Check Point Software Technologies Ltd (CHKP) 2011 Q3 法說會逐字稿

Greetings and welcome to the Check Point Software third quarter financial results 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, Kip Meintzer, Head of Global Investor Relations for Check Point Software Technologies.

Thank you, sir, you may begin.

Thank you.

I'd like to thank all of you for joining us on this beautiful fall day to discuss Check Point's record financial results for the third quarter of 2011.

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

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 October 25.

If you'd like to reach us after the call please contact Investor Relations by e-mailing kip@checkpoint.com.

Or by phone at plus-1-650-628-2040.

Before we begin with management's presentation I'd like to highlight the following items.

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 programs and the success of those products and programs, and our expectations regarding our business and financial outlook for the fourth quarter of 2011.

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 the 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 latest Annual Report on Form 20-F.

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 all the reasons for our presentation of non-GAAP information.

Now, it's my pleasure to turn this call over to Check Point's Chief Financial Officer, Tal Payne, for a review of the financial results.

Thank you, Kip, and hello, everyone.

I would like to thank you all for joining us today for a review of an excellent third quarter.

This quarter, we recorded record Q3 results across our key metrics.

Our results exceeded the high end of our projections as we continue to demonstrate solid growth across all regions.

Our revenues for the quarter increased by 13% over the same period in 2010.

While our non-GAAP EPS was $0.72, representing 14% growth year-over-year.

Before I proceed further into the numbers, let me remind you that our third quarter GAAP financial results include non-cash equity-based compensation charges, amortization of acquired intangible assets and the related tax effects.

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

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

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

Revenue reached $308.3 million, representing an increase of 13%, compared to $273.2 million in the third quarter of 2010.

This growth was driven by increased sales of Enterprise Gateway and continued growth in our new [anti] Software Blades.

Product and license revenues were $120.7 million, representing a 13% increase over the same period last year.

The growth in product sales is consistent with the growth of our deal size and was driven by high end appliances like Power-1 series and our integrated appliances.

Our software update, maintenance of subscription revenues reached an all-time high of $187.6 million this quarter, a 12% increase year-over-year.

Subscription revenues were also aided by our new [DLP] Software Blades that are becoming a significant part of both revenues and deferred revenues.

Deferred revenues as of September 30, 2011 were $454.5 million, an increase of $58.2 million or 15% over September 30, 2010, higher than seasonally expected.

The increase in deferred revenue is attributed to strong bookings from software updates and maintenance and our new anti Software Blade.

As we mentioned in the past, since we launched the Software Blade Architecture, our product offering includes many annuity blades bundled with a majority of our network security gateway.

These annuity blades includes URL filtering, anti-virus, anti-Spam, IPS, and the recently added Application Control.

In terms of revenue allocation, we extract from our product revenues the value attributed to those blades, (inaudible) as part of our deferred revenues, and recognize it over the length of the subscription.

Naturally, the more annuity blades we bundle into our product, we will see product revenue shift into subscription revenue.

Given the nice renewal rates we've seen so far, this is a positive evolution of our business model and more revenues becoming recurring.

Revenue distribution by geography for the quarter was as follows.

America contributed 45% of revenue, Europe was 38%, and Asia Pacific and Japan, Middle East and Africa regions contributed the remaining 17%.

From a deal size and quantity perspective, this quarter we continued to see an increase in the number of larger deals.

Transactions greater than $50,000 accounted for 63% of the total order value compared to 57% in the same period a year ago.

We had 35 customers that each had transactions with a value greater than $1 million compared to 17 in the same period last year.

From an operating perspective, we posted great results.

Our non-GAAP operating income was $180.7 million in the third quarter of 2011, an increase of 15% compared to the same period in 2010.

Non-GAAP operating margin for the quarter was 59%, an increase of 2 points compared to the same period last year.

This was achieved as a result of increased revenues and reduction in expenses due to regular seasonality related to marketing expenses, education utilization.

Please don't expect this to be future ongoing operating margins.

GAAP net income for the third quarter of 2011 was $134.1 million or $0.63 per diluted share, up from $114.5 million or $0.54 per diluted share in the same period a year ago, representing year-over-year increase of 17%.

Non-GAAP net income for the quarter was $152.9 million or $0.72 per diluted share, up from $132.6 million or $0.63 per diluted share in the same period a year ago.

Non-GAAP earnings per share exceeded the high end of our projections, representing 14% growth year-over-year.

Our cash balance reached $2.776 billion at the end of the quarter.

This quarter we generated $155 million from operating cash flow.

Collection continued to be very strong with our DSO at 58 days, similar to the end of the previous quarter.

We hedge our balance sheet against major currency fluctuations.

During the quarter, the dollar strengthened against most currencies in the world, resulting in a negative impact of approximately $20 million on the cash flow with no effect on our P&L as expected.

Excluding this effect, the operating cash flow increased by 21%.

During the quarter we purchased approximately 1.37 million shares for a total cost of $75 million, as planned.

And now I'll turn the call over to Gil for his thoughts on the third quarter.

Thank you, Tal, and thank you everyone for joining us on the call today.

I'm very glad to finish another quarter with record financial results.

In this quarter we saw healthy growth in all our geographies, with Asia showing high growth, the US continuing to show strength, and Europe continued to perform nicely despite the challenges presented by the economy.

I've already talked about our Software Blade business in the past quarter.

It continued to show very high growth rates this quarter, as well.

Most of this business is an annuity business, some of it is bundled with our new system, and some of it is sold a la carte, new or renewed from the past year.

All of these areas saw very healthy growth this quarter, and the overall growth rate kept increasing.

But beyond repeating the financial metrics that continued to be good, as Tal shared with you, I'd like to discuss with you our major focus for these past months, operating the vast majority of our product line.

We started in August by expanding the high end of our systems.

We introduced 2 high-end systems, the 21400 appliance for data centers and transaction intensive environment, and the 61000 system, the world's fastest firewall.

The 61,000 is a major breakthrough.

It is an expandable platform with multiple hardware blades.

It has future capacity of over 1 terabit per second of bandwidth.

And delivers almost 15,000 Security Power Units and 200 gigabits of throughput today.

Approximately 10 times faster than our fastest systems today.

The 61000 is designed for the most demanding data center and telco environment like the core of mobile networks.

In the beginning of October, we continued our appliance push by introducing 6 appliance models that update our entire enterprise product set.

As a reminder, up until now we had 3 major enterprise appliance line.

UTM-1 for mid range, Power-1 for the high end, and the IP series.

The new generation of appliances updates these 3 product lines with a single unified product set that leverages all the hardware and software benefits we have shipped over the years and adds more.

More networking expansion options, more high availability and redundancy option and easy set of time.

Most important, it delivers approximately 3 times more performance than the existing product line on all key metrics.

More security power units, more bandwidth, more concurrent connection and more connections per second.

Delivering the performance for the same budget is of course important by itself but it has an additional key element.

It enables customers to truly consolidate their security infrastructure.

Customers can now activate more Software Blades on their security gate where it was running at full speed.

This is a key element in achieving higher level of protection in the face of today's security challenges.

More sophisticated malware, expanding network, more regulation, additional bandwidth and new threats like bots and Advanced Persistent Threats.

But the appliances are only the platform on which we deliver security.

So along with the appliances we also released in August some new security functions.

New URL filtering that enables blocking of phishing and malwear websites, inspection of encrypted SSL traffic, and more data leak prevention capabilities.

With the October launch, we've also introduced an advanced technology to tackle some of today's most challenging security threats called bots.

Bots are small pieces of software that invade our computers and are activated remotely.

Bots invade many of today's endpoint security measures and are very hard to detect.

Bots are also the key in today's most sophisticated attacks, sometimes called Advanced Persistent Threats.

Our new anti-bot Software Blade is a result of several years of research and development.

And I'm proud to say that for the first time customers can easily and economically stop bots that invade their network.

The new blade is expected to be available in the beginning of 2012 but is already generating a lot of interest.

It is also very effective.

In the past month we've installed it in many customer sites and we were able to detect and block bots at 100% of installation, from mid-size companies to large conglomerates and government agencies.

So, as you can, see we're working hard to drive security forward and execute on our vision of (inaudible) securities.

We hope the fourth quarter will continue the healthy trend we've seen so far this year.

With the new product line we believe we are very well-equipped for a healthy finish to the year.

On the same token, the world economy is not exactly predictable and the major product shifts like the one we just introduced also poses some risk.

I hope to see more of the rewards associated with 3 times more performance than anything else.

Which brings me to the financial outlook.

We're increasing our projection.

We expect revenues for the fourth quarter to be in the range of $348 million to $360 million.

And non-GAAP earnings per share to be in the range of $0.79 to $0.82.

GAAP based EPS is expected to be approximately $0.08 less.

For the full year, that translates into revenues in the range of $1.238 billion to $1.250 billion.

Non-GAAP earnings per share is expected to be in the range of $2.83 to $2.86.

GAAP based EPS is expected to be approximately $0.32 less.

Once again, I'd like to thank you for being on the call with us.

We're excited as we enter into the final quarter of the year.

With that I'd like to open the call for your questions.

Thank you.

(Operator Instructions) Daniel Ives of FBR Capital Markets.

My question is just geographically speaking, just talk about any trends you saw, particularly in Europe, or maybe even vertically speaking within financials during the quarter.

I think as I mentioned, the high level, the US economy continued to show strength.

Actually, for several quarters now.

Asia and Europe is not exactly 1 economy or 1 market.

So overall both markets performed very well.

But for different countries and each country was a little bit different.

Overall, I think this quarter we saw more countries growing at higher rates than any quarter before, both in Europe and in Asia.

In Europe, we've seen some signs of economical challenges in some countries.

On the same token, there have been many other countries that have grown very well.

So, as I said, it's not 1 treatment for the entire continent.

And then just lastly, in regards to the new appliances, should we expect deal sizes incrementally to continue to increase going into 2012 in terms of 7-figure deals, especially with more high-end appliances potentially being sold?

Right now I wouldn't count on that.

I think we will be smarter about that a few months from now.

Because we are doing a major product change, and all products are being basically -- there's new models.

And I don't know how to expect what will be the customer behavior on that.

Currently, we've worked very well to give customers 3 times more performance for an equivalent budget of the previous appliances.

That will drive customers to buy more product, higher-end products, or not, it's too early to say.

And there's a lot of small items like what accessories are available for each appliance and how much they will contribute to deal size.

So I think we've done the best that we can to make things go smoothly and work out well in the future.

But I think I'll know the exact customer behavior only in a few months from now.

Shaul Eyal of Oppenheimer & Co.

Gil, 2 quick questions.

I want to go back also on the heels of Daniel's question.

When you look at the 61000 and 21400, is some of it already baked into the fourth quarter guidance?

Yes.

By the way, these 2 models I think have very high potential moving forward.

On the same time, they will have little impact on the short term.

Because long term, I think we have many large customers that really wants this kind of solution.

And they have large projects with them.

On the same time, these solutions are solutions that take very long sales cycle.

It's at least 6 months for a sales cycle.

That's why we introduced them earlier.

We already have some sale but still their contribution, which I think some of it we've estimated is not going to be very large for the fourth quarter.

And one more on that front.

Do you think that, in a way, takes you into a new set of competitors or basically the usual suspects?

I think it's the usual suspects in terms of competitors, I think it's new sizes of projects.

Again, there are some projects with existing customers that having higher-end models is what they want.

They've been buying it before.

Some from us, some not from us.

And it makes us more competitive.

But our new kinds of projects, especially in core of mobile networks and other kind of telco application, maybe in some very high-end financial transactions that customers either before didn't use enough security or we were just not involved in very high-end projects.

And that opens up a lot of nice projects for us at new market segments and I think it can be important and significant, both in terms of revenue and also strategically.

But that will take time and we'll see how much it contributes over the years.

These are projects that again are multi-year projects.

They're not something that happens in 1 or 2 quarters.

Brad Zelnick of Macquarie.

Gil, just to turn back to your guidance and comments that you've made about macro assumptions, even in your prepared remarks you've clearly indicated an awareness of what's going on in the world.

But it doesn't sound like Check Point is really seeing it in a meaningful way.

So to be clear, does your guidance bake in any sort of conservatism for any further deterioration from what you've seen this quarter?

Or do you expect the environment to sustain itself into Q4?

No, I think you're correct.

So far we haven't seen the macro-economic condition hurting our business.

I think the security business behaves quite well for us.

And the forecast for the fourth quarter, I think we're taking a realistic view but we are not expecting any big effects of best times of the economy.

We're expecting business as usual.

Can you just give us an update on Endpoint?

You didn't mention it at all in your remarks today.

Q3 wasn't a great quarter for the Endpoint business, even though in Q2, we actually had some nice deals on that.

We're working on new things.

There are some exciting things on the Endpoint front but nothing major that happens.

We actually won a few Magic Quadrants and a few awards with our Endpoint solution.

But in terms of business contribution, there wasn't any important positive change in that.

And if I could just sneak in one last one for Tal.

Tal, in your comments you said 59% operating margins, not to expect it going forward.

Should I take your comment to mean that it can be diluted by M&A?

Or at this point, does it make sense that you should be reinvesting more in the business?

And what are your hiring plans look like going forward?

Thank you.

Sure.

It's the same comment I provide every quarter.

Which basically says we are focusing on increasing our revenues and less on the management of 1% to the up or down in our margins.

And we say the same here.

Q3 is typically higher because it's utilization application and lower marketing expenses.

So do not use the 59% as a guideline for the long run.

That's all I meant.

And by the way, maybe to add to what Tal says, we are trying to hire as many people as we can.

In Q3 we actually hired, we had the big jump in number of new hires.

I don't think it's going to be significant effect, too, on Q4, as well.

But still, we didn't see the effects.

When we have new hires you hardly see the effects in the quarter they are being hired.

You see some of it the following few quarters.

It's not, again, it's a big number of people but so far in terms of expense it's not going to be significant.

But yes we are trying to hire more people.

Sterling Auty of JPMorgan.

Can you talk about the linearity in this quarter and if that had any impact on the sales and marketing expenses coming in besides just the seasonal impact you mentioned?

The linearity was usual for a quarter, which means it was back-end loaded for a third quarter.

Nothing in terms of effect on the expenses.

We actually had, for Q3 we had the nice number of marketing activities but still, just if you look at our seasonality, we have our 2 major customer and partner conferences in Europe and the US in Q2.

In Q3, we had 2 smaller conferences in Asia.

Actually I participated in 3, one in Vancouver for the Asian market, a smaller one in Australia for Australia, and one in Moscow, a smaller one in Moscow for the Russian Federation.

So we actually had a nice number of activities for third quarter.

But still, in the third quarter, less conferences, less marketing activities, and things like that.

And then my last question is, can you give us a sense of what the install base that runs on Crossbeam looks like?

Because it would seem to me the new high-end solutions would be a perfect opportunity to go back in for a refresh cycle on a lot of those early high-end Crossbeam solutions that you went to market in partnership.

So first, Crossbeam is a very important partner of ours.

And while there may be some overlap with the new 61000 system and some Crossbeam, I think the position is a little bit different between these 2 systems.

Our main aim is not to upgrade.

I think customers want to upgrade.

That's okay but our main aim is to expand the market with more high-end customers that we couldn't win before.

And, by the way, we still win a lot of customers with Crossbeam.

We actually sell some of the Crossbeam systems, we service them, and we have a lot of happy customers that are buying Crossbeam, and both Crossbeam this past quarter.

Jonathan Ruykhaver of Morgan Keegan.

Yes, looking at gateways shipped in the quarter, can you provide some color around the mix between conversion activity within the install base and gateways from new customers?

I don't know if I have the data, but we sold this quarter significantly more gateways than before.

And that was good.

And also the ASP of gateways kept going up.

Not significantly up but it kept being higher.

So both of these are actually very good signs.

I'm trying to get a sense for within license revenue the mix between new and existing customers.

Can you give us a flavor for that?

Sure.

The majority, I would say, and probably always will be the majority, since we have such a huge install base, the majority is for existing customers.

Bear in mind that many of the existing customers buy new products, be it a different appliance or new license for a new Software Blade which they purchase a la carte.

So I think it's more new products to existing customer or new appliances to existing customers versus new customers all in all.

But we add every quarter.

We add more than 1,000 new accounts, which is not an insignificant number.

It's actually, in some cases, it's bigger than the install base of some competitors that we have.

So the run rate I think overall is, it depends on the quarter, is more than 1,000 new customers every quarter, on top of 10 more thousand existing customers that we have every quarter.

And then just quickly, does an increasing mix of hardware revenue have a potential negative impact on gross margins as we look into fiscal '12?

Or do the Software Blades and annuity sales offset that issue?

I think you can see that for the last year it stabilizes the portion of the appliances out of the products for between 75% to 80%.

And it didn't affect our gross margin.

In some cases, it even improved it.

And the operating margin, as you can see, improved.

So I don't expect to see a major shift either way.

Walter Pritchard of Citigroup.

Gil, I'm wondering, we hear from some of your partners that you may actually be under-pricing the blades given what the value that those products provide.

And I'm wondering, you have a new appliance launch here and I'm wondering how you may be thinking about pricing and packaging around those add-ins.

First, it's always good to hear from customers that the price is too low rather than too high.

But I think of it, and in some cases -- first, our main aim is to get with as many customers as possible.

And that's the main philosophy in our pricing.

So if you take certain solutions like DLP, that has been priced traditionally by competitors at very high prices and got to a very small set of customers.

So our aim is to get to a lot of customers.

Some DLP competitors over the years have accumulated hundreds of customers.

Our aim is to get to thousands and tens of thousands of customers.

And so far, I think we're on the right path.

Last quarter, we sold several hundred copies of DLP.

Yes, the price wasn't very high but the main aim is to build a large install base for us.

Also the way we price some of this is different than other legacy vendors in the marketplace.

The majority of our pricing model is based on gateways.

Module gateways, Software Blades per gateway.

And it's less dependent on the size of the overall enterprise.

So for example, to start with DLP, we've asked it can be very low, in the thousands of dollars because you install it on 1 gateway.

Our expectation is if the customers like the product and like this performance and so on, they will actually grow the installation and install it on dozens, sometimes even hundreds of gateways.

And then our revenues will grow.

So the pricing model is also not the same.

But overall I'm very proud to be in a position when the partners and customers are thinking that we give very good value and low cost for certain functionalities.

And then just, Tal, on gross margins, you're launching a new appliance line here.

Probably the Nokia products diminished over time.

And my understanding is that those have lower gross margin.

I'm wondering how we should think about product gross margin as we move into this new appliance generation?

I think it will remain quite the same.

On one hand, yes, everything you said is right about.

On the other hand, we've tried to put a lot of the best hardware components, the best design into the new hardware rather than focus on -- we could have generated less performance and do it in less cost but we decided that we want to be positioned for the best in our future and do the best for our customers.

And the reason our margins, I think it's the right choice.

So I think we are working on the business model that's hopefully going to be roughly stable in terms of the gross margins.

Michael Turits of Raymond James.

Couple questions.

First, housekeeping.

Appliances, Tal, as a percentage of total product, I think it was around 80% last quarter?

Yes.

And then obviously, it was very strong bookings growth relative to what we saw on the income statement, which was also solid.

But with a stronger bookings growth, it sounds like subscriptions and blades are driving a lot of that.

Can you give us some sense for how much blades or subscription is starting to account for as a percentage of bookings and how much that's increased?

I would say it's above 10%.

It's above 10% now?

Above 10%.

And then lastly, on the new product line, so you've introduced it and the idea is to have unified product line.

What's the time line for phasing out the old products?

Do those just keep going or when do we see one replacing the other?

Currently we keep selling and supporting the previous product so customers can expect long continuity.

Our message to customers is that you're buying a product now, buy the new appliance.

It provides much better value, it's better equipped for the future.

So we are encouraging customers to buy all the new products now, and they're all shipping and available.

It's all that.

In terms of the transition itself, I think we are only about 10 days after the announcement, which is too early to say but we see a large number of customers that are actually getting the message and already buying the new appliances.

And then just, Tal, if I can follow-up on the subscription bookings, the blade bookings as a percentage of total you said it's over 10% now.

Can you give me some sense for how that's increased?

Is that up from what, a year ago, just something to give me a sense?

Yes, I said the growth is more than 50%.

It's a very strong growth in our Software Blade.

Bear in mind that as time goes by, we add more and more blades into those, specifically the annuity blades.

So if we started with anti-virus, anti-spam, URL filtering, and then we added the IPS in the beginning of the year, we added the Application Control which became very material.

And that's why I went through the accounting of that so you would understand that while we enjoyed great growth, that you can see very clearly in the deferred revenues, if you remember historically, Q3 goes down in about 3%, 4%, 5% compared to Q2 when it comes to deferred revenue.

So the deferred revenue came up more than, probably between $10 million to $15 million more than expected.

So there's a huge effect of that.

Which is a great phenomenon because it gives us much more recurring revenues which is very important for us.

On the other hand, the revenue recognition is slower.

It takes out a portion of the product and shifts it into deferred revenues, and then recognize over the 4 quarters.

So there is the 2 effects that you need to take into account.

Jonathan Ho of William Blair.

Just in terms of the competitive environment, can you talk a little bit about what you're seeing there and whether there's been any shift in terms of who you're taking share from, or whether you're seeing any impact from some smaller players that are out there?

It remains fairly consistent.

We are seeing, I think, first we have very good competitors, both the old traditional ones and some of the newer competitors.

On the same token, I think large competitors like Cisco are not showing any signs of changes, and we're taking a lot of share from them.

And I think we are now with the new technologies like Application Control and anti-bot and the new appliances makes us extremely competitive, even against competitors that have traditionally competed in price and performance.

And competitors that have been trying to compete in new functionalities.

So I think right now we are fairly strong in terms of the competitive offerings that we have.

And, again, we have a lot of differentiation.

I don't think that we are like the average on any single aspect.

I think we have much higher level of security, much better integration, much better management than any vendor in the marketplace.

And in terms of the App Control blade that you mentioned, can you talk about maybe the impact to the refresh in the base?

Are you seeing that maybe accelerate because of App Control?

You talk about it pretty positively but can you just give us a sense of how that's being received in the marketplace?

I think, first, it has a very nice contribution today to our sales.

Partly because it's bundled with all of the new appliances and partly because customers are buying it a la carte.

And they can buy it a la carte also for older systems.

It's not limited to the new system.

I don't know to estimate whether our customers are operating just because of that or just because of something else.

We have today, when I open our new product catalog, even without the new anti-bot blade, we have like 12 security gateway Software Blades.

And I think each one of them has their own contribution.

Like we've seen the mobile access blade.

Which, by the way, we're now bundling small addition of that with every new appliance.

Has a huge surge in sales the last quarter.

So each one of the security capabilities that we have is I think something that customers want and it's widely needed.

Philip Rueppel of Wells Fargo Securities.

A couple more questions around the annuity blades.

Gil, you mentioned you're bundling a number of those.

Do you have data on renewal rates from sales in years past where you can start to see any trend in where renewal rates and where renewal rates are going?

And second, could you just comment on, you talked about some of the highest growth areas but I assume the largest is still IPS and IDS.

Is that still a thriving business in the annuity blades?

Thanks.

So the answer is yes, we have some data on that.

The data is actually pretty impressive.

The annuity rates are approaching about 50% from the bundled systems and are higher than that on a la carte systems.

So once the customer has already purchased it or renewed it, it's even higher than that.

And to approach a range of 40% to 50% on blades that are bundled, it's a very high rate.

It's much higher than I anticipated.

Keep in mind that the history is limited.

It's now like 2 or 3 quarters, I think, that we have good history of that.

But it's a good track record so far and it's fairly consistent.

It doesn't look like a one-time event.

Tal, do you want to add to that?

Yes, I think that's the right data.

I will just say to you a second part, which ones are the leading blades.

When you look at the annuity, it continues to be IPS, Application Control.

URL filtering grew very nicely this quarter since we launched the new URL filtering.

So pretty much all of them doing nicely.

And on the blades that are not annuity, Gil mentioned the mobile which was very strong this quarter.

Again we're not talking about high millions of dollars but still it's becoming nice.

The mobile for the first quarter this time is more than a few hundred.

It reached 1,000, so that was very impressive.

And DLP was nice this quarter, as well.

So I think most of our new blades are doing quite well.

Some of them more significant in terms of dollar value and some of them less.

Keith Weiss of Morgan Stanley.

Tal, I was wondering if we could dig into the comments that you've been making around how bundling more annuity product into the gateways makes you carve out a bigger portion of that revenue and put it onto the balance sheet.

Is there any way you could give us an equivalent?

Like, what percentage of the average appliance sale goes onto the balance sheet this year versus this time last year or 2 years ago to give us a sense of what kind of headwinds that presents to product revenues?

Not too much but I'll tell you what I can share with you.

Definitely the amount has increased because when you think even appliance, when we launched a new blade then we included inside the bundled appliances, accounting.

We have to extract the value which is based on fair value of the blade, put it in the deferred revenues and then recognize it over a period of time.

So naturally the more bundles that you have, the more you need to take out of that product.

So if a product used to cost $10,000 and now it cost $11,000, and about 15% to 20% will be allocated to annuity blades.

As we add more and more blades, then a naked product can be the same dollars or even slightly less.

While the total increased nicely and the total ASP increased, and it gives us also the opportunity to meet that customer again in the next year and see the renewal rate that you related to, which are close to 50% now.

Which is very impressive because it's a recurring customer.

So what you see is a reduction in the product booking which goes into the deferred revenues and recognized over 4 quarters instead of 1 quarter that you used to see if it's a product.

So there's 2 effects.

The total dollar value increased, which is the most important item.

The significant part of the product becomes recurring, which is very important, as well.

And in the short-term, you can see less product and more deferred that's recognized over 4 quarters.

And I'll just say, I don't have the numbers for a year ago or 2 years, but 3 years ago that amount was close to zero.

I think that amount last year or 2 years ago started to be single percentage in average.

And today, I think it's 2 digits of every new appliance that's going into the bundle.

And I believe last quarter you talked about a annuity revenue run rate of around $150 million.

Would you be able to give us an update on that?

On the $150 million run rate at the end of the year?

I think we'll reach that.

Yes, I think we'll reach it.

I think we're close to reaching it already.

Brent Thill of UBS.

What percent of the base now is on R75?

And for Tal, VMware CFO last night indicated later in the quarter they saw a higher level of scrutiny of deal signoffs from CEOs and CFOs.

And I'm just curious, obviously results don't suggest that things are slowing but curious in terms of the scrutiny level that some of the purchases were put under the last month or 2.

Has there been any change relative to what you saw historically?

I personally didn't hear or see any change.

It might have occurred behind the scenes and we're just not aware of it, but I didn't see that.

And what was the first part of the question?

The first part, the transition to R75.

The transition is actually going quite well.

I think about half the install base is already there, roughly.

And I think it's starting to be pretty stable.

All of the new systems are shipping with the new software, existing customers are upgrading.

So I think we're now starting to reach a stable environment on that.

Which is quite fast, actually, to talk about 6 or 7 months of shipping that product for a high-end enterprise.

I think reaching that kind of an install base in such a short period is a very good phenomenon.

[Allen Wenzel] of Davis Securities.

I was just wondering, you've had these mini seminars running around the country, showing the 6 new appliance units to the channel and some of your customers.

And maybe it's going around the world next month.

I don't know.

But could you give us some of the feedback you've gotten so far from your channel managers or regional sales managers, what they've seen from, say, the 6100 or some of the game changing new products?

So yes, first, all the new models, the 6 new models that we had were just launched October 5.

So the amount of feedback that we have is still very limited.

During these 10 days we did a lot of seminars.

On the Webcast, we announced the products.

We had record attendance of all of the Webcasts we ever did.

So that was a good sign.

We got very good feedbacks on all the social media lines and so on.

So the feedback is generally very good.

The 61000 and the 21400 were launched in August so we have a little bit more mileage.

And I've been to more conferences with customers.

So the feedback is very positive.

People like the new offerings, they like the new features.

And I think pretty much the same for the new appliances.

Everybody is excited about them and really there is nothing to complain about.

We give them more value, much more value for similar price.

And I think we've tried to make, there are no compromises, so customers get more density and more built-in networking options.

Everything is better on the new appliances and I think customers are very excited about it.

There's no tradeoff there really.

If everything is unified, integrated, I've heard these words from some other vendors, maybe 5, 7, 9 years ago, but it just didn't stay that way.

So if you put all these pieces together, how much market share do you think you could take from people who have a real specialty in 1 area but don't have any expertise in a big area?

The markets say they're missing network security or they're totally missing an endpoint security.

During 2012, say, take 6 months to get major acceptance in the market, and you're really selling these things real well by, say, Q2, how much market share do you think you can take from, say, the top 10 security providers?

And that includes guys that obviously, like Intel owns whatever.

Cisco, they sell security but they're not so hot at it.

Juniper, they sell security, they're not so hot at it.

How much market share do you think you could take from these 10 top guys?

I think it's a long question.

I don't know to translate it into each and every sub market and see how much market share we can take in each submarket.

I think that the real value with what we are trying to provide is to come up with a security platform.

And I think the security platform can be customized, each customer, to their need.

If the customer just wants a very fast firewall, we have it for them.

If a customer wants a platform that can do more things, that can do all the 12 different Software Blades that we have, we also have it for them.

And that's the nice thing about the Software Blade model that we introduced 2 years ago.

And you can see that in less than 2 years, it's actually gaining a lot of ground, both in market awareness and in terms of actual revenues we generate.

We are not necessarily trying to compete with niche solutions or with vendors that are focusing on just a single market.

But overall, what we are seeing, and you can see it in some industries, that these vendors are starting to flatten up, and even to shrink sometimes.

And we are growing.

And I think that's the success of being a platform that can do many things.

Maybe the best example is not -- and it's a hot market, it's actually growing entirely -- is IPS.

I think over the last 2 years we've sold more IPS systems than all the other vendors combined because we've made the IPS integrated into the gateway.

We've made it work in represent mode.

We made it easy and simple.

And it doesn't mean that people don't appreciate any more specialty vendors that take a long time and have very sophisticated projects.

But in terms of reaching the mass market, we are able to reach the mass market in a better way with IPS.

Which is an excellent example of something that's both, I think we've gained nice share, we became a very large vendor, and we're selling.

And in terms of units, I think we have the highest market share.

I'm not sure of it in terms of dollars yet.

So I think we are doing well in most of these markets.

IPS is probably the best one.

I think over time, we'll see more and more usage of things like network, anti-malware and anti virus, URL filtering and things like that, that are today dedicated systems and I think are going to start moving into the general gateway.

DLP is probably another one.

But DLP is even too much a finished product today.

So this is generally the answer.

Thank you.

Gregg Moskowitz of Cowen and Company.

Gil, you spoken a fair amount about the macro environment today.

But could you elaborate on which verticals perform well for you and if there have been any changes one way or another over the past 2 months?

Haven't seen any changes, not yet.

I think I look more in the detailed vertical data in probably a few weeks.

We see a lot of analysis for the third quarter.

I can say that for the second quarter and for my feeling for the first quarter it wasn't a change.

Our 2 largest segments are financials and telcos, and I think we've seen good deals and good traction in both of them.

I think several businesses performed quite well this past quarter.

And so overall, I haven't seen.

And we've got some very large deals from retail businesses.

If I look on what I know and what I've seen through the analytical data, I haven't seen any major change.

And then just a quick follow-up to Brad's question earlier on Endpoint and NR80.

So it seems like the early momentum from a transaction point of view has been somewhat slow, but just wondering how things are shaping up and looking right now in terms of the pipeline there.

I think the Endpoint business will take some time.

I think we have things that we need to improve.

And also we are, it's in the market, there's a lot of very strong competitors with huge market share.

And we are, as much as we like to think of ourself as having a superior product with better integration, of more technologies and with better architecture and so on, we're still a very small player there.

And I think it will take us some time to prove ourself.

I'm always surprised -- or not surprised, but I'm pleased to see, when I'm meeting with some customers that are using our Endpoint, that they are happy, that they get better value, that they realize the value of integration between things like data security and anti-malware and data security.

So I think I'm actually getting very good feedback from customers that have deployed the Endpoint.

Phil Winslow of Credit Suisse.

Once again on the competitive side, just from a win rate perspective, just curious what you're seeing versus Cisco, Juniper, and obviously, Palo Alto Networks that's been in the news a lot recently.

Thanks.

I don't know that we measure any of that.

But my feeling is that we are gaining share significantly against companies like Cisco, and in many cases, Juniper.

I don't have any particular data about the other ones but I think we are doing quite well.

And I think with the recent announcement that we have, I think we have a very strong offering, much stronger than I think we ever had before.

Thank you, guys, for joining us today on the call.

We look forward to catching up to you again after the call and seeing you during the quarter.

Take care and have a great day.

Thank you very much.

Bye.

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