Check Point Software Technologies Ltd (CHKP) 2010 Q2 法說會逐字稿

Greetings and welcome to the Check Point Software second quarter earnings conference call.

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 Meinzter, head of Investor Relations for Check Point Software Technology.

Thank you Mr.

Meinzter, you may now begin.

Thank you.

I'd like to thank all of you joining us today to discuss Check Point's record financial results for the second quarter of 2010.

Joining me today on the call are Gil Shwed, our Founder, Chairman and CEO, and Tal Payne, our Chief Financial Officer.

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 August 5.

If you'd like to reach us after the call, please contact Investor Relations at +1-650-628-2040.

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

During the course of the 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 third quarter and full year 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 purpose of the Safe Harbor provided by the Private Securities Litigation Reform Act.

Because these statements pertain to future events, they are subject to risks-- 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.

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 the reasons for our presentation of non-GAAP information.

Now, I would like to turn the call over to Tal Payne, Check Point's Chief Financial Officer, for a review of the financial results.

Thank you, Kit, and thanks to all of you for taking the time to join us on the call today.

Once again, I am happy to review another excellent quarter with record results.

Our revenues exceeded our projections with 17% growth over the same period in 2009 while our non-GAAP earnings per share came in at the high end of our projections and was $0.58, representing 21% growth.

Before I proceed further into the numbers, let me remind you that our second quarter GAAP financial results include equity-based compensation expenses according to ASC 718; expenses relating to acquisition, including amortization of intangible assets; and restructuring costs and the related tax effects from such items.

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

This quarter we consolidated Liquid Machines for the first time in the results since June 9.

GAAP results for the quarter include the effects of certain charges relating to this acquisition.

These charges including amortization of intangible assets and restructuring charges, which in aggregate, total of $700,000.

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

In the second quarter, revenues exceeded the high end of our projections.

Revenues reached $261 million representing an increase of 17%, compared to $223.6 million in the second quarter of 2009.

This growth was driven by exceptional (inaudible) product sales.

Products and license revenues were $104 million, representing 25% increase over the same period last year.

The growth came from all main product lines, including the IP series, Power-1, UTM-1, and Smart-1.

Our software updates, maintenance and service revenues reached an all-time high of $157.2 million this quarter, a 12% increase year-over-year.

The growth in deferred revenues was also significant this quarter.

Deferred revenues as of June 30, 2010, reached $415 million, an increase of $53 million, or 15% over June 30, last year.

We had growth in revenues across all geographies, with America delivering 20% growth over Q2 2009.

Revenue distribution by geography for the quarter was as follows--Americas contributed 44% of the revenue; Europe with 41% of the revenue; and Asia Pacific and Japan, Middle East, and Africa regions contributed the remaining 15%.

From a deal size and quantity perspective, this quarter we continue to see an increasing number of larger deals.

Transactions greater than $50,000 accounted for 58% of the total order value compared to 51% in the same period a year ago.

We have 25 customers that each had transaction with a value greater than $1 million compared to 21 customers in the same period last year.

From an operating perspective, we posted great results.

Our non-GAAP operating income was $145 million in the second quarter of the year, an increase of 24% compared to the same period in 2009.

Non-GAAP operating margin for the quarter was 55%, an increase of 3% comparing to the same period last year.

This was achieved primarily as a result of the top line performance and realizing synergies after the acquisition of Nokia in Q2 last year.

GAAP net income for the second quarter of 2010 was $103 million, or $0.48 per diluted share, up from $76 million or $0.36 per diluted share a year ago, representing an increase of 33% year-over-year.

Non-GAAP net income for the quarter was $122.4 million, or $0.58 per diluted share, up from $101 million, or $0.48 per diluted share, a year ago.

Earnings per share was at the high end of our guidance representing 21% growth year-over-year.

Our cash from operations this quarter was $149 million, an increase of 32% from $113 million in the second quarter a year ago.

This is mainly a result of strong collection as reflected in our DSOs, which were 58 days this quarter compared to 79 days in the same period last year.

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

Finally, our cash balances at the end of the quarter was $2.141 billion compared to $1.630 billion as of June 30, last year.

Now, let's turn the call over to Gil for his thoughts for the second quarter.

Thank you, Tal, and good morning and afternoon to those of you joining us on the call today.

The second quarter, once again, produced some exceptional results and is a quite nice way to complete the first half of the year.

The results exceeded our expectation for the quarter.

This year, we focused our strategy on delivering more security, better security and simpler security.

Our Software Blade architecture and appliances are a reflection of this strategy and our continued top and bottom line growth are the results.

The particular area of strength this quarter was the 25% growth in product sales.

The best part about this growth is that it came from all of our product lines, which is always a good testament to the strength of our business.

As you're all aware, we continue to pursue an acquisition strategy and have now made five acquisitions of varying sizes over the past few years.

During the quarter, we completed the acquisition of Liquid Machines, which will complement our data security strategy which is focused on securing this data throughout its life cycle in a unified way.

Our full disk encryption keeps data secure on the laptop hard drive, the integrated VPN secure when it's being transmitted over the Internet, our new DLP solution keeps documents from being leaked outside the organization, and in the future, the technology acquired from Liquid Machines will help us build solutions for sharing documents securely.

This complements every solution we've already introduced since the beginning of the year.

Abra for secure mobility and the DLP which I just mentioned.

Both expanded our addressable markets.

In terms of sales, we increased our revenues and sold more products in all geographies.

The Americas demonstrated very strong results this half.

Asia produced very good results and Europe, while seeing some softness, also generated good growth this quarter.

As for financial projections, the first half of the year has provided us with a great starting point for the second half.

So we are therefore increasing our guidance for the full year 2010 and providing guidance for the third quarter.

Let's start with the third quarter.

For Q3, we expect revenues in the range of $255 million to $265 million and non-GAAP earnings per share of $0.56 to $0.60.

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

For the full year, we expect revenues in the range of $1.040 billion to $1.070 billion and non-GAAP earnings per share of $2.30 to $2.40.

Again, $2.30 to $2.40.

GAAP-based EPS is expected to be approximately $0.30 less than that.

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

Thank you.

We will now be conducting a question and answer session.

(Operator Instructions) Thank you.

Our first question comes from Daniel Ives with FBR.

Thanks.

Great quarter again.

Gil, can you talk about specifically in Europe, what you guys saw throughout the quarter, any changes and just maybe -- as you're in a lot of those engagements, what are you hearing from customers -- anything different there geographically?

I think there's no one good conclusion to say.

I think overall we had good results in Europe and in particularly, we saw some softness, I think it's too early to deduct anything out of that.

We will keep watching it.

I mean, there are good reasons to be optimistic, but at the same time we have to be cautious because we know the economy like all of you.

And again, in some countries we saw strength and some countries weakness.

I can't even completely correlate it to what we see from the global economy perspective.

Again, then just on the bleed, are you getting more -- you're seeing more interest for that going into the latter part of the year in 2011 from customers?

Can you talk about what you're seeing there?

Absolutely.

We are seeing an increase in sales of everything and that includes our blades both a la carte, the bundle blades.

Keep in mind, there's a huge potential with the higher install base that we have to purchase more blades but this will take some time because all the customers need to upgrade to R70 to use that.

R70 is the release that we're doing in blades and that takes time and now we are continuing to monitor that.

Every week, we have a few hundred customers upgrading to R70 and we are seeing it on a weekly basis and tracking that, but absolutely the Blade sales are showing an increase in all aspects.

Thanks.

Thank you.

Our next question is coming from Shaul Eyal from Oppenheimer & Co.

Thank you.

Hi guys.

Good quarter.

Congrats.

Two quick questions on my end.

How many blades do you guys sell right now by the end of the second quarter and then, Tal, any discussion on the foreign exchange impact this quarter?

Thank you.

So, first thing, we are not breaking the sales by particular blades or product family and so on, and keep in mind with the many of our blades are sold in a bundled way using the product.

But overall, we are talking tens of millions of dollars every quarter and combination of multiple Blade, multiple selling forms, and that's a significant part of business right now.

And with respect to foreign exchange?

Sure.

I'll remind you that we are ahead, so just to give you the basic data again, out of the 100% of our expenses, about 40% are in local currencies and 60% in dollars.

And out of the 40%, the main currency is obviously the Shekel, the Euro, and then the Pound, and many other currencies.

The Shekel actually -- the Israeli Shekel didn't do much this quarter so it didn't move much so it had no effect at all.

And the Euro moved significantly but we are ahead significantly as well, so all in all, a difference of a few hundred, or $200,000, net.

So no effect on this quarter.

Thank you very much, and good luck.

Thank you.

Thank you.

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

Hi guys, Michael Turits.

A couple questions.

First of all, on the software Blade side, what percentage of your base is now on the R70 release and so, in the position to be actively buying the Blades?

I don't have the data in front of me but it's still a small percentage.

As I told you we are moving customers, hundreds a week and that's on one hand, it's a good number of people actually upgrading and on the other hand, it will take us a long time to migrate the entire install base.

Also, how is Endpoint doing?

Anything -- You said you're doing tens of millions in blades.

Any sense if Endpoint is contributing about the same amount?

Again, I don't want to break it separately, but I think what I did say very clearly is that all product lines contributed to growth this quarter and that means that Endpoint did start to contribute to the growth and hopefully it's a good sign.

Okay.

Last question is more of a general question from a demand perspective.

Is it -- how much would you say that you're seeing of a product refresh cycle around firewalls along with data networking in general?

How much of the demand right now do you think is cyclical and pent up demand from last year?

And how much of it seems by contrast to be coming from expansion of data center capacity moving to 10 Gig Ethernet, things like that?

First, I think it's not necessarily separate.

I mean, refresh means that people need higher bandwidth when they want to purchase faster solutions to address their needs.

[Value] data centers that we're seeing companies operating, the reason the refresh I don't think is cyclical because we don't see a cyclical pattern.

What we see more is an ongoing pattern of people upgrading their infrastructure so it's an ongoing phenomenon and I think we see a combination.

I think every quarter we have the more than a thousand new customers.

For example, in every quarter, we sell to tens of thousands of existing customers and so again, we are doing a lot of work these days to analyze the data and get much better demographics on the exact sales that we're doing.

So far, there's no one conclusion that would tell us that growth is coming from one area to another.

It does come from multiple sources.

And if I could squeeze one last one in, I'd appreciate it.

Just any update on when application control is coming out using the new FaceTime database?

Yes.

It will come Q4 this year as an integrated Blade and in the next few weeks, we will share more data publicly with our channel and partners and with our users, so I think we will be able to demonstrate that and show that within a few weeks.

And again, delivering the plan is for this year.

Thanks, Gil.

Appreciate it.

Thank you.

Our next question is coming from Jonathan Ruykhaver of ThinkEquity.

Yes.

Thank you.

I'm wondering if you could provide some color on the Unified IPSO and [flat] Operating System in terms of when that will be delivered to the market and secondly, is there a revenue opportunity associated with that integration?

Yes, it will be integrated and we will demonstrate it and start shipping this year.

I think it will take a more centerpiece and more center stage for new appliances and new solutions that we will roll next year again on an ongoing basis.

So the target is next year.

In two or three weeks, we have a conference -- our customer and partner conference in Singapore, the third conference (inaudible) and that's part of the agenda, which is called Project Gaia, which will show the Unified Operating System.

And I don't know how much of that I can quantify is new revenue opportunity.

Clearly, it will help us internally in the consolidating product line and making things internally a little bit more efficient.

It will clearly help customers because they will be able to move from one product line to another.

For example, today on the IPSO platform, not all software blades are supported.

Once we have Unified System, people with IPSO will be able to buy more blades.

On the other hand, customers, today, like features that have an IPSO and can't get it are a little bit (inaudible).

It's good to have a unified line, and if we have good products, in many cases, it will generate more sales.

Okay good.

Thanks.

Just another quick question, just curious about the Smart-1 and SmartEvent appliances in terms of what kind of [dots] you're seeing in the marketplace and how large can that opportunity be for Check Point?

Actually, very good adoption.

Many people are buying it.

Sales are growing at very high percentage.

Still on a small basis but it is millions of dollars every quarter, so I mean, it has a positive and meaningful influence on our product sales.

Okay.

Good enough.

Thank you.

Thank you.

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

Hi, good morning and good afternoon.

I wonder -- has there been a permanent change to your collections process?

Your DSO seems to have reached a new lower level over the last couple of quarters.

Anything significant there?

We do have a very strong collection, that's correct.

I wouldn't say that there's any material change in the processes.

We've always had great collection.

If I checked the DSO based on the last month and not based on the quarter, then the DSO is pretty much stable for the last two years.

I think it's been always great and it continues to be great.

Great.

And then on Liquid Machines, Gil, can you tell us how that -- a little more color on how that (technical difficulty) -- technology could also be employed?

Sorry.

We couldn't hear you.

Can you repeat the question, please?

It's Liquid Machine, does that become a Blade?

Does DLP become a Blade?

Yes, DLP will become a Blade in our Gateway.

Liquid Machine will eventually become a Blade in the Endpoint.

Again, it's still a long time.

I mean, Liquid Machine is clearly a strategic investment on our part.

It's something that I think will come to fruition in -- hopefully, we'll be able to show some products in 2011 but I think the result that we'll see out of that will be 2012, 2013 which is a strategic investment.

Everything we will do will be a Blade and in particular, the DLP, which I think is a huge thing from the standpoint that every Check Point gateway in the world and every Check Point customers that before needed to invest hundreds of thousands of dollars in building a DLP solution.

I think we will make it extremely simple, ten times simpler, ten times more efficient.

And in terms of cost comparison, I think our cost will be 50% to 80% lower just on product sales and (inaudible) and if you take into account the complexity and the total TCO in managing the DLP solution, it will really, really create a new category in the marketplace.

So what you're looking at the DLP is not to compete with the existing complicated solutions, but rather create a new category and bring DLP to every enterprise and to every company.

Thank you.

Nice execution.

Thanks.

Thank you.

Our next question is coming from Phil Winslow of Credit Suisse

Hi guys.

Great quarter.

I just want to touch on the large deals, I think this is possibly a record high we've seen for a Q2 in terms of percentage of your bookings that come from deals over $50,000.

Just curious what trends you're seeing there and what's really driving that?

Is that an uptake of additional Blades or just broader sort of standardization agreements with corporations or just what are you seeing that's driving that up?

Thanks.

I think it's combination of all three.

One is combination of customers buying more products from us.

Second is the [unification] of the way we work with customers renewing contracts together, combining all contracts for one customer and doing it together, and third element of that is the fact that we're selling more appliances.

In the IP business which we've unified, many of our larger customers have now become bigger customers when we unified their account.

And last and not least is the execution by the sales force.

The sales force became much more focused producing great results on the large accounts and again, when we start to analyze the demographics of our sales, we clearly see there are very nice achievements there.

Again, we are not built overnight but suddenly, you start seeing the results to be very meaningful.

Great.

Thanks guys.

Thank you.

Our next question is coming from Robert Breza of RBC Capital Markets.

Hi.

Thanks for taking my questions.

Just two housekeeping items.

Tal, was there any deals greater than $5 million in the quarter and then can you talk us through how we should think about deferred revenue going through the year?

Thank you.

Sure.

I don't think we had any transaction higher than $5 million.

The answer is no, but I don't have the data in front of me.

And to the second question, the deferred revenue is a regular phenomena we used to see.

We used to the deferred revenue going up in Q4 and then reducing in Q2 and Q3 or flat, maybe slight increase, slight decrease, but nothing major there and then in Q4 going back up again.

So Q4 and Q1 are usually up and Q2 and Q3 are usually down.

That's based on the fact that many customers prefer to renew their contracts around year end.

Year end meaning December, January that ties into Q4 and Q1.

Great.

Nice quarter.

Thanks.

Your next question is coming from Gregg Moskowitz of Cowen and Company.

Hi.

Thanks very much.

Hi Gil, I was wondering if you could talk a little bit more about Europe along the lines of possibly which regions performed well, and which may have seen a little bit of softness.

I've tried to analyze it before and I've looked in all the countries and again I can't give you any pattern that will be very meaningful.

We sold more in the UK, we sold some less in Germany.

We sold much more in France and we sold more in Greece, so I mean we really can't correlate it to any -- I mean, there are some similarities, there are some correlations to what you see in the global economy and there's a lot of things that don't correlate to that.

So I can't just tell you what's very clear phenomenon what I can describe here.

Okay.

And I know it's early, but how did Abra do relative to your expectations in its first quarter?

Actually it's very early, so that's true but they actually did very, very well.

We have many, many customers, we have many thousands of units, the interest level is very high and I hope it will come to fruition.

I mean, good size and good bookings for that.

Okay, great.

Just lastly, a quick housekeeping for Tal, what were security appliances, Tal, as percentage of product revenues?

Higher.

Around 75%.

Perfect.

Thanks very much.

Nice quarter.

Thanks.

Thank you.

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

Excellent.

Thank you for taking my question.

Again, good quarter.

Also, very impressive increase in your guidance for the full year.

I was wondering if we could delve into that a little bit on two fronts.

One, what are you guys assuming for Europe into the second half?

Is there any conservativeness in your forecast given some of the softness you saw in 2Q and the second part of the question would be is there anything in there for Liquid Machines and what would the impact of Liquid Machines be on the increase in your guidance?

Liquid Machines has had nothing to do with it.

I don't know if we factored much or not factored, but it's really not significant, so I'm not counting it as a big part of our contributors for, like I said, the next two years.

I [hope] that in several years it will become very meaningful but for the time being we are not trying to be very aggressive.

As it stands right now, and for Europe, yes, on one hand, and you said that we've ramped up our guidance and it's relatively higher so that's good.

On the other hand, I tried to factor in some risk factors in the world in general and in Europe in particular, so I hope it's like we do all the time, we provide the balance forecast and that we will be able to make it.

Excellent.

And if you can update on the competitive environment, maybe in particular against Cisco, sounds like Cisco had some issues with their security appliances in the quarter.

Do you guys see any positive impact from that?

I haven't seen much from Cisco negatively or positively in recent quarters.

I think in general I would characterize that Cisco is the large and quiet competitor.

I do think that they sell a lot in our marketplace.

I don't think they are -- we compete on strategic deals things like that, we hardly hear about Cisco as a major competitor.

On the other hand, we [have various sized] account access and so on.

I think that they do sell a lot so I don't want to underestimate them.

Thank you very much, guys.

Thank you.

Our next question is coming from Israel Hernandez of Barclays Capital.

Hi.

Good morning, guys.

Could you just give us an update on the installed base -- the Nokia installed base and how much of the growth and momentum that you are seeing presently is being driven off of upgrades, off the installed base versus organic gains or competitive share gains?

Thanks.

So first, I think everything we are seeing right now is organic because Nokia was part of our results Q2 last year and it's Q2 now, so the results this year are organic including Nokia.

In terms of the growth, we're actually positively surprised to see that the IP appliance series is growing even better than we anticipated when we acquired that business.

Yet on the same time, the UTM-1, the Power-1 series are also growing very nicely.

I think this quarter, some of them grew faster than the IP series.

The Smart-1 new appliances with our new products are also selling nicely and I think I mentioned it a few times, the growth this quarter came from all product lines which is very, very encouraging to see from the Endpoint to the high-end appliances, everything was growing nicely and contributing to the results.

And as one follow-up, I think, Gil, last quarter you said that you could grow the business, I believe you said 10%.

Given the performance through the first half of the year and your implied guidance for the back half, do you care to update that guidance?

I think for this year we gave the guidance and for the future, we will see what the future will hold.

Again, we will do whatever we can to grow better and faster, and I think there's definitely a potential in that, but I think time will tell.

I mean, I don't think that I can predict what will be the state of the world economy in two years or three years.

Great.

Thanks so much.

Thank you.

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

Hi.

You've given some discussion in the past on efforts to upgrade and expand the sales force in Asia as well as your efforts around partners and delivering managed services offerings.

I'm wondering if you could give us an update on both of those now.

I think in Asia we are seeing very good traction and very good results for many countries in Asia in which we see good growth and coming from small bases and becoming countries, the results from those countries are million dollar sales a quarter.

In the large countries the trend is also quite positive but in the large countries it varies by quarter, the seasonality in Asia is somewhat different than in the rest of the world.

Like Q3 should be a good quarter there, which is the end of the fiscal year in some countries, Q1 is the end of fiscal year in other countries in Asia.

So it's a little bit different than what we see in Europe and in Americas.

Overall, I'm very, very happy from the organization.

Few years ago, it was a sales organization from which we expected an order of magnitude of $20 million, $30 million per quarter, now we expect an order of magnitude of $50 million per quarter from Asia.

That's a huge change.

A few years ago, I looked at Asia and I think for overall Asia, I was looking for $100 million a year.

Now I'm deriving $200 million so that's very nice headway we've made in that part of the world.

Sales to MSP -- we have sales to MSP, we want to do more and nothing much to report on that at this point.

Thanks.

Thank you.

Your next question is coming from Rob Owens from Pacific Crest Securities.

Great, thank you.

Was there any dilution from Liquid Machines in the quarter?

No.

You had -- I talked about the amortization, the restructures in the GAAP numbers, it was about $700,000.

And it will affect a few hundred thousand, nothing dramatic.

So the incremental expense in Q2 was only a few hundred thousand?

It's a small company, so it's not expected to be --

Great.

That being said and then the strengthening of the dollar, why did you see the margin compression sequentially?

Why didn't you see a little bit more lift there?

The marketing expenses are typically higher in Q2.

You can see, it all varies so all of Check Point experience in Q2.

Both in the Europe and US was in Q2 so it's just higher levels of marketing expenses, really.

Great.

And to some extent, we sold much more appliances than we anticipated, which is great news, and that's also reflected in the cost of goods line --

And if you want the sales reason, the salary increase always happens in the beginning of Q2 and at the end of Q1, so it's by definition higher level of expenses in Q2.

All of our employees, all our salary increases in the world are being affected in Q2 and not in Q1, so the biggest source of expense from us is payroll and all the payroll went up in Q2.

Great.

And one year into the Nokia acquisition, I'm understanding that it's organic at this point of its anniversary, do you have a sense of how much their installed base you've penetrated at this point?

All of it.

I mean, we are (inaudible) with all their install base, and all their install base was a Check Point installed base to be before, so I mean it's not that we are addressing new customers and again in many, many cases, we've seen pretty good synergy around the customers that were $200,000 customer a year before and are now $300,000 or $400,000 customers because it's now combined the accounts.

By the way, that creates very, very good synergy because now one account manager, single discussion about upgrade cycle, single ability to meet the requirements when we control both ends of the hardware and the software.

So I would characterize this acquisition as very, very successful from all aspects -- customer relations, financial, and so on.

If I can add on to that, Rob, as far as penetration into the refresh cycle, there's still much more to come in the future.

A refresh cycle doesn't happen all in one year.

So that's still out there.

Is there anything we can quantify in terms of what's been penetrated in that refresh cycle?

I think if you just do -- obviously you can't know the exact number but if you assume the line of product for IP series existed for many, many years and if you assume that the cycle is over five, three, four, five, six years, you should have approximately 20% a year.

It shouldn't be a peak in a certain year.

Okay.

Thanks, everyone.

Thank you.

Our next is coming from Walter Pritchard of Citigroup.

Thanks.

Gil, I'm wondering, you talked about in an acquisition strategy, and you mentioned five deals over the last year or so, but they've all been, with the exception of Nokia, pretty small deals.

And I'm wondering if you've contemplated anything larger in the last year or if you're looking at anything in the future, a la Zone Labs and Endpoint stuff that you've done in the past three to five years?

First, the five deals are much more than one year, so don't want confusion here.

I don't have anything right now that I'm planning, so I'm not hinting that something should be expected immediately.

We are looking actively and we are scanning the market and we are looking every month at new ideas and you think some of them are very obvious because known companies and we brainstorm about the ability to create some synergy there.

And for the most part, we decide no, so it's not that I anticipate that.

And we keep looking for that.

At this point, I won't, I am sorry to say, make any expectations of that.

I think we are having a lot on our plate.

We have a lot of new fields that we are penetrating.

We have to a lot to execute in all the areas, like I said, from mobility, DLP, secured documents, Endpoint we should execute, so I'm not expecting any large deals in the short term.

Great.

All of rest of my questions have been answered.

Thanks a lot.

Thank you.

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

Hi.

Thank you for taking my question.

Two things.

One, Tal, can you give us a little more detail on what foreign exchange contributed to your bottom line?

I know you guys have a little bit of a different [contra] movement to other software companies with respect to your expense and revenue sources, if you could give us a little bit of color there that will be great.

And also I think you talked about some marketing expenses and salary raises.

If you can you quantify what that did to the operating margin, that will be great.

And then finally for you, Gil, where are you -- it looks like you're clearly gaining share in your core business, if you can talk about which segments of the market are you gaining share, the low end against some of these start-up companies or the high end, any color, because the follow-up market obviously is not growing at the rate you're growing.

And I'm trying to understand what is really driving that above market share gain.

Thanks.

So maybe I'll start with -- I haven't measured that and again, my focus is always providing more value to customers rather than the -- market share is the result, not necessarily the main measure of what we do.

My feeling based on the data that I'm seeing is that we are gaining share on the enterprise on the high end.

I think there's a lot we can do on the lower end of the market and I think we are producing good products and we need to get more traction and more focus from our own sales force and from the channel partners to sell more to the low end of the market.

Clearly, I can understand why.

The sales people have great success on the enterprise in high end with prestigious deals, high margin and larger deals.

And their focus is, rightly so, on that.

I feel we have an untapped potential, I think we can grow everything, but I think we have untapped potential at the low and slight mid-market, I expect between zero to 5,000 users, that's a very large market that we are penetrating in the different levels and also we can do more.

And I think we have also more potential at the very high end.

The accounts we sell to all of them but in selling solutions that are much more expensive and much faster mainly than what we do today, there is also some high potential.

I think if I look two years, three years down the line, that area that we'll keep looking for them.

And definitely for the very high end which is, as I said, that's part of our core market of high end and enterprise customers.

And yes, maybe I'll take the first part of your question, the effects, I'll repeat the answer.

If you take our expenses in approximately 60% is in dollars, it means that 40% of our expenses are affected by the currency changes.

And out of that, probably around 40% or so is the Israeli Shekel, which didn't make a move -- probably low single digit move, so no effect there.

And the rest of it is Euro and Pounds and other currencies around the world.

Now the Euro did make a move, but we have a hedge.

So when I look at the net, the net effect was probably around $100,000 to $200,000, so I'll say pretty much break even, no effect on the P&L this quarter.

Now, on the revenues, it's very hard to know, because our -- remember that we are pricing everything in dollars and the majority or substantially all of our revenues so that effect is not direct but it can be indirect if it affects the budget that are available to our customers.

Their buying power is slightly lower, but (inaudible) products, we get the same amount in dollars.

That's to that question and to other question what was the effect of the salaries and the marketing.

Well, you can see pretty much that's the main reason for the increasing all the line items so some of it is the salaries and some of it is the marketing expenses and I don't really have the exact --

(inaudible) for example, pretty much all of it -- the increase.

You can see actually the gross margin, I think the operating margin was (inaudible) about 0.5% so that's the net effect.

The operating -- gross margin actually improved near 1%.

And I wouldn't look at it that way in meaning 0.5% up, 0.5% down, this is a real business and there can be a shift between margin between quarters of a percent here or there.

I think the way to model the business is that everything that's not our gross margin on the appliance sale is basically fixed expenses and that depends on the level of investment we decided to make (inaudible).

(technical difficulty) in the past few years, is that we have real cost of the hardware sales, that's reflected in the cost of product sales.

If you remember, cost of services is (technical difficulty) income, fixed amount of people.

Cost of product sale that you can find in our financial report is the varying part according to product sales, and beyond that, everything else is basically headcount and headcount-related expenses that are fixed and dependent on the level of investment and are not changing between one quarter and another.

Next caller?

Thank you.

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

Hey, Todd.

If you're using a speaker phone, please pick up your handset.

We'll go to the next question coming from Brad Zelnick of Macquarie.

Hi.

This is Bob in for Brad.

I think most of my questions have been answered but just looking at DLP and Abra, can you talk about how it's being received in the channel?

I know it's early.

And then what are you guys expecting for that for the rest of the remaining quarter?

What are you guys think it's going to do to the items?

I think it's new product categories and new products, some of them don't exist, some of them are emerging and it will take us time to build the critical mass.

But the reaction that we are getting so far is very good.

I sat yesterday a couple of hours with our sales champions for DLP that brought me their feedback from all over the world about what they are seeing with DLP and they were very positive, high level of interest and so on.

I think we have a challenge and an opportunity both to educate the market about our new approach here and we have a new approach of making DLP very simple, very straightforward, something you can embed in every system.

That opens up huge market of customers that before didn't think or couldn't afford installing such a complicated solution for DLP.

And I'm challenging our people always, get us many more customers and a broader installed base as we can get because that will be the basis for future growth, not small number of small deals but large number of deals all over that will bring us the sales.

Abra, we've already seen some traction with many hundreds of accounts that are already trying it out.

The one thing you have to remember about Abra is that the entry cost for that is very low.

You buy one, but even if you buy few of these [sticks] for $100 or $200 each, it can start with small transaction.

It's very tangible.

You take one of them, you can try it out.

Are customers using Abra more on a trial basis or are they just and then going testing it out first, and then going widespread throughout the enterprise?

It's both, it's both.

And again, somebody wants to try, obviously they want to buy $10,000 the first quarter, they'll buy few, try it and then buy the hundreds, or thousands, or whatever it may be.

Okay.

Thanks a lot.

Good quarter.

Thank you.

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

Hi, this is Stephanie Withers on for Sarah with a couple of questions on pricing.

So first, are you seeing any impact on pricing from the newer competitors in your core markets.

And secondly, since you do price in US dollars, can you quantify at all the impact you may have seen to pricing in outside of the US and are there any offsets to those that have had a more positive impact on pricing?

So what have overall ASPs done?

First, I don't know many emerging new competitors that we have in the marketplace.

ASPs, in general, have been doing quite well, and for last two years ASPs have been trending up very, very consistently and this quarter was no exception.

You see in several parameters from the number of large deals through the [mid-quarter] of it, we are checking about the specific ASP of each product line and each product sale, it's being trending up and nicely.

And for sales all over the world, again, we are selling this model for the last 17 years, all of our sales are in dollars except maybe Japan one country, and it's going well.

Customers understand it.

It's clear, it's transparent, with not much room for international arbitrage with technology customers know how to do these days very, very well.

And clearly when there's currency changes between the Euro and the dollar, that in a small way makes the customers' buying power slightly less.

But again, with 16 years of experience, I haven't seen -- I've seen that system very simple and straightforward way and it's a very effective way.

Our starting structure is very transparent and very straightforward.

Every one of you can go to the website and check our product list and see that it's simple and straightforward.

It's the same with our global partners and so on.

Thank you and then just one last follow-up.

The FX impact to deferred revenues -- is there any impact there?

Is it held in dollars or do you have to translate that into other currencies and then mark-to-market?

No impact at all.

No impact.

The impact is the seasonality.

And I'll just remind that the deferred revenue do not include the product bookings.

Actually at the end of the quarter, we had some product sales that we haven't shipped (inaudible) product because of other reasons, this is not reflected in the deferred revenues or any other financial metrics which we usually publish.

Okay, great.

Thank you.

Thank you.

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

Thanks, if you said this I apologize, I got cut off.

Can you talk about the linearity in the quarter and what you saw in the strength of the business exiting the quarter?

It remains back-end loaded.

It's much more back-end loaded today than it was ten years ago but not very different than it was a year ago.

The linearity is quite the same.

I think it's about -- we book between 50% to 60% of our sales the last month of each quarter.

Which, in effect, stays the same and my challenge to the sales force has remained the same.

It's still 30%-30%-60%.

Okay.

I just have a tough time reconciling the DSOs, you mentioned that the DSOs for the last month have been stable for the last year yet you have had a dramatic improvement in DSOs.

I would have thought that would have meant linearity maybe was a little bit less back-end loaded.

No, it wasn't.

Okay.

Then last question would be on deferred revenue, what impact are we seeing on the deferred revenue patterns from the increase in product and appliance sales?

It's actually, remember the product revenues the way it goes, we book it.

You don't see bookings as part of the balance sheet.

Well, whatever we ship is recognized as revenues we see that quarter and whatever we don't ship you don't see it and it's not part of the deferred revenues.

One part, Tal, that I think he is right about is the fact our products today we do have what we call service blades that are embedded in the product price.

When we sell an appliance with an IPS Blade, which is most of our appliances, that does contribute a little bit to the deferred revenue and net all the impact.

So, if we did book, the sales of appliance then ship it, then it can't have any effect on the deferred revenue.

(inaudible) there is an effect or no effect.

All right.

Thank you.

Thank you.

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

Hi, thanks.

I may have missed it earlier but was there any color on the strength of the lower end enterprise SMB spending?

Are we seeing increasing strength there?

And also competitively, I know there's a question about Cisco but anything changing at all in the 3Com tipping point?

3Com tipping points are more stand-alone IPS.

I think we don't really compete in that marketplace.

We're selling more -- we are in the IPS market but we are much more into the integrated IPS, so I can't say we've seen much of tipping point [frequently] in our marketplace.

In the small enterprise market, I think we're doing okay, but I think we can do much better.

If I look at our segmentation of sales, anything that's more than 5,000 user enterprises with more than 5,000 users, I think we're doing very, very well.

Enterprise is less than 5,000 users.

We are stable.

We are growing but I think we have a huge untapped potential there that eventually we can do more of.

Actually, I heard that color earlier about the how you feel there's more to do in the mid-market, but I was wondering just a commentary about the recovery of spending amongst those customers?

Do you think that they are firming up with spending?

I think that these customers are actually doing okay.

I think in most cases these customers, the smaller they are, the projects are not very significant.

Buying the product for $10,000 to $20,000 and by the way, we do have many new product and we've increased performance dramatically in this marketplace.

We've launched Top 1000 products that have gigabits performance and (inaudible) performance in the marketplace.

We've almost quadrupled performance for most products under $20,000.

We structure updates so all customers can get it so I think we are quite aggressive in terms of the products and we are seeing that results.

UTM-1 product family has produced phenomenal results in the last year.

I still think that we can add many, many more new customers there.

And big part of this is, I don't -- probably (inaudible), along with execution and focus and I think, as I mentioned, we can do more there on the same time our sales people are producing very good results in higher end account so there's no reason to complain on it.

Great.

Thank you.

Thank you.

Our last question is from Jonathan Ho of William Blair.

Great quarter, guys.

In terms of just the new products on the software Blade side.

You guys have added a number of Blades.

Can you talk maybe about the sales and distribution channel strategy in terms of how you're incentivizing and educating the sales force, just to sell so many, I guess, new products and maybe how comfortable or how mature the sales force is in upselling at this point?

I think the sales force is fairly comfortable with it.

We are doing a lot of seminars.

We are doing a lot of different programs which we do with channels, for example, we come to every city with a group of experts, we sit with our sales force, with the channel salesforce and we do joint calls and joint account analysis of how to sell additional opportunities.

We have a program for that, that we're doing in many countries and many cities and it's very successful.

And I think what we may be selling the blades a very simple way.

The entry cost to sell a new product or a new functionality with the Blade is very low.

The simplicity of that is also very good.

I think we make it easy to sell it.

Now, what we need to convince -- I think not convince but change the behavior is to show partners how much they can actually enlarge their business.

And we are doing these metrics with them.

We have many, many metrics like that we're showing them.

Look at your -- for every partner, look at your install base, look at what we have, look at what you're selling them is event analysis, IPS, two more things you can generate 30% more sales.

And it's straight, simple sales, it's not complicated sales.

So I think it will take us some time until everybody upgrades to R70 version, and I don't know if everybody gets this message.

So as far as I can tell this message is being accepted in the marketplace quite nice.

No objections.

Very straightforward.

Excellent.

And can you also give us a quick update on IPS and what you're seeing out there in terms of the renewal rates once they've gone through the free period?

It seems too early to say but I think the growth of the IPS Blade is selling quite nice.

I think, I remember about 40% year-over-year in the last year, so quite good.

Great.

Thank you.

Thanks, Jonathan.

Thanks everybody for joining us on the call.

We'll look forward to talking to you in the coming weeks.

Have a great day and enjoy your summer.

This concludes today's teleconference.

You may disconnect your lines at this time.

Thank you all for your consideration.