No. of Recommendations: 54
As I mentioned, this will be broken out into 3 posts: 1) the business, 2) the financials and 3) comparing PVTL against my earlier posted checklist. I will borrow frequently from the 10Q and S1 filings, the Q1 earnings release, presentation and transcript and the investor relations page, which I will highlight in italics. Note that my background is accounting and audit, so I don’t fully appreciate the technology and rely on others like SteppenWulf to help me better appreciate their business.

Part 1 – the business

The rise of cloud software: Cloud-native software is reshaping businesses across all industries, empowering enterprises to innovate at a higher velocity and become more digital, mobile, data-driven and always-connected. Cloud-native software is designed to be highly available, scalable and modular to allow for frequent iteration and feature releases.

The problem: Despite the widespread availability of private and public cloud infrastructure, many organizations are burdened by legacy technologies and software development processes that prevent them from fully realizing the benefits of cloud-native software.

PVTL’s solution: We provide a leading cloud-native platform that makes software development and IT operations a strategic advantage for our customers. Our cloud-native platform, <b<Pivotal Cloud Foundry ("PCF"), accelerates and streamlines software development by reducing the complexity of building, deploying and operating new cloud-native applications and modernizing legacy applications. This enables our customers' development and IT operations teams to spend more time writing code, waste less time on mundane tasks and focus on activities that drive business value – building and deploying great software. PCF customers can accelerate their adoption of a modern software development process and their business success using our platform through our complementary strategic services, Pivotal Labs ("Labs"). Enterprises across industries have adopted our platform to build, deploy and operate software, including enterprises in the automotive and transportation, industrial and business services, financial services, healthcare and insurance, technology and media, consumer and communications and government sectors.

Market Opportunity: Our cloud-native software addresses IT spending across the rapidly growing market for public cloud workloads, sometimes referred to as Platform-as-a-service ("PaaS"), and the market for application infrastructure, middleware and development software. We believe our cloud-native platform opportunity is the aggregate of these two markets, with spending today estimated at over $50 billion. According to Gartner, spending on cloud application infrastructure services (PaaS) is expected to be $16.0 billion in 2018, growing to $29.0 billion by 2021, representing a 22% compound annual growth rate ("CAGR"). According to Gartner, spending on application infrastructure, middleware and development solutions is expected to be $43.2 billion in 2018, growing to $51.4 billion by 2021, representing a 6% CAGR.

PVTL basically has two revenue streams. The fast growing subscription business:

PCF integrates an expansive set of critical, modern software technologies to provide a turnkey cloud-native platform. PCF combines leading open-source software with our robust proprietary software to meet the exacting enterprise-grade requirements of large organizations, including the ability to operate and manage software across private and public cloud environments, such as Amazon Web Services, Microsoft Azure, Google Cloud Platform, VMware vSphere and OpenStack. PCF is sold on a subscription basis.

The second revenue stream is the service business:

Labs software development experts deliver strategic services that transfer the expertise for enterprises to accelerate their cloud-native transformation by implementing modern agile development practices. With Labs, we help customers co-develop new applications and transform existing ones while accelerating software development, streamlining IT operations and ultimately driving self-sustaining business transformation.

The investment thesis is the significant growth of the PCF subscription business. The subscriptions are typically for 1 or 3 year terms and the revenue is recognized over the subscription period. The revenue that cannot be recognized when the subscription is booked is deferred into future quarters. This gives the company very good visibility into future revenue. The Labs service business helps with the implementation of PCF. Specifically the implementation services enable customers to configure, deploy, test, launch and operate PCF. Over time the PCF business will become more and more significant to the overall revenue and growth. As PCF becomes larger than Labs, PVTL will rely on systems integrator partnerships to deliver Labs-like services to customers.

Here is Rob Mee, PVTL CEO, during the earnings call on integrator partnerships:

we think there’s a large and growing opportunity for systems integrators to help enterprises modernize and re-platform their existing application portfolio. So, we’re working with global systems integrators like Accenture and Cognizant, along with other firms like Perficient that I mentioned. They’re building focused practices around Pivotal technology implementation including application migration but also including cloud-native development. So, they’re very much looking to do modern co-developments in an enablement kind of mode just like Pivotal Labs. And from our perspective, we really feel -- along with the mission of transforming how the world builds software, the more people are enabled to build that way and help others build software that way, the better for the world in general.

PVTL’s strategy is to have the Labs business support and grow the subscription business. The Labs business is low margin and so the company is relying on system integrators to help act as the Labs business in continuing to push PCF. As such, the company expects service revenue to grow slowly and PCF to become a much larger part of the overall company revenue. This is ideal given the high margins (92%) of the PCF business.

Don’t expect PVTL to be a cash cow any time soon. Given the high margin, recurring revenue that PCF generates, the focus is on expanding as soon as possible:

To realize this rapid growth, we have made and expect to continue to make substantial investments across our business. Specifically, we have increased our total employee base over time, and we intend to continue to invest in our business to take advantage of our market opportunity and to expand our sales capacity and further improve sales productivity to drive additional revenue and support the growth of our global customer base. Additionally, we continue to invest in the development and expansion of our partner ecosystem to supplement our sales and services resources and increase our reach in our target markets. We also expect to continue to make significant investments in research and development to expand our product and engineering teams to further develop our platform. We expect to incur increased general and administrative expenses to support our growth and operations as a public company.

The company has key performance indicators, which lets us know what they are focusing on. There are two and they both focus on growing revenue:

1. Subscription Customers - We believe that the number of our subscription customers is an important indicator of the growth of our business, our increased customer footprint and the market acceptance of our platform. We define the number of subscription customers as the organizations that have a subscription contract for our software resulting in at least $50,000 of annual revenue in that period. While we may enter into subscription agreements with multiple parties inside a larger organization, we count a customer as an addition to our subscription customers only if it represents a unique global ultimate parent. In the case of the U.S. government, we count U.S. government departments and major agencies as unique subscription customers. We view our total number of subscription customers as reflective of the number of sources of revenue to us and our growth and potential for future growth.

We had 339, 319 and 282 subscription customers as of May 4, 2018, February 2, 2018 and May 5, 2017, respectively. With the launch of PCF v2.0, including the release of PKS, we expect growth in new customers to continue as we increase our focus on adding new customers. Our total number of subscription customers and the net additions in any period may continue to fluctuate as a result of several factors, including the focus of our sales force, customer satisfaction with the functionality, features, performance or pricing of our offering, consolidation of our customer base and other factors, a number of which are beyond our control.


Customer growth has slowed, but may be picking back up. Customers by fiscal year is 2014 – 0, 2015 – 75, 2016 – 180, 2017 – 275, 2018 – 319, Q1 2019 – 339. While customer growth has slowed markedly in 2018 with only 44 customers added all year, the company has invested into growing customer count and added 20 customer in Q1 alone (annualized 80). Here is more on this from the call:

We haven’t had that many net adds since Q4 of fiscal ‘17. So, we were really pleased with the results. And as I mentioned earlier, we did make some pretty significant investments in the back half of last year to really help drive the field on new customer acquisition and making sure that we were both renewing our existing customers and expanding their footprint but also adding new customers. And so, I think what you saw in Q1 is kind of the starting to kind of realize the benefit of some of those earlier investments.

And

Raimo Lenschow

Thank you. And one quick follow-up for Cynthia. Just we talked a lot about the second half last year investments into increasingly singing more customers. I would assume what we saw this quarter, since they were kind of longer term investments, should be like just the beginning of something, rather than just a one-off quarter thing, correct?

Cynthia Gaylor

Yes. I would say, it’s just the beginning. And I think -- I would say, we don’t forecast guidance on customer account for quarter. So, I would expect different quarters to exhibit different trends there. But, it is a focus area for us. And so, we would expect those investments to pay off over time, but I wouldn’t say we’re forecasting that to be every quarter for the remainder of the year.


Rob Mee mentioned that they are focused on the global 2000, which are the 2,000 largest publicly traded companies in the world and represent $39 trillion is sales. (https://www.forbes.com/global2000/#142eec5335d8) Another area of growth is the US government. We have already seen them pick up the Air Force and the IRS as customers. As an approved government vendor, they may be a preferred supplier for other government entities. Here’s more form Rob:

As we look ahead, we are excited about Pivotal’s ability to penetrate the global 2000. We believe we are well-positioned to disrupt some of the largest areas in IT investment as we help enterprises across industries transform.

2. Dollar-Based Net Expansion Rate - We believe that the dollar-based net expansion rate is an important measure of our business because it is an indicator of our subscription customers’ expanded use of and demand for our platform and our ability to grow revenue and profitability. Our dollar-based net expansion rate compares our subscription revenue from a common group of customers across comparable periods. We calculate our dollar-based net expansion rate for all periods on a trailing four-quarter basis. To do so, we calculate our dollar-based net expansion rate as of each quarter end by starting with the subscription revenue from customers as of the prior year’s same quarter (the “Prior Period Subscription Revenue”). We then calculate subscription revenue from these same customers as of the current quarter end (the “Current Period Subscription Revenue”). Finally, to assess net expansion level for common groups of customers over time, we divide the aggregate Current Period Subscription Revenue for the trailing four quarters by the aggregate Prior Period Subscription Revenue for the trailing four quarters resulting in our dollar-based expansion rate.

We expect our dollar-based net expansion rate to remain a significant indicator of our business momentum and results of operations as existing customers realize the benefits of our software and expand their PCF subscriptions. Our dollar-based net expansion rate has fluctuated and we expect it to continue to fluctuate and decline over time as we scale our business and as a result of several factors, including the size of the transactions, the timing and terms of the deals and our customers’ satisfaction with our offering. Our dollar-based net expansion rate was approximately 156% for the three months ended May 4, 2018, 158% for the three months ended February 2, 2018 and 164% for the three months ended May 5, 2017.


In the earnings call, they discussed the expansion rate and how we should expect this to come down over time. However, adding new customers does support a higher expansion rate as they will likely expand as they see the initial benefits. Here is more from the earnings call:

We’re at kind of leading -- industry leading net expansion rate of 156%. Now that we’re at scale, we wouldn’t expect to maintain that rate, so you should expect that rate to come down over time. But we also saw strong demand from new customers in the quarter.

Background and Dell

We were formed in April 2013. DellEMC and VMware transferred teams and contributed assets and technology to Pivotal that have become key elements of our cloud-native platform and strategic services. Following the acquisition of EMC Corporation by Dell Technologies in September 2016, Pivotal's majority stockholder became Dell Technologies. While we initially received certain back office and other administrative services from DellEMC and VMware, over time we have implemented our own systems and processes, reducing our reliance on these partners for most of these services. Today, we jointly market and sell our products and services with DellEMC and VMware and enjoy significant and mutually beneficial commercial and go-to-market relationships with them.

Dell Technologies is our majority stockholder. For more information on our relationship with Dell Technologies, see "Certain Relationships and Related Party Transactions" and "Principal and Selling Stockholders."

Currently, Dell Technologies will own, indirectly through its subsidiaries (including VMware), 175,514,272 shares of our outstanding Class B common stock, which will represent approximately 70.1% of our total outstanding shares of common stock and approximately 95.9% of the combined voting power of both classes of our outstanding common As a result, Dell Technologies will be able to exercise control over all matters requiring approval by our stockholders, including the election of our directors and approval of significant corporate transactions. Dell Technologies' controlling interest may discourage or prevent a change in control of our company that other holders of our common stock may favor.


Competitive Strengths:

• First mover in cloud-native transformations.
• Enterprise-grade software platform integrating open source.
• Blue-chip customer adoption.
• Large and growing PCF ecosystem.
• Leading cloud-native platform with strategic services.
• Viral adoption together with C-level focus.


Growth Strategy

• Extend technology lead of our cloud-native platform.
• Maintain open cloud-native platform advantage.
• Continue to drive new customer adoption.
• Expand adoption within existing customers.
• Continue to capitalize upon our relationships with our strategic partners.
• Further leverage partnerships with public cloud vendors.
• Continue to leverage the combined strengths of PCF and Labs to drive PCF expansion.
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No. of Recommendations: 35
Part 2 – the financials

Total revenue increased from $121M to $156M up 28% yoy. Subscription revenue increased from $53M to $90M up 69% yoy, while service revenue decreased slightly from $68M to $66M.

Total gross margin was 64%, up from 54% last year. Subscription margin was 92%, up from 89% last year. Service revenue margin was 26%, which is flat from last year.

Subscription revenue was 44% of total revenue last year and is now 58% of total revenue. This is critical because investors may be overlooking the company seeing 28% total revenue growth and 64% margins, while the stock trades at a healthy valuation. With the low/no growth service revenue representing the majority of the revenue, it had a bigger impact on total revenue growth and margins. With the high growth subscription revenue now making up the larger part of the overall revenue, it will have a larger impact on overall revenue growth and have a bigger impact on margins. As PCF becomes a larger part of the total revenue, expect overall revenue growth to accelerate even if subscription growth slightly slows down its high growth.

Looking at the balance sheet, cash increased from $73M on 2/2/18 to $645M as of 5/4/18, while the company has no debt as of Q1. This increase in cash was driven by the IPO proceeds.

Jumping to the cash flow statement, cash flow from operating activities was positive $4.5M vs negative 4.4M last year.

Cash flow from financing activity was positive $565M due to $547M in IPO proceeds and $32M from Dell, which represented a tax sharing payment. The tax sharing payment was discussed on the call and management mentioned that it should be significantly lower going forward.

Seeing that the company has no debt, has $645M in cash and is cash flow positive from operating activities, it demonstrates that they are on solid financial footing.

Now let’s go back to the income statement.

Total cost of revenue remained relatively flat, increasing by $0.3 million to $59.3 million during the three months ended May 4, 2018 from $59.0 million during the three months ended May 5, 2017. Cost of subscription revenue increased by $0.6 million, or 8%, to $8.1 million during the three months ended May 4, 2018 from $7.5 million during the three months ended May 5, 2017. The increase in cost of subscription was primarily due to an increase in support personnel costs related to the increase in subscription customers. The cost of services revenue remained relatively flat, decreasing by $0.4 million, to $51.2 million during the three months ended May 4, 2018 from $51.5 million during the three months ended May 5, 2017.

It is very impressive that total cost of sales was flat when total revenue increased by 28%. This demonstrates the power of generating increasing revenue in the high margin PCF business.

Sales and marketing expense increased by $17.0 million, or 33%, to $69.1 million during the three months ended May 4, 2018 from $52.2 million in during the three months ended May 5, 2017. The increase in sales and marketing expense was primarily due to an increase of $15.4 million in personnel costs and commissions.

Research and development expense increased by $4.4 million, or 11%, to $44.4 million during the three months ended May 4, 2018 from $40.0 million during the three months ended May 5, 2017. The increase in research and development expense was primarily due to an increase of $6.2 million in personnel costs offset by a decrease of $1.8 million in cloud infrastructure costs.


The company is investing in S&M and R&D as it looks to expand PCF as quickly as possible. Given that the company is doing this while still being cash flow positive with plenty of cash on hand, I would say that this is exactly what the company should be doing.

General and administrative expense decreased by $2.0 million, or 11%, to $16.4 million during the three months ended May 4, 2018 from $18.4 million during the three months ended May 5, 2017. The decrease in general and administrative expense was associated with lower infrastructure, third party and systems implementation expenses.

Also, good to see that the company is spending money where it should to grow the business, while still saving money on G&A.

Now some key items from the recently filed 10Q:

On April 19, 2018, we commenced an initial public offering (“IPO”), which closed on April 24, 2018. As part of the IPO, we issued and sold 38,667,000 shares of our newly authorized Class A common stock, which included 5,550,000 shares sold pursuant to the exercise by the underwriters’ option to purchase additional shares at a public offering price of $15.00 per share. We received net proceeds of $548.1 million from the IPO, after underwriters’ discounts and commissions and before deducting offering costs of approximately $3.7 million, of which $2.8 million is accrued as of May 4, 2018.

As of May 4, 2018, 81,459,299 shares of the Company’s Class A common stock and 175,514,272 shares of Class B common stock were outstanding. The Class A common stock outstanding includes the shares issued in the IPO.


To get total market cap, you combine the class A and class B shares to get 256.973M total shares outstanding and then multiply that by the Friday’s closing price 24.27 to get $6.24B market cap.

Unearned Revenue and Performance Obligations

Contract liabilities consist of deferred revenue and include payments received in advance of performance under the contract. Such amounts are recognized as revenue over the contractual period. During the three months ended May 4, 2018 and May 5, 2017 we recognized revenue of $94.0 million and $59.4 million, respectively, which was included in the corresponding deferred revenue balance at the beginning of the reporting periods presented.

We receive payments from customers based upon contractual billing schedules; accounts receivable are recorded when the right to consideration becomes unconditional. We generally bill our customers annually in advance, although for our multi-year contracts, some customers prefer to pay the full multi-year contract amount in advance. Payment terms on invoiced amounts are typically 30 to 90 days. Contract assets include amounts related to our contractual right to consideration for both completed and partially completed performance obligations that may not have been invoiced; such amounts have been insignificant to date.

The typical contract term for subscription contracts is one to three years, while the contract term for professional services is generally less than twelve months. Our contracts are non-cancelable over the contractual term. As of May 4, 2018, the aggregate amount of the transaction price allocated to billed and unbilled remaining performance obligations for subscriptions and services for which revenue has not yet been recognized was approximately $800 million. We expect to recognize approximately 50% of the transaction price as subscription or services revenue over the next 12 months and the remainder thereafter. As of February 2, 2018, the aggregate amount of the transaction price allocated to billed and unbilled remaining performance obligations for subscriptions and services for which revenue had not yet been recognized was approximately $820 million.


So management already knows it will book $400M in revenue over the next 12 months based on non-cancelable contracts already signed.

Now, let’s talk stock comp.

As of May 4, 2018, there was $84.2 million of unrecognized compensation cost related to the unvested options, which is expected to be recognized over the remaining vesting period.

Restricted Stock Units

During the three months ended May 4, 2018, we granted 8,388,643 restricted stock units (“RSUs”) with an aggregate fair value of $125.8 million of which all are outstanding and unvested as of May 4, 2018. RSUs awarded under the 2018 Equity Incentive Plan will generally vest over 48 months as follows: (i) 25% vest approximately one year from the date of grant, and (ii) the remaining 75% vest on a quarterly basis over the remaining term. The vesting is contingent on the employees’ continued service through such date. RSUs are generally subject to forfeiture if employment terminates prior to the vesting date. We expense the cost of the RSUs, which is determined to be the fair market value of the shares of common stock underlying the RSUs on the date of grant, ratably over the period during which the vesting restrictions lapse. For the three months ended May 4, 2018, stock-based compensation expense associated with RSUs was $1.3 million. As of May 4, 2018, there was $124.5 million of unrecognized compensation cost related to unvested RSUs, which is expected to be recognized over the remaining vesting period.

Employee Stock Purchase Plan

Our Employee Stock Purchase Plan (the “ESPP”) became effective upon our IPO. The ESPP initially reserves and authorizes the issuance of up to a total of 2,800,000 shares of Class A common stock to participating employees. Eligible employees may elect to participate in the ESPP in accordance with the enrollment procedures, upon which the employee authorizes payroll deductions from his or her paycheck on each payroll date during the offering period in an amount equal to at least 1% of his or her compensation, but not more than the contribution limit. The contribution limit for each offering period is the lesser of (i) 15% of an eligible employee’s compensation for the offering period or (ii) $7,500. Except for the initial offering period, the ESPP provides for 6-month offering periods commencing on January 11 or July 11 and ending on July 10 or January 10 of each year. The initial offering period under the ESPP commenced on April 20, 2018 and will end on January 10, 2019. On each purchase date, eligible employees will purchase the shares at a price per share equal to 85% of the lesser of (1) the fair market value of our stock on the offering date or (2) the fair market value of our stock on the purchase date. For the three months ended May 4, 2018, stock-based compensation expense associated with the ESPP was $0.2 million. As of May 4, 2018, there was $2.9 million of unrecognized stock-based compensation expense related to the ESPP that is expected to be recognized over the remaining term of the initial offering period.

Total Stock-Based Compensation Expense was $10.7M for Q1 compared to $6.0M from prior year.


Related Party Transactions

DellEMC and VMware Agency Arrangements - Dell, including DellEMC and VMware, are our customers. Since our formation, we have also entered into agency arrangements with DellEMC and VMware that enable our sales team to sell our subscriptions and services leveraging the DellEMC and VMware enterprise relationships and end customer contracts. These transactions result in DellEMC or VMware invoicing customers and collecting on our behalf. In exchange, we pay an agency fee, which is based on a percentage of the invoiced contract amounts, for their services. Such percentage ranged from 1.5% to 5% for both the three months ended May 4, 2018 and the three months ended May 5, 2017.

In aggregate, we paid DellEMC and VMware $3.6 million and $1.3 million for the three months ended May 4, 2018 and May 5, 2017, respectively, which was deferred and amortized to sales and marketing expense over the term of the underlying customer arrangements.

Sales of our Products and Services to DellEMC and VMware - From time to time, we have sold our software products and professional, software support and other services to DellEMC and VMware for their internal use. Revenue recognized for sales of our products and services to DellEMC was $3.6 million and $2.3 million for the three months ended May 4, 2018 and May 5, 2017, respectively. Revenue recognized for sales of our products and services to VMware was $0.5 million and $0.9 million for the three months ended May 4, 2018 and May 5, 2017, respectively.

DellEMC and VMware Transition Services and Employee Matters Agreements - We and DellEMC engage in several ongoing related party transactions which resulted in costs to us. DellEMC acts as a paying agent for certain of our expenses including payments to vendors and other expenses such as payroll. Pursuant to ongoing shared services and employee matters agreements, we are charged by DellEMC for certain management and administrative services, including routine management, administration, finance and accounting based upon estimates and allocations. Additionally, in certain geographic regions where we do not have an established legal entity, we contract with DellEMC subsidiaries for support services. We are charged for overhead items such as facilities and IT systems for our employees that work from DellEMC office locations. The costs incurred by DellEMC on our behalf related to these employees are charged to us with a markup. These costs are included as expenses in our consolidated statements of operations and primarily include salaries, benefits, travel and rent. These expenses are charged to us on the basis of direct usage when identifiable, with the remainder charged primarily on the basis of headcount or other measures. Management believes the basis on which the expenses have been allocated to be a reasonable reflection of the utilization of services provided to or the benefit received by us during the periods presented. Charges received from DellEMC for the three months ended May 4, 2018 and May 5, 2017 were $8.5 million and $33.8 million, respectively.

Dell Technologies Tax Sharing Agreement - Pursuant to a tax sharing agreement Pivotal has historically received payments from Dell Technologies for the tax benefits derived from the inclusion of our losses in certain Dell Technologies U.S federal and state group returns. As of a result of stock issued during our IPO Pivotal no longer qualifies for inclusion in the Dell Technologies U.S federal consolidated tax return. This reduces the amount of benefit or expense we receive from the tax sharing agreement in prospective periods to the benefit or expense that Dell Technologies realizes from our inclusion in their unitary state returns. As of May 4, 2018, our condensed consolidated balance sheet included $9.5 million of a tax sharing receivable recorded within the due from Parent and additional paid in capital financial statement lines primarily related to our federal taxable loss for the three months ended May 4, 2018.


Looking at the breakdown of international vs domestic, for Q1, 77% of revenue came from the US and 23% from international. This percentage breakdown is consistent with last year, so US and international revenue is growing at around the same rate.

And here is management guidance from the Q1 earnings release:

For the second quarter of fiscal 2019, Pivotal currently expects:
· Subscription revenue of $92 to $93 million
· Total revenue of $157 to $159 million
· Non-GAAP loss from operations of $23 to $22 million
· Non-GAAP net loss per share of 10¢ to 9¢, assuming weighted average shares outstanding of approximately 249 million

For the full fiscal year 2019, Pivotal currently expects:
· Subscription revenue of $380 to $384 million
· Total revenue of $642 to $649 million
· Non-GAAP loss from operations of $96 to $91 million
· Non-GAAP net loss per share of 39¢ to 37¢, assuming weighted average shares outstanding of approximately 244 million


Looking at the full year guidance using the midpoint, total revenue is expected to be $645.5M and subscription revenue is expected to be around $382M. From this, we can expect service revenue to be around $263.5M.

Backing out Q1 revenue ($90M for subscription and $66M for service), you get average quarterly revenue of $97M for subscription and $66M for service for the remaining 3 quarters of the year. This would represent 47% growth in subscription revenue for the total year and 5% growth in service revenue.

To better assess management’s guidance, let’s look at past subscription revenue: Quarterly subscription revenue growth for the last 4 quarters is Q2 2018 – 22.6%, Q3 2018 – 2%, Q4 2018 – 14% and now Q1 2019 - 20%. I think their Q2 guidance of $92-93M for subscription revenue is pretty conservative as it is only 3% growth from this current quarter. Given that subscription revenue has accelerated in the last 3 quarters, it would be pretty disappointing if the average subscription revenue for the next 3 quarters was up only 7% in total. Also, given that they just landed 20 new customers in Q1 and their focus is on landing additional new customers, together with their 156% dollar expansion rate, I believe their subscription guidance is very conservative.
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No. of Recommendations: 58
Part 3 – the checklist

Here again is the post from last week that discussed what I look for in high growth companies: http://boards.fool.com/sales-growth-33108276.aspx

Now, I’ll quickly go through this for PVTL.

1.Strong sales growth guidance over the next year (40% plus)

Although on initial assessment, PVTL would appear to fail this criteria with only 28% revenue growth for Q1, I think we should focus on PCF, which is the company’s focus. Its revenue was up 69% for Q1 and management is guiding for 47% annual growth. I think this guidance is conservative and I would be surprised if PCF revenue growth is below 50%. This is due to PCF revenue growth accelerating during the past 3 quarters.

2. A large addressable market (TAM)

Part 1 covered this. Our cloud-native software addresses IT spending across the rapidly growing market for public cloud workloads, sometimes referred to as Platform-as-a-service ("PaaS"), and the market for application infrastructure, middleware and development software. We believe our cloud-native platform opportunity is the aggregate of these two markets, with spending today estimated at over $50 billion.

Given projected revenue of $645.5M for this year, a $50B TAM is significant.

3. A TAM that is expected to grow significantly

Also addressed in part 1. According to Gartner, spending on cloud application infrastructure services (PaaS) is expected to be $16.0 billion in 2018, growing to $29.0 billion by 2021, representing a 22% compound annual growth rate ("CAGR"). According to Gartner, spending on application infrastructure, middleware and development solutions is expected to be $43.2 billion in 2018, growing to $51.4 billion by 2021, representing a 6% CAGR.

The more important PaaS market growing 22% CAGR is impressive and shows that PVTL’s TAM is growing quickly.

4. A product that customers love

Tinker and other have done a good job posting how customers love PVTL - Boeing (http://boards.fool.com/pivotal-fundamentals-33097756.aspx?so...), the IRS (http://boards.fool.com/pivotal-and-irs-33103917.aspx), the Air Force (http://boards.fool.com/httpsmyoutubecomwatchvlcgxdzojgqe-331...), etc.

Boeing saw a 100 times faster infrastructure, 6 times increase in server utilization and nearly 1,000 developers delivering hundreds of apps to PCF. Here is Boeing’s CIO presenting on what Pivotal has done for them: https://m.youtube.com/watch?v=w9zYTyRrfCQ

T-Mobile saw a 37% increase in developer productivity, Liberty Mutual saw 4 times the release velocity with a 60% reduction in infrastructure costs.

There is a lot more customer stories here: https://pivotal.io/customers

5. A strong dollar expansion rate (over 100%)

PVTL leads the way here with 156%. This demonstrates how much customers really love the product. Expect this to come down somewhat, but PVTL is unmatched for this category.

6. A lot of recurring revenue

PCF is their subscription revenue business and now makes up 58% of total revenue. This will only grow higher given the slow growth service business and high growth PCF business.

Now on to the non-sales metrics.

1. A smaller market cap, preferably less than $10B

PVTL’s current market cap is $6.3B

2. High margins

Overall margins are 64%, but PCF margins are 92%. PCF margins are even expanding as they gain scale. These are great margins.

3. Growing profitability – not only do we want to see strong margins, but increasing margins. This also demonstrates pricing power and scale.

Margins have been increasing for both overall and PCF. Although not profitable, they are cash flow positive from operations while last year they were cash flow negative.

4. Light asset models – no way to have high margins with a lot of fixed assets on the books. Software companies have this and as they get larger, they become more profitable as their variable costs decrease per product sold (scale)

PVTL is definitely asset light given their 92% margins on PCF. Margins are increasing as they gain scale.

5. Little or no debt

PVTL has no debt and has $645M in cash

6. Not a ton of stock comp

Although they issue a good amount of options and RSUs, the total stock comp expense is only $10.7M for Q1. This will likely go up and is a little hard to assess after being public for only 1 quarterly earnings release. So far, the stock comp seems low, but this is something to keep an eye on.

7. High inside ownership – love to see founder led companies with larger ownership of stock. This obviously aligns their interests with fellow shareholders.

Dell owns 70% of the company, while Ford owns 17.5M shares (7%) and GE owns 15.5M shares (6%). According to Yahoo, The CEO, Robert Mee, owns 666,667 shares or around 0.25%. PVTL has not yet filed a proxy statement, so insider ownership is a little hard to assess at this point. Rob has been leading the company since it was founded in 2013.

Overall, PVTL does very well on the above items, especially sales growth.

Now quickly on to valuation. The enterprise value is $5.7B (6.3B market cap minus the 645M in cash) and forecasted sales for this year are $645.5M. That gives us an EV to sales ratio of 8.8 times. In comparison with other high growth software companies, this is not an overvalued stock. I think this is partly due to PCF’s growth and margins being overlooked as the service business brings down the overall revenue growth and margins. Also, being a relatively new IPO, I don’t think PVTL is followed as closely as other software companies. On seeking alpha, there are a few articles but minimal comments. It’s also not a Motely Fool service recommendation (yet). There are 11 analysts that cover the company with 6 with a hold rating, 4 with a buy rating and 1 lonely analyst with a strong buy rating (from Yahoo). I think PVTL’s Q1 earnings release got them some attention, but I think this attention will grow as they continue to put out earnings with heavier contributions from PCF as that becomes an even larger percentage of overall revenue.
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No. of Recommendations: 18
Thanks for the great deep-dive, Wouter. Here are some tables on Pivotal’s results that you and others might find useful. They are arranged by fiscal year, which ends with the January quarter of the fiscal year in question.
Saul


Total Revenue (in millions of dollars)

Apr Jul Oct Jan Total
2017: 88 105 110 113 416
2018: 121 126 129 133 509
2019: 156 649 guidance


Subscription Revenue (in millions of dollars)

Apr Jul Oct Jan Total
2017: 29 36 38 47 150
2018: 53 65 66 75 259
2019: 90 384 guidance unrealistically low


Service Revenue (in millions of dollars)

Apr Jul Oct Jan Total
2017: 59 70 72 65 266
2018: 68 61 63 58 250
2019: 66 265 guidance


Percent Increase in Subscription Revenue

Apr Jul Oct Jan Total
2018: 83 81 74 60 73%
2019: 70



GAAP Net Loss (in millions of dollars)

Apr Jul Oct Jan Total
2017: 64 53 60 56 233
2018: 52 35 39 37 163 (loss down $70 million)
2019: 33



Adjusted Net Loss (in millions of dollars)

Apr Jul Oct Jan Total
2018: 43
2019: 23



Adjusted Net Loss per share in cents

Apr Jul Oct Jan Total
2018: 20
2019: 10



Customers Added

Apr Jul Oct Jan Total added for year
2018: 44
2019: 20
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No. of Recommendations: 22
And this is an approximate repost of a post I made earlier in the year based on Pivotal’s IPO filing.

Saul



Consolidated Statement pre IPO http://d18rn0p25nwr6d.cloudfront.net/CIK-0001574135/9c06e5fc...


Fiscal year ended Jan 16 Jan 17 Jan 18

Revenue
Subscription Revenue $ 95 mil $150 mil $260 mil
Services Revenue $186 mil $286 mil $250 mil

Total Revenue $281 mil $416 mil $509 mil

Gross Cost of Revenue
Cost of Subscription Rev $ 34 mil $ 31 mil $ 30 mil
Cost of Services Rev $154 mil $203 mil $198 mil

Total Cost of Revenue $187 mil $234 mil $228 mil

Gross Margin Profit
Gross Margin dollars $ 94 mil $182 mil $281 mil
Gross Margin percent 33% 44% 55%

Operating Expenses
S&M $187 mil $194 mil $221 mil
R&D $120 mil $152 mil $161 mil
G&A $ 58 mil $ 62 mil $ 67 mil
Total Operating Expense $366 mil $408 mil $449 mil

Operating Loss
Op Loss dollars $273 mil $227 mil $168 mil
Op Loss percent of rev -97% -55% -33%


Net Loss
Net Loss dollars $283 mil $233 mil $164 mil
Net Loss percent of rev -101% -56% -32%


I found that really reassuring.

Subscription revenue up 174% in two years.

The gross cost of that revenue is actually DOWN 12% in that two years!!! It’s down in TOTAL dollars from $34 million to $30 million! With almost tripling revenue! And that’s where the business is going: to Subscription Revenue.

Total revenue up 81% in two years. Gross cost of revenue is up only 22% in those two years.

Total revenue up 81% in two years. Gross profit is up 199% in those two years.

Gross margin has gone from 33% of revenue to 55% in that two years.

Adj gross margin has gone from 41% of revenue to 58% in that two years.


S&M
expense is up only 18% in those two years. Just 18% !!! With sub revenue up 174%, and total revenue up 81%.

R&D expense is up only 34% in those two years. With sub revenue up 174%, and total revenue up 81%.

G&A expense is up only 16% in those two years. Just 16% !!! With sub revenue up 174% and total revenue up 81%.

Subscription revenue growth was 68% in 2016, and 73% in 2017.

Assuming Subscription revenue grew just 60% in 2018 it would grow to $416 mil and dwarf Service revenue which would become almost irrelevant. At it’s 88% gross margin, they would probably be profitable this year!

For a more optimistic (and maybe more realistic) estimate, if the rate of growth of Subscription Revenue only dropped 8 points, from 73% to 65%, Subscription Revenue would be $429 million. At 91% gross margin, Sub Rev alone would produce $390 million of GAAP gross profit.

However given that the total gross cost of subscription revenue has been falling from $34 million to $30 million over the past two years, a stable $30 million cost would be just 7% of subscription revenue, giving them a 93% gross margin.

Even a rise to $35 million would give them just a cost of 7.5% of subscription revenue, or a 91.5% gross margin.

GAAP Operating loss has fallen from 97% of revenue to 33% of revenue in two years !

Actual cash used in operations was just 23% of revenue.

Adj operating loss has fallen from 79% of revenue to 25% of revenue in two years !


319 Subscription Customers in 4 years


2014: 0
2015: 75
2016: 180
2017: 275
2018: 319

In fiscal 2018, we focused primarily on renewals and expansion of existing customer subscriptions, which resulted in fewer net additions relative to prior periods. However, with the recent launch of PCF v2.0, including the release of PKS, we intend to increase our focus on adding new customers.


Dollar-based expansion rate was 163% a year ago, and 158% now, which is enormous!

TAM estimated at $50 billion plus. Subscription revenue only $259 million. Long way to grow.


In IPO Pivotal sold 38.9 million shares at $15 and General Electric sold 3.9 million, which is about 20% of their position. There were about 216 million shares outstanding, so there should now be about 255 million shares outstanding. That gives a Market Cap of roughly $5 billion

The Fiscal Year runs to the end of January.

Deferred Revenue is $317.5 million, which is:
62% of total revenue
Up $75 million from $242.6 million a year ago
Up 31% from a year ago.

Cash after the IPO should be about $656 million.
Debt is zero
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