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Check Point Software Technologies Ltd. (NASDAQ:CHKP)

Morgan Stanley Technology, Media & Telecom Conference

February 25, 2013 6:25 pm ET

Executives

Kip Meintzer

Tal Payne - Chief Financial Officer

Analysts

Keith Weiss - Morgan Stanley, Research Division

Keith Weiss - Morgan Stanley, Research Division

Thank you, everyone, for joining us this afternoon. My name is Keith Weiss, I'm part of the software research team here at Morgan Stanley. We're very pleased to have joined with us from Check Point, both Tal Payne, CFO; and Kip Meintzer, Head of Investor Relations. Before we get started, Kip is going to run through some Safe Harbor statements.

Kip Meintzer

I'll just give you a quick summary of the Safe Harbor in accordance with the the Securities Exchange Act of 1934. During the course of this presentation, and there may be some forward-looking statements, they have risk and uncertainties associated with every one of them. You can find a full list of these risks and uncertainties in our latest 20-F filed with the SEC, I think the latest one is for December 31, 2011. With that, we also made -- take note, Judy, to update any of the statements made during the course of the presentation. With that, I'll toss it back to Keith and we can go from there.

Question-and-Answer Session

Keith Weiss - Morgan Stanley, Research Division

Excellent. So I thought maybe we could start out high level. We're hearing a lot about cybersecurity in the press recently for good reason. And, definitely showing up high on our CIO priority list. From a Check Point perspective, I'm wondering if we can start with strategic initiatives that you guys have in place. Coming into 2013, what are the top things that you guys are going to be focusing on that, either from the product perspective or distribution perspective in 2013?

Tal Payne

Sure. So like you say, if you follow the news, it actually started a few years ago, but it intensified as we go throughout the years, we see more and more attacks, which a lot of them become dedicated, attacks for specific organizations and industries. It can be activism or it can be government-related, it can be political, so there's many reasons for those. It can be criminal, trying to get into the assets of the company. But what is clear is that no matter who it is, it's becoming more sophisticated, and therefore, the protection on the customers becomes more sophisticated as well. So it's running faster than the bad guys in that regard, and we've seen it for a few years. But as you said, it's getting more intensified. You see 2 trends here, first, it's relating to CIOs, CEOs becoming more aware, board members becoming more aware, and therefore, the need to talk also in a business language, so you don't talk only in the language of the IT guys, but also in the business language, that's one. Second, you see more dollars are willing to be spent in order to protect this organization. There's more and more clear understanding that you need a layered solution, so it's not a one -- it's not enough to have just firewall or just IPS, or just Application Control, but you need to peel the nail. So if this penetrates one, the second one will stop it and so on. And also, another interesting phenomena that is just starting, but we think it's going to become more and more in the future, is that we need to take the assumption that if they really wanted to try to penetrate, they succeed. And therefore, you need also to continue look at the throughput and on the network transaction that you have inside and to keep looking for these behavioral changes inside your network in order to identify the penetration. I'll give just one example. If you look at Anti-Bot, the new product that we launched 2 quarters ago, which is basically allowing you to recognize: a, that you have a bot in your network. Bot is like a robot, that is sitting on your computer and trying to create either damage or take data and take it outside of the organization to the remote person or location that controls it, and you can identify these links and therefore, recommend to the IT guys to take care of it. So it's bots from all kinds. We see a significant increase in number of bots. We pretty much much see in majority -- I think it was 65% last time that we looked at the organization, that when we check the network, we find this is quite a bigger phenomena. And our organizations need to deal with it. So you see the Anti-Bot, it started very strong. Is already over, I think, 2,500 solutions have been sold and it's only out there for 2, maybe 3 quarters. So we think that's the phenomena of the trends relating to this solution. We also think the threat prevention, in general, and from the cloud in particular, we launched our ThreatCloud last year as well, which is coming from the realization that many organizations realize that no longer you can vacillate on your own. There has to be some form of collaboration in order to share knowledge and to share a fax so you can protect yourself when one organization gets hit, and not each one dealing with it on its own, and that's the Threat Cloud where it's allowed our customers, a, to be connected; and b, when they give us the information of the attack, we help them solve it and we update every other customer of the cloud, so that's 2 examples of how to deal with this new phenomenon.

Keith Weiss - Morgan Stanley, Research Division

Got it. So this increased awareness and increased willingness to put dollars at the solution, it's coming up against a macro backdrop that's still pretty uncertain, still pretty uneven. Can you give us the latest from the Check Point perspective of that macro backdrop, particularly in its new major markets, the Americas and EMEA?

Tal Payne

Sure. So first, the fact that customers willing to spend more, think of what type of customers, it's more typical to high end, probably less to mid lower end. So it's attacking different types of customers differently. Also note that it's dollars that are for new types of market. So it's not necessarily going through the major market, while the whole market as a whole is, in general, typically single digit market. So you need to bear that in mind, that's one. And U.S. was very strong -- America, in general, was very, very strong for many, many quarters, probably over 4 years. Q4 was slightly weaker, but then again, following such a strong 2011, phenomenally strong, it's not that surprising. Europe been spotty for I think around 2 years. So it depends which quarter, which region in Europe, but it's been spotty, so again, it's not like a new phenomenon. For us, Europe is quite big. Europe is around 40%, slightly less of our total bookings. So Europe is slowing down to a low single digit. It's affecting the total number as well. So it's not like it's a negative growth, but it's still a weak growth for us, and that's why it's affecting us slightly differently, because we are -- the largest pure security player in the industry today, and therefore, we are all around the globe. Europe, 40%. Therefore, for us, it's a bigger effect.

So that's regarding Europe. And going into next year, I think, remember Otto, that we also had an effect relating to the launch of the new product line. So when we launched the new product line in Q4 last year, the product line was a huge success. It basically allows customers to have 3x the performance for the same price level. So they can go one level down get still higher throughput, but have lower budget spend. So what we've seen, we've seen double-digit growth in the number of units in 2012, which is atypical, typically it's lower grow rate, but we still have reduction in the averages as these customers could go 1 level down. So for us, it slows significantly the product growth. Although competitive-wise, we actually increased significantly the number of units. And therefore, for the first time, according to IDC reports, moved to #1, from #2 place to #1 place, in terms of the marketplace. So competitively, we did well. Dollar-wise, in products, it was weaker.

Keith Weiss - Morgan Stanley, Research Division

Got it. And in terms of the guidance looking forward into 2013, I think you have about 6% growth at the midpoint of your guidance range. Is there any improvement in that macro environment implied in your guidance? Or are you looking for kind of more of the same?

Tal Payne

So in order to grow in these rates, you need to see not significant improvement, but healthy markets, right? So it's assuming it will stabilize and not deteriorate, right? And if you look at -- and in Europe, slight improvement, which we are already starting to see in Q4. And so hopefully, it's a reflection and not just a coincidence. So it's not assuming deterioration, it assumes some stabilization/improvement, that's one. I'll give you 2 factors that's important for next year. First, you see that the guidance that we provided for Q1 is slightly slower than the full year. The reason is as we anniversary the transition and it's important to understand the transition effect because when we launched the new product line, there was a huge increase in the number of units and the ASP dropped significantly. Pair categories didn't reduce, but because we had the reduction in the categories, more units been sold in the mid and in the high, then the averages will be moved down. Now going into next year, as we go through the quarter, the ASP should become more of a share comparable. So ASP should stabilize next year and more as we go through the year. When we talk about the number of units, Q1 is a tough one to call because it was the growth in number of the units, so a number of units was a high double-digit. And then it was double-digit slowed -- still double-digit but slowed down throughout the year, right? So as we go through the year, it should become a number of units, we start with the tough compares and it should end up with an easier compare when it comes to the number of units. So the assumption is improvement throughout the year.

Keith Weiss - Morgan Stanley, Research Division

And you saw some of that already going to Q4 because at the beginning of the year you're talking about 20%-plus unit growth. And at the end of the year, you're talking about stabilized ASPs and it was low-single digit in the quarter?

Tal Payne

Yes. The result is Q4 2011, already enjoyed the growth in the number of units, because we launched the new product line in October 2011, which means Q4 2011 also enjoyed like a huge increase in the number of years. So that's what I'm talking about, tough compares a number of units. Because when you come out of the year of a significant double-digit unit growth, this obviously becomes tough compare in the year.

Keith Weiss - Morgan Stanley, Research Division

Yes. And those toughest compares are in the first half of calendar year?

Tal Payne

Throughout the year, not easy ones, but it start with much tougher than towards the end.

Keith Weiss - Morgan Stanley, Research Division

Got it, got it. So the flip side of giving your customers more powerful appliances to work with, but it also that it enables them to run more blades and that's an important part of your strategy, on a go-forward basis is sort of being able to consolidate more functionality, being able to keep those customers on a treadmill and sort of moving faster than bad guys, if you will. Can you update us on the blade strategy, where we are? I think you talked about coming out of last year. I think it's typically been talking to $160 million, $170 million in blade revenues for 2012, growing 35% year-on-year. Where do you think you really are in terms of the -- your customer's adoptions of those blades?

Tal Payne

Sure. It depends which blades.

Keith Weiss - Morgan Stanley, Research Division

Sure.

Tal Payne

So just to remind, we're talking only about annuity blades. Annuity blade is the security services that we provided subscription and we started with the IPS. IPS is quite big. It's actually #1 blade for us and more than 50% is actually relating to the IPS. So IPS is a huge success, and it's been launched in mid-2009. So you see 3 years, and it's already a huge amount, so it's not like 10 years after, it's only 3 years after. Application Control is the second type of blade and it's been launched, and if I recall, in the beginning of 2011, I think. So it's 2 years into the blade. And it's #2 blade, very successful, very high growth rate. So that's the second blade. But if you look at the opportunity, just the IPS, you can do the math to see what the number is. Our total is around $160 million, $170 million, and IPS is let's say, 1/2, so let's say it's around $80 million, the market size is $1.2 billion itself. So still, the opportunity is big and this is #1 blade. Application Control is an early market. But still, we probably sold more Application Control than any other player in the market, in terms of number of customers that bought software blades. Our price is much lower because it's part of a bundle, it's part of the total product. That's why it presents a big opportunity but we can install it in large amount of customers. Application Control is a great success. Anti-Bot, it's not a bundle, and it's been launched only 2 quarters ago. It's not a cost. We sell it only to customers as pay day 1, but we already use it in over, probably close to 2,500 sales of blades, quite successful for 2 quarters, right? Pretty [ph] small numbers. So I think each blade can represent an opportunity between tens of millions to billions. That's probably the rate and depends which blades...

Keith Weiss - Morgan Stanley, Research Division

Pretty good range?

Tal Payne

Yes, but you know those numbers, right? If you look at the U.S. history, it's a market of $1.3 billion, $1.4 billion, we sell a few tens of millions, big opportunity. It doesn't mean that we will be successful in each one of them, but the addressable market is very big. So our job is to make sure, a, that we have great solution, some of them already great, some of them need to become greater, better. Secondly, we need to make sure customers are aware of it, and that's where the challenge is. You can't go to a customer and tell him 20 different stories. So you need to crystallize the message, you need to simplify it, you need to work on the marketing, you need to work on picturing the market and it takes time. So I think, in terms of opportunity, the opportunities lie.

Keith Weiss - Morgan Stanley, Research Division

Got it. So in terms of -- just to be clear, in terms of the $160 million, $170 million, that represents -- the majority of that represent the annuity blades that you've bundled with your solutions. The a la carte opportunity, it seems to me that's something that's ramping up, particularly since you have all these appliances out there that are more powerful. Are you seeing more of that type of buying going on?

Tal Payne

Sure. So actually, it's already that -- we already moved to that phase. I'll just explain the question. Historically, when we started, because most of the customer didn't have software blades architecture, the way to sell it was to bundle it in the product. So customers got it for free. It was part of the price of the clients. And then we said, hopefully, next year, some of them will renew it, and our assumption was 10%, 15%, maybe 20%. In reality, we sold around 40%, so it's much higher renewal rate. So you liked it when we started with it in 2009, '10. Majority of the annuity blade revenues came from the bundle. Actually, nowadays, it's no longer the case. More than 50% is already the a la carte. When we say a la carte, so I'll explain what's the definition of a la carte. A la carte means the customer bought it from a free choice, meaning either he already has an appliance and he decided he wants IPS software blades and he purchased it separately or he's already in the second year of the renewal and he's choosing it for his own free will. So today, majority is already the a la carte, which means it's not the split value of the accounting between the appliance, which portion into service and which one is into the product. It's actually customers that purchase for dollars separately for those services. So it shouldn't be possible today which is great news, right? So remember, that now that it's actually a big number, obviously, the cost of renewal rates are slowing down, because a lot of the revenues now coming from renewals, and renewals are less than 100%, much less. It's probably around 65%. So you're starting with a lower numbers than last year, and therefore, the average growth that is slowing down, still very big. Last year was 35%. But the year before, it was higher than 50%. So it's slowing down the total growth of the service line. Okay?

Keith Weiss - Morgan Stanley, Research Division

All right, got it. The other product initiative that you've been talking a lot about is some of the higher-end offerings, the 21000 series, the 6100 series, you just had a refresh of the 21000, 21700 I believe. Could you talk to us how this expands your CAM per se? Maybe not your CAM, but sort of how effectively you target some of those really high-end organizations?

Tal Payne

Sure. So when we launch the appliances, we started with UTM, and then over time, we introduced.

the Power-1, which was higher end. And then at Q3 2011, we introduced the data center appliances, which was the 21000 and the 61000. Both of them did very well, still doing very well. We actually launched another one, I think it was last quarter, the 21600, which is in between, and we are investing a lot in this area because we believe it's a big potential. We introduced also the accelerator, which I'm proud to say we ran out of the inventory last quarter, and it was a great demand. For the high end, it's doing great. It's focused on data centers because they need a lot of throughput, so we needed to create a very fast machine in the price range that is matching these types of customers and all of them been accepted by the market very well. So I think it represents a nice opportunity. How big, I think, it's a bit early.

Keith Weiss - Morgan Stanley, Research Division

Does this make you more competitive in the service provider space as well?

Tal Payne

It should make us more productive, yes. Remember, the higher end, the longer it takes to penetrate. but if it's an existing customer that was dying for us to come with this type of appliances, then it's been easier because he knows us, he knows we rate in our security solution, so now it's about him getting more throughput to the places that he needed and we didn't have an appliance for. So that's a quicker cycle. When you talk about new customer or data center that we haven't been in before, it can be much longer cycle.

Keith Weiss - Morgan Stanley, Research Division

Got it, got it. I want to take the opportunity to see if there's questions from the audience and make sure we get audience participation here. Any questions from the audience? All right, then. Actually one of the...

Tal Payne

You needed me to give them 10 seconds or...

Unknown Analyst

Tal, just a question. These days people talk about firewalls' not enough for the malware that's coming in, the APT and all these things. Trying to figure out what your thought is about how you -- your solution offer protection against those?

Tal Payne

Sure. So our philosophy, we try not to have a customized solution per customer. For some customers maybe they're really, really high-end, going more to customized solutions, where you see maybe smaller players actually doing a large deal for very few customers. When you look at us, we are an incumbent in so many customers. We're trying to give the best technology across the board to all types of customers. So we're looking for something that can work for many customers, that doesn't require very complicated customization, so they can implement it very quickly and to solve their problem. That's our goal. And in a reasonable price, not to pay $1 million for a solution or $200,000, but to pay $5,000, $10,000, $15,000 depends on the solution. That's what we're trying to do. We trying to make security available for all. So when you look at our Anti-Bot, that's exactly where it's dealing with. So it's a combination of free solution that can solve depends which problem. So APT depends on which specific one you're dealing with but Anti-Bot is basically built for that, because it's trying to recognize changing type of attacks by recognizing different patterns change. So if you look at your laptop, for example, and it knows what it typically does. And if your laptop suddenly starts to send many automatic transactions that typically doesn't do, it's supposed to spot it and say, your computer is actually doing something it's not supposed to do. So it's trying to recognize a change in patterns or to see that your computer's sending something outside of the network. And it has many, many solutions. I'm not going to give all the details of the type of checks that it does. It can check where is the data going to in the Internet, is it an area in the Internet that we know are actually bad areas? So it checks many things that happens and it raises the flag to the IT guy, to say something is happening here that probably shouldn't happen and then the IT guy should go and maybe fix the problem or reboot everything and clean the computer and so on. So and I told you, we actually checked it in the customers and we saw so much more than we expected. So it's obvious for us to the problem is across the board and many people that the bots are sitting there and we go to PLCs for new customers, people that are not our customers. We put it, we go for lunch, we come back and they see the situation they say, okay, we need protection. So I think even many people that have these PLCs, they are realizing the problem is there in your house. It's not theoretically only the big guys that you read about in the newspaper.

Keith Weiss - Morgan Stanley, Research Division

Any additional questions? Count to 10.

Okay, I wanted to make sure we touched on margins heading into FY '13 and in 2 directions, one, talk about some of the currency impact, some of the hiring impact that are pressuring margins into FY '13. I think [indiscernible] margin, it might be down a little in FY '13. And then on the flip side, you guys have a remarkable record of improving margins that are industry-wide leading. Any offsets we should be thinking about of where margin -- where you could potentially see some offsets of this pressure that you're seeing?

Tal Payne

Sure. The first thing is we have the discount [ph]. We don't really manage those margins. We don't aim to be 58.3, right? It basically depends on which drive, we invest in the business as much as where we need to invest. And if we think we need more in R&D this year, we invest more. If we need more sales, we invest more. That's the way we manage the business. In order to invest more, then it could be a valid business model, right? It's not just left to grow. We need to show that it makes sense. So we are quite an attractive company when it comes to that. The reason for the expansion, the margin come from the drivers that made the growth. So the clients typically have lower margins, software blades have higher margin. The software blade grew faster than anything. We saw an expansion of the margin. If you look at the last 2, 3 years, the dollar got stronger. 40% of our expenses are in local currencies that are not the dollar, which means if the dollar gets stronger, then the expenses translated into dollars are shrinking. And therefore, you see an expansion in the margins. So it depends what happens in that driver. When you look next year, specifically, I said when we ended the year, the dollar got weaker. So the effect that we already saw at the end of last year, taking into account, looking into 2013 with around $15 million. So you can do the math, it's about, I think around 1%, 1.5%. And if the dollar get weaker, it can increase the FX. And if it bounce back and you can eliminate the FX completely. So I'm just reminding people that when you're going to a year that the dollar is weaker, then it's increasing the expenses, and therefore, you should expect to see a reduction in the operating margin, probably 1% to 2%, that's one. Second thing that we said if we already went into the drivers, we said the income, the interest incomes are going down because as cash is being released and the new investments are with very low interest rates in the market, then the interest income is going down. And our new cash, majority of it we're using for buyback. So it's not compensated by the increased cash.

Keith Weiss - Morgan Stanley, Research Division

Okay. Is there any aspect in that increasing investments for growth, or like you're talking about earlier, educating the marketplace about what you guys have, the blade [indiscernible] you had?

Tal Payne

Yes. But every year, we have an increase. The reason you didn't see significantly the increase in 2012 was because the dollar got stronger in 2012, so it's eliminated that, so you didn't see. But we're increasing every year. Every year, we increase our sales and we increase R&D. Last year, you couldn't see because of the dollar. And this year, you will see it more because the dollar is against us. So you will see both, you'll see the dollar effect and you'll see the goal.

Keith Weiss - Morgan Stanley, Research Division

Let me try to squeeze one last one in. There's recent changes in Israeli tax law that people have speculated couldn't enable you to get more aggressive with share repurchase than you already could have increased share repurchase authorization. Any update on how you guys are thinking about that, potentially utilizing some of that cash on the balance sheet?

Tal Payne

We increased like, I think it was 2 quarters ago, we announced that we increased our buybacks to $1 billion for 2 years. It's around $125 million a quarter. Some quarters, you will see more; some quarters, you will see less, but the leverage you'll see around $125 million or so. That's just the average of that number, right? And if we think we should increase more, we can increase more, so that's not linked to that limitation. The tax change is an added bonus, you understand, that you can actually join that new law and reduce tax risks not only to increase the buybacks but reduce some of tax risks that are associated with the law, and many companies consider it, then we have until the year end to decide. And I don't know what we'll decide. It's quite complex. It's not very clear, the law, so you need to make sure it's clear before you join it. So I will say the minute we will know, you will know as well.

Keith Weiss - Morgan Stanley, Research Division

Okay. Excellent. Unfortunately, that takes us to the end of our session, but thank you very much for joining.

Tal Payne

Thank you.

Kip Meintzer

Thank you.

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