S

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

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

For the quarterly period ended December 31, 2017

☐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 ☒  No ☐

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

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

Large Accelerated Filer	☒	Accelerated Filer	☐
Non-Accelerated Filer	☐  (Do not check if a smaller reporting company)	Smaller Reporting Company	☐
Emerging Growth Company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ☐

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 52,603,746 shares of Common Stock, $0.001 par value per share, as of February 2, 2018.

Paylocity Holding Corporation

Form 10-Q

For the Quarterly Period Ended December 31, 2017

TABLE OF CONTENTS

	Page
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Unaudited Consolidated Balance Sheets	2
Unaudited Consolidated Statements of Operations and Comprehensive Income (Loss)	3
Unaudited Consolidated Statement of Changes in Stockholders’ Equity	4
Unaudited Consolidated Statements of Cash Flows	5
Notes to the Unaudited Consolidated Financial Statements	6
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	31
ITEM 4. CONTROLS AND PROCEDURES	31
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS	33
ITEM 1A. RISK FACTORS	33
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	51
ITEM 3. DEFAULTS UPON SENIOR SECURITIES	52
ITEM 4. MINE SAFETY DISCLOSURES	52
ITEM 5. OTHER INFORMATION	52
ITEM 6. EXHIBITS	52
SIGNATURES	54

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PART I

FINANCIAL INFORMATION

Item  1.    Financial Statements

PAYLOCITY HOLDING CORPORATION

Unaudited Consolidated Balance Sheets

(in thousands, except per share data)

	June 30,		December 31,
	2017		2017
Assets
Current assets:
Cash and cash equivalents	$	103,468	$	111,027
Accounts receivable, net		2,040		2,739
Prepaid expenses and other		14,879		7,456
Total current assets before funds held for clients		120,387		121,222
Funds held for clients		942,459		1,345,702
Total current assets		1,062,846		1,466,924
Long-term prepaid expenses		1,535		1,072
Capitalized internal-use software, net		17,394		18,786
Property and equipment, net		40,756		48,354
Intangible assets, net		8,907		8,189
Goodwill		6,003		6,003
Total assets	$	1,137,441	$	1,549,328
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	2,046	$	1,794
Accrued expenses		30,301		29,128
Total current liabilities before client fund obligations		32,347		30,922
Client fund obligations		942,459		1,345,702
Total current liabilities		974,806		1,376,624
Deferred rent		14,621		14,243
Deferred income tax liabilities, net		401		308
Total liabilities	$	989,828	$	1,391,175
Stockholders’ equity:
Preferred stock, $0.001 par value, 5,000 authorized, no shares issued and outstanding at June 30, 2017 and December 31, 2017	$	—	$	—
Common stock, $0.001 par value, 155,000 shares authorized at June 30, 2017 and December 31, 2017; 51,738 shares issued and outstanding at June 30, 2017 and 52,590 shares issued and outstanding at December 31, 2017		52		53
Additional paid-in capital		192,837		202,512
Accumulated deficit		(45,276)		(44,302)
Accumulated other comprehensive loss		—		(110)
Total stockholders’ equity	$	147,613	$	158,153
Total liabilities and stockholders’ equity	$	1,137,441	$	1,549,328

See accompanying notes to unaudited consolidated financial statements.

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PAYLOCITY HOLDING CORPORATION

Unaudited Consolidated Statements of Operations and Comprehensive Income (Loss)

(in thousands, except per share data)

	Three Months Ended				Six Months Ended
	December 31,				December 31,
	2016		2017		2016		2017
Revenues:
Recurring fees	$	65,347	$	81,292	$	127,267	$	158,586
Interest income on funds held for clients		731		1,783		1,448		3,400
Total recurring revenues		66,078		83,075		128,715		161,986
Implementation services and other		2,576		2,929		4,961		5,518
Total revenues		68,654		86,004		133,676		167,504
Cost of revenues:
Recurring revenues		20,716		25,638		39,819		49,729
Implementation services and other		9,667		11,202		18,923		22,070
Total cost of revenues		30,383		36,840		58,742		71,799
Gross profit		38,271		49,164		74,934		95,705
Operating expenses:
Sales and marketing		17,735		21,598		35,746		42,778
Research and development		7,222		9,274		14,523		18,169
General and administrative		14,957		18,159		28,815		34,110
Total operating expenses		39,914		49,031		79,084		95,057
Operating income (loss)		(1,643)		133		(4,150)		648
Other income		4		141		43		250
Income (loss) before income taxes		(1,639)		274		(4,107)		898
Income tax expense (benefit)		32		(157)		132		(76)
Net income (loss)	$	(1,671)	$	431	$	(4,239)	$	974
Other comprehensive loss, net of tax
Unrealized losses on securities, net of tax		—		(105)		—		(110)
Total other comprehensive loss, net of tax		—		(105)		—		(110)
Comprehensive income (loss)	$	(1,671)	$	326	$	(4,239)	$	864
Net income (loss) per share:
Basic	$	(0.03)	$	0.01	$	(0.08)	$	0.02
Diluted	$	(0.03)	$	0.01	$	(0.08)	$	0.02
Weighted-average shares used in computing net income (loss) per share:
Basic		51,384		52,502		51,308		52,197
Diluted		51,384		54,818		51,308		54,639

See accompanying notes to unaudited consolidated financial statements.

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PAYLOCITY HOLDING CORPORATION

Unaudited Consolidated Statement of Changes in Stockholders’ Equity

(in thousands)

	Stockholders’ Equity
								Accumulated
				Additional				Other		Total
	Common Stock			Paid-in		Accumulated		Comprehensive		Stockholders’
	Shares	Amount		Capital		Deficit		Loss		Equity
Balances at June 30, 2017	51,738	$	52	$	192,837	$	(45,276)	$	—	$	147,613
Stock-based compensation	—		—		15,328		—		—		15,328
Stock options exercised	669		1		5,739		—		—		5,740
Issuance of common stock upon vesting of     restricted stock units	414		—		—		—		—		—
Issuance of common stock under employee     stock purchase plan	53		—		2,045		—		—		2,045
Net settlement for taxes and/or exercise     price related to equity awards	(284)		—		(13,437)		—		—		(13,437)
Unrealized losses on securities, net of tax	—		—		—		—		(110)		(110)
Net income	—		—		—		974		—		974
Balances at December 31, 2017	52,590	$	53	$	202,512	$	(44,302)	$	(110)	$	158,153

See accompanying notes to the unaudited consolidated financial statements.

4

PAYLOCITY HOLDING CORPORATION

Unaudited Consolidated Statements of Cash Flows

(in thousands)

	Six Months Ended
	December 31,
	2016		2017
Cash flows from operating activities:
Net income (loss)	$	(4,239)	$	974
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Stock-based compensation expense		12,448		14,424
Depreciation and amortization expense		9,103		13,438
Deferred income tax expense (benefit)		102		(93)
Provision for doubtful accounts		60		76
Net accretion of discounts and amortization of premiums on available-for-sale securities		—		(141)
Net realized losses on sales of available-for-sale securities		—		2
Loss on disposal of equipment		97		106
Changes in operating assets and liabilities:
Accounts receivable		(446)		(775)
Prepaid expenses and other		845		1,583
Accounts payable		46		(88)
Accrued expenses		(2,626)		(1,290)
Tenant improvement allowance		—		5,952
Net cash provided by operating activities		15,390		34,168
Cash flows from investing activities:
Purchases of available-for-sale securities from funds held for clients		—		(95,207)
Proceeds from sales and maturities of available-for-sale securities from funds held for clients		—		23,181
Net change in funds held for clients' cash and cash equivalents		147,151		(331,078)
Capitalized internal-use software costs		(6,279)		(7,146)
Purchases of property and equipment		(10,038)		(7,998)
Lease allowances used for tenant improvements		—		(5,952)
Net cash provided by (used in) investing activities		130,834		(424,200)
Cash flows from financing activities:
Net change in client fund obligations		(147,151)		403,243
Proceeds from employee stock purchase plan		1,823		2,045
Taxes paid related to net share settlement of equity awards		(5,135)		(7,697)
Net cash provided by (used in) financing activities		(150,463)		397,591
Net Change in Cash and Cash Equivalents		(4,239)		7,559
Cash and Cash Equivalents—Beginning of Period		86,496		103,468
Cash and Cash Equivalents—End of Period	$	82,257	$	111,027
Supplemental Disclosure of Non-Cash Investing and Financing Activities
Purchase of property and equipment and internal-use software, accrued but not paid	$	2,172	$	482
Supplemental Disclosure of Cash Flow Information
Cash paid for income taxes, net of refunds	$	26	$	60

See accompanying notes to unaudited consolidated financial statements.

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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.

(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, internal-use software, valuation and useful lives of long-lived assets, definite-lived intangibles, goodwill, incurred but not reported medical and dental claims, stock-based compensation, valuation of deferred income tax assets and liabilities 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 Company’s financial position, results of operations, changes in stockholders’ equity and cash flows. The results of operations for the three and six months ended December 31, 2017 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, 2017 included in the Company’s Annual Report on Form 10-K filed with the SEC on August 11, 2017.

(c)  Funds Held For Clients and Corporate Investments

Funds held for clients is primarily comprised of cash and cash equivalents invested in demand deposit accounts. Starting in July 2017, the Company also invested a portion of its funds held for clients in marketable securities.

Marketable securities classified as available-for-sale are recorded at fair value on the consolidated balance sheets. Unrealized gains and losses, net of applicable income taxes, are reported as other comprehensive income (loss) in the consolidated statements of operations and comprehensive income (loss). Interest on marketable securities included in

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funds held for clients is reported as interest income on funds held for clients on the consolidated statements of operations and comprehensive income (loss). 

The Company reviews the composition of its portfolio for any available-for-sale security that has a fair value that falls below its amortized cost. If any security fits this criterion, the Company further evaluates whether other-than-temporary impairment exists by considering whether the Company has the intent and ability to retain the security for a period of time sufficient enough to allow for anticipated fair value recovery. The Company did not record any other-than-temporary impairment charges during the three or six months ended December 31, 2017.

(d)  Income Taxes

Income taxes are accounted for in accordance with ASC 740, Income Taxes, using 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 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. 

The Company recognizes deferred tax assets to the extent that it believes that these assets are more likely than not to be realized. In making such a determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. If the Company determines that it would be able to realize its deferred tax assets in the future in excess of their net recorded amount, it would make an adjustment to the deferred tax asset valuation allowance, which would reduce the provision for income taxes.

(e)  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.

(f)  Recently Issued Accounting Standards

In May 2014, the Financial Accounting Standards 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. In addition, in March 2016, April 2016, May 2016 and December 2016 the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) (“ASU 2016-08”), ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing (“ASU 2016-10”), ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients (“ASU 2016-12”) and ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers (“ASU 2016-20”), respectively, to amend certain guidance in ASU 2014-09. Topic 606 allows for either a retrospective or cumulative effect transition method. ASU 2014-09 was originally effective for fiscal years beginning after December 15, 2016. In July 2015, the FASB approved a one-year deferral of ASU 2014-09 and all amendments to it, with a new effective date for fiscal years beginning after December 15, 2017 with early adoption permitted as of the original effective date.

The Company currently expects to adopt the new standard in its fiscal year beginning July 1, 2018 using the full retrospective method.  While the impact the new revenue recognition standard will have on its consolidated financial statements and disclosures has not yet been fully assessed, the Company currently expects that there will be a material impact in the manner in which it treats certain costs of obtaining new contracts (i.e., selling and commission costs).  The

7

new standard will require the Company to defer these costs and amortize them versus current treatment of expensing these costs as incurred. The Company is continuing to evaluate all potential impacts as well as the changes required for systems, processes and internal controls to meet the new standard’s reporting and disclosure requirements.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”) which amends various aspects of existing guidance for leases. ASU 2016-02 requires an entity to recognize assets and liabilities arising from a lease with terms greater than twelve months, along with additional qualitative and quantitative disclosures. ASU 2016-02 also requires the use of the modified retrospective method, which will require adjustment to all comparative periods presented. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company is currently assessing the potential effects of these changes to its consolidated financial statements and expects to adopt this new standard in its fiscal year beginning July 1, 2019.

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718) (“ASU 2016-09”) which modifies accounting for excess tax benefits and tax deficiencies, forfeitures, and employer tax withholding requirements.  ASU 2016-09 also clarifies certain classifications on the statement of cash flows. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, with early adoption permitted. The Company adopted this standard effective July 1, 2017. Due to the Company’s tax valuation allowance, the adoption of this standard did not have a material impact on its consolidated financial statements and disclosures. The Company will continue to estimate forfeitures at each reporting period, rather than electing an accounting policy change to record the impact of such forfeitures as they occur.

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 other 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, 2017	$	266
Charged to expense		76
Write-offs		(85)
Balance at December 31, 2017	$	257

Capitalized internal-use software and accumulated amortization were as follows:

	June 30,		December 31,
	2017		2017
Capitalized internal-use software	$	49,663	$	57,758
Accumulated amortization		(32,269)		(38,972)
Capitalized internal-use software, net	$	17,394	$	18,786

Amortization of capitalized internal-use software costs is included in Cost of Revenues-Recurring Revenues and amounted to $1,950 and $3,314 for the three months ended December 31, 2016 and 2017, respectively, and $3,634 and $6,703 for the six months ended December 31, 2016 and 2017, respectively.

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Property and equipment, net consist of the following:

	June 30,		December 31,
	2017		2017
Office equipment	$	3,591	$	3,797
Computer equipment		24,411		27,567
Furniture and fixtures		7,547		8,821
Software		4,954		5,008
Leasehold improvements		21,426		29,324
Time clocks rented by clients		4,240		4,489
Total		66,169		79,006
Accumulated depreciation		(25,413)		(30,652)
Property and equipment, net	$	40,756	$	48,354

Depreciation expense amounted to $2,504 and $3,092 for the three months ended December 31, 2016 and 2017, respectively, and $4,707 and $6,017 for the six months ended December 31, 2016 and 2017, respectively.

Intangible assets, net consist of the following:

					Weighted
					Average
	June 30,		December 31,		Useful
	2017		2017		Life
Client relationships	$	12,580	$	12,580	9 years
Non-solicitation agreements		360		360	2 - 3 years
Total		12,940		12,940
Accumulated amortization		(4,033)		(4,751)
Intangible assets, net	$	8,907	$	8,189

Amortization expense for acquired intangible assets was $381 and $359 for the three months ended December 31, 2016 and 2017, respectively, and $762 and $718 for the six months ended December 31, 2016 and 2017, respectively.

Future amortization expense for acquired intangible assets is as follows, as of December 31, 2017:

Remainder of fiscal 2018	$	709
Fiscal 2019		1,398
Fiscal 2020		1,398
Fiscal 2021		1,398
Fiscal 2022		1,398
Thereafter		1,888
Total	$	8,189

The components of accrued expenses were as follows:

	June 30,		December 31,
	2017		2017
Accrued payroll and personnel costs	$	25,131	$	22,405
Other		5,170		6,723
Total accrued expenses	$	30,301	$	29,128

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(4) Funds Held for Clients and Corporate Investments

Investments consist of the following as of December 31, 2017:

			Gross		Gross
	Amortized		unrealized		unrealized
Type of Issue	cost		gains		losses		Fair value
Funds held for clients' cash and cash equivalents	$	1,273,819	$	—	$	(5)	$	1,273,814
Available-for-sale securities:
Corporate bonds		34,323		5		(70)		34,258
Commercial paper		25,375		—		(13)		25,362
Asset-backed securities		12,295		—		(27)		12,268
Total available-for-sale securities		71,993		5		(110)		71,888
Investments	$	1,345,812	$	5	$	(115)	$	1,345,702

Investments are classified as Funds held for clients on the consolidated balance sheets. Funds held for clients’ cash and cash equivalents included demand deposit accounts, commercial paper and money market funds as of December 31, 2017.

Available-for-sale securities that have been in an unrealized loss position for a period of less than 12 months as of December 31, 2017 had fair market values as follows:

	Gross
	unrealized
	losses		Fair value
Corporate bonds	$	(70)	$	31,549
Commercial paper		(13)		25,362
Asset-backed securities		(27)		12,268
Total	$	(110)	$	69,179

As the Company started investing funds held for clients in available-for-sale securities during the six months ended December 31, 2017, no securities have been in an unrealized loss position for more than 12 months. The Company did not make any material reclassification adjustments out of accumulated other comprehensive loss for realized gains and losses on the sale of available-for-sale securities during the three or six months ended December 31, 2017. Gross realized gains and losses on the sale of available-for-sale securities were immaterial for both the three and six months ended December 31, 2017.

The Company regularly reviews the composition of its portfolio to determine the existence of other-than-temporary-impairment (“OTTI”). The Company did not recognize any OTTI charges in accumulated other comprehensive loss during the three or six months ended December 31, 2017, nor does it believe that OTTI exists in its portfolio as of December 31, 2017. The Company plans to retain the securities in an unrealized loss position for a period of time sufficient enough to recover their amortized cost basis or until their maturity date. The Company believes that the unrealized losses on these securities were not due to deterioration in credit risk. The securities in an unrealized loss position held an A-1 rating or better as of December 31, 2017.

Expected maturities of available-for-sale securities at December 31, 2017 are as follows:

	Amortized
	cost		Fair value
One year or less	$	54,968	$	54,912
One year to two years		15,421		15,368
Two years to three years		1,604		1,608
Total available-for-sale securities	$	71,993	$	71,888

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(5)  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.

The Company measures any cash and cash equivalents, accounts receivable, accounts payable and client fund obligations at fair value on a recurring basis using Level 1 inputs. The Company considers the recorded value of these financial assets and liabilities to approximate the fair value of the respective assets and liabilities at June 30, 2017 and December 31, 2017 based upon the short-term nature of these assets and liabilities.

Marketable securities, consisting of securities classified as available-for-sale as well as certain cash equivalents, are recorded at fair value on a recurring basis using Level 2 inputs obtained from an independent pricing service. Available-for-sale securities include asset-backed securities, corporate bonds and commercial paper. The independent pricing service utilizes a variety of inputs including benchmark yields, broker/dealer quoted prices, reported trades, issuer spreads as well as other available market data. The Company, on a sample basis, validates the pricing from the independent pricing service against another third-party pricing source for reasonableness. The Company has not adjusted any prices obtained by the independent pricing service, as it believes they are appropriately valued. There were no available-for-sale securities classified in Level 3 of the fair value hierarchy at December 31, 2017, and the Company did not transfer assets between Levels during the six months ended December 31, 2017. The Company did not hold any marketable securities at June 30, 2017.

The fair value level for the funds held for clients’ cash and cash equivalents and available-for-sale securities as of December 31, 2017 is as follows:

	Total		Level 1		Level 2		Level 3
Funds held for clients' cash and cash equivalents	$	1,273,814	$	1,245,955	$	27,859	$	—
Available-for-sale securities:
Corporate bonds		34,258				34,258
Commercial paper		25,362				25,362
Asset-backed securities		12,268				12,268
Total available-for-sale securities		71,888		—		71,888		—
Investments	$	1,345,702	$	1,245,955	$	99,747	$	—

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(6)  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 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 of 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. 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.

As of December 31, 2017, the Company had 11,589 shares allocated to the plans, of which 3,940 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 following table summarizes changes in the number of shares available for grant under the Company’s equity incentive plans during the six months ended December 31, 2017:

	Number of Shares
Available for grant at July 1, 2017	8,227
RSUs granted	(845)
Shares withheld in settlement of taxes and/or exercise price	284
Forfeitures	28
Shares removed	(45)
Available for grant at December 31, 2017	7,649

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

Stock-based compensation expense related to stock options, restricted stock units (“RSUs”), and the Employee Stock Purchase Plan (as described below) is included in the following line items in the accompanying unaudited consolidated statements of operations and comprehensive income (loss):

	Three Months Ended December 31,				Six Months Ended December 31,
	2016		2017		2016		2017
Cost of revenue – recurring	$	593	$	734	$	1,136	$	1,356
Cost of revenue – non-recurring		367		377		668		749
Sales and marketing		1,683		2,205		3,208		4,143
Research and development		870		945		1,664		1,816
General and administrative		3,122		3,557		5,772		6,360
Total stock-based compensation expense	$	6,635	$	7,818	$	12,448	$	14,424

In addition, the Company capitalized $500 and $471 of stock-based compensation expense in its capitalized internal-use software costs in the three months ended December 31, 2016 and 2017, respectively, and $872 and $904 in the six months ended December 31, 2016 and 2017, respectively.

Under the 2008 and 2014 Plans, the exercise price of each option cannot be less than the fair value of a share of common stock on the grant date. The options typically vest ratably over a three or four year period and expire 10 years

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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.

There were no stock options granted during the six months ended December 31, 2016 or 2017. The table below presents stock option activity during the six months ended December 31, 2017:

Outstanding Options
		Weighted
	Weighted	average