may have an adverse effect on our results of operations and financial condition.

Our targeted customer base is diverse, and we face a challenge in adequately meeting each group’s needs.

Because we will serve both employers and employees, we must work constantly to understand the needs, standards and requirements of each group and must devote significant resources to developing products and services for their interests. If we do not accurately predict our customers’ needs and expectations, we may expend valuable resources in developing products and services that do not achieve broad acceptance across the markets, and we may fail to grow our business.

We face intense competition across all markets for our services, which may lead to lower revenue or operating margins. Competing forms of Gig Economy oriented staffing management products and services may be more desirable to consumers or may make our products and services obsolete.

Our competitors range in size from diversified global companies with significant research and development resources to small, specialized firms whose narrower service lines may let them be more effective in deploying technical, marketing, and financial resources. Barriers to entry in many of our businesses are low and many of the areas in which we compete evolve rapidly with changing and disruptive technologies, shifting user needs, and frequent introductions of new products and services. Our ability to remain competitive depends on our success in making innovative products, devices, and services that appeal to customers.

Companies compete with us based on a growing variety of business models. The competitive pressures described above may cause decreased sales volumes, price reductions, and/or increased operating costs, such as for research and development, marketing, and sales incentives. This may lead to lower revenue, gross margins, and operating income.

There are currently several different competing Gig Economy oriented staffing management product and service technologies that are being marketed to our potential customers. Further development of any of these technologies may lead to advancements in technology that will make our products and services obsolete. Consumers may prefer alternative technologies and products and services. We cannot guarantee that users of Gig Economy oriented staffing management products and services who will be using our products and services will continue to grow within the industry as a whole. Any developments that contribute to the obsolescence of our products and services may substantially impact our business, reducing our ability to sustain generating revenues.

Providing specialized Gig Economy oriented staffing management products and services is an emerging yet competitive business, and many of our competitors have greater resources that may enable them to compete more effectively.

We will compete in the same markets with many companies that offer not only staffing management products and services focused on the Gig Economy but also more traditional staffing management products and services. There are limited barriers to entry. Price competition in the industry, particularly from larger, more traditional industry model competitors, is intense, and pricing pressures from competitors and clients are increasing. New competitors entering our markets may further increase pricing pressures.

Clients may competitively bid new contracts; a trend is expected to continue for the foreseeable future. Some of our competitors have greater resources than we do, which may enable them to compete more effectively in this market. Our competitors may devote their resources to developing and marketing products and services that will directly compete with our product lines, and new, more efficient competitors may enter the market. If we are unable to successfully compete with existing companies and new entrants to the market this will have a negative impact on our business and financial condition.

We operate in an immature and rapidly evolving industry and have a relatively new business model, which makes it difficult to evaluate our business and prospects.

The industry in which we operate is characterized by rapidly changing regulatory requirements, evolving industry standards and shifting user and client demands. Our business model is also evolving and is different from models used by other companies in our industry. As a result of these factors, the success and future revenue and income potential of our business is uncertain. Any evaluation of our business and our prospects must be considered in light of these risks and uncertainties, some of which relate to our ability to:

If we are unable to successfully address the challenges posed by operating in an immature and rapidly evolving industry and having a relatively new business model, our business could suffer.

We have claims and lawsuits against us that may result in adverse outcomes.

We are subject to a variety of claims and lawsuits. These claims may arise from a wide variety of business practices, significant business transactions, operational claims, and employment practices. Adverse outcomes in some or all of these claims may result in significant monetary damages or injunctive relief that could adversely affect our ability to conduct our business. The litigation and other claims are subject to inherent uncertainties and management’s view of these matters may change in the future. A material adverse impact on our consolidated financial statements could occur for the period in which the effect of an unfavorable outcome becomes probable and reasonably estimable.

We have identified material weaknesses in our internal control over financial reporting. If our internal control over financial reporting is not effective, we may not be able to accurately report our financial results or file our periodic reports in a timely manner, which may cause adverse effects on our business and may cause investors to lose confidence in our reported financial information and may lead to a decline in stock price. 

Effective internal control over financial reporting is necessary in order to provide reliable financial reports in a timely manner. In connection with the audit of our consolidated financial statements for the year ended August 31, 2019, we concluded that there were material weaknesses in our internal control over financial reporting relating to our IT environment, controls over cut-off procedures, a related party transaction, accounting for certain litigation accruals, segregation of duties and corporate oversight functions. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.

If we are unable to successfully remediate our material weaknesses or identify any future significant deficiencies or material weaknesses, the accuracy and timing of our financial reporting may be adversely affected, a material misstatement in our consolidated financial statements could occur, we may be unable to maintain compliance with securities law requirements regarding timely filing of periodic reports, which may adversely affect our business and our stock price may decline as a result. In addition, even if we remediate our material weaknesses, we will be required to expend significant time and resources to further improve our internal controls over financial reporting, including by further expanding our finance and accounting staff to meet the demands that are placed upon us as a public company, including the requirements of the Sarbanes-Oxley Act. If we fail to adequately staff our accounting and finance function to remediate our material weaknesses, or fails to maintain adequate internal control over financial reporting, any new or recurring material weaknesses could prevent us from concluding our internal control over financial reporting is effective and impair our ability to prevent material misstatements in our consolidated financial statements, which could cause our business to suffer.

If we are unable to secure or pay for the insurance coverage required for our business operations, or if we lose any existing coverage, we may not be able to offer some of our services and our revenues could be reduced.

We are required to obtain and maintain various types of insurance coverage for our business, in particular health and workers’ compensation insurance related to our employees. Although we have contracts with all types of providers currently necessary for our business, if in the future we are unable to secure the insurance coverage required for our business operations, or if we lose any existing coverage, we may not be able to offer some of our services and our revenues could be reduced. In addition, any increases in the cost of insurance coverage we are required to maintain could reduce profitability (or increase net losses).

We provide limited self-insurance for our workers’ compensation services provided to our clients. If we have claims in excess of our collected premiums we may incur additional losses. Workers’ compensation costs for shifter employees may rise and reduce our margins and require more liquidity.

We are responsible for and pay workers’ compensation costs for our shift workers. We currently provide self-insurance for up to $500,000 per occurrence and purchase reinsurance for claims in excess of $500,000. Our workers’ compensation billings are designed to cover expected claims based on insurance annuity calculations. These calculations are based on our limited operating history and claims experiences due to our limited operating history. At times, these costs have risen substantially as a result of increased claims and claim trends, general economic conditions, changes in business mix, increases in healthcare costs, and government regulations. Although we carry insurance and currently have reserves in excess of projected losses, unexpected changes in claim trends, including the severity and frequency of claims, actuarial estimates, and medical cost inflation could result in costs that are significantly different than initially reported. If future claims-related liabilities increase due to unforeseen circumstances, or if new laws, rules, or regulations are passed, costs could increase significantly. There can be no assurance that we will be able to increase the fees charged to clients in a timely manner and in a sufficient amount to cover increased costs as a result of any changes in claims-related liabilities.

We may be subject to penalties and interest payable on taxes as a result of data entry into our software or manual error.

Our input of data in our tax processing software must be entered properly in order to process the data and payments correctly with regard to clients, employees and applicable tax agencies. If we input incorrect data or input accurate data incorrectly, we could inadvertently overbill or underbill our clients or overpay or underpay applicable taxes, resulting in the loss of net income and/or clients and/or the incurrence of tax penalties and interest. Despite our efforts to reconcile taxes on a monthly basis, we may incur additional taxes, penalties and interest for which we may or may not bill our clients.

Our ability to adjust and collect service fees for increases in unemployment tax rates may be limited.

We record our State Unemployment Tax (“SUI”) expense based on taxable wages and tax rates assigned by each state. SUI tax rates vary by state and are determined, in part, based on prior years’ compensation experience in each state. Prior to the receipt of final tax rate notices, we estimate our expected SUI tax rate in those states for which tax rate notices have not yet been received for purposes of pricing. In a period of adverse economic conditions state unemployment funds may experience a significant increase in the number of unemployment claims. Accordingly, SUI tax rates would likely increase substantially. Some states have the ability under law to increase SUI tax rates retroactively to cover deficiencies in the unemployment fund.

In addition, taxes under the Federal Unemployment Tax Act (“FUTA”) may be retroactively increased in certain states in the event the state fails to timely repay federal unemployment loans. Employers in such states are experiencing higher FUTA tax rates as a result of not repaying their unemployment loans from the federal government in a timely manner. The credit reduction is an additional tax on the FUTA wage base for employers in states that continue to have outstanding federal unemployment insurance loans beginning with the fifth year in which there is a balance due on the loan. States have the option to apply for a waiver before July 1st of the year in which the credit reduction is applicable.

Generally, our contractual agreements allow us to incorporate such statutory tax increases into our service fees upon the effective date of the rate change. However, our ability to fully adjust service fees in our billing systems and collect such increases over the remaining term of the clients’ contracts could be limited, resulting in a potential tax increase not being fully recovered. As a result, such increases could have a material adverse effect on our financial condition or results of operations.

Epidemic diseases, such as the coronavirus, could negatively affect various aspects of our business, make it more difficult to meet our obligations to our clients, and could result in reduced demand from our clients, which could have a material adverse effect on our business, financial condition, results of operations, or cash flows.

Our business could be adversely affected by the effects of a widespread outbreak of contagious disease, including the recent outbreak of respiratory illness caused by a novel coronavirus disease (“COVID-19”) first identified in Wuhan, China in December 2019. On March 11, 2020, the World Health Organization declared COVID-19 a pandemic disease. Potential impacts of the spread of COVID-19 include disruptions or restrictions on our employees’ and WSEs’ ability to travel and temporary closures of the facilities of our clients. For example, many of our WSEs perform services in the restaurant and hospitality industries, and since early March 2020, there has been significant decline in restaurant and hotel traffic. Government agencies have since declared a state of emergency in the U.S., and some have restricted movement, required restaurant, bar and hotel closures, and advised people not to visit restaurants or bars and otherwise restrict non-essential travel. In some jurisdictions, people have been instructed to shelter in place to reduce the spread of COVID-19, in response to which restaurants have temporarily closed and have shifted operations at others to provide only take-out and delivery service. Travel and tourism across the globe has significantly decreased, in response to which hotels have temporarily closed and furloughed employees.  All of these developments and similar developments that have occurred as a result of the spread of COVID-19 negatively affect our clients and the ability of our WSEs to perform services. As a result, we expect our results of operations to be materially and negatively affected by these actions.

Additionally, our headquarters are located in Irvine, CA in Orange County, a region that has seen a recent rise of confirmed cases of COVID-19. We are continuing to monitor and assess the effects of the COVID-19 outbreak on our commercial operations, including any potential impact on our revenue in 2020. However, we cannot at this time accurately predict what effects these conditions will ultimately have on our operations due to uncertainties relating to the ultimate geographic spread of the virus, the severity of the disease, the duration of the outbreak, and the length of the travel restrictions and business closures imposed by the governments of impacted countries. In addition, a significant outbreak of contagious diseases in the human population could result in a widespread health crisis that could adversely affect the economies and financial markets of many countries, resulting in an economic downturn that could affect demand for our products and likely impact our operating results.

Risks Relating to Technology

We collect, use, transmit and store personal and business information with the use of data service vendors, and a security or privacy breach may damage or disrupt our businesses, result in the disclosure of confidential information, damage our reputation, increase our costs or cause losses.

In connection with our business, we collect, use, transmit and store with data services vendors large amounts of personal and business information about our clients and shift employees, including payroll information, healthcare information, personal and limited business financial data, social security numbers, bank account numbers, tax information and other sensitive personal and business information. In addition, as we continue to grow the scale of our business, we will process and store with data services vendors an increasing volume of personally identifiable information of our users. Our data services vendors include PrismHR, Amazon Web Services, Microsoft OneDrive, ShareFile, Dropbox, Egnyte, Smartsheet, MasterTax, Microsoft Outlook, Microsoft Office 365, and RightSignature; we believe these vendors implement industry standard or more stringent data security measures to protect the data that we transmit through and/or store with them. Despite our efforts to protect customer data, perceptions that the collection, use, and storage of personal information are not satisfactorily protected could inhibit sales of our services and could limit adoption of our services. In addition, the continued occurrence of high-profile data breaches provides evidence of an external environment increasingly hostile to information security.

We are focused on ensuring that our operating environments safeguard and protect personal and business information, and we will devote significant resources to maintain and regularly update our systems and processes. The cost to maintain these safeguards is significant and may increase as we grow, which may limit our ability to employ our resources elsewhere and slow our ability to grow. Despite our efforts to maintain security controls across our business, it is possible our security controls over personal data, our training of employees and vendors on data security, and other practices we follow may not prevent the improper disclosure of customer data we or our vendors store and manage. In addition, attacks on information technology systems continue to grow in frequency, complexity and sophistication, and we may be targeted by unauthorized parties using malicious tactics, code and viruses.

We have third party contractors who monitor our activities in a manner designed to prevent, detect and respond to data security incidents. However, because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently and may be difficult to detect for long periods of time, we may be unable to anticipate these techniques or implement adequate preventive measures. In addition, hardware, software, or applications we develop or procure from third-parties may contain defects in design or manufacture or other problems that could unexpectedly compromise the confidentiality, integrity or availability of data or our systems. Unauthorized parties may also attempt to gain access to our systems or facilities, or those of third-parties with whom we do business, through fraud, trickery, or other methods of deceiving our employees, contractors, or temporary staff. As these threats continue to evolve, we may be required to invest significant additional resources to modify and enhance our information security and controls or to investigate and remediate any security vulnerabilities. In addition, while our operating environment is designed to safeguard and protect personal and business information, we do not have the ability to monitor the implementation of similar safeguards by our clients, vendors or their respective employees, and, in any event, third-parties may be able to circumvent those security measures.

Any cyber-attack, unauthorized intrusion, malicious software infiltration, network disruption, denial of service, corruption of data, theft of non-public or other sensitive information, any similar act by a malevolent party, or inadvertent acts by our own employees, could result in the disclosure or misuse of confidential or proprietary information, harm our reputation, and could have a materially adverse effect on our business operations, or that of our clients, create financial liability, result in regulatory sanction, or generate a loss of confidence in our ability to serve clients or cause current or potential clients to choose another service provider, or subject us to liability under laws that protect personal data, resulting in increased costs or loss of revenue. Although we believe that through our third-party contractors we maintain a program of information security and controls and any threats that we might have encountered to date have not materially impacted us, the impact of a data security incident could have a materially adverse effect on our business, results of operations and financial condition. While we have insurance coverage for risks for exchanging and maintaining data electronically that is designed to address certain aspects of cyber-risks, such insurance coverage may be denied or be insufficient to cover all losses or all types of claims that may arise in the continually evolving area of cyber-risk. In addition, any further security measures we may undertake to address further protections may cause higher operating expenses.

We are also subject to various federal and state laws, rules and regulations relating to the collection, use, transmission and security of personal and business information. In addition, the possession and use of personal information and data in conducting our business subjects us to laws that may require notification to regulators, clients or employees in the event of a privacy breach and may impose liability on us for privacy deficiencies, including but not limited to liability under laws that protect the privacy of personal information, such as the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”), and regulatory penalties. These laws continue to develop, the number of jurisdictions adopting such laws continues to increase, and these laws may be inconsistent from jurisdiction to jurisdiction. The future enactment of more restrictive laws, rules or regulations could have a materially adverse impact on us through increased costs or restrictions on our businesses and noncompliance could result in regulatory penalties and significant legal liability. In addition, enforcement actions and investigations by regulatory authorities related to data security incidents and privacy violations continue to increase.

Some of the activities in which our shift workers could become involved include health care information-related responsibilities that could invoke the need for compliance with HIPAA as amended by the Health Information Technology for Economic and Clinical Health Act (the “HITECH Act”). The United States Department of Health and Human Services issued regulations that establish uniform standards governing the conduct of certain electronic health care transactions and protecting the privacy and security of protected health information used or disclosed by health care providers and other covered entities. Three principal regulations with which we are required to comply have been issued in final form under HIPAA: privacy regulations, security regulations, and standards for electronic transactions, which establish standards for common health care transactions. The privacy regulations cover the use and disclosure of protected health information by health care providers. They also set forth certain rights that an individual has with respect to his or her protected health information maintained by a health care provider, including the right to access or amend certain records containing protected health information or to request restrictions on the use or disclosure of protected health information. The security regulations establish requirements for safeguarding the confidentiality, integrity, and availability of protected health information that is electronically transmitted or electronically stored. The HITECH Act, among other things, establishes certain health information security breach notification requirements. A covered entity must notify any individual whose protected health information is breached. The HIPAA privacy and security regulations establish a uniform federal “floor” and do not supersede state laws that are more stringent or provide individuals with greater rights with respect to the privacy or security of, and access to, their records containing protected health information. These laws contain significant fines and other penalties for wrongful use or disclosure of protected health information. Additionally, to the extent that we submit electronic health care claims and payment transactions that do not comply with the electronic data transmission standards established under HIPAA and the HITECH Act, payments to us may be delayed or denied.

We may be vulnerable to security breaches that could disrupt our operations and adversely affect our business.

Despite security measures and business continuity plans, our information technology networks and infrastructure may be vulnerable to damage, disruptions, or shutdowns due to unauthorized access, computer viruses, cyber-attacks, distributed denial of service, and other security breaches. An attack on or security breach of our network could result in interruption or cessation of access and services, our inability to meet our access and service level commitments, and potentially compromise customer data transmitted over our network. We cannot guarantee that our security measures will not be circumvented, resulting in network failures or interruptions that could impact our network availability and have a material adverse effect on our business, financial condition, and results. We may be required to expend significant resources to protect against such threats. If an actual or perceived breach of our security occurs, the market perception of the effectiveness of our security measures could be harmed, and we could lose customers. Any such events could result in legal claims or penalties, disruption in operations, misappropriation of sensitive data, damage to our reputation, and/or costly response measures, which could adversely affect our business. Although we maintain insurance coverage that may, subject to policy terms and conditions (including self-insured deductibles, coverage restrictions and monetary coverage caps), cover certain aspects of our cyber risks, such insurance coverage may be unavailable or insufficient to cover our losses.

If we are unable to protect our proprietary and technology rights our operations will be adversely affected.

Our success will depend in part on our ability to protect our proprietary rights and technologies, including those related to our products and services. Protecting our intellectual property rights and combating unlicensed copying and use of our software and other intellectual property is difficult. Except as otherwise noted herein, we have not applied for any formal patent, trademark or similar protection. Our failure to adequately protect our proprietary rights may adversely affect our operations. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our services or to obtain and use trade secrets or other information that we regard as proprietary. Based on the nature of our business, we may or may not be able to adequately protect our rights through patent, copyright and trademark laws. Our means of protecting our proprietary rights in the United States or abroad may not be adequate, and competitors may independently develop similar technologies. In addition, litigation may be necessary in the future to:

Any such litigation could result in substantial costs if we are held to have willfully infringed or to expend significant resources to develop non-infringing technology and would divert the attention of management from the implementation of our business strategy. Furthermore, the outcome of litigation is inherently difficult to predict and we may not prevail in any litigation in which we become involved.

Software products we use in our business may contain defects which will make it more difficult for us to establish and maintain customers.

We are currently using PrismHR software for our payroll processing. We also use MasterTax to process our tax reports and filings. We also use a host of other software products in the course of conducting our business. The mobile app component of our mobile application, along with the client portal and the ShiftPixy Command Hub, constitute our proprietary software and contain components that are licensed from third parties and that are public domain software. Our payroll processing software and other software products, including our mobile application, we use in our business may contain undetected design faults and software errors, or “bugs” that are discovered only after they has been installed and used by a greater number of customers. Any such defect or error in new or existing software or applications could cause delays in delivering our technology or require design modifications. These could adversely affect our competitive position and cause us to lose potential customers or opportunities. Since our technologies are intended to be utilized to supply human resources related services, the effect of any such bugs or delays will likely have a detrimental impact on us. In addition, given that our specialized human resources software and services has yet to gain widespread acceptance in the market, any delays or other problems caused by software bugs would likely have a more detrimental impact on our business than if we were a more established company.

If a contract relating to our mission critical software that we use in our business is terminated or not renewed, our business could be seriously disrupted and our revenues significantly reduced.

If a contract relating to our mission-critical software services, such as that applicable to payroll and payroll tax processing, is terminated or non-renewed, and we do not have an effective replacement software, our business and revenues would suffer. Although there are other software vendors we can use, it may take time to negotiate an agreement and make operational this replacement software. Accordingly, if the software agreements that we use in our business are terminated or not renewed, our business could be seriously disrupted and our revenues significantly reduced until we locate and make operational replacement software.

Our systems may be subject to disruptions that could have a materially adverse effect on our business and reputation.

Our business is and will continue to be highly dependent on our ability to process, on a daily basis, a large number of complicated transactions. We rely heavily on our payroll, financial, accounting, and other data processing systems. We may not be successful in preventing the loss of client data, service interruptions or disruptions to our operations from system failures. If any of these systems fails to operate properly or becomes disabled even for a brief period of time, we could suffer financial loss, a disruption of our businesses, liability to clients, regulatory intervention, or damage to our reputation, any of which could have a materially adverse effect on our results of operation or financial condition.

Because we store data in the cloud with providers such as Microsoft and Amazon, any disruptions in our ability to access this data or any breach of security concerning this data in the cloud could have a materially adverse effect on our business and reputation.

Our business is and will continue to be highly dependent on data storage in the cloud with providers such as Microsoft and Amazon. These cloud storage systems may fail to operate properly or become disabled even for a brief period of time. There could also be security breaches of our data stored in the cloud. If there is loss of client data, service interruptions or disruptions to our operations related to our cloud data storage, we could suffer financial loss, a disruption of our businesses, liability to clients, regulatory intervention, or damage to our reputation, any of which could have a materially adverse effect on our results of operation or financial condition.

We make significant investments in our software that may not achieve our expectations. 

Developing new technologies is complex. It can require long development and testing periods. Significant delays in new releases or significant problems in creating new products or services could adversely affect our revenue.

Third parties may claim we infringe their intellectual property rights.

From time to time, others claim we infringe their intellectual property rights. The number of these claims may grow because of constant technological change in the markets in which we compete, the extensive patent coverage of existing technologies and the rapid rate of issuance of new patents. To resolve these claims, we may enter into royalty and licensing agreements on terms that are less favorable than currently available, stop selling or redesign affected products or services, or pay damages to satisfy indemnification commitments with our customers. These outcomes may cause operating margins to decline. Besides money damages, in some jurisdictions plaintiffs can seek injunctive relief that may limit or prevent importing, marketing, and selling our products or services that have infringing technologies.

We may not be able to protect our source code from copying if there is an unauthorized disclosure of source code.

Source code, the detailed program commands for our operating systems and other software programs, is critical to our business. We take significant measures to protect the secrecy of large portions of our source code. If a significant portion of our source code leaks, we might lose future trade secret protection for that source code. It may become easier for third parties to compete with our products by copying functionality, which could adversely affect our revenue and operating margins. Unauthorized disclosure of source code also could increase the security risks described in the next paragraph.

We may have outages, data losses, and disruptions of our online services if we fail to maintain an adequate operations infrastructure.

Our increasing user traffic, growth in services, and the complexity of our services demand more computing power. We spend substantial amounts to build, purchase, or lease datacenters and equipment and to upgrade our technology and network infrastructure to handle more data. These demands continue to increase as we grow our workforce. Maintaining, securing, and expanding this infrastructure is expensive and complex. It requires that we maintain an internet connectivity infrastructure that is robust and reliable within competitive and regulatory constraints that continue to evolve. Inefficiencies or operational failures, including temporary or permanent loss of customer data or insufficient internet connectivity, could diminish the quality of our products, services, and user experience resulting in contractual liability, claims by users and other third parties, regulatory actions, damage to our reputation, and loss of current and potential users, subscribers, and advertisers, each of which may harm our operating results and financial condition.

Our software may experience quality or supply problems.

Our software may experience quality or reliability problems. The highly-sophisticated software we have been developing may contain bugs and other defects that interfere with their intended operation. Any defects we do not detect and fix in pre-release testing could cause reduced sales and revenue, damage to our reputation, repair or remediation costs, delays in the release of new products or versions, or legal liability. Although our license agreements typically contain provisions that eliminate or limit our exposure to liability, there is no assurance these provisions will withstand legal challenge.

We intend to use open source blockchain technology in our technology platform. This technology has been scrutinized by regulatory agencies and therefore we may be impacted by unfavorable regulatory action in one or more jurisdictions.

We intend to use open source blockchain technology as a secure repository for “device reputation” information acquired by our technology platform. Blockchain technologies have been the subject of scrutiny by various regulatory bodies around the world. We could be impacted by one or more regulatory inquiries or actions, including but not limited to restrictions on the use of blockchain technology, which could impede or limit the use of this technology within our product offerings.

We intend to use and leverage open source technology in our technology platform which may create risks of security weaknesses.

Some parts of our technology may be based on open-source technology, including the blockchain technology that we intend to use in our technology platform. There is a risk that the development team, or other third parties may intentionally or unintentionally introduce weaknesses or bugs into the core infrastructure elements of our technology solutions interfering with the use of such technology or causing loss to us.

Risks Relating to Management and Personnel

We depend heavily on Scott W. Absher, our Chief Executive Officer and a director. The loss of his services could harm our business.

Our future business and results of operations depend in significant part upon the continued contributions Scott W. Absher, our Chief Executive Officer and a director. If we lose his services or if he fails to perform in his current position, or if we are not able to attract and retain skilled employees in addition to Mr. Absher, this could adversely affect the development of our business plan and harm our business.

Mr. Absher has limited experience managing a public company, which may inhibit our ability to implement successfully our business plan.

Mr. Absher has limited experience managing a public company, which is required to establish and maintain disclosure controls and procedures and internal control over financial reporting. We are endeavoring to comply with all of the various rules and regulations, which are required for a public company that is reporting company with the Securities and Exchange Commission. However, if we cannot operate successfully as a public company, your investment may be materially adversely affected.

If we are not recognized as an employer of WSEs under federal and state regulations, or we are deemed to be an insurance agent or third-party administrator, we and our clients could be adversely impacted.

While in our client engagements we typically arrange for clients to act as sponsor of employee benefit plans, we sponsor the benefit plans applicable to its employees. In order for us to sponsor employee benefit plan offerings for our WSEs, we must qualify as an employer of our WSEs for certain purposes under the Code and the Employee Retirement Income Act of 1974, as amended (“ERISA”). In addition, our status as an employer is important for purposes of ERISA’s preemption of certain state laws. The definition of employer under various laws is not uniform, and under both the Code and ERISA, the term is defined in part by complex multi-factor tests.

Generally, these tests are designed to evaluate whether an individual is an independent contractor or employee and they provide substantial weight to whether a purported employer has the right to direct and control the details of an individual’s work. Some factors that the IRS has considered important in the past have included the employer’s degree of behavioral control (the extent of instructions, training and the nature of the work), the financial control and the economic aspects of the relationship, and the intent of the parties, as evidenced by the specific benefit, contract, termination and other similar arrangements between the parties and the on-going versus project-oriented nature of the work to be performed. However, a definitive judicial interpretation of “employer” in the context of joint employer relationships such as those in which we engage has not been established. For ERISA purposes, for example, courts have held that test factors relating to ability to control and supervise an individual are less important, while the U.S. Department of Labor has issued guidance that certain entities in the HR outsourcing industry do not qualify as common law employers for ERISA purposes. Moreover, when our app is fully functional, the scope of our employer status will increase, changing the legal analysis. Although we believe that we qualify as an employer of our WSEs under ERISA, and the U.S. Department of Labor has not provided guidance otherwise, we are not able to predict the outcome of any future regulatory challenge.

If we are not recognized as an employer under the Code or ERISA, we may be required to change the method by which we report and remit payroll taxes to the tax authorities and the method by which we provide, or discontinue providing, certain employee benefits to our WSEs, which could have a material adverse effect on our business and results of operations.

We may also need to qualify as an employer of our WSEs under state regulations, which govern licensing, certification and registration requirements. Nearly all states have enacted laws and regulations in this regard. While we believe that we qualify as an employer of our WSEs under these state regulations, these requirements vary from state to state and change frequently and if we are not able to satisfy existing or future licensing requirements or other applicable regulations of any states, we may be prohibited from doing business in that state.

Our business depends on our ability to attract and retain talented employees.

Our business is based on successfully attracting and retaining talented employees. The market for highly skilled workers and leaders in our industry is extremely competitive. If we are less successful in our recruiting efforts, or if we cannot retain key employees, our ability to develop and deliver services successfully may be adversely affected. If we can not hire additional qualified personnel, we may continue to have internal control weaknesses. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution. How employment-related laws are interpreted and applied to our workforce practices may result in increased operating costs and less flexibility in how we meet our workforce needs.

Lapses in our employee screening process may harm our reputation or relationship with clients, or result in litigation, which may impact our financial condition.

Our business model is dependent on hiring employees who will provide high quality service for our clients. Lapses in our screening process my result in employees being hired who are not up to the standard expected by our clients. This may hurt our relationship with our clients or result in their decision to look elsewhere, which would negatively impact our ability to remain in business. Criminal behavior by our employees resulting from a lapse in our screening process may subject us to litigation from our clients or government regulators, which may also be costly and/or damage our reputation.

We are in the business of providing employees to clients, and there is a risk that we will be sued and/or held liable for claims resulting from actions by or against our employees.

We employ people internally and in the workplaces of other businesses. Our ability to control the workplace environment of our clients is limited. Further, many of these individuals have access to client information systems and confidential information. As the employer of record of our contract professionals, we incur a risk of liability to our contract professionals for various workplace events, including claims of physical injury, discrimination, harassment or failure to protect confidential personal information. Other inherent risks include possible claims of errors and omissions; intentional misconduct; release, misuse or misappropriation of client intellectual property; employment of illegal aliens; criminal activity; torts; or other claims. The claims can carry significant financial penalties and damages.

We have not had significant claims for damages or losses from actions of our employee workers to date. However, there is a risk that we will be subject to such claims in the future and may be held liable even if our contribution to the injury is minimal or absent. We may also be required to indemnify our clients against claims brought against them by or against our employees. Even if we are successful in defending against these claims the costs of mounting our defense may be significant and damaging to us. We may incur reputational costs and/or be subject to investigations by public agencies, along with the associated negative publicity. We may lose clients as a result claims against us.

To protect ourselves, we carry a staffing liability program commercial insurance policy. We believe the insurance coverage is appropriate for a company of our size and function. The policy provides coverage with respect to: (1) “wrongful employment acts” committed against our “employees” pursuant to our agreement with that client; and (2) A “staffing services worker’s acts” committed while in the service of our client that result in a “wrongful business environment.” No insurance policy is without risk. A claim against us may not be covered by this plan, such as wage and hour disputes which are on the rise nationally. The insurer may seek to disclaim liability as not covered or for other reasons or the amount of judgment against us may exceed the policy limits. If we are unable to maintain adequate insurance coverage, we may be exposed to substantial liabilities. Any claims for damages against us as a result of actions of our work employees could damage our reputation, increase our expenses and reduce our profitability (or increase net losses) and revenues.

Catastrophic events or geopolitical conditions may disrupt our business.

Monetary and fiscal policies and political and economic conditions may substantially change. When there is a slowdown in the economy, employment levels may decrease with a corresponding impact on our businesses.

Clients may react to worsening conditions by reducing their spending on payroll and other outsourcing services or renegotiating their contracts with us.

Worsening economic conditions, including inflation, recession, or other changes in economic conditions, may cause businesses to rely less on vendors in our business, which could adversely affect our revenue. If demand for our services declines, or business spending for such services declines, our revenue will be adversely affected.

Challenging economic conditions also may impair the ability of our customers to pay for products and services they have purchased. As a result, allowances for doubtful accounts and write-offs of accounts receivable may increase.

We are dependent upon various large banks to execute Automated Clearing House and wire transfers as part of our client payroll and tax services. A systemic shutdown of the banking industry would impede our ability to process funds on behalf of our payroll and tax services clients and could have an adverse impact on our financial results and liquidity.

A disruption or failure of our systems or operations because of a major earthquake, weather event, cyber-attack, terrorist attack, fire, or other catastrophic event could cause delays in completing sales, providing services, or performing other critical functions. Our corporate headquarters, a significant portion of our research and development activities, and certain other essential business operations are in the Irvine, California area, which is a seismically active region. A catastrophic event that results in the destruction or disruption of any of our critical business or IT systems could harm our ability to conduct normal business operations. California has also experienced destructive fires recently. As a result of these fires, power and utilities are occasionally shut off to parts of the State. A fire or risk of fire may result in damage to our facilities, the temporary or permanent shut down of our or our clients’ facilities, disruption to our power supply or utilities, or other disruptions that may harm our ability to conduct business.

Abrupt political change and terrorist activity may pose threats to our business and increase our operating costs. These conditions also may add uncertainty to the timing and budget for technology investment decisions by our customers and may cause supply chain disruptions for hardware manufacturers. Geopolitical change may result in changing regulatory requirements that could impact our operating strategies, hiring, and profitability.

Risks Relating to Regulations and Compliance

Failure to comply with, or changes in, laws and regulations applicable to our business, particularly potential changes to the Patient Protection and Affordable Care Act (the “ACA”), could have a materially adverse effect on our marketing plan as well as our reputation, results of operations or financial condition, or have other adverse consequences.

Our business is subject to a wide range of complex laws and regulations. For example, many states regulate entities offering the employment related services such as those offered by us directly or through our subsidiary and require licenses as a prerequisite to operation of such enterprises in their respective jurisdictions. There can be no assurance that either we or our subsidiary, ReThink Human Capital Management, Inc. (“ReThink”), will be successful in either securing or maintaining a license or licenses in compliance with a particular state’s laws and regulations. Further, many states require variously that workers’ compensation policies offered by employment related firms such as ours to be managed according to strict rules and/or that unemployment insurance filings be administered according to strict rules.

Failure to comply with such laws and regulations could result in the suspension or revocation of licenses or registrations, the limitation, suspension or termination of services, and the imposition of consent orders or civil and criminal penalties, including fines, that could damage our reputation and have a materially adverse effect on our results of operation or financial condition.

In addition, changes in laws or regulations, or changes in the interpretation of laws or regulations by a regulatory authority, may decrease our revenues and earnings and may require us to change the manner in which we conduct some aspects of our business. For example, a change in regulations either decreasing the amount of taxes to be withheld or allowing less time to remit taxes to government authorities would adversely impact interest income from investing client funds before such funds are remitted to the applicable taxing authorities. Changes in taxation regulations could adversely affect our effective tax rate and our net income. Changes in laws that govern the co-employment arrangement between a professional employer organization (“PEO”) and its WSEs may require us to change the manner in which we conduct some aspects of our business.

Changes to the ACA, as amended, related state laws, and the regulations adopted or to be adopted thereunder, have the potential to impact substantially the way that employers provide health insurance to employees and the health insurance market for the small and mid-sized businesses that constitute our business’s clients and prospects. If the ACA is repealed or replaced, the elimination of employer mandates and similar employer requirements currently imposed by the ACA, and other regulatory changes could in the future reduce our revenues. Amendments to money transmitter statutes have required us to obtain licenses in some jurisdictions. The adoption of new money transmitter statutes in other jurisdictions, changes in regulators’ interpretation of existing state and federal money transmitter or money services business statutes or regulations, or disagreement by a regulatory authority with our interpretation of such existing statutes or regulations, could require additional registration or licensing, limit certain business activities until they are appropriately licensed, and expose us to financial penalties. These occurrences could also require changes to our compliance programs and to the manner in which we conduct some aspects of our money movement business or client funds investment strategy, which could adversely impact interest income from investing client funds before such funds are remitted.

Failure to secure any necessary registrations or licensure could affect our ability to operate certain segments of our business in certain jurisdictions.

Some states require licensure or registration of businesses offering PEO services. While some elements of our service offering overlap with PEO services, our human capital platform is more in line with a traditional staffing model. However, if we need and are unable to secure registration or licensure of such service offering in a particular state, our ability to grow that segment of our business in such state would be impaired and could affect our ability to increase our revenues and meet certain customer requirements in such states.

We may be subject to Private Attorney General’s Act (“PAGA”) claims which we may require additional capital to defend.

Our work force resides mostly in the State of California. Employment laws in the State of California can be complex and undefined where a co-employment or human capital platform relationship exists, both of which are contemplated in our current business and our future plans. The existence of a PAGA allows plaintiffs’ attorneys to bring class action-like lawsuits against employers which can result in substantial costs to defend and may result in large fines for seemingly insignificant or inadvertent clerical errors. As we move more into these areas, the risk will increase that such PAGA claims will be filed and litigated which may result in increased costs to us.

Laws related to the classification of a Gig Economy workers are changing, and we may be subject to state and local regulations impacting how we classify our workers.

A significant portion of our business is located in the State of California which recently passed AB-5 relating to the classification of certain gig workers as employees instead of independent contractors. Other states such as New York and New Jersey, two of our potential markets, are also considering similar legislation. We anticipate that classification status will continue to be an unsettled area of law for the foreseeable future. Changes in classification can result in a change to the payment of wages, tax withholding, and providing unemployment, health, and other traditional employer-employee related benefits. While we currently classify all of our WSEs as employees, our business plans potentially include the use of large numbers of independent contractors. If we are unable to utilize independent contractors, or the cost to use independent contractors is more expensive, our future growth opportunities may be limited or reduced. Costs or delays associated with revising our services to account for changes in the status of employees and independent contractors may have a significant impact on our future growth. Changes to the law may impact the desirability or applicability of our business model, which could impact our ability to continue as a going concern.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements within the meaning of the federal securities laws, which statements involve substantial risks and uncertainties. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, you can identify forward-looking statements because they contain words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans or intentions. Forward-looking statements contained in this prospectus include, but are not limited to, statements about:

We caution you that the forward-looking statements highlighted above do not encompass all of the forward-looking statements made in this prospectus.

We have based the forward-looking statements contained in this prospectus primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, results of operations and prospects. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties and other factors described in the section of this prospectus entitled “Risk Factors” and elsewhere in this prospectus. Moreover, we operate in a very competitive and challenging environment. New risks and uncertainties emerge from time to time, and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this prospectus. We cannot assure you that the results, events and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events or circumstances could differ materially from those described in the forward-looking statements.

The forward-looking statements made in this prospectus relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this prospectus to reflect events or circumstances after the date of this prospectus or to reflect new information or the occurrence of unanticipated events, except as required by law. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures, other strategic transactions or investments we may make or enter into.

USE OF PROCEEDS

We estimate that the net proceeds to us from this offering will be approximately $          million, or approximately $          million if the underwriters exercise their option to purchase additional shares in full, at the assumed offering price of $             , the closing price of our common stock as reported on Nasdaq on                , 2020, and after deducting underwriting discounts and commissions, and excluding the proceeds, if any, from the exercise of the pre-funded warrants issued in this offering.

A $              increase (decrease) in the assumed public offering price of  $                    per share would increase (decrease) the expected net proceeds to us from this offering by approximately $                     million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us and excluding the proceeds, if any, from the exercise of the pre-funded warrants issued pursuant to this offering.

Similarly, a one million share increase (decrease) in the number of shares offered by us, as set forth on the cover page of this prospectus, would increase (decrease) the net proceeds to us by approximately $                          , assuming the assumed public offering price of  $                         per share remains the same, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us and excluding the proceeds, if any, from the exercise of the pre-funded warrants issued pursuant to this offering.

We are undertaking this offering in order to access the public capital markets and to increase our liquidity. We intend to use the net proceeds we receive from this offering for general corporate purposes, including working capital, operating expenses and capital expenditures. Our management will have broad discretion in the application of the net proceeds.

The amounts and timing of our use of the net proceeds from this offering for general corporate purposes will depend on a number of factors, such as the timing and progress of our research and development efforts and the timing and progress of any collaborative or strategic partnering efforts. As of the date of this prospectus, we cannot specify with certainty all of the particular uses for the net proceeds to us from this offering. Accordingly, our management will have broad discretion in the timing and application of these proceeds.

DIVIDEND POLICY

We have never declared dividends on our equity securities, and currently do not plan to declare dividends on shares of our common stock in the foreseeable future. We expect to retain our future earnings, if any, for use in the operation and expansion of our business. The payment of cash dividends in the future, if any, will be at the discretion of our board of directors and will depend upon such factors as earnings levels, capital requirements, our overall financial condition and any other factors deemed relevant by our board of directors.

Accordingly, you may need to sell your shares of our common stock to realize a return on your investment, and you may not be able to sell your shares at or above the price you paid for them. See “Risk Factors — Risks Related to this Offering and Ownership of Our Common Stock.” We have not paid cash dividends in the past and do not expect to pay dividends in the future. Any return on investment may be limited to the value of our common stock.”

CAPITALIZATION

The following table sets forth our cash and cash equivalents, as well as our capitalization, as of November 30, 2019 as follows:

You should read this information in conjunction with the information contained in “Use of Proceeds” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and related notes in this prospectus.

DILUTION

Our net tangible book value as of November 30, 2019, as adjusted for the Vensure Asset Transfer and the Convertible Note Settlements, was approximately $              , or $               per share of common stock. Net tangible book value per share is calculated by subtracting our total liabilities from our total tangible assets, which is total assets less intangible assets, and dividing this amount by the number of shares of common stock outstanding as of such date. After giving effect to the sale by us of     shares of common stock and pre-funded warrants to purchase up to shares of common stock in this offering at an offering price of $                per share and $                    per pre-funded warrant, and after deducting the placement agent fees and estimated offering expenses payable by us, and excluding the proceeds, if any, from the exercise of the pre-funded warrants issued in this offering, and as adjusted to give effect to the offerings that occurred after                        , 2019, our as-adjusted net tangible book value as of November 30, 2019 would have been approximately $                    , or $                per share of common stock. This represents an immediate increase in the net tangible book value of $                   per share to our existing shareholders and an immediate and substantial dilution in net tangible book value of $                per share to new investors. The following table illustrates this hypothetical per share dilution:

To the extent that any outstanding options or warrants are exercised, new options are issued under our 2017 Plan or we otherwise issue additional shares of common stock in the future, there will be further dilution to new investors. Investors that acquire additional shares of common stock through the exercise of the warrants offered in the concurrent private placement may experience additional dilution depending on our net tangible book value at the time of exercise.

The above discussion and table are based on 907,047 shares of common stock outstanding as of November 30, 2019, and does not take into account further dilution to investors in this offering that could occur upon the exercise of the pre-funded warrants offered in this offering.

Assuming all of the pre-funded warrants to purchase up to                  shares of common stock were immediately exercised for cash at an exercise price of $        per share, our as adjusted net tangible book value as of              , 2019 would be $                , or $               per share of common stock. This amount represents an immediate increase in as adjusted net tangible book value of $       per share to our existing shareholders and an immediate dilution of $                  per share to investors participating in this offering.

The foregoing discussion and table are based on 907,047 shares of common stock outstanding as of November 30, 2019 and excludes the following securities:

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

The following management’s discussion and analysis should be read in conjunction with our historical financial statements, our unaudited pro forma condensed consolidated financial information and the related notes included in this prospectus. Management’s discussion and analysis contains forward-looking statements that involve risks and uncertainties, including those we detail under “Risk Factors,” “Cautionary Note Regarding Forward-Looking Statements” and elsewhere in this prospectus, such as statements of our plans, objectives, expectations and intentions. Any statements that are not statements of historical fact are forward-looking statements. When used, the words “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would” or the negative of those terms, or similar expressions, identify certain of these forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause actual results or events to differ materially from those expressed or implied by the forward-looking statements in this prospectus. Our actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of several factors. We do not undertake any obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this prospectus. 

Overview

Our current business, and the primary source of our revenues to date, has been under a traditional staffing services business model. Our initial market focus is to use this traditional approach, coupled with developed technology, to address an underserved market containing predominately lower wage employees with high turnover in light industrial, services, and food and hospitality. We provide human resources, employment compliance, insurance, payroll, and operational employment services solutions for our clients and shift work or gig opportunities for worksite WSEs. As consideration for providing these services, we receive administrative or processing fees as a percentage of a client’s gross payroll, process and file payroll taxes and payroll tax returns, provide workers’ compensation insurance, and provide employee benefits. We have built a substantial business on a recurring revenue model since our inception in 2015. For the fiscal year ended August 31, 2019, we processed over $350 million of payroll billings. Our business has significantly grown for each year since inception and we expect to continue our high degree of growth. However, we have experienced losses to date as we have invested in both our technology solutions as well as the back-office operations required to service a large employee base under a traditional staffing model.

We are currently focused on clients in the restaurant and hospitality industries, traditionally market segments with high employee turnover and low pay rates. We believe that our focus on these industries will be better served by our Human Resources Information System (“HRIS”) technology platform which provides payroll and human resources tracking for our clients and will result in lower operating costs, improved customer experience and revenue growth acceleration. All of our clients enter into service agreements with us or our wholly-owned subsidiary, ReThink Human Capital Management, Inc.

Our revenues for the year ended August 31, 2019 primarily consist of administrative fees calculated as a percentage of gross payroll processed, payroll taxes due on WSEs billed to the client and remitted to the applicable taxation authority, and workers’ compensation premiums billed to the client for which we facilitate workers’ compensation coverage. Our costs of revenues consist of accrued and paid payroll taxes and our costs to provide the workers’ compensation coverage including premiums and loss reserves. A significant portion of our assets and liabilities is for our workers’ compensation reserves. Our cash balances related to these reserves are carried as assets and our estimates of projected workers’ compensation claims are carried as liabilities. Since 2019, we have provided a self-funded workers’ compensation policy for up to $500,000 and purchase reinsurance for claims in excess of $500,000. As of November 30, 2019, we have workers’ compensation related assets in excess of our projected workers’ compensation losses. We actively monitor and manage our clients and WSEs’ workers’ compensation claims which we believe allows us to provide a lower cost workers’ compensation option for our clients than they would otherwise be able to purchase on their own.

As of August 31, 2019, we had 246 clients with over 13,000 WSEs and processed payroll of over $350 million during our fiscal year ending August 31, 2019, an increase of nearly 60% for the year ending August 31, 2018. Of these WSEs, approximately 60% represent workers in the restaurant industry. In addition, as of August 31, 2019, there were an additional 12,000 inactive WSEs in our HRIS technology platform who are available for gig opportunities. In January 2020, in connection with an asset purchase agreement, we assigned client contracts representing approximately 70% of our billable clients which comprised approximately 88% of our quarterly revenue as of November 30, 2019 and certain operating assets for $19.1 million in cash of which $9.6 million was received at closing and $9.5 million is receivable over the next four years, commencing in April 2020, subject to certain conditions, including the performance of the assigned contracts. For the month ended January 31, 2020, we added nine clients, billed 56 clients in total (all related to the food service industry), billed approximately 3,900 total WSEs and retained approximately 30,000 unbilled WSEs in our HRIS platform for an annualized growth rate of over 100% for both clients and employees since November 30, 2019. We have also entered into an agreement with a large customer with multiple locations representing approximately 1,000 additional WSEs. These new WSEs were added to our HRIS platform through our new automated onboarding process which was placed into service in November 2019. We believe there is significant business interest in our HRIS platform and scheduling tools for multi-location client opportunities.

Results of Operations

Year Ended August 31, 2019 Compared to Year Ended August 31, 2018

The following table summarizes the condensed consolidated results of our operations for the years ended August 31, 2019 and 2018. These figures include the discontinued operations. See also “Unaudited Pro Forma Condensed Consolidated Financial Information” on page 7.

We report our revenues as gross billings, net of related direct labor costs for our EAS clients and revenues without reduction of labor costs for staffing services clients. For the years ended August 31, 2019 and 2018, revenues associated with staffing services were insignificant.

Our net revenue excludes the payroll cost component of gross billings. With respect to employer payroll taxes, employee benefit programs, workers’ compensation insurance, we believe that we are the primary obligor, have latitude in establishing price, selecting suppliers, and determining the service specifications and, as such, the billings for those components are included as revenue. Revenues are recognized ratably over the payroll period as WSEs perform their service at the client worksite.

Net Revenue

Our net revenue increase of $18.4 million or 52.7% increase from $35 million in 2018 to $53.4 million in 2019 is primarily driven by the increase in business clients and the workplace employees associated with those clients. Active WSEs increased by 4,600 or 54.1% from 8,500 at the end of 2018 to 13,100 at the end of 2019.

Cost of Revenue

Our cost of revenue includes the costs of employer side taxes and workers’ compensation insurance coverage. Cost of revenues increased $11.5 million or 39.3% to $41.0 million in 2019 from $29.5 million in 2018.

The change in cost of revenues was due to the net effect of the 58.5% increase in WSEs net revenues, supported by the 54% increase in WSEs offset by a reduction in employer tax expenses of $0.9 million due to the combination of favorable rate exchanges and a non-recurring reversal of a tax expense accrual made in fiscal 2018 and reversed in fiscal 2019 due to a tax reimbursement between the U.S. federal government and the State of California.

Workers’ compensation decreased due to the combination of our operational focus on loss reduction, the full implementation of the Sunz Insurance Company (“Sunz”) workers’ compensation policy for 2019 and expense reduction due to a non-recurring return of premium related to prior reporting periods. We implemented the Sunz policy in July, 2018, and therefore the cost reduction only impacted our workers’ compensation cost for two out of twelve months in 2018 compared to a full year for 2019.

Gross Profit

Gross profit increased $6.9 million or 125% to $12.4 million in 2019 from $5.5 million in 2018. The increase is due to the combination of increased net revenues and improvement in gross profit percentages. Gross profit percentage improved 7.5% from 15.7% of revenues for the fiscal year ended August 31, 2018 to 23.2% for the fiscal year ended August 31, 2019 due to the cost of revenue improvements noted above. The impact of the accrual and reversal of the $0.9 million tax accrual accounts for 4.3% of the 7.5% due to a decrease of 2018 gross profit percentage by 2.6% and increase of 2019 gross profit percentage by 1.7%. The remaining 3.2% margin improvement is due to cost savings and tax rate improvements.

Operating Expenses

The following table presents certain information related to our operating expenses.

Operating expenses increased $5.0 million or 29.2% to $22.1 million in 2019 from $17.1 million in 2018. The components of operating expenses changed as follows:

Salaries, Wages and Payroll Taxes

These consist of gross salaries, benefits, and payroll taxes associated with our executive management team and corporate employees for the fiscal year ended August 31, 2019, increased by $2.3 million to $7.7 million from $5.4 million for the fiscal year ended August 31, 2018. The increase is due to the increase in corporate employees including the addition of our technical team hired to replace outside software developers at a higher average salary than previously hired corporate employees.

Approximately $1.8 million is due to the headcount increase of which $0.7 million is attributable to the increase in costs related to our development team, and $0.5 million is due to raises and benefits costs increases for existing employees and $0.6 million due to additions to our customer service and operations team. Our corporate employee monthly average increased from 44 employees in 2018 to an average of 58 employees in 2019. Ending employee count increased from 58 corporate employees for the fiscal year ended August 31, 2018, to 68 employees for the fiscal year August 31, 2019.

Share-Based Compensation

Our share-based compensation increased by $0.25 million or 68.9% to $0.6 million for the fiscal year ended August 31, 2019. This increase was primarily due to additional stock option awards granted to our corporate employees in 2018 and 2019 and share grants issued to our non-employee board of directors.

Commissions

Commissions include payments made to third party brokers and inside sales personnel. Commissions increased by $1.1 million or 71.4% to $2.7 million, from $1.6 million for the fiscal year ended August 31, 2018. Commissions are primarily associated with compensation to our sales force for sales as well as to our property and casualty agents. Commission expenses approximates 0.77% and 0.72% of our gross billings for the fiscal years ended August 31, 2019, and 2018, respectively.

Professional Fees

Professional fees consist of legal fees, accounting and public company costs, board fees, and consulting fees. Professional fees for the fiscal year ended August 31, 2019, increased by $1.8 million or 88.5% to $3.9 million, from $2.1 million for the fiscal year ended August 31, 2018. The increase is due to $1.1 million of increased legal fees and legal settlements, $0.3 million in increased sales and marketing related consulting, $0.3 million increase for outsourced development related consulting costs, $0.3 million for increased administrative costs associated with our Sunz workers’ compensation policy, and a $0.3 million reduction in public company related costs, primarily due to reduced accounting and audit related costs.

General and Administrative Expenses

Our general and administrative expenses consist of office rent and related overhead, software licenses, insurance, penalties, business taxes, travel and entertainment, and other general business expenses. General and administrative expenses for the fiscal year ended August 31, 2019, increased by $0.8 million or 27.9% to $3.8 million, from $3.0 million for the fiscal year ended August 31, 2018. The increase is due to $0.3 million in higher software license fees related to our mobile application, $0.2 million in increased accrued tax penalties, and $0.3 million higher rent and overhead relating to our increased revenues, personnel, and the support required for the business growth.

Marketing and Advertising

Our marketing and advertising expenses consist of advertising, website costs, marketing promotions, corporate marketing, and tradeshow related costs. Marketing and advertising costs increased by $0.7 million or 120.8% to $1.2 million in fiscal 2019 from $0.5 million in the prior year. The increase is due to increased marketing, improvements to our website, increased tradeshows and advertising, and increased costs associated with marketing our mobile application.

Software Development

Our software development expenses consist of outsourced research and development to third parties. Software development costs decreased $2.6 million or 68.4% to $1.2 million for the fiscal year ended August 31, 2019 from $3.8 million in the prior year. The decrease is due to $2.8 million lower expenses in 2019 related to work contracted to Kadima, who we are currently in arbitration over non-delivery of the software and represented the entire expense in 2018. In 2019, Kadima represented $1.0 million of the expense and we incurred $0.2 million for contracted offshore developers in India and South America to support our U.S. based mobile application development.

Depreciation and Amortization

Depreciation and amortization increased by $0.6 million or 206.2% from our previous fiscal year. We capitalized $2.8 million of software development costs related to the application development stage during the fiscal year ended August 31, 2018 and $0.9 million in 2019 for a total of $3.7 million in capitalized software development. The increase is due to increased amortization on that capitalized software.

Other expenses increased from $5.3 million for the fiscal year ended August 31, 2018 to $6.8 million for the fiscal year ended August 31, 2019:

Interest Expense

Interest expense consists of cash interest on interest bearing notes, financing charges for the excess of fair value over carrying amounts of notes issued during any reporting period, amortization of recorded discount and associated deferred financing costs, and acceleration of discounts and deferred financing costs due to early conversions on notes payable. Interest expense increased $6.7 million to $8.5 million from $1.8 million in 2018. The increase is due to the increased interest expense and financing costs associated with the June 2018 Notes and the March 2019 Notes. The 2019 balances include: $2.6 million financing charge for the excess fair value over the carrying amount of the June 2019 Notes, non-cash interest expense related to amortization of convertible notes discount of $5.6 million and cash based interest of $0.9 million offset by the recovery of a $0.6 million interest accrual recorded into 2018 as part of the registration rights penalties that was cured and reversed in December 2018. The 2018 balances include $0.6 million for the accrual of the guaranteed twelve months of interest as part of the mandatory default clause of the debentures that was triggered following the event of default, $0.9 million of non-cash interest related to the amortization of the debt discount and debt issuance costs related to the June 2018 Notes, and $0.2 million is related to the cash basis coupon payments on the outstanding principal amount of the convertible notes.

Loss on Debt Extinguishment

The balance in 2019 represents the additional loss required to be recorded for note conversions below the stated conversion rate and associated with $8.4 million of principal conversions that were converted into common stock in fiscal 2019. No such conversions occurred in 2018.

Change in Fair Value of Derivative

The balance in 2019 represents the reduction in fair value of the derivative liabilities recorded with the March 2019 Notes payable. No such derivative existed in 2018. See also Note 8 to the Financial Statements.

Gain (Loss) Associated with Note default, Net

For 2018, the loss of $3.5 million relates to the accrual of penalties and liquidated damages associated with technical defaults under the registration rights agreements relating to our 8% senior secured convertible notes. Those penalties were settled in fiscal 2019 by the issuance of $0.9 million of additional convertible notes in December 2018 resulting in a gain of $2.6 million recorded in fiscal 2019. The gain was offset by $1.8 million of accrued potential default damages related to our senior secured notes in default as of August 31, 2019.

Net Loss

As a result of the explanations described above, the net loss for the fiscal year ended August 31, 2019, was $18.7 million, compared to a net loss of $16.8 million in the prior year representing an increase of $1.9 million or 11.3% and due to an improvement in the operating loss resulting from increased gross profit of $6.9 million offset by operating expense increases of $5.0 million and other expense increase of $3.8 million.

Results of Operations

Three Months Ended November 30, 2019 Compared to Three Months Ended November 30, 2018

The following table summarizes the condensed consolidated results of our operations for the three months ended November 30, 2019, and 2018, prior to the reclassification of discontinued operations. See “Unaudited Pro Forma Condensed Consolidated Financial Information” on page 7 for a pro forma statement of operations for the quarter ended November 30, 2019 reflecting the exclusion of the discontinued operations assigned to Vensure.

Revenue

Revenue for the three months ended November 30, 2019 increased by $5.3 million, or 50.8%, to $15.9 million compared to $10.5 million for the three months ended November 30, 2018.

Gross billings are a non-GAAP measurement and are the metric in which we earn our revenue. Gross billings for the three months ended November 30, 2019 were earned from billings to clients providing HR and payroll services and consist of gross payroll, employer taxes, administrative fees, and workers’ compensation insurance premiums. Gross billings for the three months ended November 31, 2019 increased by $39.8 million, or 56.1%, to $110.7 million compared to $70.9 million for the three months ended November 30, 2018.

The gross payroll costs of our WSEs accounted for 85.7% and 85.2% of our gross billings for the three months ended November 30, 2019 and 2018, respectively. The mark-up components of gross billings (consisting primarily of administrative fees, employer payroll taxes, and workers’ compensation insurance premiums) account for approximately 16.7% and 17.4% for the three months ended November 30, 2019 and 2018, respectively.

The revenue increase was primarily due to the increase in WSEs by an average of 3,000 to an average of 12,000 WSEs, compared to 9,000 WSEs in the three months ended November 30, 2018. Revenues are recognized ratably over the payroll period as WSEs perform services at client worksites. 

Cost of Revenues

Cost of revenues mainly includes the costs of employer-side taxes and workers’ compensation insurance coverage. Our cost of revenues for the three months ended November 30, 2019 increased by $5.5 million or 75.9% to $12.6 million, compared to $7.1 million for the three months ended November 30, 2018. The above increase was impacted by the reversal of approximately $1.0 million of California Federal Unemployment Tax during the three months ended November 30, 2018 and which did not recur in the three months ended November 30, 2019. Excluding this credit, the increase in the cost of revenues attributable to the increase in WSEs is $4.5 million, or 55%, of adjusted fiscal 2019 cost of revenues and is consistent with the increase in revenues and gross billings increases.

Gross Profit

Gross profit for the three months ended November 30, 2019 decreased by $0.1 million, or 2.1%, to $3.3 million, compared to $3.4 million for the three months ended November 30, 2018. The three months ended November 30, 2018 had two non-recurring events that resulted in $1.1 million of non-recurring year-over-year gross profit differences including the $1.0 million tax credit. Excluding the non-recurring items for fiscal 2019 described above, the three months ended November 30, 2019 gross profit increased $1.0 million, or 43.7%, from the recurring gross margin of the three months ended November 30, 2018 and represents increased gross profit from higher WSE levels and higher administrative fees.

Operating Expenses

The following table presents certain information related to our operating expenses.

Operating expenses increased $1.0 million or 20.9% to $5.7 million for the three months ended November 30, 2019 from $4.7 million for the three months ended November 30, 2018. The components of operating expenses changed as follows:

Salaries, Wages and Payroll Taxes

These consist of gross salaries, benefits, and payroll taxes associated with our executive management team and corporate employees as well as share based compensation. Salaries, wages and payroll taxes increased by $0.4 million, or 21.9%, from $1.9 million for the quarter ended November 30, 2018. The increase is due to the increase in corporate employees including the addition of our technical team hired to replace outside software developers at higher salaries.

Commissions

Commissions consist of commission payments made to third party brokers and inside sales personnel. Commissions increased by $0.2 million, or 40.0%, to $0.8 million, from $0.6 million compared to the three months ended November 30, 2018. Commissions are primarily associated with compensation to our sales force for sales as well as to our property and casualty agents. Commission expenses approximate 0.71% and 0.78% of our gross billings for the three months ended November 30, 2019 and 2018, respectively.

Professional Fees

Professional fees consist of legal fees, accounting and public company costs, board fees, and consulting fees. Professional fees for the three months ended November 30, 2019 increased by $0.2 million, or 34.6%, to $0.8 million, from $0.6 million for the three months ended November 30, 2018. The increase is due to increased legal fees related to our note default and product development litigation.

External Software Development

External software development consists of payments to third party contractors for licenses, software development, IT related spending for the development of our HRIS platform and mobile application. External software development for the three months ended November 30, 2019 increased by $0.1 million, or 13.9%, to $0.4 million from $0.3 million compared to the three months ended November 30, 2018. The increase was due to increased license spending in the three months ended November 30, 2019 and reduced contracted software development from the fiscal 2019 levels.

General and Administrative

General and administrative expenses consist of office rent and related overhead, marketing, insurance, penalties, business taxes, travel and entertainment, depreciation and amortization and other general business expenses. General and administrative expenses for the quarter ended November 30, 2019 increased by $0.1 million, or 6.5%, from $1.3 million for the quarter ended November 30, 2018. The increase is primarily due to higher depreciation and overhead offset by lower marketing spending.

Other Expenses

Other expenses represented in the table below decreased from $0.9 million for the quarter ended November 30, 2018 to $0.2 million for the quarter ended November 30, 2019:

Interest Expense

Interest expense consists of cash interest on interest bearing notes, financing charges for the excess of fair value over carrying amounts of notes issued during any reporting period, amortization of recorded discount and associated deferred financing costs, and acceleration of discounts and deferred financing costs due to early conversions on notes payable. Interest expense increased by $0.2 million to $1.2 million for the quarter ended November 30, 2019 from $0.9 million in the quarter ended November 30, 2018. The increase is due to the increased interest expense and financing costs associated with our March 2019 Notes offset by a reduction in the similar expenses for our June 2018 Notes and $0.3 million of default interest accrued on the remaining notes payable.

Change in Fair Value of Derivative

The balance for the three months ended November 30, 2019 represents the reduction in fair value of the derivative liabilities recorded with the March 2019 Notes payable. No such derivative existed during the three months ended November 30, 2018.

Net Loss

The net loss for the three months ended November 30, 2019 was $2.6 million compared to a net loss of $2.2 million for the three months ended November 30, 2018, representing an increase of $0.4 million or 13.8%. The increase in net loss was due to $1.1 million of additional operating losses consisting of $0.2 million lower gross margins resulting from a one time tax credit in the three months ended November 30, 2018 of $1.0 million offset by additional gross margin from revenue increases and a $0.9 million increase in the operating expenses. The increase in operating losses were reduced by $0.5 million decrease in other expenses.

Liquidity and Capital Resources

Going Concern

As of November 30, 2019, we had cash of $0.1 million and a working capital deficiency of $18.5 million. During the three months ended November 30, 2019, we used approximately $1.5 million of cash in our operations, consisting of a net loss of $2.6 million, reduced by net non-cash charges and gains of $0.3 million and working capital changes of $0.8 million. During the year ended August 31, 2019, we used approximately $2.1 million of cash in our operations, consisting of a net loss of $18.7 million, reduced by net non-cash charges and gains of $10.8 million and working capital changes of $6.0 million. We have incurred recurring losses resulted in an accumulated deficit of $48 million as of November 30, 2019. These conditions raise substantial doubt as to our ability to continue as a going concern within one year from issuance date of the financial statements.

Our ability to continue as a going concern is dependent upon generating profitable operations in the future and obtaining additional funds by way of public or private offering to meet our obligations and repay our liabilities when they become due. We have a recurring revenue business model that generated $12.4 million of gross profit for the year ended August 31, 2019 and $3.3 million for the quarter ended November 30, 2019.

Our plans and expectations for the next twelve months include raising additional capital to help fund expansion of our operations, including the continued development and support of our IT and HR platform and settling our outstanding debt as it comes due. We engaged an investment banking firm to assist us in (i) preparing information materials, (ii) advising us concerning the structure, price and conditions and (iii) organizing the marketing efforts with potential investors in connection with a financing transaction.

Historically, our principal source of financing has come through the sale of our common stock and issuance of convertible notes. We successfully completed an IPO on Nasdaq on June 29, 2017, raising a total of $12 million ($10.9 million net of costs). In June 2018, we completed a private placement of the June 2018 Notes to institutional investors raising $9 million of gross proceeds ($8.4 million net of costs). In March 2019, we completed a private placement of the March 2019 Notes to institutional investors raising $3.75 million ($3.3 million net of costs). As of November 30, 2019, all of the $6.8 million of principal was in default. Subsequent to November 30, 2019, approximately $2.7 million of the Senior Convertible Notes in default were exchanged for new convertible notes payable. In January 2020, an additional $1.2 million of the Senior Convertible Notes was repaid in cash and $2.1 million was converted into shares of common stock. In March 2020, the remaining $1.0 million of the Senior Convertible Notes were converted into shares of common stock.  The remaining $0.8 million of March 2019 Notes were amended to increase the amount of March 2019 Notes outstanding to $1.0 million and remove the antidilution provisions, and the remaining $1.8 million of the December 2019 Exchange Notes were amended to remove the antidilution provisions. As of March 24, 2020, there was $2.8 million of Senior Convertible Note principal outstanding, comprised of $997,000 of the March 2019 Notes and $1,828,550 of the December 2019 Exchange Notes.  Both series are convertible at $9.20 per share of common stock.

Subsequent to November 30, in January 2020, we assigned client contracts representing approximately 70% of our billable clients which comprised approximately 88% of our quarterly revenue as of November 30, 2019 in exchange for $9.6 million in cash and expect to receive an additional $9.5 million ratably over the four years following the transaction close, subject to certain closing conditions. We transferred approximately $1.6 million of working capital after closing the Vensure Asset Transfer and will transfer approximately $6 million of our annualized gross profit subject to certain adjustments.

Our management believes that our current cash position, along with our revenue growth and the financing from potential institutional investors will be sufficient to fund our operations for at least the next twelve months. If these sources do not provide the capital necessary to fund our operations during the next twelve months, we may need to curtail certain aspects of our operations or expansion activities, consider the sale of our assets, or consider other means of financing. We can give no assurance that we will be successful in implementing our business plan and obtaining financing on terms advantageous to us or that any such additional financing would be available to us as these conditions would raise substantial doubt as to our ability to continue as a going concern within one year from the issuance date of the financial statements. Additionally, the recent COVID-19 outbreak has caused additional uncertainty and management is still evaluating the full extent of the threat and its potential impact on our operations. These condensed consolidated financial statements do not include any adjustments from this uncertainty.

Cash Flows

The following table sets forth a summary of changes in cash flows for the twelve months ended August 31, 2019 and 2018:

As of August 31, 2019, we had cash and cash equivalents of $1.6 million and a working capital deficiency of $15.9 million. During the fiscal year ended August 31, 2019, we used approximately $2.1 million of cash in our operations, consisting of a net loss of $18.7 million, reduced by net non-cash charges of $10.8 million and working capital changes of $6.0 million, primarily in accounts payable and accrued payroll. During the year our workers’ compensation cash reserves increased by $4.4 million and our accrued workers’ compensation liabilities increased by $4.7 million. A significant portion of our operating cash spending for 2019 was attributable to approximately $4.0 million of expensed development and marketing costs associated with the development of our mobile application.

During the fiscal year ended August 31, 2018, we used approximately $9.5 million of cash in operations consisting of a net loss of $16.8 million, reduced by net non-cash charges of $5.1 million and working capital changes of $2.2 million, primarily in accrued payroll. During the year our workers’ compensation cash reserves increased by $1.5 million and our accrued workers’ compensation liabilities increased by $1.2 million. A significant portion of our operating cash spending for 2018 was attributable to approximately $4.7 million of expensed development and marketing costs associated with the development of our mobile application.

The cash used in investing activities was primarily due to the capitalization of the mobile application development costs performed by outside software consultants for both 2019 and 2018.

For the fiscal year ended August 31, 2018, cash from financing activities were primarily due to $4.75 million in proceeds ($3.3 million net of original issue discount and closing costs) from the issuance of the March 2019 Notes, exercise of warrants for common stock of $0.7 million, and $0.4 million repayment of the Senior Convertible Notes in cash.

Share Repurchase Plan

On July 9, 2019, our board of directors authorized the repurchase of up to 10 million shares of our outstanding shares of common stock as market conditions warrant over a period of 18 months. We have not implemented the share repurchase plan to date and have not repurchased any shares under the plan.

Critical Accounting Policies and Significant Judgment and Estimates

Our management’s discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates based on historical experience and make various assumptions, which management believes to be reasonable under the circumstances, which form the basis for judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The notes to our audited consolidated financial statements contain a summary of our significant accounting policies. We consider the following accounting policies critical to the understanding of the results of our operations:

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates include:

Revenue and Direct Cost Recognition

We provide an array of human resources and business solutions designed to help improve business performance.

We account for our revenues in accordance with Accounting Standards Codification (“ASC”) 605-45, Revenue Recognition, Principal Agent Considerations. Our EAS solutions revenue is primarily derived from our gross billings, which are based on (i) the payroll cost of our WSEs and (ii) a mark-up computed as a percentage of payroll costs for payroll taxes and workers’ compensation premiums.

Our revenues are primarily attributable to fees for providing staffing solutions, EAS and human capital management services. We recognize revenue when all of the following criteria are met: (i) persuasive evidence of an arrangement exists; (ii) the services have been rendered to the customer; (iii) the sales price is fixed or determinable, and (iv) collectability is reasonably assured. We enter into contracts with our clients for EAS services based on a stated rate and price in the contract. Our contracts generally have a term of twelve months, but are cancellable at any time by either party with thirty days’ notice.

Gross billings are invoiced to each client concurrently with each periodic payroll of our WSEs which coincides with the services provided and which is typically a fixed percentage of the payroll processed. Revenues, which exclude the payroll cost component of gross billings and therefore consist solely of markup are recognized ratably over the payroll period as WSEs perform their service at the client worksite. Revenues that have been recognized but not invoiced are included in unbilled accounts receivable on our consolidated balance sheets and were $6,878,000 and $6,193,000 for the years ended August 31, 2019 and August 31, 2018, respectively.

Consistent with our revenue recognition policy, our direct costs do not include the payroll cost of our WSEs. Our cost of revenue associated with our revenue generating activities are primarily comprised of all other costs related to our WSEs, such as the employer portion of payroll-related taxes, employee benefit plan premiums and workers’ compensation insurance costs.

We have evaluated our revenue recognition policies in conjunction with our future expected business which may be migrating to a staffing business model. For fiscal years 2018 and 2019, we determined that we did not have any revenues which should have been evaluated under a staffing business model. Such a staffing business model would have included the payroll costs in revenues with a corresponding increase to cost of revenues for payroll costs associated with staffing services.

We reviewed the costs associated with acquiring our customers under ASC 340-40 Other Assets and Deferred Costs and determined that no such costs should be capitalized. Costs relating to our customers are typically commissions paid as a percentage of some of our revenue components and are expensed as they are incurred because the terms of our contracts generally are cancellable by either party with a 45-day notice. These costs are recorded in commissions in our Consolidated Statement of Operations.

Fixed Assets

Fixed assets are recorded at cost, less accumulated depreciation and amortization. Expenditures for major additions and improvements are capitalized and minor replacements, maintenance, and repairs are charged to expense as incurred. When fixed assets are retired or otherwise disposed of, the cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is included in the results of operations for the respective period. Leasehold improvements are being amortized over the shorter of the useful life or the initial lease term.

Fixed assets are recorded at cost and are depreciated over the estimated useful lives of the related assets using the straight-line method. The estimated useful lives for purposes of computing depreciation for equipment is five years and for furniture and fixtures is five to seven years. The amortization of leasehold improvements and the depreciation of equipment and furniture is included in depreciation expense on the consolidated statements of operations.

Computer Software Development

Software development costs relate primarily to software coding, systems interfaces and testing of our proprietary employer information systems and are accounted for in accordance with ASC 350-40, Internal Use Software.

Internal software development costs are capitalized from the time the internal use software is considered probable of completion until the software is ready for use. Business analysis, system evaluation and software maintenance costs are expensed as incurred. The capitalized computer software development costs are reported under the section fixed assets, net in the consolidated balance sheets.

We determined that there were no material internal software development costs for the years ended August 31, 2018 or 2019. All capitalized software recorded was purchased from third party vendors. Capitalized software development costs are amortized using the straight-line method over the estimated useful life of the software, generally five years.

The amortization of these assets is included in depreciation expense on the consolidated statements of operations.

Impairment and Disposal of Long-Lived Assets

We periodically evaluate our long-lived assets for impairment in accordance with ASC 360-10, Property, Plant, and Equipment. ASC 360-10 requires that an impairment loss be recognized for assets to be disposed of or held-for-use when the carrying amount of an asset is deemed to not be recoverable. If events or circumstances were to indicate that any of our long-lived assets might be impaired, we would assess recoverability based on the estimated undiscounted future cash flows to be generated from the applicable asset. In addition, we may record an impairment loss to the extent that the carrying value of the asset exceeded the fair value of the asset. Fair value is generally determined using an estimate of discounted future net cash flows from operating activities or upon disposal of the asset. During the fiscal year ended August 31, 2019 we conducted an impairment analysis of our capitalized software and determined that there was no impairment loss required.

Workers’ Compensation

Everest Program

Up to July 2018, a portion of our workers’ compensation risk was covered by a retrospective rated policy, which calculates the final policy premium based on our loss experience during the term of the policy and the stipulated formula set forth in the policy. We fund the policy premium based on standard premium rates on a monthly basis and based on the gross payroll applicable to workers covered by the policy. During the policy term and thereafter, periodic adjustments may involve either a return of previously paid premiums or a payment of additional premiums by us or a combination of both. If our losses under that policy exceed the expected losses under that policy, then we could receive a demand for additional premium payments.

We utilize a third-party to estimate our loss development rate, which is based primarily upon the nature of WSEs’ job responsibilities, the location of WSEs, the historical frequency and severity of workers’ compensation claims, and an estimate of future cost trends. Each reporting period, changes in the assumptions resulting from changes in actual claims experience and other trends are incorporated into our workers’ compensation claims cost estimates. As of August 31, 2019, we classified $0.1 million in short term accrued workers’ compensation and $0.3 million in long term accrued workers’ compensation in our consolidated balance sheets.

Sunz Program

Starting in July 2018, our workers’ compensation program for our WSEs has been provided through an arrangement with United Wisconsin Insurance Company and administered by Sunz. Under this program, we have financial responsibility for the first $0.5 million of claims per occurrence. We provide and maintain a loss fund that will be used to pay claims and claim related expenses. The workers’ compensation insurance carrier established monthly funding requirements comprised of premium costs and funds to be set aside for payment of future claims (“claim loss funds”). The level of claim loss funds is primarily based upon anticipated WSE payroll levels and expected worker’s compensation loss rates, as determined by the insurance carrier. Monies funded into the program for incurred claims expected to be paid within one year are recorded as Deposit - workers’ compensation, a short-term asset, while the remainder of claim funds are included in deposits- workers’ compensation, a long-term asset in our consolidated balance sheets.

As of August 31, 2019, we had $1.9 million in “deposit – workers’ compensation”, classified as a short-term asset and $6.3 million, classified as a long-term asset.

Our estimate of incurred claim costs expected to be paid within one year is included in short-term liabilities, while our estimate of incurred claim costs expected to be paid beyond one year is included in long-term liabilities on our consolidated balance sheets. As of August 31, 2019, we had short term accrued workers’ compensation costs of $1.8 million and long term accrued workers’ compensation costs of $4.1 million.

Because we bear the financial responsibility for claims up to the level noted above, such claims, which are the primary component of our workers’ compensation costs, are recorded in the period incurred. Workers’ compensation insurance includes ongoing health care and indemnity coverage whereby claims are paid over numerous years following the date of injury. Accordingly, the accrual of related incurred costs in each reporting period includes estimates, which takes into account the ongoing development of claims and therefore requires a significant level of judgment. In estimating ultimate loss rates, we utilize historical loss experience, exposure data, and actuarial judgment, together with a range of inputs which are primarily based upon the WSE’s job responsibilities, their location, the historical frequency and severity of workers’ compensation claims, and an estimate of future cost trends. For each reporting period, changes in the actuarial assumptions resulting from changes in actual claims experience and other trends are incorporated into our workers’ compensation claims cost estimates. The estimated incurred claims are based upon: (i) the level of claims processed during each quarter; (ii) estimated completion rates based upon recent claim development patterns under the plan; and (iii) the number of participants in the plan.

Debt Issuance Costs and Debt Discount

Debt issuance costs and debt discounts are being amortized over the lives of the related financings on a basis that approximates the effective interest method. Costs and discounts are presented as a reduction of the related debt in the accompanying balance sheets. Portions attributable to notes converted into equity are accelerated to interest expense upon conversion.

Beneficial Conversion Features

The intrinsic value of a beneficial conversion feature (“BCF”) inherent to a convertible note payable, which is not bifurcated and accounted for separately from the convertible note payable and may not be settled in cash upon conversion, is treated as a discount to the convertible note payable. This discount is amortized over the period from the date of issuance to the stated maturity using the straight-line method which approximates the effective interest method. If the note payable is retired prior to the end of the contractual term, the unamortized discount is expensed in the period of retirement to interest expense. In general, the BCF is measured by comparing the effective conversion price, after considering the relative fair value of detachable instruments included in the financing transaction, if any, to the fair value of the common stock at the commitment date to be received upon conversion.

Derivative Financial Instruments

When a company issues debt that contains a conversion feature, it first evaluates whether the conversion feature meets the requirement to be treated as a derivative: a) the settlement amount is determined by one or more underlying, typically the price of our stock, b) the settlement amount is determined by one or more notional amounts or payments provisions or both, generally the number of shares upon conversion; c) no initial net investment, which typically excludes the amount borrowed; and d) net settlement provision, which in the case of convertible debt generally means the stock received upon conversion can be readily sold for cash. There are certain scope exceptions from derivative treatment, but these typically exclude conversion features that provide for a variable number of shares. When we issue warrants to purchase our common stock, we evaluate whether they meet the requirements to be treated as derivative. Generally, warrants would be treated as a derivative if the provisions of the warrants agreements create uncertainty as to a) the number of shares to be issued upon exercise, or b) whether shares may be issued upon exercise. If the conversion feature within convertible debt or warrants meet the requirements to be treated as a derivative, we estimate the fair value of the derivative liability using the lattice-based option valuation model upon the date of issuance. If the fair value of the derivative liability is higher than the face value of the convertible debt, the excess is immediately recognized as interest expense. Otherwise, the fair value of the derivative is recorded as a liability with an offsetting amount recorded as a debt discount, which offsets the carrying amount of the debt. The derivative liability is revalued at the end of each reporting period and any change in fair value is recorded as a change in fair value in the consolidated statement of operations. The debt discount is amortized through interest expense over the life of the debt. Derivative instrument liabilities and the host debt agreements are classified on the consolidated balance sheets as current or non-current based on whether settlement of the derivative instrument could be required within twelve months of the consolidated balance sheet date.

The accounting treatment of derivative financial instruments requires that we record the embedded conversion option and warrants at their fair values as of the inception date of the agreement and at fair value as of each subsequent balance sheet date. Any change in fair value is recorded as non-operating, non-cash income or expense for each reporting period at each balance sheet date. We reassess the classification of our derivative instruments at each balance sheet date. If the classification changes as a result of events during the period, the contract is reclassified as of the date of the event that caused the reclassification.

 Share-Based Compensation

At August 31, 2019 and 2018, we had one stock-based compensation plan under which we may issue both share and stock option awards. We account for this plan under the recognition and measurement principles of ASC 718, Compensation- Stock Compensation, which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the consolidated statements of operations on their fair values. Share grants are valued at the closing market price on the date of issuance which approximates fair value.

For option grants, the grant date fair value is determined using the Black-Scholes-Merton (“Black-Scholes”) pricing model. Our option grants are typically issued with vesting depending on a term of service. For all employee stock options granted, we recognize expense over the requisite service period over the employee’s requisite service period (generally the vesting period of the equity grant).

Our option pricing model requires the input of highly subjective assumptions, including the expected stock price volatility and expected term. The expected volatility is based on our historical volatility since our IPO. Any changes in these highly subjective assumptions significantly impact stock-based compensation expense.

Following the adoption of Accounting Standards Update ASU 2016-09, we elected to account for forfeitures as they occur. Any compensation cost previously recognized for an unvested award that is forfeited because of a failure to satisfy a service condition is reversed in the period of the forfeiture.

Off-Balance Sheet Arrangements

We did not have during the periods presented, and we do not currently have, any off-balance sheet arrangements.

Contingencies

Certain conditions may exist as of the date the financial statements are issued, which may result in a loss to us, but which will only be resolved when one or more future events occur or fail to occur. Our management, in consultation with our legal counsel, as appropriate, assesses such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against us or unasserted claims that may result in such proceedings, we, in consultation with legal counsel, evaluate the perceived merits of any legal proceedings or unasserted claims, as well as the perceived merits of the amount of relief sought or expected to be sought therein. If the assessment of a contingency indicates it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would be accrued in our financial statements. If the assessment indicates a potentially material loss contingency is not probable, but is reasonably possible, or is probable, but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss, if determinable and material, would be disclosed. Loss contingencies considered remote are generally not disclosed unless they involve guarantees, in which case the guarantees would be disclosed.

Emerging Growth Reporting Requirements

We are a public reporting company under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We are required to publicly report on an ongoing basis as an “emerging growth company” (as defined in the JOBS Act) under the reporting rules set forth under the Exchange Act. For so long as we remain an “emerging growth company”, we may take advantage of certain exemptions from various reporting requirements that are applicable to other Exchange Act reporting companies that are not “emerging growth companies”, including but not limited to:

We expect to take advantage of these reporting exemptions until we are no longer an emerging growth company. We would remain an “emerging growth company” for up to five years, although if the market value of our common stock that is held by non-affiliates exceeds $700 million as of any June 30 before that time, we would cease to be an “emerging growth company” as of the following December 31.

BUSINESS

Business Overview

Our current business, and the primary source of our revenues to date, has been under a traditional staffing services business model. Our initial market focus is to use this traditional approach, coupled with developed technology, to address an underserved market containing predominately lower wage employees with high turnover in light industrial, services, and food and hospitality. We provide human resources, employment compliance, insurance, payroll, and operational employment services solutions for our clients and shift work or gig opportunities for WSEs. As consideration for providing these services, we receive administrative or processing fees as a percentage of a client’s gross payroll, process and file payroll taxes and payroll tax returns, provide workers’ compensation insurance, and provide employee benefits. We have built a substantial business on a recurring revenue model since our inception in 2015. For the fiscal year ended August 31, 2019, we processed over $350 million of payroll billings. Our business has significantly grown for each year since inception and we expect to continue our high degree of growth. However, we have experienced losses to date as we have invested in both our technology solutions as well as the back-office operations required to service a large employee base under a traditional staffing model.

We are currently focused on clients in the restaurant and hospitality industries, traditionally market segments with high employee turnover and low pay rates. We believe that our focus on these industries will be better served by our Human Resources Information System (“HRIS”) technology platform which provides payroll and human resources tracking for our clients and will result in lower operating costs, improved customer experience and revenue growth acceleration. All of our clients enter into service agreements with us or our wholly-owned subsidiary, ReThink Human Capital Management, Inc.

Our revenues for the year ended August 31, 2019 primarily consist of administrative fees calculated as a percentage of gross payroll processed, payroll taxes due on WSEs billed to the client and remitted to the applicable taxation authority, and workers’ compensation premiums billed to the client for which we facilitate workers’ compensation coverage. Our costs of revenues consist of accrued and paid payroll taxes and our costs to provide the workers’ compensation coverage including premiums and loss reserves. A significant portion of our assets and liabilities is for our workers’ compensation reserves. Our cash balances related to these reserves are carried as assets and our estimates of projected workers’ compensation claims are carried as liabilities. Since 2019, we have provided a self-funded workers’ compensation policy for up to $500,000 and purchase reinsurance for claims in excess of $500,000. As of November 30, 2019, we have workers’ compensation related assets in excess of our projected workers’ compensation losses. We actively monitor and manage our clients and WSEs’ workers’ compensation claims which we believe allows us to provide a lower cost workers’ compensation option for our clients than they would otherwise be able to purchase on their own.

As of August 31, 2019, we had 246 clients with over 13,000 WSEs and processed payroll of over $350 million during our fiscal year ending August 31, 2019, an increase of nearly 60% for the year ending August 31, 2018. Of these WSEs, approximately 60% represent workers in the restaurant industry. In addition, as of August 31, 2019, there were an additional 12,000 inactive WSEs in our HRIS technology platform who are available for gig opportunities. In January 2020, in connection with an asset purchase agreement, we assigned client contracts representing approximately 70% of our billable clients which comprised approximately 88% of our quarterly revenue as of November 30, 2019 and certain operating assets for $19.1 million in cash of which $9.6 million was received at closing and $9.5 million is receivable over the next four years, commencing in April 2020, subject to certain conditions, including the performance of the assigned contracts. For the month ended January 31, 2020, we added nine clients, billed 56 clients in total (all related to the food service industry), billed approximately 3,900 total WSEs and retained approximately 30,000 unbilled WSEs in our HRIS platform for an annualized growth rate of over 100% for both clients and employees since November 30, 2019. We have also entered into an agreement with a large customer with multiple locations representing approximately 1,000 additional WSEs. These new WSEs were added to our HRIS platform through our new automated onboarding process which was placed into service in November 2019. We believe there is significant business interest in our HRIS platform and scheduling tools for multi-location client opportunities.

We believe that our customer value proposition is to provide the combination of overall net cost savings to the client as follows: