No. of Recommendations: 36
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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