Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Check Point Software Technologies Ltd. (NASDAQ:CHKP)

Q2 2013 Earnings Call

July 18, 2013 8:30 am ET

Executives

Kip Meintzer

Tal Payne - Chief Financial Officer

Gil Shwed - Co-Founder, Executive Chairman and Chief Executive Officer

Analysts

Michael Turits - Raymond James & Associates, Inc., Research Division

Shebly Seyrafi - FBN Securities, Inc., Research Division

Shaul Eyal - Oppenheimer & Co. Inc., Research Division

Gregg S. Moskowitz - Cowen and Company, LLC, Research Division

Walter H. Pritchard - Citigroup Inc, Research Division

Gregory Dunham - Goldman Sachs Group Inc., Research Division

Daniel H. Ives - FBR Capital Markets & Co., Research Division

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Tal Liani - BofA Merrill Lynch, Research Division

Gray Powell - Wells Fargo Securities, LLC, Research Division

Philip Winslow - Crédit Suisse AG, Research Division

Keith Weiss - Morgan Stanley, Research Division

Aaron Schwartz - Jefferies & Company, Inc., Research Division

Brent Thill - UBS Investment Bank, Research Division

Daniel T. Cummins - B. Riley Caris, Research Division

Jonathan Ho - William Blair & Company L.L.C., Research Division

Brad A. Zelnick - Macquarie Research

Operator

Greetings, and welcome to the Check Point Software Second Quarter 2013 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Kip Meintzer, Head of Global Investor Relations for Check Point Software Technologies. Thank you. Mr. Meintzer, you may now begin.

Kip Meintzer

Thank you, Jessie. I'd like to thank all of you for joining us today to discuss Check Point's financial results for the second quarter of 2013.

Joining me on the call 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 July 25. If you'd like to reach us after the call, please contact Investor Relations by emailing kip@checkpoint.com or dialing +1 (650) 628-2040.

Before we begin with management's presentation, I'd like to highlight the following items: during the call course of this call, Check Point representatives will make certain forward-looking statements. These forward-looking statements may include our expectations regarding demand for our security products, our expectations regarding the introduction of new products and programs and the success with those products and programs and our expectations regarding our business and financial outlook for the third quarter and full year of 2013. Other statements, which may be made in response to questions, which refer to our beliefs, plans, expectations or intentions, are also forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.

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 filed on Form 20-F. As a reminder, Check Point assumes no obligation to update its forward-looking statements except as required by law. 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'd like to turn the call over to Check Point's Chief Financial Officer, Tal Payne, for a review of the financial results.

Tal Payne

Thank you, Kip, and hello, everyone. I would like to thank you all for joining us today for a review of the second quarter of 2013. Our revenues for the second quarter increased to $340 million, representing a 4% growth over the same period last year and towards the higher end of our guidance. Non-GAAP EPS was $0.83, representing an 8% growth over the same period last year and at the top of our guidance.

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

Now let's take a look at the financial highlights for the quarter. In the second quarter, revenues reached $340.2 million, representing an increase of 4% compared to $328.6 million in the second quarter of 2012. Product and license revenues were $120.8 million compared to $123 million last year. Sequentially, we had a strong increase of 13% coming mainly from our higher-end products and data center.

Our software update, maintenance and subscription revenues reached $219 million, representing a growth of 7% year-over-year. The growth was driven by our annuity Software Blade that are recognized as subscriptions. We continue to see great success in our annuity blades led by our intrusion prevention blade and the threat prevention blades, including Application Control and Anti-Bot.

Deferred revenues as of June 30, 2013, were $580.4 million, an increase of $43.8 million or 8% over June 30, 2012. Sequentially, we had 1% decrease as seasonally expected.

Revenue distribution by geography for the quarter was as follows: Americas contributed 47% of revenues; Europe with 37%; and Asia-Pacific, Japan Middle East and Africa region contributed the remaining 16%.

From a deal size and quantity perspective, this quarter, we saw an increasing number of larger deals. Transactions greater than $50,000 accounted for 68% of the total order value compared to 66% in the same period last year. We had 41 customers that each had transactions with a value greater than $1 million compared to 40 in the same period last year.

Our non-GAAP operating margin this quarter continues to be strong at 58%. GAAP net income for the second quarter of 2013 increased to $151 million from $150 million last year. GAAP earnings per share increased to $0.76 from $0.71 per diluted share in the same period last year.

Non-GAAP net income for the quarter was $165 million or $0.83 per diluted share, up from $161.8 million or $0.77 per diluted share in the same period last year. Non-GAAP earnings per share were towards the top end of our guidance, representing 8% growth year-over-year.

Our cash balances reached $3,571,000,000 at the end of the quarter. Our cash from operations this quarter was $204.7 million, an increase of 30% from $157.5 million in the second quarter a year ago. We had very strong collections from customers resulting in our DSO, days outstanding, reducing to 71 days from 78 days in the first quarter of 2013.

During the quarter, we repurchased approximately 2.9 million shares for a total cost of $143 million.

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

Gil Shwed

Thank you, Tal. I would also like to thank everyone for joining us on the call today. Tal addressed the financial results. Now we would like to provide some further information to you about our business and products. The second quarter was very good one. We've seen an impressive increase in business volumes in the second quarter compared to the first one. While the first quarter had decent results with soft growth, the second quarter provided a very healthy upswing in business volume. The mainframe came from 2 areas: the North American sales organization and data center solutions. In North America, we saw a very healthy increase in business activity with the biggest jump in new product sales. This is always encouraging as the U.S. market is the largest, most sophisticated and competitive market in the world.

Europe provided solid results this quarter. However, we did experience some softness in Asia, partly as a result of severe currency change that occurred in the past year. In particular, in Japan, there was a devaluation of 23% in currency, resulting in reduction to our dollar revenues.

On the appliance side, over the last few months, we've continued to increase the performance of our data center appliances with the introduction of new 21000 series model, the 21600 at the end of 2012, and 21700 at the beginning of 2013 and the 13500 model we just introduced yesterday.

The 21000 series has provided stellar results this quarter with high growth in both units and dollars. Once again, this is encouraging since this is the most lucrative segment of our industry. Furthermore, we demonstrated the need of customers to utilize more power as they turn on additional layers of security and purchase new software blades.

On the other side of the prem [ph] spectrum, we released a new series of products. These low-end products complete the product transition and unification we executed last year and utilized our new embedded GAiA secure operating system. The 1100 series appliances targeted at branch offices opens many opportunities for large-scale deployment in various industries, such as retail, industrial applications and more. The 600 series is targeted at small businesses. It include a new web user interface that enables these users to run the device with no dedicated IT staff. And it is priced very attractively with prices ranging from $400 to $1,200.

Both these products are off to a good start with healthy sales. The superiority of the 600 series technology and value was demonstrated by a recent Network World review in which our 640 model received an excellent score of 4.7 out of 5 compared to mediocre scores of 3 to 3.8 for 7 other competitors. This is a huge lead, especially in this market segment. We are proud of this achievement and look to invest more in sales and marketing in this market segment.

We've also had good amount of marketing activities this quarter. We held our 2 largest Check Point Experience customer and partner conferences that enjoyed a very healthy level of attendees. In the U.S. conference, we realized a jump of almost 50% in number of participants. Hopefully, this increased interest will lead to higher levels of investment in cyber security. So overall, I'm very pleased with the business activity and results we experienced in the second quarter.

With that said, this brings me to the financial outlook. You know my regular caveats. It is always hard to predict the future. There are many factors that could point to better results and there are many reasons to be cautious. I would now like to provide you our projections for the third quarter and update our annual projection based on the first half results.

For the third quarter, revenues are expected to be in the range of $330 million to $350 million, and non-GAAP EPS in the range of $0.80 to $0.86. GAAP earnings per share is expected to be approximately $0.06 less.

For the full year, revenues are expected to be in the range of $1,360,000,000 to $1,410,000,000 and non-GAAP EPS in the range of $3.33 to $3.46. GAAP EPS is expected to be approximately $0.27 less than that.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is coming from the line of Michael Turits with Raymond James.

Michael Turits - Raymond James & Associates, Inc., Research Division

Two questions. Obviously, you beat a little bit here, but you did lower on the back half, just lower for the year. So what are your thoughts on the back half? And then also, can you talk a little bit about blades? What are the renewal rates for both bundled and unbundled and maybe what the growth rates are?

Gil Shwed

So first, let's start with our projection moving forward. I think we've basically adjusted our ranges based on the first half results. I do expect a healthy second half. And actually, if you look at the numbers, you can see that our earnings per share target or midpoint remained the same as it was 6 months ago when we first gave the projections for the year. We've actually narrowed a little bit the range from $3.30 to $3.50 to $3.33 to $3.46. The midpoint is actually in the same place. So we -- so overall, I'd like to think that we'll see the business volumes continue to pick up like we've seen in the second quarter, but I'd also like to be cautious and adjust the annual numbers to the first half results.

Tal Payne

Yes, and I would -- sorry, so -- and I would look -- sequentially, you'll see that we're assuming that we will have reasonable growth and healthy growth sequentially as we typically see between Q3 and Q4. When we talk about your question to the renewal rates, I'll remind you that these renewal rates can shift easily because the people can move from regular blades to packages and so on. They can buy a new one. There rates remain in the same like previous quarters, but I wouldn't make that as a specific guidance that we provide every quarter.

Michael Turits - Raymond James & Associates, Inc., Research Division

Can you tell us anything about blade revenues, annuity blade revenues maybe as a percentage of total revenues, as a percentage of service revenues or the growth rate?

Tal Payne

Yes, revenues picked up more than 25% this quarter. So the growth year-over-year was above 25%. Probably as a percentage of the update maintenance subscription, over 20%. I don't know if it was -- I don't remember if it was 21% or 23%, but you have all the numbers. You can calculate them.

Operator

The next question is coming from the line of Shebly Seyrafi with FBN Securities.

Shebly Seyrafi - FBN Securities, Inc., Research Division

Can you also -- can you talk about the unit growth last quarter and the ASP change? And separately, when do you expect product revenue to go positive? Do you expect it to go positive this quarter?

Tal Payne

I'll remind you Q3, usually, if you look at the last 4 years, I think most years except for one, typically, product booking and revenues in Q3 are slightly below Q2. It can be obviously a few million more or a few million less, but it's the same range. And services increase typically in a few million, so the run rate continue. And that's how you can see our guidance. It's -- you can see that where we are in the midpoint and so on. And when you look at -- and I don't expect that to change in this Q3 because that's the regular Q3 phenomena where half of the world is taking vacation. So there's nothing new there. Q4, we expect to see growth in the products and you can see it in the range of the guidance and in the midpoint that we provided.

Shebly Seyrafi - FBN Securities, Inc., Research Division

Okay. On the unit ASP changes?

Tal Payne

So when we looked sequentially, everything grew. The units and the ASP, it was very healthy from both perspective. Year-over-year, units reduced slightly and ASP increased. So it's the same phenomena we saw in Q4 and Q1. It continues in Q2, which is great and now we're starting to see number of units basically stabilizing, and hopefully, we'll start to see growth going forward.

Operator

The next question is coming from the line of Shaul Eyal with Oppenheimer & Co.

Shaul Eyal - Oppenheimer & Co. Inc., Research Division

A couple of quick questions on my end. In the press release, you specifically indicate the app control and the threat prevention blades are kind of really in some kind of good growth. Can you provide us kind of with some kind of more granularity on that front? In what way the app control might be different than other competing products out there? And what about kind of this threat prevention at this point?

Tal Payne

Gil will relate to the product. In terms of the numbers, our top blade wherein [ph] remains intrusion prevention, which has been there for a while. It's still going in double digit, which is very nice to see although it's been there for since mid-2009. Application Control is our #2 blade, doing great with strong double-digit growth as well. Both, by the way, bundled and unbundled. So when we see it in the unbundled, it means that customers are buying it from their own free will, and it continues to grow and it's great to see, which allows us to see a growth of over 25% in our -- up in our subscription annuity blades revenues, which is great. So that's why I mentioned those. Anti-Bot is a pretty new one. It's a small number, but we've still seen a very nice increase there or actually, a few hundredths of a percentage, but it's a small number. But it was -- it's a nice number because it's not $0.5 million or $1 million or $2 million. It's even more. So it's nice to see that growing as well.

Gil Shwed

In terms of the technology, I think our Application Control provides more -- much more granularity than competing products. We have a much bigger database of application over the Internet. We know how to do different methodologies of in-depth analysis, and I think it's a great value. And our threat prevention, when I say threat prevention, it's actually a combined name for several technologies and several blades. The intrusion prevention, which is the biggest one, both in terms on the content and the amount of sales, but it also, just like Tal said, the Anti-Bot, which is now several million dollars in revenues already. And the other blades, like the antivirus, and coming soon will be the Threat Emulation blade and so on. So I think together, we have very, very strong coverage for different layers and different cyber security risks that companies are facing. And I think that today, we're the only product that provides this kind of total protection or an overall multilayer protection that the enterprises need so much in fighting the risks in cyber -- in the cyberspace.

Shaul Eyal - Oppenheimer & Co. Inc., Research Division

Got it. And performance in Europe, Gil, you indicated all-in-all stable. Kind of can you provide us with more color of that specific countries, regions that performed well or a little less this quarter?

Gil Shwed

No, I think Europe this quarter performed exactly like expected by the model. There were some countries that were better. There were some countries that were soft. But overall, the performance was as expected. And again, nothing -- in the U.S., we had a nice jump in the volume. In Europe, everything was as planned.

Tal Payne

I can give you some color in the sense that, remember, we're talking about the microeconomic environment that is weak. So taking that into account, we did okay there, which meant we had growth. We didn't decrease, but it's a single digit, of course. And when we look at the region, some countries were weaker, some countries were stronger. Every quarter, it's really different, different countries in Europe. So this quarter, it was some countries like the mid -- U.K. and East Europe and a few others, and we had some other countries that were weaker.

Operator

We'll move on to the next question, which is coming from the line of Gregg Moskowitz with Cowen and Company.

Gregg S. Moskowitz - Cowen and Company, LLC, Research Division

Gil, you mentioned, I believe, that North America saw the biggest jump in new product sales, but was this mostly selling into your installed base? Or did you attract a fair amount of new customers as well?

Gil Shwed

I think it was typical. It was a combination. There's always new customers and there's always -- again, we have a very large installed base. So most of the large customers are already customers but we have a few nice wins, and we have a few nice win-backs from competition. And I think overall, we're very pleased with what we saw.

Gregg S. Moskowitz - Cowen and Company, LLC, Research Division

Okay, great. And Tal, was the ASP increase that you saw, both sequential and year-over-year, purely due to a mix shift towards the higher end? Or are there any other factors as well?

Tal Payne

Yes, it's usually relating to a shift -- to a mix shift. So if we sell more high end, we typically will see an increase in ASP, which is maybe not in line with what we talked about last year, that we said maybe the long -- the larger products take longer to certify with customers and maybe that's why we start to see now an increase in the higher-end products.

Gregg S. Moskowitz - Cowen and Company, LLC, Research Division

Okay. Perfect. And one last one, if I could, for Gil. What is the early response been to the Threat Emulation blade? And is it being more -- deployed more often on prem or in the cloud?

Gil Shwed

Well, Threat Emulation blade is not [indiscernible] yet so the early responses from early access [ph] sites that we've tested it on and I think the overall reaction is very positive on every site that we have. We found some new attacks and many attacks that weren't discovered by other technologies. I think it performs quite well, and I think it's provided very unique value to date. The only integrated one actually scales the file document, which is the main source of a malware when you get this kind of a strange office or PDF file which would look innocent. Then, when you actually open them, you don't notice anything strange but then something infects your computer. So we're actually getting very, very positive responses from the sites that already tested it. I'm looking into offering it mainly as a cloud service. I think it uses the value of our ThreatCloud infrastructure, and it's a great way to have people deploy it simply and quickly and get the results out of the box.

Operator

The next question is coming from the line of Walter Pritchard with Citigroup.

Walter H. Pritchard - Citigroup Inc, Research Division

Can you talk about the return of capital and any potential for upticking the rate of buyback that you have going at this time, especially as it relates to the $1.8-or-so billion in cash you have that's covered under some of the approved and privileged enterprise jurisdictions in Israel?

Gil Shwed

I think, first, we are very pleased with the fact that we did increase the amount of buyback, and we'll always look into that. We announced the $1 billion buyback program. I think we've executed on it pretty well right now. And once we get there, more to the bottom of this program, we will reconsider a new one and what's the rate that we want to do, but I think we are very positive about that.

Walter H. Pritchard - Citigroup Inc, Research Division

And Tal, just a follow-up to that. Tal, are you thinking about that being an end of -- that's kind of in November, December time frame in terms of getting to the bottom of the issue that Gil is discussing, just to clarify that?

Tal Payne

Yes, as we said, Gil was talking in general, as we did for many years, and we want to continue right now, that to continue and have buyback, and this year, we increased it. And when we finish this program, we will consider increasing again based on the board discussion. So that's what Gil's relating to specifically. You're asking about the November time frame, regarding the ability to increase from all the cash or from the cash that was before the beginning of 2012. And for that, if we have time until November and we will know by that point, as we discussed before, there's some consideration for, there's a few consideration against. So we are taking our consideration. We will decide by the time we will need to make the decision.

Operator

The next question is coming from the line of Greg Dunham with Goldman Sachs.

Gregory Dunham - Goldman Sachs Group Inc., Research Division

I guess, first question is, can you maybe describe how the business progressed in Americas during the quarter just from a linearity perspective? And then a follow-up to the previous question. You haven't done an acquisition in a while either since 2011. Can you just comment on your acquisition strategy and what we should expect going forward?

Gil Shwed

I think linearity in the quarter was typical to most quarters, a little bit less back-end loaded in previous quarter. But again, it's still, this is -- we're talking about a hockey stick phenomena always and that was the case. I think this -- the last quarter, we had quite nicely from the standpoint with the business volumes were higher from the beginning of the quarter. But as I said, since most of the -- since most of the revenues or the bookings arrived at the last 2 weeks, this can always change and not only always indicative. But last quarter was very positive all along. What was the second part of the question?

Gregory Dunham - Goldman Sachs Group Inc., Research Division

Okay. The acquisition. I mean, the cash balance is up like 30% since '11 and you haven't done an acquisition since that time. I know you got the tax issue with the cash balance and you're actually on the buyback. But I just wanted to get clarity on, did you feel that there's an opportune time to be more aggressive in terms of acquisitions?

Gil Shwed

Yes, I mean, we are investing more time and more resources in trying to find the right opportunities for acquisition. And I would like to think that we will find an acquisition. As I said, we're still being very selective because I think there's still the main value long term is finding the right synergies and the right quality of companies and that's always hard to find and it's not becoming any easier. But if you look at the allocation of my time and several more members of the Check Point management team, we are spending more time in trying to find the right acquisition target.

Operator

The next question is coming from the line of Daniel Ives with FBR Capital Markets.

Daniel H. Ives - FBR Capital Markets & Co., Research Division

In regards to -- just anecdotally, are you starting to see more customers going for sort of end-to-end, sort of next-gen security product portfolio rather than bits and pieces? I mean, you're definitely starting to see that the trade-down effect started to diminish pretty significantly. But maybe you can talk about the difference in your conversations with customers. Is it going from small projects to just larger and larger? That seems what the numbers indicate.

Gil Shwed

I think, overall, the answer is yes. I mean, the level of professionalism and the level that we discuss with customers is getting higher and higher. Remember, they're still a small percentage. I mean, we're seeing a consistent growth in large deals but we have several dozen large deals or huge deals every quarter. There's still thousands of smaller deals that we see every quarter. But overall, I must say that I'm meeting and the rest of the Check Point team and the sales team meets with more higher level people, we have new projects for a full security assessment of the customer environment, which is also turns to be very successful. We are coming to customer site, and for a week, conduct open discussion, open review and then provide the customers with total security recommendation, not just about Check Point products but what should be their security policy, what should they change, improve and do on their security in general. And I think overall, I think the level of security discussion is going up and elevated.

Tal Payne

I would just add that you will see from the software blade numbers that we see more and more customers using more blades on our gateway, which allows the nice growth that we've seen, the software blade revenues.

Daniel H. Ives - FBR Capital Markets & Co., Research Division

Okay. And then just sort of as a follow-on, I mean, obviously, you guys are well aware the perception over the last, we'll call it a year or 2, losing share to some competitors. Obviously, we've seen some of those stumble in terms of numbers. Do you feel like the tide has maybe turned a little in the channel from what you've come out with from a prior perspective, as well as just broader high-end deals? Maybe -- you don't have to talk about specific compares, but just what you could talk what you're seeing in the bake-offs and maybe how things have changed over the last 6 months.

Gil Shwed

I don't think things have changed much in the last 6 months. I think I would like to say that we're doing better and I think we are doing fine. The market remains competitive. I think what we are able to offer compared to some of these vendors is much more comprehensive view of security, much more scalable solution and solution to many more problems, even including things like the end point. We didn't highlight it too much recently, but I think we have a lot of things there on our plans and -- that we are offering now that makes our security offering much broader. I think the IDC report that's published every quarter does indicate that we are keeping and even increasing our share. So I think, overall, the indications are good and yet, at the same time, I don't want to create the impression like we are not in a competitive market. We're in a very competitive market and I think the ability to win and do it on a consistent and stable basis is, I think, one of the qualities that we have in Check Point.

Operator

The next question is coming from the line of Sterling Auty with JPMorgan Chase.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

I wanted to dive into the comment, Gil, that you made in terms of data center. Can you clarify -- I think you may have mentioned it a little bit earlier, but which products are you seeing adopted by the data center? What type of data centers are we talking about? Are you talking about telco data center or enterprise? And are these upgrades of previous products? And where are you seeing the upgrades coming from? Either your own solutions or competitor solutions?

Gil Shwed

The data center series that we have is ranging from the upper end of the 12000 family to the 21000. These are

[Audio Gap]

with data center model and so on. And they have a quite wide range in price and performance. It's not just one product. It's a combination. I mean, there are a lot of new projects that we win that companies are doing a new security architecture. There are some places that there's new data centers that we equip. And there are some upgrades, obviously, because we have a lot of customers. And there are even some win-backs in places when there are some emerging vendors that have won a project a year or 2 years ago and the customer is now coming back to Check Point and wants to do the new data center with us, or in some cases, even throw out a year-old competitive product for -- and get back to Check Point once they realize the value.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Okay. And then on a different topic. Tal, on Bloomberg, there was a comment either yesterday or the day before saying that the finance minister was reviewing taxes paid by top companies, including yourselves and Teva. Did you see that? And is there any commentary that you can give us?

Tal Payne

Sure. Yes, of course, I saw it. I'll just give you the context. If you remember, in the beginning of 2012, the tax laws had changed in a way that the interest rates were, instead of having different tax rates, now there is a flat tax rate for companies who have approved enterprise. And then there was a reduction in the tax rate. And now because of the macroeconomic, in general, in the world and specifically in Israel, there is a need maybe to increase it. There is a proposal to increase it. If it will pass, it means that it will increase back to the level that you've seen in 2012. So you saw it wasn't a significant change. It can increase the tax in 1% to 2%. But we'll have to wait and see what will pass in the government.

Operator

The next question is coming from the line of Tal Liani with Bank of America Merrill Lynch.

Tal Liani - BofA Merrill Lynch, Research Division

I have -- I'm looking at, this year, numbers in your guidance. This year, the sequential growth rate is worse than every quarter last year, including your guidance. But we should have had acceleration this year, and I'm trying to understand the guidance. That's the question. On the other hand, your commentary is very positive. So can you talk about the areas of growth, where do you see improvement and what's driving it, spending versus product? And also, what causes you -- in areas of weakness, what causes you to be guiding for flat revenues when things need to accelerate right now?

Gil Shwed

I think, first and second quarter, we've seen a very nice sequential growth in business volumes in all indicators, both the product revenues but also a lot of internal indication that we are looking inside. As I said, the main areas of strength were the North American market, in general. Sequentially, we saw a very healthy growth in sales of all products. And year-over-year, the biggest growth were in data center products that we've seen overall. I think for the year itself, we are maintaining kind of the same levels of growth quarter-over-quarter that we anticipated before. We are adjusting the numbers for the year based on the first half results. And I think overall, we anticipate to be in good levels of business and good levels of profit.

Tal Liani - BofA Merrill Lynch, Research Division

And Gil, what are the challenges that you have now into the second half of the year? Now that maybe spending is recovering, competition had gone up over the last few years, specifically over the last 2 years. You have new products also out. What are the challenges, the main challenges? Are they on the technology side to come up with new product, et cetera, or maybe on the sales side? And how do you address the challenges?

Gil Shwed

First, I don't know -- I don't know if the spending environment is improving or not. We had a very nice quarter in North America and we are very happy with that. I don't know if it's indicative to the overall spending environment or not, I hope it is. Challenges, I think we always have a lot of challenges. I think the main challenge that we have today is feet on the street, more salespeople being more aggressive on our sales and marketing campaign. Again, I think that for the first -- the last 3 months, it seems that things worked out. I hope that will continue to work out for the rest of the year. But we are definitely seeing that we are -- when we are fighting for accounts and we are showing the value of our products, customers love it and customers do their large projects with us. So I think that's, I would say, the main challenge that we have.

Tal Liani - BofA Merrill Lynch, Research Division

And are you happy with the current investment in sales and marketing, in a sense that any need to change it going forward to increase it or reduce it? How would you characterize your OpEx as a way to address the opportunities?

Gil Shwed

Generally, I'm very happy with it. I must also say that I think we are hiring salespeople whenever we -- as fast as we can and whenever we find that there is the potential to do so. Long term or even midterm, there shouldn't be much impact to the operating model because salespeople do provide good return on the investment and in the reasonable period of times, I mean, within months, not within years. So I think to change the model, the challenge is find good people and the challenge is to find the good people in the right places and that's -- and we have a competitive market on that front. And it's very, very hard to find good people. And I don't want -- I mean, I think I want -- don't want to compromise on the quality of people that we have in Check Point [indiscernible] for many, many years. If the return is good in the short to midterm, it should be the relationship that I see with our employees are long term. So I'd like to have good people in the company and not compromise on that.

Operator

Our next question is coming from the line of Gray Powell with Wells Fargo.

Gray Powell - Wells Fargo Securities, LLC, Research Division

Can you talk about the inroads that you're making on the lower end of the market with the 600, 1100 series appliances? And how do you view the competitive environment and margin profile of that part of the market?

Gil Shwed

So I think, first, we've just started with these 2 products and then we started quite well, actually. We did see a nice increase in both units and double-digit increase in units from these areas of the market and nice increase in dollar volume for these after many, many years that we haven't really provided with new product for their market segment. I mean, the previous product family that we are replacing is based on products that are almost 10 years old. I mean, they updated a little bit over the years, but basically, almost 10 years old. So I think it's a big change in what we are providing right now. The indication so far is very good. Now the reason that there are 2 different families is because they are also targeting different audiences. The 1100 is going into our typical installed base, large corporations. And then it's our existing sales force that needs to be more assertive and more -- and address more the large scale sort of branch office deployment. That's the 1100. The 600 opens a lot of new doors. It's a different market segment -- market segment which has a lot of competitors that are not always the competitors on the enterprise side. It's a market that's more price sensitive that has sometimes different distribution arms. I think we have the entry into that market. It's not completely new to us but it's a blue sky. I mean, there is a lot of openings in that marketplace. There's thousands -- actually, tens of thousands of small retailers that we are not working with yet. There's hundreds of thousands of small companies that haven't heard yet about Check Point, and there, we are looking for more and to find the right leverage point, the right distribution arms, the right people that can get us into this bigger market opportunity.

Tal Liani - BofA Merrill Lynch, Research Division

Got it. And then just a follow-up, if I can. Like, I mean, do you feel that there's a potential for you to be disruptive on the lower end?

Gil Shwed

I think we can. I think, again, we were positively very happy about the review that I described in Network World because it does show that in a market that we are coming with a brand new product, completely redesigned, we're getting into a market that there are many companies. For them, it's their bread and butter and they improve the product every quarter, and we are doing quite well. We are not bad company. We're getting to the #1 spot instantly in such a big gap. So I hope it does provide some opportunity for some disruption in this marketplace. But again, remember, getting to tens of thousands of resellers takes time. Sometimes, customers in that marketplace are not that educated about the product. They just want something to do the job. They are in a typical small business -- is not the one would do a month long bake-off of 3 different security products to see the differences. And one thing that's important to us, on one end, I think we see the opportunity and we want to address in that market but we definitely don't want that market to disrupt our core market of enterprise sale. That remains the first priority for us. And I think we want to do the 2 together and not take from the opportunity on the enterprise side.

Operator

The next question is coming from the line of Phil Winslow with Credit Suisse.

Philip Winslow - Crédit Suisse AG, Research Division

Just had a question for Gil on the pricing environment, just the competitive environment out there. I mean, there's been a lot of -- obviously, security has been a very competitive space for a long time. Just curious if you think the pricing environment is stable or getting better or getting worse? And also, just from a competitive perspective, I wonder if you could comment just generally on win rates and if you're doing particularly better against any one of your competitors.

Gil Shwed

I think the pricing environment varies. Our -- and I think there are some changes. I mean, sometimes we see a competitor that would go into one country and be extremely aggressive in one country. And then we see in that quarter, a big decrease in prices in a specific region. Usually, it moves to a different place in the next quarter. So I don't see anything very, very consistent there. The market remains competitive. It hasn't changed. I don't know if there was big change in the win rate. I don't -- we don't measure specific numbers. So I'm not -- so I don't have any long-term data. I get the feeling that we win more projects and that we are doing quite well. But I don't have any measurable indication to a -- to justify that beyond the feeling of our people, especially North America, when I think we had a very good quarter and our sales force was feeling very good about that.

Operator

The next question is coming from the line of Keith Weiss with Morgan Stanley.

Keith Weiss - Morgan Stanley, Research Division

You guys did have a really nice rebound in North America growth this quarter. It doesn't sound like you're completely bought into the environment got better. Did you guys do anything different in terms of sales process or marketing process during the quarter or in the first half that started to gain traction, in particular in North America?

Gil Shwed

I mean, we've implemented a lot of new programs targeting new customers, bringing more salespeople that started again at the tail end of last year. We had the 2 big Check Point Experience conference, and especially, the American one had much more attendance than any year before. So I mean, all things -- all these things are good things. I don't know if there are dramatic changes or they are just incremental, evolutionary changes that we are doing. But obviously, our people are working very hard to bring the results.

Keith Weiss - Morgan Stanley, Research Division

Got it. And then maybe a couple for Tal. In terms of FX impacts, can you walk us through the details on the FX impacts to both the top line and the operating expenses or overall expenses?

Tal Payne

It was very hard to understand you but if you ask what was the effect of the FX this quarter, it was pretty much less than $0.01. It wasn't material. Last year, average rate and this year average rate was -- I'm talking about majority of the currencies in total had a breakeven effect. So some of them went up, some of them went down against the dollar. Total on the expenses, it didn't have any material effect. On the revenues, when you look, again, related specifically to Japan, the currency there year-over-year moved about 23% or so. And that effect is obviously quite material in one country. Remember, in Japan, we sell specifically in yen, which is not the policy in any other country. So there, it had not an effect on the actual booking in yen, but an effect in the translation back into dollars. Just as an example, what the currency did, we had the same, by the way, few quarters ago in India where you had a big change in the currency there. I think also there it moved in 20% or so and you see the same phenomena. So -- but in general, I would say that it's very hard to measure the effect on the booking because majority of the world and majority of our sales around the world are in dollars except for Japan. And the only thing it does, it affects of the budgets of customers, which is different. But what we can measure is the expenses in there this quarter, it was pretty much breakeven effect.

Keith Weiss - Morgan Stanley, Research Division

Got it. Maybe last one, high level, more philosophical question on the cash balance. Cash balance is now, I think it's over 30% of your market cap, around 33% of your market cap. Do you guys feel any pressure to sort of better optimize that balance sheet or any increasing pressure to do something with that cash rather than just have it sitting there on the balance sheet?

Tal Payne

Sure, sure. Like Gil related to that, I mean, we can see as well that the cash balance is $3.6 billion. I will tell you 2 phenomena that's happening. We are very interested and we said for a few years in M&As. And as you can see, valuation in the security markets are going up significantly. If you would have looked 5 years ago, you would be -- it would be very hard for you to find companies in a valuation of more than $1 billion and now it seems like it's quite easy. So if you look and want to keep options open, then you need to have the cash to enable you to have M&As, assuming it's the right M&A, right valuation, have synergies and allow you to grow in the future. And that's where the challenge is. It's not about the cash, for us, it's more about the valuation and that it makes sense economically. So that's -- but we would definitely like to find M&As and we said it very clearly. The second thing is in the buyback. Obviously, I mean, we started 3 years ago and with about $200 million a year. And now we're in a run rate of $500 million, $600 million a year. It's quite a big increase. And there might be increase in the future because we'll continue that way.

Gil Shwed

And I would also add to that. I think everything Tal said is correct. But those aren't to say that this is a problem that I think we share with several high-quality companies and I'm actually very proud to have this kind of problem and not other types of problems in terms of balance sheet. So I think that's always the right problem to have, is to have enough cash or too much cash rather than less cash than what we need.

Operator

The next question is coming from the line of Aaron Schwartz with Jefferies & Company.

Aaron Schwartz - Jefferies & Company, Inc., Research Division

I just had a question on the data center products. You talked about strength there. Can you talk about the blade attach rate on those products? Is that any different than sort of your broader enterprise sale? And then secondly, you talked about the sales hiring and the productivity there. It seems like maybe a little more focused on North America at this point. Can you help reconcile that with the guidance? I know you said it's just an adjustment from the first half here, but the adjustment falls a little bit more on the product line. Are you a little more conservative with the macro? And do the currency adjustments come into play with the guidance here? Or is this just the level of conservatism into the back half?

Gil Shwed

I think that in terms of the guidance in general and so on, I would hate to predict a lot of upbeat business getting into the third quarter. The third quarter is always the most challenging one. Everyone is on vacation all over the world. People are not rushing to spend their budget on new or existing projects because they're always back for Q4. So I don't want to deduct from one good quarter in Q2 to assume that that's going to be the run rate also in Q3 or the growth rate in Q3. I always want to be cautious there, and I think there's good reasons for that. It's not just being conservative or cautious. It's the real behavior of whole world. Q2, people had the first quarter, they were considering what to do and glad that they chose us and glad that they chose to do more projects with us. That's great. I'm not sure if they'll continue that in the third quarter or in the fourth quarter. So that's a little bit about how we look at the guidance and the model. And what was the second part?

Aaron Schwartz - Jefferies & Company, Inc., Research Division

The question was the blade attach rate for the data center products.

Tal Payne

So here, I can say one thing. It can be either way because it depends how much blade is actually taken on the box, and they have a lot of options to choose from. They can take very few or a lot because they can add the package with more blades into the boxes. Theoretically, in the lower end, there's a predefined more blades than in the higher end. But on the higher end, they can add more. And just as an example, actually, this quarter, the proportion of the bundled Software Blade out of the total product was slightly higher than the previous quarter, which may have meant slightly more moved into the deferred revenue than into the service revenue line versus the product, which might have affected slightly on the product revenues, which reduced it slightly more, but it can fluctuate. I think we got to a point that it can be pretty balanced between the quarter. Sometimes, it will take a few more percentage, sometimes less. But the range runs probably between 10% to 15% for the last 2 years.

Operator

The next question is coming from the line of Brent Thill.

Brent Thill - UBS Investment Bank, Research Division

Gil, just as you dig deeper in the U.S. business, were there any verticals that stood out to you that were showing signs of strength that you had not seen in past quarters? And a quick follow-up for Tal.

Gil Shwed

I'm always presenting [ph] that the broad statistics covers are what's indicative of the future, but we did have wins in the energy sector and think financial sector continues to be a very strong sector. Beyond that, everything is normal, and I think we have a very healthy mix of industrials -- everything, all kinds of customers, especially in the U.S. market.

Brent Thill - UBS Investment Bank, Research Division

Okay. So there wasn't one area, one vertical, like financials, that sat back. It was across the board.

Gil Shwed

Yes.

Tal Payne

Yes.

Brent Thill - UBS Investment Bank, Research Division

Okay. And Tal, just in the second half of the year guidance, when you look at the strength of the U.S. business, are you expecting that strength to continue? Or can you just give us a sense of how you're thinking about the -- each of the 3 big regions as you look at the second half?

Tal Payne

I mean, if you look -- again, if you look at sequential growth, if you look at the total numbers, I mean, you saw America had a great quarter but Asia had less and Europe was somewhere in between. But if you can look at the total growth, Q2 versus Q1 and you know that Q3 is usually the same or slightly less from Q2 and then Q4 typically grows in 20-something percent, then you can do the math and see what was our assumption. So -- and the reason you look at it that way is because we don't have visibility into Q4, really. As Gil said, majority of our booking come in the last few weeks of the quarter. So I can't pretend to have a big visibility, that there is a lot of science behind it. There are statistics. You have the data. You have the historical trend sequentially. I know the compare year-over-year is tougher because of the phenomena of last year, but sequentially, we have a good historical comparable, and that's how we based it.

Brent Thill - UBS Investment Bank, Research Division

Okay. And just real quick with the U.S. upswing, are you changing your hiring plans based on what you saw in Q2? Or are you still continuing at the plan that you started the year with?

Gil Shwed

We are continuing the plan that we started and we have a very healthy plan. So I think we are meeting up our internal plans in general in terms of hiring, but it's not easy. We have to work very hard every week to hire more people.

Operator

Our next question is coming from the line of Dan Cummins with B. Riley.

Daniel T. Cummins - B. Riley Caris, Research Division

I wonder if you could discuss with us how you're optimizing your spending efforts, your spending this year, with regard to getting new customers in the door? As you look at roughly $500 million of product revenue that you're likely to book in 2013, can you tell us how much you're expecting to come from new customers? And what will the improvement or the net change be from 2012? And if you could really characterize it with some color about verticals and product strata, that would be great.

Gil Shwed

I won't disclose too much of it. I think it's a very competitive data and I don't want to reveal all our tactics and strategies to our competitors. But we are active on all fronts and we're looking around.

Daniel T. Cummins - B. Riley Caris, Research Division

Well, how about just roughly kind of looking at a pie chart of product revenue this year versus last year? I mean, first half of the year is in the books, I mean, how much is being contributed by net new customers to Check Point?

Tal Payne

Typically -- we discussed it before. Typically, majority of our revenue is the #1 in the market. And the major part of our revenues is update and maintenance. Typically, a lot of it is coming from existing customers, and that hasn't changed for many years.

Daniel T. Cummins - B. Riley Caris, Research Division

Okay. Could I ask a follow-up? We've talked a lot this year about price sensitivity in firewall at all tiers of the market. Do you sense a bigger opportunity for you to use your scale, your balance sheet, to be more aggressive perhaps in the mid- and low tier to gain share?

Gil Shwed

I think we're definitely looking into that, but we also don't want to defocus our efforts, and so I think there is a nice opportunity, especially on small businesses that we can -- that we are executing on. But yet, we don't want to distract our focus from the main core areas in which we are competing, in which we are very successful, especially as we just saw with the success of our data center product. So the low end is a great opportunity. We will do more on that without taking our eyes off the ball on the data center and enterprise space.

Tal Payne

Yes, and I will add, since we know that in the lower end, there's a higher sensitivity to price, we price it in a very competitive way. And so far, it's too early to clap for us, but I will say, we had really good result in the first quarter when it comes to the growth in the units and in the booking. It obviously means that the pricing was right. And so you're right in your question. In the areas that we think that there's a price, then we can adjust the price. If we think it's the relevant thing to do, definitely.

Operator

Our next question is coming from the line of Jonathan Ho with William Blair.

Jonathan Ho - William Blair & Company L.L.C., Research Division

Just wanted to get a sense from you in terms of how many software blades customers are now subscribing to you at this point? I just wanted to get a rough sense of -- due to that pattern or the absolute number.

Tal Payne

How many what?

Daniel T. Cummins - B. Riley Caris, Research Division

Software blades customers are adopting on average at this point.

Tal Payne

Very hard to calculate because we have the packages. Many of the customers buy in packages that have 3, 4, 5 blades in the bundle. It can have as much as 7 or 8 blades versus only 3 or 4. I can't really calculate the number. But when you look at the total, you can see -- if I look at the total blades that we actually sell, we can see the number continue to increase nicely.

Jonathan Ho - William Blair & Company L.L.C., Research Division

Got it. And just in terms of clarifying the ASP comment, I just want to understand the trade-down effect that happened in prior years. Has that completely normalized at this point? And are -- if we look at it relative to prior years, is the ASP now actually higher than it has been in the past, so people on average shoot it down one level? I just want to get a sense of whether that effect's totally negated at this point.

Tal Payne

I think it's pretty much going back to the ASP level that we saw 2 years ago, so if that's what you mean in your question. And again, not exactly, because remember -- but in the same area, and obviously, just to be fair, it can fluctuate easily between quarters because the mix can shift every quarter. What we did see in the last 3 quarters is a phenomena of a higher level of products which led to an increase in the ASP.

Operator

Our last question is coming from the line of Brad Zelnick with Macquarie.

Brad A. Zelnick - Macquarie Research

I'll just ask one. Tal, cash flow looks really strong. Looks like collections were good. But can you take us through the highlights of your cash flow statement, and specifically, where do you stand on cash taxes?

Tal Payne

I'm not sure I understand the question about the cash taxes but I will try to answer. And if not, you can ask a following question. The main growth in the cash flow came from a -- the collection. Collection from customer was significantly stronger. And if you noticed, last quarter, we had a very strong cash flow. A lot of the cash flow last quarter came from the tax refund that we received. This quarter, it came from a strong collection. Another effect may be year-over-year, last year, the balance sheet hedge a negative effect, and this year, it was pretty much balanced. And that's the main item's indication. All in all, a very strong cash flow, mainly from -- as a result of the collection. When it comes to cash tax payment, all I can say is that it can fluctuate between quarters because you pay advances, and then during the year, you catch up and you pay more. So you can see some quarters that you pay less and then some quarters that you pay more. So on the taxes, I would look at the total year and not a specific quarter.

Brad A. Zelnick - Macquarie Research

And that was really the question, as to whether or not this quarter was one where you paid fewer taxes in the quarter. But just even if I look down at changes in operating assets and liabilities, that's a $40 million inflow this year versus an $8 million outflow last year. Within that, that's the balance sheet hedges and -- or is there anything else that's there -- significant in that line?

Tal Payne

Yes, you can see material change came from the deferred revenues line and accounts receivable line, which is relating to the collection. You see some increases in the taxes, which means you'll see some increase in next quarter payment of taxes. It's a lag on the tax payments like every quarter. But I would say, it's regular, nothing special, really.

Operator

Ladies and gentlemen, we have reached the end of our question-and-answer session. I would now like to turn the floor back over to Mr. Meintzer for any concluding comments.

Kip Meintzer

Thank you, everybody, for joining us today. If you'd like to get a hold of us, drop an email or give us a call and we'll be glad to address any of your questions further. Thank you, and have a great day.

Operator

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Check Point Software Technologies Ltd. (CHKP) CEO Discusses Q2 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts