ITEM 1A. RISK FACTORS
Investing in our Class A common stock involves a high degree of risk. You should carefully consider the following risks, together with all of the other information contained in our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K before making a decision to invest in our Class A common stock. Any of the following risks could have an adverse effect on our business, results of operations, financial condition and prospects, and could cause the trading price of our Class A common stock to decline, which would cause you to lose all or part of your investment. Our business, results of operations, financial condition, or prospects could also be harmed by risks and uncertainties not currently known to us or that we currently do not believe are material.
Risks Related to Our Business and Industry
We have a limited operating history as an independent company, which makes it difficult to evaluate our prospects and increases the risk of your investment.
We have a limited operating history as an independent company and are scaling quickly, which makes it difficult to evaluate our business and prospects, including our ability to plan for and model future growth. As a relatively early stage company, we have encountered and will continue to encounter risks and uncertainties frequently encountered by companies in new and rapidly evolving fields, including the risks described here. If we do not plan appropriately or do not address these risks successfully, our business and prospects will be adversely affected, and the market price of our Class A common stock could decline.
We have incurred substantial losses and may not be able to generate sufficient revenue to achieve and sustain profitability.
We have incurred net losses in each year since we were formed, including net losses of $141.9 million for fiscal 2019 and $163.5 million for fiscal 2018, respectively. As of August 2, 2019, we had an accumulated deficit of $1,344 million and our net cash provided by operating activities was $63.7 million for the six months ended August 2, 2019. We may not achieve sufficient revenue to attain and maintain profitability. We expect our operating expenses to increase significantly in the future as we hire additional sales, marketing, research and development and other employees across functions, increase or make strategic investments, scale relationships with ecosystem partners and open new offices. In addition, we expect to incur significant additional legal, accounting and other expenses related to being a public company. As a result of these increased expenses, we will have to generate and sustain increased revenue in order to become profitable in future periods. Because some of the markets for our offering are rapidly evolving and are not mature, it is difficult for us to predict our future results of operations. We cannot assure you that we will achieve profitability in the future or that, if we do become profitable, we will be able to sustain profitability. Any failure by
us to achieve, sustain or increase profitability or generate positive cash flow from operations on a consistent basis could cause the value of our Class A common stock to decline.
Our future success depends in large part on the growth of our target markets. Even if our target markets grow as expected, our ability to further penetrate these markets is uncertain.
Our ability to increase sales of PCF and Labs depends on growth in our target markets, which include the markets for cloud application infrastructure, Platform-as-service and application infrastructure, middleware and development solutions. Our expectations regarding the potential for future growth in the markets for these types of offerings are subject to uncertainty. In particular, even if there is increased enterprise adoption of public cloud strategies, we cannot assure you that enterprise demand for multi-cloud solutions like ours will grow commensurately. If market demand does not grow as expected, our business and prospects may be adversely affected.
Even if these markets grow as expected, we cannot be sure that our business will grow at a similar rate, or at all. Our experience in the markets and our experience selling PCF are relatively limited, and PCF has been commercially available for a limited period of time. We began selling PCF in fiscal 2014 and frequently update its features and functionality. Our ability to increase sales of PCF and our other offerings is affected by a number of factors beyond our control, including market acceptance of our offerings by existing customers and potential new customers, the extension of our offerings to new use cases and workloads, changing open-source platform technologies and standards and the timing of development and release of new products, capabilities and functionality by our competitors and by us. In addition, while we seek to expand the use of PCF through our Labs projects, we cannot assure you that we will be successful or that PCF and Labs as a complementary offering will produce the benefits that we expect. In addition, we cannot assure you that our offerings and future enhancements to our offerings will be able to address future advances in technology or requirements of existing customers or potential new customers. If we are unable to meet customer demands, to leverage the strengths of PCF and Labs as complementary offerings or to achieve more widespread market acceptance of our offerings, our business, results of operations, financial condition and growth prospects will be adversely affected.
Our future growth is largely dependent on PCF and platform-related services, and challenges in market acceptance, adoption and growth of PCF could harm our business, results of operations and prospects.
We expect that we will depend on PCF and platform-related services, which include all of our Labs services and most of our implementation services, to generate the vast majority of our future revenue, as revenue from PCF and platform-related services has represented a substantial majority and an increasing portion of our total revenue from fiscal 2017 to fiscal 2019. As a result, our operating results could suffer due to:
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declines in demand for PCF;
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failure of PCF to achieve continued market acceptance;
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the market for cloud-native software not continuing to grow, or growing more slowly than we expect;
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introduction of products and technologies that serve as a replacement or substitute for, or represent an improvement over, PCF;
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technological innovations or new open-source standards that PCF does not address or that favor competitors;
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sensitivity to current or future prices offered by us or competing solutions; and
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our inability to release enhanced versions of PCF on a timely basis.
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If the market for PCF grows more slowly than anticipated or if demand for PCF does not grow as quickly as we anticipate, whether as a result of competition, pricing sensitivities, product obsolescence, technological change, unfavorable economic conditions, uncertain geopolitical environment, budgetary constraints of our customers or other factors, our business, results of operations and prospects will be harmed.
Our subscription revenue growth rate, both in absolute terms and relative to total revenue, in recent periods may not be indicative of our future performance and ability to grow. Similarly, our services revenue growth rate has fluctuated in recent periods, may continue to fluctuate and will likely decline over the long term as we scale our PCF business.
We have experienced significant growth in recent periods, particularly in subscription revenue, which increased to $400.9 million in fiscal 2019 from $259.0 million in fiscal 2018. Subscription revenue also increased as a percentage of total revenue in each of the last three fiscal years, resulting in an increase of our overall gross profit. Our strategy is to continue to increase subscription revenue in general, relative to services, and as a proportion of our total revenue.
You should not consider our subscription revenue growth rate in recent periods as indicative of our future performance. We may not achieve similar growth rates in future periods. Any success that we may experience in the future will depend in large part on our ability to, among other things:
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add new customers and retain our existing customers;
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increase revenue from existing customers through increased or broader use of our platform within their organizations;
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improve the performance and capabilities of our platform through research and development;
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continue to successfully expand our business domestically and internationally; and
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During the same periods, our services revenue increased to $256.6 million in fiscal 2019 from $250.4 million in fiscal 2018. We are focused on prioritizing the growth of PCF and intend to leverage our existing services and are increasing our reliance on our emerging SI partners to deliver platform-related services to our customers.
Our business and prospects will be harmed if our customers do not renew their subscriptions and expand their use of our platform.
Our future growth depends in part on customers renewing their subscriptions and expanding their use of our platform. The broad adoption of our platform within a customer presents challenges, including changing the customer’s culture and approach to the customer’s development of internal expertise and infrastructure to manage and utilize our platform effectively.
Existing customers have no obligation to renew their subscriptions after the initial term. Given our limited operating history, the limited commercial availability of PCF and the immaturity of the markets in which we operate, we may not be able to accurately predict the rate at which customers will renew their subscriptions. Our customers may not renew their subscriptions or may renew at lower levels or on terms that are less economically beneficial to us. Our customers’ renewal rates may decline or fluctuate as a result of a number of factors, including customer dissatisfaction with our pricing or the functionality, features or performance of our platform, our inability to meet our contractual commitments, competitors’ product offerings, internally-developed, open-source solutions that do not require vendor assistance, changing open-source standards, consolidation within our customer base and other factors, a number of which are beyond our control. If our customers do not renew their subscriptions or renew on less favorable terms, our revenue may grow more slowly than expected, if at all, and our business, results of operations and financial condition will be adversely affected.
Even if our existing customers renew their subscriptions and continue to use PCF, it is important for our success and growth that these customers expand their use of our platform. The rate at which our customers expand their use of our platform depends on a number of factors, including general economic conditions, the functioning of our platform, the ability of our field organization, together with our partners, to assist our customers in identifying new use cases, modernizing their software development approach and IT operational infrastructure and achieving success with ingraining a new culture and our customers’ overall satisfaction.
The purchase of our software and services is discretionary and can involve significant expenditures. If our existing customers cut costs, they may significantly reduce their enterprise software expenditures, and they may not renew or expand their use of our platform.
As technologies and the markets for our software and services change, our subscription-based business model for PCF may no longer meet the needs of our existing customers. Consequently, we may need to develop new and appropriate software and services and marketing and pricing strategies for our solutions. If we are unable to adapt our business model to changes in the
marketplace or if demand for our software and services declines, our business, results of operations, financial condition and cash flows could be harmed.
We operate in a highly competitive industry. Any failure to compete effectively could materially and adversely affect our business, results of operations and financial condition.
The markets within which we operate are highly competitive. A significant number of companies and open-source projects have developed or are developing products and services that currently, or in the future may, compete with some or all of our offerings. In addition, in some instances, we have strategic or other commercial relationships with companies with which we currently or in the future may compete. We face competition from:
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legacy application infrastructure and middleware from vendors such as IBM and Oracle;
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open-source based offerings supported by vendors such as Red Hat; alternative Cloud Foundry-based offerings such as IBM Cloud and SAP Cloud Platform, which have proprietary features that are unique to their offerings; or potential customers’ internally-developed, integrated and maintained efforts; and
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proprietary public cloud offerings from vendors such as Amazon Web Services (including its on-premise cloud offerings), Google Cloud Platform and Microsoft Azure.
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Many of our principal competitors have substantially longer operating histories, larger numbers of existing customers, greater capital and research and development resources, broader sales and marketing capabilities, stronger brand and customer recognition, larger intellectual property portfolios and broader global distribution and presence. Our competitors may be able to offer products or functionality similar to ours at a more attractive price than we can by integrating such products with their other product offerings. Acquisitions and consolidation in our industry, such as IBM’s proposed acquisition of Red Hat, may provide our competitors even more resources or may increase the likelihood of our competitors offering integrated products with which we cannot effectively compete. New innovative start-ups and existing large companies that are making significant investments in research and development could also launch new products and services that we do not offer and that could gain market acceptance quickly. If we were unable to anticipate or react to these competitive challenges, our competitive position would weaken, which would adversely affect our business, results of operations and financial condition.
In addition, one of the characteristics of open-source software is that, subject to specified restrictions, anyone may modify and redistribute such software and use it to compete in the marketplace. Such competition can develop with a smaller degree of overhead and lead time than required by traditional proprietary software companies. New open source-based platform technologies and standards are consistently being developed and can gain popularity quickly. Improvements in open source could cause customers to replace software purchased from us with their internally-developed, integrated and maintained open-source software. It is possible for competitors with greater resources than ours to develop their own open-source software-based products and services, potentially reducing the demand for our solutions and putting price pressure on our offerings. We cannot guarantee that we will be able to compete successfully against current and future competitors, that competitive pressure or the availability of new open-source software will not result in price reductions, reduced operating margins or increased sales and marketing expenses or that we will increase our market share, any one of which could harm our business, financial condition, results of operations and cash flows.
Our sales cycles can be long, unpredictable and vary seasonally, which can cause significant variation in the number and size of transactions that close in a particular quarter.
Our results of operations may fluctuate, in part, because of the resource-intensive nature of our sales efforts, the length and variability of the sales cycle for our platform and the difficulty in making short-term adjustments to our operating expenses. Many of our customers are large enterprises, whose purchasing decisions, budget cycles and constraints and evaluation processes are unpredictable and out of our control. Further, the timing of our sales is difficult to predict. The length of our sales cycle, from initial evaluation to payment for our subscriptions can range from several months to well over a year and can vary substantially from customer to customer. Our sales efforts involve significant investment in resources in field sales, partner development, marketing and educating our customers about the use, technical capabilities and benefits of our platform and services. Customers often undertake a prolonged evaluation process, which frequently involves not only our platform but also those of other companies or the consideration of internally developed alternatives including those using open-source software. Some of our customers initially deploy our platform on a limited basis, with no guarantee that these customers will deploy our platform widely enough across their organization to justify our substantial pre-sales investment. As a result, it is difficult to predict exactly when, or even if, we will make a sale to a potential customer or if we can increase sales to our existing customers. Large individual sales have, in some cases, occurred in quarters subsequent to those we anticipated, or have not occurred at all. If our sales cycle lengthens or
our substantial upfront investments do not result in sufficient revenue to justify our investments, our operating results could be adversely affected.
We have experienced seasonal and end-of-quarter concentration of our transactions and variations in the number and size of transactions that close in a particular quarter, which impacts our ability to grow revenue over the long term and plan and manage cash flows and other aspects of our business and cost structure. Our transactions vary by quarter, with the fourth quarter typically being our largest. In addition, within each quarter, a significant portion of our transactions occur in the last two weeks of that quarter. If expectations for our business turn out to be inaccurate, our revenue growth may be adversely affected over time and we may not be able to adjust our cost structure on a timely basis and our cash flows may suffer.
We do not control and may be unable to predict the future course of open-source technologies, including those used in our offering, which could reduce the market appeal of our offering and damage our reputation.
We do not control the development of the open-source technology in our offering. We incorporate disparate inputs from various open-source developers and open-source projects, including Kubernetes, whose technology and development decisions we may not control. Different open-source projects may also overlap or compete with the ones that we incorporate into our offering. The technology developed by one group for one project may become more widely used than that developed or integrated by us. Additionally, another company’s distribution of the same open-source technology may be favored by customers over ours if such other company is viewed as a more important contributor to such technology. If we acquire or adopt a new technology and incorporate it into our offering but a competing technology or distribution becomes more widely used or accepted, the market appeal of our offering may be reduced and that could harm our reputation, diminish our brand and harm our prospects.
Different groups of open-source software programmers collaborate with one another to develop certain of the open-source software that may be contained in our offering. If open-source software programmers, many of whom we do not employ, or our own internal programmers do not continue to use, contribute to and enhance the open-source technologies that we rely on, the market appeal of our offering may be reduced, which could harm our reputation, diminish our brand and result in decreased revenue. We also cannot predict whether further developments and enhancements to these open-source technologies will be available from reliable alternative sources. If the open-source technologies that we rely on become unavailable, we may need to invest in researching and developing alternative technologies.
Security and privacy breaches could expose us to liability, damage our reputation, compromise our ability to conduct business, require us to incur significant costs or otherwise adversely affect our financial results.
Any security breach, unauthorized access or usage, virus or similar breach or disruption of our systems or software could result in the loss of confidential information, damage to our reputation and brand, early termination of our contracts, litigation, regulatory investigations or other liabilities. We have implemented administrative, technical and physical measures designed to prevent breach or disruption of our systems and may incur significant costs in connection with implementing additional preventative measures in the future. We have in the past and may in the future experience security breaches. Techniques used to obtain unauthorized access or to sabotage systems change frequently and are often not recognized until launched against a target. As a result, we may be unable to anticipate these techniques or to implement adequate preventative measures. Any significant security breaches could result in the loss of business, litigation and regulatory investigations and penalties that could damage our reputation and adversely impact our results of operations and financial condition. We also rely heavily on third-party applications and cloud services, which may contain software vulnerabilities and other defects. If our security measures are breached as a result of third-party action, employee error, malfeasance or otherwise and, as a result, someone obtains unauthorized access to sensitive data, including intellectual property, proprietary business information or personal information, our reputation would be damaged, our business may suffer and we could incur significant liability. Our existing cybersecurity insurance may not cover any, or cover only a portion of any, potential claims related to security breaches to which we are exposed or may not be adequate to indemnify us for all or any portion of liabilities that may be imposed and our cybersecurity premiums may go up.
Critical vulnerabilities and security defects could harm the market perception of our products or services.
If an actual or perceived critical security vulnerability is reported in our products or services, the market perception of our security measures and the security capabilities of our products or services could be harmed and we could lose sales and customers. For example, we market PCF’s security as one of its principal benefits, so the market perception of PCF’s security is important to our business. Our offerings are highly technical and complex and, when deployed, have contained and may contain errors, defects or security vulnerabilities. Any errors, defects or security vulnerabilities discovered in our offerings could result in loss of revenue or delay in revenue recognition, loss of customers and increased service and warranty cost, any of which could adversely affect our business results of operations and financial condition. Moreover, if a high-profile security breach occurs with
respect to another PaaS solution provider, our customers and potential customers may lose trust in PaaS solutions generally, which could adversely impact our ability to retain existing customers or attract new ones.
Moreover, PCF is deployed on a customer’s private cloud, a public cloud of its choice, or multiple clouds, and we have no control over our customers and their security personnel, processes or technology. We do not monitor or review the content that our customers store or transmit through PCF or the security measures they implement to deploy PCF. Customers may also delay the installation of, or not install, security updates, leaving them vulnerable. Accordingly, if there is a breach of PCF deployed at a customer’s location or within a customer’s control, our reputation could be damaged, our business may suffer and we could incur significant liability, even though our product was not necessarily the cause of such issue. We are also growing our partner ecosystem, which includes public cloud vendors, SIs and strategic partners, to sell, implement and support our offerings. We also sell our partners’ offerings through the Pivotal Services Marketplace. We lack control over their security measures, and any breach of their security systems could similarly adversely affect us.
Our security profile is also impacted by our use of open-source software in our offering. Open-source software enables public access to source code, which is generally not a security risk posed by proprietary products.
If we do not effectively hire, train, retain and oversee our sales force, we may be unable to add new customers or increase sales to our existing customers, and our business may be adversely affected.
We depend on our sales force to obtain new customers and increase sales with existing customers. Our software and services offering is complex and there is competition for sales personnel with the range of abilities that we require. Our ability to achieve significant revenue growth will depend, in large part, on our success in continuing to hire, train and retain sufficient numbers of sales personnel to support our growth, including in international markets. In addition, a large percentage of our sales force is new to our company. New hires require significant training and oversight, typically over a period of several quarters, before they can achieve full productivity. Our recent hires and planned hires may not become productive as quickly as we expect, and we may be unable to hire or retain sufficient numbers of qualified individuals in the markets where we do business or plan to do business. In addition, as we grow our sales force, its organization, management and leadership become increasingly difficult and complex, and, as a result, we may not be able to grow it successfully. If we are unable to hire, train and retain a sufficient number of effective sales personnel, if we are ineffective at overseeing a growing sales force or if the sales personnel we hire are otherwise unsuccessful in obtaining new customers or increasing sales to our existing customers, our business may be adversely affected.
Our future growth depends in large part on the success of our partner relationships.
In addition to our sales force, we rely on partners, including our strategic partners Dell and VMware, public cloud vendors and SIs, to increase our sales and distribution of our software and services. We also have ISV partners whose integrations increase our ecosystem of services. We are dependent on partner relationships to contribute to our growth and to create leverage in our business model. Our future growth will be increasingly dependent on the success of our partner relationships, and if those partnerships do not provide such benefits, our ability to grow our business will be harmed. If we are unable to scale our partner relationships effectively, or if our partners are unable to serve our customers effectively, we may need to expand our services organization, which could adversely affect our results of operations.
Our agreements with our partners are generally non-exclusive, meaning our partners may offer products themselves or from several different companies to their customers or have their products or technologies also interoperate with products and technologies of other companies, including products that compete with our offerings. Moreover, some of our partners also compete with us. If our partners do not effectively market and sell our offerings, choose to use greater efforts to market and sell their own products or those of our competitors or fail to meet the needs of our customers, our ability to grow our business and sell our offerings will be harmed. Furthermore, our partners may cease marketing our offerings with limited or no notice and with little or no penalty, and new partners could require extensive training and may take several months or more to achieve productivity. The loss of a substantial number of our partners, our possible inability to replace them or the failure to recruit additional partners could harm our results of operations. Our partner structure could also subject us to lawsuits or reputational harm if, for example, a partner misrepresents the functionality of our offerings to customers or violates applicable laws or our corporate policies.
We may not be able to respond to rapid technological changes with new offerings, which could have a material adverse effect on our sales and profitability.
The markets for our software platform are characterized by constant technological changes, changing open-source software platform technologies and standards, changing customer needs and frequent new software product introductions and improvements. The introduction of third-party solutions embodying new technologies and the emergence of new industry standards, including any open-source projects that have become widely adopted, could make our existing and future software offerings obsolete and
unmarketable. In addition, as the enterprise software landscape evolves, we will continue to reassess the amount and timing of our initiatives. In the near term, we are increasing our investments in and expenditures for additional engineering resources and personnel necessary to compete with these rapidly-changing technologies, and these investments and expenditures will affect our profitability.
If we are not able to maintain and enhance our brand, our business and results of operations may be adversely affected.
We believe that protecting our Pivotal brand and maintaining and enhancing our reputation as a pioneer in cloud-native software, agile software development and DevOps is critical to our relationship with our existing customers and partners and our ability to attract new customers and partners. The successful promotion of our brand will depend on a number of factors, including our ability to continue to develop high-quality features and functionality for our offerings, our ability to successfully differentiate our offerings, delivery of customer value, leadership in open-source software, our marketing efforts and our continued protection of our brand. Our brand promotion activities may not be successful or yield increased revenue.
In addition, independent industry analysts often provide reviews of our offerings, as well as offerings of our competitors, and the perception of our offerings in the marketplace may be significantly influenced by these reviews. If these reviews are negative, or less positive as compared to those of our competitors’ products and services, our brand may be adversely affected. The performance of our partners may also affect our brand and reputation if customers do not have a positive experience with our partners’ services. The promotion of our brand requires us to make substantial expenditures, and we anticipate that the expenditures will increase as our market becomes more competitive, as we expand into new markets, and as more sales are generated through our partners and more services are performed by our partners. To the extent that these activities yield increased revenue, this revenue may not offset the increased expenses we incur. If we do not successfully maintain and enhance our brand, our business may not grow, we could lose customers or fail to attract potential customers, all of which would adversely affect our business, results of operations and financial condition.
Our stock price and trading volume are heavily influenced by the way analysts and investors interpret our financial information and other disclosures. Any unfavorable interpretations published by analysts or held by investors could have a negative impact on our stock price, regardless of accuracy, and any decline or lapse in the publication of research by analysts could cause our stock price and trading volume to decline.
The trading market for our Class A common stock depends in part on the research reports that analysts publish about our business. If few analysts cover us, demand for our Class A common stock could decrease and our Class A common stock price and trading volume may decline. Similar results may occur if one or more of these analysts stop covering us in the future or fail to publish reports on us regularly.
Even if our stock is actively covered by analysts, we do not have any control over the analysts or the measures that analysts or investors may rely upon to forecast our future results. For example, in order to assess our business activity in a given period, analysts and investors may look at the combination of revenue and changes in deferred revenue in a given period (sometimes referred to as "billings").
Over-reliance on billings or similar measures may result in analyst or investor forecasts that differ significantly from our own for a variety of reasons, including:
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a relatively large number of transactions occur at the end of the quarter. Invoicing of those sales may or may not occur before the end of the quarter based on a number of factors, including: the volume of transactions, the timing of receipt of information from the customer, the timing of subscription contract start dates, the timing and end dates of our fiscal quarters and fiscal years now that we have changed to a 52- or 53-week fiscal year basis ending on the Friday nearest to January 31 of each year (a "4-4-5 Fiscal Year") and the resulting shifting dates of our quarter end, and holidays. A shift of a few days has little economic impact on our business, but can shift deferred revenue from one period into the next;
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multi-year upfront billings may distort trends;
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subscriptions that have deferred start dates; and
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services that are invoiced upon delivery.
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In addition, as required by the revenue recognition standard under Accounting Standard Codification Topic 606, Revenue From Contracts With Customers ("ASC 606"), we disclose our remaining performance obligations. This disclosure obligation is
prepared on the basis of estimates based upon contractual arrangements and historical patterns of delivery. Market practices surrounding the calculation of this measure are still evolving. It is possible that analysts and investors could misinterpret our disclosure or that the terms of our customer contracts or other circumstances could cause our methods for calculating this disclosure to differ significantly from others, which could lead to inaccurate or unfavorable forecasts by analysts and investors.
Regardless of accuracy, unfavorable interpretations of our financial information and other public disclosures could have a negative impact on our stock price. If one or more of the analysts who cover us publish unfavorable research about our business or otherwise downgrade our Class A common stock for any reason, the price of our Class A common stock would likely decline.
The loss of one or more members of our senior management team or an inability to attract and retain highly skilled employees, for which competition is intense, could adversely affect our planned growth.
Our success depends largely upon the continued service of our senior management team. From time to time, there may be changes in our senior management team, which could disrupt our business. Members of our senior management could terminate their employment with us at any time.
To execute our growth plan, we must attract and retain highly skilled employees. Competition for such personnel is intense, especially for engineers with high levels of experience in designing, developing and supporting software and for senior sales executives. We work on open-source software-based projects, making our developers highly marketable to other companies that work on similar projects. We may not be successful in attracting and retaining qualified personnel. We have from time to time experienced, and we expect to continue to experience, difficulty in hiring and retaining highly skilled employees with appropriate qualifications. Many of the companies with which we compete for experienced personnel have greater resources than we have. In addition, our compensation arrangements, such as our equity award programs, may not always be successful in attracting new employees and retaining and motivating our existing employees. Further, many of our employees may be able to receive significant proceeds from sales of our Class A common stock in the public markets, which may reduce their motivation to continue to work for us. In addition, employees may be more likely to leave us if the exercise prices of the stock options that they hold are significantly above the market price of our Class A common stock. If we fail to attract new personnel or fail to retain and motivate our current personnel, our business and future growth prospects could be severely harmed.
Failure to manage our growth and maintain our corporate culture will harm our business.
We have substantially increased our overall headcount and expanded our business and operations in recent periods. Our headcount increased to 3,018 full-time employees at the end of our second quarter of fiscal 2020 from 2,671 full-time employees at the end of our first quarter of fiscal 2019. We have also expanded into additional geographic locations and added office space, including outside the United States. We expect to continue to expand our operations and employee headcount in the near term; however, our recent growth rates may not be indicative of our future growth. Our success will depend in part on our ability to continue to grow and to manage this growth effectively.
Our recent growth has placed, and future growth will continue to place, significant demands on our management, infrastructure and other resources and increased our costs. We will need to continue to develop and improve our operational, financial and management controls, and our reporting systems and procedures to manage the expected growth of our operations and personnel, which will require significant capital expenditures and allocation of valuable management and employee resources. If we fail to implement these infrastructure improvements effectively, our ability to ensure uninterrupted operation of key business systems and comply with the rules and regulations that are applicable to public reporting companies will be impaired. Further, if we do not effectively manage the growth of our business and operations, the quality of our platform and services could suffer, and we may not be able to adequately address competitive challenges. This could impair our ability to attract new customers, retain existing customers and expand their use of our platform, all of which would adversely affect our brand, overall business, results of operations and financial condition.
We believe that our culture has been and will continue to be a key contributor to our success. Our culture and core principles are critical to how we run our business, how we engage with our key constituencies, including our customers, and how we build and deliver our offerings. If we do not continue to maintain our unique culture as we grow, our business could be harmed.
Incorrect or improper implementation or use of our software or inability of our platform to integrate with third-party software or hardware could result in customer dissatisfaction and negatively affect our business, operations, financial results and growth prospects.
Our software is deployed in a wide variety of complex technology environments, and we believe our future success will depend on our ability to increase sales of our software subscriptions for use in such deployments. Our platform must also integrate
with a variety of operating systems, software applications and hardware developed by others. We often assist our customers in achieving successful implementations for large, complex deployments. If we or our customers are unable to implement our software successfully, or are unable to do so in a timely manner, or if we are unable to devote the necessary resources to ensure that our solutions inter-operate with other software, systems and hardware, customer perceptions of our company may be impaired, our reputation and brand may suffer and customers may choose not to increase their use of our software.
Once our platform is implemented on our customers’ selected hardware, software or cloud infrastructure, our customers may depend on our support organization services to help them take full advantage of PCF, quickly resolve post-deployment issues and provide effective ongoing support. If our support organization or those of our partners do not offer high-quality services, our ability to sell our offerings to existing customers or to have them renew their subscriptions would be adversely affected. In addition, as we expand our operations internationally, our support organization will face additional challenges, including those associated with delivering support, training and documentation in languages other than English.
The reliability of our platform will continue to be critical to our success. Sustained errors, failures or outages could lead to significant costs and service disruptions, which could negatively affect our business, financial results and reputation.
Our reputation and ability to attract, retain and serve our customers are dependent upon the reliable performance of our platform and our underlying technical and network infrastructure. We have experienced, and will in the future experience, interruptions, outages and other performance problems. In addition, we rely on third-party service providers to host and deliver our cloud-based offerings, and these third parties may also experience interruptions, outages and other performance problems. Such disruptions may be due to a variety of factors, including infrastructure changes, human or software errors, capacity constraints and inadequate design. A future rapid expansion of our business could increase the risk of such disruptions. In some instances, we may not be able to identify the cause or causes of these performance problems within an acceptable period of time.
In addition, we could face claims for product liability, tort or breach of warranty. Our contracts with customers contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld. Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention and adversely affect the market’s perception of us and our offerings. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms or at all, our business, results of operations and financial condition could be adversely impacted.
Adverse economic conditions or reduced information technology spending may adversely impact our revenues.
Our business depends on the overall demand for information technology and on the economic health of our current and prospective customers. The purchase of our offerings is often discretionary and may involve a significant commitment of capital and other resources. Weak economic conditions, or a reduction in information technology spending even if economic conditions improve, would likely adversely impact our business, results of operations and financial condition in a number of ways, including by lengthening sales cycles, lowering prices for our products and services and reducing sales. In addition, any changes in the domestic or international political environment or deterioration in international relations as well as resulting regulatory or tax policy changes may adversely affect our business and financial results. Furthermore, during challenging economic times our customers may face issues in gaining timely access to sufficient credit, which could result in an impairment of their ability to make timely payments to us. If that were to occur, we may be required to increase our allowance for doubtful accounts, which would adversely affect our financial results.
We do not have an adequate history with our subscription or pricing models to accurately predict the long-term rate of customer adoption or renewal, or the impact these will have on our revenue or operating results.
We have a limited history with our subscription offerings and pricing model and if, in the future, we are forced to reduce prices for our subscription offerings, our revenue and results of operations will be harmed. We may not be able to accurately predict the long-term rate of customer adoption or renewal, or the impact these will have on our revenue or operating results. We also have limited experience with respect to determining the optimal prices and pricing models for our solution. As a result, in the future we may be required to reduce our prices, which could adversely affect our revenue, gross margin, profitability, financial position and cash flow.
We generate revenue from sales outside of the United States, and we are therefore subject to a number of risks associated with international sales and operations. Challenges presented by international economic, political, legal, accounting and business factors could negatively affect our business, financial condition or results of operations.
Our business is subject to several risks associated with our non-U.S. operations. These risks may intensify to the extent we successfully scale our non-U.S. business. Accordingly, our future results could be materially and adversely affected by a variety of factors relating to our non-U.S. operations, including, among others, the following:
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fluctuations in foreign currency exchange rates;
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changes in a specific country’s or region’s economic conditions;
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political or social unrest;
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import or export licensing requirements;
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changes in international tax laws;
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changes in regulatory requirements;
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difficulties in staffing and managing international operations;
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stringent data protection regulations in some foreign countries;
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compliance with a variety of foreign laws and regulations; and
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longer payment cycles or collectability concerns in certain countries.
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The occurrence of any one of these risks could harm our business and results of operations. Additionally, operating in international markets requires significant management attention and financial resources. We cannot be certain that the investment and additional resources required to operate in other countries will produce desired levels of revenue or profitability.
Sales to customers located outside of the United States represented 23% of our total revenue for both fiscal 2019 and fiscal 2018. We intend to continue to increase sales outside of the United States. In order to maintain and expand our sales internationally, we need to hire and train experienced personnel to staff and manage our foreign operations. To the extent that we experience difficulties in recruiting, training, managing and retaining international staff, and specifically sales management and sales personnel, we may experience difficulties in growing our international sales and operations. If we are not able to maintain successful partner relationships internationally, our future success in such markets could be limited. In addition, the costs associated with scaling our business outside the United States may be significant.
We are exposed to fluctuations in currency exchange rates, which could negatively affect our results of operations.
Our sales contracts are primarily denominated in U.S. dollars, and therefore substantially all of our revenue is not subject to foreign currency risk. However, a strengthening of the U.S. dollar could increase the real cost of our platform to our customers outside of the United States, which could adversely affect our results of operations. In addition, an increasing portion of our operating expenses is incurred and an increasing portion of our assets is held outside the United States. These operating expenses and assets are denominated in foreign currencies and are subject to fluctuations due to changes in foreign currency exchange rates, which could have an adverse impact on the results of our operations.
Due to the global nature of our business, we could be adversely affected by violations of the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act or similar anti-bribery laws in other jurisdictions in which we operate, and various international trade and export laws.
Non-U.S. operations, particularly in those countries with developing economies, are also subject to risks of violations of laws prohibiting improper payments and bribery, including the U.S. Foreign Corrupt Practices Act, U.K. Bribery Act and similar anti-bribery laws in foreign jurisdictions, which generally prohibit U.S.-based companies and their intermediaries from making improper payments for the purpose of obtaining or retaining business to non-U.S. officials, or in the case of the U.K. Bribery Act,
to any person. Our global operations require us to import from and export to several countries, which geographically stretches our compliance obligations. In addition, changes in such laws could result in increased regulatory requirements and compliance costs which could adversely affect our business, financial condition and results of operations. Our employees, contractors and agents may take actions in violation of the U.S. Foreign Corrupt Practices Act, U.K. Bribery Act or other anti-bribery laws. Any such violations, even if due to acts or inadvertence of our employees, or due to the acts or inadvertence of others, could subject us to civil or criminal penalties or otherwise have an adverse effect on our business and reputation.
Our sales to government entities and highly regulated organizations are subject to a number of challenges and risks.
We sell to U.S. federal and state and foreign governmental agency customers, as well as to customers in highly regulated industries such as financial services, pharmaceuticals, insurance and healthcare. Sales to such entities are subject to a number of challenges and risks. Selling to such entities can be highly competitive, expensive and time-consuming, often requiring significant upfront time and expense without any assurance that these efforts will generate a sale. Government contracting requirements may change and in doing so restrict our ability to sell into the government sector until we have attained the revised certification. Government demand and payment for our offerings are affected by public sector budgetary cycles and funding authorizations, with funding reductions or delays adversely affecting public sector demand for our offerings.
Further, governmental and highly regulated entities may demand shorter subscription periods or other contract terms that differ from our standard arrangements, including terms that can lead those customers to obtain broader rights in our offerings than would be standard. Such entities may have statutory, contractual or other legal rights to terminate contracts with us or our partners due to a default or for other reasons, and any such termination may adversely affect our reputation, business results of operations and financial condition.
Because we recognize subscription revenue over the terms of our contracts, fluctuations in new transactions will not be immediately reflected in our operating results and may be difficult to discern. Professional services revenue may fluctuate significantly from period to period.
We generally recognize subscription revenue from customers ratably over the terms of their contracts, which are typically one to three years. As a result, most of the subscription revenue we report for each quarter is derived from the recognition of deferred revenue relating to subscriptions entered into during previous periods. Consequently, a decline in subscription sales in any single quarter would likely have only a small impact on our revenue for that quarter. However, such a decline would negatively affect our revenue in future quarters. Accordingly, the effect of significant downturns in transactions and market acceptance of our platform may not be fully apparent from our reported results of operations until future periods.
We may be unable to adjust our cost structure to reflect the changes in revenues. In addition, a significant portion of our costs is expensed as incurred, while subscription revenue is recognized over the applicable subscription term. As a result, increased growth in the number of our customers could result in our recognition of more costs than revenue in the earlier periods of the terms of our contracts. Our subscription model also makes it difficult for us to rapidly increase our revenue through additional transactions in any period, as revenue from new customers must be recognized over the applicable subscription term.
Professional services revenue is recognized as the services are performed or delivered, depending on the type of engagement. Professional services engagements often span from a few weeks to several months, which makes it somewhat difficult to predict the timing of revenue recognition for such services and the corresponding effects on our results of operations. Professional services revenue has fluctuated and may continue to fluctuate significantly from period to period. In addition, because professional services expenses are recognized as the services are performed or upon completion of the project, professional services and total margins can significantly fluctuate from period to period.
If our goodwill or amortizable intangible assets become impaired, we may be required to record a significant charge to earnings.
Under Generally Acceptable Accounting Principles ("GAAP"), we review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is required to be tested for impairment at least annually. Factors that may be considered a change in circumstances indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable include a decline in our stock price and market capitalization, reduced future cash flow estimates and slower growth rates in our industry. We may be required to record a significant charge to earnings in our financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, which could harm our results of operations.
We may acquire other businesses which could require significant management attention, disrupt our business, dilute stockholder value and adversely affect our results of operations.
As part of our business strategy, we have in the past made, and may in the future make, acquisitions or investments in complementary companies, products and technologies that we believe fit within our business model and can address the needs of our customers and potential customers. In the future, we may not be able to acquire and integrate other companies, products or technologies in a successful manner. We may not be able to find suitable acquisition candidates, and we may not be able to complete such acquisitions on favorable terms, if at all. In addition, the pursuit of potential acquisitions may divert the attention of management and cause us to incur additional expenses in identifying, investigating and pursuing suitable acquisitions, whether or not they are consummated. If we do complete acquisitions, we may not ultimately strengthen our competitive position or achieve our goals, including increases in revenue, and any acquisitions we complete could be viewed negatively by our customers, investors and industry analysts.
Future acquisitions may reduce our cash available for operations and other uses. We may have to pay cash, incur debt or issue equity securities to pay for any such acquisition, each of which could adversely affect our financial condition or the value of our Class A common stock. The sale or issuance of equity to finance any such acquisitions would result in dilution to our stockholders. The incurrence of indebtedness to finance any such acquisition would result in increased fixed obligations and could also include covenants or other restrictions that would impede our ability to manage our operations. In addition, our future results of operations may be adversely affected by the dilutive effect of an acquisition, performance earnouts or contingent bonuses associated with an acquisition. Furthermore, acquisitions may require large, one-time charges and can result in increased debt, contingent liabilities, adverse tax consequences, additional stock-based compensation expenses, and the recording and subsequent amortization of amounts related to certain purchased intangible assets, any of which items could negatively affect our future results of operations. We may also incur goodwill impairment charges in the future if we do not realize the expected value of any such acquisitions.
We rely on third-party proprietary and open-source software for our offerings, and our inability to obtain third-party licenses for such software, or obtain them on favorable terms, or any errors or failures caused by such software could adversely affect our business, results of operations and financial condition.
Some of our offerings include software or other intellectual property licensed from third parties. It may be necessary in the future to renew licenses relating to various aspects of these applications or to seek new licenses for existing or new applications. There can be no assurance that the necessary licenses will be available on acceptable terms or under open-source licenses permitting redistribution in commercial offerings, if at all. The inability to obtain certain licenses or other rights or to obtain such licenses or rights on favorable terms, could result in delays in product releases until equivalent technology can be identified, licensed or developed, if at all, and integrated into our products and may have a material adverse effect on our business, results of operations and financial condition. In addition, third parties may allege that additional licenses are required for our use of their software or intellectual property, and we may be unable to obtain such licenses on commercially reasonable terms or at all. Moreover, the inclusion in our offerings of software or other intellectual property licensed from third parties on a non-exclusive basis could limit our ability to differentiate our offerings from those of our competitors. In addition, to the extent that our platform depends upon the successful operation of third-party software in conjunction with our software, any undetected errors or defects in such third-party software could prevent the deployment or impair the functionality of our platform, delay new feature introductions, result in a failure of our platform and injure our reputation.
Our use of open-source software could subject us to possible litigation or cause us to subject our platform to unwanted open-source license conditions that could negatively impact our sales.
A significant portion of our platform incorporates open-source software, and we will incorporate open-source software into other offerings or products in the future. Such open-source software is generally licensed by its authors or other third parties under open-source licenses. There is little legal precedent governing the interpretation of certain terms of these licenses, and therefore the potential impact of these terms on our business is unknown and may result in unanticipated obligations regarding our products and technologies. If an author or other third party that distributes such open-source software were to allege that we had not complied with the conditions of one or more of these licenses, we could be required to incur significant legal expenses defending against such allegations. In addition, if we combine our proprietary software with open-source software in a certain manner, under some open-source licenses, we could be required to release the source code of our proprietary software, which could substantially help our competitors develop products that are similar to or better than ours.
Our products are based in large part on open source provided under the Apache License 2.0. This license states that any work of authorship licensed under it, and any derivative work thereof, may be reproduced and distributed provided that certain conditions are met. It is possible that a court would hold this license to be unenforceable or that someone could assert a claim for
proprietary rights in a program developed and distributed under it. Any ruling by a court that this license is not enforceable, or that open-source components of our products may not be reproduced or distributed, may negatively impact our distribution or development of all or a portion of our products. In addition, at some time in the future it is possible that the open-source cores of our products may be distributed under a different license or the Apache License 2.0 may be modified, which could, among other consequences, negatively impact our continuing development or distribution of the software code subject to the new or modified license.
We are subject to governmental export and import controls that could impair our ability to compete in international markets due to licensing requirements and subject us to liability if we are not in compliance with applicable laws.
Our offerings are subject to export control and import laws and regulations, including the U.S. Export Administration Regulations, U.S. Customs regulations and various economic and trade sanctions regulations administered by the U.S. Treasury Department’s Office of Foreign Assets Control. Exports of our offerings must be made in compliance with these laws and regulations. If we fail to comply with these laws and regulations, we and certain of our employees could be subject to substantial civil or criminal penalties, including the possible loss of export or import privileges, fines which may be imposed on us and responsible employees or managers and, in extreme cases, the incarceration of responsible employees or managers. Obtaining the necessary authorizations, including any required license, for a particular sale may be time-consuming, is not guaranteed and may result in the delay or loss of sales opportunities. In addition, changes in our offerings or changes in applicable export or import regulations may create delays in the introduction and sale of our offerings in international markets, prevent our customers with international operations from deploying our offerings or, in some cases, prevent the export or import of our offerings to certain countries, governments or persons altogether. Any change in export or import regulations, shift in the enforcement or scope of existing regulations, or change in the countries, governments, persons or technologies targeted by such regulations, could also result in decreased use of our offerings, or in our decreased ability to export or sell our offerings to existing or potential customers with international operations. Any decreased use of our offerings or limitation on our ability to export or sell our offerings will likely adversely affect our business.
Furthermore, we incorporate encryption technology into certain of our offerings. Various countries regulate the import of certain encryption technology, including through import permitting and licensing requirements, and have enacted laws that could limit our ability to distribute our offerings or could limit our customers’ ability to implement our offerings in those countries. Encrypted products and the underlying technology may also be subject to export control restrictions. Governmental regulation of encryption technology and regulation of imports or exports of encryption products, or our failure to obtain required import or export approval for our offerings, when applicable, could harm our international sales and adversely affect our revenue. Compliance with applicable regulatory requirements regarding the export of our offerings, including with respect to new releases of our offerings, may create delays in the introduction of our offerings in international markets, prevent our customers with international operations from deploying our products throughout their globally-distributed systems or, in some cases, prevent the export of our offerings to some countries altogether.
Moreover, U.S. export control laws and economic sanctions programs prohibit the shipment of certain applications and services to countries, governments and persons that are subject to U.S. economic embargoes and trade sanctions. Any violations of such economic embargoes and trade sanction regulations could have negative consequences, including government investigations, penalties and reputational harm.
If we are unable to protect our intellectual property rights, our competitive position could be harmed or we could be required to incur significant expenses to enforce our rights.
Our ability to protect our intellectual property affects the success of our business. We rely on trade secret, patent, copyright and trademark laws and confidentiality agreements with our personnel and third parties, all of which offer only limited protection. The steps we have taken to protect our proprietary rights may not be adequate to preclude misappropriation of our proprietary information or infringement of our intellectual property rights, and our ability to police such misappropriation or infringement is uncertain, particularly in countries outside of the United States. While we have patents and patent applications pending, we may be unable to obtain patent protection for the technology covered in our patent applications or the patent protection may not be obtained quickly enough to meet our business needs. Even if patents are issued from our patent applications, which is not certain, they may be contested, circumvented or invalidated in the future. Moreover, the rights granted under any issued patents, such as in connection with open-source software, may not provide us with proprietary protection or competitive advantages, and, as with any technology, competitors may be able to develop similar or superior technologies to our own now or in the future. In addition, we rely on contractual and license agreements with third parties in connection with their use of our products and technology. There is no guarantee that such parties will abide by the terms of such agreements or that we will be able to adequately enforce our rights.
Detecting and protecting against the unauthorized use of our products, technology and proprietary rights is expensive, difficult and, in some cases, impossible. Litigation may be necessary in the future to enforce or defend our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Such litigation could result in substantial costs and diversion of management resources, either of which could harm our business, results of operations and financial condition, and there is no guarantee that we would be successful. Furthermore, many of our current and potential competitors have the ability to dedicate substantially greater resources to protecting their technology or intellectual property rights than we do. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing upon or misappropriating our intellectual property, which could result in a substantial loss of our market share.
Claims by others that we or our customers, whose software applications we helped to create, infringe the proprietary technology of such other persons could force us to pay damages or prevent us from using certain technology in our products.
Third parties could claim that our products or technology infringe their proprietary rights. This risk may increase as the number of products and competitors in our market increases and overlaps occur. Any claim of infringement by a third party, even one without merit, could cause us to incur substantial costs defending against the claim, and could distract our management from our business. Furthermore, a party making such a claim, if successful, could secure a judgment that requires us to pay substantial damages. A judgment could also include an injunction or other court order that could prevent us from offering our products. In addition, we might be required to seek a license for the use of such intellectual property, which may not be available on commercially reasonable terms or at all. Alternatively, we may be required to develop non-infringing technology, which could require significant effort and expense and may ultimately not be successful. We have received, or may in the future receive, notices alleging that we have misappropriated, misused or infringed other parties’ intellectual property rights, including allegations made by our competitors or by non-practicing entities, and, to the extent we gain greater market visibility, we face a higher risk of being the subject of intellectual property infringement assertions. Any of these events could seriously harm our business, results of operations and financial condition.
Third parties may also assert infringement claims against our customers and strategic partners. Any of these claims could require us to initiate or defend potentially protracted and costly litigation on their behalf, regardless of the merits of these claims, because we generally indemnify our customers and strategic partners from claims of infringement of proprietary rights of third parties in connection with the use of our products. If any of these claims succeed, we may be forced to pay damages on behalf of our customers or strategic partners, which could materially affect our results of operations and cash flows.
Our business could be materially adversely affected as a result of war, acts of terrorism, natural disasters or climate change.
War, acts of terrorism and natural disasters, such as an earthquake, may cause damage or disruption to our employees, facilities, customers and partners, which could have a material adverse effect on our business, results of operations or financial condition. Such events may also cause damage or disruption to transportation and communication systems and to our ability to manage logistics in such an environment. These risks may be heightened due to the location of our headquarters in the San Francisco Bay Area, an area known for seismic activity.
Investments made in our growth may not achieve the expected associated benefits on a timely basis or at all.
We have experienced, and may continue to experience, rapid growth and organizational change, which has placed, and may continue to place, significant demands on our management and our operational and financial resources. Additionally, we continue to increase the breadth and scope of our offerings and our operations. To support this growth, and to manage any future growth effectively, we must continue to improve our IT and financial infrastructures, our operating and administrative systems and our ability to manage headcount, capital and internal processes in an efficient manner. Our organizational structure is also becoming more complex as we grow our operational, financial and management infrastructure and we must continue to improve our internal controls as well as our reporting systems and procedures. We intend to continue to invest to expand our business, including investing in research and development and sales and marketing operations, hiring additional personnel, improving our internal controls, reporting systems and procedures, upgrading our infrastructure and increasing our office space. If we do not achieve the benefits anticipated from these investments, or if the achievement of these benefits is delayed, our results of operation may be adversely affected.
Operating as a public company, including maintaining effective internal control over financial reporting, requires us to incur substantial costs and requires substantial management attention. We expect we will no longer be an emerging growth company after the end of this fiscal year and the additional requirements we must comply with may further strain our resources and divert management’s attention from other business concerns. In addition, our management team has limited experience managing a public company.
As a public company, we incur substantial legal, accounting and other expenses that we did not incur as a private company, particularly one that had operated as part of a larger corporate organization. For example, we are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), the applicable requirements of the Sarbanes-Oxley Act and the Dodd-Frank Wall Street Reform and Consumer Protection Act and the rules and regulations of the SEC. Stock exchange rules also apply to us. As part of the new requirements, we will need to maintain effective disclosure and internal controls and make changes to our corporate governance practices. Compliance with these requirements is increasing our legal and financial compliance costs and is making some activities more time-consuming.
Most of our management and other personnel have limited experience managing a public company and preparing public filings. Our management and other personnel will need to divert attention from other business matters to devote substantial time to the reporting and other requirements of being a public company. In particular, we are incurring significant expense and devoting substantial management effort to complying with the requirements of Section 404 of the Sarbanes-Oxley Act when applicable. We will no longer qualify as an emerging growth company after January 31, 2020 and therefore our independent registered public accounting firm will be required to provide this attestation beginning with our Annual Report on Form 10-K for the year ending January 31, 2020, which will require increased costs, expenses and management resources. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. We are continuing to develop and refine our disclosure controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we will file with the SEC is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that information required to be disclosed in reports under the Exchange Act is accumulated and communicated to our principal executive and financial officers. We are also continuing to improve other aspects of our internal control over financial reporting. We may need to hire additional accounting and financial staff with appropriate public company experience and technical accounting knowledge.
We are implementing several new systems and process improvements as part of our increased independence from Dell. If these new systems or processes prove ineffective or inadequate, or if we fail to successfully implement them, our business and results of operations may suffer.
We implemented several new systems during the last two years to support our operations, and are continuing to implement technology and process improvements. For example we implemented new systems and processes and added personnel for enterprise resource planning, invoicing, accounts receivable, accounts payable, human capital management and payroll and benefits. We previously received some of these services from Dell and certain of its subsidiaries.
There can be no assurance that our operation of such systems will continue to be successful. We may be unable to implement or operate these systems and processes or add personnel in a timely and cost-effective manner.
We may require additional financing in the future and may not be able to obtain such financing on favorable terms, if at all, which could slow or stop our ability to grow or otherwise harm our business.
We intend to continue to make investments to support our business growth and may require additional funds to respond to business challenges, improve our operating infrastructure or acquire complementary businesses and technologies. We financed our operations primarily through equity financings, including our IPO, and before that through the accumulation of a net payable due to Dell, which was subsequently converted into equity, and through funds borrowed under our revolving credit facility. We may not be able to obtain additional financing on terms favorable to us, if at all. We may need to engage in equity or debt financings to secure additional funds. If we raise additional equity financing, our stockholders may experience significant dilution of their ownership interests and the per share value of our Class A common stock could decline. There can be no assurance that we will be able to meet the conditions necessary to obtain loans under our existing revolving credit facility or any future debt financing arrangement. In addition, with respect to debt financing transactions, the holders of debt would have priority over the holders of our common stock, and we may be required to accept terms that restrict our ability to incur additional indebtedness and our ability to operate our business. We may also be required to take other actions that would otherwise be in the interests of the debt holders and force us to maintain specified liquidity or other ratios, any of which could harm our business, financial condition and operating results. If we are unable to obtain adequate financing or financing on terms satisfactory to us when we require it, our ability to continue to support our business growth and to respond to business challenges could be significantly impaired, and our business may be adversely affected.
Our future quarterly results and key metrics may fluctuate significantly and may be difficult to predict, and if we fail to meet the expectations of analysts or investors, our stock price and the value of your investment could decline substantially.
Our results of operations, including our revenue, operating expenses and cash flows, as well as our key metrics (including our dollar-based net expansion rate), have fluctuated from quarter to quarter in the past and may continue to fluctuate as a result of a variety of factors, many of which are outside of our control, may be difficult to predict and may or may not fully reflect the underlying performance of our business. Some of the factors that may cause our results of operations to fluctuate from quarter to quarter include:
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our ability to attract new customers;
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our ability to retain existing customers and expand their use of our platform;
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our ability to successfully execute our partner strategy;
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success of our pricing strategy;
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changes in customers’ budgets and in the timing of their purchasing decisions;
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the focus of our sales force;
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the timing, terms and size of our initial and subsequent transactions with customers;
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our ability to successfully expand our business internationally;
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seasonal and end-of-quarter concentration of our transactions;
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our adoption of a 52- or 53-week fiscal year which may change the date of the last day of each of our fiscal quarters each fiscal year;
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the timing and success of new products, features and services by us and our competitors or any other change in the competitive dynamics of our industry, including consolidation among competitors, customers or ecosystem partners;
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changes in the enterprise software technology landscape that could cause us to increase or accelerate our spending on engineering resources and personnel;
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customer satisfaction with the functionality, features, performance and pricing of our products and service offerings;
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significant security breaches of, technical difficulties with, or interruptions to, the delivery and use of our software or services;
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our ability to leverage the synergies between Labs and PCF and increase subscription revenue as a percentage of revenue;
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consolidation of our customer base;
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our ability to fully utilize our strategic services resources;
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potential asset impairments, charges or other expenses;
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potential claims or litigation;
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the collectability of receivables;
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general economic conditions, both domestically and internationally, as well as economic conditions specifically affecting industries in which our customers participate;
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the impact of new accounting pronouncements; and
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foreign currency exchange rate fluctuations.
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We realigned our fiscal calendar to coincide with Dell's fiscal calendar. This realignment could adversely impact our business and results of operations.
Prior to February 2017, the fiscal calendars for Dell and Pivotal did not align. We reported on a calendar year basis through December 31, 2016, whereas Dell reports on a 4-5-5 Fiscal Year. Following Dell's acquisition of EMC Corporation in September 2016, we changed our fiscal calendar effective January 1, 2017 so that our fiscal calendar would align with that of Dell.
Our new fiscal year is more typical for companies in the retail sector and less typical for software companies. Seasonal buying patterns in the software sector tend to be concentrated in the fourth calendar quarter of the year and, within each quarter, in the last two weeks of that quarter. It is possible that the change in fiscal year could negatively impact the performance of our sales force and the purchasing activities of our customers.
Furthermore, the invoicing of sales may or may not occur before the end of the fiscal quarter as a result of our adoption of a 4-4-5 Fiscal Year. This arises when the last day of a fiscal quarter is not the same date as the last day of the same fiscal quarter from the prior year. This type of change can shift our deferred revenue and billings from one period to another given the change in date of the quarter end, particularly since a relatively large number of sales occur at the end of the quarter.
As a result of our adoption of a 4-4-5 Fiscal Year, the impact of seasonal factors that we have observed in our business may be compounded by end of fiscal quarter or end of fiscal year purchases by our customers and the timing of holiday and vacation periods on our quarterly results. Consequently, it may be difficult to accurately determine the extent to which year-over-year changes in our financial results represent actual changes to business conditions and trends.
Our reported financial results may be adversely affected by changes in accounting principles generally accepted in the United States.
GAAP are subject to interpretation by the Financial Accounting Standards Board (the "FASB"), the SEC and various bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant effect on our reported financial results for periods prior to and subsequent to such change, and could affect the reporting of transactions completed before the announcement of a change.
For example, in May 2014, the FASB issued ASC 606, which superseded the revenue recognition requirements in ASC 605, Revenue Recognition. We adopted this standard and its impact is reflected in our consolidated financial statements, which includes several newly required disclosures. Market practices with respect to these disclosures are still evolving, and securities analysts and investors may not fully understand the implications of our disclosures or how or why they may differ from similar disclosures by other companies. Any additional new accounting standards could have a significant effect on our reported results. If our reported results fall below analyst or investor expectations, our stock price could decline.
We are an emerging growth company and the reduced disclosure requirements applicable to emerging growth companies may make our Class A common stock less attractive to investors.
We are an emerging growth company as defined in the JOBS Act. For as long as we continue to be an emerging growth company, we intend to take advantage of some of the exemptions from the reporting requirements applicable to other public companies. For example, we intend to take advantage of the exemption from the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, the reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and the exemptions from the requirements of holding a non-binding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. It is possible that investors will find our Class A common stock less attractive as a result of our reliance on these exemptions. If so, there may be a less active trading market for our Class A common stock and our stock price may be more volatile. We will no longer qualify as an emerging growth company after January 31, 2020, and at that time, we will no longer be permitted to use these reporting exemptions.
Our business is subject to a wide range of laws and regulations, including privacy and data protection laws, and our failure to comply with those laws and regulations could harm our business, results of operations and financial condition.
Our business is subject to regulation by various federal, state, local and foreign governmental agencies, including agencies responsible for monitoring and enforcing employment and labor laws, workplace safety, product safety, environmental laws, consumer protection laws, anti-bribery laws, import and export controls, federal securities laws and tax laws and regulations. In certain foreign jurisdictions, these regulatory requirements may be more stringent than those in the United States. These laws and
regulations are subject to change over time and thus we must continue to monitor and dedicate resources to ensure continued compliance.
In addition, our business is subject to regulation by various federal, state and foreign governmental agencies responsible for monitoring and enforcing privacy and data protection laws. The regulatory framework for privacy issues worldwide is rapidly evolving and is likely to remain uncertain for the foreseeable future, as many new laws and regulations regarding the collection, use and disclosure of personal information have been adopted or are under consideration and existing laws and regulations may be subject to new and changing interpretations. In the United States, these include rules and regulations promulgated under the authority of the Federal Trade Commission, and state breach notification laws. Internationally, many of the jurisdictions in which we operate have established their own data security and privacy legal framework with which we or our customers must comply. We expect that there will continue to be new proposed laws, regulations and industry standards concerning privacy, data protection and information security in the United States, the European Union (the "E.U.") and other jurisdictions, and we cannot yet determine the impacts such future laws, regulations and standards may have on our business or the businesses of our customers.
Non-compliance with applicable regulations or requirements could subject us to investigations, sanctions, enforcement actions, disgorgement of profits, fines, damages, civil and criminal penalties or injunctions. If any governmental sanctions are imposed, or if we do not prevail in any possible civil or criminal litigation, our business, results of operations, and financial condition could be materially adversely affected. In addition, responding to any action will likely result in a significant diversion of management’s attention and resources and an increase in professional fees. Enforcement actions and sanctions could harm our business, results of operations and financial condition. Furthermore, the costs of compliance with, and other burdens imposed by, the laws, regulations and policies that are applicable to the businesses of our customers may limit the use and adoption of, and reduce the overall demand for, our software.
In addition to government regulation, privacy advocates and industry groups have established or may establish new self-regulatory standards that may place additional burdens on us. Our customers may contractually obligate or expect us to meet voluntary certification or other standards established by such third parties, and if we are unable to meet these standards, it could adversely affect our ability to provide our solutions to certain customers and could harm our business.
We may have exposure to additional tax liabilities, and our operating results may be adversely impacted by higher than expected tax expense.
As a multinational corporation, we are subject to income taxes in both the U.S. and various foreign jurisdictions. Our domestic and international tax liabilities are subject to the allocation of revenue and expenses in different jurisdictions and the timing of recognizing revenue and expenses. Significant judgment is required in determining our worldwide provision for income taxes and other tax liabilities. While we believe we have complied with all applicable income tax laws, a governing tax authority could have a different interpretation of the law and assess us with additional taxes.
Our tax expense in the future will depend upon the proportion of our income earned in the U.S. and in jurisdictions with a tax rate lower or higher than the U.S. statutory rate. During October 2014, Ireland announced revisions to its tax regulations that would require foreign earnings of our subsidiaries organized in Ireland to be taxed at higher rates. We will be impacted by the changes in tax laws in Ireland beginning in 2021. It is likely that we will proactively make structural changes in Ireland that may reduce the impact to our future tax rates. There are certain risks associated with structural changes, and we could be subject to higher tax obligations than we have currently estimated. In addition, numerous other countries have recently enacted or are considering enacting changes to tax laws, administrative interpretations, decisions, policies and positions. These changes could adversely affect our tax expense or result in higher cash tax liabilities
Risks Related to Our Relationship with Dell and VMware
Holders of our Class A common stock have limited ability to influence matters requiring stockholder approval.
Dell owns 175,514,272 shares of our outstanding Class B common stock, which represent approximately 64.0% of our total outstanding shares of common stock and approximately 94.7% of the combined voting power of both classes of our outstanding common stock (subject to certain exceptions, including with respect to the election of directors, certain actions to convert the Class B common stock and certain actions that require the consent of the holders of the Class B common stock) as of August 2, 2019. Our Class B common stock has ten votes per share, and our Class A common stock, which is our publicly traded stock, has one vote per share, subject to certain exceptions. Moreover, the holders of Class B common stock, voting as a separate class, are entitled to elect at least 80% of the total number of directors that we would have if there were no vacancies on our board of directors at such time. Subject to any rights of any series of preferred stock to elect directors, the holders of Class A common stock and the holders of Class B common stock, voting together as a single class, are entitled to elect our remaining directors with each share of Class A common stock and each share of Class B common stock entitled to one vote per share in any such election. Accordingly, Dell will control the vote to elect all of our directors and to approve or disapprove all other matters submitted to a stockholder vote.
In addition, our amended and restated certificate of incorporation and our master transaction agreement with Dell provide that until such time as Dell (or a successor entity) and its subsidiaries (the "Dell Entities") cease to beneficially own in the aggregate shares of our capital stock representing at least 30% of the votes entitled to be cast by our issued and outstanding capital stock, voting together as a single class with each share of Class B common stock having ten votes and each share of Class A common stock having one vote (the "Voting Power"), or no shares of our Class B common stock remain outstanding, the prior affirmative vote of the holders of a majority of the outstanding shares of Class B common stock, voting as a separate class, is required in order to authorize us to take certain actions, including, subject to certain exceptions:
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adopting or implementing any stockholder rights plan or similar takeover defense measure;
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entering into a merger, consolidation, business combination or sale of all or substantially all of our assets, or selling, transferring or licensing any of our business, operations or intellectual property for aggregate consideration in excess of $100 million in any calendar-year period;
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acquiring the stock or assets of another entity in transactions involving in excess of $250 million;
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issuing any capital stock or stock equivalent except to our subsidiaries, pursuant to the conversion, exercise or exchange of any outstanding stock equivalent or pursuant to our employee benefit or compensation plans;
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authorizing the aggregate amount of our equity awards to be granted in any fiscal year;
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taking any actions to dissolve, liquidate or wind up our company;
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declaring dividends on our stock;
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entering into any exclusive or exclusionary arrangement with a third party involving, in whole or in part, products or services that are similar to those of Dell;
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approving, amending or repealing our amended and restated certificate of incorporation or bylaws, or the certificate of incorporation or bylaws of certain of our subsidiaries;
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acquiring the business, operations, securities or indebtedness of another entity for consideration in excess of $250 million in any calendar-year period;
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incurring indebtedness in excess of $200 million;
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approving, modifying or terminating any employee equity or pension plan;
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entering into any legal settlement resulting in payment by us in excess of $100 million or that would impose limitations on our operations that would reasonably be expected to have a material adverse effect on us; and
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entering into any other types of transactions involving consideration in excess of $100 million.
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If Dell or any other holders of our outstanding Class B common stock do not provide any requisite affirmative vote on matters requiring stockholder approval or any requisite consent, in each case allowing us to conduct such activities when requested, we will not be able to conduct such activities and, as a result, our business and our results of operations may be adversely affected.
Dell has the ability to prevent a change in control transaction and may sell control of Pivotal without benefiting other stockholders.
Dell's voting control and the consent rights of holders of our Class B common stock give Dell the ability to prevent transactions that would result in a change in control of Pivotal, including transactions in which holders of our Class A common stock might otherwise receive a premium for their shares over the then-current market price. In addition, Dell is not prohibited from selling a controlling interest in us to a third party and may do so without the approval of the holders of our Class A common stock and without providing for a purchase of any shares of Class A common stock held by persons other than Dell. Accordingly, shares of Class A common stock may be worth less than they would be if Dell did not maintain voting control over us.
Dell's ability to control our board of directors may make it difficult for us to recruit independent directors.
Our board of directors is divided into two groups, Group I and Group II. The holders of Class B common stock, voting as a separate class, are entitled to elect our Group I directors, who will constitute at least 80% of the total number of authorized directors. Subject to any rights of any series of preferred stock to elect directors, the holders of Class A common stock and the holders of Class B common stock, voting together as a single class, are entitled to elect our remaining Group II directors, with each share of Class A common stock and each share of Class B common stock entitled to one vote per share in any such election. If at any time or from time to time any Group I directorship is vacant, one of the existing Group I directors to be designated in writing by Dell will be entitled to cast, on all matters upon which a vote or consent of the board of directors is taken, a number of votes equal to one plus the number of vacant Group I directorships then existing, and all other directors will be entitled to cast one vote. There are currently three vacant Group I directorships. Mr. Dell is the initial Group I director entitled to cast one vote for each such vacant directorship and, as a result, is entitled to cast four votes on any matter submitted to a vote of our board of directors. So long as Dell beneficially owns shares of our common stock representing a majority of the votes entitled to be cast in the election of our Group I and Group II directors, Dell can effectively control and direct our board of directors. Further, the interests of Dell and our other stockholders may diverge. Under these circumstances, it may become difficult for us to recruit independent directors.
We engage in related party transactions with Dell and/or VMware that may divert our resources, create opportunity costs and prove to be unsuccessful.
We currently engage in a number of related party transactions with Dell and VMware through our joint marketing and sales of our products and services and our mutually beneficial commercial and go-to-market relationships, and we expect to engage in additional related party transactions with Dell and VMware to leverage the benefits of our strategic alignment, including the proposed merger with VMware and our joint efforts with VMware concerning Pivotal Container Service ("PKS"). Our participation in these transactions may prove not to be successful, may create go-to-market complexity, may divert our resources or the attention of our management from other opportunities, and may cause certain of our other vendors and ecosystem partners who compete with Dell and its subsidiaries and VMware to also view us as their competitors. We also cannot predict whether our stockholders and industry or securities analysts will react positively to announcements of new related party transactions.
Dell and VMware may compete with us, which could reduce our market share.
There can be no assurance that Dell or VMware will not compete with us in the future. None of our agreements with Dell or VMware contain any restrictions on their ability to compete with us.
Dell could also assert control over us in a manner which could impede our growth or our ability to enter new markets or otherwise adversely affect our business. Further, Dell could utilize its control over us to cause us to take or refrain from taking certain actions, including entering into relationships with strategic, technology and other marketing partners, enforcing our intellectual property rights or pursuing corporate opportunities or product development initiatives that could adversely affect our competitive position, including our competitive position relative to that of Dell or VMware in markets where we compete with them.
Conflicts of interest may arise because some of our directors and officers own stock or other equity interests in Dell or VMware and hold management positions with Dell or VMware.
Some of our directors and officers own stock or other equity interests in Dell or VMware. In addition, some of our directors are officers or directors of Dell or VMware. Ownership of such equity interests by our directors and officers and the presence of executive officers or directors of Dell or VMware on our board of directors could create, or appear to create, conflicts of interest with respect to matters involving both us and any one of them that could have different implications for any of these investors than they do for us. Provisions of our amended and restated certificate of incorporation address corporate opportunities that are presented to our directors and officers that are also directors of officers of Dell or VMware. We cannot assure you that our amended and restated certificate of incorporation will adequately address potential conflicts of interest or that potential conflicts of interest will be resolved in our favor or that we will be able to take advantage of corporate opportunities presented to individuals who are officers or directors of both us and Dell or VMware. As a result, we may be precluded from pursuing certain advantageous transactions or growth initiatives.
Our inability to resolve in a manner favorable to us any potential conflicts or disputes that arise between us and Dell or its subsidiaries with respect to our past and ongoing relationships may adversely affect our business and prospects.
Potential conflicts or disputes may arise between Dell or its subsidiaries and us in a number of areas relating to our past or ongoing relationships, including:
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actual or anticipated variations in our quarterly or annual results of operations;
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tax, employee benefit, indemnification and other matters arising from our relationship with Dell or its subsidiaries;
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business combinations involving us;
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our ability to engage in activities with certain ecosystem partners;
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sales or dispositions by either of Dell or VMware of all or any portion of their beneficial ownership interest in us;
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the nature, quality and pricing of services Dell or its subsidiaries have agreed to provide us;
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business opportunities that may be attractive to us and Dell or its subsidiaries;
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intellectual property or other proprietary rights; and
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joint sales and marketing activities with Dell or its subsidiaries.
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The resolution of any potential conflicts or disputes between us and Dell or its subsidiaries over these or other matters may be less favorable to us than the resolution we might achieve if we were dealing with an unaffiliated party.
The agreements we have entered into with Dell and certain of its subsidiaries are of varying durations and may be amended upon agreement of the parties. The terms of these agreements were primarily determined by Dell or its subsidiaries, and therefore may not be representative of the terms we could obtain on a stand-alone basis or in negotiations with an unaffiliated third party. For so long as we are controlled by Dell, we may not be able to negotiate renewals or amendments to these agreements, if required, on terms as favorable to us as those we would be able to negotiate with an unaffiliated third party.
We are a "controlled company" within the meaning of the New York Stock Exchange rules and, as a result, we qualify for and rely on exemptions from certain corporate governance requirements. Accordingly, holders of our Class A common stock will not have the same protections afforded to stockholders of companies that are subject to such requirements.
Dell owns, indirectly through its subsidiaries (including VMware), none of the outstanding shares of our Class A common stock and all of the shares of our Class B common stock, representing 64.0% of the total outstanding shares of common stock or 94.7% of the combined voting power of the outstanding common stock (subject to certain exceptions, including with respect to the election of directors, certain actions to convert the Class B common stock and certain actions that require the consent of the holders of the Class B common stock). Through its control of shares of common stock representing a majority of the votes entitled to be cast in the election of our Group I and Group II directors, Dell controls the vote to elect all of our directors. As a result, we are a "controlled company" within the meaning of the New York Stock Exchange rules. Under these rules, a "controlled company"
may elect not to comply with certain corporate governance requirements, including the requirements that, within one year of the closing of an initial public offering, a listed company have a:
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board that is composed of a majority of "independent directors," as defined under the rules of the New York Stock Exchange;
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compensation committee that is composed entirely of independent directors; and
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nominating and corporate governance committee that is composed entirely of independent directors.
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We are utilizing these exemptions. Our board of directors does not have a majority of independent directors and only our audit committee is subject to requirements under SEC and New York Stock Exchange rules to consist entirely of independent directors, subject to the phase-in rules of the New York Stock Exchange. Accordingly, holders of our Class A common stock do not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance requirements of the New York Stock Exchange.
We utilize our contractual arrangements with our strategic partners to facilitate and expedite a significant portion of our revenue.
Transactions primarily driven by our direct sales force and processed through our strategic partners under our agency agreements with Dell and VMware accounted for 36% and 37% of our total revenue in fiscal 2019 and fiscal 2018, respectively. We rely on these agency agreements to expedite and facilitate the sales of our products and services. Any adverse changes in our joint sales arrangements or the effectiveness of such arrangements with Dell or VMware could have a material impact on our results of operations.
Our stock price could be impacted by the reported results and other statements of Dell.
As the majority owner of our stock, Dell includes our accounts in its consolidated financial statements, subject to non-controlling interest adjustments to eliminate the portion of our accounts that are attributable to other stockholders outside of the Dell consolidated group of companies. Such non-controlling interest adjustments include those pertaining to both Pivotal and other companies for which Dell is a less than 100% owner. Dell does not report Pivotal’s financial information as a standalone segment. Accordingly, any information about Pivotal that is included in Dell's financial statements or other public statements is necessarily limited. Nevertheless, the information provided or the conclusions that investors or analysts draw from such information could have an adverse impact on the trading price of our Class A common stock.
Third parties may seek to hold us responsible for liabilities of Dell or VMware, which could result in a decrease in our income.
Third parties may seek to hold us responsible for liabilities of Dell or VMware. Under the original contribution agreements with Dell and VMware pursuant to which Dell and VMware contributed certain of their businesses to us when we were first formed, Dell and VMware agreed to indemnify us for claims and losses relating to liabilities related to Dell’s and VMware’s businesses and not related to our business. The original contribution agreements have no set terms, and these indemnification obligations will continue indefinitely except to the extent limited by law or the mutual agreement of the parties. In addition, under the master transaction agreement, we will indemnify Dell for claims and losses relating to liabilities related to our business. If those liabilities are significant and we are ultimately held liable for them, we cannot assure you that we will be able to recover the full amount of our losses from Dell or VMware.
Dell or VMware’s competitive position in certain markets may constrain our ability to build and maintain partnerships.
Our existing and potential partner relationships may be negatively affected by our relationships with Dell and VMware, our largest stockholders. We do and may partner with companies that compete with Dell or VMware in certain markets. Dell's control over us and VMware may affect our ability to effectively partner with these companies. These companies may favor our competitors because of our relationship with Dell and VMware.
To preserve Dell's ability to conduct a tax-free distribution of the shares of our Class B common stock that it beneficially owns, we may be prevented from pursuing opportunities to raise capital, acquire other companies or undertake other transactions, which could hurt our ability to grow.
To preserve its ability to effect a future tax-free spin-off of us, or certain other tax-free transactions involving us, Dell is required to maintain "control" of us within the meaning of Section 368(c) of the Internal Revenue Code, which is defined as 80% of the total voting power and 80% of each class of nonvoting stock. We entered into a tax sharing agreement with Dell, which restricts our ability to issue any stock, issue any instrument that is convertible, exercisable or exchangeable into any of our stock or which may be deemed to be equity for tax purposes, or take any other action that would be reasonably expected to cause Dell to beneficially own stock in us that, on a fully diluted basis, does not constitute "control" within the meaning of Section 368(c) of the Internal Revenue Code. We also agreed to indemnify Dell for any breach by us of the tax sharing agreement. Additionally, under our amended and restated certificate of incorporation and the master transaction agreement, until such time as the Dell Entities cease to beneficially own in the aggregate shares of our capital stock representing at least 30% of the Voting Power or no shares of our Class B common stock remain outstanding, the prior affirmative vote of the holders of a majority of the outstanding shares of Class B common stock, voting as a separate class, is required in order to authorize us to issue stock or other securities, subject to certain exceptions. We also agreed to indemnify Dell for any breach by us of the master transaction agreement. As a result, we may be prevented from raising equity capital or pursuing acquisitions or other growth initiatives that involve issuing equity securities as consideration.
Our net operating loss carryforwards and other tax assets prior to our initial public offering are generally unavailable for our use.
Since fiscal 2014, our U.S. federal and state net operating losses and research credits and foreign tax credits were fully applied against Dell’s consolidated returns as we were included in the group consolidated U.S. federal and state income tax returns. As a result of our IPO, we left Dell's U.S. federal and certain state returns and all tax assets which had been utilized in the group return were reduced to the actual balances we will carry into our separate returns. Certain state net operating loss carryforwards are still reflected on a separate return basis and would be reduced in a similar manner if we were to leave those group returns. We will continue to maintain a valuation allowance for such net operating loss carryforwards and credits. Pursuant to our tax sharing agreement with Dell, we are limited in our ability to carryback net operating losses. Additionally, recently-enacted U.S. federal tax reform may limit our ability to use future net operating losses.
We could be held liable for the tax liabilities of other members of Dell's consolidated tax group.
When we become subject to income tax audits for any periods when we were a member of Dell's group return, the tax sharing agreement provides that Dell has authority to control the audit and represent Dell's and our interests to the tax authority. Accordingly, if we and Dell differ on appropriate responses and positions to take with respect to tax questions that may arise in the course of an audit, our ability to affect the outcome of such audits may be impaired.
Each member of a consolidated group during any part of a consolidated return year is jointly and severally liable for tax on the consolidated return of such year and for any subsequently determined deficiency thereon. Similarly, in some jurisdictions, each member of a consolidated, combined or unitary return for state, local or non-U.S. income tax purposes is jointly and severally liable for the state, local or non-U.S. income tax liability of each other member of the consolidated, combined or unitary return. Accordingly, for any period in which we were included in the Dell consolidated return for U.S. federal income tax purposes or any other consolidated, combined or unitary return of Dell and its subsidiaries, we could be liable in the event that any income tax liability was incurred, but not discharged, by any other member of any such return. In addition, if a distribution by Dell of our Class B common stock fails to qualify as a tax-free spin-off, and neither we nor Dell has breached the tax sharing agreement, we will generally be liable for 50% of any resulting tax.
Risks Related to Ownership of Our Class A Common Stock
An active trading market for our Class A common stock may not continue or be sustained.
Although our Class A common stock is listed on the New York Stock Exchange under the symbol PVTL, we cannot assure you that an active trading market for our Class A common stock will continue on that exchange or elsewhere or that any market will be sustained. Accordingly, we cannot assure you of the likelihood of your ability to sell your shares of Class A common stock when desired, the prices that you may be able to obtain for your shares or the liquidity of any trading market.
The price of our Class A common stock may be volatile, which could cause the value of your investment to decline.
Technology stocks have historically experienced high levels of volatility. The trading price of our Class A common stock is likely to be highly volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control and may not be related to our operating performance. These fluctuations could cause you to lose all or part of your investment in our Class A common stock. Factors that may cause the market price of our Class A common stock to fluctuate include:
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announcements of new offerings, services or technologies, relationships with partners, acquisitions or other events by us or our competitors;
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changes in economic conditions;
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price and volume fluctuations in the overall stock market from time to time;
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significant volatility in the market price and trading volume of technology companies in general and of companies in our industry;
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fluctuations in the trading volume of our shares or the size of our public float;
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actual or anticipated changes or fluctuations in our results of operations or other key metrics;
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whether our results of operations or other key metrics meet the expectations of securities analysts or investors;
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actual or anticipated changes in the expectations of investors or securities analysts;
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the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections;
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developments or disputes concerning our intellectual property or other proprietary rights;
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litigation involving us, our industry or both, or investigations by regulators into our operations or those of our competitors;
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changes in accounting standards, policies, guidelines, interpretations or principles;
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regulatory developments in the United States, foreign countries or both;
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major catastrophic events in our domestic and foreign markets;
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sales of large blocks of our stock; and
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departures of key personnel.
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In addition, if the market for technology stocks or the overall stock market experience a loss of investor confidence, the trading price of our Class A common stock could decline for reasons unrelated to our business, results of operations or financial condition. For example, we are currently the subject of litigation relating to disclosures made in connection with our IPO and with the disclosure of our earnings results for the first quarter of fiscal 2020. The trading price of our Class A common stock might also decline in reaction to events that affect other companies in our industry even if these events do not directly affect us.
In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been brought against that company. If our Class A common stock price is volatile, we may become the target of securities litigation. Securities litigation could result in substantial costs and divert our management’s attention and resources from our business, and this could have a material adverse effect on our business, results of operations and financial condition.
We are involved in numerous class action lawsuits and other litigation matters that are expensive and time consuming, and, if resolved adversely, could harm our business, financial condition, or results of operations.
We are involved in numerous lawsuits, including putative class action lawsuits, many of which claim statutory damages. For example, we are currently the subject of multiple putative class action suits relating to disclosures made in connection with our IPO and with the disclosure of our earnings results for the first quarter of fiscal 2020. At this time, it is not reasonably possible
to determine the ultimate resolution of, or estimate the liability related to, these matters. Any negative outcome from any such lawsuits could result in payments of substantial monetary damages or fines, and accordingly our business, financial condition, or results of operations could be materially and adversely affected.
There can be no assurances that a favorable final outcome will be obtained in all our cases, and defending any lawsuit is costly and can impose a significant burden on management and employees. Any litigation to which we are a party may result in an onerous or unfavorable judgment that may not be reversed upon appeal or in payments of substantial monetary damages or fines, or we may decide to settle lawsuits on similarly unfavorable terms, which could adversely affect our business, financial conditions, or results of operations.
Sales of a substantial number of shares of our Class A common stock in the public market by our existing stockholders could cause the price of our Class A common stock to decline.
Sales of a substantial number of shares of our Class A common stock in the public market, or the perception that these sales might occur, could depress the price of our Class A common stock and could impair our ability to raise capital through the sale of additional equity securities. We cannot predict the effect that sales may have on the prevailing price of our Class A common stock.
All of the shares of common stock issuable upon the exercise of stock options, and the shares reserved for future issuance under our equity incentive plans, are registered for public resale under the Securities Act. Accordingly, these shares will be able to be freely sold in the public market upon issuance, subject to applicable vesting requirements.
As of August 2, 2019, holders of up to approximately 193.0 million shares of our Class A common stock (including shares issuable upon conversion of Class B common stock) will have rights, subject to certain conditions, to require us to file registration statements covering the sale of their shares or to include their shares in registration statements that we may file for ourselves or other stockholders. We have also registered the offer and sale of all shares of capital stock that we may issue under our equity compensation plans.
Future sales and issuances of our common stock or rights to purchase common stock could result in additional dilution to our stockholders and could cause the price of our Class A common stock to decline.
We may issue additional Class A or Class B common stock, convertible securities or other equity in the future. We also expect to issue Class A common stock to our employees, directors and other service providers pursuant to our equity incentive plans. Such issuances could be dilutive to investors and could cause the price of our Class A common stock to decline. If we seek to engage in additional equity financing, we may not be able to obtain such financing on favorable terms, if at all. New investors in such issuances could receive rights senior to those of holders of our Class A common stock.
The difference in the voting rights of our classes of capital stock may harm the value and liquidity of our Class A common stock.
Our Class B common stock has ten votes per share, and our Class A common stock has one vote per share. The difference in the voting rights of the Class A common stock and the Class B common stock could harm the value of the Class A common stock to the extent that any current or future investor in our common stock ascribes value to the voting rights associated with the Class B common stock. The existence of dual classes of our common stock could result in less liquidity for any such class than if there were only one class of our capital stock.
The dual class structure of our common stock may adversely affect the trading price of our Class A common stock.
Our Class B common stock has ten votes per share and our Class A common stock, which is our publicly traded stock, has one vote per share subject to certain exceptions, including with respect to the election of directors, certain actions to convert the Class B common stock and certain actions that require the consent of the holders of the Class B common stock. As discussed in "Risk Factors-Holders of our Class A common stock have limited ability to influence matters requiring stockholder approval," these differences in voting rights may adversely affect the market price of our Class A common stock.
In addition, in 2017, FTSE Russell and S&P Dow Jones announced changes to their eligibility criteria for inclusion of shares of public companies on certain indices to exclude companies with multiple classes of shares of common stock from being added to such indices. FTSE Russell announced plans to require new constituents of its indices to have at least five percent of their voting rights in the hands of public stockholders, whereas S&P Dow Jones announced that companies with multiple share classes, such as ours, will not be eligible for inclusion in the S&P 500, S&P MidCap 400 and S&P SmallCap 600, which together make
up the S&P Composite 1500. In 2017, MSCI also opened public consultations on their treatment of no-vote and multi-class structures and temporarily barred new multi-class listings from its ACWI Investable Market Index and U.S. Investable Market 2500 Index. After an 18-month consultation period, MSCI decided to continue to include companies with no-vote and multi-class structures on their indices, although they will also launch a new index series that will include voting rights in the eligibility criteria and construction methodology. We cannot assure you that other stock indices will take a similar approach to MSCI and not follow FTSE Russell and S&P Dow Jones in the future. Under the announced policies, our dual class capital structure would make us ineligible for inclusion in many of these indices and, as a result, mutual funds, exchange-traded funds and other investment vehicles that attempt to passively track these indices will not invest in our stock. These policies are new and it is unclear what effect, if any, they will have on the valuations of publicly traded companies excluded from the indices, but it is possible that they may depress these valuations compared to those of other similar companies that are included.
We do not expect to pay any cash dividends for the foreseeable future. Investors may never obtain a return on their investment.
We have never paid dividends to our stockholders. Anyone considering investing in our Class A common stock should not rely on such investment to provide dividend income. We do not anticipate that we will pay any cash dividends to holders of Class A common stock in the foreseeable future. Instead, we currently plan to retain any earnings to maintain and expand our existing operations. In addition, our current revolving credit facility and future debt financing arrangements contain terms prohibiting or limiting the amount of dividends that may be declared or paid on our common stock. Accordingly, investors must rely on sales of their Class A common stock after price appreciation, which may never occur, as the only way to realize any return on their investment. As a result, investors seeking cash dividends should not purchase the Class A common stock.
Delaware law and our amended and restated certificate of incorporation and bylaws contain anti-takeover provisions that could delay or discourage takeover attempts that stockholders may consider favorable.
Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that could delay or prevent a change in control of our company. These provisions could also make it difficult for stockholders to elect directors who are not nominated by the current members of our board of directors or take other corporate actions, including effecting changes in our management. These provisions include:
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the provision that our Class B common stock is generally entitled to ten votes per share, while our Class A common stock is entitled to one vote per share, subject to certain exceptions, enabling Dell, as the beneficial owner of all outstanding shares of our Class B common stock and a majority of the outstanding shares of our Class A common stock, to control the outcome of substantially all matters submitted to a vote of our stockholders, including the election of directors;
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the provision that, so long as any shares of our Class B common stock are outstanding, the holders of shares of our Class B common stock, voting as a separate class, will be entitled to elect at least 80% of our directors, and that Dell may designate a Group I director that will be entitled to cast, on all matters upon which a vote or consent of the board of directors is taken, a number of votes equal to one plus the number of vacant Group I directorships then existing;
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the provision that any merger, consolidation, business combination or sale of all or substantially all of our assets must be approved by the holders of a majority of the outstanding shares of our Class B common stock until such time (if any) as the Dell Entities cease to beneficially own in the aggregate shares of our capital stock representing at least 30% of the Voting Power or no shares of Class B common stock are outstanding;
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certain supermajority thresholds for our stockholders to amend certain provisions of our amended and restated certificate of incorporation or to amend our bylaws;
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a classified board of directors with three-year staggered terms, which could delay the ability of stockholders to change the membership of a majority of our board of directors;
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the provision that a director may be removed only for cause at any time when the Dell Affiliates, as defined in our Amended and Restated Certificate of Incorporation ("Dell Affiliates"), do not beneficially own in the aggregate shares of capital stock representing a majority of the votes entitled to be cast to elect such director;
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the provision that any vacancy on the board of directors may be filled only by the affirmative vote of, (i) in the case of any Group I director, a majority of votes entitled to be cast by the remaining Group I directors then in office at any time when the Dell Affiliates do not beneficially own in the aggregate shares of capital stock representing a majority of the votes entitled to be cast to elect any Group I director, and (ii) in the case of any Group II director, a majority of votes
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entitled to be cast by the remaining directors then in office at any time when the Dell Affiliates do not beneficially own in the aggregate shares of capital stock representing a majority of the votes entitled to be cast to elect any Group II director, in each case, which would prevent other stockholders from being able to fill vacancies on our board of directors;
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the provision that a special meeting of stockholders may be called only by the board chairperson, the vote of a majority of the votes entitled to be cast by the directors then in office or, so long as the Dell Affiliates beneficially own in the aggregate shares of our capital stock representing a majority of the Voting Power, Dell;
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the prohibition of cumulative voting in the election of directors or any other matters, which would otherwise allow less than a majority of stockholders to elect director candidates;
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the requirement for advance notice for nominations for election to the board of directors or for proposing matters that can be acted upon at a stockholders’ meeting;
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the provision that at any time when the Dell Affiliates do not beneficially own in the aggregate shares of our capital stock representing a majority of the Voting Power, any action required or permitted to be taken by our stockholders at any annual or special meeting may not be effected by a written consent in lieu of a meeting (other than any exercise of the consent rights of the holders of our Class B common stock); and
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the ability of our board of directors to issue without stockholder approval, other than approval by holders of our Class B common stock exercising their consent rights to provide for the issuance of up to 500,000,000 shares of preferred stock, in one or more series, with terms and conditions, and having rights, privileges and preferences, to be determined by the board of directors.
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In addition, we will become subject to Section 203 of the Delaware General Corporation Law at such time (if any) as the Dell Affiliates cease to beneficially own in the aggregate shares of our capital stock representing at least 10% of the Voting Power. This statute prohibits a Delaware corporation listed on a national securities exchange from engaging in a business combination with an interested stockholder (generally a person who, together with its affiliates, owns or within the last three years has owned 15% or more of our voting stock) for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner.
These provisions in our amended and restated certificate of incorporation and bylaws and under Delaware law could discourage potential takeover attempts and could reduce the price that investors might be willing to pay for shares of our common stock.
Our amended and restated certificate of incorporation provides that the Court of Chancery of the State of Delaware will be the exclusive forum for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.
Our amended and restated certificate of incorporation provides that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will be the exclusive forum for:
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any derivative action or proceeding brought on our behalf;
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any action asserting a claim of breach of a fiduciary duty owed by, or other wrongdoing by, any of our directors, officers or other employees, or stockholders to us or our stockholders;
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any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law or as to which the Delaware General Corporation Law confers jurisdiction on the Court of Chancery of the State of Delaware; and
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any action asserting a claim governed by the internal affairs doctrine.
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Any person purchasing or otherwise acquiring or holding any interest in shares of our capital stock is deemed to have received notice of and consented to the foregoing provisions. This choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds more favorable for disputes with us or with our directors, our officers or other employees, or our other stockholders, including our majority stockholder, which may discourage such lawsuits against us and such other persons. Alternatively, if a court were to find this choice of forum provision inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business, results of operations and financial condition.
Risks Related to Our Proposed Acquisition by VMware
On August 22, 2019, we entered into the Merger Agreement with VMware and Merger Sub. The Merger Agreement provides that, subject to the terms and conditions set forth therein, Merger Sub will merge with and into Pivotal, with Pivotal surviving the Merger and becoming a wholly owned subsidiary of VMware.
The announcement and pendency of our proposed merger with VMware could adversely affect our business, financial results and operations.
The announcement and pendency of the proposed acquisition of our Company by VMware could cause disruptions in and create uncertainty surrounding our business, including affecting our relationships with our existing and future customers and employees, which could have an adverse effect on our business, financial results and operations, regardless of whether the proposed merger is completed. In particular, we could potentially lose important personnel as a result of the departure of employees who decide to pursue other opportunities in light of the proposed acquisition. We could also potentially lose customers, and new customer contracts could be delayed or decreased. In addition, we have diverted, and will continue to divert, significant management resources towards the completion of the transaction, which could adversely affect our business and results of operations.
We are also subject to restrictions on the conduct of our business prior to the consummation of the merger as provided in the Merger Agreement, including, among other things, certain restrictions on our ability to acquire other businesses, sell, transfer or license our assets, hire and retain employees, amend our organizational documents, enter into contracts, incur indebtedness and make capital expenditures. These restrictions could result in our inability to respond effectively to competitive pressures, industry developments and future opportunities and may otherwise harm our business, financial results and operations.
Failure to complete the proposed merger could adversely affect our business and the market price of our common stock.
There is no assurance that the closing of the merger will occur. Consummation of the merger is subject to various conditions, including, among other things, the approval of the Merger Agreement and the merger by the holders of (i) at least a majority of the outstanding shares of Class A common stock not owned by VMware or any of its affiliates, including Dell and EMC LLC, (ii) at least a majority of the outstanding shares of Class A common stock, (iii) at least a majority of the outstanding shares of Class B common stock and (iv) at least a majority of the outstanding shares of Class A and Class B common stock, voting together as a single class. Consummation of the merger is also subject to certain other customary conditions, including, among other things, the absence of laws or judgments prohibiting or restraining the merger. We cannot predict with certainty whether or when any of these conditions will be satisfied. In addition, the Merger Agreement may be terminated under certain specified circumstances, including, but not limited to, a termination of the Merger Agreement by the Company to enter into an agreement for a "superior proposal". If the merger is not consummated, our stock price will likely decline as our stock has recently traded at prices based on the proposed per share price for the merger. We will have incurred significant costs, including, among other things, the diversion of management resources, for which we will have received little or no benefit if the closing of the merger does not occur. A failed transaction may result in negative publicity and a negative impression of us in the investment community. The occurrence of any of these events individually or in combination could have a material adverse effect on our results of operations and our stock price.