Check Point Software Technologies Ltd (CHKP) 2012 Q3 法說會逐字稿

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

Mr. Meintzer, you may now begin.

Thank you.

Good morning, everyone.

I'd like to thank all of you for joining us today to discuss Check Point's financial results for the third quarter of 2012.

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 24.

If you'd like to reach us after the call, please contact Investor Relations by e-mailing Kip@CheckPoint.com or by phoning at +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, programs, or the success of those products and programs, and our expectations regarding our business and financial outlook for the fourth quarter of 2012.

Other statements which may be made in response to questions which refer to or 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 the reasons for our presentation of non-GAAP information.

Now, I would like to turn the 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 the third quarter financial results.

Our revenues for the quarter increased by 8% year over year and non-GAAP EPS was $0.79 representing 10% growth, both in the upper half of our guidance.

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 effect.

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 reached $332.4 million, representing an increase of 8%, compared to $308.3 million in the third quarter of 2011.

This growth was driven by continued strength in our software update, maintenance, and subscription revenues.

These revenues reached $211.3 million with growth of 13% year-over-year.

The growth was driven by our annuity software blades that are recognized as subscription.

We continue to see great success in our annuity blades, led by IPS, application control, and our recent introduced Anti-Bot blade.

Product and license revenues were $121 million, compared to $120.7 million in the same period last year.

The number of enterprise gateways sold continued to grow at an impressive double-digit pace.

This growth was offset by customers opting to purchase slightly lower-end models as result of the increased performance of our new appliance line.

Our results were also affected by current macroeconomic environment and by our customers' [cyto] budgets.

As you recall, our worldwide pricelist is in dollars.

The continued weakening of many local currencies against the dollar, specifically in Europe, effectively reduced the buying power in dollars of customers.

On the other hand, North America continued to show great results with double digit growth both in products and in services.

Deferred revenues as of September 30, 2012, was $505.9 million, an increase of $51.5 million or 11% over September 30, 2011.

Revenue distribution by geography for the quarter was as follows -- Americas contributed 45% in revenue, Europe contributed 37%, and Asia Pacific, Japan, Middle East, and Africa Region contributed the remaining 18%.

From a deal size and quantity perspective this quarter, transactions greater than $50,000 accounted for 66% of total order value compared to 63% in the same period a year ago.

We had 31 customers that had transactions with value greater than $1 million.

From an operating perspective, we posted great results.

Our non-GAAP operating income was $195.6 million in the third quarter of 2012, an increase of 8% compared to the same period in 2011.

We continue to invest in our business and have increased our headcount by 15% year-over-year mainly in R&D, sales, and technical support.

The effect of this increased cost was offset partially this year by the strengthening of the dollar.

Our non-GAAP operating margin this quarter was 59%, the same level as the third quarter of 2011.

GAAP net income for the third quarter of 2012 was $152.4 million or $0.73 per diluted share, up from $134.1 million or $0.63 per diluted share in the same period a year ago, representing a GAAP net income increase of 14% year-over-year.

Non-GAAP net income for the quarter was $164.1 million or $0.79 per diluted share, up from $152.9 million or $0.72 per diluted share in the same period a year ago.

Non-GAAP earnings per share were in the upper range of our guidance, representing 10% growth year-over-year.

Our cash balances reached $3.247 billion at the end of the quarter.

Cash from operations this quarter was $180.4 million compared to $154.5 million in the same period a year ago.

Collection continued to be strong.

Our DSO was 72 days, similar to the previous quarters.

During the quarter we purchased approximately 3.2 million shares for a total cost of $156 million, more than double of what was purchased last quarter and consistent with our announcement to increase our share repurchase program.

Now, I'll turn the call over to Gil for his thoughts on the first quarter.

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

In the first quarter, we produced decent results with revenues and EPS in the upper half of our projection.

Tal has already addressed the financial results for the quarter and I would like to share some further information with you.

From a geographical standpoint we have distinctly different results from different parts of the world.

Europe has been stable this quarter with mixed results from different regions and countries.

This is not surprising taking into account the vacation (technical difficulty) summer months and the economic environment.

On the other hand, in the US, we continue to see double-digit growth and very good results.

This has been reflected in all parameters -- increased number of units, improved average selling price, ASP, and increases in all categories, products, subscriptions, and services.

This is very important especially given the concern that some of you might have regarding the competitive environment.

The market continues to be competitive as its always been, yet in the most competitive market, the United States, we continue to do exceptionally well.

If you recall last quarter we discussed the trend in our product segment.

Our new appliances produce about 3X more performance than the previous generation.

This has resulted in unit increases on one hand and some shifts toward lower price model in the past three quarters.

Some customers chose to get the same performance at the lower price.

The good news is that this trend improves our market share as a result of the double-digit growth in unit sales.

This growth in appliance unit sales has been true in all geographies -- America, Europe, and Asia.

This quarter we started to experience a slight increase in the average selling price compared to the second quarter as customers began realizing the benefits of our higher-end data center model and the need for more speed when activating additional security defense measures.

The success of our appliances business was also connoted by IDC, a leading market research firm which recommends Check Point security appliance leadership and ranks us in the number one position for the first time in the [clients'] report that was published in the first quarter.

Our a la carte software blade sales also continue to be a source of strength and grew by more than 50% year-over-year.

In the second quarter, we announced the Anti-Bot software blade which detects and blocks the software agents used in the most sophisticated hostile attack.

The Anti-Bot software blade is starting to gain traction and in the third quarter was purchased by several hundreds of customers.

GAiA, our next generation secure operating system which was launched in April continued to be very well received and has continued to gain traction with [ending solidly].

Looking forward, we are planning many exciting security initiatives in mobility, virtualization, and cloud environments.

Of course, we also continue to focus on strengthening our core network security and extend the performance of our product line with introduction of additional product models.

From a business perspective where we've seen continued strength from the US, Europe has continued to be unimpacted by economic uncertainties in the strengthening of the dollar.

Please keep in mind that due to the risks around the economy and the shift in our products mix, we must provide a wider forecast range.

Projections for the fourth quarter are as follows.

We expect revenues in the range of $355 million to $387 million and non-GAAP earnings-per-share in the range of $0.83 to $0.91 per share.

GAAP EPS is expected to be approximately $0.07 less.

With that, I'd like to thank you once again for joining us for the call today and open the call for your insightful questions.

Thank you.

(Operator Instructions).

Shaul Eyal, Oppenheimer & Company.

Solid quarter, indeed, given the environment.

Gil, Tal, couple of quick questions on my end.

Gil, sales of the 61000 and 21400 -- how did they fare this quarter?

And your comment about ASP increase, does that also apply to sales of those products?

What was the last part?

Your comment about ASP heading up a little bit during the quarter, does that apply also to the 61000, 21400?

In terms of product mix, yes, customers have been purchasing more of the 21400 and I think also a little bit more of the 61,000 and also, at least of other products, the 12000 series and so on, which all impact a slight increase on the ASP from the second quarter to the third quarter which is something we planned and worked on.

So all of that has been happening in the last quarter.

Got it.

And Tal, with respect to foreign exchange impact, is there any kind of way to quantify that roughly this quarter?

In the expenses, it's theoretically easy to calculate because if I compare it to Q3 last year then it is probably around $0.01 or $0.02, about $5 million, or so.

In the revenue it is much harder, obviously, because customers in many regions around the world, their budgets are in local currencies and different currency -- the majority of them versus last year got weaker against the dollar.

Some of them in 10%, some of them in 15%, some of them in 20% -- it is quite a significant effect on customers and how much it affected the revenues I can't tell.

Probably some of it is responsible to the shift in the ASP towards the mid and large units versus the high.

Again, like Gil said, the good news we actually started to see some shift already in the ASP to the higher product and therefore higher ASP, but it's still early days.

Got it.

And maybe final question, Gil, any initial thoughts about fiscal '13 or is it too early at this stage?

What's early in this stage?

Fiscal '13 thinking in terms of guidance and projections.

Too early.

Oh, 2013.

It won't come until next year.

Okay, got it, thank you very much.

Maybe I will use this opportunity to repeat the guidance.

The guidance for Q4 was $355 million to $387 million.

And the EPS, non-GAAP EPS, $0.84 to $0.91.

Rob Owens, Pacific Crest Securities.

As you guys talk about the ASP pressure, do I understand it correctly from your comments, are you seeing that more internationally than you are here in the US markets?

And I guess the follow-on question to that is, how do we think about the model as some of these appliance changes anniversary in the fourth quarter?

Should we see pricing normalize as we get into the first half of next year?

First we don't see much ASP pressure.

What we see is the fact that customer had purchased a lower end model and get the same performance for a lower price.

We are not talking about a bigger discount or things like that.

What I see with customers with slightly lower budgets find out if the new appliance gives them three times more performance they can purchase a slightly lower-end model and maybe purchase two of them.

One of the things we did see consistently in the last three quarters is double-digit growth in unit sales which is the good news.

That has been true in all geographies.

In all geographies we've seen slight shift into lower-end models and in all geographies we've seen the double-digit increase in the unit sales including in Europe this quarter and all the other regions.

And as some of those changes annualize should we expect a little more consistency in pricing, relative to customer budgets?

I think the big shift in the appliance we did a year ago and I think we are not planning any major product shift, product change in the next few months, so next year should be a little bit more stable in that.

I would like to hope that we will see continued increased number of units which will translate into the revenue and so on.

I think the first quarter which will be truly comparable year over year is Q2, Q1, Q2 next year.

And then, Tal, as we think about deferred revenue for the fourth quarter, if I remember last year there was a nice spike there as you guys had early renewal blades and some other factors, Do think that was more one-time in nature?

Would you expect the same type of phenomenon to play out here in the fourth quarter of '12?

Thanks.

I would say, remember -- first, seasonally expected Q3 is the lowest and the biggest drop in the deferred revenue in the balance sheet.

Q4 is typically the highest, so it is in line with the general phenomena.

Bear in mind that some of our -- the billing that you calculate which is the revenues plus the deferred, it's implied booking, but it is not real booking.

I know when you calculate it now, you see a negative number.

The booking was not negative; the booking was positive, slightly weaker because of what we've seen in Europe which we alluded to in the beginning of the call.

Shebly Seyrafi, FBN Securities.

You talked about -- the number one concern I see in this report is the billings decline of about 1% year-to-year, I calculate, although you just said bookings grew.

But I just wanted to see, besides what you've already talked about, to what extent are you seeing increased competition from A, the likes of Palo Alto Networks, and B, perhaps a revitalization from Cisco and Juniper and the bigger players.

In our environment for people to be competitive -- and it is competitive; it is always been.

Now, the generation and the different competitors have been changing along the year.

I think Cisco and Juniper have not been the strong competitors the last year or so and more than a year actually, and they haven't seen a huge shift there in the last quarter.

I think that the good evidence, and I already mentioned that, is in the US which is the most competitive market in our industry, everybody's focusing on that market, everybody's focusing on the same accounts and most sales in the marketing efforts are focused on that market.

We had very, very good success and that has been consistent for the last few quarters.

Which means that the market remains competitive; we have a lot to offer and we get a lot of that feedback from customers that choose Check Point.

I guess perhaps a larger investor concern these days is the momentum of Palo Alto Networks itself.

Are you seeing them in more competitive situations and how have your win rates been changing with them?

I think we've done pretty well.

We've been displacing Palo Alto in some places already which is not a good indicator for a young company emerging like they are doing.

And I think it is not very different than the previous generation of competitors which we've seen and I really don't discount any competitor.

I think they are good competitors.

I think what we've shown in the last 18 years is that we keep focusing on the real needs of the customer; we keep focusing on providing the best security, the most comprehensive security, and in the long-run we sustain that leadership and I'm sure that we will this time, as well.

Okay.

And you're large deal activity appears to have slowed down.

I think you had 31 deals over a million versus 40 in Q2 and 53% of transactions over $50,000 of your total over value.

That's down as well.

Are you seeing this trend toward larger deals slowing down and do you think it will turn around perhaps in the fourth quarter?

Maybe I'll first relate to the data and then Gil can comment on that.

In terms of the transactions larger than $50,000 it is actually increased to 66% from 63%.

And in terms of transaction it was 31 customers this time; as far as I recall it was 35 in Q3 last year, not 40.

Actually, Americas grew in the number of customers and in dollar value.

Also the total -- although we had 31 versus 35, the total dollar value increased.

The reduction in the number of customers is actually relating mainly to Europe and in line with the results.

Okay, last one for me is on Europe itself.

You did have, according to my estimate, because you give rounded percentage of revenue numbers.

I'm calculating 5% growth in Europe year-to-year versus 9% in Q2.

As you go into the fourth quarter, is it possible that we see a year-to-year decline in Europe?

What are you seeing right now so far in calendar Q4 in Europe?

Everything is possible, but our forecast is positive growth in Europe as well as in all the other regions.

Okay, thank you.

Walter Pritchard, Citi.

Tal, just a follow-up on the deferred revenue question that was asked earlier and I'm wondering, understanding that the bookings and the billings don't match in lock step, but was the disconnect between what you saw and what you saw in the bookings or what you saw in the revenue related to product or related to the subscription and update side?

In both, actually.

In the deferred revenues, remember that there's quite a large amount that is not billed every time, every quarter, there's nothing new.

But this quarter, specifically, it's increased in a few high millions, singular millions, and therefore affect some the deferred.

It does not imply that the booking was significantly higher, it just wasn't negative; it was positive close to the midpoint.

Got it.

And then, Gil, I think you mentioned that you saw some ASP improvement over what you've seen in the last couple quarters.

Could you talk about in what part of the product line you saw that ASP improvement?

The improvement is not in the ASP for product; it is in the product mix.

It's in the overage for all product and what you are seeing is a slight increase in customer buying more of the 12000 product, the 21000 product, than the 4000 product in previous quarters.

The year-to-year comparable is still changing the ASP towards lower-end model because of the higher performance.

In the quarter-over-quarter we are starting to see the improvement which we took care of in the last quarter in terms of creating some more, in educating more the customer and creating more models which would allow customers to buy the right model for them.

Got it.

Great, thanks a lot.

Daniel Ives, FBR Capital Markets.

Gil, a lot of moving parts, but at the end of the day, licenses is flat to looks like it is going to decline year-over-year in Q4.

So what do you say to investors -- is Check Point going forward and are they a low single-digit license grower?

Is this more a phenomenon in the model in terms of what's happened in the field, in terms of belated opportunity?

Just speak to that -- I know you're not giving guidance for next year, but that's obviously a big question just given the license growth.

I think first we did see this year double-digit growth in appliance unit sales which is the most important indicator.

I think we did see a shift in the product, we feel, because of the complete change of the product line, unification of all the products, entire new product line with much better performance.

I think in the long run that's the right thing, to be competitive and to have the best product and to have the number of units growing.

I think it is too early to say what will happen next year, but I'm hoping for the good and there's a lot of challenges in the marketplace but there's also good things to hope for for next year, especially as we've seen consistent double-digit growth in the number of units in the last three quarters.

And that's by the way, much higher growth in units than we've seen in previous years.

When I'm highlighting that point, it is not for no reason; in previous years we've seen a much slower growth in unit sales and higher growth in ASP.

Okay, thanks.

I hope that next year is going to be a better comparison for this year.

Thanks.

Brad Zelnick, Macquarie.

Gil, in terms of your product pipeline, I've heard a lot of anticipation from the channel of exciting things to come next year.

I appreciate you might not want to show your hand to competitors, but is there anything you can share with us about what's coming down the pike?

I think we will see more things around cloud and they operate and bring security from the cloud and for the cloud.

We're already doing security for the cloud but will be security provided by the cloud.

I think we will see some nice innovation around mobility and some of which relates to the network security side, some of which relates a little bit more to our endpoint product line.

And I think we will continue in the core products with more software blades with more innovation and with more performance on the pushing the envelope of the existing product line, some of which we'll see -- the big changes we will see next year when we plan on the annual product cycle and so on.

The expansion of performance is a continuing process and I think we will see every couple months something innovative or something new in terms of higher performance for our clients.

Thanks, Gil could I can see why they're excited.

And Tal, it's nice to see the increased rate of share buyback.

Is there any update on Israeli tax law and how you think about repurchases into the future?

I think we saw it last quarter and increased it from 300 to 1 billion over two years so it is quite significant and you can see we are executing on it and we increasing -- more than doubled actually from $75 million to $156 million.

When it comes to the Israeli law, and again, I always said don't expect it to be steady over the quarter -- some quarters you will see more, some quarters you will see less, and we said we are going to be opportunistic about it, that's one.

When it relates to the new law, they are contemplating some changes in the taxes relating to improved tax payment depending on what you distribute more.

It is too early, it hasn't passed yet, and I just don't know how to treat it at this point in time.

Thanks for the update.

Philip Winslow, Credit Suisse.

Just want to dig into the deferred revenue line again this quarter.

One of the questions I'm getting is have you guys seen any sort of change in your renewal rates on the subscription and maintenance side this quarter and also do you see any change in the attach rate of blades.

Also, one of the things you've talked about in the past was a shifting of deals of the renewal cycle towards Q4.

Was that any effect in Q3 -- the deferred is just a bigger drop off sequentially than we've seen ever before in a Q3, so just looking for more detail there.

Thanks.

The first thing, generally we don't see a shift or a change in the discount rate, nothing significant.

We don't see a significant change in the attach rate again There is definitely a shift between quarters which is very hard to follow on that.

Some of them renew earlier, sometime some of them renew later so we can create the shift easily between quarters.

Q4 is the highest one and expected to stay significantly the highest one, but in terms of a shift between quarters of $10 million to the right or to the left, it can happen very easily.

Remember that when customers buy new product, then they are many times doing a true-up or realigning all the contract to that specific quarter, so sometimes it is also correlated with the product of that specific quarter.

So in general, yes it can shift between quarters, and yes, Q4 should be the highest.

Got it.

Also a question on unit growth rate -- you guys have been talking about 20%-plus for the first couple quarters here.

You guys said you had double-digit this quarter.

Maybe just some color.

Are you still seeing a high teens growth rate or where in that double-digits are units falling?

Then I'll will turn it over to other questions.

In the units, yes, we did see double digits, yes.

This quarter as well.

Michael Turits, Raymond James.

First, sorry about this, just a clarification.

The bottom end of your EPS range, is $0.83 or $0.84?

$0.84.

Okay.

It is $0.84.

Great.

Then one other issue possibly around ASPs, over a period time you got some uplift from the mix shift to appliances.

I think that we are largely through that, so is that something also that may have been weighing on ASPs and as we get into next year could we be anniversarying that to provide an easier comp?

I think yes, we will see easier comp, especially now that we shifted the entire product line and I think over time, we will see also the renewal cycle of the appliances.

Remember now we are moved from selling pure software into selling mostly appliances.

We also sell, by the way, about 20% software licenses for product, which I think is a great competitive advantage to us.

And in the future we will start to see a replacement cycle by customers that take the 2010 or 2011 appliances and replace them with the new model which should provide a very nice addition to the business model.

Okay.

Then on the renewal rates on blades, any change in those?

I think you'd been saying it was about 30% to 40% on bundled blades and 60% to 70% on stand-alone blades.

Any change there and as you get to more people being on R70 and R75, has that been helping to improve those renewal rates at all?

I think the renewal rates this quarter has been pretty consistent.

I think as we mentioned we've seen 50% increase in the a la carte blades which is always blades -- blades that are not bundled with new product, blades that the customer chooses to either renew or to purchase as a brand new one.

I think that's been very, very positive traction for the last few years.

Thanks, Gil.

Rick Sherlund, Nomura

Just to follow up on the previous question, this mix shift to annuity blades that you started seeing last year in Q4, just the year-over-year change in accounting, shouldn't we anticipate some improvement in billings as you anniversary the change in the revenue policy from last year?

Remember that when you come from the previous year and already last year we had quite a significant portion of software blades as part of this services, the renewal rates are not the regular renewal rates that you see in the update and maintenance line.

Here the renewal, as was mentioned before, for the bundles, they are around 40%, and for the unbundled or a la carte, the renewal rate is 60%.

So you are losing a significant portion out of it when you start the year and then all the additional a la carte that you get are the ones that compensated for it.

In total, the growth rate as you account for more from last year is slowing down over time.

Still significantly quicker than all the rest of the lines, both products and update and maintenance, but the subscription in the first year was a 100% growth rate.

Over time the growth is going lower into a still high double-digit but lower than the previous year.

If we are shifting to more annuity business, why aren't we seeing that -- it would seem like the deferred would be growing faster than revenues and we are seeing the opposite.

Can you reconcile that for me?

So when you are in the first and the second year then it's a much material percentage of growth and therefore you see more effect on the deferred revenues.

Once you are already in the third year of the software blades initiative, then you have significant revenue recognition and significant number going into the deferred.

The next is becoming less and less material.

Still the growth rate of the software blade in the deferred revenue is faster than the growth of the revenues in the subscription line.

I will follow-up on that.

All right, thank you.

Brent Thill, UBS.

Tal, I think we are all having a hard time reconciling your deferred down 6% almost; your four-year seasonal is down 2%.

So what piece of the deferred did not hit your expectation?

Can you help us understand the composition of deferred because we are all trying to really understand this and that I don't think we are getting a good answer.

That's actually two different questions.

The question of subscription of the annuity blade is a small portion out of the deferred.

The majority of the deferred is actually the update and the maintenance portion.

That number seasonally is reducing, you're right, it is reduced more.

It is actually the short-term reduced, if remember correctly, about 5%.

If you look at the past five years, it ran between 2% to negative 5%, depends on which year.

So the range was 2% to 5%.

This year was in the higher, it was 5%.

Some of it is relating to the fact that more are waiting for Q4, some came earlier through the year and some of them relating to the true-up and also to the fact that Europe booking was lower than expected.

I think, remember that can be a simple shift between quarters.

Customers that have chosen to renew last year in September, with summer vacation, with just aligning their entire enterprise contract to Q4, can choose to renew in October, November, or December.

Nothing major happens to them if they renew a month later and so on and that happens.

In this amount that we are seeing that's not an unexpected phenomenon.

Okay.

As deferred making up more of your revenue, I would think that you'd have better visibility, yet your Q4 guidance range is almost three times as big as it was last Q4.

Can you just help us understand what your assumptions are on close rates and how you are making up that guidance for Q4?

We're just trying to understand why the range is so big.

First, I think I've been very consistent saying that predicting the future is always challenging but in our business, I think we have a good foreign customer sales force.

I think we have a nice list of deals, but at the same time we have thousands and thousands of deals and with small deals, we don't know accurately what's going to happen.

With large deals, there's always the risk that the deal won't close on the last day for some reason.

I think what we've been seeing this year is that, I've talked a little bit about Europe and with the uncertainty around Europe, especially around Europe, I'd like to be a little bit more conservative this year than before.

I'd like to hope that my conservatism here is unbased and we will see in the next quarter much better results than [opening the trange] and what we predict here.

But I also need to be slightly more conservative given what we've seen on the European side of our business this year.

We haven't seen anything bad -- we've seen stable business that's growing but not growing enough, as much as we want it to grow.

We need to be very aware of that and realistic about that.

Thanks, Gil.

Aaron Schwartz, Jefferies & Company.

I hate to keep coming back to this, but the deferred is really getting the attention here.

I guess if you've gone through this product line transition, we've seen the deceleration in product growth in the income statement but we have expected somewhat of an offset due to a larger accumulation of the software blade annuity revenue and it just doesn't -- seemed like that broke down a little bit here in the quarter.

But you're saying this is a lot more due to just maintenance and Europe, is that correct?

I think the entire European business has been stable, a little bit softer than what we've seen in the US.

In the US we've continued to see double-digit growth and we've continued to see the same kind of momentum and the same kind of growth which we've seen the year before and for a long time now.

In Europe we've seen slightly softer behavior this past quarter.

Again, I would try to help you a bit more just to collect all the data that we said on the call that relates to this specifically.

We said Europe was stable, meaning it wasn't growing fast so that's obviously a factor in deferred revenue.

We did say we have lower than $10 million of bookings at that did not go into the deferred, so that's also a fact.

It's relating to updates and maintenance and services that was not part of the deferred.

That's also a fact of the deferred and we did relate to the seasonality.

The annuity blades are a small portion of the total deferred revenues and that's why I said that it is not shifting that number in that significant manner.

Okay.

And if you've talked about the product mix shift, the lower-end appliances that's played out this year, does that impact at all the annuity blade contribution?

Are you just seeing a lower attach rate on some of those blades, is that having a factor?

No, actually the attach rate is similar in that regard.

Okay.

And last question for me if I could and I know you've talked about last quarter, some very subtle pricing changes to try to steer the mix shift back up, and I think you made some maybe very subtle operational changes, as well.

Is that just starting to slowly play out in terms of bringing the mix shift back up and would you expect that to play out more fully in Q4 next year?

Can you talk about some of those changes and in addition, are you making any other changes there?

Yes, we've seen an increase in the ASP from Q3 -- in the mix, the ASP the result of the mix.

We've seen a small change from Q2 to Q3 and that's a result of realigning some of the products that we've done.

We've introduced another model between the low-end and the mid-size model in helping customers get slightly up from the real low side.

And we did some realignment of product in the high-end and data center product, and the key again, we've seen a very nice increase in those products from Q2 to Q3.

The comparison to last year is very different because it was a different product line.

The comparison between Q2 and Q3 is actually very favorable, very nice change and increase in the enterprise and the high-end and data center appliances.

Thank you.

Overall, by the way, I'm very proud of the very big increases that we have on the [meterage] product.

I think it is great to see that we are gaining share and getting more units for more projects for more customers.

I think overall for the long run, it is always good to base yourself on the wide spread of customers and get less focused on the huge high-end deals which are great in the short-term, but in the long-term they are not always fully repeatable every year.

Greg Dunham, Goldman Sachs.

Just one follow-up on that question regarding, as customers go down to the lower end boxes or the lower price point boxes with the same performance.

Did you say that the attach rates on the blades is the same in those boxes and then specifically are you seeing the attach rates of IPS and application control on the boxes that are more lower end as the same?

Thank you.

Let me make sure I understand the question.

The percentage of software blades -- the bundles on those appliances are similar, meaning the median have the highest one like we've had previously and the higher end have lower number of software blades attached to it.

Did I understand your question correctly?

Yes.

That was the question but then I wanted to ask is, you are talking about the number of blade attach is the same as the high end as the low end, but I want to actually know specifically, are the application control and IPS attach rates the same on the high end as the low end?

I think they are very similar.

I think with some of the lowest-end models we don't bundle the application control, and actually the lowest-end model we allow customers to purchase it without IPS.

On the high-end it is bundled with all the appliances, application control, and the IPS for the first year.

Okay.

Thank you.

Sterling Auty, JPMorgan.

On the software blades, can you give us a sense of the mix between how much of the blade revenue is coming from the bundles and renewals versus the stand-alone blade purchases?

Today the bigger portion is from the a la carte one, not from the bundled one.

And the growth rate in the bundled one is directly related to the growth rate in new products and the growth rate in the unbundled one in whatever customer choose to renew or purchase a new one.

As we said on the a la carte one, we had more than 50% growth year-over-year.

Can you give us a sense -- when you look across your installed base, what percentage of the installed base actually now has blades running?

I know there's a portion that isn't on a version that can run it, but still, just looking at it as a percentage of your total installed base, how penetrated are blades at this point?

I don't have the update.

To date, I think it is starting to be a significant -- I don't know, around 50%, probably slightly below the 50% of installed base.

Okay.

Maybe you don't have this one as well, but the last question.

I think it has been some time, can you actually give us an update, what does the installed base actually look like in terms of units?

Hundreds of thousands, but we don't provide that data.

Okay.

Thank you.

Jonathan Ho, William Blair.

Can you walk through for us some of the levers that you see that could potentially drive upside in the quarter just given maybe some conservatism and maybe some more concerns around Europe?

I just want to understand what are maybe some of the positive drivers that you see that could impact in this upcoming quarter?

I think bear in mind that in terms of the service line, the majority of it is already part of the deferred revenues and then the current Q4 booking of the services, only a small portion out of it will actually come into the P&L.

When it comes to the product, the product Q4 is the highest.

It typically has a very significant growth and hence the risk and the wider range.

Product is very hard to predict and we are back-end loaded.

So typically Q4 is significantly higher from Q3.

Therefore we expect a significant increase and the rest is depending on the market, the budget of the customers, and so on.

So that's why we need a bigger range.

If the economy is better, if budgets of customers are healthy, then it should be a very good quarter as usual.

And if we see more pressure in terms of the economy, then it can continue to affect Europe and other regions and therefore lead us more towards the lower end.

Got it.

Just in terms of the annuity blades, can you give us the actual run rate in terms of revenue that's coming from the blades or do you intend to break that out at some point?

I can tell you it is below $50 million.

It's a few tens.

I think the annual one is way more than $200 million in bookings.

Great, thank you.

Keith Weiss, Morgan Stanley.

Excellent guys.

Thank you for taking my question.

Tal, I just wanted to clarify.

Did you say headcount growth in the quarter was up 15% year-on-year?

Year-on-year it was 15% and it was significant growth.

I provided this data because many of you asked me what happens with headcount, so this quarter, we decided to discuss it.

We increased it mostly in R&D, sales and marketing, and technical support.

And the reason you don't see that clearly in the P&L in dollars is because of the effect of the dollar because as the dollar is getting stronger the effect on salaries in local currencies, when you translate it into dollars, is less dollars, and therefore you don't see that increase in that significant way in the P&L, but we did increase our headcount significantly, yes.

Got it.

If we look at those headcount increases and look at it against the midpoint of your guidance that looks for about 4%, 5% revenue growth at the midpoint, US dollar getting stronger, should we'd be starting to anticipate, maybe start to put into our model maybe some pressure on operating margins into Q4 potentially into FY '13 as that headcount growth works its way through the model?

I think you can see our guidance and our guidance pretty much you can see similar margin.

So are there offsets to that 15% headcount growth that's going to enable you to keep overall expense growth in line with that type of mid-single digit growth rate you're seeing on the top line?

The offset happens with the currencies already.

If the currencies would get stronger, then it will have the effect on the operating margin as we have every year.

Outside of currency, are there other cost reduction programs you have in place that shift fundamentally the expenses or is it just currency, is that difference?

I think there are [drawings not] cost reduction programs, but what we do and one of the reasons this quarter in particular we had the huge growth in headcount, we do a lot of entry-level program and we ask people in the beginning of their career and therefore also at a relatively low compensation level and we let them grow in Check Point.

Overall, that keeps the expense relatively flat with the headcount -- usually when you have people you have annual raises.

It keeps the per person amount fixed because we try to get people at the bottom of the picture when they start.

Right.

But you guys have done that for a while and 15% unit growth in the number of heads, that's the net new portion in terms of the income statement is that you just have a lot more employees on board even if they are at the same kind of per unit price.

Again, the overall range remains the same.

Remember when you have employees, they usually get a raise every year, so the per person rate goes up every year.

At the same time what we are trying to do is handle the mix with many, many new entry-level programs and the entry-level programs that we did with Q3 was much higher than any year before; we've almost doubled it from the year before.

I think we've hired about more than 200 people in entry-level programs in the last few months.

That's been pretty significant, a pretty big investment in training and investment in the future.

I think it's true to the product organization, to the services organization and we even have an entry-level sales program now that's running in New York.

Got it.

If I can maybe sneak one in on the geographic mix.

You spoke to double-digit growth in the US, I believe.

Americas was 45% of revenues, I believe that's in line with what you talked about last year in 3Q at 45% of revenues.

Is there an offset to the US in the broader Americas, perhaps Latin America or Canada that is dragging down growth for overall Americas to be pretty much in line with the overall Company?

It's not a drag to the overall Company, but Latin America is much smaller than North America and the US right now.

So the growth was much lower than the US in Latin America?

Latin America, but it is pretty small so remember that.

Got it.

Excellent.

Thank you guys.

Tal Liani, Bank of America, Merrill Lynch.

Hello.

I have a question about strategy more than the quarter.

You're clearly growing below the segment.

Cisco, Fortinet, and others are having double-digit growth and in the higher end of double-digits -- high-end of teens, I mean.

If I look at your product revenue growth or even if I head back to the changes in deferred, your growth rate decelerated from plus-20 to negative levels this quarter and the deceleration is pretty consistent.

The product revenue growth was zero this quarter.

So the question is, what would you do or are there any plans to do something different in order to reaccelerate the growth or is it just economy dependent?

And if you plan on doing something, will it require greater investment in OpEx in a way that will reduce operating margins?

Thanks.

First, there aren't many differences but I just want to refer first to your facts.

I think that we are growing in the last few years, much, much faster than Cisco and much faster than many other players in the industry, so saying that some of the larger players in our industry are growing faster than us is absolutely not the case.

We actually had very, very nice growth in the recent year and in previous years.

This year we did have a shift in the product line, but the unit numbers which we have are growing very, very nicely and that's a very good sign and that's been actually accelerating this year, the growth rate in unit growth.

So if everything continues well, next year it should produce some very good results because then we will have apples to apples comparison with growing number of units and with the same ASP or hopefully increasing ASP which is the opposite of what we have this year.

In terms of internal operating plans we are doing a lot in that.

I don't want to reveal all of that; a lot of that is sales strategies and working with the partners and the sales force in different ways.

There is a big investment in the headcount in the sales force and we are seeing that new sales reps are producing very good results.

We are doing a lot of investment in getting more people, more feet on the street to extend the sales and we are not seeing much decreasing productivity.

Quite the opposite.

We are seeing that our sales people are remaining very productive so we are making a lot of efforts to add more salespeople whenever it makes sense, wherever there's a potential market.

And I think that's part of what I referred to when we spoke about the increase in headcount; I think that's very important.

Some of it is done in the seasoned people that will show results in two to three quarters, some of it is entry-level program with people that will hopefully be part of our future generation sales people in the year timeframe or more.

I think what we are trying to do as much as we can in that.

Again, I think some of it was already done in changing the product sale lines and I think it hopefully will have a positive effect next year on the booking line and some of it is already in the making and we are doing it these days.

So if you just look at -- no guidance again for '13 -- but if you look at your plans at the very high level for 2013, would you say that your main focus now is go-to-market sales marketing as well as services, that's where the bulk of spending, bulk of attention?

Or will you also focus on expansion of the product lines into either different segments or different verticals within the segments, et cetera?

I'm trying to understand whether the focus of the Company is more on the sales side or on the R&D side for next year?

I think it is both.

We are expanding both sales, marketing and the R&D side, and we're doing as much as we can on both sides.

And we are doing it I think in the most responsible and innovative way on both sides.

Thank you.

Scott Zeller, Needham & Company.

Another question on deferred.

Can you tell us again, we've heard several comments on it, but how is it that we are not seeing subscription revenue that actually is being sold, not showing up in deferred and why is it not being billed?

I'm not sure I understand the question.

I think we heard earlier that not all the annuity subscription revenue actually shows up in deferred because it is not billed.

Can you give us more color on that and why it is -- and perhaps how much of the subscription annuity revenue is not billed?

Sure.

Yes.

Every quarter we have actually a lot of tens of millions that are not part.

Accounting-wise, the part that is part of the deferred revenues is only the part that are invoiced.

So if it was not invoiced yet, you cannot see it as part of the difference.

So it shifts between quarters and this quarter it is actually increased.

Is there any way to share some color about how much of it is not invoiced, percentage-wise?

No.

I gave you already the number.

It is slightly less than $10 million, so that's as much color is I can give it.

Okay, thank you.

Brian Freed, Wunderlich Securities.

Two quick questions.

First on your application control blades, you mentioned that Application Control and Anti-Bot were two of your best performing blades.

But can you give us some qualitative or quantitative commentary on those, perhaps uptake relative to past blades, such as IPS?

I think we're all doing well.

New appliances both the Application Control and the IPS are bundled, so that is [the thinking].

The overall growth rates, they are both doing quite well.

IPS is a little bit more seasoned so it has a bigger install base and bigger portion of the revenues.

The Application Control is a little bit newer, but it is doing extremely well.

And the Anti-Bot is completely new.

We already had the many, many hundreds of installations of that which is pretty good traction for a new software blade in a brand-new category and a brand-new technology, so we are encouraged about that.

On the other hand, it is still fairly small being in a new category and so on.

The Anti-Bot is all a la carte; the Anti-Bot is not bundled with anything.

It is all things that people choose to buy rather than get bundled and decide to renew.

I just wanted to make sure and clarify -- I was saying that the strongest ones in terms of the growth, in terms of dollars, IPS is number one and Application is number two, and number three is probably one of the UTM ones, the URL filtering, probably.

The Anti-Bot is very small in terms of dollars, but since it started only a quarter or two ago, its start is quite impressive.

We already have the low hundreds of customers and the mid-hundreds of units or blades that are already sold.

So it is quite a nice beginning, again, taking into account that it's sold not as a bundle in the appliances but actually as a separate blade an a la carte blade alone.

So if you look at the trajectory of adoption for Application Control, would you say it is following a similar trajectory to the pace of adoption you saw in IPS or better or worse?

Our IPS was a huge success.

I would say similar.

It is close or around 100% growth, so it is quite fast.

Okay, and then your assumptions on the euro/dollar exchange rate embedded in guidance?

It is the same rates that I saw in Q3.

I have no other assumptions on that.

Okay, thanks.

Gregg Moskowitz, Cowen.

Just one follow-up to Tal's question.

Your R&D expense went up by $2 million sequentially, which we haven't seen a long time and that would've grown by more if not for currency.

Gil, could you talk a little more about your product development strategy going forward and specifically whether it is different now than it has been previously?

I don't think that our development strategy in any way is different.

I think we continue to strengthen that and this quarter alone was a very important quarter in that.

I think we became this year -- these are very technical things that are internal to our R&D development -- but this year we've actually became much more aggressive in getting many more excellent students and graduates out of universities here in Israel and we've started some new programs that so far have been extremely successful.

We've been able to create this, nothing short term, I'm talking about getting the top talent from around here and these people will produce products that will be in the market a year or two years from now, maybe two or three years from now.

But I think there's a lot of strategic initiatives in the product that I won't reveal here that will bear fruit next year.

And this year, by the way, alone, was also very, very important in what we did to the product infrastructure.

We had GAiA, the unified operating system; we had the full 64 bit support; we are having now the IPv6 full support in our product that's coming up soon.

So we have a lot of infrastructural things in our product which enable us to win a larger product in very interesting environment.

Again, this technical stuff is not necessarily a big new product, but it helps to do a lot with what we're doing in terms of new product.

Again, when you look at the Anti-Bot, if we look at some of our cloud offerings to-date, these are brand-new things that I think can be very, very important in the future and provide a lot of innovation in the marketplace and some of them are quite unique.

Look at things like the Anti-Bot I think we are very different from anything else in the industry today.

Okay, thank you.

Thank you guys for joining us and we look forward to speaking to you next quarter.

Take care and have a great day.

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