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Check Point Software Technologies Ltd. (NASDAQ:CHKP)

Q2 2008 Earnings Call

July 22, 2008 8:30 am ET

Executives

Kip Meintzer - Director of IR

Tal Payne - CFO

Jerry Ungerman - Vice Chairman

Gil Shwed - Chairman and CEO

Analysts

Rob Owens - Pacific Crest Securities

Sterling Auty - JPMorgan

Phil Winslow - Credit Suisse

Robert Breza - RBC

Daniel Ives - Friedman, Billings, Ramsey

Todd Raker - Deutsche Bank

Walter Pritchard - Cowen

Israel Hernandez - Lehman Brothers

Garrett Becker - Merrill Lynch

Manish Hemrajanii

Brian Freed - Morgan Keegan

Michael Turits - Raymond James

Todd Weller - Stifel

Operator

At this time, I'd like to welcome everyone to the Check Point's second quarter earnings call. (Operator Instruction). Thank you.

I'll now turn the call over to Mr. Meintzer, Director of Investor Relations. Go ahead, sir.

Kip Meintzer

Welcome to all of you joining us today. This is Kip Meintzer, Director of Investor Relations for Check Point Software. On the call with me today are Gil Shwed, Chairman and CEO, Jerry Ungerman, Vice Chairman and Tal Payne, Chief Financial Officer. We'd like to thank all of you for joining us today to discus Check Point second quarter results.

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 www.checkpoint.com. For your convenience, the second quarter results replay will be available through August 5th. If you'd like to reach us after the call, please contact investor relations at +1-650-628-2050.

Now, before we begin with management's presentation, I would like to bring the following disclaimer to your attention. During the course of this call Check Point representatives will make certain forward-looking statements. These forward-looking statements may include expectations for our total security strategy, expectations that it will continue to execute on its strategic initiatives in the third quarter and beyond, beliefs that it will continue expanding and enhancing product offerings and expectations for its financial performance and growth for the third quarter and fiscal year 2008.

Other statements which may be made in response to questions which refer to our beliefs, plans, expectations or intentions are also forward-looking statements for the purposes of the Safe Harbor provided by the Securities Litigation Reform Act. Because these statements pertain to future events they are subject to various risks and uncertainties and actual results could differ materially from Check Point's current expectations and beliefs.

Factors that could cause or contribute to such differences include but are not limited to the risks discussed in Check Point's annual report on form 20F for the year ended December 31, 2007 which is on file with the Securities and Exchange Commission. Check Point assumes no obligation to update its forward-looking statements.

Now, it's my pleasure to turn the call over to Tal Payne, Check Point's Chief Financial Officer.

Tal Payne

Thank you, Kip. I'd like to welcome everyone and thank you for joining us today. I've been on board since mid June and had a chance to spend some time with management and my team. I'm very impressed with the quality of both as well as the rest of organization. I think it goes without saying that I'm very pleased to be part of such a great company. I look forward to spending time with those of you on the call at upcoming meetings and conferences.

Now I'd like to share with you the financial results for another great quarter for Check Point. Our quarterly results came in at the high end of our projections, as we continue to execute on our strategy and delivered results above our plans for the last six quarters in a row.

Before I'll provide you with an overview of the financial highlights for the quarter, I'd like to remind you that our second quarter GAAP financial results include equity-based compensation expenses according to FAS 123(NYSE:R) and expenses related to our acquisition.

Non GAAP information is presented excluding these items. In our press release which has been posted on our website, we presented GAAP and non GAAP results along with reconciliations table which highlight these data.

Now, let me share with you the financial highlights of the second quarter of 2008. Revenues for the second quarter were $199.6 million, an increase of 13% compared to the second quarter of 2007 and 4% sequential increase over the first quarter of 2008. We continued to see strength across the business from Check Point's branded appliance leading this organic growth.

Geographically, revenues growth was led by our enterprise business in the U.S. with increased demand in Asia Pacific. The distribution of the quarter is 44% of revenues coming from the Americas, Europe, Middle East and Africa contributed 44% and Asia Pacific and Japan region contributed the remaining 12% of the quarter revenue.

Our product and license revenues were $85 million with growth of 16% over the second quarter of last year. We believe these results underscore the success of many initiatives we put in over the recent quarters, including the introduction of our new high end Power-1 security appliance and the extension of the UTM-1 product line.

We exceeded our earnings per share plans for the second quarter of 2008 and achieved GAAP EPS of $0.36 and non-GAAP EPS of $0.43 at the high end of our guidance. We also maintained very high non-GAAP operating margins at 51% consistent with the first quarter of 2008 and the fiscal year of 2007. We achieved that despite the weakness of the dollar against different currencies around the world.

So here is an explanation about the effect of the dollar in our result. So potentially, all of our revenues are dollar denominated while approximately half of our expenses are non-dollar currencies, mainly the Euro and Israeli shekel.

The devaluation of the dollar increases our operating financial and tax expenses. This quarter the dollar devaluation increased our expenses compared to our plan by approximately $6 million representing $0.03 earning per share.

Our effective GAAP and non-GAAP income tax rate for the second quarter was approximately 18%, caused by the continued devaluation of the dollar and valuation of the tax provisions.

Deferred revenue this quarter were $279.2 million, an increase of $43 million or 18% over June 30, 2007. Also unlike June 30, 2006 and 2007 where deferred revenue decreased sequentially in line with the tradition of seasonality, this quarter we experienced a sequential increase of approximately $1 million over last quarter, as a result of strong subscriptions and maintenance in our new security services, such as the total security update services that continued to increase.

For the second quarter our DSO were 71 days compared to 69 days in the first quarter of 2008. As the number of large deals increased and our business remains back-end loaded. In the second quarter, we generated cash flow from operations of $82.6 million. Our cash and investment balances at the end of the quarter were over $1.34 billion.

During the quarter we purchased approximately 2.1 million shares for $50 million. We have approximately $350 million remaining in our current active share repurchase program. In addition, we made the last payment for the acquisition of Pointsec in the amount of $9 million.

So overall, I'm glad to report such good results in my first quarter as a CFO of Check Point. I'm looking forward for your feedback and support.

Now I'd like to turn the call over to Jerry.

Jerry Ungerman

Thank you, Tal and good morning to all of you joining us today. I'm very pleased to say that second quarter continued the trend of the last five quarters. One of the key drivers of the success continues to be that our customers are embracing our total security strategy of delivering a comprehensive suite of security products for the enterprise. We have continued to realize success across our product lines as customers look to reduce the complexity of their security infrastructure and increase overall security by utilizing the best of breed suite of technologies. At the same time, they're also reaping the benefits of reducing the complexity associated with utilizing multiple vendors and the headaches of integration.

Two areas that we continue to address, as we look to expand on our current success are the Asia region and middle market. Our new management team in the Asia region has begun to generate success, which has been reflected in the region's growth over the last couple quarters.

One factor contributing to the success in the region, as well as the other regions, is our appliance strategy which has been well received with the introduction in this past quarter of the two new Power-1 appliances and five UTM-1 models.

From the middle market perspective, we have delivered our new UTM-1 appliances with price points favorable to the middle market that have been well received. We look to further build on our success by developing initial new relationships with partners that specifically address these markets. We have realized early indications of the success of the efforts we have made to date by winning many new customers against our established competitors in this market segment.

Now let's take a look at the deal metrics for the quarter. This quarter we continue to see a number of larger deals, transactions greater than $50,000 accounted for 41% of total order value compared to 37% a year ago. We had 14 customers that each had transactions with a value of greater than $1 million coming from both network security and end point security products.

From the competitive standpoint, we continue to make inroads against our competitors during the quarter across all regions for both network and end point security solutions. This includes both new opportunities and displacements worldwide, as we believe we continue to increase our market share as evidenced by our results and input we received from our partners around the world. They are very excited about our ever-expanding security solutions and feel that we're well-positioned to meet our customer security needs with our total security solutions.

Now I will turn the call over to Gil.

Gil Shwed

Thank you, Jerry, and thank you all for joining us today. Tal and Jerry have already covered our financial performance during the quarter. I won't tell much from a financial perspective, except to emphasize that we continue to be very pleased with our results over the last year and a half. We believe that our financial performance is a balanced result of our total security strategy of delivering our customers with the unified security architecture for their infrastructure.

We just completed our Asia Pacific, Check Point Experience conference in Thailand and our customers continue to voice their approval of our product roadmap in total security strategy. The partners, I met with, were all supportive and showed great enthusiasm by the potential of our new products and strategy.

Moving forward, we intend to continue with that strategy. We intend to continue, execute on the total security strategy and further expand and integrate our comprehensive suite of security products toward continue and address the future needs of our customers.

Now for what, you've been waiting for, our guidance. Despite the uncertainty in the world's economy and the challenging condition, we've continued to produce strong results over the last few quarters. It's hard to say whether these market conditions are going to impact our business moving forward.

However, so far based on the information we've collected from our sales team, there continues to be an optimistic and empty outlook for the rest of the year. So for the first quarter, we expect revenues to be in the range of $194 million and $204 million.

GAAP earnings per share is expected to be between $0.34 to $0.38 per share. Non-GAAP EPS excluding the effect of acquisitions and stock-based compensation is expected to be between $0.41 and $0.45 per share is non-GAAP EPS. For the entire year I've likely slightly raised our annual revenue expectation to a revenue range of $805 million to $825 million.

Thank you for being here today. And now we'd like to open the call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Rob Owens.

Rob Owens - Pacific Crest Securities

Could you give me a sense of what the appliance revenue was as a percentage of licensed sales during the quarter?

Gil Shwed

Appliance revenues were approximately one-third of new product and licensing.

Rob Owens - Pacific Crest Securities

One-third. Okay. Then relative to the gross margin, as you've seen appliance revenue really take off as a percentage of the mix, your gross margins held in well over 91% here. What's the difference between the appliance business and your traditional business? And what should we expect with your gross margin going forward?

Gil Shwed

I think overall the appliance sales are contributing higher revenues, higher contribution to the bottom line. We changed a little bit the subscription model but we also increased the maintenance and subscription revenues. So I think overall our contribution so far is all positive. And, I don't know yet about the margin and how we will see them moving forward. But we do have good margins on our appliance business, consistent by the way, from what you see from any other security companies and networking companies, that all have high margin. And giving their percentage of our total revenues, that's how we maintained the overall growth margin number.

Rob Owens - Pacific Crest Securities

And I guess, more specifically on that since you've been in the appliance market now for six quarters, have you driven any cost efficiencies? Are you seeing higher margins now, then say, you were a year ago at this time? Or are your gross margins on the appliance business consistent with where they were a year ago? Thanks.

Gil Shwed

I think it's slightly improving. Again, it depends on the mix, but for example, this quarter we introduced five new models with update our entire UTM-1 appliance range. And these appliances all have much higher performance, higher capabilities for the customers, and we were able to reduce the cost that we have on these appliances.

So, I think overall we are focusing on both ends of the scale. The main focus that we have is to keep being on the forefront of technology. But we are doing that while making sure that we maintain a healthy cost structure and if you look at the traditional history of Check Point for the years, I think we are focused on both sides, and making sure our business is effective and efficient, and mainly on the customer needs and growing them.

Operator

Your next question comes from the line of Sterling Auty with J.P Morgan.

Sterling Auty - JPMorgan

Guys, couple of questions. First, I didn't hear it if this was in the prepared remarks. What was the mix between the network security and the data security?

Gil Shwed

I think last quarter we mentioned that we are not going to break it separately and we are consistent with that policy.

Sterling Auty - JPMorgan

Okay. And then on the appliance strategy, you talked about the margins but can you talk to us in a little bit more detail about the revenue capture that you might be getting in some of your appliances relative to the opportunity of just selling with a traditional hardware partner?

Gil Shwed

I think first, there are two things to explain. Obviously the revenue and the contribution per sale and per unit is much higher when we sell the total integrated solution. But our main focus here is not to capture more revenue from our partners but to expand to market segments and to customers we didn't capture before and that's what we are doing. So first, most of our appliances are in price ranges and performance ranges that couldn't be met before.

And second, we do analyze very closely to check what the deals we are winning and against whom. And for the most part, our replacement of appliances are against Check Point competitors and not against Check Point's partners. It's not replacement of all Check Point's partners. So, I think our metric what I checked last time, we surveyed that it's not in data point that we have all the time, but we did a month or so ago, a short survey of customers to see which platform we won again, for which platform we replaced with them, and more than 80% were competitive wins with our appliances, again Check Point's old competitors.

Sterling Auty - JPMorgan

And last question is, can you talk to us, with doing more larger deals, are you starting to do more of these deals direct to the customer? And what impact is that having both on revenue as well as the expense lines?

Gil Shwed

So far all our deals were through partners and with our consistent strategy. We do have main account manager we've worked with large customers for many, many years, I think it's like eight years now or something like that, so that's not new. And as I said, all our large deals we've done with partners and together with partners. So we didn't have too much effect not on the cost structure and not on the margin structure and they are all in there, and the good impact is that is high revenue, but nothing beyond that.

Sterling Auty - JPMorgan

All right. Thank you.

Operator

Your next question comes from the line of Phil Winslow with Credit Suisse.

Phil Winslow - Credit Suisse

Just a couple of questions, first, I know you introduced a new high-end appliance this quarter, I wonder if you give us a sense for attraction on that and in addition to the UTM-appliances? Two would be, Gil, I know you raised the revenue guidance for the full year, but just wondering if you could comment on the EPS. And then three just what is your outlook for tax rate for the rest of this year?

Gil Shwed

Okay, so I'll start with the appliances and then I'll let Tal, to speak more about the tax rate. The new Power-1 appliance line which we introduced, actually caught up quite nicely, it didn't have a huge effect yet, because it was shipping for about a month and a half in the quarter and remember in high-end sales, the sale cycle is relatively long. Having said that, it did contribute couple of millions, we did win couple of deals with it and we did one larger deal which will show effect later in the year.

So, I think overall we're very pleased with that performance of the Power-1. The Power-1, by the way of price, from lease price basis between roughly $35,000 to $50,000 would deliver performance of up to 14 gigabit per second and one metric were introduced to show our strength is that they deliver a price performance of less than $4 of megabit per second.

So, overall I think we got very enthusiastic responses for the first few weeks of shipping the Power-1 appliances. What was the other part of the question about appliances? That was about the outlook for the EPS. So I think we didn't change the EPS outlook for the year. I think Tal, clearly stated that given the very good results that we have on sales and bookings, I believe that we could have achieved much higher EPS. Unfortunately, the devaluation of the dollar didn't help us much. We could have had EPS higher by $0.03 this quarter.

It's very hard to estimate how it will affect the rest of the year for us, both because of the currency changes and also because of fall of our operating trends and how we would structure for them. So, we decided so far not to focus yet on the EPS but focus on growing the business and we keep the EPS guidance for the year.

Tal, about the tax rate?

Tal Payne

Yeah and on the tax rate, it's a continuation of what you just said regarding the devaluation of the dollars and obviously it's also affect the tax rate that we're seeing. In this quarter it was in 18% and we expect to see its remaining on 18% until the end of the year, and hopefully with the balance of the dollar back, we would see a reduction at the level that we used to see from the tax percentage.

Phil Winslow - Credit Suisse

Great, thanks guys.

Operator

Next question comes from the line of Robert Breza with RBC.

Robert Breza - RBC

Gil, I was wondering, if you could talk to us about the endpoint and what percentage maybe of revenues or product licensing that contributing and then when you look at the large deals, I'm assuming most of those are multiple products. But I was wondering if there is one product that kind of stands out amongst the large deals. Thanks.

Gil Shwed

It's a nice mix of deals, it was not one. The entire endpoint strategy is working quite well. We have our new unified single agent for security which were introduced earlier in the year and that's coming up nicely. Again, this is a relatively new market for us. We haven't been selling these kinds of products in the past. And we saw nice attraction and won some nice deals, even with endpoint and data security we won some very large deals. We won this quarter, a deal over $4 million that's a very nice win for us. I think as our overall customers, our large customers are buying our entire product mix, but fair deal we usually buy one product or one system.

So, if you look at the purchasing cycle, usually were the big projects and best project is end point or projects about branch offices or projects about network security and usually each project is separate that's a typical one. It does help if we have the full scale and does help our relationship with the customer when they know they can base their entire strategy on us. Typical deal are a sort of, not a single product but single product line deal, each one of them.

Robert Breza - RBC

Maybe this is a quick follow-up for Jerry. You specifically called out Asia is starting to see rebound there with the new management. Can you talk to us about how we should expect, maybe the geographic mix to shift over the second half of year? Thanks.

Jerry Ungerman

I don't know that will change significantly, it's just that they're doing better but it's the smallest of the three major regions, the way we would monitor our business and they're doing well. We're very pleased with the pickup, with the success they've had especially with the new appliances and the endpoint stuff. I think we just have the right management team in place today, so we'll see them continue to grow and I think they have a chance of growing faster than the other regions. But it's still going to be in that 12%, 13%, 14% for our revenues, to the rest of the year.

Robert Breza - RBC

Great, thank you.

Operator

Your next question comes from the line of Daniel Ives with Friedman, Billings, Ramsey.

Daniel Ives - Friedman, Billings, Ramsey

Can you, maybe when you guys speak to customers, there obviously continue to be naysayer's, who listen to this call even though you continue to do extremely well. What is it when you talk to customers and what is it about your product that's continuing to see this type of growth? Maybe you can just anecdotally speak to that as you go around the world, talking to customers in a tough environment? Thanks.

Gil Shwed

I think our customers like very much the security management capabilities that Check Point has. They do value the quality of the product and the level of security we deliver, even though it's a little bit harder for them to quantify that. I think they like the fact that we have a unified architecture and that how other products work and work for many, many years. Remember, we are talking about customers that have been buying the Check Point architecture and keep upgrading it for 10 years, and it's very difficult to meet customers like that.

We do like the concept of total security. I mean our customers would love to see, our ease of management and enterprise capabilities of management, which they know from, the network security side grow to the end point security, even though it's still early to show that. We're starting to demonstrate that and starting to deploy that if that remains for the future. So that's a lot of enthusiasm that we do see today. And what else, they do like the flexibility of that business model.

Again, most of our deals are structured in a very diversified way, and in a way that the customers buy what they want. Most of our deals are not structured, like other enterprise software companies that you need to pre-invest millions of dollars before you install. Most of our large customers buy from us every quarter actually I think that all of our large customers buy from us every single quarter. And if we have, I don't know, a $5 million deal it would usually come among four to eight quarter in which we deploy the product. So these are few points. Jerry.

Jerry Ungerman

I'll just add a couple, Daniel. It's a good question. We do spend a lot of time on that, as Gil said, when it gets down to it, it really is that we have the best product technology and management. But the other thing they like that I hear consistently that's in addition to what Gil said is we're a security company. And that's very, very important to them that they have us as a security company providing a security layer independent of the network and the infrastructure that they have. And that's been a very, very loudly discussed for years now, point and position that I think is still valid and being resonated in the market everyday. So Gil talked about all the products and technologies, but it's also our position as the security company that they highly value.

Daniel Ives - Friedman, Billings, Ramsey

Okay, thanks. Good answer. Just one more question on the Pointsec. I noticed on the cash flows that you did pay out some about $9 million on Protect Data. Now I know you guys have turned earn-out, so it triggers, is that associated with one of those earn-outs that obviously you hit one during the quarter and you had to pay out some more cash?

Tal Payne

No, it's not relating to earn-out, just the remainder of the shareholders that it took just time to purchase their shares. So this is there the last minority shareholders of Pointsec.

Daniel Ives - Friedman, Billings, Ramsey

Okay. Thanks, guys. Great quarter.

Jerry Ungerman

Thank you.

Gil Shwed

And there (inaudible) deal being it's a public company. So there was nowhere an opportunity.

Daniel Ives - Friedman, Billings, Ramsey

Okay. Thanks.

Operator

Your next question comes from the like of Todd Raker with Deutsche Bank.

Todd Raker - Deutsche Bank

Hey, guys, nice quarter.

Gil Shwed

Thanks, Todd.

Todd Raker - Deutsche Bank

Two questions for you. First, can you dig into interest income, your cash balance is growing, I see the interest income is coming down and interest rates clearly are going down. Do you expect that to stabilize around current levels or how should we think about that going forward?

Tal Payne

I think as the portfolio is being invested over a period of time, we're actually seeing the effect of the reduction of the deliver and the Fed rates in the last half year. The Fed rates reduced from 425 in the beginning of the year to 2 right now. So we're seeing the effect in the delay of the quarter, so I expect to see continuing to reduce in the next quarter also.

Todd Raker - Deutsche Bank

Okay. And given the interest income reductions, why not get more aggressive on the stock buyback, $50 million this quarter to me it's a little bit disappointing given where your stock is?

Gil Shwed

We're continuing to evaluate that. We discuss it every once in a while. Last quarter we approved the new buyback program, I think we've executed on that. I think we also want to make sure that we have enough resources in case we do decide to acquire companies and have the right resources for that. But I think that you're right. This is a good opportunity for us and our Board of Directors will discuss that, and will decide how to continue that policy.

Todd Raker - Deutsche Bank

Okay. And then last question for you, I know you don't want to break Pointsec out, but can you just give us some qualitative commentary were you happy with the performance of that business unit this quarter?

Gil Shwed

Yeah, this quarter the performance was good. The growth was very healthy. As I said, we won a very large deal, many, many lot smaller deals. Another point that I think is very interesting is that we've analyzed how many channels of Check Point sold Pointsec, and we saw very high percentage of our golden, platinum channels that sold Pointsec.

Most of these deals were still very small by all channels. So we didn't have the huge revenue contribution, but very good news is we start to see the pickup. And if every channel buys or sells one or two deals, then that means that we'll start picking up in the next one, two and three quarters moving forward. What I think, if I remember correctly, went about 80% of our top tier partners have done data security deals in the past few months.

Jerry Ungerman

Which is a very, very big pick up, its excellent traction rate right now.

Todd Raker - Deutsche Bank

Okay. Thanks, guys.

Gil Shwed

The board talked about one huge deal. We also had some nice large deals, but we also had the lot of small deals, which was very important for us, which is to drive this technology to the hundred thousand Check Point accounts that we have rather than stick to a start of to few small customers every quarter, few large deals, small number of customers.

Todd Raker - Deutsche Bank

Okay, thanks.

Operator

Your next question comes from the line of Walter Pritchard with Cowen.

Walter Pritchard - Cowen

Probably two questions. One, just on the maintenance, support and services line, I mean that line, I think a couple years ago was accelerating dramatically. It seems to have leveled off and was almost flat sequentially. Just wondering if you could talk about what caused that to flatten out in the last couple of quarters here?

Gil Shwed

I think first, we did see very good traction of the subscription and subscription support, security updates. Actually I think Tal mentioned that, but this quarter it's for the first time in four years that the deferred revenue is growing between Q1 and Q2. I think overall what we've seen this quarter is that, I guess the pattern of renewal has changed or stabilized a little bit. Maybe we've seen more renewals in the first quarter, and thus impacted the second quarter. I also think we are seeing more longer term contracts. We clearly see more customers purchasing a two-year and three-year and sometimes even longer maintenance contracts. And that affects the amortization of the deferred revenue. But overall I think that we are very pleased with this. If you look year-over-year, our subscription revenue grew very nicely from the same quarter and from especially for the second half of the year. So overall, all the metrics are pretty positive about the new revenue.

Walter Pritchard - Cowen

And in just second question, you did mention that on the cash you are looking to keep some cash to do acquisitions. I'm just wondering in the current environment, given there is not much of an IPO window and the capital markets are tough, are you seeing a more favorable sort of buyers market so to speak, and therefore more likely to do acquisitions as relates to the environment? Or just kind of talk us through what you're thinking about there.

Gil Shwed

Yes, there may be a slightly better on that, but the main challenge is to find the sizeable companies that would fit our strategy. I think the biggest challenge is that not many companies either fit our strategy or show significant revenue and significant revenue momentum. And that would be the main test for a company technology, not just to say well, this company has a cool technology, we can use some of it but seeing that customers are actually willing to pay that price. Because of the proliferation of the security and because there are so many security companies, it's just hard to find the attraction and that's the main challenge what everybody sees. But I think, yes, there is a potential for acquisitions and we keep looking for that.

Walter Pritchard - Cowen

Just last quick question, of the $1.4 billion in cash, roughly how much of that is in the U.S. available to do buyback?

Gil Shwed

I don't know the answer I think it's, whether if it's about the US or non-US, I think that what's available for buyback, I think what's left in our buyback program is $350 million at the moment. So I think that's the number you are looking for?

Walter Pritchard - Cowen

Okay. Thanks very much.

Operator

Your next question comes from the line of Israel Hernandez with Lehman Brothers.

Israel Hernandez - Lehman Brothers

Can you talk about some of the successes with your appliances? How much of the success is attributed to successes within the installed base? There seems to be a replacement cycle underway, particularly around some of these Nokia appliances. And also, can you talk about, perhaps, some of your competitive win rates with these new appliances relative to either, Cisco and Juniper?

Gil Shwed

I think first as we've said it before, but more than 80% of our appliance sales are replacing and winning against Check Point competitors. So most of it is not just renewing, let's say a Nokia customers, Nokia customers are usually happy with Nokia. Nokia has a good quality of maintaining customers and getting customers to a high satisfaction level. Most of our wins are in places that we either had harder time winning before or in some cases that we replaced very old platforms of open servers that Check Point had in the past.

And I think we had the old cases, we had cases of new customers, we have cases of refresh of installed base again from all Check Point platforms that weren't before, and I think it's really all over the map, I don't Jerry if you?

Jerry Ungerman

I'd agree, Israel. Like Gil said early on, a lot of the appliances we now have are addressing market segments and price points that we've never been in. And our partners are not in. So this is, you know, 80 plus percent is going into competitive situations in displacing installed competitors and/or new projects. But it's been great for us, it's a very good addition to our portfolio, helping to drive our revenue and our successes as you can see.

And, we're winning a lot against our competitors, there is just no doubt in my mind from anecdotal stuff, as well as partners in our results that we're winning market share and gaining market share in the segments we're serving and the new segments we're moving into. So we're very pleased with the position that we have vis-à-vis our competitors and in our success in the marketplace today. It's very solid, very sound and it's a good story.

Israel Hernandez - Lehman Brothers

Great. And lastly, are you seeing any lengthening of sales cycles due to the macro?

Jerry Ungerman

We've been in this I think, for a long time where people are really evaluating and looking at the value they're getting and the alternatives they have. But it's out there, it's a concern, it's an issue. We've been in this for a long time now of people being aware of their cost, and their investments and what they are doing.

Gil Shwed

Anecdotally, as in case of those customers saying yes, we need to purchase that and we will. Other customers saying slowdown in economy, please be aware our budgets might be cut. But there are also seen that customers saying, our budgets might be cut so we want to accelerate the purchasing before it hits us. So, we've seen, so anecdotally amongst some large customers, I have heard all three answers.

So, it's very hard to speculate what would happen in the future and even in about the past. Maybe without the pressure of the economy our business would have been better for us last quarter. I try not to speculate on that and focus on doing what we can to optimize and maximize the business.

Israel Hernandez - Lehman Brothers

Okay.

Operator

Your next question comes from the line of Garrett Becker with Merrill Lynch.

Garrett Becker - Merrill Lynch

Just, on the appliances, you guys have continued to keep up a pretty strong pace of introducing new appliances. Just wondering if we should expect that to continue at a similar pace going forward, if you think you pretty much have the different market segments pretty well covered at this point?

Gil Shwed

I think we have the right market segments covered. I think we're up-to-date now with the latest advances of platforms for the year and we'll start looking what's our next step for next year. But, I think one of the things I'll try to institute is that we want to be at the forefront of technology. We chose platforms that we can rely on revolution of harder platforms and pretty quickly get more price performance and more performance to our customers and we'll keep that.

I don't know now to say if our next update to the products line on the harder platform would be six months from now or, I don't know or 18 months from now. We're right now our last cycle that we had was good, was about one year and I think it was intentional that we wanted to show that we'll keep in enhance the leadership and keep raising the bar for the prized performance we can deliver. And we just completed that two weeks ago, with the introduction of our, of two new UTM-1 model that we did in our Check Point experience in Thailand.

Jerry Ungerman

I think another important fact there is that unlike our competitors when they do a refresh on their hardware, they actually usually change their platform completely. With Check Point, our software remains consistent while we may upgrade the hardware or such, the software that our customers are receiving on our appliances and also directly in our software program or through our partners remains consistent.

Garrett Becker - Merrill Lynch

Okay, that's helpful. And then just on the shekel impact, you mentioned before, I don't know if you mentioned, did that have a greater proportionate impact on R&D or did that also impact sales and marketing line?

Gil Shwed

I think the biggest proportion was in R&D, but it also impacted sales as we have many sales people but are not in the U.S., in Europe, in Asia and other places. So, I think probably the biggest impact is in the shekel also, the shekel was the strongest currency against the dollar, did much better in the euro, so that's the other reason, but I guess I said the deal has also effect on the our results, especially sales. Marketing too, but towards somehow, somewhat lesser extent.

Garrett Becker - Merrill Lynch

Great. Okay, thanks very much.

Operator

Your next question comes from the line of [Manish Hemrajanii].

Manish Hemrajanii

Good quarter. Are you seeing more of a demand on the lower end or the higher end of the appliance front, and can you also talk a little bit on ASPs, how they're trending sequentially?

Jerry Ungerman

I'll talk about the demand across the different appliances. I don't know that I could off the top of my head say it was one of the other. We've been doing both and I'm just trying to think a lot of the successes and that has been with the whole UTM-1 line, we announced low end models and better performance, but we've been very successful with our integrated appliance strategy at the high end. The new Power-1 as Gil said, it was late in the quarter or middle of the quarter when we introduced it but we're seeing great enthusiasm there.

So, I don't think there is one that's stands out in mine mind, in don't know if Gil has a perspective from his different travels and meetings. But, I think across the whole spectrum, we see a lot of success and excitement because they're addressing different market segments which appropriate in different parts of the world. But, it's not one over the other they're all doing very well right now from interest in the marketplace standpoint. What was the second part of the question?

Manish Hemrajanii

Can you talk about the ASPs on the appliance front, how are they trending sequentially?

Jerry Ungerman

Do we have that?

Gil Shwed

But I can say for sure, (inaudible) as we keep seeing and not too much again about that again about the appliances. We have great growth over last year with the high-end appliances we had excellent growth both against last year and quarter-over-quarter with the mid-range appliances. And the lower end appliances I think continue to stay stable that's the part that we have the lowest, the low-end some 2000. The 5,000 to lets say 20,000 appliances for example, almost doubled Q2 over Q1, for example.

Manish Hemrajanii

Got it.

Gil Shwed

That's due to UTM-1 model, by the way.

Manish Hemrajanii

Regionally, can you throw some color on where you're seeing strength geographically in terms of both revenues and deals?

Gil Shwed

First, this quarter I think we've seen very balanced performance of all our sales organizations. So that's very good. I think Jerry did mention, the two best regions so far for the year are the U.S. and Asia Pacific. But as I said, I think we had great performance across the world. So I'm not going to currently indicate anything else.

Manish Hemrajanii

Okay. One last question. What are your assumptions for the shekel in your guidance?

Gil Shwed

I think it would be, if I can say Tal might have a better financial expertise. I would say that I think we should stop guessing. I think the devaluation was so strong in the last few quarters and it always looks like it hit bottom and it didn't. So I can only hope that it did and it will rise now. But I think it would be unfair to make any guess.

Tal Payne

No. But I think if I understood your question. You're asking what did, we assume in the guidance for the rest of the year. And I would say we assumed that there won't be any material addition or devaluation.

Manish Hemrajanii

Okay. So you're using the current level of the shekel.

Tal Payne

Yes.

Manish Hemrajanii

Okay, Tal.

Gil Shwed

Even a slightly better one here, because most of our budgets have done in slightly different budget levels.

Manish Hemrajanii

Got it. Thank you.

Operator

At this time due to time, we request that you limit your questions to just one question. Your next question comes from the line of Brian Freed with Morgan Keegan.

Brian Freed - Morgan Keegan

We've talked a lot about your enterprise business. Can you talk a little bit about your consumer and small business and particularly what you're seeing in terms of up take for your virtual browser?

Gil Shwed

Virtual browser has the first quarter. It's a new category, a new product, it is a very material affect on revenues but it is a very good acceptance in terms of, market reviews and even generated some revenue which is not bad for a consumer product that is sold for a $20 or $30. So it seems that the consumer business actually improved this quarter, but again, it's not a big part of our business and I don't think that's where the strength of our business comes from.

Brian Freed - Morgan Keegan

Okay. And one just clarification, there's been a couple questions asked about strength, within the U.S. enterprise, which was obviously strong. Were there any particular industry segments that were strong or weak and I imagine we're all particularly interested in financial services?

Gil Shwed

Financial services were good the first half of the year, and also the second half of last year. But I don't think there was one sector that drives. Even with the best financial services for Check Point is less than 20% of revenue. One segment by the way is interesting about the financial sector, that the sector is harder to classify in terms of its geography. The real big financial institution today are completely global and I'm not saying, it's random, but you can take the same company and they can decide that their purchasing is going out of London, Switzerland, Germany, New York and let's put it that way, between London and New York it's almost random where you see the purchases coming from in the big financials.

Brian Freed - Morgan Keegan

Okay. Thanks.

Operator

Your next question comes from the line of Michael Turits with Raymond James.

Michael Turits - Raymond James

I know data security, I know you're not breaking it out, but the growth rate you said last quarter was 25%. Just wanted to see if it was roughly that level or higher or lower? And also on the refresh cycle, sounds like you're saying refresh, by definition more or like 20% of 80% from new customers. So, it's meaningful. Do you see any slowing the opportunity for the refresh cycle going into 2009?

Gil Shwed

The growth, as I said, we don't want to break that. I think it's the same order of magnitude in terms of continued growth rate. So I don't want to break it separately or hint it to the higher or lower, but same kind of ballpark. And again, the second part was?

Michael Turits - Raymond James

The second part was on the refresh cycle in hardware, which has created and opportunity this year. You said that 80% is from new customers and new opportunities. On the other 20%, do you see any slowing in that opportunity in the hardware refresh cycle either off of Nokia or off of Cisco going into 2009?

Jerry Ungerman

Remember, the 80%, a lot of that is refreshed. We're displacing currently installed product. But they're looking in refreshing and refreshing with Check Point as opposed to the incumbent.

Michael Turits - Raymond James

So same question any slowing at all in the refresh opportunity into 2009?

Gil Shwed

It's very hard to say, but I won't say, it should be maybe the opposite.

Michael Turits - Raymond James

Okay.

Gil Shwed

I think the market is not, first of all, the market is relatively diversified. It's not a market of like one or two big side deals and also diversifying in terms of competitors. So I really don't think that we have a refresh cycle, that's start and end. And it's very hard for me to say if it was part of recycling.

Jerry Ungerman

I think it's ongoing, Michael. People are continually looking at the next generation and upgrading and expanding. Some are new projects, but a lot of it is a continual thing. There's not just one refresh cycle that happens once every three or four years. It may be three or four years after they buy it. So people buy every month, every quarter, and every year.

Gil Shwed

And again the one more thing to remembering, our sales model, some deals that we won let's say Q4, Q1 or Q2 are sort of the one or two-year deals. So what we recognize and what we told you about was the revenues or the orders that we already got. But in many cases let's say a $5 million project we got the first one, the first two.

First quarter, we get a little bit more Q2, a little bit more Q3, a little bit more Q1 next year and they roll in the device, it's usually not one time, and I think that's slightly different when the typical enterprise software kind of sales when you buy 10,000 licenses for the entire enterprise. Here let's say that we buy 300 gateways to operate the network, slightly that upgrade will take anything from six months to 18 months.

Michael Turits - Raymond James

Lastly Gil, you said that the maintenance contracts seem to be getting a little bit longer. So Tal, has there been any shift to a higher percentage of long-term deferred as a percentage of the total deferred revenue account?

Tal Payne

I think we're starting to see some shape but it's still minor and not material at this stage. But I think we will probably going to start seeing the larger transaction over a longer period of time where we will see some shift towards that in the deferred revenue.

Michael Turits - Raymond James

Thanks guys.

Operator

Your next question comes from the line of Todd Weller with Stifel.

Todd Weller - Stifel

And if you look at your core network security business, growth had been trending kind of in the 14% area. Just curious, how you think about the sustainable growth of that business? Are you trying to drive this more to a mid-teens growth story or more of a 10%? How do we think about that or how do you think about that?

Gil Shwed

We would like to drive it as high as we can, and basically the efforts that we are making, I think we are making all the right efforts for that. We'll see 10% growth, 20% growth, more or less because it's hard to say, but we definitely are putting all the ingredients to continue and see growth in that. And things like larger solutions that we provide, like appliances, all provide a lot of potential for future growth.

Todd Weller - Stifel

And one other follow-up Gil, on the Power-1 appliances, has there been any change in the way you're kind of packaging and pricing, the support for those appliances relative to your other appliances?

Gil Shwed

Yes. Generally speaking, the support percentage is lower than other solutions but the total support revenue is much higher, because we sell at much higher price that product. So I think that (inaudible) extremely well with customers. On one hand we get very attractive rate, I mean, usually when you buy a product you look at what percentage is support. So, we pay much lower rate, so we are extremely happy about that.

On the other hand, because we are selling the solution at the price that's two, three, four times higher than what we got before for the same unit, we are getting more dollars per unit. So, I think it's a win-win for everyone.

Todd Weller - Stifel

Thanks.

Kip Meintzer

All right. I think we're out of time. Thank you today for all your questions. We'd like to thank you for your participation. If you'd like to speak with management or our Investor Relations following the call, please give a call to our Investor Relations department at 650-628-2050, and we'll be happy to take your call. Market is about to open folks, so have a great day. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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Source: Check Point Software Technologies Ltd. Q2 2008 Earnings Call Transcript
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