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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 


 

Form 10-Q

 


 

x      Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended March 31, 2015

 

o         Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from        to      

 

Commission file number 001-36348

 


 

PAYLOCITY HOLDING CORPORATION

(Exact name of registrant as specified in its charter)

 


 

Delaware

 

46-4066644

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

 

3850 N. Wilke Road

Arlington Heights, Illinois

 

60004

(Address of principal executive offices)

 

(Zip Code)

 

(847) 463-3200

(Registrant’s telephone number, including area code)

 


 

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

 

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

 

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

 

Large Accelerated Filer o

 

Accelerated Filer o

 

 

 

Non-Accelerated Filer x

 

Smaller Reporting Company o

(Do not check if a smaller reporting company)

 

 

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 50,624,561 shares of Common Stock, $0.001 par value per share, as of May 1, 2015.

 

 

 



Table of Contents

 

Paylocity Holding Corporation

Form 10-Q

For the Quarterly Period Ended March 31, 2015

 

TABLE OF CONTENTS

 

 

Page

PART I. FINANCIAL INFORMATION

 

 

ITEM 1. FINANCIAL STATEMENTS

 

 

 

Unaudited Consolidated Balance Sheets as of June 30, 2014 and March 31, 2015

1

 

 

Unaudited Consolidated Statements of Operations for the three and nine months ended March 31, 2014 and 2015

2

 

 

Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the nine months ended March 31, 2015

3

 

 

Unaudited Consolidated Statements of Cash Flows for the nine months ended March 31, 2014 and 2015

4

 

 

Notes to the Unaudited Consolidated Financial Statements

5

 

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

15

 

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

30

 

 

ITEM 4. CONTROLS AND PROCEDURES

30

 

 

PART II. OTHER INFORMATION

 

 

ITEM 1. LEGAL PROCEEDINGS

31

 

 

ITEM 1A. RISK FACTORS

31

 

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

46

 

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

46

 

 

ITEM 4. MINE SAFETY DISCLOSURES

46

 

 

ITEM 5. OTHER INFORMATION

46

 

 

ITEM 6. EXHIBITS

46

 

 

SIGNATURES

48

 

i



Table of Contents

 

PART I

FINANCIAL INFORMATION

 

Item 1.                                   Financial Statements

 

PAYLOCITY HOLDING CORPORATION

Unaudited Consolidated Balance Sheets

(in thousands, except per share data)

 

 

 

June 30,

 

March 31,

 

 

 

2014

 

2015

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

78,848

 

$

93,227

 

Accounts receivable, net

 

756

 

1,070

 

Prepaid expenses and other

 

2,694

 

4,844

 

Deferred income tax assets, net

 

706

 

684

 

 

 

 

 

 

 

Total current assets before funds held for clients

 

83,004

 

99,825

 

Funds held for clients

 

417,261

 

731,616

 

 

 

 

 

 

 

Total current assets

 

500,265

 

831,441

 

Long-term prepaid expenses

 

313

 

213

 

Capitalized software, net

 

5,093

 

6,206

 

Property and equipment, net

 

13,125

 

15,715

 

Intangible assets, net

 

6,320

 

5,750

 

Goodwill

 

3,035

 

3,035

 

 

 

 

 

 

 

Total assets

 

$

528,151

 

$

862,360

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

2,133

 

$

2,122

 

Taxes payable

 

5

 

 

Consideration related to acquisition

 

2,985

 

 

Accrued expenses

 

10,744

 

15,985

 

 

 

 

 

 

 

Total current liabilities before client fund obligations

 

15,867

 

18,107

 

Client fund obligations

 

417,261

 

731,616

 

 

 

 

 

 

 

Total current liabilities

 

433,128

 

749,723

 

Deferred rent

 

3,175

 

3,020

 

Deferred income tax liabilities, net

 

714

 

751

 

 

 

 

 

 

 

Total liabilities

 

$

437,017

 

$

753,494

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.001 par value, 5,000 authorized, no shares issued and outstanding at June 30, 2014 and March 31, 2015

 

 

 

Common stock, $0.001 par value, 155,000 shares authorized at June 30, and March 31, 2015, 49,564 shares issued and outstanding at June 30, 2014; and 50,616 shares issued and outstanding at March 31, 2015

 

50

 

51

 

Additional paid-in capital

 

125,255

 

152,529

 

Accumulated deficit

 

(34,171

)

(43,714

)

Total stockholders’ equity

 

$

91,134

 

$

108,866

 

Total liabilities and stockholders’ equity

 

$

528,151

 

$

862,360

 

 

See accompanying notes to unaudited consolidated financial statements.

 

1



Table of Contents

 

PAYLOCITY HOLDING CORPORATION

Unaudited Consolidated Statements of Operations

(in thousands, except per share data)

 

 

 

Three months ended
March 31,

 

Nine months ended
March 31,

 

 

 

2014

 

2015

 

2014

 

2015

 

Revenues:

 

 

 

 

 

 

 

 

 

Recurring fees

 

$

30,719

 

$

43,335

 

$

73,602

 

$

104,532

 

Interest income on funds held for clients

 

491

 

601

 

1,222

 

1,354

 

 

 

 

 

 

 

 

 

 

 

Total recurring revenues

 

31,210

 

43,936

 

74,824

 

105,886

 

Implementation services and other

 

2,556

 

3,336

 

5,216

 

6,808

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

33,766

 

47,272

 

80,040

 

112,694

 

Cost of revenues:

 

 

 

 

 

 

 

 

 

Recurring revenues

 

10,246

 

12,606

 

27,320

 

34,616

 

Implementation services and other

 

4,679

 

6,676

 

12,670

 

18,164

 

 

 

 

 

 

 

 

 

 

 

Total cost of revenues

 

14,925

 

19,282

 

39,990

 

52,780

 

Gross profit

 

18,841

 

27,990

 

40,050

 

59,914

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing

 

8,678

 

12,673

 

19,290

 

31,152

 

Research and development

 

2,443

 

5,053

 

6,746

 

14,351

 

General and administrative

 

5,587

 

8,559

 

14,726

 

24,068

 

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

16,708

 

26,285

 

40,762

 

69,571

 

Operating income (loss)

 

2,133

 

1,705

 

(712

)

(9,657

)

Other income (expense)

 

59

 

51

 

109

 

180

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before income taxes

 

2,192

 

1,756

 

(603

)

(9,477

)

Income tax benefit (expense)

 

(1,042

)

(4

)

197

 

(66

)

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

1,150

 

$

1,752

 

$

(406

)

$

(9,543

)

 

 

 

 

 

 

 

 

 

 

Net income (loss) attributable to common stockholders

 

$

430

 

$

1,752

 

$

(2,688

)

$

(9,543

)

 

 

 

 

 

 

 

 

 

 

Net income (loss) per share attributable to common stockholders:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.01

 

$

0.03

 

$

(0.08

)

$

(0.19

)

 

 

 

 

 

 

 

 

 

 

Diluted

 

$

0.01

 

$

0.03

 

$

(0.08

)

$

(0.19

)

 

 

 

 

 

 

 

 

 

 

Weighted-average shares used in computing net income (loss) per share attributable to common stockholders:

 

 

 

 

 

 

 

 

 

Basic

 

44,360

 

50,533

 

32,437

 

49,954

 

 

 

 

 

 

 

 

 

 

 

Diluted

 

44,870

 

52,203

 

32,437

 

49,954

 

 

See accompanying notes to unaudited consolidated financial statements.

 

2



Table of Contents

 

PAYLOCITY HOLDING CORPORATION

Unaudited Consolidated Statement of Changes in Stockholders’ Equity

(in thousands)

 

 

 

Stockholders’ Equity

 

 

 

Common Stock

 

Additional
Paid-in

 

Accumulated

 

Total
Stockholders’

 

 

 

Shares

 

Amount

 

Capital

 

Deficit

 

Equity

 

Balances at June 30, 2014

 

49,564

 

$

50

 

$

125,255

 

$

(34,171

)

$

91,134

 

Follow-on offering, net of issuance costs

 

750

 

1

 

18,366

 

 

18,367

 

Stock-based compensation expense

 

 

 

11,162

 

 

11,162

 

Stock options exercised

 

342

 

 

2,464

 

 

2,464

 

Issuance of common stock upon vesting of restricted stock units

 

112

 

 

 

 

 

Issuance of common stock under employee stock purchase plan

 

36

 

 

670

 

 

670

 

Net settlement for taxes and/or exercise price related to equity awards

 

(188

)

 

(5,388

)

 

(5,388

)

Net loss

 

 

 

 

(9,543

)

(9,543

)

Balances at March 31, 2015

 

50,616

 

$

51

 

$

152,529

 

$

(43,714

)

$

108,866

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

3



Table of Contents

 

PAYLOCITY HOLDING CORPORATION

Unaudited Consolidated Statements of Cash Flows

(in thousands)

 

 

 

Nine Months Ended March 31,

 

 

 

2014

 

2015

 

Cash flows provided by operating activities:

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(406

)

$

(9,543

)

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

Stock-based compensation

 

1,714

 

10,672

 

Depreciation and amortization

 

4,544

 

6,245

 

Deferred income tax (benefit) expense

 

(58

)

59

 

Provision for doubtful accounts

 

79

 

89

 

Loss on disposal of equipment

 

 

45

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(130

)

(403

)

Prepaid expenses

 

(1,629

)

(2,042

)

Trade accounts payable

 

947

 

359

 

Accrued expenses

 

3,016

 

4,720

 

Net cash provided by operating activities

 

8,077

 

10,201

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capitalized internally developed software costs

 

(2,919

)

(2,544

)

Purchases of property and equipment

 

(4,954

)

(6,331

)

Payments for acquisition

 

 

(2,985

)

Net change in funds held for clients

 

(185,818

)

(314,355

)

Net cash used in investing activities

 

(193,691

)

(326,215

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Net change in client funds obligation

 

185,818

 

314,355

 

Proceeds from follow-on offering, net of cash paid for issuance costs

 

 

18,367

 

Proceeds from initial public offering, net of issuance costs

 

82,709

 

 

Payments on initial public offering costs

 

 

(75

)

Proceeds from exercise of stock options

 

 

247

 

Proceeds from employee stock purchase plan

 

 

670

 

Taxes paid related to net share settlement of equity awards

 

 

(3,171

)

Principal payments on long-term debt

 

(1,563

)

 

Net cash provided by financing activities

 

266,964

 

330,393

 

Net Change in Cash and Cash Equivalents

 

81,350

 

14,379

 

Cash and Cash Equivalents—Beginning of Year

 

7,594

 

78,848

 

Cash and Cash Equivalents—End of Year

 

$

88,944

 

$

93,227

 

Supplemental Disclosure of Non-Cash Investing and Financing Activities

 

 

 

 

 

Build-out allowance received from landlord

 

$

580

 

$

253

 

Unpaid initial offering costs

 

$

678

 

 

Purchase of property and equipment, accrued but not paid

 

$

784

 

$

701

 

Supplemental disclosure of cash flow information

 

 

 

 

 

Cash paid for income taxes

 

$

202

 

$

28

 

Cash paid for interest

 

$

70

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

4



Table of Contents

 

PAYLOCITY HOLDING CORPORATION

Notes to the Unaudited Consolidated Financial Statements

(all amounts in thousands, except per share data)

 

(1) Organization and Description of Business

 

Paylocity Holding Corporation (the “Company”), through its wholly owned subsidiary, Paylocity Corporation, is a cloud-based provider of payroll and human capital management software solutions for medium-sized organizations. Services are provided in a Software-as-a-Service (“SaaS”) delivery model utilizing the Company’s cloud-based platform. Payroll services include collection, remittance and reporting of payroll liabilities to the appropriate federal, state and local authorities.

 

Follow-On Offering

 

In December 2014, the Company completed a follow-on offering in which it issued and sold 750 shares of common stock and existing shareholders sold 3,850 shares of common stock at a public offering price of $26.25 per share. The Company did not receive any proceeds from the sale of common stock by the existing shareholders. The Company received net proceeds of $18,367 after deducting underwriting discounts and commissions of $935 and other offering expenses of $385.

 

In January 2015, the underwriters for the Company’s follow-on offering exercised their option to purchase 360 additional shares from certain shareholders of the Company of the 690 available as described in the final prospectus filed with the SEC in December 2014.  The Company did not receive any proceeds from the sale of common stock by the existing shareholders.

 

(2) Summary of Significant Accounting Policies

 

(a) Consolidation and Use of Estimates

 

These unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”).  The unaudited consolidated financial statements include the accounts of the Company and its wholly owned subsidiary.  All intercompany accounts and transactions have been eliminated in consolidation.

 

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant items subject to such estimates and assumptions include the allowance for doubtful accounts, software developed for internal use, valuation and useful lives of long-lived assets, definite-lived intangibles, goodwill, stock-based compensation expense, valuation of net deferred income tax assets and the best estimate of selling price for revenue recognition purposes. Future events and their effects cannot be predicted with certainty; accordingly, accounting estimates require the exercise of judgment. Accounting estimates used in the preparation of these consolidated financial statements change as new events occur, as more experience is acquired, as additional information is obtained and as the operating environment changes.

 

(b) Interim Unaudited Consolidated Financial Information

 

The accompanying unaudited consolidated financial statements and notes have been prepared in accordance with GAAP and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, the interim financial information includes all adjustments of a normal recurring nature necessary for a fair presentation of the results of operations, financial position, changes in stockholders’ equity and cash flows. The results of operations for the three-month and nine-month periods ended March 31, 2015 are not necessarily indicative of the results for the full year or the results for any future periods. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes for the year ended June 30, 2014 included in the Company’s Annual Report on Form 10-K filed with the SEC on August 22, 2014.

 

(c) Income Taxes

 

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using

 

5



Table of Contents

 

enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rate is recognized in income in the period that includes the enactment date. Research and development tax credits are recognized using the flow-through method in the year the credit arises.

 

Valuation allowances are provided when necessary to reduce deferred tax assets to the amount more likely than not to be realized. Significant management judgment is required in determining the period in which the reversal of a valuation allowance should occur. The Company is required to consider all available evidence, both positive and negative, such as historical levels of income and future forecasts of taxable income among other items, in determining whether a full or partial release of its valuation allowance is required. The Company is also required to schedule future taxable income in accordance with accounting standards that address income taxes to assess the appropriateness of a valuation allowance, which further requires the exercise of significant management judgment.

 

The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. The Company records interest and penalties as an element of income tax expense.

 

(d) Stock-Based Compensation

 

The Company recognizes all employee stock-based compensation as a cost in the financial statements. Equity-classified awards, including those under the 2014 Employee Stock Purchase Plan (“ESPP”), are measured at the grant date fair value of the award and expense is recognized, net of assumed forfeitures, on a straight-line basis over the requisite service period for each separately vesting portion of the award. The Company estimates grant date fair value using the Black-Scholes option-pricing model and periodically updates the assumed forfeiture rates for actual experience over the option vesting term or the term of the ESPP purchase period.

 

(e) Recently Issued Accounting Standards

 

In May 2014, the Financial Accounting Standard Board “(FASB)” issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 supersedes a majority of existing revenue recognition guidance under US GAAP, and requires companies to recognize revenue when it transfers goods or services to a customer in an amount that reflects the consideration to which a company expects to be entitled. Companies may need to apply more judgment and estimation techniques or methods while recognizing revenue, which could result in additional disclosures to the financial statements. Topic 606 allows for either a “ retrospective” or “cumulative effect” transition method. The Company is currently evaluating which adoption method it will use. Early application is not permitted. The Company plans on adopting ASU 2014-09 beginning July 1, 2017, or in accordance with the FASB’s final guidance, and is currently assessing the potential effects of these changes to its consolidated financial statements.

 

From time to time, new accounting pronouncements are issued by the FASB or other standard setting bodies that are adopted by the Company as of the specified effective date. Unless otherwise discussed, the Company believes that the impact of recently issued standards that are not yet effective will not have a material impact on the Company’s consolidated financial statements upon adoption.

 

(3) Balance Sheet Information

 

The following tables provide details of selected consolidated balance sheet items:

 

Activity in the allowance for doubtful accounts was as follows:

 

Balance at June 30, 2014

 

$

126

 

Charged to expense

 

89

 

Write-offs

 

(57

)

Balance at March 31, 2015

 

$

158

 

 

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Table of Contents

 

Capitalized software and accumulated amortization were as follows:

 

 

 

June 30,

 

March 31,

 

 

 

2014

 

2015

 

Internally developed software

 

$

19,863

 

$

22,897

 

Accumulated amortization

 

(14,770

)

(16,691

)

Capitalized software, net

 

$

5,093

 

$

6,206

 

 

Amortization of capitalized internal-use software costs is included in Cost of Revenues-Recurring Revenues and amounted to $580 and $643 for the three months ended March 31, 2014 and 2015, respectively and $1,809 and $1,921 for the nine months ended March 31, 2014 and 2015, respectively.

 

Property and equipment consist of the following:

 

 

 

June 30,

 

March 31,

 

 

 

2014

 

2015

 

Office equipment

 

$

1,449

 

$

1,837

 

Computer equipment

 

7,726

 

11,947

 

Furniture and fixtures

 

2,317

 

2,350

 

Software

 

4,963

 

5,198

 

Leasehold improvements

 

6,059

 

6,727

 

Time clocks rented by clients

 

2,360

 

3,014

 

 

 

24,874

 

31,073

 

Accumulated depreciation

 

(11,749

)

(15,358

)

Property and equipment, net

 

$

13,125

 

$

15,715

 

 

Depreciation expense amounted to $1,040 and $1,252 for the three months ended March 31, 2014 and 2015, respectively and $2,735 and $3,754 for the nine months ended March 31, 2014 and 2015, respectively.

 

The components of accrued expenses were as follows:

 

 

 

June 30,

 

March 31,

 

 

 

2014

 

2015

 

Accrued payroll and personnel costs

 

$

8,781

 

$

13,968

 

Current portion of deferred rent

 

577

 

681

 

Other

 

1,386

 

1,336

 

Total accrued expenses

 

$

10,744

 

$

15,985

 

 

Intangible assets consist of the following:

 

 

 

June
30, 2014

 

March
31, 2015

 

Weighted
Average
Useful
Life

 

Client relationships

 

$

6,180

 

$

6,180

 

9 years

 

Non-solicitation agreement

 

220

 

220

 

3 years

 

Total

 

6,400

 

6,400

 

 

 

Accumulated amortization

 

(80

)

(650

)

 

 

Intangible assets, net

 

$

6,320

 

$

5,750

 

 

 

 

There was no amortization expense for acquired intangible assets for the three months or nine months ended March 31, 2014.  Amortization expense for acquired intangible assets was $190 for the three months and $570 for the nine months ended March 31, 2015.

 

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(4) Fair Value Measurement

 

The Company applies the fair value measurement and disclosure provisions of ASC 820, Fair Value Measurements and Disclosures, and ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A three-level fair value hierarchy prioritizes the inputs used to measure fair value. The hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:

 

· Level 1—Quoted prices in active markets for identical assets and liabilities.

 

· Level 2—Quoted prices in active markets for similar assets and liabilities, or other inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

 

· Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets and liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

 

Substantially all of the Company’s assets that are measured at fair value on a recurring basis are measured using Level 1 inputs. The Company considers the recorded value of its financial assets and liabilities, which consist primarily of cash and cash equivalents, accounts receivable, and accounts payable, to approximate the fair value of the respective assets and liabilities at June 30, 2014 and March 31, 2015 based upon the short-term nature of the assets and liabilities.

 

(5) Benefit Plans

 

(a) Equity Incentive Plan

 

The Company maintains a 2008 Equity Incentive Plan (the “2008 Plan”) and a 2014 Equity Incentive Plan (the “2014 Plan”) pursuant to which the Company has reserved 8,872 shares of its common stock for issuance to its employees, directors and non-employee third parties. The 2014 Plan serves as the successor to the 2008 plan and permits the granting of options to purchase common stock and other equity incentives at the discretion the compensation committee of the Company’s board of directors. No new awards have been or will be issued under the 2008 Plan since the effective date of the 2014 Plan.  Outstanding awards under the 2008 Plan continue to be subject to the terms and conditions of the 2008 Plan. The number of shares of common stock reserved for issuance under the 2014 Plan will increase automatically each calendar year, continuing through and including January 1, 2024 (“Evergreen provision”). The number of shares added each year will be equal to the lesser of (a) four and five tenths percent (4.5%) of the number of shares of common stock of the Company issued and outstanding on the immediately preceding December 31, or (b) an amount determined by the Company’s Board of Directors. On January 1, 2015, the number of common shares in reserve increased by 2,272 shares as determined by the Board of Directors.

 

Under the 2008 and 2014 Plans, the exercise price of each option is not less than the fair value of a share of common stock on the grant date. As of March 31, 2015, the Company had 8,872 shares allocated to the 2014 Plan, of which 4,481 shares were subject to outstanding options or awards.  Generally, the Company issues previously unissued shares for the exercise of stock options or vesting of awards; however, shares previously subject to 2014 Plan grants or awards that are forfeited or net settled at exercise or release may be reissued to satisfy future issuances.  The options typically vest ratably over a three or four year period and expire 10 years from the grant date.  Stock-based compensation expense for the fair value of the options at their grant date is recognized ratably over the vesting schedule for each separately vesting portion of the award.

 

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Stock-based compensation expense related to stock options and the vesting of restricted stock awards (“RSAs”) and restricted stock units (“RSUs”) is included in the following line items in the accompanying unaudited consolidated statements of operations:

 

 

 

Three months ended
March 31,

 

Nine months ended
March 31,

 

 

 

2014

 

2015

 

2014

 

2015

 

Cost of revenue — recurring

 

$

113

 

$

431

 

$

113

 

$

1,245

 

Cost of revenue — non-recurring

 

97

 

354

 

97

 

1,031

 

Sales and marketing

 

175

 

861

 

175

 

2,639

 

Research and development

 

139

 

717

 

139

 

2,101

 

General and administrative

 

841

 

1,172

 

1,190

 

3,656

 

Total stock-based compensation expense

 

$

1,365

 

$

3,535

 

$

1,714

 

$

10,672

 

 

In addition, the Company capitalized $76 and $180 of stock-based compensation expense in its internal use software in the three months ended March 31, 2014 and 2015, respectively.  The Company capitalized $76 and $490 of stock-based compensation expense in its internal use software in the nine months ended March 31, 2014 and 2015, respectively.

 

The Company values stock options using the Black-Scholes option-pricing model, which requires the input of subjective assumptions, including the risk-free rate, expected life, expected stock price volatility and dividend yield.  The risk-free interest rate assumption is based upon observed interest rates for U.S. Treasury securities consistent with the expected term of the Company’s employee stock options.  The expected life represents the period of time the stock options are expected to be outstanding and is based on the simplified method.  Under the simplified method, the expected life of an option is presumed to be the mid-point between the vesting date and the end of the contractual term.  The Company utilizes the simplified method due to the lack of sufficient historical exercise data to provide a reasonable basis upon which to otherwise estimate the expected life of the stock options.  The Company has a limited history of trading as a public company.  Therefore, the expected volatility is based on historical volatilities for publicly traded stock of comparable companies over the estimated expected life of the stock options.  The Company assumes no dividend yield because it does not expect to pay dividends in the near future, which is consistent with the Company’s history of not paying dividends.

 

The following table summarizes the assumptions used for estimating the fair value of stock options granted for the nine months ended March 31:

 

 

 

Period ended
March 31,

 

 

 

2014

 

2015

 

Valuation assumptions:

 

 

 

 

 

Expected dividend yield

 

0%

 

0

%

Expected volatility

 

29.5 – 44.5%

 

43.9

%

Expected term (years)

 

4.0 – 6.0

 

6.25

 

Risk-free interest rate

 

0.52 – 1.94%

 

1.91

%

 

The following table summarizes changes during the nine months ended March 31, 2015 in the number of shares available for grant under our equity incentive plans:

 

 

 

Number of
Shares

 

Available for grant at July 1, 2014

 

2,581

 

January 1, 2015 Evergreen provision increase

 

2,272

 

RSU’s granted

 

(397

)

Options granted

 

(322

)

Shares withheld in settlement of taxes and exercise price

 

188

 

Forfeitures

 

274

 

Shares removed

 

(205

)

Available for grant at March 31, 2015

 

4,391

 

 

Shares removed represents forfeitures of shares and shares withheld in settlement of taxes and payment of exercise prices related to grants made under the 2008 Plan. As noted above, no new awards will be issued under the 2008 Plan.

 

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The table below presents stock option activity during the nine months ended March 31, 2015:

 

 

 

Outstanding Options

 

 

 

Number of
shares

 

Weighted
average
exercise
price

 

Weighted
average
remaining
contractual
term

 

Aggregate
intrinsic
value

 

Balance at July 1, 2014

 

4,388

 

$

10.00

 

8.58

 

$

51,017

 

Options granted

 

322

 

24.80

 

 

 

 

 

Options forfeited

 

(257

)

13.27

 

 

 

 

 

Options exercised

 

(342

)

7.20

 

 

 

 

 

Balance at March 31, 2015

 

4,111

 

$

11.19

 

7.92

 

$

71,727

 

Options exercisable at March 31, 2015

 

1,722

 

$

7.31

 

7.05

 

$

36,718

 

Options vested and expected to vest at March 31, 2015

 

3,951

 

$

10.95

 

7.88

 

$

69,920

 

 

There were no options granted during the three-month period ended March 31, 2015. The weighted average grant date fair value of options granted during the three-month period ended March 31, 2014 was $7.62.  The weighted average grant date fair value of options granted during the nine-month periods ended March 31, 2014 and 2015 was $6.39 and $11.15, respectively. The total intrinsic value of options exercised during the three and nine month periods ended March 31, 2015 was $5,054 and $7,117, respectively.  There were no options exercised in the three-month or nine-month periods ended March 31, 2014. At March 31, 2015, there was $7,280 of total unrecognized stock-based compensation expense, net of estimated forfeitures, related to unvested stock option granted under the Plan. That expense is expected to be recognized over a weighted average period of 1.73 years.

 

The Company may also grant RSAs, RSUs and other equity incentive awards under the 2014 Plan with terms determined at the discretion of the compensation committee of the Company’s board of directors. The following table represents restricted stock unit activity during the nine months ended March 31, 2015:

 

 

 

Units

 

Weighted
average
grant date
fair value

 

RSU balance at July 1, 2014

 

102

 

$

17.00

 

RSUs granted

 

397

 

24.79

 

RSUs vested

 

(112

)

18.01

 

RSUs cancelled/forfeited

 

(17

)

24.80

 

RSU balance at March 31, 2015

 

370

 

$

24.71

 

RSUs expected to vest at March 31, 2015

 

338

 

$

24.70

 

 

At March 31, 2015, there was $5,503 of total unrecognized stock-based compensation expense, net of estimated forfeitures, related to unvested restricted stock awards granted under the Plan. That expense is expected to be recognized over a weighted average period of 2.07 years.

 

(b) Employee Stock Purchase Plan

 

The Company’s 2014 Employee Stock Purchase Plan (“ESPP”) was adopted by the Company’s board of directors and approved by the stockholders on February 6, 2014 and was effective upon completion of the Company’s initial public offering.

 

Under the Company’s ESPP, the Company can grant stock purchase rights to all eligible employees during specific offering periods not to exceed twenty-seven months.  Each offering period will begin on the first trading day on or after May 16 and November 16 of each year, effective after the first offering period after the Company’s initial public offering (“IPO”).  Shares are purchased through employees’ payroll deductions, up to a maximum of 10% of employees’ compensation for each purchase period, at a purchase price equal to 85% of the lesser of the fair market value of the Company’s common stock at the first trading day of the applicable offering period or the purchase date.  Participants may purchase up to $25 worth of common stock or 2 shares of common stock in any one year.  The ESPP is considered compensatory and results in compensation expense.

 

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As of March 31, 2015, a total of 1,100 shares of common stock have been reserved for future issuance under the ESPP. The number of shares of common stock reserved for issuance under the ESPP will increase automatically each calendar year, continuing through and including January 1, 2024.  The number of shares added each year will be equal to the lesser of (a) 400, (b) seventy-five one hundredths percent (0.75%) of the number of shares of common stock of the Company issued and outstanding on the immediately preceding December 31, or (c) an amount determined by the Company’s board of directors. On January 1, 2015, the number of common shares in reserve increased by 136 shares as determined by the Company’s board of directors.

 

The Company commenced its initial ESPP four-month offering period on July 16, 2014, issued 36 shares at the completion of that four-month offering period and commenced a six-month offering period on November 16, 2014. The Company recorded compensation expense attributable to the ESPP of $176 and $460 for the three-month and nine-month periods ended March 31, 2015, respectively, which is included in the summary of stock-based compensation expense above. The grant date fair value of the ESPP offering periods was estimated using the following weighted average assumptions:

 

 

 

Period ended
March 31,

 

 

 

2014

 

2015

 

Valuation assumptions:

 

 

 

 

 

Expected dividend yield

 

N/A

 

0%

 

Expected volatility

 

N/A

 

35.5 – 41.7%

 

Expected term (years)

 

N/A

 

0.3 – 0.5

 

Risk-free interest rate

 

N/A

 

0.04 – 0.06%

 

 

(c) 401(k) Plan

 

The Company maintains a 401(k) plan with a safe harbor matching provision that covers all eligible employees. The Company matches 50% of the employees’ contributions up to 6% of their gross pay. Contributions were $316 and $474 for the three-month periods ended March 31, 2014 and 2015, respectively and were $793 and $1,183 for the nine-month periods ended March 31, 2014 and 2015, respectively.

 

(6) Commitments and Contingencies

 

Reseller Agreements

 

The Company had agreements with two organizations that sell the Company’s offerings and services in defined areas of the country, one of which was terminated in May 2014. The Company exercised its right to terminate the first reseller agreement and acquired substantially all of the assets of the reseller in May 2014 as described in Note 5 of the audited consolidated financial statements and related notes for the year ended June 30, 2014 included in the Company’s Annual Report on Form 10-K filed with the SEC on August 22, 2014.  The Company paid the first reseller $898 and $2,249 during the three and nine months ended March 31, 2014, respectively, under the terminated reseller agreement. The Company paid the first reseller $400 and $2,985 during the three and nine months ended March 31, 2015, respectively, under the terms of the asset purchase agreement signed in May 2014.

 

The initial term of the second reseller agreement commenced in June 2009 and is set to expire in June 2016 unless renewed or terminated.  The second reseller agreement originally provided that the reseller may terminate the agreement by providing nine months’ prior notice or upon an initial public offering by the Company. The Company amended this agreement in December of 2013 to provide that the reseller may not give a nine-month termination notice until after the earlier of (i) six months following the closing of an initial public offering by the Company or (ii) December 31, 2014. In addition, the Company, but not the reseller, has the right to terminate the agreement at any time. The Company paid the second reseller $557 and $928 during the three-month periods ended March 31, 2014 and 2015, respectively and $1,520 and $2,258 during the nine-month periods ended March 31, 2014 and 2015, respectively.

 

In April 2015, the Company exercised its right to terminate the second reseller agreement as part of its sales channel simplification strategy and closed on the purchase of substantially all of the reseller’s assets for an estimated purchase price of $9,529. The Company paid $8,994 at closing, will pay an estimated $235 in August 2015 and will pay an estimated $300 in January 2016 subject to any qualifying indemnification claims in accordance with the asset purchase agreement.  This acquisition will be accounted for as a business combination in accordance with ASC 805, Business Combinations and the Company will finalize the allocation of the purchase price to the assets acquired as the Company receives additional information regarding the acquisition, including a final valuation of the assets purchased.

 

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(7) Earnings Per Share

 

For the periods presented prior to the Company’s IPO, basic and diluted net loss per common share is presented in conformity with the two-class method required for participating securities. Concurrently with the closing of the Company’s IPO on March 24, 2014, all shares of outstanding Redeemable Convertible Preferred Stock automatically converted into 11,933 shares of the Company’s common stock.  Following the date of the IPO, the two-class method was no longer required as the Company has one class of securities issued and outstanding.

 

Prior to the conversion of the Redeemable Convertible Preferred Stock, holders of Series A and Series B Redeemable Convertible Preferred Stock each were entitled to liquidation preferences payable prior and in preference to any dividends on any shares of the Company’s common stock.  In the event a dividend was paid on common stock, the holders of Redeemable Convertible Preferred Stock were entitled to a proportionate share of any such dividend as if they were holders of common stock (on an as-if converted basis). The holders of the Company’s Redeemable Convertible Preferred Stock did not have a contractual obligation to share in the losses of the Company. The Company considered its Redeemable Convertible Preferred Stock to be participating securities and, in accordance with the two-class method, earnings allocated to Redeemable Convertible Preferred Stock and the related number of outstanding shares of Redeemable Convertible Preferred Stock have been excluded from the computation of basic and diluted net loss per common share.

 

Under the two-class method, net loss attributable to common stockholders is determined by allocating undistributed earnings, calculated as net loss less current period Redeemable Convertible Preferred Stock cumulative dividends, between common stock and Redeemable Convertible Preferred Stock. In computing diluted net loss attributable to common stockholders, undistributed earnings are re-allocated to reflect the potential impact of dilutive securities.

 

Basic net loss per common share is computed using the weighted-average number of common shares outstanding during the period. Since the Series A and Series B Redeemable Convertible Preferred Stock were entitled to participate should any common stock dividends have been declared but were not obligated to participate in any losses generated by the Company, basic net income per share is computed using the weighted-average number of common shares outstanding during the period plus the Series A and Series B Redeemable Convertible Preferred Stock on a weighted-average basis.

 

Diluted net loss per share is computed using the weighted-average number of common shares outstanding during the period and, if dilutive, potential common shares outstanding during the period. Since the Series A and Series B Redeemable Convertible Preferred Stock were entitled to participate should any common stock dividends be declared but were not obligated to participate in any losses generated by the Company, diluted net income per share is computed using the weighted-average number of common shares plus the Series A and Series B Redeemable Convertible Preferred Stock on a weighted-average basis and, if dilutive, potential common shares outstanding during the period. The Company’s potential common shares consist of the incremental common shares issuable upon the exercise of stock options. The dilutive effect of outstanding stock options and unvested RSU’s is reflected in diluted earnings per share by application of the treasury stock method.

 

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The following table presents the calculation of basic and diluted net income (loss) per share:

 

 

 

Three months ended
March 31,

 

Nine months ended
March 31,

 

 

 

2014

 

2015

 

2014

 

2015

 

Basic net income (loss) per share:

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

1,150

 

$

1,752

 

$

(406

)

$

(9,543

)

Less: Preferred dividend rights attributable to participating securities

 

(720

)

 

(2,282

)

 

Net income (loss) attributable to common stockholders

 

$

430

 

$

1,752

 

$

(2,688

)

$

(9,543

)

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted-average shares used in computing net income (loss) per share attributable to common stockholders:

 

 

 

 

 

 

 

 

 

Basic (in thousands)

 

44,360

 

50,533

 

32,437

 

49,954

 

Weighted-average effect of potentially dilutive shares:

 

 

 

 

 

 

 

 

 

Employee stock options, restricted stock units and employee stock purchase plan shares (in thousands)

 

510

 

1,670

 

 

 

Diluted (in thousands)

 

44,870

 

52,203

 

32,437

 

49,954

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) per share attributable to common stockholders:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.01

 

$

0.03

 

$

(0.08

)

$

(0.19

)

Diluted

 

$

0.01

 

$

0.03

 

$

(0.08

)

$

(0.19

)

 

The following table summarizes the outstanding employee stock options, restricted stock units and shares purchasable via the employee stock purchase plan as of the balance sheet date that were excluded from the diluted per share calculation for the periods presented because to include them would have been anti-dilutive:

 

 

 

Three months ended
March 31,

 

Nine months ended
March 31,

 

 

 

2014

 

2015

 

2014

 

2015

 

 

 

 

 

 

 

 

 

 

 

Restricted stock units

 

 

6

 

102

 

370

 

Employee stock purchase plan shares

 

 

 

 

36

 

Employee stock options

 

 

328

 

4,441

 

4,111

 

Total

 

 

334

 

4,543

 

4,517

 

 

(8) Income Taxes

 

The Company’s quarterly provision for income taxes is based on an estimated annual income tax rate.  The Company’s quarterly provision for income taxes also includes the tax impact of certain unusual or infrequently occurring items, if any, including changes in judgment about valuation allowances and effects of changes in tax laws or rates, in the interim period in which they occur.

 

The Company recorded income tax benefit (expense) of $(1,042) and $(4) for the three-month periods ended March 31, 2014 and 2015, respectively and $197 and $(66) for the nine-month periods ended March 31, 2014 and 2015, respectively.  The Company’s effective rate for the three and nine months ended March 31, 2014 differed from statutory rates primarily due to federal and state research and development credits and expenses not deductible for income tax reporting purposes.  The Company’s effective tax rate for the three and nine months ended March 31, 2015 differ from statutory rates primarily due to the existence of a valuation allowance recorded against the preponderance of the net deferred tax assets.

 

The Company reviews the likelihood that it will realize the benefit of its deferred tax assets and, therefore, the need for a valuation allowance on a quarterly basis. It established a valuation allowance on all of its net deferred tax assets except for deferred tax liabilities associated with indefinite-lived intangible assets during fiscal 2014, given that the company determined that it was more

 

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likely than not that the Company would not recognize the benefits of its net operating loss carryforwards prior to their expiration.  As of March 31, 2015, the Company had no unrecognized tax benefits.

 

On September 13, 2013, the IRS issued final regulations and re-proposed regulations that provide guidance with respect to (i) the treatment of materials and supplies, (ii) capitalization of amounts paid to acquire or produce tangible property, (iii) the determination of whether an expenditure with respect to tangible property is a deductible repair or a capital expenditure, and (iv) dispositions of MACRS property.  The final regulations are effective for the fiscal year ending June 30, 2015 and have not had a material impact on the Company’s results of operations, financial position, or cash flows.

 

(9) Related Party Transactions

 

The Company has a Memorandum of Understanding (“Memorandum”) and a Non-Competition and Non-Solicitation Agreement (“Non-Compete”) with its Chairman Steve Sarowitz and Blue Marble, a separate legal entity owned by Mr. Sarowitz.

 

The Memorandum established the ongoing market based terms between the Company and Blue Marble for services provided to or on behalf of each other.  In addition, Paylocity obtained a right of first refusal on the sale of Blue Marble, an option exercisable starting three years from the date of the Memorandum to purchase Blue Marble, and the right of first refusal to purchase any acquisition target of Blue Marble outside the United States of America, all at fair market value.  The Memorandum requires Blue Marble to obtain written consent from Paylocity should Blue Marble intend to acquire an entity that provides or partners with other service providers to provide products and services to clients located in the United States of America.  The Company provides no management guidance to the entity, has no equity interest in the entity, no obligation or intention to fund any of the entity’s operational shortfalls, and no right to any operational surpluses generated by the entity.

 

The Non-Compete agreement outlines the permissible activities and ongoing responsibilities of Mr. Sarowitz and Blue Marble including an obligation not to compete with services offered by Paylocity and an obligation not to solicit employees of Paylocity.

 

(10) Subsequent Events

 

In April 2015, the Company exercised its right to terminate its remaining reseller agreement. See Note 6 for further details.

 

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

 

The statements included herein that are not based solely on historical facts are “forward looking statements.” Such forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties. Our actual results could differ materially from those anticipated by us in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this prospectus, particularly under the section titled “Risk Factors.”

 

Overview

 

We are a cloud-based provider of payroll and human capital management (or “HCM”) software solutions for medium-sized organizations, which we define as those having between 20 and 1,000 employees. Our comprehensive and easy-to-use solutions enable our clients to manage their workforces more effectively. Our solutions help drive strategic human capital decision-making and improve employee engagement by enhancing the HR, payroll and finance capabilities of our clients.

 

Effective management of human capital is a core function in all organizations and requires a significant commitment of resources. Medium-sized organizations operating without the infrastructure, expertise or personnel of larger enterprises are uniquely pressured to manage their human capital effectively.

 

Our solutions were specifically designed to meet the payroll and HCM needs of medium-sized organizations. We designed our cloud-based platform to provide a unified suite of applications using a multi-tenant architecture. Our solutions are highly flexible and configurable and feature a modern, intuitive user experience. Our platform offers automated data integration with over 200 related third-party systems, such as 401(k), benefits and insurance provider systems.

 

Our Paylocity Web Pay product is our core payroll solution and was the first of our current offerings introduced into the market. We believe payroll is the most critical system of record for medium-sized organizations and an essential gateway to other HCM functionality. We have invested in, and we intend to continue to invest in, research and development to expand our product offerings and advance our platform.

 

We believe there is a significant opportunity to grow our business by increasing our number of clients and we intend to invest in our business to achieve this purpose. We market and sell our solutions primarily through our direct sales force. We have increased our sales and marketing expenses as we have added sales representatives and related sales and marketing personnel. We intend to continue to grow our sales and marketing organization across new and existing geographic territories. In addition to growing our number of clients, we intend to grow our revenue over the long term by increasing the number and quality of products that clients purchase from us. To do so, we must continue to enhance and grow the number of solutions we offer to advance our platform.

 

We believe that delivering a positive service experience is an essential element of our ability to sell our solutions and retain our clients. We seek to develop deep relationships with our clients through our unified service model, which has been designed to meet the service needs of medium-sized organizations. We expect to continue to invest in and grow our implementation and client service organization as our client base grows.

 

We believe we have the opportunity to continue to grow our business over the long term, and to do so we have invested, and intend to continue to invest, across our entire organization. These investments include increasing the number of personnel across all functional areas, along with improving our solutions and infrastructure to support our growth. The timing and amount of these investments vary based on the rate at which we add new clients, add new personnel and scale our application development and other activities. Many of these investments will occur in advance of experiencing any direct benefit from them which will make it difficult to determine if we are effectively allocating our resources. We expect these investments to increase our costs on an absolute basis, but as we grow our number of clients and our related revenues, we anticipate that we will gain economies of scale and increased operating leverage. As a result, we expect our gross and operating margins will improve over the long term.

 

As our business has grown, we have become increasingly subject to the risks arising from adverse changes in domestic and global economic conditions. If general economic conditions were to deteriorate further, including declines in private sector employment growth and business productivity, increases in the unemployment rate and changes in interest rates, we may experience delays in our sales cycles, increased pressure from prospective customers to offer discounts and increased pressure from existing customers to renew expiring recurring revenue agreements for lower amounts. Our interest income on funds held for clients continues to be negatively impacted by historically low interest rates.

 

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Our operating subsidiary Paylocity Corporation was incorporated in July 1997 as an Illinois corporation. In November 2013, we formed Paylocity Holding Corporation, a Delaware corporation, of which Paylocity Corporation is now a wholly-owned subsidiary. Paylocity Holding Corporation had no operations prior to the restructuring. All of our business operations have historically been, and are currently, conducted by Paylocity Corporation, and the operating financial results presented herein are entirely attributable to the results of its operations.

 

Key Metrics

 

We regularly review a number of metrics, including the following key metrics, to evaluate our business, measure our performance, identify trends affecting our business, formulate financial projections and make strategic decisions.

 

Recurring Revenue Growth

 

Our recurring revenue model and high annual revenue retention rates provide significant visibility into our future operating results and cash flow from operations. This visibility enables us to better manage and invest in our business. Recurring revenue, which is comprised of recurring fees and interest income on funds held for clients, increased from $74.8 million for the nine months ended March 31, 2014 to $105.9 million for the nine months ended March 31, 2015, representing a 42% year-over-year increase. Recurring revenue represented 94% of total revenue during the nine months ended March 31, 2014 and 2015. Recurring revenue increased from $31.2 million for the three months ended March 31, 2014 to $43.9 million for the three months ended March 31, 2015, representing a 41% year-over-year increase. Recurring revenue represented 92% and 93% of total revenue for the three month periods ended March 31, 2014 and 2015, respectively.

 

Recurring Fees from New Clients

 

We calculate recurring fees from new clients as the percentage of year-to-date recurring fees from all clients on our solutions which had not been on or used any of our solutions for a full year as of the start of the current fiscal year. We believe recurring fees from new clients is an important metric to measure the expansion of our existing client base as well as the growth in our client base. Our recurring fees from new clients was 41% and 42% for the nine-month periods ended March 31, 2014 and 2015, respectively.

 

Adjusted Gross Profit, Adjusted Recurring Gross Profit and Adjusted EBITDA

 

We disclose Adjusted Gross Profit, Adjusted Recurring Gross Profit and Adjusted EBITDA because we use them to evaluate our performance, and we believe Adjusted Gross Profit, Adjusted Recurring Gross Profit and Adjusted EBITDA assist in the comparison of our performance across reporting periods by excluding certain items that we do not believe are indicative of our core operating performance. We believe these metrics are used in the financial community, and we present it to enhance investors’ understanding of our operating performance and cash flows.

 

Adjusted Gross Profit, Adjusted Recurring Gross Profit and Adjusted EBITDA are not measurements of financial performance under generally accepted accounting principles in the United States, or GAAP, and you should not consider Adjusted Gross Profit as an alternative to gross profit, Adjusted Recurring Gross Profit as an alternative to total recurring revenues, or Adjusted EBITDA as an alternative to net loss or cash provided by operating activities, in each case as determined in accordance with GAAP. In addition, our definition of Adjusted Gross Profit, Adjusted Recurring Gross Profit and Adjusted EBITDA may be different than the definition utilized for similarly-titled measures used by other companies.

 

We define Adjusted Gross Profit as gross profit before amortization of capitalized internal-use software, stock-based compensation expenses, and employer payroll tax related to stock releases and option exercises, if any. We define Adjusted Recurring Gross Profit as total recurring revenues after cost of recurring revenues and before amortization of capitalized internal-use software, stock-based compensation expenses, and employer payroll tax related to stock releases and option exercises, if any. We define Adjusted EBITDA as net loss before interest expense (income), income tax expense (benefit), depreciation and amortization, stock-based compensation expenses, and employer payroll tax related to stock releases and option exercises, if any. The table below sets forth our Adjusted Gross Profit, Adjusted Recurring Gross Profit and Adjusted EBITDA for the periods presented.

 

16



Table of Contents

 

 

 

Three months ended 
March 31,

 

Nine months ended 
March 31,

 

 

 

2014

 

2015

 

2014

 

2015

 

 

 

(in thousands)

 

(in thousands)

 

Adjusted Gross Profit

 

$

19,631

 

$

29,435

 

$

42,069

 

$

64,130

 

Adjusted Recurring Gross Profit

 

$

21,657

 

$

32,415

 

$

49,426

 

$

74,447

 

Adjusted EBITDA

 

$

5,199

 

$

7,526

 

$

5,722

 

$

7,651

 

 

 

 

Three months ended 
March 31,

 

Nine months ended 
March 31,

 

 

 

2014

 

2015

 

2014

 

2015

 

 

 

(in thousands)

 

(in thousands)

 

Reconciliation from Gross Profit to Adjusted Gross Profit

 

 

 

 

 

 

 

 

 

Gross profit

 

$

18,841

 

$

27,990

 

$

40,050

 

$

59,914

 

Amortization of capitalized research and development costs

 

580

 

643

 

1,809

 

1,921

 

Stock-based compensation expense and employer payroll taxes related to stock releases and option exercises

 

210

 

802

 

210

 

2,295

 

Adjusted Gross Profit

 

$

19,631

 

$

29,435

 

$

42,069

 

$

64,130

 

 

 

 

Three months ended 
March 31,

 

Nine months ended 
March 31,

 

 

 

2014

 

2015

 

2014

 

2015

 

 

 

(in thousands)

 

(in thousands)

 

Reconciliation from Total Recurring Revenues to Adjusted Recurring Gross Profit

 

 

 

 

 

 

 

 

 

Total recurring revenues

 

$

31,210

 

$

43,936

 

$

74,824

 

$

105,886

 

Cost of recurring revenues

 

10,246

 

12,606

 

27,320

 

34,616

 

Recurring gross profit

 

20,964

 

31,330

 

47,504

 

71,270

 

Amortization of capitalized research and development costs

 

580

 

643

 

1,809

 

1,921

 

Stock-based compensation expense and employer payroll taxes related to stock releases and option exercises

 

113

 

442

 

113

 

1,256

 

Adjusted Recurring Gross Profit

 

$

21,657

 

$

32,415

 

$

49,426

 

$

74,447

 

 

 

 

Three months ended 
March 31,

 

Nine months ended 
March 31,

 

 

 

2014

 

2015

 

2014

 

2015

 

 

 

(in thousands)

 

(in thousands)

 

Reconciliation from Net Income (Loss) to Adjusted EBITDA

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

1,150

 

$

1,752

 

$

(406

)

$

(9,543

)

Interest expense

 

22

 

 

67

 

 

Income tax (benefit) expense

 

1,042

 

4

 

(197

)

66

 

Depreciation and amortization

 

1,620

 

2,085

 

4,544

 

6,245

 

EBITDA

 

3,834

 

3,841

 

4,008

 

(3,232

)

Stock-based compensation expense and employer payroll taxes related to stock releases and option exercises

 

1,365

 

3,685

 

1,714

 

10,883

 

Adjusted EBITDA

 

$

5,199

 

$

7,526

 

$

5,722

 

$

7,651

 

 

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Table of Contents

 

Basis of Presentation

 

Revenues

 

Recurring Fees

 

We derive the majority of our revenues from recurring fees attributable to our cloud-based payroll and HCM software solutions. Recurring fees for each client generally include a base fee in addition to a fee based on the number of client employees and the number of products a client uses. We also charge fees attributable to our preparation of W-2 documents and annual required filings on behalf of our clients. Over the past three years, our clients have consistently had on average over 100 employees. We derive revenue from a client based on the solutions purchased by the client, the number of client employees as well as the amount, type and timing of services provided in respect of those client employees. As such, the number of client employees on our system is not a good indicator of our financial results in any period. Recurring fees attributable to our cloud-based payroll and HCM solutions accounted for 91% and 92% of our total revenues during each of the three-month periods ended March 31, 2014 and 2015, respectively, and 92% and 93% of our total revenues during each of the nine-month periods ended March 31, 2014 and 2015, respectively.

 

Our agreements with clients do not have a specified term and are generally cancellable by the client on 60 days’ or less notice. Our agreements do not include general rights of return and do not provide clients with the right to take possession of the software supporting the services being provided. We recognize recurring fees in the period in which services are provided and when collection of fees is reasonably assured and the amount of fees is fixed or determinable.

 

Interest Income on Funds Held for Clients

 

We earn interest income on funds held for clients. We collect funds for employee payroll payments and related taxes in advance of remittance to employees and taxing authorities. Prior to remittance to employees and taxing authorities, we earn interest on these funds through financial institutions with which we have automated clearing house, or ACH, arrangements.

 

Implementation Services and Other

 

Implementation services and other revenues primarily consist of implementation fees charged to new clients for professional services provided to implement and configure our payroll and HCM solutions. Implementations of our payroll solutions typically require only three to six weeks at which point the new client’s payroll is first run using our solution, our implementation services are deemed completed, and we recognize the related revenue. We implement additional HCM products as requested by clients and leverage the data within our payroll solution to accelerate our implementation processes. Implementation services and other revenues may fluctuate significantly from quarter to quarter based on the number of new clients, pricing and the product utilization.

 

Cost of Revenues

 

Cost of Recurring Revenues

 

Costs of recurring revenues are generally expensed as incurred and include costs to provide our payroll and other HCM solutions primarily consisting of employee-related expenses (including wages, stock-based compensation expense, bonuses and benefits) and costs relating to the provision of ongoing client support, payroll tax filing, distribution of printed checks and other materials. These costs also include third-party reseller costs, delivery costs, computing costs and amortization of capitalized software costs, as well as bank fees associated with client fund transfers. We expect to realize cost efficiencies over the long term as our business scales, resulting in improved operating leverage and increased margins.

 

We capitalize a portion of our costs for software developed for internal use, which are then all amortized as a cost of recurring revenues. We amortized $0.6 million during both of the three months ended March 31, 2014 and 2015, and $1.8 million and $1.9 million during each of the nine months ended March 31, 2014 and 2015, respectively.

 

Cost of Implementation Services and Other

 

Cost of implementation services and other consists almost entirely of employee-related expenses involved in the implementation of our payroll and other HCM solutions for new clients. Implementation costs are generally fixed in the short-term

 

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Table of Contents

 

and exceed associated implementation revenue charged to each client. We intend to grow our business through acquisition of new clients, and doing so will require increased personnel to implement our solutions. Therefore our cost of implementation services and other is expected to increase in absolute dollars for the foreseeable future.

 

Operating Expenses

 

Sales and Marketing

 

Sales and marketing expenses consist primarily of employee-related expenses for our direct sales and marketing staff, including wages, commissions, stock-based compensation expense, bonuses and benefits, marketing expenses and other related costs. Commissions are primarily earned and recognized in the month when implementation is complete and the client first utilizes a service. Bonuses paid to sales staff for attainment of certain performance criteria are accrued in the fiscal year in which they are earned and are subsequently paid annually in the first fiscal quarter of the following year.

 

We will seek to grow our number of clients for the foreseeable future and therefore our sales and marketing expense is expected to continue to increase in absolute dollars as we grow our sales organization and expand our marketing activities.

 

Research and Development

 

Research and development expenses consist primarily of employee-related expenses for our research and development and product management staff, including wages, stock-based compensation expense, benefits and bonuses. Additional expenses include costs related to the development, maintenance, quality assurance and testing of new technologies and ongoing refinement of our existing solutions. Research and development expenses, other than software development expenses qualifying for capitalization, are expensed as incurred.

 

We capitalize a portion of our development costs related to internal-use software. The timing of our capitalized development projects may affect the amount of development costs expensed in any given period. The table below sets forth the amounts of capitalized and expensed research and development expenses for the three and nine months ended March 31, 2014 and 2015, respectively.

 

 

 

Three months ended 
March 31,

 

Nine months ended 
March 31,

 

 

 

2014

 

2015

 

2014

 

2015

 

Capitalized portion of research and development

 

$

1,136

 

$

1,145

 

$

2,995

 

$

3,034

 

Expensed portion of research and development

 

2,443

 

5,053

 

6,746

 

14,351

 

Total research and development

 

$

3,579

 

$

6,198

 

$

9,741

 

$

17,385

 

 

We expect to grow our research and development efforts as we continue to broaden our product offerings and extend our technological leadership by investing in the development of new technologies and introducing them to new and existing clients. We expect research and development expenses to continue to increase in absolute dollars but to vary as a percentage of total revenue on a period-to-period basis.

 

General and Administrative

 

General and administrative expenses consist primarily of other employee-related costs, including wages, benefits, stock-based compensation expense and bonuses for our administrative, finance, accounting, and human resources departments. Additional expenses include consulting and professional fees, insurance and other corporate expenses.

 

We expect our general and administrative expenses to increase in absolute dollars as a result of our operation as a public company. These expenses will also include costs associated with compliance with the Sarbanes-Oxley Act and other regulations governing public companies, increased costs of directors’ and officers’ liability insurance and increased professional services expenses.

 

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Table of Contents

 

Other Income (Expense)

 

Other income (expense) consists primarily of interest income and expense. Interest income represents interest received on our cash and cash equivalents. Interest expense consists primarily of the interest incurred on borrowings under notes payable, if any.  As of March 31, 2015, the Company had no notes payable outstanding.

 

Results of Operations

 

The following table sets forth our statements of operations data for each of the periods indicated.

 

 

 

Three months ended
March 31,

 

Nine months ended
March 31,

 

 

 

2014

 

2015

 

2014

 

2015

 

 

 

(in thousands)

 

(in thousands)

 

Consolidated Statements of Operations Data:

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Recurring fees

 

$

30,719

 

$

43,335

 

$

73,602

 

$

104,532

 

Interest income on funds held for clients

 

491

 

601

 

1,222

 

1,354

 

Total recurring revenues

 

31,210

 

43,936

 

74,824

 

105,886

 

Implementation services and other

 

2,556

 

3,336

 

5,216

 

6,808

 

Total revenues

 

33,766

 

47,272

 

80,040

 

112,694

 

Cost of revenues:

 

 

 

 

 

 

 

 

 

Recurring revenues

 

10,246

 

12,606

 

27,320

 

34,616

 

Implementation services and other

 

4,679

 

6,676

 

12,670

 

18,164

 

Total costs of revenues

 

14,925

 

19,282

 

39,990

 

52,780

 

Gross profit

 

18,841

 

27,990

 

40,050

 

59,914

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing

 

8,678

 

12,673

 

19,290

 

31,152

 

Research and development

 

2,443

 

5,053

 

6,746

 

14,351

 

General and administrative

 

5,587

 

8,559

 

14,726

 

24,068

 

Total operating expenses

 

16,708

 

26,285

 

40,762

 

69,571

 

Operating income (loss)

 

2,133

 

1,705

 

(712

)

(9,657

)

Other income (expense)

 

59

 

51

 

109

 

180

 

Income (loss) before income taxes

 

2,192

 

1,756

 

(603

)

(9,477

)

Income tax benefit (expense)

 

(1,042

)

(4

)

197

 

(66

)

Net income (loss)

 

$

1,150

 

$

1,752

 

(406

)

$

(9,543

)

 

20



Table of Contents

 

The following table sets forth our statements of operations data as a percentage of revenue for each of the periods indicated.

 

 

 

Three months ended
March 31,

 

Nine months ended
March 31,

 

 

 

2014

 

2015

 

2014

 

2015

 

 

 

(in thousands)

 

(in thousands)

 

Consolidated Statements of Operations Data:

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Recurring fees

 

91

%

92

%

92

%

93

%

Interest income on funds held for clients

 

1

%

1

%

2

%

1

%

Total recurring revenues

 

92

%

93

%

94

%

94

%

Implementation services and other

 

8

%

7

%

6

%

6

%

Total revenues

 

100

%

100

%

100

%

100

%

Cost of revenues:

 

 

 

 

 

 

 

 

 

Recurring revenues

 

30

%

27

%

34

%

31

%

Implementation services and other

 

14

%

14

%

16

%

16

%

Total costs of revenues

 

44

%

41

%

50

%

47

%

Gross profit

 

56

%

59

%

50

%

53

%

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing

 

26

%

26

%

24

%

27

%

Research and development

 

7

%

11

%

9

%

13

%

General and administrative

 

17

%

18

%

18

%

21

%

Total operating expenses

 

50

%

55

%

51

%

61

%

Operating income (loss)

 

6

%

4

%

(1

)%

(8

)%

Other income (expense)

 

0

%

0

%

0

%

0

%

Income (loss) before income taxes

 

6

%

4

%

(1

)%

(8

)%

Income tax benefit (expense)

 

(3

)%

0

%

0

%

0

%

Net income (loss)

 

3

%

4

%

(1

)%

(8

)%

 

Comparison of Three Months Ended March 31, 2014 and 2015

 

Revenues

 

 

 

Three Months Ended
March 31,

 

Change

 

 

 

2014

 

2015

 

$

 

%

 

Recurring fees

 

$

30,719

 

$

43,335

 

$

12,616

 

41

%

Percentage of total revenues

 

91

%

92

%

 

 

 

 

Interest income on funds held for clients

 

491

 

601

 

110

 

22

%

Percentage of total revenues

 

1

%

1

%

 

 

 

 

Implementation services and other

 

2,556

 

3,336

 

780

 

31

%

Percentage of total revenues

 

8

%

7

%

 

 

 

 

 

Recurring Fees

 

Recurring fees for the three months ended March 31, 2015 increased by $12.6 million, or 41%, to $43.3 million from $30.7 million for the three months ended March 31, 2014. Recurring fees increased primarily as a result of revenue from new clients and increased revenue per client.

 

21



Table of Contents

 

Interest Income on Funds Held for Clients

 

Interest income on funds held for clients for the three months ended March 31, 2015 was not materially different as compared to the three months ended March 31, 2014. The increase in interest income was primarily due to an increase in the amount of funds held for clients.

 

Implementation Services and Other

 

Implementation services and other revenue for the three months ended March 31, 2015 increased by $0.8 million, or 31%, to $3.3 million from $2.6 million for the three months ended March 31, 2014. Implementation services and other revenue increased primarily as a result of an increase in the number of new clients during the three months ended March 31, 2015 in comparison to the three months ended March 31, 2014.

 

Cost of Revenues

 

 

 

Three Months
Ended
March 31,

 

Change

 

 

 

2014

 

2015

 

$

 

%

 

Cost of recurring revenues

 

$

10,246

 

$

12,606

 

$

2,360

 

23

%

Percentage of recurring revenues

 

33

%

29

%

 

 

 

 

Recurring gross margin

 

67

%

71

%

 

 

 

 

Cost of implementation services and other

 

4,679

 

6,676

 

1,997

 

43

%

Percentage of implementation services and other

 

183

%

200

%

 

 

 

 

Implementation gross margin

 

(83

)%

(100

)%

 

 

 

 

 

Cost of Recurring Revenues

 

Cost of recurring revenues for the three months ended March 31, 2015 increased by $2.4 million, or 23%, to $12.6 million from $10.2 million for the three months ended March 31, 2014. Cost of recurring revenues increased primarily as a result of the continued growth of our business, in particular $1.3 million in employee-related costs resulting from additional personnel necessary to provide services to new and existing clients, $0.3 million stock-based compensation expense associated with our broad based equity incentive plan and $1.2 million of fees related to the delivery of our services, partially offset by a $0.5 million decrease in reseller expenses primarily due to our acquisition of substantially all of the assets of one of our resellers during fiscal 2014. Recurring gross margin increased from 67% for the three months ended March 31, 2014 to 71% for the three months ended March 31, 2015, primarily due to the reduction in reseller expenses.

 

Cost of Implementation Services and Other

 

Cost of implementation services and other for the three months ended March 31, 2015 increased by $2.0 million, or 43%, to $6.7 million from $4.7 million for the three months ended March 31, 2014. Cost of implementation services and other increased primarily due to an increase in new clients, and a corresponding increase of $1.4 million in employee-related and other costs to implement our solutions for new clients and $0.3 million stock-based compensation expense during the three months ended March 31, 2015.

 

22



Table of Contents

 

Operating Expenses

 

Sales and Marketing

 

 

 

Three Months
Ended
March 31,

 

Change

 

 

 

2014

 

2015

 

$

 

%

 

Sales and marketing

 

$

8,678

 

$

12,673

 

$

3,995

 

46

%

Percentage of total revenues

 

26

%

26

%

 

 

 

 

 

Sales and marketing expenses for the three months ended March 31, 2015 increased by $4.0 million, or 46%, to $12.7 million from $8.7 million for the three months ended March 31, 2014. The increase in sales and marketing expenses was primarily the result of $3.2 million of additional employee-related expenses incurred due to the expansion of our sales team by 50 personnel (including management, direct sales and sales administration) and the addition of 9 sales lead generation personnel. The increase was also attributable to $0.7 million of stock-based compensation expense during the three months ended March 31, 2015 associated with our broad based equity incentive plan.

 

Research and Development

 

 

 

Three Months
Ended
March 31,

 

Change

 

 

 

2014

 

2015

 

$

 

%

 

Research and development

 

$

2,443

 

$

5,053

 

$

2,610

 

107

%

Percentage of total revenues

 

7

%

11

%

 

 

 

 

 

Research and development for the three months ended March 31, 2015 increased by $2.6 million, or 107%, to $5.1 million from $2.4 million for the three months ended March 31, 2014. The increase in research and development expense was primarily as a result of $1.9 million in employee-related expenses related to 55 additional development personnel and $0.7 million of stock-based compensation expense associated with our broad based equity incentive plan. The Company’s emphasis is on hiring highly skilled technical personnel as well as expanding the management team in this area, resulting in higher average salaries and increased research and development expense per incremental employee for the three months ended March 31, 2015.

 

General and Administrative

 

 

 

Three Months
Ended
March 31,

 

Change

 

 

 

2014

 

2015

 

$

 

%

 

General and administrative

 

$

5,587

 

$

8,559

 

$

2,972

 

53

%

Percentage of total revenues

 

17

%

18

%

 

 

 

 

 

General and administrative expenses for the three months ended March 31, 2015 increased by $3.0 million, or 53%, to $8.6 million from $5.6 million for the three months ended March 31, 2014. The increase was primarily the result of $1.5 million of employee-related expenses related to 25 additional personnel, $0.3 million of additional stock-based compensation expense, $0.4 million of increased occupancy costs incurred as a result of our requirement for added office space and $0.3 million of professional fees.

 

Other Income (Expense)

 

 

 

Three Months
Ended
March 31,

 

Change

 

 

 

2014

 

2015

 

$

 

%

 

Other income (expense)

 

$

59

 

$

51

 

$

8

 

14

%

Percentage of total revenues

 

*

 

*

 

 

 

 

 

 


*                                         Not Meaningful

 

Other income for the three months ended March 31, 2015 was not materially different as compared to the three months ended March 31, 2014.

 

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Table of Contents

 

Income Tax Expense

 

 

 

Three Months
Ended
March 31,

 

Change

 

 

 

2014

 

2015

 

$

 

%

 

Income tax expense

 

$

1,042

 

$

4

 

$

1,038

 

100

%

Percentage of total revenues

 

(3

)%

*

 

 

 

 

 

 


*                                         Not Meaningful

 

Income tax expense for the three months ended March 31, 2015 decreased by $1.0 million as compared to the three months ended March 31, 2014 due to the recognition of a deferred tax asset valuation allowance since the three month period ended March 31, 2014.

 

Comparison of Nine Months Ended March 31, 2014 and 2015

 

Revenues

 

 

 

Nine Months Ended
March 31,

 

Change

 

 

 

2014

 

2015

 

$

 

%

 

Recurring fees

 

$

73,602

 

$

104,532

 

$

30,930

 

42

%

Percentage of total revenues

 

92

%

93

%

 

 

 

 

Interest income on funds held for clients

 

1,222

 

1,354

 

132