Check Point Software Technologies Ltd (CHKP) 2010 Q1 法說會逐字稿

Greetings and welcome to the Check Point Software first quarter 2010 financial results.

At this time all participants are in a listen only mode.

A brief question and answer session will follow the formal presentation.

(Operator Instructions) As a reminder this conference is being recorded.

It is now my pleasure to introduce your host, Mr Kip Meintzer, Head of Investor Relations for Check Point Software Technologies.

Thank you Mr Meintzer, you may now begin.

Thank you.

Welcome to all of you joining us today.

This is Kip Meintzer, Head of Global Investor Relations for Check Point Software.

On the call with me today are Gil Shwed, Chairman and CEO and Tal Payne, Chief Financial Officer.

We would like to thank all of you for joining us today to discuss Check Point's financial results for the first quarter of 2010.

As a reminder this call is being webcast live on our website and is being recorded for replay.

To access the live webcast and replay information please visit the Company's website at checkpoint.com.

For your convenience, the conference call replay will be available through May 3.

If you'd like to reach us after the call please contact Investor Relations at 650-628-2050.

Before we begin with managements presentation, I'd like to bring the following to your attention.

During the course of this call Check Point representatives will make certain forward-looking statements.

These forward-looking statements may include our expectations regarding demand for our security products, our expectations regarding the introduction of new products and the success of those products, and our expectations regarding our business and financial outlook for the second quarter of 2010.

Other statements which may be made in response to questions which refer to our beliefs, plans expectations or intentions are also forward-looking statements for the purposes of the Safe Harbor provided by Private Securities Litigation Reform Act.

Because these statements pertain to future events they are subject to various risks and uncertainties and actual results could differ materially from Check Point's current expectations and beliefs.

Factors that could cause or contribute to such differences include, but are not limited to, the risks discussed in Check Point's annual report on Form 20-F for the year-ended December 31, 2009, which is on file with the Securities and Exchange Commission.

As a reminder Check Point assumes no obligation to update its forward-looking statements.

Now I'd like to turn the call over to Tal Payne, Check Point's Chief Financial Officer.

Thank you, Kip.

Good morning and good afternoon to everyone joining us on the call today.

I'm happy once again to begin the review of an excellent quarter.

This quarter, we achieved record first quarter results which came in at the high end of our projection, as we continue to demonstrate solid growth across all regions.

Our revenues for the first quarter increased by 26% over the same period in 2009, while our non-GAAP EPS was $0.55 representing 22% growth year-over-year.

Before I proceed farther into the numbers, let me remind you our first quarter GAAP financial results include equity based compensation expenses according to AFC 718, expenses relating to acquisitions including amortization of intangibles and the related tax effects from such items.

Keep in mind that non-GAAP information is presented excluding these items.

In our press release, which has been posted on our website, we present GAAP and non-GAAP results along with reconciliation tables which highlight this data as well as reasons for our presentation of non-GAAP information.

Now, let's take a look at the financial highlights for the quarter.

In the first quarter revenues came in at the high end of our projections.

Revenues reached $245.1 million representing an increase of 26%, compared to $195 million in the first quarter of 2009.

This high growth rate is attributed mainly to the acquisition of Nokia security appliance business from last April to Blade architecture and the new appliances we launched last year, which I'll discuss in a minute.

Moving forward I would like to remind you the anniversary of Nokia's appliance business acquisition will be in mid April and our future growth, excluding future acquisitions, is expected to be organic.

We have growth across all geographies with our Americas delivering 26% and Europe 31% growth for the quarter.

Revenue distribution by geography for the quarter was as follows.

Americas contributed 43% of the revenues, Europe was 42%, and Asia Pacific and Japan, Middle East and Africa region contributed the remaining 15%.

You will notice that this quarter we changed the way we report our revenues by geography.

Since the beginning of the year, we've reorganized the sales to have Middle East and Africa as part of Asia Pacific and Japan region.

Looking at the revenues by type, our product and license revenues were $91 million, representing 27% growth over the same quarter a year ago.

This growth came in mainly out of the integrated appliance product, lead by IPC, Power-1 UTM and Smart-1 appliances showed strong growth compared to the parallel quarter in 2009.

Our [segment] update, maintenance and service revenues reached an all-time high of $154 million this quarter, a 25% increase year-over-year.

The increase was driven by the consolidation of the IPC reservice, our annuity blades and security services.

The growth in deferred revenue was also significant this quarter.

Deferred revenue as of March 31, 2010, were $420 million, an increase of $95 million or 29% over March 31, 2009.

From a deal side and quantity perspective, this quarter we saw an increase in number of larger deals.

Transactions greater than $50,000 accounted for 53% of the total order value, compared to 44% in the same period a year ago.

We had 21 customers that each had transactions with a value greater than $1 million, compared to 13 in the same period last year.

From an operating perspective we posted great results.

Our non-GAAP operating income was $137.6 million in the first quarter of 2010, an increase of 26% compared to the same period in 2009.

Operating margins remained at the high 56%.

GAAP net income for the first quarter of 2010 was $98 million or $0.46 per diluted share.

The GAAP income in the first quarter of 2010 included additional amortization of intangible assets in the amount of $3.3 million or $0.02 per diluted share, relating to the acquisition of Nokia security appliance business in the second quarter of 2009.

Non-GAAP net income for the quarter was $116.8 million or $0.55 per diluted share, up from $95.5 million or $0.45 per diluted share a year ago.

Earnings per share was at the high end of our guidance representing 22% growth year-over-year.

This was achieved primarily as a result of the top line performance and expense management.

I would like to draw your attention to the fact that this quarter the number of shares used in the computation of diluted earnings per share increased to 213.5 million, mainly as the result of increase in Check Point share price.

For the first quarter, our DSOs, day sales outstanding, was 69 days compared to 81 days last year, a reduction of 12 days.

While we saw a decrease in DSO during the quarter, our business remains back end loaded as we have indicated in previous quarters.

We had record cash flow from operations this quarter of $218 million, an increase of 27% from $172 million in the first quarter a year ago.

This is mainly as a result of strong collection of last years revenues.

During the quarter we purchased approximately 1.5 million shares for the total cost of $50 million as part of our share purchase program.

Finally, our cash balances crossed the $2 billion mark, it's $2.052 billion.

Now let me turn the call over to Gil for his thoughts on the quarter.

Thank you, Tal.

Good morning and thank you all for joining us today.

The first quarter produced some exceptional results and is quite a nice way to begin the year.

These results were ahead of our expectation for the quarter and continue to underscore the success of our product initiative and our acceptance by our customers.

Our appliance strategy in our Software Blade architecture continued to drive results to date and it nicely is reflected in both product and service revenues that benefited from the Blade, like our IPS Blade which is sold within the annuity model.

But we are managing and growing our core business, we've also made some big steps recently to expand our future potential.

Since the beginning of the year, we announced our entering into two new and exciting markets with the introduction of Abra and our DLP solution.

Abra is a new type of mobility solution.

It is an encrypted USB drive that provides user with secure virtual work space with remote access to the corporate network.

It enables users to work remotely from any PC while maintaining a highly secure work environment.

Abra presents a great extension to our mobility and end point strategy.

There is an interest in Abra for multiple applications.

For example, disaster recovery implementation.

Number one is consultants that carry their own laptops and require access to corporate assets and of course there's the obvious need of any employee that wants to work from home or on their own.

The second product is our DLP solution.

DLP stands for data loss or data leak prevention.

This is an universal need that we all experience.

Each one of us has sent an e-mail to the wrong recipient or witnessed a file mistakenly uploaded to a public website.

DLP solutions is to protect against intentional or unintentional data loss and are also driven by regulatory requirements.

Today, the solution in the marketplace can usually be found working only in the text mode and not providing customers with true prevention of data loss.

With some solutions are pretty sophisticated they also tend to be very complicated.

Thus, today's solutions are focused on a small portion of the market and leave most of the marketplace untapped.

We've built our DLP solution to work in the true prevent mode with the simple and cost effective implementation.

We intend to bring DLP solution to a much broader audience and believe that each one of our hundred thousand plus accounts is a potential customer for our DLP.

To take our time in DLP products will have significant impacts on our revenues, however it does provide us with two new high potential product areas we will pursue aggressively.

It is also consistent with our strategy.

We want to provide customers with more security, better security and simple security.

Delivering on this will enable us to secure a bigger part of our customers infrastructure.

As for financial projection, the first quarter has provided us with a great start for the year.

We continue to be cautiously optimistic as we move through 2010.

So for the first quarter we expect revenues to be in the range of $245 million to $259 million, non-GAAP earnings per share is expected to be between $0.52 to $0.58.

GAAP based EPS is expected to be approximately $0.09 less than that.

Thank you all for being with us on the call today and now let's open the call for your questions.

(Operator Instructions) Thank you.

Our first question is coming from Sterling Auty of JPMorgan Chase & Company.

Yes, thanks, hi.

I think one of the questions that a lot of us have and the second quarter guidance gives us some indication but Gil, now that you've got Nokia under your belt for a year, you have these new solutions and like IPS that are doing well.

How do you think about the organic growth rate of Check Point moving forward?

So I think overall it will vary over time, and again you've got our guidance for the second quarter, and ultimately we will see more changes in the marketplace.

As I mentioned, I think we are positive and optimistic about the year, but I haven't seen yet our industry moving into a very high growth rate.

So I think we are now kind of around the 10% growth rate in our modeling and I think with the future product, I think we have a lot in our strategy, but this will provide more meaningful results only in 2011 and beyond.

And then just one follow-up, specifically to IPS.

Is there either any quantitative evidence you can give us of the success you're having earlier on or at least can you talk to us about how you expect that transition and what IPS can provide from a revenue perspective that may be smart defense and the NFR acquisition just couldn't get for you.

I don't have any data in front of me, but I think we are seeing good traction for that.

For example, our IPS Blade revenue grew this quarter by about 50%, compared to the old SmartDefense and other products like that that we had.

The big part of it, keep in mind, is in our deferred revenues and in our support services revenue line, because we do sell IPS, it's an annuity service and it's recorded there in the service line and not in the product line.

So I think so far the traction is pretty positive.

All right, thank you.

Thank you.

Our next question is coming from Brad Zelnick of Macquarie Bank Limited.

Thanks, good morning.

Just to be clear, you didn't say anything about full year guidance and I just want to make sure that the original guidance you'd given last quarter still stands for $2.20 to $2.30 in non-GAAP EPS, and $990 million to $1.040 billion in revenue.

Is that accurate?

That's accurate and I think the last one quarter was no need to update the range for the full year and I guess the range for the second quarter and the range for the year still holds, yes.

Thanks, Gil and if I could just follow-up.

On DLP, was this technology completely developed internally and over what time frame, and many of your competitors talk about strengths and being able to classify and recognize various content types.

I'd be curious to know how deep your expertise is there and how it might compare to other leaders in the market.

And lastly on DLP, this is obviously a more sophisticated, higher value type proposition for customers and as you think about taking it to market, maybe you can talk a little bit about how that might be different and how you plan on taking it to market, thank you.

Okay, it's a very good subject.

I'll try to answer it shortly, even though I can speak about that for very long.

We've generally started the vision of say providing more data security when we did the Protect Data Point acquisition at the beginning of 2007.

So when we started developing your road map about data security, it started with static data that's stored on your hard drive, but as we started there we said our vision is to protect the data all over and that's roughly where we started developing our product.

Over these past three years we've looked at many companies in the marketplace and we've actually really wanted to acquire a company in that space, but what we did see is that with sales today and these products today are too complicated.

Again, they work primarily in prevent mode, sorry, in the text mode.

Almost nobody is using them in true prevention mode, and they are just too complex and that's why you're saying that you have a high value sale because it's a sale that's focused on a small niche of extremely complicated, expensive deals.

Now, my vision and I think our vision in Check Point is that the need is universal.

The need is everyone and what we do want to do is bring DLP to everyone and I think that's what we focused over the past few years is developing a solution that we'll be able to do that.

So I think we compare very well in terms of data analysis.

We have, what we call, multi-spec technologies that are even more sophisticated in the ability to detect multiple conditions and multiple data types.

We have like 600 different data types and the potential rule out of the products.

So we have a lot of depth in the technology that we've developed, but there is two key elements in the product that makes it completely different than others.

One is its simplicity of the fact that like a Software Blade you can activate your gateway.

So it's really easy on the environment and really easy to activate that and use that and it's very different than most DLP solutions today.

And the second is what I call self-enforcement, or what we call the user check technology that basically brings the real decision about the data back to the user.

I think one of the challenges or the problems with many DLP solutions today, almost all of them is that they try to make an impossible decision about the file, wherever this file should be passed or shouldn't and this decision cannot be made in the computer.

Look at the earnings release.

A couple of days ago, this file was extremely confidential, almost criminal issue to send it outside the Company.

Two days later it's become a public file we send all over the world.

How can a computer make that determination?

It's very hard and I think what our technology does is brings the knowledge and the decision back to the user, so the user is prompted seamlessly with something that tells him or her.

That's the policy that is suspicion.

Do you really mean to do that and the user can make the determination and give a reason and then it would say that it's now seven AM in the morning, it's time to issue the press release and then we have a clear permission to issue that and that would make our product very different in the marketplace.

So I think we have that combination and in terms of pricing and so on, I think we're going on that very aggressively.

Aggressively from the sense that we want to make DLP widely available to the marketplace and we want to get to thousands of customers, not to dozens or hundreds like most major DLP players today.

Thank you, Gil.

Just the last quick follow-up here, is your current channel sophisticated enough to take this to market and with that I'll just pass it on.

Thank you again.

Yes, absolutely.

I think for many discussions I've had with channel partners and potential customers, I think it will take us a long time because it's still not a huge market and it's still a project that's surely complicated, but our commitment is to the customers and channels within a few hours of installing the product they can get effective results with it.

And I think our channel is focusing on security and they want more value and I think we'll have some success there.

Thanks again.

Thank you.

Our next question is coming from Shaul Eyal of Oppenheimer & Company.

Thank you, hi.

Good afternoon.

Good quarter.

Two quick questions on my end.

Tal, can you help us with kind of the foreign exchange impact you had this quarter?

Yes, it was quite minor, and we hedged a certain portion -- we hedged a few currencies in the portion that is actually a specific hedge, so the net effect was about half a million dollars.

Okay, thank you for that and maybe Gil, on the heels of the former question, so the Blades are doing great and the appliances are doing great.

Is that going to be the year of when kind of the former points acquisition comes into play this year and next year?

Well I hope so.

I don't know yet, but I think we still have some challenges on our end point strategy.

I think with Abra and with other things we're doing, I think we are quite well positioned but I think we still have a lot of work there and it will still take time to get to the results that I think we can deliver and that we deserve.

Is it kind of too early to talk about some market share gains even though kind of you're kind of the runner up in that space?

I think it's does too early for that.

Thank you, good luck.

Thank you.

Thanks.

Thank you.

Our next question is coming from Katherine Egbert of Jefferies & Company.

Hi.

Good quarter.

A couple of things.

Can you talk about the change in the sales structure where you split out the [lease] in Africa?

Why was that done?

That's a minor change.

There's no change in structure of the organization itself.

We just have the group that's in Israel reporting to the VP.

There's also in Israel, all other leaders in the sales the team are doing extremely well, the sales team are doing well.

So it's just a minor change in putting a little bit more local focus.

And the one potential is Africa where we sell very little and I think we want to grow that business and another market that's actually working very well is the Middle East, which again reports just to a local Vice President rather than reporting out of Israel to a Vice President that's in Europe to manage our home market.

But it really doesn't have much impact.

Okay, and then on the 10% organic growth for this year, is that an acceleration over what it's been the last couple of years?

Good question.

I think it's maybe an acceleration over 2008, probably not an acceleration over 2009, so it's mixed.

Okay, and then last one, the large deals, number of large deals was up dramatically.

Can you talk about why that might be true and also what are you seeing in Europe?

Thank you.

I think the large deals is a result of getting closer to our customers, more focused on our named account but also off the appliance strategy.

Now that we sell larger deals with the hardware and the software on that, these deals are clearly getting a much higher ASP and they clearly become larger deals.

So that's a very natural extension of what we've done in the business in terms of our organic strategy and the acquisition strategy.

I would just add also that as we have also the IP series consolidated with the Nokia acquisition, it allows larger transactions with specific customers.

Thank you.

Thank you.

Our next question is coming from Daniel Ives of FBR Capital Markets.

Yes, thanks.

Can you just talk vertically speaking, were there any significant changes in terms of spending specifically on financials, talking about the shrink there that you saw?

Haven't seen much change on that.

I don't know that we did a very in depth analysis, but I haven't seen any major shift or change into that.

Okay, and then just with a better spending environment, are you seeing a change in terms of DLP buying behavior?

Is it just now more spending out there, is it easier to get deals done?

We were just talking with DLP, so we'll see how it's going.

I think it's a little bit premature and I think overall customers are showing willingness to spend and are showing willingness to consider new technologies and on the same time it's not that we are coming up with huge budgets that and saying let's throw the money away.

So I think what we have now is an okay environment, it's a balanced environment where people aren't shutting the door, but they are also not rushing to throw away money.

Personally I like that environment because it's a good rational environment to do business in.

Thanks.

Thank you.

Our next question is coming from Michael Turits of Raymond James.

Hi.

It sounds like Software Blade sales are going well.

Can you give us some sense of how much subscription revenue they are comprising now and also a related question, I noticed gross margins on product caught up nicely this quarter on a sequential basis.

Was that in any way a function of mix between hardware and software?

I'm sorry, I missed the second part, if you could repeat the second.

But the first part regarding the annuity blades, if it's becoming more and more significant still not a huge amount.

In booking, it's the low tens and in the revenues, and annuity blade so you can recognize it's only over a few quarters.

So it's slightly above $5 million at this point.

Okay, and then the related question was that you had a nice sequential increase in your product gross margins.

Was that in any way a function of the software versus hardware mix?

No, that's actually referring to the operating margin and the growth I think were staying pretty much stable.

The appliances are a significant part of our products at this point and we were able to keep it in the quite high level.

So if you look at the perspective of two or three years, you can see the gross margin is slightly reduced but the operating margin stayed the same way or even increased slightly.

And then high level question.

As you see investment both in network securities as well as in related network data networking products, is your sense that people are just replacing products that had gotten long in terms of life over the last few years, or are they significantly accelerated there -- the capacity that they are building out in data centers?

I think it's a combination.

I think we are seeing people increasing their capacity in data center, I think we're seeing a lot of replacement of products and again part of the replacement is increasing capacity too.

So I'm seeing all of the combination.

I'm seeing customers that are building brand new data center, I'm seeing customers just upgrading their bandwidth and upgrading their performance, I see customers that need more functionality.

I don't think there's one major driver to the market.

It's a combination of all of the above.

Okay, thanks very much, Gil, and Tal.

Thanks.

Thank you.

Our next question is coming from Brian Freed of Morgan Keegan and Company.

Good morning.

Good quarter.

Can you talk a little bit about if you have a target in terms of what percentage of revenue you'd like to get from an annuity model over time?

I don't think we have a specific target.

I think we want to grow all parts of the business.

I think we like the annuity business because it provides more long term stability, but in the same time we also like to grow the immediate product that we get.

So I think the main thing is we want to sell as much as we can and we want to provide more value to customers and we want them to buy that, so there's no one magic number.

Great, and secondly, you talked about strength in the IPS and your goals for DLP, but within your other appliance blades, can you talk about any of them that you might be seeing notable strength in?

I think they are all doing well.

I think the smart -- the management appliances are doing quite well.

We just launched a new event management blade that I think has a great potential.

I didn't mention it, I didn't speak much about that and the huge potential because I think it's mainly organic to our business, it's less breakthrough like DLP and Abra that I mentioned.

I think that we can do much better and I think once we also -- keep in mind that most of our installed base is not yet running the version of the Software Blades and I think towards 2011, most of our installed base will move to Software Blade architecture and then we'll be able to upsell or to provide more value with additional blades.

And that's the major focus that we have, is getting to the point where every customer can just add blades.

Today by the way, most of the new sales are on the Software Blade architecture but the big huge install base that we have still runs last year release R65, and again the big focus for us is moving everyone to the R70, which is a Software Blade and then I think we'll have, again the big potential just adding more blades to every customer.

Great.

Thanks.

Thank you.

Our next question is coming from Jeff Evenson of Sanford C Bernstein and Company.

Hi.

As we think about new architectures for enterprises, virtualization and cloud seem to be two of the biggest trends.

Could you give us an update on the discussions you're having with enterprises moving that direction and how the importance of the firewall fits in there versus more traditional architectures?

So I think in virtualization we have great solutions, both the ability to virtualize buy the firewalls with our DS6 solution on a single hardware and also the ability to run in the virtualized environment and be a virtual firewall to like a virtual server farm, which is called our VE Edition for the product.

This is actually doing quite well.

It's not a new product, it's almost 10 years old and it's actually growing nicely and drives a lot of our high end installation.

VE is about a year and a half old and I must tell you there is a high level of interest, but not a whole lot of revenues around that yet which means that customers are talking about it but they aren't changing drastically our networking to our consolidating servers, but that doesn't mean they completely change the security infrastructure around that because we still keep buying the existing infrastructure.

Cloud computing is another potential, I think in no case the cloud computing means that companies are changing drastically the network architecture, actually becoming a little bit more challenging because they open up their network to include some external parts in it and that's a security challenge.

I must say that we haven't sold all of these challenges primarily because most of the leading cloud computing environments are proprietary environments that won't let any third party get into them and provide a higher level of security, but we are definitely investing some thinking in R&D into how to provide value there as well.

As mobile data continues to grow and service providers invest to build their infrastructure, how are you pursuing those opportunities if at all?

So, there's many things we do around mobility.

We used to have actually a sophisticated product line for mobility with the acquisition of Protect Data and Pointsec.

I must say that they offered it for the past three years as people are doing more mobile devices, the level of security implemented does not grow consistently with that there.

I think for the future, there are a lot of mobility solutions that we're developing, software for all of the mobile platform, we've actually just now have a new software for Symbian that is about to go to market and as many outer platforms that we also run that we use daily.

Abra is a mobility solution, it's not for mobile phones or mobile devices, but definitely for the mobile work.

So we are doing more and more of it.

Still the challenge is that in many cases with mobile solutions the customers are not yet spending, or can get an independent security solution into that environment.

So we are still -- we have a lot on the gateway side of protecting the enterprise, but we're still a little bit lighter to my opinion from the device side itself.

And what about selling infrastructure, like to wireless service providers such as AT&T or Orange?

We do sell a lot to these companies.

All of the large service providers are huge customers of ours and almost all of them use many different applications from securing the mobile infrastructure, to providing managed services, to do all of that and they are all very large customers and I think we're working all the time with them to find new applications.

This represents a great customer base for us already.

All right, thank you.

Thank you very much.

Thank you.

Our next question is coming from Keith Weiss of Morgan Stanley.

Thank you.

Thank you for taking my question.

I had two questions.

One, I wanted to ask about competitive environment particularly around pricing pressure, how has that been putting out in Q1 or you seeing more or less pricing pressure?

And the second question was about expense growth.

You had another great quarter of controlling expenses and giving operating margin upside to what we were looking for.

How do you look at expenses through calendar year 2010, what is kind of the headcount growth plans, how do you expect the expenses to trend over the course of the year?

From a competitive landscape, there wasn't a huge change.

I think we still have the same competitors, each one has its own strengths and weaknesses.

I believe personally that we are gaining share and that we are doing relatively well in the marketplace.

Our focus, our dedication, our delivery so far looks very nice.

Some competitors we've seen in problems with products and had a very hard time with new generation of products, other competitors had supply chain issues but I think most of it are not the key drivers for the marketplace.

The key drivers is that people want to buy the product that's good for them and not the tactical issue and the timing issue for the long term and I think from that perspective it's a great quality of our market, but it's not a commodity market.

It's a market when customers are fair to value, loyal to the vendor, loyal to the architecture, which I think a big part of it or most of it reflects in our customer base and the way they work with us.

But as I said, I think overall the competitive trends have been relatively positive to us in the last few months.

As for the operating model in 2010, I'll let Tal start and I'll add a little bit more.

There aren't going to be material changes in the structure, excluding obviously acquisitions.

In general, you would see us continuing to recruit people, mainly in the sales and the R&D and I'll just mention that this year, there are salary increases.

So you will see it from the next quarter going forward.

Again nothing dramatic, but just as a part of ordinary course of business.

Excellent.

Thank you.

Thank you, our next question is coming from Jonathan Ho of William Blair.

Great quarter.

Can you talk a little bit about what's happening with IPSO to SPLAT customer migrations and whether that could be a catalyst for Software Blade architecture upgrades over the near term?

And the second question is the use of cash and maybe your thoughts in terms of this environment whether you'll look at acquisitions of share buybacks, thanks.

Okay, so just to explain the question, SPLAT is the Check Point platform for security secure platform and IPSO is the former Nokia based operating system which runs the same software from us, and our plans moving forward for that is to merge the two into a new project, new operating system that will have the features and the benefits of both platforms.

The platforms itself are not dramatically different.

Technologically they are based on very similar architecture and so most of the work is technical work, but also the big part of the work in merging the good fields.

There's a high level of loyalty among the former Nokia hardware to the IPSO operating system.

So we're working very hard to move all of the relevant features to the new operating system, and obviously the Check Point SPLAT has gained used traction over the last three years and it's also the most widely used one.

So of course we want to make sure that we preserve that and keep that.

The new operating system that we have, which will be the unified operating system for our product is going to start delivering toward the year-end, Q3, Q4.

It's going to be more sort of -- we think we will see success and starting to see success in mid 2011 and overall, I think we've seen a lot of when customers are very happy with that on our customer conference last year and this year that we just did the major European customer conference and partner conference in London two weeks ago, and next week, we have the same conference in the US.

There is a lot of interest in recessions because customers care about that and the overall reaction is extremely positive.

They like the strategy.

They think that we listen to them and we understand what they want and I think it's now up to us to deliver on that.

And the second part of the question, can you repeat the second part?

It was just the use of cash question in terms of looking at the current environment and sort of your thoughts on either acquisitions or share buyback.

So we'll keep doing the share buyback.

Our run rate today is approximately $50 million a quarter and we'll keep being around that area, and we'll keep doing that.

We keep looking on acquisitions and the response I think that it's fair to say that we are likely to do some small technology acquisition.

We also keep looking for larger potential acquisitions, but there aren't too many large security companies.

So I'm not anticipating anything that's really anticipated soon on that front.

Thank you.

Thank you.

Our next question is coming from Todd Raker of Deutsche Bank.

Hi, nice quarter.

Just a quick follow-up on Michael's question on gross margins.

You did see gross margin step up about half a percentage point this quarter.

Should we be thinking about this as kind of the baseline going forward, or do you expect gross margins to deteriorate a little bit from here?

It started around 22%, 23%, sorry, 92%, 93% if you look at a year ago.

Yes, exactly.

It's now stabling around 88% and obviously it's going to tick 1% up or 1% down depending on the proportion of the appliance, what type of appliance and so on.

So I don't expect a major change at this point.

My main focus when I look at that is that all of our products and all of our sales have a nice contribution to both our revenue line and the bottom line.

I don't think being 90% or 80% gross margin is good or better.

I don't think that having a product which contributes to the bottom line 40% or 60% of operating margin is good.

I mean both of these are good things to add.

The main focus that we have is generate and get things that contribute, and grow the business both from the top line and the bottom line.

So there's no -- I don't think there's any magic in any of these numbers.

It's mainly finding out where we can generate expansion in growth.

Okay, thanks.

Thank you.

Our next question is coming from Sarah Friar of Goldman Sachs.

Great.

Thanks for taking my question.

Two things.

One, could you just give us a little bit more color on Europe specifically, given that to date broadly for a lot of companies it's lagged and yet it seems like this quarter it's finally picking up?

And secondarily on Abra, do you see that as a competing product to some of what the virtual desktop vendors are bringing, such as Mocha 5, or is it complimentary that you would work with the VDI vendors as kind of the security front end?

Thank you.

Yes, I'll take the first part regarding Europe.

Europe had a great quarter.

You can see it in the growth.

We typically don't provide the growth rate per region, but this quarter we provided it.

So you can see I reported the 31% growth in Europe which is very impressive, including the IPC obviously, and when you look at the percentage in the revenue it's 42%.

So it's remaining pretty much the same in terms of the portion of the pie of the revenue.

So very strong quarter in Europe and it's pretty much across-the-board.

And Tal, were there any countries that really stood out that have really come back strong?

I think the usual ones, nothing extraordinary.

Got it.

Okay, thank you.

In terms of the Abra solution, I haven't seen the products that's just like Abra.

I think really there isn't any product that does exactly the same.

There's one or two products that have encrypted USB drives, but again we don't provide VPN connectivity and so on.

Most other virtual desktops are not connected to a way that's so integrated and I think that's the big potential here that you're providing something that's completely integrated.

It's not a new infrastructure for the Company, but it's integrating into our existing VPN, it's simple and so on, and mainly when we have seen customers with that, we're seeing a lot of interest in that, every customer gets it thinks it's great.

On the same time, let's remember at least the way I see it is most customers also look for it if it's a new solution and therefore it means it's in very early stages, it's the market in general, and the cost of entry into that is very low because we are talking about devices that cost hundred, hundred plus dollars per device.

So it's not huge sales, doesn't have to be huge sales even though we definitely are working on deals that are tens of thousands of seats, but again we don't have to start there, so I think it's very unique.

I think there's of course many different remote access and the accessibility solution, we have many of them as well, but I think customers do look at it as a new category.

Right.

Thank you.

Thank you.

Our next question is coming from Phil Winslow of Credit Suisse.

Hi.

Good quarter.

Gil, I think last quarter you mentioned about 80% of product sales are based on the Blade architecture.

Just curious what you saw this quarter and also second question, related to the large deals, obviously you've had great success there, but wondering if you could just let us know what you're seeing in the small and mid size business category.

Thanks.

Okay, so in terms of the percentage of the Software Blade, I think it remains quite the same, maybe slightly up.

Most of our new platforms are shipping with that and the customers deploy that.

With regards to -- what was the second part?

Small and mid size businesses.

Small and mid size business, first I think we've done some pile ups in the last quarter or two about penetrating more channels and more places with SMB channels, with more SMB products.

Of course we sell to a very wide customer base.

Every time we speak about that I don't want it to sound like we sell only to the higher because that's definitely not the case.

We have a hundred thousand plus more accounts.

We are selling to businesses of all sizes and even if you look at the large deals that we have, they contribute 10% or 20% of the business every quarter and not 80% of the business so just to keep that in proportion.

So we've done some more pile ups and getting into more areas of the marketplace.

Later this year or next year, we plan to have more low end appliances and low end solutions that will keep addressing that and I think there's still a large market there that we're not addressing yet where we have other competitors that we can still capture and I think we're working on that.

Great.

Thanks.

Thank you.

Our next question is coming from Walter Pritchard of Citigroup.

Hi, Gil.

I was wondering if you could talk a bit about the business, at this point the network business that's not appliances.

I think it's still a reasonable percentage of the business.

I'm wondering, do you think that remains as with customers continuing to buy software and pulling it on their own hardware or do you see a further catalyst here to drive those customers who have not yet adopted your appliances towards that architecture?

I think we are not driving and I'm very happy with the software business and so on, but I must tell you that even I'm surprised with the level of acceptance of our clients.

I think most customers today do share the simplicity of the appliance and they pay the premium for that in many cases.

It depends where, actually on the low end sometimes it's cost effective to buy an appliance.

On the high end I think the customer wants it but we do pay a premium for buying the appliances and right now I see most of the business is still in the appliances.

I think it's still a good thing to have the open choice for customers, I think it's still a good thing to remember our value proposition, that our value proposition is in the software itself and in the functionality and in the architecture and not in the type of hardware.

And again, it's great results to the hardware side, but still the value is in the software and overall, I think we are enjoying the benefit of that because we generate nice revenue growth and nice profit growth out of it.

Great, and then Tal, on the $2 billion in cash, and the buyback at $50 million, you could buyback stock until the end of time at that level and cash is still going to creep quite a bit higher.

Is there any issue with you upping that buyback level in terms of really tax issues and any other thoughts in terms of what maybe to do with that cash in lieu of a restricted buyback level?

Sure.

First thing, a, we don't have limitation in terms of legal limitations so we could do it practically if we wanted.

The effect is on you, the shareholders, that if we would decide to do it then we would have to withhold taxes above a certain amount.

So the amount we can distribute without having a tax effect on the Company and on the shareholder in that respect is up to $200 million to $250 million.

On top of it, the Company will have to pay taxes on the distribution before obviously the withholding taxes on the shareholders.

So it's more effective at this point to go up to the level of what has no tax implication on the Company and that's why we are using that amount as the guidelines of what's the buyback that we're doing.

Great.

Thank you very much.

Thank you.

Our next question is coming from Scott Zeller of Needham & Company.

Hi, thanks.

First question, could you tell us the percentage of revenue from appliances this quarter?

You've given that out in the past.

Yes.

If you look at Q1 last year, it was around 45% and this quarter it's above 70%.

Okay, and then the comments earlier about -- I think Gil, you said you mentioned you'd hoped over the next year or two to get the entire customer base onto the blade architecture.

Does that suggest that you have a formal plan in place to migrate the Nokia customer base?

Is there a formal plan to migrate those customers?

It's a new software version.

It runs both on the old Nokia platform and on future platforms and our regular platform and of course, always we want to upgrade customers to the latest version.

It usually takes customers some time to do that, between two to three years to move from an older version to a newer version.

So we're just at the first trimester of doing that, but it's no different for Nokia or to our other Check Point or open platforms that we have and yes we do have many many programs to let them do that from, converting the old licensing model to the new licensing model at no cost, automatic upgrades for the licensing data.

Our help is if any field upgrades are needed, but at the end of the day we just have to remember that our products deploy the critical infrastructure and customers are not easily upgrading critical infrastructure, it takes them time.

And actually our time frame is relatively short.

Three years to convert most of the installed base compared to enterprise software companies is extremely short and the reason by the way it should be short is because, one thing everybody needs to remember, is security software upgrade is not just functionality or something that's nice to have.

In security software upgrade means more security and that's the main reason that people buy the product for the first place, so this is an ongoing process that we have all the time.

Okay, and last question.

Could you give us a percentage of revenue or a dollar amount for Nokia contribution and for the end point protection contribution in the quarter?

No, I mentioned that many times before.

It's pretty much impossible to do that in the sense that we don't see it as separate dollars.

The customers, historically IP an purchase power and UTM and vice versa, historical customers of Check Point can move from UTN-1 or Power-1 to the relevant ones in the IP series, and in addition we change the pricing model as well as in the IP series where we added the Software Blade into it.

So it's very hard to separate this and slightly misleading to do so.

Well maybe just in general terms could you tell us if end point is growing again?

No, the end point stays stable at this time.

Stable.

Thank you very much.

You're welcome.

Thank you.

Our last question is coming from Kash Rangan of Merrill Lynch.

Hi, thank you very much.

You've been executing on your appliance strategy for a few years.

I was wondering if you could comment on the refresh cycle that's happening with the newer install base.

And also secondly, are you considering measures from a product and execution standpoint as much as the growth rate that's quite impressive, I'm just wondering if you're considering measures to actually accelerate your growth rate in the years ahead?

Thank you very much.

So first, I think there's many things about providing what our solution in the integrated appliances, but in terms of the product cycle and the annuity cycle I think we've just started it, because we've moved many customers to appliances and the good news around that unlike software, appliances have an annuity cycle.

Hardware lasts for X many years, two, three, four, five years and then customers have to replace it.

We didn't finish converting all of the install base to our appliance yet, and I think on the same time we're starting the second generation.

So if you look at the mainstream Check Point appliances, not the IP series required from Nokia, they are about three, three and a half years old.

That means that we haven't even started the annuity cycle on this product, because I do think the hardware we have lasts for at least two or three years.

So we are just going to start the first upgrade cycle around that between 2011 and 2012.

Now, what impact it will have, will it have a huge boost of revenues or will it keep things stable, it's a little premature to say, but at least there's something to hope for in that annuity cycle.

Thank you.

There are no further questions at this time.

I'd like to hand the floor back over to management for any closing comments.

Thanks, everybody, for joining us for the call.

We'll be taking calls after and making calls after and we'll look forward to speaking with you next quarter.

Thank you and we hope you have a great day.

Bye-bye now.

This concludes today's teleconference.

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Thank you all for your participation.