Logo of jester cap with thought bubble with words 'Fool Transcripts' below it

Image source: The Motley Fool.

Pivotal Software, Inc. (NYSE:PVTL)
Q3 2019 Earnings Conference Call
Dec. 11, 2018, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon. My name is Chris and I'll be your conference operator today. At this time, I would like to welcome everyone to Pivotal Third Quarter Fiscal Year 2019 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press "*1" on your telephone keypad. If you would like to withdraw your question, please press "#". Thank you.

Helyn Corcos, Vice President of Investor Relations, you may begin the conference.

Helyn Corcos -- Vice President of Investor Relations

Good afternoon and welcome to Pivotal's Third Quarter Fiscal 2019 Earnings Call. We will be discussing the results and guidance reported in our press release, which is posted on our Investor Relations website. This call is being simultaneously webcast and the replay will be available on our website. Also available on the website are our prepared remarks, supplemental tables, and our updated investor presentation.

With me today are Rob Mee, our CEO, and Cynthia Gaylor, our CFO.

During the call, we will make forward-looking statements, such as our guidance for the fourth quarter and the fiscal year 2019, related to our business. These statements are based on our current expectations and information available as of today and are subject to a variety of risks, uncertainties, and assumptions. Actual results may differ materially as a result of various risk factors that have been described in our S1 prospectus and our periodic filings with the SEC. As a result, we caution you against placing undue reliance on these forward-looking statements. We assume no obligation to update any forward-looking statements as a result of new information or future events, except as required by law.

In addition, during today's call, unless otherwise stated, references to our results are provided as non-GAAP financial measures and are reconciled to our GAAP results, which can be found in the earnings release and supplemental tables. 

With that, let me hand it over to Rob. 

Rob Mee -- Chief Executive Officer

Thank you Helyn and thank you all for joining our third quarter earnings call. I'm pleased to report that Pivotal had a strong quarter, driven by sales of our cloud-native platform and strategic services. With this market-leading offering, we continue to help enterprises transform their businesses.

Reflecting on our market opportunity, it remains clear that digital transformation is a high priority for companies across every industry and geography. Enterprises are seeking to modernize the applications that run their businesses, to grow revenue, and to build new ways to engage their customers.

For organizations that accomplish this transformation there are distinct competitive advantages to be had. However, the path forward for most companies is not an easy one. This year there has been significant consolidation across the market, while the public cloud providers have launched on-premises offerings. At the same time, the technical capabilities that enterprises will require in order to modernize are rapidly expanding-containers, Kubernetes, microservices, agile, and DevOps are just the start. Faced with this complexity, many organizations stall or are unsure how to get started.

Pivotal is uniquely positioned to help enterprises navigate through the hype and technical complexity toward a solution that enables enduring success while delivering measurable business outcomes. Pivotal Cloud Foundry, or PCF, is designed to simplify all this complexity and allow developers to focus on writing great software. Because PCF is built for the multi-cloud world, our customers are ready to run their applications anywhere. And through Pivotal Labs, we enable organizations to modernize their existing applications while creating a culture of highly productive developers ready for innovation.

However we know we cannot stand still. In the last year, we've successfully launched Pivotal Container Service, or PKS, and Pivotal Function Service, or PFS. Winning in this market will require us to continue to invest significantly in R&D to enhance our market-leading platform capabilities. Although interest around Kubernetes is very high, we also see enterprises facing challenges getting to production with Kubernetes. Our PKS offering and our customer-focused teams have consistently helped enterprises address these challenges and ultimately achieve meaningful business outcomes.

We are still in the early stages of this exciting market, where the rate of change is staggering and where Pivotal is at the forefront of enabling customers to build modern software. As a company, our focus continues to be on driving innovation and providing customers with a proven model that they can adopt and scale to enable their transformation journey. We will continue to broaden our portfolio of offerings to enable enterprises to build and operate their most important applications securely on any cloud, as we take a long term perspective on winning in this very large market opportunity.

In September, we held the third edition of our annual user conference, SpringOne Platform. This event brings together developers, operators and executives to learn about the newest capabilities across our product portfolio. For me, the event is a great opportunity to meet with customers directly and to thank them for their partnership

During the conference, we held our Partner Summit with over 90 companies in attendance. Pivotal recognized 21 of our partners for their excellence in bringing innovative solutions to difficult technical and business challenges. Our ecosystem continues to be a key advantage for our go-to-market and customer success efforts. Also, customers from around the world take to the stage to share significant business outcomes they've achieved with the adoption of PCF, Spring, and the Pivotal Labs methodology.

I'd like to share a few customer stories with you.

Ted Colbert, the CIO of Boeing, said, "In a very short time we've changed the culture of software development and working in IT is fun again. It's about delivering outcomes to our company. Partnering with Pivotal, we've retrained our staff and with Pivotal Cloud Foundry, they are empowered to deliver new solutions faster than ever before."

Jason Williams, VP of Customer Technology at Dick's Sporting Goods, described how the company's rapid growth had led to a complex technical landscape. By reorganizing around balanced product teams deploying to PCF, they've seen a 25% increase in developer productivity and new product features launching in just weeks.

And Siew Choo Soh, the Managing Director and Group Head of Consumer Banking of DBS Bank, said, "We are the bank that wants you to live more and bank less. In order to do this, we've had to rearchitect our applications to be cloud-native. Two years ago, we started our adoption of PCF and in that time we've had no downtime. We've reduced our average time to market from 6 months down to 1 month."

Also, during the conference, we announced important updates to Pivotal Application Service and PKS. Specifically, the release of PAS 2.3 makes it easier for developers to secure applications with enhancements to Credhub our integrated credential management service. The release also includes updates to Spring Cloud Data Flow, Spring Cloud Services and PCF Metrics, which reinforce PAS as the best place to run Java microservices.

PKS 1.2 added support for AWS, making it easier for teams to get Kubernetes running on the cloud of their choice quickly and securely. As with every release, we've updated to the latest version of Kubernetes, maintaining constant compatibility with Google Kubernetes Engine. PKS now features automatic configuration of cluster topology across availability zones, making it easy to build highly available clusters.

In the year since we first introduced PKS with our partners at VMware, we've delivered over 10 releases and have built the best Kubernetes offering for enterprises available today. This has been validated by organizations who are rapidly adopting this new product and by industry observers such as CRN who recently named PKS the most innovative container platform.

In addition, with VMware's announcement of a definitive agreement to acquire Heptio, we expect to see an acceleration of the PKS roadmap and an expansion of the product vision. We believe this will cement the Pivotal platform as the best place for enterprises to run apps, containers, and functions securely on any cloud.

Finally, I'm excited to share that this past Friday, we shipped our first customer-ready alpha version of Pivotal Function Service. PFS is a key part of our vision to offer customers a single platform to run their most important applications, including event-driven functions on any cloud.

Our sales and marketing organization continues to focus on deepening our relationships with existing customers to drive expanded use of our technology while also winning new customers. While enterprises face a complex technology landscape, our unique combination of software and services remains the best solution for organizations to succeed at digital transformation. We continue to expand our direct sales capacity by adding account executives and technical resources to our field organization in order to pursue this large and growing market opportunity.

Our strategic partnerships with Dell Technologies and VMware continue to complement our direct sales force. We are in the beginning stages of realizing leverage from Dell and VMware and are encouraged by the early traction we are seeing, particularly with PKS in our customer pipeline.

Our SI partner ecosystem continues to grow. In October, NTT-Data, a leading global services company, announced their investment to build out a large scale Pivotal practice. Our strategic partners expand our overall market reach and are often involved in the transformative initiatives we seek, giving us leverage in our sales and deployment capacity. 

In summary, we continue to gain share with the most valuable enterprises and public sector entities as they address their modern software development needs for both on-prem and cloud. We remain focused on executing for the long term, driving innovation and customer satisfaction as we broaden our portfolio of differentiated offerings.

With that, let me turn it over to Cynthia to review our results in more detail.

Cynthia Gaylor -- Chief Financial Officer

Thanks, Rob, and good afternoon, everyone. We delivered a strong quarter, with total revenue of $168.1 million, representing growth of 30% year-over-year, driven by subscription revenue growth of 53%. Our subscription outperformance was primarily driven by customer expansions as more workloads move onto the platform. Subscription revenue of $100.8 million represented 60% of total revenue, compared to 51% a year ago, and continues to be the primary driver behind our top-line growth and, in turn, revenue mix shift and margin improvement.

Our subscription customer base relative to Q3 of last year grew 17%, finishing the quarter with a total of 368 subscription customers. We added 14 net new customers in the quarter, bringing new customer adds to 49 year-to-date, up 26% compared to 39 for the same period a year ago.

Our dollar-based net expansion rate held steady at 150%. As we've said previously, we are at an industry-leading rate and would expect this metric to decline near-term.

Services revenue grew 7% to $67.4 million and represented 40% of total revenue, compared to 49% a year ago. Let me say a little bit about our services strategy. Services revenue is not a growth driver on its own. We deliver our services to drive subscription growth. Our services are at scale and we are leveraging partners and system integrators to build virtual services capacity to ensure customer success on PCF. Quarterly seasonality for services is typically lower in Q4 because of fewer billable days and some clients who wait until after the New Year to start projects.

Total gross margin rose to 67% and improved 7 points year-over-year, primarily as a result of top-line subscription revenue growth, which drove a continue mix shift toward subscription. Subscription gross margin was 93% and services gross margin was 27%.

Turning to operating expenses, sales and marketing expenses were $63.9 million or 38% of total revenue. We will continue to invest in sales and marketing to deepen our relationships with existing customers and also acquire new customers.

R&D expense was $46.4 million or 28% of total revenue. As Rob mentioned, the market and technical complexity that enterprises are facing require our ongoing investments in R&D to enhance our market-leading platform capabilities. G&A was $16.8 million or 10% of total revenue.

Operating loss for the quarter was $14.8 million, with a margin loss of 9%, improving 11 points from Q3 of last year. We are encouraged by the operating leverage we are seeing in comparison to the prior year, even as we invest strategically to drive our customer and product footprint. However, as we continue to invest in product innovation and field sales, we do not expect to continue to maintain operating loss improvement and margin at these levels and expect variability in margin before we reach sustainable breakeven.

Net loss per share was $0.05 based on 258 million weighted average shared outstanding, compared to a loss of $0.13 per share and 217 million shares in Q3 of last year.

Now, turning to the balance sheet and cash flow items, we exited Q3 with $664.8 million in cash and cash equivalents, down $7 million sequentially. Cash flow from operations was negative $36.2 million. As a reminder, our operating cash flow has meaningful variability from quarter to quarter due to seasonality of our billing cycle and expenses.

Now, turning to RPO, we finished the quarter with $790 million of RPO and we expect approximately 50% of these obligations to be realized in the next 12 months. As we've said previously, we expect RPO to peak for the year in Q4 due to seasonality. As we continue to scale, we expect the RPO growth rate year-over-year to decline compared to the prior periods. Relative to Q4 last year, we expect RPO this year to grow at a modest rate, particularly given the difficult compare.

As we have shared on our prior calls, we have quarter-to-quarter variability in our deferred revenue due to contract start dates, timing, and multiyear payments. As such, this variability may not always accurately reflect the momentum in our business. We encourage investors to look at trailing 12-month growth rates for these metrics in order to smooth out the quarter-to-quarter variability. Looking ahead to Q4, we are comfortable with the current expectations for short-term and total deferred revenue and expect both of these metrics to increase compared to Q3.

I will conclude by providing guidance for the remainder of our fiscal year. Please note that growth rates are based on the midpoint of the guidance range compared to Q4 or to fiscal year 2018.

For the fourth quarter, we expect: subscription revenue between $109.5 million and $110.5 million, representing growth of approximately 47%; total revenue between $169 million and $171 million, representing growth of 28%; operating loss between $26 million and $25 million, representing improvement of 25%; and net loss per share of $0.10 to $0.09 based on weighted average shares outstanding of approximately 264 million.

We therefore estimate the fiscal year as follows: subscription revenue between $398 million and $399 million, representing growth of approximately 54%; total revenue to be in the range of $657 million and $659 million, representing growth of 29%; operating loss between $76.5 million and $75.5 million, representing improvement of 41%; and net loss per share of $0.32 to $0.31 based on weighted average shares outstanding of approximately 251 million.

In closing, we will continue to focus on subscription growth as we drive customer success and expand customer workloads on our platform, while helping customers navigate their increasing technology complexity.

We will now turn it back to the operator to take your questions.

Questions and Answers:

Operator

At this time, I would like to remind everyone, in order to ask a question, press "*1" on your telephone keypad. We ask that you please limit yourself to one question and one follow-up. We'll pause for just a moment to compile the Q&A roster.

Your first question is from Sanjit Singh with Morgan Stanley. Your line is open.

Sanjit Singh -- Morgan Stanley -- Analyst

Hi. Thank you for taking the questions and congrats on the strong set of results this quarter. Maybe to start with you, Rob, just can you give us some context around the competitive environment? Obviously, IBM purchased Red Hat there this quarter or the deal is expected to close relatively soon. I just wanted to get your thoughts on what the implications could be, in terms of battling IBM Red Hat in the large enterprise market? And what kind of support have you seen from VMware and Dell around the PKS offering and Cloud Foundry as a whole? Thank you.

Rob Mee -- Chief Executive Officer

Yeah, thank you, Sanjit, for the question. I think as I mentioned in the comments, it's a pretty complex landscape and rapidly changing with some of the consolidation that you mentioned, as well as the public clouds coming on-premises as I discussed. Overall, we think the challenging landscape is a long-term positive for Pivotal. All these various options are destinations for us. And so we simplify the complexity there for a lot of these things.

Specifically, with regard to IBM's acquisition, I think, again, it reinforces the importance of multi-cloud and underscores that we have a good position in the marketplace here. We don't comment directly on other companies' acquisitions but we don't think that this is a negative for Pivotal.

Sanjit Singh -- Morgan Stanley -- Analyst

And then maybe, Cynthia, as we head into Q4, which is the biggest quarter of the year, could you just give us any sort of qualitative comments about how you feel about the pipeline going into Q4, in terms of both on the new customer side as well as some of the expansion in renewal deals we may see in Q4? Any comments there would be helpful. Thank you.

Rob Mee -- Chief Executive Officer

Yeah, this is Rob. I'll just take that quickly and let Cynthia elaborate a little bit. Q4 has traditionally been a really important quarter for us. And our reps are focused on delivering for that, as well as expanding. They're driving many new deals. And we are encouraged by the pipeline of our Q4 opportunities.

Cynthia Gaylor -- Chief Financial Officer

Yeah, I think that covers it, Rob.

Operator

Your next question is from Brad Zelnick with Credit Suisse. Your line is open.

Brad Zelnick -- Credit Suisse -- Analyst

Excellent. Thank you and congrats on a strong third quarter. Rob, in your prepared remarks, you mentioned you're in the beginning stages of realizing leverage in your go-to-market with Dell and VMware, which is a little surprising given they contributed 37% of your revenue last year. How should we think about the leverage increasing from here?

Rob Mee -- Chief Executive Officer

Hey, Brad. Good to hear from you. Let me have Cynthia address that 37% because that's a misconception a little bit.

Cynthia Gaylor -- Chief Financial Officer

Hey, Brad, it's Cynthia. Thanks for the question. On the 37%, I think you're probably pulling that out of our Q and out of our S1. We book revenue sometimes on Dell and VMware paper but the revenue is going through our direct channel. And so we use Dell and VMware, if there's a master agreement at some of our customers, and that's what that 37% represents. But there's not 37% of the revenue coming from those places.

Brad Zelnick -- Credit Suisse -- Analyst

Yeah. I wasn't really honing in on the number as much as, Rob, just trying to get a sense of the leverage in regards to your comment in the prepared remarks, saying that you're in the beginning stages. It sounds like there's a lot of great things to come and was just wondering to hear a bit more about your optimism.

Rob Mee -- Chief Executive Officer

Yeah. I do have optimism and it is relatively early. Traditionally, and, obviously, as the situation has changed from the EMC federation to the Dell Technologies family, we've had quite a lot of changes and an evolving landscape there. But we are seeing more traction than we've ever had with VMware and with Dell Technologies. I think I've described in previous calls how Michael Dell at Dell Technologies is very, very helpful in customer introductions and co-selling and so forth.

VMware, of course, is different now in the situation that has evolved over the last year, in which we are actually offering a product together which we co-engineer and we take to market together. And as I mentioned in our last call, it takes a while for a big sales force like the one VMware has to spin up. And so in the early sales of PKS, a lot of the action came from Pivotal's field and our existing customers buying PKS and being quite excited about it. But now we're really seeing VMware's field start to spin up and seeing the pipeline of customers that VMware goes after that we don't touch really materializing. So we are encouraged about that.

Brad Zelnick -- Credit Suisse -- Analyst

Thanks for the color, Rob. And just, Cynthia, to follow up with you, your comments for RPO in Q4, you talked about growing at a modest rate. Can you maybe put a finer point to that and perhaps give us a sense of historical seasonality? What that's been for RPO Q3 to Q4 and if that's even any gauge for how you're thinking about how you might finish the year? Thanks.

Cynthia Gaylor -- Chief Financial Officer

Sure. Sure, Brad. Thanks for the question. So, in terms of the RPO growth rate, when we get to Q4, you'll have the Q4 compare from last year. And we would expect the RPO growth rate in Q4 to be significantly less than the growth that we saw in Q4 of '18. Q4 RPO growth last year was strong off a much lower base the prior year. It was 73%. And so we expect it to be significantly less as a percentage this year given how much larger we are and also running that percent off a much higher number over last year.

Brad Zelnick -- Credit Suisse -- Analyst

Okay. Thanks so much.

Operator

Your next question is from Daniel Ives with Wedbush. Your line is open.

Daniel Ives -- Wedbush Securities -- Analyst

Yeah, hey. Thanks for taking my question. So, can you maybe just talk about deal sizes and just the progression of a typical customer? Not necessarily in terms of the actual numbers but maybe the progression. And are you starting to see that accelerate, in terms of just larger deals in the pipeline and customer's maturity starting to accelerate versus where they were maybe a year or two ago?

Cynthia Gaylor -- Chief Financial Officer

So, in terms of deal sizes, we're not really seeing very much change there. Our initial deal sizes and our average deal sizes have remained about the same, in the few hundred thousand dollar range for an initial PCS deal. And if you look at kind of annualized revenue per customer and just do the math of subscription revenue times four divided by the number of customers, you get to an average of just over $1 million per customer. So when you think about progression, you kind of go from the initial of a few hundred thousand dollars, that customer could expand to kind of $1 million, and then to kind of multi-million and upward. As the customers get larger, they move more workloads onto the platform. We see that type of expansion, which you see in our net expansion rate as well.

Daniel Ives -- Wedbush Securities -- Analyst

That's very insightful. And then as a follow-up to that, what do you think, from a time perspective, would be the average customer moving from a traditional deal size to getting to that sort of full-state, about $1 million?

Cynthia Gaylor -- Chief Financial Officer

Yeah. I mean, it can vary. We're really focused on providing, as I mentioned in my prepared remarks, strategic services to help customers succeed on the platform and then expand. It can sometimes happen within the initial year. They may do an expansion depending on how quickly they get ramped on the platform and what their strategic initiatives are, in terms of their transformation journey. But it can also be kind of a year or two years out. Our average contracts, as I think you know, are between two and three years. And so sometimes we see the expansions before that initial contract is up for renewal and sometimes we see it at or around the time of renewal. So it does vary.

Rob Mee -- Chief Executive Officer

And I can add a little color there, too, if it's OK. In terms of customers expanding, it's really about getting workloads on the platform. And in terms of how we interact with customers and how we bring our services to them, we've really focused on engaging very quickly and in getting mission-critical workloads on the platform. So, for example, our app transformation practice, which takes legacy workloads and moves them onto the platform, has really developed and we're engaging more and more with customers that way. That helps them be more successful with the platform and gets them to an expansion faster. So it's definitely something that we're focused on and I think it's something we're getting better at.

Daniel Ives -- Wedbush Securities -- Analyst

Thanks for that color. Great quarter.

Operator

Your next question is from Walter Pritchard with Citi. Your line is open.

Walter Pritchard -- Citigroup -- Analyst

Thanks. Two questions, I think, for Rob. On PKS, I know it's early, I'm wondering if you're seeing adoption more come from new customers there or existing, maybe especially in terms of what you're seeing in terms of pipeline for Q4 and into next year?

Rob Mee -- Chief Executive Officer

Yeah. I think the initial bulk of the sales is really expansions with existing customers. But if you look into the pipeline, then you are seeing new customers coming in and especially as VMware's sales force gets ramped up. That pipeline is really mostly new customers. And expansion, one example I can give you was T-Mobile, which started with PAS and then they really expanded PAS significantly and they recently added workloads with PKS. And they actually have mission-critical, high-volume, consumer-facing workloads using PKS in production.

Walter Pritchard -- Citigroup -- Analyst

Got it. And then, I guess, on services intensity of PKS, can you comment on what you're seeing in terms of services attach? And then, generally, an update on how you're progressing with SIs? Maybe any metric on trained reps or trained headcount on the SI side as you look to move that work to partners over time?

Rob Mee -- Chief Executive Officer

Cynthia, do you want to talk about the services attach rate on PKS?

Cynthia Gaylor -- Chief Financial Officer

Yeah. So, I think on PKS, it's similar to on the platform. We attach services in a similarly strategic way. We don't really necessarily talk about attach rates but we customers who use services are more successful and move workloads onto the platform more quickly so we are very focused on that as part of our strategy. So, PKS is really no different than the other attractions on the platform.

Rob Mee -- Chief Executive Officer

To specifically talk about some of the partners and the SIs, with Accenture, we're now in operation with the Accenture Pivotal Business Group, or APBG. And we're actually seeing really encouraging results with customers. We've jointly built applications with them and their Columbus, Ohio lab has really spun up and really going well. And that's very much sort of an analog of a Pivotal Labs operation and functions just like it. So, we're seeing, really, a pretty large and growing opportunity for the SI partners and we are seeing them engage in new application development as well as migration.

Walter Pritchard -- Citigroup -- Analyst

Great. Thanks.

Operator

Your next question is from Alex Kurtz with KeyBanc Capital Markets. Your line is open.

Alex Kurtz -- KeyBanc Capital Markets -- Analyst

Yeah. Thanks for taking the questions. I just wanted to go back to this VMware question because I think, from the outside looking into your company, I think investors are seeing a very large global platform, especially around VMware and their reach into IT organizations. So, beyond PKS, do you see opportunities where they can find opportunities for you, whether it's late in this fiscal year or going into next fiscal year, in the pipeline around the core product, PAS? And has that started to bubble up a bit from field sales that VMware can, in fact, deliver you a Global 2000 somewhere in Asia or Eastern Europe?

Rob Mee -- Chief Executive Officer

Absolutely. They can and they do. I think because we now really have this intense focus on PKS and on the joint go-to-market there, for us, PKS is not sold in isolation. It's part of PCS and it's driven by the same underlying technologies. It brings the same kinds of benefits that we've been working on in our technology stack over the last five years. And PKS is really a foothold for us and leads to the capability to sell the other extractions there. So, in that sense, going to market with VMware does give us access to those customers.

Alex Kurtz -- KeyBanc Capital Markets -- Analyst

All right. Thank you.

Operator

Your next question is from Jennifer Lowe with UBS. Your line is open.

Jennifer Lowe -- UBS -- Analyst

Great. Thank you. Given that you have some very "blue chip" folks in your customer base and people are starting to think about calendar '19, I know you're not providing guidance for that yet, but just based on what you're seeing in your pipeline, is there any reason to think that these types of digital transformation projects are in any different level of prioritization heading into next year than we saw this year? Or any differences in the conversations you're having with your customers as they start to think about their calendar '19 budgets?

Rob Mee -- Chief Executive Officer

Thanks for the question, Jennifer. It's a good one. I think what I'd say is, over the last year, the last five years, we've had these conversations with customers. And five years ago, I would say folks were sort of early pioneers in a digital transformation and some folks really weren't that interested in it. But I've always maintained that every company is really going to need to become a software company, in some form or fashion, over time. And more and more, we're seeing customers across circles do that. And so I think the trend just continues to accelerate and continues to increase and we continue to get new blue chip customers and will continue to do so next year. And I don't really see it slowing down at all. I think customers are getting more confident in their ability to engage with a company like Pivotal and adopt methods and technologies that they might not have considered a few years ago.

Jennifer Lowe -- UBS -- Analyst

Great. And then just one more from me. I know GE was sort of a meaningful customer for you in the past. As your business has grown, it's becoming potentially less meaningful. But there was a filing that they've sold some of their stock in Pivotal and I know there's been some changes in the Board composition. So, can you just update us on the GE relationship and whether there's any sort of change in the customer relationship that we should be thinking about as you head into next year?

Rob Mee -- Chief Executive Officer

Yeah. I mean, obviously, as you've probably seen, a lot is going on with GE and their business more generally. GE did step off our Board in September. And they're focusing their efforts on a number of things, not necessarily related to Pivotal. As you would expect, we don't provide specific information on specific customers, but I can say that they do remain a subscription customer.

Jennifer Lowe -- UBS -- Analyst

Great. Thank you.

Operator

Your next question is from Nikolay Beliov with Bank of America. Your line is open.

Nikolay Beliov -- Bank of America Merrill Lynch -- Analyst

Hi. Thanks for taking my questions. To start off, Rob, a question for you. One thing that we've been consistently hearing about PAS is that, by design, it's prescriptive in light of the security and compliance requirements that large enterprises have. If you could just comment, in general, how that might be impacting the sales cycle? And when you were talking about decreasing complexity, how do you trade off the prescriptive nature of your core product versus the increasingly required flexibility, in terms of the variety of environments people need to deploy to?

Rob Mee -- Chief Executive Officer

Right. So, it was a little bit hard to hear your question but I think, if I can rephrase it, you're asking about the prescriptive, opinionated nature of PAS and some benefits that that can provide and the trade -off there with greater flexibility that different abstraction might provide. Is that correct?

Nikolay Beliov -- Bank of America Merrill Lynch -- Analyst

Correct.

Rob Mee -- Chief Executive Officer

Yeah. So, I think you're quite right and this is, indeed, why we do offer multiple abstractions on the platform. And PAS is quite opinionated. That allows us to build in a lot of security and compliance features that many of our customers -- banks, healthcare, the U.S. federal government -- a lot of them have really benefited from those kinds of things, to have those core capabilities built into the platform. A lot of our customers also want to be able to deploy containerized applications or services directly and have the flexibility to do that as they desire. And that's one of the reasons for PKS. That said, I think a lot of the underlying opinionated approach -- continuous updates for securities, vulnerabilities, operating systems being embedded in the product -- those kinds of things accrue to PKS as well as to PAS. So I think we are probably doing a good job of balancing the opinionation and the automation and the security benefits that come with that with flexibility of different abstractions.

Nikolay Beliov -- Bank of America Merrill Lynch -- Analyst

Got it. Thank you.

Rob Mee -- Chief Executive Officer

Sorry. Go ahead.

Nikolay Beliov -- Bank of America Merrill Lynch -- Analyst

I just had a question for Cynthia. Cynthia, your color on the breakeven, are you implying that you might breakeven beyond where the Street is or there's going to be variability until you get to breakeven according to current Street estimates? I just wanted to clarify that.

Cynthia Gaylor -- Chief Financial Officer

Sure. We talked about this on the last few calls. We expect variability to breakeven and we have been posting significant year-on-year margin improvement, in terms of gross margin and operating margin, and we wouldn't expect that to be linear to breakeven. So, we are investing in the business, particularly in sales and marketing and R&D, to grow the top line and we'll continue to do that as we move toward breakeven but we wouldn't expect it to be linear. We'd expect it to be variable, kind of up and down on the path there.

Nikolay Beliov -- Bank of America Merrill Lynch -- Analyst

And the timing of breakeven has not changed, correct?

Cynthia Gaylor -- Chief Financial Officer

Correct.

Nikolay Beliov -- Bank of America Merrill Lynch -- Analyst

Got it. Thank you.

Operator

Your next question is from Bhavan Suri with William Blair. Your line is open.

Bhavan Suri -- William Blair -- Analyst

Thanks for taking my questions, guys, and congrats again. I apologize for the background noise here. I guess just to first touch on sort of the mix. I was just traveling and met with a bunch of your partners and a lot of the applications that people are building are sort of net new digital applications, digital transformation type stuff. And some are starting to see some of the -- sort of taking a legacy application and sort of modernizing it. It feels like that's improved year-over-year. So, some people are getting past some of the initial stuff and now you're seeing some of the uptick in existing application modernizing. I guess two questions in there, quickly. One, is that what you're seeing across the board? Sort of more and more legacy stuff being modernized? And is there an inflection there yet or is it still pretty early days for that?

Rob Mee -- Chief Executive Officer

Great question. Thanks. I do think there's an inflection point and you correctly sort of reflect what we understand of our own business, which is when we first commercialized the platform, we really were seeing net new applications and helping customers build those. I think as the platform matured and our customers were really seeing not just the productivity of developing applications but the operational efficiencies from running the application, we're at least as compelling and perhaps even more so. And they really wanted those operational efficiencies for their existing portfolio of applications, which could be quite large.

And so we really, I think, in the last year, have seen an inflection point where we're seeing probably more of those legacy applications comprising the workloads that are running on our platform than net new applications. And in order to accommodate that, we've scaled up our application transformation service, as well as engaged partners in that. And, really, I can safely say that the majority of workloads running on the platform are legacy applications or modernized legacy applications.

Bhavan Suri -- William Blair -- Analyst

Got it. I've got another quick one for Cynthia here. You had some moving parts in the deferred revenue part of the business, billing terms, etc. Just as we look at Q4, is there anything you'd want to point out or highlight about sort of the billing terms, duration, contracts, anything else that might be affecting those or impact sort of what we might see optically when that comes through?

Cynthia Gaylor -- Chief Financial Officer

Nothing specific, other than I did mention that we're comfortable with current expectations on deferred revenue for Q4 and so I would point you to that, for sure. And then on any of the balance sheet metrics, in general, we spent some time on this last quarter and the quarter prior, but we would encourage folks, if they're looking at balance sheet metrics, to look at them on a trailing 12-month basis because, from a quarter-to-quarter perspective, they can be lumpy due to the contract start dates, the timing, and the multiyear prepayments. And so I would just keep that in mind.

Bhavan Suri -- William Blair -- Analyst

Got it. Thanks, guys. Appreciate it. Thanks for taking my questions.

Operator

Your next question is from Matt Hedberg with RBC Capital Markets. Your line is now open.

Matthew Swanson -- RBC Capital Markets -- Analyst

Thank you. This is Matt Swanson on for Matt. Congratulations on the quarter. Rob, we were at re:Invent this year and there was a lot of buzz around Outposts with VMware and I was just curious if you think that could have a positive benefit for Pivotal.

Rob Mee -- Chief Executive Officer

Yeah. I mean, I do think that Outposts really reinforces that on-premises data centers aren't going anywhere anytime soon. For us, of course, it's another infrastructure destination for our workloads. So that is good as well. And I think the fact that VMware has a growing partnership with AWS is good for them and what's good for VMware is good for us. So, overall, I'd say yeah.

Matthew Swanson -- RBC Capital Markets -- Analyst

That's helpful. And then do you have any commentary about the U.S. federal business during the quarter?

Rob Mee -- Chief Executive Officer

I'd just say we have a lot of momentum in the federal space and we're seeing a lot of activity there. I've gone to the D.C. office a couple of times recently and had some really great meetings there and just to see the activity in the D.C. office is kind of inspiring. I think we're doing a lot of really important work there and changing the way that the federal government and the U.S. military procures and develops software. And, yeah, I'm pretty excited about it.

Matthew Swanson -- RBC Capital Markets -- Analyst

All right. Thanks.

Rob Mee -- Chief Executive Officer

Thank you.

Helyn Corcos -- Vice President of Investor Relations

Chris, we have time for one more question, please.

Operator

Your last question is from Raimo Lenschow with Barclays. Your line is open.

Raimo Lenschow -- Barclays -- Analyst

Hey. Thanks for squeezing me in and congrats from my side as well. Rob, can you talk a little bit about your expectations around the long-term evolution of Kubernetes. At the Kubernetes conference in Seattle, the talk was like, look, at the moment, the cloud vendors, when they do native Kubernetes, there's still a lot of customization that is needed so the lock-in is relatively high but, in the long run, that might change as more and more of this stuff goes into the open core. Can you talk a little bit how you think about that will impact Kubernetes and your positioning around that in the long run? Thank you.

Rob Mee -- Chief Executive Officer

Yeah. Great question and I like the way you phrased that. I think you're right. Enterprises that have tried other Kubernetes offerings, whether it's the open source or commercial offering, immediately draft what we've done with PKS because it reduced the operational burden and complexity. So it's always up to date, open source Kubernetes with constant compatibility with GKE. Also, the ability to deploy and operate tens or even hundreds of Kubernetes clusters with a really small team. So we've definitely made that very efficient. It's a complete solution of directing network and storage complexity in Kubernetes.

Now, as you've mentioned, Kubernetes open-source sequence system is moving very quickly and, for us, that's actually good because we're continuing to build capabilities on top of that and additional abstractions on top of that, including PSS, which is the first commercialization of Knative. And Knative being an application abstraction framework that we were very early to work with Google on and we think is a next-generation abstraction framework that a lot of people will be building these next-generation application platforms on. So, we'll continue pushing forward with that. I think while these technologies are complex and difficult to use, we'll make them easier. And as they get easier to use, we'll continue to build value on top of that and make them more productive.

Raimo Lenschow -- Barclays -- Analyst

Perfect. And one more follow-up for me. Obviously, IBM was working on Cloud Foundry as well and the question is, now that they go after Red Hat, they might do more on open chip. How important of a contributor were they versus you and does that have implications for you and the Cloud Foundry ecosystem or is that something that actually shouldn't impact you at all? Thank you.

Rob Mee -- Chief Executive Officer

I think the Cloud Foundry ecosystem is strong and there are a number of contributors. IBM is a part of that. They continue to be a part of that and I don't expect them to disappear. If they reduce their contributions, I don't think it will have a material impact on the progress of the open source.

Raimo Lenschow -- Barclays -- Analyst

Perfect. Thank you.

Operator

This concludes the Q&A portion of the call. I'll now turn it back to Rob for any closing remarks.

Rob Mee -- Chief Executive Officer

Good. Thank you, everyone, for joining us on this quarterly earnings call. Great questions. Really appreciate your time. Thanks.

Operator

This concludes today's conference call. You may now disconnect.

Duration: 48 minutes

Call participants:

Helyn Corcos -- Vice President of Investor Relations

Rob Mee -- Chief Executive Officer

Cynthia Gaylor -- Chief Financial Officer

Sanjit Singh -- Morgan Stanley -- Analyst

Brad Zelnick -- Credit Suisse -- Analyst

Daniel Ives -- Wedbush Securities -- Analyst

Walter Pritchard -- Citigroup -- Analyst

Alex Kurtz -- KeyBanc Capital Markets -- Analyst

Jennifer Lowe -- UBS -- Analyst

Nikolay Beliov -- Bank of America Merrill Lynch -- Analyst

Bhavan Suri -- William Blair -- Analyst

Matthew Swanson -- RBC Capital Markets -- Analyst

Raimo Lenschow -- Barclays -- Analyst

More PVTL analysis

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

10 stocks we like better than Pivotal Software, Inc. Class A
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Pivotal Software, Inc. Class A wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of November 14, 2018

Motley Fool Transcription has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.