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PAYLOCITY HOLDING CORP - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) 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. 33 -------------------------------------------------------------------------------- Table of Contents 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 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 $52.5 million in fiscal 2012 to $72.8 million in fiscal 2013, representing a 39% year-over-year increase. Recurring revenue increased from $72.8 million in fiscal 2013 to $101.9 million in fiscal 2014, representing a 40% year-over-year increase. Recurring revenue represented 95%, 94% and 94% of total revenue in fiscal 2012, 2013, and 2014, respectively. Client Count Growth We believe there is a significant opportunity to grow our business by increasing our number of clients. We have increased our number of clients from approximately 5,500 as of June 30, 2012 to approximately 8,500 as of June 30, 2014, representing a compound annual growth rate of approximately 24%. The table below sets forth our client count for the periods indicated, rounded to the nearest fifty. Year Ended June 30, 2012 2013 2014 Client Count 5,500 6,850 8,500 The rate at which we add clients is highly variable period-to-period and highly seasonal as many clients switch solutions during the first calendar quarter of each year. Although many clients have multiple divisions, segments or locations, we only count such clients once for these purposes. Annual Revenue Retention Rate Our annual revenue retention rate has been in excess of 92% during each of the past three fiscal years. We calculate our annual revenue retention rate as our total revenue for the preceding 12 months, less the annualized value of revenue lost during the preceding 12 months, divided by our total revenue for the preceding 12 months. We calculate the annualized value of revenue lost by summing the recurring fees paid by lost clients over the previous twelve months prior to their termination if they have been a client for a minimum of twelve months. For those lost clients who became clients within the last twelve months, we sum the recurring fees for the period that they have been a client and then annualize the amount. We exclude interest income on funds held for clients from the revenue retention calculation. We believe that our annual revenue retention rate is an important metric to measure overall client satisfaction and the general quality of our product and service offerings. 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 for both fiscal 2013 and 2014 were 44%. 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. 34 -------------------------------------------------------------------------------- Table of Contents 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 income (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 one-time founder funded bonus pay-outs, 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 expense and one-time founder funded bonus payouts. We define Adjusted EBITDA as net income (loss) before interest expense (income), income tax expense (benefit), depreciation and amortization, stock-based compensation expenses and one-time founder funded bonus pay-outs. The table below sets forth our Adjusted Gross Profit, Adjusted Recurring Gross Profit and Adjusted EBITDA for the periods presented. Year Ended June 30, 2012 2013 2014 (in thousands) Adjusted Gross Profit $28,729 $40,695 $57,029Adjusted Recurring Gross Profit $33,147 $46,972 $67,458 Adjusted EBITDA $7,660 $6,301 $5,448 For a further discussion of Adjusted Gross Profit, Adjusted Recurring Gross Profit and Adjusted EBITDA, including a reconciliation of Adjusted Gross Profit, Adjusted Recurring Gross Profit and Adjusted EBITDA to GAAP, see Part II, Item 6: "Consolidated Selected Financial Data." 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 between 95 and 115 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 approximately 93%, 92% and 92% of our total revenues during the years ended June 30, 2012, 2013 and 2014, 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 four 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. 35 -------------------------------------------------------------------------------- Table of Contents 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, bonuses and benefits, relating to the provision of ongoing client support, payroll tax filing and 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 $2.7 million, $3.1 million and $2.2 million of capitalized internal-use software costs in fiscal 2012, 2013 and 2014, 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 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, 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, typically by running its first payroll. 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, 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 each of fiscal 2012, 2013 and 2014. Year Ended June 30, 2012 2013 2014 (in thousands)Capitalized portion of research and development $3,716 $1,967 $4,674 Expensed portion of research and development 1,788 6,825 10,355 Total research and development $5,504 $8,792 $15,029 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. 36 -------------------------------------------------------------------------------- Table of Contents General and Administrative General and administrative expenses consist primarily of other employee-related costs, including wages, benefits, stock-based compensation 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 regulations governing public companies, increased costs of directors' and officers' liability insurance and increased professional services expenses. 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 outstanding borrowings under our note payable prior to its retirement in March 2014 using proceeds of our initial public offering. Results of Operations The following table sets forth our statements of operations data for each of the periods indicated. Year Ended June 30, 2012 2013 2014 (in thousands) Consolidated Statements of Operations Data: Revenues: Recurring fees $51,211 $71,309 $100,362 Interest income on funds held for clients 1,263 1,459 1,582 Total recurring revenues 52,474 72,768 101,944 Implementation services and other 2,622 4,526 6,743 Total revenues 55,096 77,294 108,687 Cost of revenues: Recurring revenues 22,054 28,863 37,319 Implementation services and other 7,040 10,803 17,775 Total costs of revenues 29,094 39,666 55,094 Gross profit 26,002 37,628 53,593 Operating expenses: Sales and marketing 12,828 18,693 28,276 Research and development 1,788 6,825 10,335 General and administrative 8,618 12,079 21,980 Total operating expenses 23,234 37,597 60,611 Operating income (loss) 2,768 31 (7,018) Other income (expense) (196) (16) 163 Income (loss) before income taxes 2,572 15 (6,855) Income tax (benefit) expense 884 (602) 255 Net income (loss) $1,688 $617 $(7,110) 37 -------------------------------------------------------------------------------- Table of Contents The following table sets forth our statements of operations data as a percentage of revenue for each of the periods indicated. Year Ended June 30, 2012 2013 2014 Consolidated Statements of Operations Data: Revenues: Recurring fees 93% 92% 92% Interest income on funds held for clients 2% 2% 2% Total recurring revenues 95% 94% 94% Implementation services and other 5% 6% 6% Total revenues 100% 100% 100% Cost of revenues: Recurring revenues 40% 37% 34% Implementation services and other 13% 14% 17% Total costs of revenues 53% 51% 51% Gross profit 47% 49% 49% Operating expenses: Sales and marketing 23% 24% 26% Research and development 3% 9% 10% General and administrative 16% 16% 20% Total operating expenses 42% 49% 56% Operating income (loss) 5% 0% (7)% Other income (expense) (0)% 0% 0% Income (loss) before income taxes 5% 0% (7)% Income tax (benefit) expense 2% (1)% 0% Net income (loss) 3% 1% (7)% Comparison of Fiscal Years Ended June 30, 2012, 2013 and 2014 Revenues Change from Change from Year Ended June 30, 2012 to 2013 2013 to 2014 2012 2013 2014 $ % $ % Recurring fees $51,211 $71,309 $100,362 $20,098 39% $29,053 41% Percentage of total revenues 93% 92% 92% Interest income on funds held for clients $1,263 $1,459 $1,582 $196 16% $123 8% Percentage of total revenues 2% 2% 2% Implementation services and other $2,622 $4,526 $6,743 $1,904 73% $2,217 49% Percentage of total revenues 5% 6% 6% Recurring Fees Recurring fees for the year ended June 30, 2014 increased by $29.1 million, or 41%, to $100.4 million from $71.3 million for the year ended June 30, 2013. Recurring fees increased primarily as a result of the continued growth of our client base in fiscal 2014, as well as increased revenue per client. Our client count at June 30, 2014 increased by 24% to approximately 8,500 from approximately 6,850 at June 30, 2013. Recurring fees for the year ended June 30, 2013 increased by $20.1 million, or 39%, to $71.3 million from $51.2 million for the year ended June 30, 2012. Recurring fees increased primarily as a result of the continued growth of our client base in fiscal 2013, as well as increased revenue per client. Our client count at June 30, 2013 increased by 25% to approximately 6,850 from approximately 5,500 at June 30, 2012. Interest Income on Funds Held for Clients Interest income on funds held for clients for the year ended June 30, 2014 increased by $0.1 million, or 8%, to $1.6 million from $1.5 million for the year ended June 30, 2013. Interest income increased primarily as a result of an increased average daily balance of funds held due to the addition of new clients to our client base partially offset by declining interest crediting rates during fiscal 2014. 38 -------------------------------------------------------------------------------- Table of Contents Interest income on funds held for clients for the year ended June 30, 2013 increased by $0.2 million, or 16%, to $1.5 million from $1.3 million for the year ended June 30, 2012. Interest income increased primarily as a result of an increased average daily balance of funds held due to the addition of new clients to our client base during fiscal 2013. Implementation Services and Other Implementation services and other revenue for the year ended June 30, 2014 increased by $2.2 million, or 49%, to $6.7 million from $4.5 million for the year ended June 30, 2013. Implementation services and other revenue increased primarily as a result of the continued growth of our new client base during fiscal 2014. Implementation services and other revenue for the year ended June 30, 2013 increased by $1.9 million, or 73%, to $4.5 million from $2.6 million for the year ended June 30, 2012. Implementation services and other revenue increased primarily as a result of the continued growth of our new client base during fiscal 2013. Cost of Revenues Change from Change from Year Ended June 30, 2012 to 2013 2013 to 2014 2012 2013 2014 $ % $ % Cost of recurring revenues $22,054 $28,863 $37,319 $6,809 31% $8,456 29% Percentage of recurring revenues 42% 40% 37% Recurring gross margin 58% 60% 63% Cost of implementation services and other $7,040 $10,803 $17,775 $3,763 53% $6,972 65% Percentage of implementation services and other 268% 239% 264% Implementation gross margin (168)% (139)% (164)% Cost of Recurring Revenues Cost of recurring revenues for the year ended June 30, 2014 increased by $8.5 million, or 29%, to $37.3 million from $28.9 million for the year ended June 30, 2013. Cost of recurring revenues increased primarily as a result of the continued growth of our business, in particular $4.0 million in additional employee-related costs resulting from additional personnel to provide services to new and existing clients, $0.5 million stock-based compensation associated with our broad based IPO grant to all employees, $0.4 million of additional costs attributable to resellers, and $3.5 million other processing-related fees. Recurring gross margin increased by 3% from 60% in fiscal 2013 to 63% in fiscal 2014 primarily due to a 2% reduction in amortization expense as a percentage of total recurring revenue and a 1% reduction in costs attributable to resellers as a percentage of total recurring revenue. Cost of recurring revenues for the year ended June 30, 2013 increased by $6.8 million, or 31%, to $28.9 million from $22.1 million for the year ended June 30, 2012. Cost of recurring revenues increased primarily as a result of the continued growth of our business, in particular $2.9 million in additional employee-related costs resulting from additional personnel to provide services to new and existing clients, $1.2 million of additional costs attributable to resellers, and $2.4 million of other processing-related fees. Recurring gross margin increased by 2% from 58% in fiscal 2012 to 60% in fiscal 2013 primarily due to a 1% reduction in amortization expense as a percentage of total recurring revenue and a 1% reduction in personnel-related and other costs as a percentage of total recurring revenue. Cost of Implementation Services and Other Cost of implementation services and other for the year ended June 30, 2014 increased by $7.0 million, or 65%, to $17.8 million from $10.8 million for the year ended June 30, 2013. Cost of implementation services and other increased primarily due to an increase in new clients during fiscal 2014, and a corresponding increase of $5.4 million in employee-related and other costs to implement our solutions for new clients and $0.4 million stock-based compensation associated with our broad based IPO grant to all employees. Cost of implementation services and other for the year ended June 30, 2013 increased by $3.8 million, or 53%, to $10.8 million from $7.0 million for the year ended June 30, 2012. Cost of implementation services and other increased primarily due to an increase in new clients during fiscal 2013, and a corresponding increase of $3.0 million in employee-related and other costs to implement our solutions for new clients. 39 -------------------------------------------------------------------------------- Table of Contents Operating Expenses Sales and Marketing Change from Change from Year Ended June 30, 2012 to 2013 2013 to 2014 2012 2013 2014 $ % $ % Sales and marketing $12,828 $18,693 $28,276 $5,865 46% $9,583 51% Percentage of total revenues 23% 24% 26% Sales and marketing expenses for the year ended June 30, 2014 increased by $9.6 million, or 51%, to $28.3 million from $18.7 million for the year ended June 30, 2013. The increase in sales and marketing expenses in fiscal 2014 was primarily the result of $8.5 million of additional employee-related costs from the expansion of our sales team including management, direct sales and sales administration personnel by 62 personnel, the addition of 24 sales lead generation personnel, whose function was previously outsourced and recorded in sales and marketing as lead generation expense rather than employee-related expense in prior periods and other miscellaneous sales and marketing related expenses. The increase was also attributable to $0.8 million of stock-based compensation associated with our broad based IPO grant to all employees. Sales and marketing expenses for the year ended June 30, 2013 increased by $5.9 million, or 46%, to $18.7 million from $12.8 million for the year ended June 30, 2012. The increase in sales and marketing expenses in fiscal 2013 was primarily the result of $5.2 million of additional employee-related costs from the expansion of our direct sales force by 23 personnel, the hiring of additional sales management and administrative personnel to support our growing business and other miscellaneous sales and marketing related expenses. Research and Development Change from Change from Year Ended June 30, 2012 to 2013 2013 to 2014 2012 2013 2014 $ % $ % Research and development $1,788 $6,825 $10,355 $5,037 282% $3,530 52% Percentage of total revenues 3% 9% 10% Research and development for the year ended June 30, 2014 increased by $3.5 million, or 52%, to $10.4 million from $6.8 million for the year ended June 30, 2013. Research and development costs increased in fiscal 2014 primarily due to $5.1 million of additional employee-related expenses related to 27 additional development personnel, $0.6 million of stock-based compensation associated with our broad based IPO grant to all employees and $0.5 million related to the one-time founder funded bonus pay-outs. This was offset by an increase of $2.7 million in our capitalized internally developed software costs as we developed significant additional functionality in our human capital management applications during the year. Research and development for the year ended June 30, 2013 increased by $5.0 million, or 282%, to $6.8 million from $1.8 million for the year ended June 30, 2012. Research and development costs increased in fiscal 2013 primarily due to $3.3 million of additional employee-related expenses related to 39 additional development personnel. Additionally, in fiscal 2013 one of our core payroll applications transitioned beyond the development stage into the maintenance and incremental improvements stage, and therefore our capitalized internally developed software costs decreased by $1.7 million in fiscal 2013 as compared to fiscal 2012. General and Administrative Change from Change from Year Ended June 30, 2012 to 2013 2013 to 2014 2012 2013 2014 $ % $ %General and administrative $8,618 $12,079 $21,980 $3,461 40% $9,901 82% Percentage of total revenues 16% 16% 20% General and administrative expenses for the year ended June 30, 2014 increased by $9.9 million, or 82%, to $22.0 million from $12.1 million for the year ended June 30, 2013. General and administrative expenses increased primarily as a result of $4.3 million of additional employee-related expenses relating to 18 additional personnel, $2.1 million of additional stock-based compensation costs associated with IPO related grants of options and restricted stock units, $1.7 million in additional professional fees and $0.6 million of increased occupancy costs incurred as a result of our requirement for additional office space. 40 -------------------------------------------------------------------------------- Table of Contents General and administrative expenses for the year ended June 30, 2013 increased by $3.5 million, or 40%, to $12.1 million from $8.6 million for the year ended June 30, 2012. General and administrative expenses increased primarily as a result of $2.2 million of additional employee-related expenses relating to 17 additional personnel, as well as $0.7 million of increased occupancy costs incurred as a result of our requirement for additional office space. Other Income (Expense) Change from Change from Year Ended June 30, 2012 to 2013 2013 to 2014 2012 2013 2014 $ % $ % Other income (expense) $(196) $(16) $163 $180 * $179 * Percentage of total revenues * * * -------------------------------------------------------------------------------- * Not Meaningful Other income (expense) for the year ended June 30, 2014 increased by $0.2 million as compared to the year ended June 30, 2013. Other income for the year ended June 30, 2014 primarily consists of interest income earned on our cash and cash equivalents, partially offset by interest expense incurred on our note payable and other debt, which was repaid in full in March 2014. Other income (expense) for the year ended June 30, 2013 increased by $0.2 million as compared to the year ended June 30, 2012. Other expense for the year ended June 30, 2013 primarily consists of interest expense incurred on our note payable and other debt, which was reduced as compared to the year ended June 30, 2012 due to increased principal payments in fiscal 2013. Income Tax (Benefit) Expense Change from Change from Year Ended June 30, 2012 to 2013 2013 to 2014 2012 2013 2014 $ % $ % Effective tax rate 34% * (4)% Income tax (benefit) expense 884 (602) 255 (1,486) * (857) * Percentage of total revenues 2% (1)% * -------------------------------------------------------------------------------- * Not Meaningful Income tax (benefit) expense for the year ended June 30, 2014 increased by $0.9 million, as compared to the year ended June 30, 2013 primarily due to the expiration of federal research and development tax credit allowances resulting in a $0.5 million decline in amount claimed and an increase in non-deductible expenses as a result of our growing business. The Company also recognized a valuation allowance as of June 30, 2014 on substantially all of its net deferred tax assets, many of which were generated in the three month period ended June 30, 2014, given its determination that it was more likely than not that the Company would not recognize the benefits of its net operating loss carryforwards prior to their expiration. Income tax (benefit) expense for the year ended June 30, 2013 decreased by $1.5 million, as compared to the year ended June 30, 2012. The decrease in income tax provision was primarily the result of income before taxes of $0 for the year ended June 30, 2013, as compared to income before taxes of $2.6 million for the year ended June 30, 2012. Additionally, our income tax provision for the year ended June 30, 2013 was reduced by $0.7 million due to the application of various research and development tax credits. Critical Accounting Policies and Significant Judgments and Estimates In preparing our financial statements and accounting for the underlying transactions and balances in accordance with GAAP, we apply various accounting policies that require our management to make estimates, judgments and assumptions that affect the amounts reported in our financial statements. We consider the policies discussed below as critical to understanding our financial statements, as their application places the most significant demands on management's judgment. Management bases its estimates, judgments and assumptions on historical experience, current economic and industry conditions and on various other factors deemed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Because the use of estimates is an integral part of the financial reporting process, actual results could differ and such differences could be material. Revenue Recognition We derive revenues predominantly from recurring revenues associated with our cloud-based payroll and HCM software applications and one-time service fees for implementation of our solutions. Our agreements with clients do not include general rights 41 -------------------------------------------------------------------------------- Table of Contents of return and do not provide clients with the right to take possession of the software supporting the services being provided. As such, revenue is recognized as services are performed. We recognize revenue when all of the following criteria are achieved: † There is persuasive evidence of an agreement; † The service has been provided to the client; † Collection of the fees is reasonably assured; and † The amount of fees to be paid by the client is fixed or determinable. For arrangements with multiple-elements, we recognize revenues in accordance with Accounting Standards Update (ASU) 2009-13, Multiple-Deliverable Revenue Arrangements. For each agreement, we evaluate whether the individual deliverables qualify as separate units of accounting. If one or more of the deliverables does not have standalone value upon delivery, the deliverables that do not have standalone value are generally combined and treated as a single unit of accounting. Revenue for arrangements treated as a single unit of accounting is generally recognized within the same month that the services are rendered given that the agreements are cancellable with 60 days' or less notice. In determining whether revenues from implementation services can be accounted for separately from recurring revenues, we consider the nature of the implementation services and the availability of the implementation services from other vendors. We established standalone value for implementation primarily due to the number of partners that perform these services and account for such implementation services separate from the recurring revenues. If we determine that the services have standalone value upon delivery, we account for each separately and revenues are recognized as the services are delivered with allocation of consideration based on the relative selling price method. That method requires the selling price of each element in a multiple deliverable arrangement to be based on, in descending order: (i) vendor- specific objective evidence of fair value, or VSOE, (ii) third-party evidence of fair value, or TPE, or (iii) management's best estimate of the selling price, or BESP. We are not able to demonstrate VSOE of selling price with respect to our recurring fees paid for our solutions because the deliverables are sold across an insufficiently narrow range of prices on a stand-alone basis. We are also not able to demonstrate TPE for subscription fees because no third-party offerings are reasonably comparable to our product offerings. We thus establish BESP by service offering, requiring the use of significant estimates and judgment. To determine BESP, we consider numerous factors, including the nature of the deliverables themselves, the geography for the sale, internal costs, and pricing and discounting practices utilized by our direct sales force. Arrangement consideration is allocated to each deliverable based on the established BESP and subject to the limitation that because the arrangements are cancellable with 60 days' or less notice, recurring revenue is not allocated to any deliverable until the consideration has been earned, typically with each payroll cycle or monthly, depending on the service. Property and Equipment and Long-Lived Assets We state property and equipment at cost. We calculate depreciation on property and equipment using a straight-line method over the estimated useful lives of the assets, generally three to seven years for most classes of assets, or over the term of the related lease for leasehold improvements. We recognized depreciation expense of $1.9 million, $2.5 million and $4.1 million during the years ended June 30, 2012, 2013, and 2014, respectively. We review long-lived assets, such as property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long-lived asset or asset group be tested for possible impairment, we first compare the undiscounted cash flows expected to be generated by that asset or asset group to its carrying amount. If the carrying amount of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, we recognize impairment to the extent that the carrying amount exceeds its fair value. We determine fair value through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary. Capitalized Internal-Use Software Costs We apply ASC 350-40, Intangibles-Goodwill and Other-Internal-Use Software, to the accounting for costs of internal-use software. Software development costs are capitalized when application development begins, it is probable that the project will be completed, and the software will be used as intended. Costs associated with preliminary project stage activities, training, maintenance and all other post implementation stage activities are expensed as incurred. We also capitalize certain costs related to specific upgrades and enhancements when it is probable the expenditures will result in significant additional functionality. The capitalization policy provides for the capitalization of certain payroll costs for employees who are directly associated with developing internal-use software as well as certain external direct costs. Capitalized employee costs are limited to the time directly spent on such projects. 42 -------------------------------------------------------------------------------- Table of Contents Internal-use software is amortized on a straight-line basis over 18 to 24 months. We evaluate the useful lives of these assets on an annual basis and tests for impairments whenever events or changes in circumstances occur that could impact the recoverability of these assets. There were no impairments to capitalized software developed for internal use during the years ended June 30, 2012, 2013 or 2014. We capitalized $3.7 million, $2.0 million, and $4.7 million of software development costs for the years ended June 30, 2012, 2013 and 2014, respectively including stock-based compensation costs of $0.3 million in the year ended June 30, 2014. We amortized $2.7 million, $3.1 million, and $2.2 million of capitalized research and development costs for the years ended June 30, 2012, 2013 and 2014, respectively. In fiscal 2014, we developed significant additional functionality in several of our applications. This development resulted in an increase in capitalized internally-developed software costs in fiscal 2014 as compared to fiscal 2013. In fiscal 2013, one of our solutions transitioned beyond the development stage into the maintenance and incremental improvements stage, which resulted in lower capitalized internally-developed software costs in fiscal 2013 as compared to fiscal 2012. Goodwill and Intangible Assets Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized. We have recorded goodwill in connection with the acquisition of BFKMS, Inc. Goodwill is not amortized, but instead is tested for impairment at least annually. ASU 2011-08, Testing Goodwill for Impairment provides an entity the option to perform a qualitative assessment to determine whether it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount prior to performing the two-step impairment test. If it is the case that the estimated fair value of a reporting unit is less than its carrying amount, including goodwill, the two-step goodwill impairment test is required. Otherwise no further analysis is required. If the two-step goodwill impairment test is required, first the fair value of the reporting unit is compared with its carrying amount, including goodwill. If the fair value of the reporting unit is less than its carrying amount, an indication of goodwill impairment exists for the reporting unit and we perform step two of the impairment test. Under step two, an impairment loss is recognized for any excess of the carrying amount of the reporting unit's goodwill over the implied fair value of the goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation and the residual fair value after this allocation is the implied fair value of the reporting unit goodwill. Fair value of the reporting unit is determined using a discounted cash flow analysis. If the fair value of the reporting unit exceeds its carrying amount, step two does not need to be performed. We will perform its annual impairment review of goodwill in our fiscal fourth quarter and when a triggering event occurs between annual impairment tests. However, given that we did not have recorded goodwill until its fiscal fourth quarter of 2014, no impairment tests were required to be completed. Intangible assets are comprised primarily of client list acquisitions and are reported net of accumulated amortization on the Consolidated Balance Sheets. Client relationships use the straight-line method of amortization over an accelerated nine year time frame, while the non-solicitation agreement uses the straight-line method of amortization over the three year life of the agreement. Amortization expense associated with our intangible assets was $0, $0, and $80 during the years ended June 30, 2012, 2013 and 2014, respectively. We test intangible assets for potential impairment when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. There were no such events or changes in circumstances during the years ended June 30, 2012, 2013 and 2014. Income Taxes We account for federal income taxes 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 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 rates is recognized in income in the period that includes the enactment date. Deferred tax assets may be reduced by a valuation allowance to the extent we determine it is more likely than not that some portion or all of the deferred tax assets will not be realized. The valuation of deferred tax assets requires judgment in assessing the likely future tax consequences of events that have been recognized in our financial statements or tax returns and future profitability. Our accounting for deferred tax consequences represents the best estimate of those future events. Changes in current estimates, due to unanticipated events or otherwise, could have an adverse impact on our financial condition and results of operations. In assessing the need for a valuation allowance, we consider both positive and negative evidence related to the likelihood of realization of the deferred tax assets. The weight given to positive and negative evidence is commensurate with the extent to which the 43 -------------------------------------------------------------------------------- Table of Contents evidence may be objectively verified. As such, it is generally difficult for positive evidence regarding projected future taxable income exclusive of reversing taxable temporary differences to outweigh objective negative evidence of recent financial reporting losses. Cumulative losses in recent years are significant negative evidence that is difficult to overcome in determining that a valuation allowance is not needed against deferred tax assets. We recognize 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. Stock-Based Compensation We maintain a 2008 Equity Incentive Plan (the "2008 Plan") and a 2014 Equity Incentive Plan (the "2014 Plan") pursuant to which we have issued options to purchase shares of our common stock and grants of restricted stock awards to employees, officers, directors and consultants. 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 of the compensation committee of our board of directors. We will not grant any additional awards under our 2008 Plan, though our 2008 Plan will continue to govern the terms and conditions of all outstanding equity awards granted under the 2008 Plan. As of June 30, 2014, options to purchase 4,387,722 shares of our common stock were outstanding, 101,764 restricted stock units were outstanding and 2,581,513 shares of our common stock were reserved for future grant. The following table presents data related to stock options granted on the dates indicated: Aug. 21, Sept. 17, July 8, Aug. 26, Mar. 18, 2012 2012 2013 2013 2014 Options granted 893,332 33,333 466,663 50,000 2,065,541 Fair value of stock $4.88 $4.88 $7.04 $7.04 $17.00 Exercise price $4.88 $4.88 $7.04 $7.04 $17.00 Fair value of option $1.22 $1.22 $1.71 $1.71 $7.62 Equity-classified awards 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. We estimate grant date fair value using the Black-Scholes Option-Pricing Model, or Black-Scholes, which requires the use of certain subjective assumptions. Below is a table of the key weighted-average assumptions used in the option valuation calculation for options issued on the dates indicated. We did not grant stock options in fiscal 2012. Aug. 21, Sept. 17, July 8, Aug. 26, Mar. 18, 2012 2012 2013 2013 2014 Valuation assumptions: Weighted average expected dividend yield - - - - - Weighted average expected volatility 30.7% 30.7% 29.5% 29.5% 44.5% Weighted average expected term (years) 4.0 4.0 4.0 4.0 6.0 Weighted average risk-free interest rate 0.6% 0.6% 0.5% 0.5% 1.94% We use a dividend yield assumption of zero as we have not paid regular cash dividends on our common stock and presently have no intention of paying any such cash dividends. Since our shares were not publicly traded prior to March 2014, expected volatility is estimated based on the average historical volatility of similar entities with publicly traded shares. We calculate the expected term using company specific historical data, such as employee option exercise and employee post-vesting departure behavior. Separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The risk-free rate for the expected term of the option is based on the U.S. Treasury yield curve at the date of grant. Stock-based compensation expense was $0.2 million, $0.5 million and $4.9 million for the years ended June 30, 2012, 2013 and 2014, respectively. If factors change and we employ different assumptions, stock-based compensation expense may differ from what we have recorded in the past. If there is a difference between the assumptions used in determining stock-based compensation expense and the actual factors which become known over time, we may change the input factors used in determining stock-based compensation costs for future grants. These changes, if any, may adversely impact our results of operations in the period such changes are made. We expect to continue to grant stock options in the future, and to the extent that we do, our actual stock-based compensation expense recognized in future periods will likely increase. 44 -------------------------------------------------------------------------------- Table of Contents One significant factor in determining the fair value of our options granted through August 2013, when using Black-Scholes, is the fair value of the common stock underlying those stock options. Prior to March 2014, we were a private company with no active public market for our common stock. Therefore, the fair value of the common stock underlying our stock options was determined by our board of directors, which considered in making its determination of fair value a variety of factors including contemporaneous periodic valuation studies from an independent and unrelated third-party valuation firm. Now that we have a public market for our stock, we observe the fair value of our common stock on the date of grant in accordance with the terms of the award. Based on the closing stock price on June 30, 2014 of $21.63, the aggregate intrinsic value of outstanding options to purchase shares of our common stock as of June 30, 2014 was $51.0 million, of which $20.9 million related to vested options and $30.1 million to unvested options. The aggregate intrinsic value of outstanding restricted stock units as of June 30, 2014 was $2.2 million, of which all were unvested. Third-Party Valuation Methodology In performing its analysis, the valuation firm engaged in discussions with management, analyzed historical and forecasted financial statements, and reviewed our corporate documents. The valuation consultant utilized the guidelines outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation. The valuation study was prepared using a combination of four generally accepted approaches to determining the fair market value of a business: the discounted cash flows, or DCF, method, the guideline public company method, the prior transaction method and the market transactions method. The discounted cash flows method forecasted future cash flows utilizing a terminal value based on our expectation of long-term growth to arrive at a valuation. The guideline public company method utilizes a market approach which estimates the fair value of a company by applying to that company the market multiples of publicly-traded companies to arrive at a valuation. The prior transaction method looks to recent arms-length transactions in a company's capital stock to arrive at a valuation. The market transactions method utilizes a market approach which estimates the fair value of a company by applying to that company the market multiples of publicly-traded and private companies to arrive at a valuation. Fiscal 2013 The independent third-party valuation as of June 30, 2012 was performed using the DCF method, the guideline public company method and the prior transaction method. The valuation firm considered our nature and history, the condition and outlook of the industry in which we operate, our financial condition, our current operations and earning capacity, our relative position within the industry in which we operate, prior transactions involving our stock, our strategic direction and management and our goodwill and intangible value. The valuation firm took into account our financial statements for fiscal 2007 through 2012. In applying the guideline public company method, the valuation firm analyzed the prices that investors are willing to pay for the publicly-traded common stock of companies that are comparable to us. The valuation firm then calculated total market value of invested capital multiples based on each of (i) TTM earnings before interest, taxes, depreciation and amortization, (ii) TTM earnings before interest and taxes, (iii) TTM net sales and (iv) book value. The valuation firm applied the average of the public companies' TTM net sales multiple to our TTM net sales. The valuation firm then adjusted the resulting value downward by 35% to reflect our smaller size, limited access to capital, historical and future growth expectations, and differences in liquidity, profitability and leverage among the guideline companies. In applying the DCF method, the valuation firm analyzed financial projections prepared by our management for fiscal 2013 through 2016. The valuation firm calculated our net cash flows to invested capital by taking our debt-free net income, as estimated by management, adding depreciation expenses and subtracting both capital expenditures, as estimated by management, and incremental working capital needs, which were estimated based on a review of an industry average. For the terminal year, the valuation firm applied a revenue multiple, calculated using the guideline public company method. A discount rate of 35% was then applied. To determine the discount rate, the valuation firm reviewed published investment hurdle rates typically required by institutional investors for companies of comparable size and risk. In applying the prior transaction method, the valuation firm reviewed three arms-length transaction in our capital stock. The most recent transaction occurred on June 28, 2012, two days prior to the date of the valuation, in which we sold shares of Series B preferred stock for approximately $4.88 per share. Our value was then allocated among our shares of Series A preferred stock, our shares of Series B preferred stock and our shares of common stock using the option pricing equity allocation method, using Black-Scholes. In utilizing the Black-Scholes method, our volatility was estimated at 31% which was based on the average volatility of the guideline public companies over one-year, two-year and five-year period. The assumed time to expiration was three years, which was based on the estimated timing of a potential liquidity event. Finally, the valuation firm applied a marketability discount of 10% to reflect the lack of an active market in shares of our common stock, which resulted in a fair market value of $4.88 per share. 45 -------------------------------------------------------------------------------- Table of Contents Our board of directors considered this third party valuation and the other factors discussed above in determining that the fair market value of our common stock was $4.88 on August 21, 2012 and September 17, 2012. Fiscal 2014 The independent third-party valuation as of May 31, 2013 was performed using the DCF method, the guideline public company method and the market transactions method. The valuation firm considered our nature and history, the condition and outlook of the industry in which we operate, the book value of our stock and our financial condition, the earning capacity of our business, the dividend-paying capacity of our business, prior transactions involving our stock, the market price of public traded stock of companies engage in the same or a similar line of business and our goodwill and intangible value. The valuation firm took into account our financial statements for fiscal 2009 through 2012, as well as interim financial statements for the eleven months ended May 31, 2013 and May 31, 2012. In applying the guideline public company method, the valuation firm analyzed the prices that investors are willing to pay for the publicly-traded common stock of companies that are comparable to us. The valuation firm then calculated total market value of invested capital multiples based on TTM earnings before interest, taxes, depreciation and amortization and TTM revenues. The valuation firm considered our smaller size, limited access to capital, historical and future growth expectations, and differences in liquidity, profitability and leverage among the guideline companies before selecting a TTM multiple that was slightly above the average of the TTM revenues multiples for the companies determined to be most comparable to us. In applying the DCF method, the valuation firm analyzed financial projections prepared by our management for a five year period. The valuation firm calculated our net cash flows to invested capital by taking our debt-free net income, as estimated by management, adding depreciation expenses and subtracting both capital expenditures, as estimated by management, and incremental working capital needs, which were estimated based on a review of an industry average. For the terminal year, the valuation firm applied a revenue multiple, calculated using the guideline public company method. A discount rate of 35% was then applied. To determine the discount rate, the valuation firm reviewed published investment hurdle rates typically required by institutional investors for companies of comparable size and risk. The 35% discount rate was equal to the discount rate applied in the DCF analysis conducted as of June 30, 2012. In applying the market transactions method, the valuation firm reviewed publicly available data regarding transactions that have occurred in the industry, as well as prior arms-length transactions in our capital stock. The valuation firm applied a revenue multiple that was slightly above the median revenue multiple of all transactions and in-line with the sale of our Series B preferred stock in June 2012. Our value was then allocated among our shares of Series A preferred stock, our shares of Series B preferred stock and our shares of common stock using the option pricing equity allocation method, using Black-Scholes. In utilizing the Black-Scholes method, our volatility was estimated at 31% which was based on the average volatility of the guideline public companies over a five-year period. The assumed time to expiration was four years, which was based on the estimated timing of a potential liquidity event. Finally, the valuation firm applied a marketability discount to reflect the lack of an active market in shares of our common stock, which resulted in a fair market value of $6.90 per share. Our board of directors considered this third-party valuation and the other factors discussed above in determining that the fair market value of our common stock was $7.04 on July 8, 2013 and August 26, 2013. Reverse Stock Split On March 5, 2014, we effected a three-for-two reverse stock split on our Common Stock. Initial Public Offering In March 2014, we completed our initial public offering or IPO in which we issued and sold 5,367 shares of common stock and existing shareholders sold 2,735 shares of common stock at a public offering price of $17 per share. We did not receive any proceeds from the sale of common stock by the existing shareholders. We received net proceeds of $81.9 million after deducting underwriting discounts and commissions of $6.4 million and other offering expenses of $2.9 million. Liquidity and Capital Resources Our primary liquidity needs are related to the funding of general business requirements, including working capital requirements, research and development, and capital expenditures. As of June 30, 2014, our principal sources of liquidity were $78.8 million of cash and cash equivalents. 46 -------------------------------------------------------------------------------- Table of Contents In order to grow our business, we intend to increase our personnel and related expenses and to make significant investments in our platform, data centers and infrastructure generally. The timing and amount of these investments will vary based on the rate at which we can add new clients and new personnel and the scale of our application development, data center and other activities. Many of these investments will occur in advance of our experiencing any direct benefit from them which could negatively impact our liquidity and cash flows during any particular period and may make it difficult to determine if we are effectively allocating our resources. However, we expect to fund our operations, capital expenditures and other investments principally with cash flows from operations, and to the extent that our liquidity needs exceed our cash from operations, we would look to our cash on hand and available borrowings to satisfy those needs. Our cash flows from investing activities and our cash flows from financing activities are influenced by the amount of funds held for clients which varies significantly from quarter to quarter. The balance of the funds we hold depends on our clients' payroll calendar, and therefore such balance changes from period to period in accordance with the timing with each payroll cycle. Funds held for clients are restricted solely for the repayment of client fund obligations. We believe our current cash and cash equivalents and cash flow from operations will be sufficient to meet our working capital, capital expenditure and other investment requirements for at least the next 12 months. Cash Flows The following table sets forth data regarding cash flows for the periods indicated: Year Ended June 30, 2012 2013 2014 Net cash provided by operating activities $8,564 $6,228 $7,199 Cash flows from investing activities: Capitalized internally-developed software costs (3,716) (1,967) (4,349) Purchases of property and equipment (3,446) (3,987) (6,667) Payments for acquisitions - - (6,450) Net change in funds held for clients 35,724 (92,650) (61,356) Net cash provided by (used in) investing activities 28,562 (98,604) (78,822) Cash flows from financing activities: Net change in client funds obligation (35,724) 92,650 61,356 Principal payments on long-term debt (312) (1,625) (1,563) Proceeds from IPO, net of issuance costs - - 82,032 Capital contribution - - 1,052 Proceeds from issuance of redeemable convertible Series B preferred stock 27,234 - - Proceeds from exercise of stock options 88 76 - Payments for redemption of common stock (27,371) (162) - Net cash provided by (used in) financing activities (36,085) 90,939 142,877 Net increase (decrease) in cash and cash equivalents $1,041 $(1,437) $71,254 Operating Activities Net cash provided by operating activities was $8.6 million, $6.2 million and $7.2 million for the years ended June 30, 2012, 2013 and 2014, respectively. The increase in net cash provided by operating activities from fiscal 2013 to fiscal 2014 was the primarily the result of the change of $2.3 million in working capital partially offset by the increase in net loss and increases in non-cash items including stock-based compensation and depreciation and amortization. The decline in net cash provided by operating activities from fiscal 2012 to fiscal 2013 was primarily the result of a decrease of $1.1 million in net income, as well as a decline of $0.9 million in working capital, partially offset by increased depreciation and amortization. Investing Activities Changes in net cash (used in) provided by investing activities are significantly influenced by the amount of funds held for clients at the end of a reporting period. Changes in the amount of funds held for client from period to period will vary substantially. Our payroll processing activities involves the movement of significant funds from the account of an employer to employees and relevant taxing authorities. During the year ended June 30, 2014 we processed almost $39 billion in payroll transactions. Though we debit a client's account prior to any disbursement on its behalf, there is a delay between our payment of amounts due to employees and taxing and other regulatory authorities and when the incoming funds from the client to cover these amounts payable actually clear into our operating accounts. We currently have agreements with nine banks to execute ACH and wire transfers to support our client payroll and tax services. We believe we have sufficient capacity under these ACH arrangements to handle our transactions for the foreseeable future. 47 -------------------------------------------------------------------------------- Table of Contents Other investing activities that influence our net cash (used in) provided by investing activities are our capitalization of internally developed software costs and purchases of property and equipment. Net cash (used in) provided by investing activities was $28.6 million, $(98.6) million and $(78.9) million, for the years ended June 30, 2012, 2013 and 2014, respectively. Excluding the net change in funds held for clients, our net cash (used in) provided by investing activities was $(7.2) million, $(6.0) million and $(17.5) million, for the years ended June 30, 2012, 2013 and 2014, respectively. The decrease in net cash used by investing activities of $19.7 from fiscal 2013 to fiscal 2014 was primarily due to the timing of receipts and disbursements of cash and cash equivalents held to satisfy client funds obligations of $31.3 million partially offset by payments of $6.5 million to acquire certain assets of one of our resellers, increased purchases of property and equipment by $2.7 million and increased capitalization of internally developed software costs by $2.4 million. The increase of $127.2 million in net cash used in investing activities from fiscal 2012 to fiscal 2013 was primarily the result of the timing of receipts and disbursements of cash and cash equivalents held to satisfy client fund obligations of $128.4 million partially offset by a decrease of $1.7 million in capitalized internally developed software costs. Financing Activities Net cash provided by (used in) financing activities was $(36.1) million, $90.9 million and $142.9 million for the years ended June 30, 2012, 2013 and 2014, respectively. The increase in net cash provided by financing activities from fiscal 2013 to fiscal 2014 was primarily the result of the $82.0 million in proceeds received from our IPO, net of issuance costs. This was partially offset by the $31.3 million change on the net change in funds held for clients. The decrease in net cash used in financing activities from fiscal 2012 to fiscal 2013 was primarily the result of a $128.4 million change in the net change in funds held for clients, partially offset by a net increase of $1.3 million of principal payments on long-term debt. Contractual Obligations and Commitments Our principal commitments consist of operating lease obligations and consideration due to one of our resellers to complete the purchase of certain of its assets. The following table summarizes our contractual obligations at June 30, 2014: Payment Due By Period Less than More than Total 1 Year 1 - 3 Years 3 - 5 Years 5 years Operating lease obligations $17,350 $3,353 $6,749 $5,611 $1,637 Unconditional purchase obligations 1,224 406 818 - - Consideration related to acquisition 2,985 2,985 - - - $21,559 $6,744 $7,567 $5,611 $1,637 Each of our two reseller agreements provided that we are required upon a termination of the agreement to acquire the assets of the reseller. One of the agreements provided that either party may terminate the agreement by electing not to renew the agreement beyond its original term ending in February 2016 unless renewed. We, but not the reseller, also had the right to terminate the agreement at any time following the completion of an initial public offering by the Company. We paid this reseller $1.7 million, $2.4 million and $2.5 million for the full fiscal years 2012, 2013 and 2014, respectively. We exercised our right to terminate the agreement in April 2014 and closed on the purchase of the reseller's client base in May 2014 at a total purchase price of $9.4 million. The second reseller agreement provides that the reseller may terminate the agreement by providing nine months' prior notice or upon an initial public offering by the Company. We 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 us or (ii) December 31, 2014. In addition, we, but not the reseller, now have the right to terminate the agreement at any time after the date that is six months following the completion of an initial public offering by us. If a termination were to occur, the purchase price of the assets would be equal to 3.3 times the net revenues of the reseller for the 12 months preceding the termination effective date. We paid this reseller $1.3 million, $1.8 million and $2.1 million for the full fiscal years 2012, 2013 and 2014, respectively. 48 -------------------------------------------------------------------------------- Table of Contents Capital Expenditures We expect to increase capital spending as we continue to grow our business and expand and enhance our data centers and technical infrastructure. Future capital requirements will depend on many factors, including our rate of sales growth. In the event that our sales growth or other factors do not meet our expectations, we may eliminate or curtail capital projects in order to mitigate the impact on our use of cash. Capital expenditures were $3.4 million, $4.0 million and $6.7 million for the years ended June 30, 2012, 2013 and 2014, respectively, exclusive of capitalized internally developed software costs of $3.7 million, $2.0 million, and $4.3 million for the same periods, respectively. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that may be material to investors. New Accounting Pronouncements 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 "full retrospective" adoption or a "modified retrospective" adoption. 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 and is currently assessing the potential effects of these changes to its consolidated financial statements. Although we are eligible under the JOBS Act to delay adoption of new or revised financial accounting standards until they are applicable to private companies, we have elected not to avail ourselves of this exclusion. This election by us is irrevocable. |