Check Point Software Technologies Ltd (CHKP) 2016 Q3 法說會逐字稿

Greetings, and welcome to Check Point Software Technologies third-quarter 2016 financial results conference call.

(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 begin.

Thanks, Kevin. Hello, everyone. I would like to thank all of you for joining us today to discuss Check Point's 2016 third-quarter financial results. Joining me today on the call are Gil Shwed, Founder and CEO, along with our CFO and COO, Tal Payne.

As a reminder, this call is webcast live on our website and is 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 November 6. If you'd like to reach us after the call, please contact Investor Relations by email at kip@checkpoint.com or by phone at 650-628-2040.

Before we begin with Management's presentation, I would like to highlight the following. During the course of this presentation, Check Point's representatives may make certain forward-looking statements. These forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934, include but are not limited to statements related to Check Point's expectations regarding business, financial performance, and customers; the introduction of new products, programs, and the success of those products and programs; the environment for security threats; demand for our solutions; and our business and financial outlook, including our guidance for Q4 2016.

Because these statements pertain to future events, they are subject to various risks and uncertainties. Actual results could differ materially from Check Point's current expectations and beliefs. Factors that could cause or contribute to such differences are contained in Check Point's earnings release issued on October 31, 2016, which is available on our website, and other factors and risks, including those discussed in Check Point's annual report on Form 20-F for the year ended December 31, 2015, which is on file with the Securities and Exchange Commission.

Check Point assumes no obligation to update information concerning its expectations or beliefs, except as required by law. In our press release, which has been posted on a website, we present GAAP and non-GAAP results, along with a reconciliation of such results, as well as the reasons for our presentation of non-GAAP information. Now it's my pleasure to turn the call over to Tal Payne for a review of the financial results.

Thank you, Kip. Good morning and good afternoon to everyone joining us the call today. I'm pleased to begin the review of the third quarter. Revenues for the quarter increased by 6% year-over-year to $428 million, towards the upper end of our guidance. Our non-GAAP EPS grew 9% to $1.13, exceeding our guidance.

Before I proceed further into the numbers, let me remind you that our 2016 third-quarter GAAP financial results includes stock-based compensation charges, amortization of acquired intangible assets, and acquisition-related expenses, and the related tax effects. Keep in mind that, as applicable, non-GAAP information is presented excluding these items.

Let's take a look at the financial highlights for the quarter. Product in Software Blades revenues increased this quarter by 10% over the same quarter last year, reaching $236 million. We continue to see strong transition to our new product family launched earlier this year, and now over 70% of our sold appliances are from the new family.

We had good growth in our core appliances, both in units and in total dollars, led by a broad variety of appliances, including our small business, branch, and enterprise appliances. We see a continued success of our Software Blades subscription, with a 24% growth year-over-year. The strong sales of our threat prevention and threat extraction packages continue to contribute to our increased Software Blade revenues.

We had an exceptional success in our SandBlast Advanced Zero-Day Attack Solution, which grew over 200% this quarter compared to last year. Software subscription now accounts for 23% of our total revenues. This portion continues to grow as a percentage of our total revenues, more customers adopt new technologies and advanced protection.

As we discussed in the previous calls, the new appliances are bundled with richer Software Blades package. The new package carries a higher value. According to accounting rules, the dollar value of the Software Blades is separated from the appliance price, deferred, and recognized over the service period.

The increase in the value of the bundled Software Blade is probably around $9 million to $11 million this quarter. This amount shifted from product revenues to our deferred revenues and recognized over 12 months. The net effect is somewhere between $6 million to $8 million on the total revenue.

Our software updates and maintenance revenues reached $192 million, representing 2% growth year-over-year. We see similar discount levels to the previous quarter. Deferred revenues as of September 30, 2016, reached $889 million, an increase of $116 million, or 15%, over September 30, 2015.

Revenue growth during the quarter was from across all of our regions. Revenue distribution by geography for the quarter was as follows: 49% of the revenues came from the Americas; 35% of revenues came from Europe; the remaining 16% came from Asia-Pacific, Japan, Middle East, and Africa regions.

From a deal size perspective, the number of customers with transactions over $1 million increased by 30% to 65 customers this quarter compared to 50 in the same period last year. Transactions greater than $50,000 were 73% of total order value, compared 70% in the third quarter of 2015.

GAAP net income for the third quarter of 2016 was $170 million, or $0.99 per diluted share, an increase of 7% from the third quarter of 2015. Non-GAAP net income for the quarter was $194 million, or $1.13 per diluted share, up from $188 million, or $1.04 per diluted share, in the same period last year. Non-GAAP earnings per share grew by 9%, and exceeded the top end of our guidance by $0.03.

Our cash balances reached $3.708 billion at the end of the quarter. Our cash from operations for the quarter was strong at $214 million. Net of fluctuations relating to tax payments over the year, our cash from operations from the third quarter increased in 3% over the same period in 2015, similar to the growth in the operating income.

Our financial income was $12 million, including $2 million gain from exercise of investments. In the next quarter, our financial income is expected to be back at normal levels, around $10 million. We continued to implement our share buyback program during the quarter and repurchased approximately 3.2 million shares for a total cost of $247 million. Now let's hand the call over to Gil for his comments on the third quarter.

Thank you, Tal. Good morning to all of you joining us on the call today. We had a very good Q3, with revenues at the upper one-half of our range and earnings per share that exceeded our projections. Third-quarter results are usually a little bit more challenging as a result of the summer months; however, results for this Q3 were very positive across various areas of our business.

Some of the success is driven from new positive trend, and some build upon previous strengths like our new appliance product line that were launched in the first half of the years in SandBlast Advanced [Modular] Prevention. Geographically, North America had a very good quarter, with a great improvement over previous quarters, which is very good sign and I hope that it is a positive indicator for the future.

Europe had good results year-to-date, while Asia-Pacific, Middle East, and Africa regions demonstrating the best growth momentum this quarter. Our newly refreshed appliance product lines continue to achieve very good traction. These new appliance families now represent the majority of our core product sales and we continue to see very nice adoption in the marketplace.

Keep in mind that you don't see all revenues from the new appliances in our P&L statement, as more revenues are attributed to the Software subscriptions that are bundled in the product. Overall subscription revenues, including all advanced security Blades, have reached almost $100 million this quarter, posting 24% growth over last year.

Our SandBlast products providing zero-day protection have shown exceptional business results with triple-digit growth. Securing the mobile environment remains a very important area, in my opinion. We're seeing quite significant increase in attacks on mobile devices.

In July, they grew by 50% compared to June, and now represent approximately 10% of all attacks according to our ThreatCloud network. Our sale of mobile security have also grown quite significantly this quarter, but in absolute dollars are still small, which highlights the potential in this marketplace with a lot of greenfield opportunities.

All the evidence shows that the cyber attacks are becoming more sophisticated and that the numbers of attacks keep growing. The need to combat the most advanced types of malware by every organization is evident. New attacks are discovered constantly, and just this summer, we saw the NSA expert toolkits were leaked and found their way to the dark market of cyber-criminals.

In the past few weeks, we've seen that Internet of Things devices are not theoretical attack targets, but actual malware is penetrating those devices and leveraging them to facilitate attack. Preventing the most sophisticated attacks and providing perimeter defense for all environments and all type of [metric] devices is the core of our business.

It is critical to get security that can actually protect from the increasing level of attack sophistication. While it is hard to [measure] the level of security, there are good studies that can show how much the Check Point technology is superior to other technologies in the marketplace. The latest evidence comes from NSS Labs, an organization which specializes in high technical tests for security products.

Their latest tests for next-generation intrusion prevention capabilities tested eight vendors against over 1,900 exploits with 120 invasion techniques. Results ranged from 24.9% to 99.9%. We were the one to achieve the 99.9% score. Total cost of ownership ranged from $27 per megabit per second to $8.

Not only did we have the highest catch rate, our product had the lowest total cost of ownership at $8 per megabit per second. This is the first NSS test that we participated in this year, each test checking different security technologies.

We were the only vendor to win the recommended rating on all of these tests: next-generation firewall; breach detection, which checked our SandBlast technology; and this time, the next-generation intrusion prevention system test. These results are great testimonial for our leadership of our security technology for both security effectiveness and total cost of ownership.

So to summarize, I am very pleased with our results this quarter. The pace of business has improved, our technology leadership is driving adoption, and we've started to see some of the results of the investment we made in sales in the past year. Now that brings me to the financial projections for the fourth quarter.

Revenues are expected to be between $460 million to $490 million. Non-GAAP earnings per share are expected to be between $1.20 to $1.28 per share. GAAP EPS is expected to be approximately $0.15 less.

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

(Operator Instructions)

Gregg Moskowitz, Cowen and Company.

Thank you very much, and good afternoon, guys. First question, Gil, you mentioned the rise in mobile attacks, which is very interesting, but I'm also wondering, within network security, has there been any change or recent change in the security demand environment from what you are observing?

Not much. I'm actually seeing a pretty healthy environment in the demand for our solutions and in the market, in general. So from my perspective, all is good and there's a lot of opportunity and a lot of challenges in front of us.

Okay. Fair enough. And then, investors were expecting to see a year-over-year decline in product revenue, given two things: one, a growing impact of higher deferrals on your new appliance family; and then also just a product deceleration that we have seen from some of your peers. But if you look at your results, you've managed to grow product revenue slightly this quarter on a year-over-year basis. Can you talk about why you think you were able to grow product this quarter, as well as whether you think this can continue?

First, as I said, I'm pretty optimistic. There's of course many challenges, and we remain in a very competitive environment, but we had some good business trends this quarter. With our new appliance line, are clearly gaining share and are getting very good acceptance.

We had nice growth in both units and dollar in them, a quite significant one, so we are becoming more competitive and showing great advantages of our product. By the way, even the NSS report shows that, giving us the lowest total cost of ownership. That's a great number, and again, when you compare $8 per megabit per second to $27 at some of our competitors, this is quite significant difference in price performance, and remember, this is price performance, not absolute price.

We are also gaining new customers. This quarter we had a very nice increase in business from new customers and a nice increase in number of new customers, so we are starting to execute well. As you know, in the last 1.5 years, we've made a lot of investments in our sales organization. I don't want to conclude from one quarter, but at least this quarter, we have seen some good signs to the success of that investment.

Terrific. If I could just ask one last question for Tal, your Blades subscription revenue grew 24% year over year. That was the most growth we've seen since Q1 of 2014. What's driving the acceleration? Is it mostly SandBlast with the pretty phenomenal 200%-plus growth or are there other factors as well? Thank you.

There's two factors. One is the SandBlast, which is the package that we call Next-Generation Threat Extraction. That's included in this line. The second is some of the revenues are starting to be recognized from the Next-Generation Threat Prevention package that is bundled into the appliances. So it's both.

Jonathan Ho, William Blair.

Congratulations on the strong results. Just wanted to start out with a little bit more color on the SandBlast side. Why is it that you guys think that it picked up as much as it did this quarter and what's driving that adoption?

SandBlast, first, it is the best technology. The only technology that actually blocks the attacks before they enter into the organization. There's also a lot of differentiators, not just -- of course, the result of, not small, but very technical things that are different in the product, but also there are a lot of very big differences compared to other technologies. For example, we have the Threat Extraction that actually takes every file, and within, almost instantly, removes the potential damage in content. So that's something that nobody else has. And I can give you many, many examples due to the superiority the technology.

Our sales force has been also focused a little bit more on highlighting this technology to customers, and customers are picking up on it. So these are the main factors. It is already happening for several quarters. This one is not a change that happened this quarter, but with the pace of impact and the significance of that is becoming now real and I hope that it will continue in this pace.

Got it. And then, just in terms of the shift to more cloud-based architectures and virtual firewalls, can you talk about what you are seeing there, especially with the use of public [cloud]?

First, we are seeing a nice level of interest. We already got a very nice number of customers adopting these kinds of technologies. It is still very early. People are talking about it, people are interested in that. Today, I see more business coming from private clouds than from public clouds.

With the unique thing that we offer to the marketplace is a single architecture that controls both the traditional network and the cloud. Our vSEC solution is very unique in its ability to support both the Amazon environment, the Microsoft Azure environment, on the public side; the VMware and the Cisco environment, on the private side. This is a very unique capability that we have. We are also providing a lot of security services from the cloud. That's another trend that we are seeing. And again, this trend is also working very well for us.

Great, thank you.

Shaul Eyal, Oppenheimer.

Hi. Good morning, guys. Congratulations on solid results and guide. Two quick questions, here. Last quarter, I believe the refreshed line of appliances accounted for 50%. This quarter, Tal indicated 70%. In that context and in the content of your high-end appliances, the 15000, the 23000, can you talk to us about some of the trends that those high-end appliances specifically have been seeing throughout the quarter?

Just to clarify, I said over 50%, and over 70%, so it's not 70%, it's more, so that's one thing. Second, if you recall, the high end was launched in Q1, and the rest of the family was launched in Q2. So naturally, in Q2, a lot of the growth came from the high end because that was the only family that was replaced. In Q2, it just started on the whole. This quarter was very interesting because we saw both the small and mid-size, and then the branch and also the core appliances, moving up. High end grew nicely, but the main growth this quarter actually came from the mid and lower, so that was very nice to see.

Fair enough. Now, Gil, you flagged the strong performance in the US this quarter. Is that just driven by prior investments, new hiring, some change in competitive trend? What's driving that this quarter?

I don't know. Probably all of these apply to some extent. We got a lot of new hires, especially in the past. We've got some new leadership in recent months. But a lot of it is the investment which we've done over 1.5 years and I'd like to think that we are also winning on some of the competitors.

Fair enough. Thank you very much.

Walter Pritchard, Citi.

Hi, thanks. One thing on the maintenance revenue, the support revenue, it looks like it declined sequentially. I know overall the total revenue was better. Could you talk a bit about what drove that trend? We haven't seen that happen for quite a while.

Actually, it was quite expected. We talked in length about it in the Q before, and actually, two quarters in a row, where we said we see two trends. On the one hand, we see strong product growth that has being shifting into subscription as a result of the bundle. The second thing we said we see, we saw increase of discount rates year over year.

Actually, this quarter, we saw stabilization, so there was no longer a continued increase. It stabilized on the same levels of the previous quarter, which was good to see, but obviously it takes time to translate this decrease into the P&L, so you see it only two, three quarters after. So you started to see some of these effect in Q2 and in Q3, and you see some of it in Q4, as well.

Great. And then just on the transition impact. You did give us the $9 million to $11 million in gross impact for the Q3. Any update on what impact you expect to see on a gross or net basis to product revenue as a result of the deferrals that continue to happen here in Q4?

I gave the numbers last quarter. Last quarter, I said between $8 million to $10 million in Q3 and it came out slightly below that, but very similar, and in Q4, we expect something similar, as well, just times 2. So it means, we said between $16 million to $20 million. It might be $14 million to $18 million, but it's basically in the same range.

And then last one here, your [in dust a ton of postures] for investment. You've talked at times about maybe accelerating sales investments and so forth. Can you talk to us about how you are thinking about that into 2017?

We haven't really formed our plan for 2017. It's a little bit too early to discuss that.

Yes. We -- remember, Q4 is very material before we make the plans for 2017, so we need to wait in Q4 and then give the guidance for 2017.

Great. Thanks for taking the questions.

John DiFucci, Jefferies.

Thank you. Tal, I have a follow-up to Walter's first question on the maintenance, and thank you for that, and you did mention that you discounted similar to last quarter. But how should we think about that dynamic going forward? Should we just assume that this is going to be a consistent theme just so we get our models great, because we had modeled maintenance? That was the only line. Everything looked really good this quarter. That was the one line we were a little bit -- we didn't model it greater than what you had.

Yes, when you look at that, we see -- year over year, we saw the increase so the step-down happened and now we see stabilization. So probably you will see it for the next two quarters when you look at the P&L and in the revenues, and then hopefully it will stabilize there. It looks like it's stabilized for now.

If you remember the main reasons, then remember what the currencies did around the world. It's very clear that currencies, when they are moving 20%, 30% in some countries, then it affects the budget of customers. The focus of our team, from last year, we talked about it again in length, the focus is to sell new products, new customers, and new technologies.

That has been very successful. Some of it is probably is a result of that focus, is some increase in the discount on the updated maintenance. But all in all, I hope it stabilized. It looks like it did and you will see it in the P&L in another quarter or two, and then hopefully, it will stay in those levels.

Just to be clear, the primary reason for the discounting is currency, it's not competitive issues?

It's three reasons. It's very hard to differentiate which one it is. Currencies is the main one in the countries that had a big effect, like you think about UK, Russia, Brazil, Mexico. There's many countries that -- and remember we are a very global Company. So we have a lot of income coming from the international and not dominant in the US for customers' budgets, right? So that's one major factor. Competition can be another factor, but mainly the focus of the team on new customers, new product, which has been very successful.

Okay, great. If I could, just a follow-up for Gil. Gil, you mentioned that demand is good, but you also mentioned there were challenges, and everybody has them a couple of times. You did have a competitor put up a difficult quarter this quarter, and you mentioned that demand for network security is good, but what about the macro environment? Have you seen any changes in either the macro environment or the competitive environment?

In large scale, I haven't seen big changes. In some countries, yes. There is countries that as, like Tal mentioned, currency fluctuation. Take Russia, for example. Their currency is 20% weaker this year, so that has some impact on their buying power.

By the way, coincidentally, with that can impact the discount rate and so on. There are many, many examples like that because we do have a pretty big world around. At the macro level, I can't say that there is a slowdown in the marketplace. We haven't seen it. Again, it may happen, but we haven't seen any effect yet.

Any change in the competitive environment? I know it's competitive, but any changes this past quarter?

No, it remains a competitive environment. We focus on our own execution and that's the most important. We have a lot to offer.

Great, thank you very much.

Tal Liani, Bank of America Merrill Lynch.

Hi, guys. Thank you. This is Mike Feldman on for Tal Liani. Would you be able to give us some color on the service provider verticals? Some of your competitors had seen some softness there and elongated cycles. Have you seen any changes to the competitive position in that vertical?

And then, R&D has picked up quite a bit over the last year. What's driving the increase and how should we think about the level of spending there going forward? Thanks.

Service provider, we haven't seen big changes. There are a few large opportunities and large deals that we are seeing, but they didn't have yet any impact on our results so it didn't impact that yet. In terms of spending, Tal, I don't know if you can --?

Yes, R&D is mainly -- the R&D people, the majority of them are located in Israel, so you can have some influence of the currencies. But, in general, if you recall, last year, we talked about an increase in headcount mainly in sales, marketing, and R&D.

R&D is typically the large increase and headcount comes in Q3 and Q4, because that's when the students come out of the university. So, year over year, that's when you see the full effect of the growth, but nothing dramatic. Everything is pretty much in line.

Thank you. Actually, one more. You mentioned last quarter that SandBlast was about $10 million run rate for the quarter. Would you be able to give us an update there? Thanks.

I don't think we said $10 million.

Much higher.

Much higher. We are talking this quarter much higher, yes, but we don't provide the numbers, but I can tell you -- the main message was that we are not talking about $1 million or $2 million or $3 million and then to say triple growth or 200%, over 200%. It might be impressive in percentage but not in dollars.

Actually, we're talking now about quite a large business. We didn't provide the number, but we're not talking about $10 million and not $15 million. It's already more, so it's very nice revenue, a very nice business, and it is growing very nicely. So we feel like we have a winning technology here and customers are adopting it quickly.

Overall, if you look at all our advanced security technologies that are represented by our Software Blades and by our subscription revenue line, this is this quarter almost $100 million, which shows a run rate of almost $400 million annually. Think about it, the business that didn't exist four or five years ago.

It's a pretty significant business today. Purely the subscription part, not including the hardware, which is separate, not including the platform, which is again separate of that. It's a business worth about $400 million on an annual basis. It's quite significant in our industry.

Next caller, please? Next question.

Andrew Nowinski, Piper Jaffray.

Thanks. Congrats on the nice quarter. I just want to ask one question on did you see any change in your new customer growth this quarter, perhaps driven by the adoptions from your new appliances and your SandBlast products?

We don't provide new customers, but Gil alluded to that we see a very nice increase also in that area, but we don't provide detailed numbers.

Okay. Fair enough. And then, on the sales and marketing expense, the growth continues to moderate. It even declined sequentially this quarter. You had many channel partners that we talk to consistently say you need to spend more aggressively on marketing like some of your peers. What is your view on increasing the marketing spend at the same time that you are increasing discounting on maintenance contracts?

First I agree, I do agree that we need to be more effective and do more in marketing. Q3, specifically, it's the weakest quarter for marketing because everyone is on vacation and because all our big marketing events are around Q2. So seasonally, that's the weakest quarter.

But we are very open to it and we actually increased it nicely in the last year. You can see sales and marketing together, that's increased quite significantly. Remember that Q3 is the lowest one because Q2 is the highest one.

Okay. Thanks.

Michael Turits, Raymond James.

Hey, guys. Thanks. Two questions. One, have there been any changes in the sales management structure, especially in North America? What are they and how have their impact been? And another SandBlast question, how have renewals been on SandBlast?

In terms of sales management, we are making some changes. Overall, by the way, our sales management in the US is quite stable at most levels, but we do have a new head of worldwide sales, which is now handling North America, too. That can have and did have an impact. What was the second part?

The renewal rates.

The renewal rates for SandBlast.

It's very similar to the other, Blade. We see very nice renewal rates. We don't provide it, but if you remember the historical that we talked about, 35% for bundled and it started with 65% and moved up to 70% renewal on the unbundled, it's actually moving up, so it's nice to see that, as well.

Great. Last, any more detail on the head of worldwide sales? Who was he or she and where did they come in from and what changes that you anticipate?

We want to put more emphasis on sales. That is very important. We want to have more people that can meet with customers, especially at the top level. We want to create more sales discipline that will add more value.

Our new head of worldwide sales, his name is Pierre-Paul Allard. He is with us for now three months, so he's now getting from the learning phase to the implementation phase. His latest job was President for the enterprise business for Avaya, if I remember correctly the title.

Thanks a lot.

Ken Talanian, Evercore ISI.

Hi, guys. Thanks for taking my question. Another question on Software Blades. You saw good growth in the quarter. I was wondering if you could give us a sense of the breakdown of Software Blades revenue related to new appliance sales versus selling into your existing installed base?

Majority is always to the existing installed base, right? Because it can be new Blades or new packages, but majority of the sales by far has always been -- we have a huge installed base, so it's to the existing installed base.

When you talk about the Software Blades, in general, then I can say majority is the unbundled and maybe that's what you are relating to. Majority of it is not attached to the appliance, and actually been purchased or renewed by the customer on an annual basis. A smaller portion is coming from the bundle that is part of the appliance.

And can you give us a sense for how much the unbundled has increased in this quarter relative to the past couple quarters?

We don't provide, but I can tell you much more than you see in the P&L.

Okay. Great. Thank you very much.

Sterling Auty, JPMorgan.

Yes, thanks. Hi, guys. Gil, you mentioned in one of the earlier responses that you saw a pick-up in new customers. One, is there any way to quantify the improvement that you are seeing, maybe by sharing with us how much revenue is coming from new customers versus existing, this quarter versus either last quarter or a year ago?

First, I acknowledge, we had some nice changes, and nice growth in new customers in both revenues and number of customers. We decided not to share this data. I don't think it is the right thing to share it. It's not the best business thing for us.

In terms of whether it should continue or not, it can fluctuate. But we are putting a lot of emphasis on winning new customers. This quarter, I can definitely say -- not just this quarter, this year, it was actually quite successful effort and we are definitely seeing that it's going in the right direction.

And then, one follow-up question. You mentioned starting to see the payoff on the sales investments. Can you give us a sense of which geography you are seeing the biggest impact of those investments and where are you seeing the impact? Is it in lead generation? Is it in helping getting deals closed? Is it in deal size? Or something else?

First, it's all of those. We have seen a slight increase in deal size. Tal gave some statistics about that, but even the statistics that we haven't shared, they all point to a slightly higher deal size. We are seeing more new customers and more deals from existing customers, so it's all in the right direction.

In terms of geography, I've already said some of the changes that we've seen. Europe has been providing healthy growth year to date since the beginning of the year. In the US, we have seen a very nice increase in the biggest results this quarter. In Asia-Pacific, we have seen the highest momentum of sales growth this quarter, and actually a few quarters before, too. So we are seeing it generally across most regions.

Maybe to clarify, the reason it's a bit hard for you to see it is because there's the two effects that are reducing the numbers in the P&L. One is the move from product into subscription, so that's quite a large number that has been taken off the revenues every quarter, and we talked about it last quarter and this quarter. The second is the discount in the update and maintenance, which decelerated the growth there and ate some of the growth.

Got it, thank you.

Karl Keirstead, Deutsche Bank.

Hi, thank you. A question for Tal. I want to understand the mechanics of moving $30 million, $40 million a year of product revs to deferred revenues. First, it seems that you should see an uptick in short-term deferred revenues as that happens, and in fact, in this third quarter, short-term DR did accelerate from the prior couple of quarters. So I just want to confirm that the reason it did is exactly this kind of move.

And then, secondly, could you just talk through what the impact on operating cash flow should be? I noticed through the first nine months of the year that operating cash flow was up about 5%, so that's running a little bit short of your roughly 10% non-GAAP EPS and I want to see if this phenomenon is impacting that at all. Thank you.

Okay. I forgot the first part of the question. The second part regarding the cash flow, it shouldn't have really an effect on the cash flow because the revenue recognition, just moving from product revenue recognition into subscription over time, doesn't change the cash flow because we collect the entire amount of the appliance booking as part of the regular cash flow, so that's not part of the effect.

You're referring to the growth in the EPS of 9%. You are right. The operating cash flow is slower. The reason is that part of the EPS growth is the buyback, and the buyback is actually part of the -- not part of the operating cash flow. That's why. So if you look at the net income, it's pretty much in line with the net income, or the operating income, so that's the cash flow question. The first part of the question, can you repeat it again?

Yes. First part of the question was, we did see a slight acceleration in the growth of short-term deferred revenues. Is the reason we saw that because of this impact you're talking about?

Yes. You're absolutely right. As a result of the fact that some of the appliance booking revenues have been deferred, they're going into the deferred revenue, so it's part of it. You are right. Typically, Q3, deferred revenues are going down and this quarter it was $0, so it means it didn't go down, which is higher than what you expect. The reason is that it gets some of the deferred into it.

Okay. Thank you, Tal. That's helpful.

Matt Hedberg, RBC Capital Markets.

Thanks for taking my questions, guys. Gil, from a high level, you talked about a good spending environment for security. Are you seeing more customers want to consolidate spending, given your focus on Blades? Could you even see an acceleration in some of that consolidation versus past years?

Yes. We do see customers that wants to consolidate. For the large customers, it is not always as easy as what we want because they do have different people in different departments that are in charge of different domains, but in terms of the general market trend, yes, the market will need to consolidate more. People will need to get solutions that provide broader architecture and single management and we have exactly that strength in our product and in our strategy.

That's great. Then maybe one follow-up. With $3.7 billion in cash, I believe that's your balance, how do you think about investing additional capital into the endpoint market, which still seems to be a fairly wide open market in terms of opportunity? Thank you.

First, we keep looking for opportunities for expansion and acquisition and so on. I don't know that playing in the traditional market of endpoint is currently on my top priority for consolidation and for spending, but being involved in some of the more advanced mobility and advanced endpoint technology is clearly something that we are doing.

Jayson Nolan, Robert W. Baird.

Great, thank you. I wanted to follow up on public cloud. You mentioned some traction there. What types of customers? Where are you seeing adoption? Is it SMB driven? And then are there any trends by geography?

In terms of the public cloud, we are seeing all types of customers. Not actually, not the small customers. It's more the larger, more traditional customers that we have that want to leverage their architecture into the cloud. Geographies, I don't have much. I think it's mainly Europe and the US, but I don't have a good handle of that.

And then a follow-up. It looks like Europe was roughly flat year on year. You saw more strength in the Americas and Asia. Is that a currency dynamic or was some of that UK driven?

You'll remember in Q1 and in Q2, they had really, really high results, so when you look year to date, they actually had pretty good results this year. Probably some effect of the currencies, UK and Russia, which slowed their growth in Q3.

Okay. Thank you.

Brent Thill, UBS.

Good morning, Tal and Gil. Thanks for taking the questions. This is Fatima on for Brent. Tal, a question for you on the deferred revenue. As your Blades revenue approaches about one-quarter of the business, can you help us appreciate the composition of deferred revenue split between Blade-related revenues and pure maintenance? Then I have a follow-up for Gil, if I may?

We actually don't provide a breakdown. Actually, in the annual report, you will be able to see it, so you will have to wait another quarter. But the trends are clear. We see the portion of the subscription is moving up in strong double digits. Related to it, you see in the P&L, 24%. In the deferred is higher because the growth rate is faster there. When you look at the update and maintenance, it actually suffers from the increase in the discount and therefore, there, you don't see growth, in general.

Just another quick one on deferred. Any potential FX impact that you could quantify on deferred revenues? I know you price in dollars.

If I'll give it, then it would look like our results are way too good, right? Because obviously we suffer more than anyone else in the market because we're global. That's our advantage as well. So when you see currency effects like the UK and Russia and Brazil and Mexico, and last year, you had Colombia and the EU.

If you take that into account, because it also takes time for customers to adjust, it's probably tens of million a quarter, but we more -- we put a focus on ourself to execute all the time more and to find ways to cover for that. You see we did it pretty well this year, with the subscription, with the product refresh, but the effect on an Excel file, I will say, it's probably tens of millions negative effect.

That's helpful. Now, Gil, a quick one for you. You've talked for several quarters now the importance of mobility. Can you remind us very quickly how you are currently going to market for that suite of products? What do you think the biggest gating factor really is for adoption?

This is really in the context of the large DDoS attack from last week, where it seems like the culprit was infected devices. So would just love your thoughts on why this isn't a top-of-mind spending item for most organizations? That's it for me. Thank you.

First, I don't have a good answer why people are not putting securing their mobile devices as a top priority. I definitely think it is a top priority. We have seen last quarter that the number of attacks on mobile devices and by mobile devices is becoming quite significant.

It's not -- three years ago, two years ago, you could have talked about the fact that there's a possibility, but we haven't really seen much attacks. Today it's a significant portion of the attacks. Our research showed a lot of malware families that are attacking specifically mobile phone from all the major vendors, so clearly that's a real issue. We are seeing a nice traction.

We had very nice growth with that, but we have seen hundreds of customers every quarter that start to use that technology and the go-to market -- you asked about the go-to-market -- it's very similar to our existing go-to market. We talk to large enterprises, and through them, we try to go to older users using the enterprise tools that the Company has. I don't have a good explanation why the companies are not aware and it presents a very nice opportunity moving forward.

Gabriela Borges, Goldman Sachs.

Thanks for taking my question. Maybe just on the sustainability of the demand environment. As your sales people build out their pipeline and talk to customers about the go-forward, is there any color that you can share with us on how customers are thinking about 2017 budgets and their willingness or lack of willingness to invest? Thanks.

2017, again, it is a bit far. We saw a great Q3. We need to see the trends in Q4 and then conclude on 2017. In general, we see healthy spending, but Q3, remember, it is quite a small quarter. It's not the size of Q4, so we need to follow up and to see how it's going.

Some countries that you see more pressures mainly coming from currencies. We discussed it. We saw great [among], in general, like Middle East and Africa and Asia, and we saw great US this quarter, and we need to follow up in Q4. We don't see a trend that shows cutting of budgets.

Sometimes you see shifting, right? We see much more investment in Advanced Threat and in the Zero-Day Attack. We see it our new technologies. That's why the place you actually see the main growth is in the subscription line. That's what we said, expect to see the subscription going up and the rest slowing down because the market is moving to the consolidation, to the adoption of the new Software Blades or the new technologies and it's working very well for us.

Erik Suppiger, JMP Securities.

Thank you very much. Congrats on a good quarter. One, can you just confirm, in light of one of your peers that did cite extended sales cycles, are you now seeing any extension in the sales cycle? Then secondly, can you just comment a little bit on where you plan to invest in terms of your channel strategy at this point?

We haven't seen a change in the sales cycle, so I can't associate myself with that. Regarding the channels, we are and we will make a large investment in working better with our channels. It's one of our leverage points. We have very strong channels and if we work better with our channel, that can increase our growth rate.

What can you do to work better with the channel?

Every year, we review it, we make some changes in the core program, we make changes in the -- there's many changes. You work better, you make sure there's more salespeople dealing with the channel, going together to account, there's many things to this.

There's a lot of it. It's not mainly an issue of just marketing program. It's really working and partnering with the channel. It's levering the channel effect. It's better working on a deal with channel partners, and it's a lot of work in the field. We think we did grow our headcount to support the channels and that's already starts to show results and hopefully will show more results in the future.

We've reached the end of our question-and-answer session. I'd like to turn the floor back over to Management for any further or closing comments.

Thank you, everybody, for joining us on the call today. We look forward to talking with you throughout the quarter, and obviously look forward to next quarter's conference call. Thank you and have a great day. Bye-bye.

That does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.