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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

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

For the quarterly period ended March 31, 2014

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

For the transition period from     to     

Commission file number 001-36348

PAYLOCITY HOLDING CORPORATION

(Exact name of registrant as specified in its charter)

(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 o  No x

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

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 49,563,736 shares of Common Stock, $0.001 par value per share, as of May 5, 2014.

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Paylocity Holding Corporation

Form 10-Q

For the Quarterly Period Ended March 31, 2014

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PART I. FINANCIAL INFORMATION

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PART I

FINANCIAL INFORMATION

Item  1.                                Financial Statements

PAYLOCITY HOLDING CORPORATION

Unaudited Consolidated Balance Sheets

(in thousands)

See accompanying notes to unaudited consolidated financial statements.

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PAYLOCITY HOLDING CORPORATION

Unaudited Consolidated Statements of Operations

 (in thousands, except per share data)

See accompanying notes to unaudited consolidated financial statements.

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PAYLOCITY HOLDING CORPORATION

Unaudited Consolidated Statements of Changes in Stockholders’ Equity (Deficit)

 (in thousands)

See accompanying notes to the unaudited consolidated financial statements.

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PAYLOCITY HOLDING CORPORATION

Unaudited Consolidated Statements of Cash Flows

 (in thousands)

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”) 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.

The Company was formed on November 6, 2013 upon which Paylocity Corporation became a wholly-owned subsidiary resulting in the inclusion of Paylocity Corporation in the consolidated financial statements of Paylocity Holding Corporation. All holders of Paylocity Corporation equity instruments at the time were issued Paylocity Holding Corporation equity instruments with identical rights and obligations in exchange for their Paylocity Corporation equity instruments. Upon the completion of these transactions, Paylocity Holding Corporation was the sole stockholder of Paylocity Corporation.

In March 2014, the Company amended its Certificate of Incorporation to execute a reverse three for two stock split on its common stock.  All share and per share amounts in the Company’s unaudited consolidated financial statements and notes to the financial statement reflect the impact of this change on the number of shares authorized, issued, and outstanding and earnings per share.

Initial Public Offering

In March 2014, the Company completed its initial public offering (“IPO”) in which it 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.  The Company did not receive any proceeds from the sale of common stock by the existing shareholders.  The Company received net proceeds of $82,001 after deducting underwriting discounts and commissions of $6,387 and other offering expenses of $2,851.  Upon the closing of the IPO, all shares of the Company’s then-outstanding redeemable convertible preferred stock automatically converted into 11,933 shares of its $0.001 par value common stock.

In March 2014, after the conversion of the Company’s then-outstanding redeemable convertible preferred stock into common stock, the Company amended its Certificate of Incorporation to increase the number of authorized common stock to 155,000 and reduce the number of authorized preferred stock to 5,000.

(2) Summary of Significant Accounting Policies

(a) Principles of Consolidation

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.

(b) Interim Unaudited Consolidated Financial Information

The accompanying unaudited consolidated financial statements and notes have been prepared in accordance with GAAP and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, the interim financial information includes all adjustments of a normal recurring nature necessary for a fair presentation of the results of operations, financial position, changes in stockholders’ equity (deficit) and cash flows. The results of operations for the three and nine-month periods ended March 31, 2014 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, 2013 included in the Company’s final prospectus filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended, with the SEC on March 19, 2014.

(c) Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires the Company to make estimates and assumptions that affect the reported amounts in the consolidated financial statements and accompanying notes. Significant items

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subject to such estimates and assumptions include (1) allowance for doubtful accounts; (2) software developed for internal use; (3) impairment of property and equipment; (4) stock-based compensation; (5) evaluation of net deferred income tax assets and (6) the best estimate of selling price for revenue recognition purposes. These estimates are based on the Company’s knowledge of current events and actions it may undertake in the future as well as on various other assumptions that it believes to be reasonable. Actual results could differ from those estimates.

(d) Income Taxes

Differences in the normal relationship between the income tax (expense) benefit and pre-tax income (loss) result from federal and state research and development credits and expenses not deductible for income tax reporting purposes.

(e) Recently Issued Accounting Standards

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

(3) Balance Sheet Information

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

Activity in the allowance for doubtful accounts was as follows:

Capitalized software and accumulated amortization were as follows:

Amortization of capitalized internal-use software costs is included in Cost of Revenues-Recurring Revenues and amounted to $751 and $580 for the three months ended March 31, 2013 and 2014, respectively and $2,346 and $1,809 for the nine months ended March 31, 2013 and 2014, respectively.

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Property and equipment consist of the following:

Depreciation expense amounted to $661 and $1,040 for the three months ended March 31, 2013 and 2014, respectively and $1,799 and $2,735 for the nine months ended March 31, 2013 and 2014, respectively.

The components of accrued expenses were as follows:

(4) Fair Value Measurement

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

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

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

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

Substantially all of the Company’s assets that are measured at fair value on a recurring basis are measured using Level 1 inputs. The Company considers the recorded value of its financial assets and liabilities, which consist primarily of cash and cash equivalents, accounts receivable, and accounts payable, to approximate the fair value of the respective assets and liabilities at June 30, 2013 and March 31, 2014 based upon the short-term nature of the assets and liabilities.

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(5) Benefit Plans

(a) Equity Incentive Plan

The Company maintains a 2008 Equity Incentive Plan (the “2008 Plan”) and a 2014 Equity Incentive Plan (the ‘2014 Plan”) pursuant to which the Company has reserved 7,071 shares of its common stock for issuance to its employees, directors and non-employee third parties. The 2014 Plan serves as the successor to the 2008 plan and permits the granting of options to purchase common stock and other equity incentives at the discretion the compensation committee of the Company’s board of directors. No new awards will be issued under the 2008 Plan as of 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.

Under the 2008 and 2014 Plans, the exercise price of each option is not less than the fair value of a share of common stock on the grant date. As of March 31, 2014, the Company had 2,528 shares allocated to the 2014 Plan, but not yet issued or subject to outstanding options or awards.  Generally, the Company issues previously unissued shares for the exercise of stock options; however, previously acquired shares may be reissued to satisfy future issuances.  The options typically vest ratably over a three or four year period and expire 10 years from the grant date.  Compensation expense for the fair value of the options at their grant date is recognized ratably over the vesting schedule.

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

In addition, the Company capitalized $76 of stock compensation costs in its internal use software in the three month and nine month periods ended March 31, 2014.  No such amounts were capitalized in internal use software in the three month and nine month periods ended March 31, 2013.

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

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

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Stock option activity during the periods indicated is as follows:

The weighted average grant date fair value of options granted during the three-month period ended March 31, 2014 was $7.62.  There were no options granted during the three-month period ended March 31, 2013.  The weighted average grant date fair value of options granted during the nine-month period ended March 31, 2013 and 2014 was $1.22 and $6.39, respectively. The total intrinsic value of options exercised during the nine month period ended March 31, 2013 was $87.  There were no options exercised in the three month periods ended March 31, 2013 and 2014 and nine month period ended March 31, 2014.

The Company may also grant RSAs and RSUs under the Plan with terms determined at the discretion of the Compensation Committee of the Company’s Board of Directors. Prior to the IPO, the Company had 269 RSAs outstanding to certain employees.  The RSAs vested and were issued as common shares as a result of the satisfaction of the vesting criteria upon the completion of the IPO in March 2014 at which time the Company recorded compensation expense in the amount of $351 which is included in the compensation expense recognition table above.  Concurrent with the IPO in March 2014, the Company granted 108 RSUs primarily to certain employees and members of its Board of Directors of which 93 vest over a period of six months commencing on the date of the IPO, 6 vested immediately, 4 vest one year from the date of the IPO, and 5 vest two years from the date of the IPO.  Compensation expense related to these newly issued RSUs is reflected in general and administrative expense, included in the compensation expense table above, based on the fair value of the instruments on the date of grant and recognized in the period between the date of grant and the date of vesting as the vesting is based on the passage of time.  In addition, approximately 2 of the 6 RSUs that vested immediately were issued to consultants that provided professional services directly related to the IPO and, thus, the Company recognized the $30 cost associated with those RSUs as an offering cost offsetting the net proceeds from the IPO.

At March 31, 2014, there was $14,680 of total unrecognized compensation cost, net of estimated forfeitures, related to unvested stock option and restricted stock awards granted under the Plan. That cost is expected to be recognized over a weighted average period of 1.76 years.

(b) 401(k) Plan

The Company maintains a 401(k) plan with a safe harbor matching provision that covers all eligible employees. The Company matches 50% of the employees’ contributions up to 6% of their gross pay. Contributions were approximately $197 and $316 for the three months ended March 31, 2013 and 2014, respectively and $493 and $793 for the nine months ended March 31, 2013 and 2014, respectively.

(6) Commitments and Contingencies

Reseller Agreements

The Company has agreements with two organizations that sell the Company’s offerings and services in defined areas of the country. The initial term of the first reseller agreement commenced in February 2007 and expires in February 2016 unless renewed or terminated. The initial term of the second reseller agreement commenced in June 2009 and expires in June 2016 unless renewed or terminated. Each of the Company’s reseller agreements provides that the Company is required upon a termination of the agreement to acquire the assets of the reseller.

The first reseller agreement provides that either party may terminate the agreement by electing not to renew the agreement beyond its original term. The Company, but not the reseller, also has the right to terminate the agreement at any time following the completion of an initial public offering by the Company. The Company exercised its right to terminate the agreement in April 2014 and expects to

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close on the purchase of the reseller’s client base in May 2014.  The termination agreement calls for a $6 million payment due upon closing and an additional payment currently estimated at $3 million payable within 90 days of closing.  The Company expensed $0.8 million and $0.9 million during the three-month period ended March 31, 2013 and 2014, respectively and $1.8 million and $2.2 million during the nine-month period ended March 31, 2013 and 2014, respectively, as per the terms of the revenue sharing agreement with the first reseller.

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. The Company amended this agreement in December of 2013 to provide that the reseller may not give a nine-month termination notice until after the earlier of (i) six months following the closing of an initial public offering by the Company or (ii) December 31, 2014. In addition, the Company, but not the reseller, now has 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 the Company. 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. The Company expensed the second reseller $0.5 million and $0.6 million during the three-month period ended March 31, 2013 and 2014, respectively and $1.3 million and $1.5 million during the nine-month period ended March 31, 2013 and 2014, respectively, as per the terms of the revenue sharing agreement with the second reseller.

(7) Earnings Per Share

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

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

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

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

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

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

The following table summarizes the outstanding employee stock options, restricted stock units, and redeemable convertible preferred stock that were excluded from the diluted per share calculation for the periods presented because to include them would have been anti-dilutive:

Restricted Stock Awards were excluded from both basic and diluted earnings per share calculations for the three and nine month periods ended March 31, 2013 as the vesting conditions had not been met as of that date.

(8) Line of Credit and Long-Term Debt

On March 31, 2014, the Company terminated its line of credit and paid the remaining outstanding balance of $1,146 on its note payable with a bank.  There were no prepayment penalties assessed in accordance with the terms of the agreement.

(9) Income Taxes

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

The Company recorded income tax expense of $575 and $1,042 for the three month periods ended March 31, 2013 and 2014 respectively.  The Company’s effective rate for the three months ended March 31, 2013 differed from statutory rates primarily due to the retroactive benefit related to the extension of the Federal research and development credit by Congress during the period ended March 31, 2013 and state research and development credits and expenses not deductible for income tax reporting purposes.  The Company’s effective rate for the three month period ended March 31, 2014 differed from statutory rates primarily due to state research and development credits available to the Company and expenses not deductible for income tax reporting purposes.  No benefit from federal research and development credits were recorded in the three month period ended March 31, 2014 due to there being no authorizing legislation for periods after December 31, 2013.

The Company recorded income tax benefits of $(106) and $(197) for the nine month periods ended March 31, 2013 and 2014 respectively. The Company’s effective rate for the nine months ended March 31, 2013 differed from statutory rates primarily due to the retroactive benefit related to the extension of the Federal research and development credit by Congress during the period ended March 31, 2013 and state research and development credits and expenses not deductible for income tax reporting purposes. The Company’s effective rate for the nine month period ended March 31, 2014 differed from statutory rates primarily due to state research and development credits available to the Company, expenses not deductible for income tax reporting purposes,

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and Federal research and development credits available to the Company until December 31, 2013 at which point the authorizing legislation expired.

The Company reviews the likelihood that is will realize the benefit of its deferred tax assets and, therefore, the need for a valuation allowance on a quarterly basis.  Specifically, the Company has a recent history of utilizing past net operating loss carryforwards, has tax planning strategies available to generate taxable net income in future periods, expects carryforward periods through 2031 to utilize the available net operating loss carryforwards and has carryforwards for research and development tax credits available until between 2017 and 2032.  As of March 31, 2014, the Company had no unrecognized tax benefits that would affect the Company’s effective tax rate if recognized.

(10) Related Party Transactions

The Company purchased sales leads from an entity owned by one of the stockholders in the amount of approximately $277 and $0 for the three months and $701 and $231 for the nine months ended March 31, 2013 and 2014, respectively. The Company provided no management guidance to the entity and had no equity interest in the entity, no obligation or intention to fund any of the entity’s operational shortfalls, and no right to any operational surpluses generated by the entity. Accounts payable due to this entity were $65 and $0 of June 30, 2013 and March 31, 2014, respectively.

As of October 14, 2013, the Company hired substantially all of the employees of this entity and no longer purchases sales leads from the sales lead generation entity described above.

(11) Subsequent events

The Company has evaluated subsequent events from the balance sheet date through May 14, 2014, the date at which the financial statements were available to be issued.

In April 2014, the Company exercised its right to terminate one of its reseller agreements.  See Note 6 for further details.

On May 6, 2014, the Company announced that its principal stockholder was contributing approximately $1.1 million to the Company for the express purpose of paying a cash bonus to long-term employees in recognition of their past service. The Company intends to record a capital contribution to additional paid-in capital for the amount received from the shareholder and compensation expense for the amount paid to employees in the three-month period ending June 30, 2014 accordingly.

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

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

Overview

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

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

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

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

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

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

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

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

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Our operating subsidiary Paylocity Corporation was incorporated in July 1997 as an Illinois corporation. In November 2013, we formed Paylocity Holding Corporation, a Delaware corporation, of which Paylocity Corporation is now a wholly-owned subsidiary. Paylocity Holding Corporation had no operations prior to the restructuring. All of our business operations have historically been, and are currently, conducted by Paylocity Corporation, and the 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 $53.5 million for the nine months ended March 31, 2013 to $74.8 million for the nine months ended March 31, 2014, representing a 40% year-over-year increase. Recurring revenue represented 94% of total revenue for the nine months ended March 31, 2013 and 93% for the nine months ended March 31, 2014. Recurring revenue increased from $22.3 million for the three months ended March 31, 2013 to $31.2 million for the three months ended March 31, 2014, representing a 40% year-over-year increase. Recurring revenue represented 93% and 92% of total revenue during the three months ended March 31, 2013 and 2014, respectively.

Recurring Fees From New Clients

We calculate recurring fees from new clients as the percentage of year-to-date recurring fees from all clients on our solutions which had not been on or used any of our solutions for a full year as of the start of the current fiscal year. We believe recurring fees from new clients is an important metric to measure the expansion of our existing client base as well as the growth in our client base. For the first nine months of fiscal 2013 and fiscal 2014, our recurring fees from new clients was 41% for both periods.

Adjusted Gross Profit, Adjusted Recurring Gross Profit and Adjusted EBITDA

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

Adjusted Gross Profit, Adjusted Recurring Gross Profit and Adjusted EBITDA are not measurements of financial performance under generally accepted accounting principles in the United States, or GAAP, and you should not consider Adjusted Gross Profit as an alternative to gross profit. Adjusted Recurring Gross Profit as an alternative to total recurring revenues, or Adjusted EBITDA as an alternative to net 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 and stock-based compensation expenses, 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 and stock-based compensation expenses, if any. We define Adjusted EBITDA as net income (loss) before interest expense (income), income tax expense (benefit), depreciation and amortization and stock-based compensation expenses. The table below sets forth our Adjusted Gross Profit, Adjusted Recurring Gross Profit and Adjusted EBITDA for the periods presented.

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