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Pivotal Software, Inc. (NYSE:PVTL)
Q1 2020 Earnings Call
Jun 4, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon. My name is Christine, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Pivotal Software First Quarter Fiscal '20 Earnings Call. All lines will be placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

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

Helyn Corcos -- Vice President of Investor Relations

Good afternoon, and welcome to Pivotal's first quarter of fiscal 2020 earnings call. We will be discussing the results and guidance reported in our press release, which is available on our Investor Relations website. This call is being webcast, and a replay will be available on our website.

Also available on the website are our prepared remarks, supplemental tables and an 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 guidance for the second quarter and fiscal year 2020 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 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 a 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

Thanks, Helyn, and thank you everyone for joining our call today.

Pivotal delivered a solid Q1 with 43% subscription growth driving total revenue growth of 19%. Customer expansions continue to drive our revenue growth, resulting in our strong net expansion rate of 143% in the quarter. We exited the quarter with 383 subscription customers, up 13% year-over-year, underscoring the continued demand for our platform. Despite this good news, we closed fewer deals than we expected in Q1 due to sales execution and a complex technology landscape that is lengthening our sales cycle.

Some of the deals we expected to close in Q1 slipped. A few of those have already closed in early Q2, and we expect some to close in the coming quarters. We have taken steps to improve our sales execution including putting a new head of sales for the Americas in place, continuing to focus on building pipeline by increasing demand-gen and sales-enablement activities, and introducing a new version of PAS that runs on Kubernetes. I'll go into that in more detail in a moment.

We remain confident in our strategy and market opportunity for the long term. Pivotal continues to be the best partner for organizations that want to modernize their most important applications. Take the United States Air Force for example. We partnered with the Air Force Operations Center and its Kessel Run Experimentation Lab in August 2017 to design and deliver a new, software-based aircraft refueling solution.

Using PCF and the Pivotal Labs agile methodology, the joint team developed an accredited solution in just 120 days. It saves the Air Force $750,000 per day by decreasing the time it takes to plan refueling from one day to just two hours, and reducing the number of refueling tankers it scrambles. Because our platform and the methodology enable them to deliver mission outcomes so quickly, the Air Force awarded us several contracts over the last two years, including a major new agreement that was announced last week.

These types of business outcomes are fueled by our unique combination of services and powerful capabilities that we continue to build into PCF, our platform. For example, we've expanded the types of applications that run on Pivotal Application Service, we've launched the alpha version of our functions offering called Pivotal Function Service, and we've incorporated Kubernetes into PCF by bringing Pivotal Container Service to market with VMware.

Customers have told us they wanted to run Kubernetes as part of their cloud platform, but they struggled to operationalize it because it's complex. So we took the years of experience we've gained building and delivering our platform and we applied it to the Kubernetes domain via PKS. We now have more than 140 PKS customers, and PKS has become the best Kubernetes product for enterprises. While it's still early, PKS is showing initial signs of a stronger net expansion than our overall net expansion rate of 143%.

Because of our traction with PKS, we are now moving onto the next phase of our Kubernetes journey. Next month, we will introduce a version of PAS that is built to run on Kubernetes. PAS on Kubernetes will initially be available for PKS. Eventually it will run on public cloud Kubernetes services as well. In addition to PAS on PKS, we will be introducing new product offerings on top of PKS to expand our market opportunity, simplify our sales process, and make it easier for new customers to get started with Pivotal. These product updates will grow our addressable market and accelerate our sales cycle. I look forward to providing more information, as we unveil these products throughout the fiscal year.

We continue to see strength across industries including healthcare, energy, insurance,transportation, and telecom. Customers included American Eagle Outfitters, PepsiCo and Softbank. I'd like to share two customer stories with you to underscore the business outcomes customers are experiencing.

First, we've been working with a Fortune 100 financial services company to help them build a new online-banking platform. What started as a Labs project quickly expanded to the company implementing PAS on Amazon Web Services. It took the joint team less than five weeks to deliver a production-grade PAS deployment running on AWS. Our partnership has been so effective that the Company is rapidly adding related workloads to PCF. This illustrates how successful Labs projects can propel customer success on the platform and fuel subscription growth.

Second, a Fortune 500 corporate services leader chose PAS and PKS with Kafka to automate day one and day two operations for multi-cloud deployment of services and capabilities for their new customer platform. With the growth of the platform, they need to -- needed to provide their large multinational customers with faster deliverables to market and with a seamless experience that adheres to compliance and security protocols. They have vastly improved time-to-market for customer deliverables, and have significantly improved cost efficiencies.

Moving on to strategic partnerships, as we've said, Dell and VMware complement our direct sales force. We are encouraged by the ongoing traction and pipeline, our combined sales teams are building with PKS. Dell and VMware have thousands of customer relationships globally, which provides an important avenue for us to grow our business. We continue to collaborate to make it easier for customers to rapidly adopt our software and modernize their most important applications.

Our partner ecosystem helps customers scale their platform-adoption and application-modernization efforts. A number of our SI partners continue to invest significantly in creating global Pivotal practices powered by our platform and enablement services. This is consistent with our long-term services strategy to ramp services outside of the work we are doing directly with customers.

There are a few partnerships I'd like to highlight: Perficient's investment in developing capabilities around Pivotal is continuing to pay off as they expect 100% utilization rates for their Pivotal practice. And Mphasis has more than 350 people driving PCF consumption at Pivotal customers. We're also honored to receive Wipro's Digital Transformation Partner of the Year award. We are thrilled with the growth of Wipro's application transformation practice. They have invested broadly in software and training enablement, and our collaboration has created focused go-to-market initiatives.

In summary, Pivotal continues to be the place, where some of the best organizations in the world come to turn themselves into software companies able to deliver value continuously to their own customers. The complex technology landscape and sales execution impacted our Q1 performance, but I'm confident that Pivotal's unique culture, multi-cloud application platform and Kubernetes capabilities and strategic -- strategy collectively position us to capitalize over time on what are major technology market opportunities.

With that, I'll turn the call over to Cynthia to discuss our financial results and guidance in more detail.

Cynthia Gaylor -- Chief Financial Officer

Thanks, Rob and good afternoon, everyone.

Subscription revenue generated $128.9 million in Q1 with year-over-year subscription growth at 43%, and Q1, total revenue of $185.7 million, represented 19% growth year-over-year. Our subscription customer base grew 13% year-over-year to finish the quarter with a total of 383 subscription customers. We added 6 net new customers in the quarter.

We continue to be pleased with the business outcomes PCF delivers for customers and the expansions that continue to drive our subscription growth. Our dollar based net expansion rate was 143%. As we've noted previously, our net expansion rate remains at industry leading levels, and we expect it will continue to decline sequentially in each quarter, as we scale.

Our subscription outperformance in Q1 was driven primarily by expansions as customers increased the number of workloads they are running on PCF and expanded their consumption of our software. As subscription revenue grows, our mix continues to shift toward subscription, now representing 69% of total revenue, compared to 58% a year ago, and continues to drive our top line growth and margin improvement.

In Q1, services revenue declined 13% year-over-year to $56.9 million and represented 31% of total revenue compared to 42% a year ago. Services revenue came in slightly lighter than we were expecting due to fewer customer engagements and fewer software deals than expected. Our focus is on enabling customers, delivering the right level of services to grow subscriptions and to make customers successful on our platform, while we continue to build virtual capacity with our SI partners.

Total gross margin rose 70% for Q1 and improved 6 points year-over-year, primarily as a result of our top line subscription revenue growth, which continued to drive mix shift toward subscription revenue. This marks the first quarter in which we've achieved a 70% gross margin and moved above the 60% range. Subscription gross margin was 94% and services gross margin was 17%.

Turning to operating expenses. Sales and marketing expenses were $74.1 million or 40% of total revenue in Q1, an increase of 15% year-over-year, reflecting investments in our direct sales capacity and enablement resources. As we grow our revenue, we will invest in our Go to Market teams, while continuing to build our pipeline, deepen our relationships with existing customers, and acquire new customers.

R&D expense was $49.8 million in the quarter, or 27% of total revenue, an increase of 20% year-over-year, reflecting continuing investments in our product roadmap and engineering talent. We will continue to make ongoing investments in R&D as we evolve the platform and integrate Kubernetes into PCF, while enhancing our cloud-native products and platform differentiation.

G&A was $18.3 million, or 10% of total revenue, an increase of 29% to support the scale and growth of the Company. Operating loss for the quarter was $11.8 million, with an operating margin loss of 6%, improving 7 points from Q1 of last year. We are encouraged by the overall operating leverage even as we invest strategically to drive our customer and product footprint. Net loss per share was $0.03 compared to a loss of $0.10 per share in Q1 of last year.

Now, turning to the balance sheet and cash flow items. We exited Q1 with $854.2 million in cash and cash equivalents. Cash flow from operations was $122.2 million in Q1 versus $4.5 million in Q1 of last year. Strong cash flow generation was attributable to strength in collections activity. As a reminder, our operating cash flow has meaningful variability from quarter-to-quarter due to the seasonality of our business and timing associated with our billing cycle and expenses. Also as a reminder, we face a tougher compare next quarter due to prepayments received in Q2 of last year.

Now turning to RPO. We finished the quarter with $880 million of RPO, up 10% year-over-year. This was lower than we expected mainly driven by sales execution and shorter contract duration. We expect approximately 55% of these obligations to be delivered in the next 12 months. As we've noted previously, RPO will have variability quarter-to-quarter based on the timing of deals and renewals, as well as contract duration. In Q2, we expect RPO to be flat year-over-year relative to Q2 of last year.

Short-term deferred revenue was $351 million, up 34% year-over-year, and total deferred revenue was $417.1 million, up 23% year-over-year. These growth rates were slightly lower than expected due to deals that slipped from Q1. As a reminder, deferred revenue is impacted by timing of deals and renewals as well as prepayments. Looking ahead to Q2, we expect short term and total deferred revenue growth to be in the low to mid 20% range compared to the same period last year. For the fiscal year, we expect short term deferred revenue growth to be in the mid single to low teens percent range and total deferred revenue growth to be in the low to high single digit percent range relative to last year.

I will conclude by providing guidance for the second quarter of fiscal '20 and for the full year. Please note that we are providing year-over-year growth rates based on the midpoint of the guidance range compared to Q2 or to fiscal year '19.

For the second quarter, we expect subscription revenue between $131 million and $133 million, representing growth of approximately 35%. Total revenue between $185 million and $189 million, representing growth of 14%. Operating loss between $11 million and $9 million, representing improvement of 32%. And net loss per share of $0.04 to $0.03 based on weighted average shares outstanding of approximately 274 million.

For the full year 2020, we expect subscription revenue to be in the range of $530 million and $538 million,representing growth of approximately 33%. Total revenue will be in the range of $756 million and $767 million, representing growth of 16%. We expect operating loss to be in the range of $49 million and $44 million, representing improvement of 35%. And net loss per share of $0.15 to $0.13 based on weighted average shares outstanding of approximately 275 million.

In closing, we have a large opportunity ahead of us to continue to drive strategic business outcomes for our customers. I'm confident in our ability to drive long-term sustainable growth with the investments we're making to evolve PCF, while improving sales execution.

With that, I'll turn it back to the operator to take your questions.

Questions and Answers:

Operator

Thank you. (Operator Instructions) Your first question comes from the line of Sanjit Singh from Morgan Stanley. Your line is open.

Sanjit Singh -- Morgan Stanley -- Analyst

Hi, thank you for taking the questions. Maybe to start off as we think about the full year guide and putting that in the proper context. Rob, you mentioned a -- you mentioned sales execution issues and I'm trying to understand whether this is sales execution issues, maybe a softer spending environment or something more competitive. And so I was wondering if you could maybe address those other two points, whether you saw any sort of macro weakness or sort of competitive issues? Because if you look at sort of Red Hat OpenShift platform they have well above a thousand plus customers, and you guys are sitting at just south of -- just south of 400. And so I'm wondering, if the Docker/Kubernetes message is the message that's resonating more strongly in the market versus what PAS is doing? Maybe we could start there.

Rob Mee -- Chief Executive Officer

Yeah. I mean, I think -- I think addressing that question for the Docker/Kubernetes numbers, if you notice our PKS, which is really the comparator for OpenShift more than PAS in our opinion, you see that we're up to 140 logos already. So that's pretty rapid -- pretty rapid growth in that area, but the deals are much smaller. Now, we expect to see expansion there and we're already seeing expansion, but it's still representing a relatively small proportion of what we do. So I don't think if you -- if you're just comparing us to the competition in that aspect that we're necessarily wildly different in that respect. We have a relatively new product that is competitive to that.

But in terms of the larger deals that we've traditionally done and the strategic relationships that we have with our customers, we are seeing lengthening in the sales cycles. And I think it really is due to a lot of complexity in the technology landscape. If you think about the public clouds coming on-prem, if you think about the rise of Kubernetes and related technologies, people are experimenting with those, they're wondering where to go, there have been acquisitions in the market. So I think it's really causing customers to take their time and think about what they're doing. And as Cynthia said with some of the Q1 deals have slipped into Q2, we haven't lost any of them. They're taking longer. So that's my view on that.

Sanjit Singh -- Morgan Stanley -- Analyst

Understood and that's helpful. And then if I -- if I think about, what I -- what I heard on your script at the top of the call, what was resonating sort of loud and clear is Kubernetes, and I guess my question is sort of why now. Because it's been, in terms of the industry, Kubernetes has sort of been viewed as the industry standard. And so now sitting here in fiscal year 2020, the message is that we're going to put PAS on Kubernetes. And so I guess, the base of the question is it's like why now and why would it take so long to get to this point when it seemed like the -- the industry had -- had sort of made that decision that this was Kubernetes based world.

Rob Mee -- Chief Executive Officer

So why now is the right question and I'll break that apart. I mean, I think in terms of running containerized workloads right, some of which you could run on PAS, some of which would not be appropriate for PAS, but would run well on Kubernetes, we've been in that game now for over a year with PKS and we actually think it's the best Kubernetes implementation on the market for enterprises. So we're there and we've been there.

And then the second -- the second part of your question I think what you're really getting at here is, why putting PAS on Kubernetes now and the thing that you have to realize with the rise of Kubernetes and all of the related technology, so it's not just the container orchestration that is represented by Kubernetes, but there is a lot of other pieces. A lot of that underlying technology that we built ourselves for PAS is very mature, very scalable, very reliable and very secure. And the Kubernetes ecosystem is only now in many of the areas that really matter to us, with the PCF platform generally and within PAS and really matter to our customers, who are running mission critical workloads on it. Only now are those capabilities in the Kubernetes community getting to the point, where we can contemplate replacing the pieces in PAS that we built for ourselves.

And I want to emphasize that we're definitely not -- not invented here shop. Our job has consistently been to curate the best of open source and build in all of the pieces that aren't yet there and then to industrialize the whole thing all put together. And now that the Kubernetes community and the Kubernetes technology is maturing to the point, where it can actually begin to replace some of what we have, we're going to aggressively do that because the real advantage in what we do is at a higher level, it's the higher level abstractions and the developer productivity and the operational efficiency and all the automation that we do. So the more plumbing (ph) and I considered Kubernetes container orchestration to be plumbing, the more of that -- that we can use mature hardened industry standards, we will and we're just now getting to that point. Even so you're going to see an evolution over time. A lot of the maturity isn't there. So for example, PAS runs Windows workloads, mission critical windows workloads, tens of thousands of containers for many of our customers. You can't yet do that at the same level with Kubernetes.

So that technology integration running PAS on Kubernetes is going to be a process and we're going to ship the first version in July and it's going to be available for our customers to try out and then we're going to continue to iterate on it and integrate pieces of the Kubernetes' ecosystem into our platform as appropriate. We'll contribute to the Kubernetes ecosystem to help harden it to the level of our own technology that we've already built and we'll continue to converge those, as they really all form pieces of a greater ecosystem anyway, right. So -- so I think the answer, I know that was a long answer, but I hope that information was relevant and informative because I think it is really, really important point and I'm very glad you asked the question. Why now is because it's finally time.

Sanjit Singh -- Morgan Stanley -- Analyst

Got it. I appreciate the thoughts, Rob.

Operator

Your next question comes from the line of Brad Zelnick from Credit Suisse. Your line is open.

Brad Zelnick -- Credit Suisse -- Analyst

Excellent. Thanks so much for taking the questions. And Rob, just a follow up on Sanjit's first question. I'm trying to better understand the contributing factors to your performance in Q1. The contribution of longer duration sales cycles, technology complexity, deferring decisions, along with the execution challenges you talk about and the changes that you're making in the field, can you double click on the changes that you're making and give us any sense for at least, your expectation for how long these take to come out the other side because having seen this movie before I think many of us would typically expect there to be several quarters of disruption from something like this.

Rob Mee -- Chief Executive Officer

Yeah. I mean, I think honestly we've had some of these changes under way for a while. So I mentioned last quarter, we're refocused on driving business using services and some of those changes that we put in place in Q1, we're just now starting to see some of the results and seeing some improvement in that. And so we have some of these things under way and I think we'll see some results over the next -- the next few quarters.

The North America operation is really at scale. And I think being at scale and improving that and executing better at scale is really what we -- we need to do next and that's why we've put a new leader in place someone that we think can scale with a strong technical background, decades of large enterprise experience, someone who's tenured in the family of Dell and VMware, who can navigate and accelerate those go to market efforts there and has run very large organizations. So I'm confident that this new leader can motivate and influence people to bring systematic approach to sales execution as we scale there.

Brad Zelnick -- Credit Suisse -- Analyst

Great. And just a follow-up for Cynthia. Hi, Cynthia, just trying to reconcile the comments that you've made about slipped deals landing in 2Q with your guidance for significant deceleration in deferred revenue and RPO, it would seem you're expecting the business gets worse. How much of that is demand environment? How much is execution? And what's embedded in terms of close rates and duration in that guidance that you've given us on deferreds and RPO?

Cynthia Gaylor -- Chief Financial Officer

Sure. That's a great question, Brad. I guess, in terms of the quarter itself we did have some deals that slipped in Q1 and as Rob said, the good news there is that we don't lose the deal. So they're very much still in play and a few of them have already closed in Q1 and we're expecting others to close in the coming quarters. Our sales cycle in places is elongating, I think partly due to a lot of the things that Rob talked about in terms of the complex tech landscape. And then from a sales execution perspective, I think you hit the nail on the head, these things tend to take time and we think we have kind of the right team and the right process and place to make it happen, but it takes time and I think that's what you're seeing reflected in the balance sheet metrics if you will.

Brad Zelnick -- Credit Suisse -- Analyst

Okay. Thank you.

Operator

Your next question comes from the line of Jacek Rycko from Citi. Your line is open.

Jacek Rycko -- Citi -- Analyst

Thank you very much. I want to observe that you took down your full year guidance for services by order of magnitude of $30 million to $35 million or so and that's been the -- the primary portion of the drag on the guidance. And so mark (ph) a question from that perspective, you sell expensive pieces of software that take a while to implement. What are you seeing as far as propensity of your consumer -- customers to go on and procuring, obviously expensive pieces of software that may take a little bit -- a bit of time to implement? Are you seeing a positive spend or maybe people taking a bit of a pause and doing these kinds of expensive and long term duration implementations?

Cynthia Gaylor -- Chief Financial Officer

Yeah. So I think it's a good question, and I think you're spot on. You probably as you noted, we guide to subscription revenue and we guide to total revenue and the strategy around services is to sell the amount of services that customers need to really enable them on the platform and it's really about enabling them. I think in Q1, specifically, the slipped deals that we saw did play into kind of the services revenue line and we would expect that to kind of continue, as you look through the year. We just had a lower level of attach to software. I think the other thing is, we are partnering with ATICE to kind of scale services outside of our four walls. I would say that probably less played into the quarter, but it is a careful balance as we operationalize it and scale. So I think that's a piece of the puzzle there as well.

Jacek Rycko -- Citi -- Analyst

Thank you. And just one follow-up. It seems like you've had a little bit of challenges as far as adding new customers in the previous quarters. And just from the perspective of timing, by -- you're lowering (ph) this guidance, are you implying that you observe some lightness on expansion deals and not only on new customer acquisitions. What should we be reading with regards to your expectations for those two separate drivers of top line growth for 2020?

Cynthia Gaylor -- Chief Financial Officer

So I think from a customer perspective, I mean, we're focused on continuing to grow our customer base. Rob talked a little bit about PKS and we have over 140 PKS customers. We're expecting that over time, there'll be more volume there both in dollars, but also in accounts (ph), as the go-to-market strategy -- as the go-to-market strategy there ramps. I think in terms of -- it's important for us to acquire new customers, and we're very focused on that motion. I think part of that plays into kind of some of the sales execution pieces and making sure we're building pipeline through both top of the funnel activity and enablement. And those are two key priorities for us in terms of continuing to build on the number of customers that we have.

Jacek Rycko -- Citi -- Analyst

Thank you. That's helpful.

Operator

Your next question comes from the line of Heather Bellini from Goldman Sachs. Your line is open.

Caroline Liu -- Goldman Sachs -- Analyst

Hi, this is Caroline Liu on for Heather. Question on your net expansion rate. So you've talked about how you expected to be decelerating over time. Can you give some more color on how we should think about the net expansion rate going forward for the full year given the sales execution changes that you've made?

Cynthia Gaylor -- Chief Financial Officer

So I think our view on net expansion hasn't really changed. We believe it will continue to decline just as the Company's revenue is now at scale from a subscription perspective. But we remain at kind of a best-in-class rate, but we would expect it to continue to decline as you've seen the last few quarters and remember, it is subscription, so it's really coming off of the revenue waterfall of subscription, which is fairly consistent. So we expect it to decline, but we expect it to decline gradually, I guess is maybe the best way to characterize it.

Caroline Liu -- Goldman Sachs -- Analyst

Got it. And then on the 140 PKS customers that you currently have, can you talk about what types of customers they are? Are they existing or new? And then any color on the role that Dell and VMware has played on getting those customers on PKS?

Rob Mee -- Chief Executive Officer

Yeah. So as we've brought PKS to market over the last five quarters, I'd say the first half of that time period was really driven by Pivotal and particularly with our existing PAS customers, expanding into -- into PKS. As we predicted, VMware sales machine was going to take a little bit longer to spin up and that they would drive new logos. And as you can see with 140 PKS logos, there have been a number of new logos and VMware's contribution to that has really accelerated over the last couple of quarters. And we continue to see that accelerating. We see their field continuing to be enabled more and more VMware sales folks being able to sell PKS effectively. So I think the contribution there is very strong from VMware and will increase.

From the -- from the Dell side, we see with things like Pivotal Ready Architecture, which is a reference architecture that allows Pivotal VMware and Dell all to be put together into an integrated vertical stack that -- that helps -- that helps drive us to.

Caroline Liu -- Goldman Sachs -- Analyst

All right. Thanks for the color.

Operator

Your next question comes from the line of Bhavan Suri from William Blair. Your line is open.

Bhavan Suri -- William Blair -- Analyst

Hey guys, thanks for taking my question. I guess Rob, maybe first for you. I guess. as you look at the sales organization, maybe historically and hopefully where it's headed to, I guess, how are they communicating with customers, as it relates to deciding between PAS and PKS? And how do customer sort of think about what products right for them? Do they use both products? Do they start with one? And if some of the confusion around that, how should we think about how they're approaching that?

Rob Mee -- Chief Executive Officer

That's a really good question. I think from the point of view of existing customers, who are running on PAS, they wouldn't really even consider putting their application workloads on PKS. They wouldn't want to really move them because they get so much productivity with PAS. That said as PAS users they've looked at a number of workloads, third party applications and certain types of data workloads and so on that they've said, hey, these aren't really suitable for PAS. Where we going to run these? Do we -- do we need to look outside of Pivotal for something else. And I think having PKS has really answered that question and allowed them to move those workloads there. So for existing PAS customers it's really, really very, very simple.

When we've got new customers, it can get a little more complex, right, because some folks can come in and say, I need a Kubernetes platform and then we're sort of saying OK, well let's talk about PKS and you can run applications there, but you can have more productivity on PAS. So -- so then you get into a conversation, where you might initially sell them PKS and convince them that PAS is actually better for some of their workloads and that they can run these things consistently on both different parts of the platform.

And so that complexity, I think is going to get quite a bit simpler when we simply are able to say PAS is actually running on PKS and PAS sort of is Kubernetes, even though, in the end actual operational result it's not that different than today. From the market point of view and from customers sort of demanding Kubernetes the fact that PAS will be running on Kubernetes will help them to feel that they don't have to make a decision one between the other. And that will help us with newer customers and getting them onto the platform more holistically.

Bhavan Suri -- William Blair -- Analyst

Got it. Got it. And then a quick follow-up just to push back a little bit sort of you've got the VMware sales force ramping, you've got Dell providing sort of the reference architecture, you've got guys like Accenture building up (inaudible) Perficient et cetera. I guess with all of that activity especially with the consulting PSIs with CSO (ph) type level relationships, I guess, I'm trying to understand sort of -- I understand deal slippage, but customer counts or new ads or expansions, is it the complexity associated with PKS and PAS? Is it the fact that they're still trying to figure out Kubernetes, but they're all building Pivotal and specific PCF practices. I'm just trying to understand sort of how that plays into sort of the slower customer count, the slip deals, the lower guidance because certainly partner activity seems up, VMware has ramped a little bit, Dell is providing this, they don't -- they don't sort of drive. So just trying to figure out what's happening there?

Rob Mee -- Chief Executive Officer

Yeah. No, I get it. That's a good question. And I think if you look at the net expansion rate, I think that is being driven in part by a lot of these partners having PCF practices and doing application modernization. If you look at the PKS count and logos that's being driven by the partnership with Dell and VMware even though it's -- at the moment it's relatively low impact in terms of our total bookings, our total revenue. And I think you kind of put it out there nicely that's a lot of activity, and it should be driving a lot of momentum.

And I think what that says to me is that we've got -- we do have a lot of momentum and the future is looking really, really good. And the challenges of people taking longer to make decisions and some of that market confusion is holding us back at the moment. But I am truly optimistic about the future because I think we're really well positioned and there is an awful lot of activity, there's a lot of great partnership, and we continue to do the same kind of work that we've always done with really amazing outcomes for strategic customers. So I do think the future is still -- still very bright despite our challenges this quarter.

Bhavan Suri -- William Blair -- Analyst

Got it. Thanks for taking my questions, guys.

Operator

Your next question comes from the line of Matt Hedberg from RBC Capital Markets. Your line is open.

Dan Bergstrom -- RBC Capital Markets -- Analyst

Hey, it's Dan Bergstrom for Matt Hedberg. Thanks for taking my questions. Say to build off a few prior questions with the slip deals, complexities around technologies, could you talk to initial deal sizes? I know they've been rather tight historically, is that still the case? And then any change in the timing of expansion?

Cynthia Gaylor -- Chief Financial Officer

Sure. So I think there hasn't been real changes to the average deal sizes outside of PKS tend to be smaller. So just our average initial deal tends to start in the couple of hundred thousand dollar range and then increases to greater than a million over time and then those kind of expand beyond there to call it $3 million to $5 million and then $5 million to $7 million, and then $7 million to $10 million and we have a few above those levels on an annualized basis.

Our average revenue per customer from a subscription perspective on a trailing 12 month basis for Q1 would be $1.3 million. So we continue to see mainly driven by our net expansion there that continues to tick upwards, but we haven't really seen any big movement in average deal size. I think PKS would be the notable one, where those tend to be smaller. But as Rob said, we've seen some early expansions there, which is encouraging.

Dan Bergstrom -- RBC Capital Markets -- Analyst

Great. And then maybe just switch it up. Just thinking about out of all the Pivotal Labs work, what do you estimate is the share done by you versus partners. Any sense in how that's trended? Or how you'd like it to trend?

Rob Mee -- Chief Executive Officer

That's hard for us to measure. I mean, we certainly know how much Pivotal Labs work we're doing and we see our partners getting better and better at doing that kind of work. But we don't have a real way to actually measure how much work they're doing. And one of the things that I'm very interested in is how much consumption our partners influence on the platform, as we see customers grow especially when we're not working directly with them and we know partners are involved, but even there it's hard to get metrics on that because we just don't own that data. So I don't have a great answer for how much is Pivotal Lab style services, our partners are doing.

The bulk of the work that I think our partners are really doing with our customers is application transformation and modernization, and we see a lot of that. We do a lot of projects, where we actually do blended teams with ourselves and with our partners and with our customers. And then after a project or a couple of projects, we will hand that off to the partners to run with and scale out. And they can do that quite effectively.

Dan Bergstrom -- RBC Capital Markets -- Analyst

Great. Thank you.

Operator

Your next question comes from the line of Raimo Lenschow from Barclays. Your line is open.

David Rainville -- Barclays -- Analyst

Hey, this is actually David Rainville on for Raimo today. Thanks for taking our questions. Really nice -- Rob really nice to see the PAS announcement for Kubernetes and I guess, you guys hinted to that at the recent Cloud Foundry Summit with the Abby Kearns (ph) presentation the keynote. As we think of that and you mentioned shipping it to customers for the first time in July of this year, as we think of like customers taking delivery of that product, should we expect any replatforming of applications that are currently on the PAS version on Diego and not -- and moving to a PKS/Kubernetes application going forward?

Rob Mee -- Chief Executive Officer

No. When we release PAS on PKS for GA, it's going to be just another upgrade. We will attempt to make that completely automated, as all of our upgrades are. I think there is some additional complexity there, so there's a possibility that it will be -- there will be some additional complication. But right now, our view is that when we are able to do that and bring PAS to general availability on Kubernetes that it will -- we'll actually be able to do just another upgrade.

David Rainville -- Barclays -- Analyst

Makes sense. Thanks. Maybe just...

Rob Mee -- Chief Executive Officer

So no downtime for platform or applications.

David Rainville -- Barclays -- Analyst

Got it. Got it. And maybe just a follow-up to that. As you replatform, your hybrid capabilities to Kubernetes, how would you see the competitive landscape evolving with the public cloud and you mentioned that earlier in the call, public cloud players moving on-prem and capabilities like PKS and AKS from Microsoft, how do you are going to position the platform on Kubernetes against these guys in an hybrid world?

Rob Mee -- Chief Executive Officer

Yeah. I mean, I think the reality is that the value that Pivotal provide is at the higher layers. And we continue to build whatever -- whatever kind of infrastructure is necessary for us to provide that higher level value that really results in operational efficiency and developer productivity. And so as these infrastructure providers whether it's public cloud providers or others are delivering container platforms, container orchestration platforms on-prem, they just become more places for us to run our platform in the long run. We showed you (ph) some of them compete with PKS, yes. But in the long run, our strategy to provide higher levels of automation and productivity, it's -- it all helps us.

David Rainville -- Barclays -- Analyst

Thanks for the color.

Rob Mee -- Chief Executive Officer

Yeah.

Operator

Your next question comes from the line of Alex Kurtz from KeyBanc Capital Markets. Your line is open.

Alex Kurtz -- KeyBanc Capital Markets -- Analyst

Yes. Thanks for taking a couple of questions here. So just want to understand going back to what happened this quarter and looking into next quarter, was this really driven by new customers delaying deals or these renewals, then I have a follow up after that.

Cynthia Gaylor -- Chief Financial Officer

Yeah, I would say -- I would say it's a little bit of both. We had some deals kind of across categories that slipped out of the quarter. And again, the good news there is they are still very much in play and some of them have closed. But I think that's what you're seeing kind of in the balance sheet metrics for this quarter, and then in the guide.

Alex Kurtz -- KeyBanc Capital Markets -- Analyst

But Cynthia, these are mostly deals with existing customers is that a fair characterization?

Cynthia Gaylor -- Chief Financial Officer

Well, as you know (multiple speakers) yeah, expansions and renewals drives the larger dollars, but things like customer count and those types of things can also impact some of the numbers that you're looking at. So I would say -- I would say it's a mix of -- it's a mix of both. But the dollars consistently for us are driven by existing customers that are expanding or renewing.

Alex Kurtz -- KeyBanc Capital Markets -- Analyst

Okay. Thanks. And then, Rob, just about what you're doing here with PAS on Kubernetes and thinking about PKS the way that you -- way you have been positioned to us is that PKS was a kind of a downmarket product, Kubernetes for the masses, much more affordable and I'm a little worried that all this movement that you're making here to make PAS available on Kubernetes could be maybe an indication that the core platform was just -- it's really too expensive for the -- for a lot of customers or that this whole process that you're working through now is just going to kind of dilute the ASPs and the deal sizes. So I was wondering if you could kind of walk us through what that may look like over time?

Rob Mee -- Chief Executive Officer

I think continuing to offer PKS as well as PAS, PKS is going to continue to be a lower price point, simply running containers on Kubernetes is a lower level abstraction and less automation than what we do with PAS. And I think those things will continue. Our customers have really found a lot of value in the capabilities of PAS and that's not going to diminish, it's only going to increase, as we continue to evolve it and move it onto Kubernetes and continue building it. So I understand how you could arrive at a thesis that -- that may happen, but from my vantage point, I wouldn't say that's the case. I think we're going to continue to have differentiation at the higher levels.

Alex Kurtz -- KeyBanc Capital Markets -- Analyst

Okay. All right. Thank you.

Rob Mee -- Chief Executive Officer

Yep.

Operator

Your next question comes from the line of Jack Andrews from Needham. Your line is open.

Jack Andrews -- Needham -- Analyst

Well, good afternoon, and thanks for taking my question. I want to ask about the legacy application modernization opportunity. I was wondering if your comments around the increasingly complex technology landscape really carry over to this particular area, when I think about specific types of applications that are written on mainframes and client server architectures, do this represent more straightforward opportunities for you or do they fall into this complexity issues that you're seeing more broadly?

Rob Mee -- Chief Executive Officer

Yeah. I think that the complexity cuts across different types of application workloads and software development efforts including modernization. And I think in the last couple of years, people have heard a lot of noise about sort of lift and shift, get things in containers and move them onto a platform. I think there's been some disillusionment in what that -- what the outcomes are that -- that brings and folks have started talking about move and improve, which definitely gets closer to what we think of as application modernization and transformation.

But when people say should I do that on Kubernetes, should I do it on PAS, how much work do I need to do, how much is going to pay dividends for my different application workloads, all the choices that are available definitely adds complexity to the decision making process. So I think that our newer offerings on top of Kubernetes are going to allow us to be in more conversations, where we can provide the clarity to customers to help them navigate that and say, hey here are your workloads that really belong on Kubernetes directly and here are your workloads, you're going to be better off doing modernization and putting onto an application platform like PAS. And as we engage with them and have those conversations at the high level that's going to be -- that's going to be good for our business and it's going to be good for the customers. So I think -- I think it will help us simply be in more of those conversations and have a -- and be able to have more influence there.

Jack Andrews -- Needham -- Analyst

Great. Thanks for the color.

Operator

Your next question comes from the line of Dan Ives from Wedbush Securities. Your line is open.

Dan Ives -- Wedbush Securities -- Analyst

Yeah. Thanks. Looking in light of the execution issues, what should give investors confidence that this is not going to continue to happen going forward? And then ultimately, I mean, do you feel like this is the management scenario that's going to become more proactive in terms of execution issues versus reactive, in terms I think what most investors are sort of doing this quarter? Thanks.

Rob Mee -- Chief Executive Officer

I mean -- yeah, thanks for the question. I hope that we are proactive and we're definitely not sitting still or not looking at a much longer term future. We don't -- we don't -- we try not to live quarter-to-quarter. Obviously, we have these calls and and we talk to you all and we are responsible for reporting every (technical difficulty) really our focus and our vision is on a longer time cycle and how are we really approaching these secular changes in technology and how do we take advantage of them and help our customers navigate because it is truly complex and things are moving very rapidly. And there is some -- folks need a lot of guidance through this and we need to remain focused on that and not just try to -- try to respond precipitously to one quarter or another.

Dan Ives -- Wedbush Securities -- Analyst

Thanks.

Operator

Your next question comes from the line of Rakesh Kumar from UBC -- UBS. Your line is open.

Rakesh Kumar -- UBS -- Analyst

Hi, thanks for taking my question. One for Cynthia. The Q1, RPO growth came in at 10% and Q2, you're guiding for flat growth. How should we think about RPO growth in the second half?

Cynthia Gaylor -- Chief Financial Officer

So it's really too soon in the year, just too -- it's too soon to tell. I mean, remember, RPO is impacted by timing of deals, and renewals and contract duration. And so similar to last quarter, we're really only giving general ranges based on one quarter out. And so I think it's really too soon to tell in the year, just based on deal timing and duration.

Rakesh Kumar -- UBS -- Analyst

Got it. And then if I may add a follow-up. One of the reasons you talk about is tech complex -- technology complexity and customers navigating to one of these (ph) landscape. And when I think about your Labs expertise that the reason itself (ph) is designed to kind of guide customers to better navigate this transformation. So should we think about a greater focus on that area specifically within -- within services business or how should -- how should I think about...

Rob Mee -- Chief Executive Officer

Yeah. Excellent question. It is, yes. That is the strength and that -- that is one way our services are very strategic and we can help guide customers through the change. I mean, even through the changing Pivotal technology right, there's a a lot of complexity in that alone know not to mention the rest of the technology landscape. So I think it is something that we're going to continue to focus on. And it is helpful to us and it's helpful to our customers. So we will rely on it going forward.

Rakesh Kumar -- UBS -- Analyst

Thanks. If I may add one more. Nice to see subscription gross margins move up, but services margins have ticked down sequentially for the last two quarters. How should we think about services gross margins, as we go from here?

Cynthia Gaylor -- Chief Financial Officer

So I think what you're seeing in the last couple of quarters is services has been a little bit lighter than we were expecting. And so when you think about how that runs, we can't level set kind of in quarter. So it impacts our utilization and impacts the margin kind of in quarter. So we would expect that to improve, as we go into the back half of the year. But we'd also say that the year will be more back end loaded in that regard as well.

Rakesh Kumar -- UBS -- Analyst

Thank you.

Operator

There are no further questions at this time. Rob I turn the call back over to you.

Rob Mee -- Chief Executive Officer

All right. Well, thank you everyone for joining us today, and thank you for your questions. And we'll look forward to talking to you in future quarters. Thanks very much.

Operator

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

Duration: 0 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

Jacek Rycko -- Citi -- Analyst

Caroline Liu -- Goldman Sachs -- Analyst

Bhavan Suri -- William Blair -- Analyst

Dan Bergstrom -- RBC Capital Markets -- Analyst

David Rainville -- Barclays -- Analyst

Alex Kurtz -- KeyBanc Capital Markets -- Analyst

Jack Andrews -- Needham -- Analyst

Dan Ives -- Wedbush Securities -- Analyst

Rakesh Kumar -- UBS -- Analyst

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