Check Point Software Technologies Ltd. (CHKP) Q1 2012 Earnings Report, Transcript and Summary

Greetings and welcome to the Check Point Software First Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Kip E. Meintzer, Head of Global Investor Relations for Check Point Software Technologies. Thank you. Mr. Meintzer, you may begin.

Thank you, Melissa. Good afternoon and good morning. I’d like to thank all of you for joining us today to discuss Check Point’s record financial results for the first quarter of 2012. Joining me on the call today are Gil Shwed, Chairman and CEO; and Tal Payne, Chief Financial Officer. 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 May 1st. If you’d like to reach us after the call, please contact Investor Relations by emailing kip@checkpoint.com or by phone at +1 650-628-2040. Before we begin with management’s presentation, I’d like to bring the following to your attention. During the course of this call, Check Point representatives will make certain forward-looking statements. These forward-looking statements may include our expectations regarding demand for our security products, our expectations regarding our taxes in Israel, our expectations regarding the introduction of new products and programs and the success of those products and programs, and last but not least our expectations regarding our business and financial outlook for the second quarter of 2012. 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 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 the risks discussed in Check Point’s Annual Report on Form 20-F for the year ended December 31, 2011, which is on file with the Securities and Exchange Commission. As a reminder, Check Point assumes no obligation to update its forward-looking statements, except as required by law. In our GAAP press releases, which have 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 presentation of non-GAAP information. Now I’d like to turn the call over to Tal Payne, Check Point’s Chief Financial Officer for a review of the financial results.

Thank you, Kip. Good morning and good afternoon to everyone joining us on the call today. I’m happy once again to begin the review of the first quarter of 2012. Our revenues for the first quarter increased by 11% and were towards the high-end of our projections. Non-GAAP EPS was $0.74 representing 16% growth year-over-year and $0.01 above the top end of our guidance. Before I proceed further into the numbers, let me remind you that the first quarter GAAP financial results include non-cash equity based compensation charges, amortization of required intangible assets, net gain on marketable securities previously impaired, 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 first quarter, revenues reached $313.1 million towards the high-end of our projection, representing an increase of 11% compared to $281.3 million in the first quarter of 2011. This growth was driven by all our business elements. We sold more products, had growth in support services and a continued significant increase in software blades. Towards the end of last year we launched our new appliance line. It was received with great enthusiasm in the markets. Approximately 80% of our enterprise appliances sold this quarter from the new product line. Our next -- our new datacenter products did great as well, with the $61,000 revenues doubled relative to Q4 2011 and the $21,400 provided significant contribution this quarter. Our software update maintenance and service revenues reached an all-time high of $202.9 million this quarter, with an outstanding growth of 15% year-over-year. The growth was driven by our annuity software blades that are recognized as subscriptions. Deferred revenues as of March 31, 2012 were $542.2 million, an increase of $82 million or 18% over March 31, 2011. Short-term deferred revenues increased by 15%, higher than seasonally expected. We had growth in revenues across all geographies with Americas and Asia Pacific leading the growth. Revenue distribution by geography for the quarter was as follows; Americas contributed 45% of revenues, Europe with 38% and Asia Pacific and Japan, Middle East and Africa region contributed the remaining 17%. From a deal-size and quantity perspective, this quarter we saw an increasing number of larger deals. We had 34 customers that each has transactions with a value greater than $1 million, compared to 27 in the same period last year. Transactions greater than $50,000 accounted for 60% of total order value similar to last year. From an operating perspective we posted great results. Our GAAP operating income was $172.9 million in the first quarter of 2012, an increase of 22% compared to the same period in 2011. GAAP operating margins for the quarter was 65%, an increase from the 50% in the same period last year. Our non-GAAP operating margin this quarter reached 60% similar to the fourth quarter last year, which is the highest in the last 6 years. This represents an increase of 3 points compared to the same period last year. It was achieved primarily as a result of our top-line performance and the tailwinds from the strengthening of the dollar against other currencies compared to the same period last year. This year the new tax reform in Israel came into effect. The reform simplifies the tax structure, reduces many tax uncertainties and lifts the tax limitations of cash distribution from future income. As a result of the reform, the effective tax rate in our P&L is expected to reduce next year, while we will see an increase in tax payments. GAAP net income for the first quarter of 2012 increased by 18% year-over-year from $122.1 million or $0.57 per diluted share to $143.6 million or $0.68 per diluted share. Non-GAAP net income for the quarter was $156.9 million or $0.74 per diluted share, up from $137.1 million or $0.64 per diluted share in the same period a year-ago. Earnings per share exceeded the high-end of our guidance, representing 16% growth year-over-year. We had record cash from operations this quarter of $275 million, an increase of 30% from $212 million in the first quarter a year ago. This was mainly as a result of excellent collection of last year bookings as well as a positive cash effect of our balance sheet hedge. Our DSO, is a 72 days similar to the previous quarter. During the quarter, we repurchased approximately 1.3 million shares of a total cost of $75 million. Finally, our cash balances crossed the $3 billion bar, reaching $3.121 billion. Now let’s turn the call over to Gil for his thoughts on the first quarter.

Thank you, Tal, and thank you everyone for joining us on the call today. Tal has already addressed the financial results for the quarter, and I’m glad to meet with you with these good results. As Tal mentioned, we saw very nice adoption of our new appliance line. We’ve seen a very nice growth in mid-size appliance units and in the super high-end systems. Software blades also continue to grow nicely and are becoming more and more substantial part of our business. As you’ll hear in a second we’re continuously adding new software blades to our portfolio to elevate the security we provide to our customers. We open the second quarter with some major announcements for the year. The most significant one is the introduction of ThreatCloud. While the need for more collaboration in fighting cybercrime appears obvious, we believe the ThreatCloud is the first and only such initiative in the marketplace. When we analyze the challenges facing cyber security, we find that it takes very long time, weeks and even years to identify some attacks. Attacks will usually appear in many places, yet today’s organization is alone in trying to analyze and combat these attacks. The result is that even after an attack is identified by a customer, most of the world remains unaware and unprotected. This can be changed through collaboration. An attack is identified by one gateway somewhere in the world can turn into a warning sign to the rest of the world, which is the idea behind ThreatCloud, creating the world’s first collaborative network to fight cybercrime. Gateway participating in ThreatCloud will be able to contribute to the network, when we become aware of a new attack will update the ThreatCloud and all other participants in the network will be able to quickly detect and block the attacks. In addition, ThreatCloud employs a network of sophisticated sensors in key places in the internet in order to further identify threats. This collaboration should shorten the response time to attacks from days, weeks, and even months to hours or even minutes and extend the scope of addressable threats by orders of magnitude providing for great breakthroughs in cyber security. ThreatCloud isn’t another long-term vision. It is actually working now and its part of R75.40 software which we released last week. It powers our new Anti-Bot Software Blade, which is now shipping in our enhanced Antivirus Software Blades by providing threat updates directly to customers’ gateways, enabling them to enforce pre-emptive protection against advanced threats such as both entities and other forms of sophisticated malware. And ThreatCloud is only one part of R75.40. R75.40 has over 100 new features in all areas of management and security. One of the most important features is our new secure operating system, GAiA. GAiA combines the two operating system we had in our product portfolio, the Nokia IP operating system and the SecurePlatform. Both offer some unique characteristics and have earned some loyal customers. Loyal IP curious customers were reluctant to move to our newer appliance model who didn’t run the IP operating system. Now with GAiA these customers will be able to move to our unified product line, taking advantage of our familiar interface and all the features they needed and getting the benefits, the great new platforms we provide. Many customers have been waiting for GAiA for a long time, and it seems that the reaction so far is very positive. We made this announcement last week on our Check Point Experience Partnering Customer Conference that we held in Orlando. It appears that these new announcements were very well received. In terms of numbers, as we are all aware, there are always risks in predicting the future. That being said, we continue to expect good performance for the year, and we are maintaining our annual and quarterly projection. Specifically, for the second quarter, we expect revenues in the range of $324 million to $336 million, and non-GAAP earnings per share in the range of $0.74 to $0.77 per share. GAAP EPS is expected to be approximately $0.07 less. Once again, I’d like to thank you for being on the call with us. We had a great first quarter and we look forward for the remainder of 2012. With that, we can open the call for your questions.

[Operator Instructions] Our first question comes from the line of Shaul Eyal with Oppenheimer.

Two quick questions on my end. I know kind of, Tal, you provided some good color about the 61,000 and the 21,400, but maybe Gil, can you provide us with kind of more color? I recall that last time you talked about I think it was kind of the retail vertical that was kind of a little strong, what have you seen this quarter, how kind of the ASPs have been trending on both those products?

[Indiscernible] season being high-end actually was very good and specifically for the 61,000 we had some very, very large deals that drove ASP up. I don’t know if it’s indicative for the future, but people bought fully populated systems that are relatively costly. And other than that, I think we’ve seen a good mix of a gateway. I think I mentioned in my part that when we saw a nice increase it was actually in the low-to-mid sized gateways, an area that we didn't necessarily focus on, but I think that our latest appliance, the 2012 model has done a great job in making us a very competitive in that segment of the market. So, that's where we’ve seen the big advance in terms of units.

Got it. And Tal, one question for you, operating margins strong I think for the second consecutive quarter now, where we had 60%. Is that kind of the type of metric from the operating margin perspective we should be thinking about down the road, kind of what's behind this kind of continued consistent of the operating margin and we used to think about it more kind of mid-high 50s, but 60 kind of appears to be becoming kind of the new norm?

I wouldn’t call it the new norm, it’s 2 quarters, you’re right. Remember that Q4 is typically higher margin than the first quarter. So, Q3 and Q4 are typically higher margins than Q1 and Q2. So Q4 is not indicative. Q1 was at higher margins as you can see. Two reasons for that. One, as we continue to perform in our revenue growth it allows to see some improvements as a result of the leverage in our business model. We did have tailwinds from the dollar. Q1 this year, the average of the dollar versus the average in Q1 last year was higher meaning the dollar got stronger versus last year, which meant that it allow to improve the margin, I think it gave us around $2 million, $3 million this quarter. So take that into account. You can’t predict that it will continue in the future. That’s why I don’t want to commit to that type of percentage. And we also had some of the company event in Mexico this quarter, which means that around 2 weeks out of the first quarter, we had lower levels of expenses. So, I wouldn’t make that as a new mark and as you know, so we don’t aim for increasing the gross margin or in the operating margin, we aim to continue and grow our business.

Our next question comes from the line of Brad Zelnick with Macquarie.

Gil, with billings growing slower than they have in the prior 6 quarters despite the strong uptake in software blades, can you help with that in context and specifically speak to what gives you the confidence to maintain your double-digit revenue growth outlook at the midpoint of your guidance versus billings in this quarter at least that are high-single-digit and I know you don't guide to deferred revenue, but how should we think about that as we put our models together?

First, we don’t publish booking or billing, so I don’t know how you gathered the data, but in terms of our internal metrics, we actually performed very much in line with our plans for the year. And seasonally, Q1 is always the slowest quarter and then quarter starts to ramp up very, very quickly and I think that's what we exactly saw. We met our internal plans and again, I think we're doing quite well against all our internal metrics.

And just a quick follow-up for Tal on DSOs, it seemed they were up very slightly sequentially from Q4, which is not the typical pattern in Q1, just curious if you can speak to the linearity in the quarter?

It’s the regular phenomena of very back-end loaded. I think it was quite similar. It was 72 days according to my calculation. I can tell you from the facts, collection is very, very good and nothing has changed in our collection pattern, and you can see it very clearly in our cash flow. This was the strongest cash flow ever, $275 million with 30% growth, and as you know the growth comes from the collection of the booking of Q4. So, DSO is one calculation, maybe it went up one day, but it’s completely in line in terms of collection.

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

I actually want to follow-on that linearity question, while the quantitative, I agree with the DSOs, I’m just kind of curious qualitatively, Gil, in terms of your conversations with the channeling customers, how did you feel demand develop through the quarter? We have heard different things from different regions in terms of months -- that were really good months that were sluggish, kind of curious how you saw the demand developed through the quarter?

I think the quarter went according to plan. I think we have got the sales people made their forecast, and the quarters are backend loaded in the last few years, so there is no surprise in that. Nothing really to report about that, and we expect good numbers for the second quarter.

Okay. And then one follow-up question on the high-end on the 61,000, where are you seeing the biggest demand for that? In other words, are these Greenfield opportunities, are these datacenter network security upgrades, and what is it that you see, you are replacing, if it is an upgrade?

It's a combination of that. I mean it’s not the upgrades of -- mostly not upgrades of all the models here, but customers that really needed a high-end performance and now can get it. There is really a host of different usages. There is some in the financial sector. There are some that are used to fight denial of service attacks at very high rates. I must say that, I mean, we have government, we have healthcare, we have industrial, we have financial, I mean, there is many different types of different customers here, and there is no one kind of usage. Again, this is not -- that’s one thing, remember, this is not huge number of deals, because these will tend to be very large, but the direction is very positive here.

Our next question comes from the line of Robert Breza with RBC Capital Markets.

Maybe as a follow on to Sterling’s question, Gil, as you step back and talk to customers, you mentioned having some success at the low-end of the market. What are you seeing across the landscape, maybe from a differentiated perspective at the low-end versus the high-end, meaning are you seeing people redesign their networks differently today than maybe they were 3 years ago and how that's driving demand?

No. No big changes on that. I think our latest product line that we announced at the end of 2011 to 2012 model is very competitive and customers are very happy to purchase the new model. And I haven’t -- we just had a Check Point Experience Conference in Orlando, and I must say that all I heard was very positive feedback from channel. I don’t want to say that the channels are now refocusing or focusing on broader market segments, because that's not what I heard. I do think that customer channels would still like to see large deals, and on the same time, all our channels have the mix of customers on all avenues of the market, and the only thing I can deduct is that we became more competitive and in places where they weren't really putting their big effort in the smaller deals, we’re now much more competitive and we’re just able to offer our models in an easier way. I know that on the high-end on the large deals, everybody is making a big effort to win, and then we’re doing really great, and I think we have a lot of potential on the small-to-mid size deal, and I’d like to see that some of that potential starts to unfold.

Our next question comes from the line of Daniel Ives with FBR Capital Markets.

In regards to the change in the Israeli tax code effective January 1st, just walk through how you guys or the Board is thinking about the cash balance and just the timing of sort of things in terms of how you’re thinking about things in the second half of the year?

In terms of the tax as I said, we adopted new reforms. It's coming into effect from the beginning of this year. A positive effect all around in the sense that it takes away limitations, in case we would like to have buyback or dividend above certain amount, as you know it, from the new income we’ll be able to do it without having any tax effect. It takes away many uncertainties that existed in the tax, Israeli Law, so that’s very positive. And as a result the P&L tax -- effective tax rate is expected to reduce in the next year or 2, and the cash tax payments will increase slightly as a result of that.

Our next question comes from the line of Aaron Schwartz with Jeffries & Company.

In terms of the changing product deferral rates with the success of blades here; is there any way you can talk a little bit more about your expectations for product growth as sort of this mid-single-digit growth rates are the right way to think about this for the remainder of the year or do you expect it to accelerate off the Q1 level?

I would say first and I have been recommending that for quite a long period. I would recommend to look first at the top 12 growth rate of the revenues, since it depends how we introduce new product. The more annuity blades we introduce, the more you should expect to see a shift in the product into the service line as you have been seeing in the last year and a half. So future product depends how we introduce them, but in general I would expect to see more services and less product.

But I think the growth rates can be higher than what it’s been in this quarter. I think the growth rate will be higher in future quarters. So again maybe to explain a little bit what Tal said; when we bundle a new software blade with our client phase with our product then immediately a big portion of the product sale is moving to the subscription line, and that’s what's happening sometimes. Now that really depends because we tend to change from time-to-time the bundling of different blades with different model. I mean bundling more blades creates a great long-term opportunity because the customers gets them almost bundled for the first year and then the renewal from the second year, so that has a positive effect, it has -- I mean, it has less positive effect from the standpoint of the growth of the product line and less positive effect from the standpoint that we don’t take full advantage of selling these blades at full price when we start and that’s why we are all the time trying to create this right bundle to create the right incentives. So that’s the main question that, it’s harder for us to answer because with new model and new blades we are playing with this all the time. But again just to be clear, I think that for the reminder of the year we can see a higher product growth rate than we've seen in the first quarter.

Okay, that’s helpful. And second question if I could, now that you have a little longer track record for your IPS blade. Do you have any firmer views on renewal rates and then also are the renewal rates consistent across all your annuity blades, are you seeing a large variance by the different type of blade?

That’s really quite similar, obviously there’s some variance but it’s quite similar. We've seen that this quarter a slight increase in the renewal rate. I wouldn’t turn it into a metric here just because we need to see for a few quarters that it continue to go that route, but its -- I’ll remind you that we said its around 60% renewal rate for the a la carte blades and around 40% for the bundled blades which was very high. When we launch a software blade we expected the bundle to be renewed 10%, 15%. I’ll just remind you when we say bundle, it means we sold them bundle together with the appliance and we assume that in the second year about 10%, 15% will come back to renew. We were pleasantly surprised with around 40% and in the second year we see renewals in the higher rates. And this quarter it’s past the 60%, so it’s a positive trend and we hope to continue to see increase in the renewal rates in the second and third year.

Our next question comes from the line of Shelby Seyrafi with FBN Securities.

Talking about product growth again, do you think mid-single-digit product growth is possible going forward and also as you shift more to software your margins are higher there, so could that produce even further operating margin expansion as that transition takes place, and related to that as well, do you think GAiA is going to be a catalyst for additional sales starting this quarter to the Nokia customer base, the IP base?

These are 3 separate questions; I’ll try to address them. So first I’ll start from the end. Gaia basically has the nice potential, I mean we do think that many customers are waiting for GAiA in order to move from the IP series to the new appliance model; so that’s one indication we need to get. That’s the first one. I think in terms of product growth, I think I mentioned it in previous question, I think the current growth is nice, but I think we can also anticipate higher growth on the product line and I think overall the growth of software blade is already positive. Regarding the margin we're not -- I mean, I think our margins are very high and definitely not trying to shoot for certain to manage the operating margin. What we try to manage is to run the business effectively and generate the most effective growth that we can. So, I mean, I am not anticipating new changes in the operating margin in the short-term but we’re also not trying to shoot for a certain margin or manage the margin into -- today as we try to grow the revenues and to grow the profit and the margin is the byproduct.

And the improvement in operating margin in the last 3 years moved up from 53% to close to 60% on average, so we understand that we've seen a great improvement in the margin and definitely one of the reason there is the leverage in the business model and the fact that we sell many software blades. So you’ve seen the effect of that and you’re writing your intuition that software blades carry higher margins fixing the software, so you’ve seen that effect already and at the end what will happen to the total margin it depends on the mix of the growth of the hardware, appliances versus software blades and software in general.

Okay, good. What kind of tax rate should we use this year and next?

This year I will keep the same, it’s around 20% if I recall, and next year probably it will start going down, probably 1% maybe even 2%.

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

I got 4 questions. Couple of questions; first Gil, when you say you think that it looks like product growth rate could accelerate. What would be the drivers, why would it be, have been slower this quarter and how would that accelerate? And one other question, somebody pointed out that at least the calculated billings growth was little down. Could that by any chance be, is there any function of people hesitating to buy ahead of GAiA were they waiting ahead of that release?

I think we have many different drivers to the business. This is definitely one of them, no driver like that is major is going to make a huge shift in our sales in the future, but as I said there are customers waiting for GAiA, we know that, there are -- I mean when we’re looking through the entrance to the year, we had an extremely strong year in the fourth quarter which means that the sales people started the year with almost an empty pipeline and still generated amazing results by any criteria. I think when we go into the second quarter we’ll have a bigger pipeline and that should help in additional sales. All of that is built in the old model, I think its -- we’re very, very much in line with our plan. I think that’s the main thing I can say. So I mean, I don’t expect here any major changes but within smaller margins I think we can expect both things.

Okay. And then just one follow-up question, on a revenue basis calculated off the percentages, it looks like Europe decelerated a little bit relative to its trend in the last couple of quarters in revenue growth rate; anything to observe there in terms of how Europe did as a geographic region?

Tal, maybe able to do more of the calculation. What we’ve seen in the last several quarters is that the U.S. economy is strong and that’s a very positive thing. In Asia we also see very nice growth but in Europe it varies, I mean, I don’t even want to look at Europe as one entity because in Europe we’re seeing some countries that are growing extremely well, other countries that are growing differently. Overall Europe is behind and thereby which flips over the next quarter, it’s not that where some countries for the last 2 years are growing fast and some that are not growing. It changes from the quarter-by-quarter and the same phenomena we saw last quarter and I think our forecast for Europe for the next quarter are quite positive.

Our next question comes from the line of Walter Pritchard with Citigroup.

Tal, a question -- a follow-up question on the tax rate around the tax implications here with return on capital. You guys have previously been rebounded to about or you have been buying back about $300 million in the last couple of years. Does that in theory completely go away the restriction on buyback or does that phase out over time?

In theory it goes away immediately.

Okay, got it. And then Gil, any way of quantifying for us on the GAiA and Nokia install base? I mean, you’ve had the product line -- their product line there for about 3 years. Any way to quantify how much of install base is left or how many of your customers are still primarily putting in place the Nokia IP appliances still at this point in time?

I don’t remember the exact percentage, but it turned out that the IP series install base was much more loyal than we anticipated and by the way that produced great results, but am only saying it on the positive side. And I think we are seeing now a lot of the IP series that are seeing the new appliance model which provides 3 times more a price performance which wants to shift to our new product line and that’s not a good phenomena and I think many of them, some of them at least are waiting for GAiA so that’s the positive thing that can happen. As I said I don’t think -- we’re not talking about a huge jump or big changes in the mix, but I think we are starting to see -- I mean, we started seeing in the last quarter the shift starting and that’s after about 3 years when the IP series that were very stable.

Just to clarify, it doesn’t mean that they didn’t refresh in the past, but they probably refreshed to other IP products and not necessarily to the other products.

Our next question comes from the line of Philip Winslow with Credit Suisse.

Good quarter. I just got a question on the blade strategy obviously Gil you mentioned the Anti-Bot blades, just curious how you kind of gauged your expectations for that blade versus some of your recent introductions. And also just, and particularly with the blades obviously you have the applications control blade that’s gotten a lot of focus here. I wonder if you can give us just an update on that, and also just sort of what you are seeing competitively, versus some of the other folks out there?

So, I think the application control blade is doing very well. The IPS blade is also doing very well. I’m very much in the dark it’s the Anti-Bot, I think it’s completely a new type of blade and our history shows that most of these blades it took them some time to ramp up and they ramped up quite nicely. The only way we ramped up things quickly was to bundle these blades with existing appliances. At the moment we haven’t bundled the Anti-Bot blades with any model. So it’s not bundles it’s sold a la carte. Based on the surveys and based on the demand on the marketplace we may consider to bundle it, but right now the Anti-Bot blade is only offered with a la carte and especially given the subscription model that it has, I am not expecting in the next, I don’t know 6 to 9 months any substantial difference to the number based on that. But I think long term it has a huge potential. I think everything I discussed on the ThreatCloud is very well demonstrated by the Anti-Bot and that’s a pretty big delay I think.

And just compatibly just curious what you guys are seeing out there?

Not too much, I must say that the last quarter or so wasn’t -- we've seen, I mean, I think our market is also competitive so I would hate to see that it became less competitive, it’s very competitive but we've seen less pressure on that. I think with the 2 large competitors that we have, we’re seeing and we have a lot of evidence from research data and show all that we're weakening when we’re getting stronger. There are 2 smaller players that are doing quite well and the least -- now the only thing I can say within the last quarter or so we've seen that competitive pressure slightly weakening and not strengthening.

[Operator Instructions] Our next question comes from the line of Phil Rueppel with Wells Fargo Securities.

Could you just kind of clarify a little bit for us sort of how you see the financial impact of GAiA, do you expect your existing IP -- Nokia IP customers to just upgrade or do you think they will buy or refresh the whole appliance, and then as far as ThreatCloud goes, is that just really an integral part of GAiA or are you going to market that as an annuity, or is it really just a platform that would hopefully drive larger adoption of blades going forward?

And so I think ThreatCloud will be an integral part of the R75.40, it’s part of the Anti-Bot, it’s part of the new antivirus, it's a part of the URL filtering and I think we wanted to be an integral part of our network and right now we’re not considering any special pricing changes based on that. In the future again we'll see how the adoption is going on and we'll continue different economical options, but right now it's bundled with the software blades pricing and what we expect is simply the customers that buy more software blades will see the benefit of participating in that collaborative network.

It’s so GAiA.

And the GAiA effect, again customers know the GAiA will run on all the old appliances that we have including the IP series. So customers are free to upgrade. I do expect that many customers that have been refreshing their appliances will now refresh to the new Check Point series appliances and I think there is a little bit of pent-up demand for that in the marketplace.

Our next question comes from the line of Greg Dunham with Goldman Sachs.

I just have one follow-up on kind of IPSO hold-up dynamic. Is there any way you could give us a sense of how weak the IPSO install base was in purchasing in Q1, any way to quantify that? Is it a couple of million dollars or is it something more significant than that? And the follow-up would be; I know you guys haven't had a release like this in many years, but how should we think about the ramp-up in terms of upgrades from that install base going forward?

So I think first, the IPSO install base was very strong for many, many years, and I can't tell you, what was the situation exactly in Q1 because in Q1 we had a total shift of all of our product lines. I mean in the last, in Q4 we announced the new appliances then we started seeing all the sales moving to the new appliances. So, I don't know if something is particular to that model or this model of appliances. What I think I mentioned, and I'm saying that we're starting to see the shift from the IP series install base that was relatively loyal in both things within the same line to the general product line and that I think is very, very positive because the general product appliance line is more competitive, offers more power; from an investor standpoint, we get higher margins on that. It's very positive that customers will move to a product that provides them better value and us better value.

Our next question comes from the line of Brent Thill with UBS.

Gil, I think we're all trying to reconcile a 5% license on product revenue growth rate which massively decelerate and obviously you had tough comps, but given your comment about a less competitive environment, that would only point to internal execution issues then for Q1 on product. Is that a fair outcome, because that's the only thing we could point back to for that type of deceleration?

I think -- where there’s one point that you may be missing, then that’s the point about the software blade. The software blades are part of the product of the product price. Just accounting-wise they fall into a different line. And I think there are a few points of software blades that are moving from the product line to the subscription line, and that’s something that can be missed. So, if you overall take seasonality plus few points moving from -- mean that are sold with this part of the product. When the customer is paying $20,000 for an appliance, they paid for a single product. Accounting-wise, $5,000, $6,000 of that move from the product line to the subscription line, that's software blade, and that rate has grown in the last few years. It's grown consistently because we kept adding more blades to the product.

And I can just remind you that in proportion now the software blade out of the product is more than 10%. The card that has been separated from their appliance value, it's not 2%, 3%, 4%. It's more than 10%. So, it's quite significant and therefore that portion is growing from the product to the deferred and then to the service line.

Just to add to it, without giving any numbers, if you take 2, 3 points which are the shift from the product to blade and 2, 3 points which are the seasonal effect of Q1, you would actually see that if we normalize that, I think our run rate is pretty healthy and we hope it will continue this way. Now again, this is a margin of Q2, it can improve and the comp-to-quarters will also change because in previous years we also kept adding blade, so I think that's things that can change in the next few quarters.

But I just want to be clear; the number of gateways we sold this quarter was very healthy, I mean all of the other indicators that I have internally are very nice.

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

Just a quick follow-up in terms of the products at the high-end of the market. Can you guys talk a little bit about your pipeline build there and how significant a part of the business you think this can be exiting the year assuming that you guys double that on a quarter-over-quarter basis in some lines?

First, it's build out quite nicely and we have a nice pipeline of large, I mean, the 61,000 so on deal. I should still be careful about that because that's concentrated on small number of large deals. Small number of large deals can easily shift from one quarter to another, it can easily move between them, but so far the momentum is very, very positive, and I mean we’ve built a very nice product line in 2 or 3 quarters and that's again doubling every quarter and again, it’s very hard for me and the pipeline is nice. It’s hard for me to predict when these growth rates will start to balance to get in line with the rest of the business or how long it can grow in a rate like this. But the pipeline is there and the opportunity is there and it seems to be very much in line with what we plan, when we’ve started with these high end products.

Got it. And just in terms of your updated view between the product and subscription revenue percentages, how should we think about that on a longer term basis given that you're seeing that faster uptake on the subscription line? What do you see that eventual mix kind of falling out to, even as you add these new, I guess recurring components?

I think you can see that the service portion is slightly more than 60%, including the subscription. So I don't expect it to move quickly to the 70s, but I think we’re pretty much where it should be right now.

And let's not forget that it is very, very positive because products are seasonal and products have ups and downs. The subscriptions are much more stable, and that’s why we made the shift to a software blade. We could have easily taken the same blades that we have today, and price them, on sort of a fixed price basis, and charge for them one time and recognize it one time. I think what we’re building here is for the long-term model, and I think it’s a very good long-term model.

Got it.

Our next question comes from the line of Gregg Moscowitz with Cowen and Company.

Just to follow-up on the previous question, Gil, the 61,000 is off to a very good start, and last quarter I believe you said that you expect sales of the 61,000 to reach the tens of millions by Q2 or Q3 and I understand there is some uncertainty around large deals, but is that still how you’re thinking about the trajectory of that appliance line?

Yes, I think we’re pretty much there.

Okay, great. And then just a quick follow-up and a quick housekeeping, roughly, what percentage of customers are currently on R70 and R75?

Probably around half -- 50%. Remember, we said it will take around 5 to 6 years. We launched it in mid-2009. So it’s around 3 years, slightly less than 3 years, and we are around 50%.

And again I think I want to just to be clear. All the new customers, and all the new installation and updates are now R75. I know in the past, when I mentioned customers, we were always challenged, what about the new features, I’m still on the old version to-date, on our meeting with customers, there wasn't the issue. All of them were R75 and so on. So we are talking about customer deploying new things, that’s not an issue, everybody is deploying the new version, that’s great actually.

Great. And if I could ask just one last one, in the previous quarter, on a couple of occasions, you guys had single data or talked about premium support being quite strong in the Q4, and I realized there are some seasonal aspects, but how is premium support sales, kind of as a percentage of total support this quarter versus what you guys saw, a quarter or 2 ago?

It’s kept on the same rate, so it’s pretty good. Remember that also if you already bringing that issue up in Q4, we also had a lot of professional booking, professional service booking which are typically the highest in Q4. So that’s part of the higher growth rate that you see in Q4 versus the other quarters, Q4 you have a nice portion also that’s coming from professional services to customers.

Our next question comes from the line of Dan Cummins with ThinkEquity.

Could you give us some idea of how well you think you performed in the service provider and the managed services business in Q1 and I am curious if ThreatCloud will work when the customers are using a managed outsource provider?

First, ThreatCloud would work on any environment. I had some discussion with some telcos that were interested in sort of offering, ThreatCloud with the services they provide and we by the way are fully ready to provide ThreatCloud not only as a big service from Check Point, but also it’s a private service from whoever wants to build such a network. Beyond that I think the service provider market was fine. I think there is still a lot of potential ahead with that market and there is lot of deals that are still waiting inside that market something that I don’t want to set any expectation for this market, but it has a lot of upside.

Our next question comes from the line of Keith Weiss with Morgan Stanley.

I believe last quarter, we passed probably 10% contribution from the blade revenues or billings. Is there any chance that we will get more granularity or sort of more color on how big the blade contribution is, and any chance that you could get a target on where you think that goes, in terms of revenues or billings for 2012?

Last quarter, it was more than -- I think you’re talking specifically as a portion outside -- out of the total revenues, correct?

Yes.

So, it’s continuing to increase naturally, since our software blade business is increasing. I will remind you, that we reached a run rate of more than $200 million in Q4 2011, like for the annual 2011 Q4 times 4, and software blade continue to grow rapidly. Their growth is much higher than you see in our revenue growth or even booking growth that we tried to calculate. Significantly, more it’s not 10%, it’s not 20%, it’s not even 30%, it’s more. So it’s a very nice software blade that continues to grow. Naturally, over time, you will see that the growth rate growing to more normal levels, but we will have -- we’re having new blades that hopefully will continue to keep the momentum of the software blade grow. So, it continue to grow significantly as part of the booking and as part of the revenues as a result.

Got it. And then perhaps one follow-up on sort of margins or investment versus growth, you guys have come out with a lot of new product over the past, let’s call it 6 months, you have a whole new appliance line, you have the new unified platform with GAiA, there is a new ThreatCloud out there. When you guys look into 2012, should we be thinking about any changes in the way you guys look at investment versus growth? If you look over the past 2 quarters, I think sales and marketing, granted you still had some impact on that growth, it was just around 5%. Is there any chance for that ramping up in terms of more sales or the more marketing support around all these new products or should we be thinking about investment generally in line with what you guys have done in the past?

First, I think, we would like to invest more. In terms of the sales and marketing expenses, it’s composed of many different items. Some of them for example is seasonality in marketing activities. And in Q2 for example, we have a lot of marketing activities like I mentioned the Check Point Experience Conference that we just had in Orlando, there is another Check Point Experience in Berlin in a month. So I mean -- and by the way, Q4 and Q1 is the opposite. Q4, people are busy closing the pipeline for the year, and in Q1, they’re building -- starting to build that pipeline. Kind of Q2 is the stronger one, in terms of most marketing activities, a little bit also in Q3, we have a lot of Asian Conferences and things like that in Q3. But overall, where we would very much like to invest, I think, we want to keep the business as effective and efficient, but I think in all our discussion about operating margin, we said our focus is how to invest and grow effectively, rather than how to keep the -- to shoot for a certain margin number.

Got it. And if I could sneak in one last one, did you guys give a headcount number for the end of the quarter?

We didn’t give it. Its approximately 2,500 people at the end of the quarter.

Mr. Meintzer, we have come to the end of our allotted time for Q&A. I’d like to turn the floor back over to you, for any closing comments.

I'd just like to say, thank you for everybody joining us, and we look forward to seeing you throughout the quarter. Have a great day and we'll talk to you soon. Bye-bye.

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.