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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Greetings and welcome to the Check Point Software 2018 First Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. 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. Thank you. You may begin.
Thanks, Donna. I'd like to thank all of you for joining us today to discuss Check Point's first quarter 2018 financial results. Joining me today on the call are Gil Shwed, Founder and CEO along with our CFO and COO, Tal Payne.
As a reminder, this call is webcast live on our website and is recorded for replay. To access the live webcast and replay information, please visit the company's website at checkpoint.com. For your convenience, the conference call replay will be available through May 2. If you'd like to reach us after the call, please contact Investor Relations by email at kip@checkpoint.com or by phone at +1-650-628-2040.
Before we begin with management's presentation, I'd like to highlight the following. During the course of the presentation, Check Point representatives may make certain forward-looking statements. These forward-looking statements within the meaning of Section 27A of the Securities Exchange Act (sic) [Securities Act] of 1933 and Section 21E of the Securities Exchange Act of 1934, include or but are not limited to statements related to Check Point's expectations regarding business, financial performance, and customers, the introduction of new products and programs and the success of those products and programs; the environment for security threats and trends in the market, our strategy and focus areas for 2018, demand for our solutions and our business and financial outlook including our guidance for Q2 2018 and full year 2018.
Because these statements pertain to future events, they are subject to various risks and uncertainties. Actual results could differ materially from Check Point's current expectations and beliefs. Factors that could cause or contribute to such differences are contained in Check Point's earnings press release issued on April 25, 2018, which is available on our website; and other factors, risks including those discussed in Check Point's Annual Report on Form 20-F, for the year ended December 31, 2016, which is on file with the Securities and Exchange Commission.
Check Point assumes no obligation to update information concerning its expectations or beliefs, except as required by law. In our press release, which has been posted on our website, we present GAAP and non-GAAP results, along with a reconciliation of such results, as well as the reasons for our presentation of non-GAAP information.
Now, it's my pleasure to turn the call over to Tal Payne for a review of the financial results.
Thank you, Kip. Good morning and good afternoon to everyone joining us on the call today. Before I proceed further into the numbers let me remind you that our GAAP financial results include stock-based compensation charges, amortization of acquired intangible assets and acquisition-related expenses as well as the related tax effects. Keep in mind that the applicable non-GAAP information is presented excluding these items.
Now, let's take a look at the financial highlights for the quarter. Revenues for the quarter increased by 4% year-over-year to $452 million in line with our projections. Products and security subscription revenues increased this quarter by 3% over the same quarter last year reaching $245 million.
Our security subscription revenues continued to be strong with 14% growth year-over-year reaching $127 million. Our software update and maintenance revenues increased to $207 million representing 5% growth year-over-year.
Last quarter we launched the Infinity Total Protection, our Infinity Total Protection solution offers the entire Check Point solutions in a simple financial model priced per-user, per-year. We already closed few multiyear deals in several millions and we see a strong pipeline of the deals. The pipeline is from organizations from all geographies verticals and all sizes.
From accounting perspective, as majority of Check Point solutions are offered as a security subscription a small portion of the deals is and will be recognized as products while majority of the deal is recognized as recurring revenues over the life of the contracts. Some of it is subscription and some of it is support, update and maintenance.
Deferred revenues as of March 31, 2018 reached $1.166 billion, a growth of $103 million or 10% over March 31, 2017. Revenue distribution by geographies for the quarter was as follows. 47% of revenues came from the Americas, 36% of revenues came from Europe and the remaining 17% came from Asia Pacific, Japan, Middle East and Africa regions.
From a deal size perspective, this quarter we had 44 customers with transactions over $1 million. Transactions greater than $50,000 were 71% of total order value similar to last year.
Gross margin increased this quarter mainly as a result of changes in the mix of revenues and products. Non-GAAP operating margin for the quarter was strong at 53%.
Effective non-GAAP tax rate for the quarter was 17% similar to last year and in line with our expectations.
GAAP net income for the first quarter of 2018 was $187 million or $1.16 per diluted share, an increase of 7% from the first quarter of 2017. Non-GAAP net income for the quarter was $210 million or $1.30 per diluted share, an increase of 9% from the first quarter of 2017 and was at the top end of our guidance range.
Our cash balances as of March 31 were $4 billion compared to the $3.8 billion in December last year.
Operating cash flow was very strong and showed an increase of 18% from $355 million last year to $419 million.
During the quarter, we had a large tax refund relating to prior year for $45 million. Net of the tax refund, our cash flow from operations increased by 5%.
We continued to implement our share buyback program during the quarter and repurchased approximately 2.4 million shares for a total cost of approximately $249 million.
Now let's turn the call over to Gil for his comments.
Thank you, Tal. As you just heard from Tal, our results for the first quarter were good, with revenues at the midpoint of our projection and earnings per share at the top of our projection. We started the year with a new and unique strategy that aims to bring the world into the fifth generation of cyber protection. Before I elaborate on that let's provide you with a little perspective.
This past year has been quite significant for everyone in cyberspace. There has been a change in the cyber threat landscape with attacks that are coming increasingly sophisticated. These attacks – these Gen V attacks are in many cases multi-vector attacks, polymorphic and attackers are utilizing the most sophisticated attack tools. While the level of attacks are of the fifth generation, we believe that the vast majority of enterprises are still using security tools that are somewhere between the second and third generation of cyber protections.
Second generation attacks are focused on penetrating the network, and we believe that our firewalls provide the best protection against these type of attacks. Third generation attacks are focused on exploiting vulnerabilities in application inside the network and applications that are accessing or are accessible from the Internet. We lead the markets for integrated intrusion prevention in the network security infrastructure which is the key element in Gen III security.
However, fourth and fifth generation attacks disguise themselves well in network traffic and especially in content files. Fifth generation attacks add the multi-vector element and in many cases can utilize cloud and mobile to deliver themselves into their target.
Bridging the gap between the third generation of attack and the fifth generation of attack isn't an easy task. Customers are investing heavily in many technologies and increasingly more vendors, yet our surveys indicate that only 3% believe that we are ready for the fifth generation, 97% are simply not there. This is a huge challenge and a tremendous opportunity.
I believe that Check Point is uniquely positioned to close this gap. Check Point offers a broad solution that can address Gen V cybersecurity challenges in a holistic way. Our solution are designed to prevent zero-day attacks across the traditional and new attack vectors including cloud and mobile.
Gen V architecture is focused not only on speed and (9:34) of the firewalling capabilities but encompasses many other areas of security that have been developed in Check Point and are unique in the marketplace. Real-time threat sharing, first-time prevention technologies, cloud security enforcement and mobile threat prevention are a few examples. On top of that, to truly manage this type of security architecture the customer must have a unified security management platform where Check Point has always been way ahead of the market.
Some of the above may sound too technical for many of you, but just to illustrate the differences, most of our industry has been putting their focus on detecting different families of attacks. This is simply not enough. I believe that attacks can and should be prevented, and we are demonstrating it every day at Check Point.
We introduced the Gen V strategy in the first quarter at our Check Point Experience 360 conferences in Europe, U.S., and Asia. We had record attendance and the highest level of customer ratings for our conference and strategy in our history. It seems that our message of addressing the fifth generation of cyber threat is well received by our target audiences.
In every discussion that I had with chief information security officers and with key IT leaders, they all agree that their challenges are Gen V, yet their staff is still focused on managing the Gen II and Gen III technologies. Empowering customers to make this big step forward is a great privilege, but not a simple task.
In the first quarter, we already delivered a few wins where customers purchased a full Gen V security solution using our Infinity Total Protection security offering. These deals demonstrated how the conversation is shifting from transactional product purchases into strategic security architecture which carry more value, a value that's recognized financially over a longer period given that these deals are all based on annuity models.
We continue to enhance the cloud capabilities of our Infinity architecture. We launched the CloudGuard family of products, addressing both infrastructure cloud security and software-as-a-service or SaaS security. In the area of cloud security for the infrastructure, we saw very high percentage increase in sales this past quarter. This quarter we will start shipping our CloudGuard SaaS technologies.
To execute on Infinity and CloudGuard we invest not only in research and development, we also continue to refine our go-to-market strategy. Key elements which we are making changes is the focus on being much more proactive in approaching new customers and in reaching the higher level in our customers' organizations. The CISOs, CIOs and others have the ability to see the bigger picture and update their overall security architecture to fifth generation protection.
We have elevated the level of our marketing activities and will continue to do so. Yet this task of changing the behavior of our productive sales force takes time. We're asking them to learn new sales techniques, reach much higher in the organization and learn new tactics in approaching new customers and opportunities. At the same time, we continue to hire new salespeople to augment our coverage where needed.
This quarter we already saw some early successes of the new changes in the Gen V initiatives. For example, a financial customer attended the CPX conference in February, saw the Gen V and Infinity Total Protection, returned home, and said that's what I want. Within a month, it resulted in a five-year multimillion dollar deal. We have other early success in the Infinity space in multiple customer segments and geographies, U.S., Europe and Asia Pacific. These early successes demonstrate the huge potential ahead of us.
However, with the positives of these early successes, there are also some other implication. Changing sales execution takes longer than what I'd like, and while these deals are much bigger than a typical product deal, they take longer to show as they come in the (13:40). In other cases they can lead to longer sales cycles. Therefore, while I'm pleased with the first quarter revenues and EPS, our overall sales are softer than what I would have hoped to see. It will also slightly reduce our projection for the remainder of the year.
With that, I would like to provide my projection for the second quarter and update some of the full year numbers. As you know, my usual caveat, predicting the future always carry a high level of uncertainty. There's risks and there's potential upside.
With that in mind, I'd like to share some of the numbers. For the second quarter, revenues are expected to be in the range of $445 million to $475 million and non-GAAP EPS in the range of $1.25 to $1.35. GAAP EPS is expected to be approximately $0.15 lower. For the full year, I'd also like to update our projections by approximately 2% to 3% to reflect the changes we are making. Full-year revenues are expected to be between $1.85 billion, and $1.93 billion. Non-GAAP EPS in the range of $5.45 to $5.75. GAAP EPS is expected to be approximately $0.62 lower.
With that, I'd like to open the call for your insightful questions and looking forward for your great feedback on our strategy.
Thank you. In the interest of time, we do ask that you limit yourself to one question and one follow-up. Our first question is coming from Jonathan Ho of William Blair. Please go ahead.
Hi. Good morning. Just wanted to maybe start out with some of the sales execution challenges. Can you maybe talk about where we are in that process? Maybe what's worked, what's continued to be challenging and maybe the timeframe that you see for that to be corrected at this point?
I think there's many things that we're doing and there's no – it's not one thing that we are doing and it simply takes time. And again, as I said, a little bit more than I would hoped it to change. There are some things like we promoted a new sales leader for our U.S. organization. But the main issue is really about teaching our salespeople how to approach higher in the organization, how to reach the C level, how to go to cross department and cross projects.
Again, our people have great relationships and great success usually with the network security people within the organization. We really need to expand that. And again, especially for a very productive sales force like we have, it's hard to adapt to this challenge.
When we talk about Infinity, again in the past it was, here's a product, take the product, maybe check its performance. I think one of the most successful sales strategies that we have is doing what we call checkup report. We come to a customer, we analyze their network, we give them a report. We've seen tremendous success on that.
It can be in a small organization, it can be in some of the largest banks in the world when we carry that checkup situation. And almost always they result in them adopting a broader strategy and understanding the superiority of the Check Point technology. We've kicked by the way many competitive products when they saw that their network is unprotected with this checkup report.
So these are all things that we're making and changing and they simply take time.
Got it. And then just with regard to Infinity Total Protect, can you maybe give us a sense of what the impact has been on product revenue versus subscription? I know it's relatively early days, but there's clearly some shifts that are going to happen between those lines and can you give us a little bit more color in terms of maybe what's happening with that?
Sure. Like I said, it was very early, but there's already a few deals and when I'm looking forward, it's obvious that there is a shift that you experience just like when we historically sold IPS as a product and then we moved into the subscription.
So I'll just give you an example. If you typically sell appliances and all of this is in the product line and then you might have a touch of subscription which might be – depends on the package, but it can be, let's say, 15% to 30% of that value and then you have update and maintenance, let's say 20%. In a typical Infinity deal, the products portion is going to be significantly lower of that pie. Probably around 80% is going to the subscription and support portion and around 20% will go to the product line, so it's quite a significant shift.
Thank you.
Thank you. Our next question is coming from Saket Kalia of Barclays. Please go ahead.
Hey. Good morning, guys, and thanks for taking my questions here. First, maybe for you, Gil, clearly a nice early success on Infinity Total Protect. You've talked a little bit about kind of how it attacks or handles Gen V attacks. But in your conversations with customers, how are they responding to sort of the very different pricing model with a chance for more usage?
I think the pricing model we actually like. The challenge is not there. The pricing model we like because it makes our life simple because it's a predictable model. I think it's very fair model, the deals that we closed were all at the price that – the price that we came up with. It wasn't – there wasn't much price pressure there on that. So I think from that perspective, it's going very well.
The bigger challenge is actually to get them to consolidate the review. Today, customers are – especially, large customers are looking at these technologies in many different silos, in different places, in different organizations. And it's really, really hard for them to see how to consolidate, to take the bigger picture and to take that bigger view. And I think that's one of the sales challenges that we have and just not about Infinity, by the way, in general selling a more architectural sale.
That makes sense. And then for my follow-up, maybe for you Tal, just thinking about the historical subscription packages that we've sold. We're a couple quarters now past the anniversary date for that big pricing change you made last time. Can you just talk about qualitatively how renewal rates have trended on subscription packages over the last couple of quarters?
Frankly, if you remember, I always told you they're moving between packages, so that's why we don't provide it, but in general renewal rates are pretty steady, the installed base is steady, the renewal rate is steady. The challenge is to move up into the levels and sell additional solutions.
So historically, in our offers if a customer had next generation firewall, you moved in and offer them a higher value with next generation threat prevention. And then we bundle the next generation threat prevention, and the upsell was to move into next generation threat extraction, now – which is advanced threat protection.
Now you have to go all the way up to Infinity and sell him the entire total solutions in one price to be implemented all around the organization, and that will be majority of it in those subscription and update and maintenance lines.
Got it. Thanks very much.
Thank you. Our next question is coming from Sterling Auty of JPMorgan. Please go ahead.
Yeah. Thanks. Hi, guys. Just curious. You talk about sales execution, but what where win rates like during the quarter on a competitive? How are you sure that it's not a technology and a competitive issue?
I think the competitive win rates were the same. We had many cases when we kicked out competitors from accounts all over the world. As I mentioned with our checkup report we've seen cases, even again in the most sophisticated and largest accounts in the world, not just accounts that have limited stocks on them, some huge banks.
We sold deals when we did the checkup report, and they were shocked to see how many malware they have on their network that penetrated what they were thinking is a good security solution. And again, we started, especially in the very large one, we started the early process of replacing them.
So I don't think that our issue today is in technology quite the contrary, and again, if you remember last quarter there was the NSS report that shows the Breach Prevention System report, the first NSS test that they did that actually really tested advanced threats and the ability to prevent them. We scored a clean 100% ratio on that, and we were, by the way, the only vendor that even got to this test with a single gateway and not with a host of five or six different technologies.
If you would add to that, by the way, our other systems would keep the 100%, but again, it can't get any better unless by the way we got to the test with the simplest system out of all vendors and still got the highest rank. So I'm pretty sure about the capabilities of our technology.
Got it. And then as a follow-up, with the promotion for the head of sales in North America, is there additional changes you feel that need to be made underneath? Or it's more just the training and experience issue at this point?
I think we will keep making changes, and I think there's a lot of places that we have to build and we have to change and especially augment where we hire. We are hiring especially in the Americas. We have a lot of open positions, and we encourage our salespeople to add the people in the right places. And I think we will add people all over the place, both at the top and then the people that are actually doing the work.
Thank you.
Thank you. Our next question is coming from Shaul Eyal of Oppenheimer. Please go ahead.
Thank you. Good afternoon, guys. Maybe building on Sterling's prior question, so Gil, on the sales and marketing front, I think all of us taken United Airlines flights over the course of the past few weeks have seen the Check Point commercials, but as it relates to sales force hiring, can you maybe quantify for us how many salespeople were added during the first quarter? And maybe the second question in that respect, a very competitive landscape right now both in Israel and without a doubt you mentioned the U.S. How can Check Point draw top talent? And when you draw talent, where are you bringing this talent from?
I don't have in front of me the number of people we hired and so on, but I think it is a nice number. But as I said, we have many open headcounts, so we can still hire more especially in the U.S.
In terms of drawing talent, again, it is a competitive market. It is hard to recruit people, but I think we're able to do that. It's very, very different when you speak about the sales force in the U.S. or in the rest of the world. And by the way, U.S., rest of the world, and Israel are very, very different. In most countries, I think Check Point is quite an attractive, leading vendors for new people to join in most European countries in Asia and so on. So I think there we can attract very, very good talent.
In the U.S., I think we're also a very attractive vendor in the cybersecurity space. And by the way, we see that. We see that people that left Check Point two, three years ago to move to other vendors in the security space, sometimes even to our competitors – there aren't, by the way, many people that leave us for competitors. But even some of these people are asking to come back, and some did come back. Some we did recruit back, and I think what they all quote it's not just the work atmosphere but the fact that they like to work with the best technology, and they like to stand in front of the customer knowing that what we sell is a credible story with the leading technology.
In Israel, it's quite different because first we try to get developers, researchers and so on. The market here is competitive, but here I think we're definitely considered one of the most prominent companies that people want to come and learn and grow in.
In Israel, we mainly recruit people in the early stage – not even early stage of their career – before they start their career. Most of the people we recruit are during their second and third years in university. They become interns and then during their university studies, and then when they graduate we can pick the best one to stay here.
I can give you one excellent example of a program that's really unique that we've done last year. We call it the Check Point Security Academy. We trained really the top, top talent of security researchers. Usually most companies are looking for people with prior experience in that, and there aren't that many people that have prior experience from that. So we understood that at the macro level there's a limit of how many we can try and recruit, and we simply created our own program. We got the first round of people in that program, and they are amazing. One of the graduates of that program that again came with no prior experience, fresh out of the program, within a month found one the most significant vulnerabilities in Microsoft Office, for example. So we have some very, very nice wins in there.
Thank you. The next question is coming from Gregg Moskowitz of Cowen. Please go ahead.
Okay. Thank you very much. And hi, guys. Question, Tal, just on software updates and maintenance because the revenue did decline by 2% sequentially, and by our estimates, that does represent the biggest sequential decline that we've seen in the last decade or so. It sounds like you're not seeing any change in win rates. But with that being the case, does this reflect any change in pricing on maintenance contracts? Or is there some other factor that you would attribute it to?
Typically, between Q4 and Q1 the reduction, it depends how much – you don't have only update and maintenance recurring. You also have there training, you have installations, you have professional services that sometimes you have more in Q4 as a result of implementation of large projects. So nothing dramatic, no.
Okay. Thank you. And then just getting back, Gil, briefly to the go-to-market changes that you've discussed on this call and previously. Do you guys have a line of sight into when things will be back on track? Because you talked about the architectural sale that Infinity entailed and obviously, that had a lot of promise, but it does also introduce more complexity. And I'm just kind of curious when you sort of think you may get to that point of returning to better execution.
I think we will see changes. We will see some effect already this quarter and some improvement compared to some of the internal metrics that we have over the first quarter. And even in the internal, the first quarter we saw improvement in some metrics that we are starting to track and starting to work on. The overall impact on the revenues, I think it can take time because we're talking here really about different phenomenas that it's hard for us to estimate. Like large deals, I really like us to penetrate more strategic large deals. These deals by definition are very long sales cycles. So if we win them, it will take time. If we don't win them, I don't consider that even an option. Let's put it that way.
Small deals that are more architectural and so on with smaller customers, these deals can come faster in some cases but their overall impact is hard to mitigate. And again, if we talk about these architectural deals, their revenue recognition would cause the revenues to come a little bit later. So it's a little bit hard to predict that. Yet I'm very, very optimistic about what we have and the acceptance of the new messages that we have in the marketplace.
Okay. Great. Thank you very much.
Thank you. Our next question is coming from Andrew Nowinski of Piper Jaffray. Please go ahead.
All right. Thanks a lot, guys. And maybe just starting with a clarification. It looked like product and license sales declined about 6.5% year-over-year which sounds like it's just due to that mix shift from the Infinity program. I guess, in light of your lowered annual outlook, are you still expecting product and license growth in the second half of 2018 or is that no longer on the table?
If you look at the guidance, you will see that in our midpoint it doesn't assume that. So we – and I just want to clarify, there's two things. It's not that the Infinity takes longer to recognize as revenues which is obviously a significant effect, but what Gil was relating to is also the length of the time it takes to close such deals on architecture moving up in the hierarchy in the large organizations, getting the right people in order to get the big picture and purchase an Infinity.
So while we see a very nice pipeline, we estimate it to take longer to close it. So on the one hand it delays product refreshes because now you can get into the Infinity, so you see an effect on the products revenues. And then it takes the time, A, to close the deal and, B, once you close it to recognize it into the revenues.
All right. Thanks. And then last quarter you had talked about making progress winning new customers, but we're not really seeing that showing up in billings which were flat again despite even a higher duration. I guess, is Infinity driving any new customer growth or are you seeing Infinity driving really more sales to your existing customer base?
Maybe just because we started with accounting, so I didn't discuss it at all but I can just say, note that Infinity is paid over annually, which means you won't even see it in the deferred revenues, unless it's a customer that decided to pay everything up-front. So just take that also into consideration.
All right. Thank you.
In terms of customers, we have a mix of both existing and new. I think it's a potential for both and we're working on both opportunities.
I can give you one example of a customer that we won that – where we actually received five vendors with the Infinity solution and that's a great solution. And we did win over some of our key prominent competitors in that deal. And again, kicked out of the account five other vendors, so the solution is really, really comprehensive.
Thank you. Our next question is coming from Anne Meisner of Susquehanna Financial Group. Please go ahead.
Yeah. Hi, everyone. Thanks for taking my question. I just wanted to dig into the subscription growth deceleration a little bit, more that's beyond what we've been modeling for deceleration. So this is maybe a bit of a follow-up to Saket's question, but is there any further color you can provide on pricing of the subscription bundle renewals? You did say the renewal rates were good, but maybe there's some pricing going on there? And then any commentary you can provide on subscription attach rates on new business?
Sure. Just to remind is when we discussed it last quarter, I said to expect some deceleration in the subscription as a result of the acceleration last year. Some of it was relating to bundling in 2016 of the NGTP into the appliances which created a pressure on the product, but then acceleration in the subscription over close to the entire year last year which means this year you see some of the deceleration back to normal rates.
Okay. Great. And then a quick follow-up. So considering your strong cash balance, strong cash flows still and you're kind of going through a bit of a sluggish period for sales, is there – any thoughts, I guess, on just increasing your stock repurchase beyond the $1 billion per year that you've been doing?
It's something which can consider. It's an option. Again, I don't even have a strong position for or against. What we usually do, by the way, on these things, of course, it's a board decision and the board decides that. And usually we collect feedback from shareholders before we make major decisions in that space.
And I'll just add that typically as the old program is coming now to an end, then we have a discussion, we bring all the data, and based on that make a decision.
Okay. Perfect. Thank you very much.
Thank you. Our next question is coming from Ken Talanian of Evercore ISI. Please go ahead.
Hi, guys. Thanks for taking the question. I was wondering if you could frame how your renewal pipeline compares for the remainder of the year versus this time last year?
Wow. Should be the same, slightly up, since our subscription is the same and slightly up versus last year.
Our installed base is a little bit bigger and therefore...
Exactly. So it's a little bit bigger, so the opportunity should be slightly higher. So in that area, I would say not much drama, right? Like it can fluctuate between quarters, just depends on long term contracts, but when you talk about the regular potential we've got, if you put aside multiyears then it's pretty much the same.
And I guess as a follow-up, do you expect there to be more or less multiyear deals than you've seen over the past year?
Really hard to predict. I'm not driving it into big multiyear deals. It's always a struggle with the sales force that in many cases wants to make these multiyear deal. I'm actually not pushing for that because I think there's no reason to sacrifice future revenues and give higher discounts for that. But again, it varies, and if somebody comes up with a great proposal then of course we accept the booking.
Great. Thank you very much.
Thank you. Our next question is coming from Phil Winslow of Wells Fargo. Please go ahead.
Hey, guys. Thanks for taking my question. Just to continue on Infinity, obviously it's a big change not only from a technology platform perspective but just pricing and packaging, not just for you guys but really relative to the industry. So curious just what you're seeing competitively, the response being from the others in the market to Infinity, whether it be pricing promotion? Just any sort of competitive response that you're seeing would be great.
I think there are some responses. I'm not that familiar with the details, but I think realistically they can't do that because they don't have the full architecture. Our competitors don't have the management to manage a holistic security. Most of our competitors don't even have the management to manage just the network security as one unit. They don't have the mobility portion of that.
They lack on the cloud and definitely on the cloud SaaS part of application, and the overall message of let's bring you to Gen V and do full prevention, none of our competitors does full prevention at this point. And again, people hardly miss that because they take benchmarks on bits and pieces of their technology capabilities, but to do first-time prevention, that's really, really unique to us.
Got it. Thanks, guys.
Thank you. Our next question is coming from John DiFucci of Jefferies. Please go ahead.
Hi. This is Julian Serafini on for John. So big picture question I guess for Gil. You talked about multi-vector attacks, and I'm thinking about the endpoint particularly. And I know some of your competitors are pushing more into the endpoint. I know Check Point offers the SandBlast solution on endpoint, but realistically Check Point hasn't been considered a large endpoint player. I guess how do you consider that market, is it a market that interests you more, will interest you more in the future? Or how do you think about it?
Very good question, and I apologize, by the way, for the noise. It started an amazing rain here which is very untypical for Tel Aviv in the spring. And so I think first we do have excellent endpoint suite that we can put on customer networks, and I think it's very integrated. It has all the capabilities, and especially on the (39:40). I mean, the basic features of an endpoint like antivirus and so on. We have an excellent package, much better than our direct competitors in the network security space, and we have the best AV engines and so on. And on the advanced capabilities, we really have very, very unique capabilities on that.
But the real big story, I think this is very, very good for the security story on the architecture, but I don't think that most customers would replace their existing endpoint suite from (40:14), McAfee and many of the other endpoint vendors that are out there. I think that the endpoint business – again, I think the impact we can have really doesn't affect Check Point. All the network security companies can have on the endpoint is very, very limited. It's very hard to replace a full endpoint suite. And what we can do is augment that with the advanced technologies. And there I think we have a lot to offer from our advanced SandBlast agent and the advanced capabilities to the browser extension that we have which is very, again, unique to us. A browser extension that checks all the downloads that we're doing on the web browser.
Okay, thank you.
Thank you. Our next question is coming from Walter Pritchard of Citi. Please go ahead.
A question for Gil just on sales and marketing. I'm wondering if you think from a multiyear perspective, given the industry remains pretty competitive, do you expect to have to increase sales and marketing as a percentage of revenues as we go out, not necessarily this year, but in out years? It just seems like the industry is kind of not let up in its spending. I'm wondering if you have to respond in that way.
I think we will increase slightly the sales and marketing spend. But I think overall the issue is not just increasing the spend, the issue is doing it smartly. So now this year, yes, we're doing two, three times more marketing activities. And when I'm talking about increasing marketing activities, it's really, really high percentages. You can see the impact on the financial is hard to spot. Can we do more? Yes. Will we do more? Probably yes. But if we will do more, I also expect revenues to come in return to that.
Great. And then, Tal you've referenced mix shift in gross margins. Can you talk about mix shift in product and especially address what you're seeing on the Virtual series, which is all software?
Yes. No, what I meant is if you see, you see our gross margin slightly moved up. And I always say the gross margin can move up 1% or move down 1%, depends on the product mix. So this product, when you look at the product, product was lower and the growth came from subscriptions, subscriptions came with higher margin hence the improvement on the margins. And on the vSEC, it's the software. So we understand that anything that has to do with virtual software subscriptions, mobile, anything that we discussed in the gross margin is like 98% margin, right? The cost is actually in the R&D expenses.
Thank you. Our next question is coming from Brad Zelnick of Credit Suisse. Please go ahead.
Good morning. It's actually Will Lunn on behalf of Brad. Thanks very much for taking my question. I wanted to ask, when we think about segmentation of the business in terms of low, medium and high-end, so I guess branch, SMB, enterprise and the data center. It would be really interesting to know where you're seeing the most momentum and perhaps any color you can share around discounting trends within those buckets. Thank you.
I think that it varies every quarter and there is no direct pattern. Right now we're seeing strength in the low end, in the midsize and in the super high-end. Where I see softness is actually in the part of the large products, but not the super-high end. The super-high end we see that. In the cloud space (43:55), we see a big strength. We've seen very nice growth on the cloud sales, the infrastructure cloud sales and that trend just continues now for more than a year.
Thanks very much.
I'll give you guys some insight on the noise you're hearing. This is golf-ball sized hail, something that doesn't happen in Tel Aviv. Very, very rarely, I think, is the way to look at it. So we apologize for the sound, but proceed with the questions.
Thank you. Our next question is coming from Keith Weiss of Morgan Stanley. Please go ahead.
Excellent. Thank you for the question. And Gil congratulations on that Israel Prize. That's definitely a big honor, really a testament to what you guys at Check Point have done in the overall security industry. My question was kind of along the lines of the investment dent. With the changes that are going on with the sales organization, we did see sales and marketing expense up like 11% this quarter. Should we expect that investment to continue? Or do sort of the new leaders have to come into place and sort of get efforts into place before you sort of hire on additional resources under that?
Sorry, because of the noise here, it's very hard for me to hear. Can you repeat the last part of the question?
So the general gist of the question is, with changes in sales leadership going on in the Americas, do you have to pause the investment in the Americas while you're making those changes? Or does the investment continue with the new leadership?
No, we actually need to accelerate what we're doing. And the new leader that was promoted, she's been a Check Point veteran for many years so she knows – so she knows all the market, she knows all the people, she knows – I mean, she's an internal promotion which is always better. And I think she will push all the people inside to ramp up to where they need to be.
Got it. And then on the cloud side of the equation, in the press release you talked a lot about CloudGuard and the ability to protect those cloud-based environments. Can you talk a little bit about sort of virtual firewalls and sort of the adoption you're seeing of those virtual firewalls in cloud-based environments? Has that started to pick up? Is it becoming a more significant part of your business today?
It is a small part but it is – it did ramp up significantly, almost double this quarter. Take into consideration that this is also sold today, mostly it's an annuity model. So in the past, people purchase software firewall, it's a onetime forever price, basically. Now, with the cloud this is actually also moving into annuity pricing which in the long run is good, in the short run you see, again, a shift from the product revenue to the subscription revenue.
Got it. Excellent. Thank you very much, guys.
Thank you. Our next question is coming from Fatima Boolani of UBS. Please go ahead.
Good morning. Thank you for taking the question. Tal, a question for you and just want to better understand the sequential decline in subscription revenue. I can appreciate some of the changes that are happening on the product side which you've characterized as kind of being dehydrated. But subscription revenues being down sequentially is the first time I'm seeing that since you started breaking it out. So can you help me better understand what the driver would be for that to happen and what the trajectory for growth for the subscription line looks like for the rest of the year?
Sure. So when we talked about the guidance in the beginning of the year, I said we expect it to go back to the levels of 13%, 14%, 15%. So it's actually quite expected. Think that the process of subscription is built in layers, so when we move from NGFW to NGTP then it created an uplift and acceleration. It started as a bundle which – the way we do it, we put it as a bundle and then the next year it's renew and you enjoy a very nice growth.
Then we move edge solutions. So we move to advanced threat protection, we added NGTP and then we added NGTX. Again, the first year of the bundling, this creates a pressure on the product and then a year after you see a very nice accelerated growth.
This year, Infinity is that next phase. Meaning, now we see people – but Infinity is not bundled, remember that. So actually Infinity you need to introduce to the market. The more Infinity transactions you will have, you will see more pressure on the product, but three, four quarters later you will start – well, second quarter later you will start to see revenue recognition and again acceleration in the subscription line.
So the more you succeed the first year you see pressure on the product and the second year you start to see an acceleration on the subscription. And that's what we were relating to and that's also part of the effect of the Infinity, the cycle of closing the deals and once you close it, you will see it over time in the revenues.
That's helpful. And maybe a question for Gil. I know you spent a lot of time talking through the sales cycle elongation associated with Infinity and some of the go-to-market changes you're making to empower your salespeople around Infinity. Can you speak to the efforts you have around your partner community and your channel community and how – and what sort of investments are going in that distribution avenue to help with Infinity and improving the sales velocity there? And that's it for me. Thank you.
So first, our partners are very, very important in this cycle. And when I talked about our CPX 360 conference, for example, that's the perfect example. This the first time we're doing that conference. It's a joint conference for all of our sales force, all of our partners and our customers. This is why the conference has become very, very big.
And for the first time, by the way – that's why, by the way, they moved from the second quarter to the first quarter because we combined that with our sales kickoff meeting. And I think overall, we need to do more and work more with our partners to explore that opportunity to get to them – by the way, still 100% of our business is fulfilled and is done jointly with the partners. So our business remains 100% joint business with the partners. And absolutely, yes, we need to invest more in doing it with partners. There are some, by the way, large nice opportunities around that, like working better with large system integrators to give a customer a fully integrated approach for security, and in many cases the system integrator, not just the local resellers, can help us address that. And there's plenty of opportunities with our channels and resellers, all levels that can promote these values.
Thank you. Our next question is coming from Matt Hedberg of RBC Capital Markets. Please go ahead.
Hey, guys. Thanks for taking my questions. Maybe a first one. With your exposure to Europe, I'm curious with GDPR going live next month, is that impacting sales at all? I mean, are you seeing a positive benefit there? Is it coming up in customer conversations? Just sort of curious any other color there?
I think GDPR definitely raises the conversation, and it's a good way to speak to some executives in the marketplace. So far I haven't seen a big impact on sales but, again, it's a way to bring people to activities, to do seminars, to educate people. People are very interested.
We have some material and white papers and so on about GDPR and what you should do in terms of security to comply to that. And by the way, I think that we have plenty of technologies in our product and technology that can help customers in that, things in the spaces of data leak prevention and then document security encryption and so on that are really, really helpful for customers if they need to comply to GDPR regulation.
That's great. And maybe a quick one. Somebody asked earlier about the potential for an increased buyback. I'm curious, with – I believe you have about $4 billion in cash, thoughts on incremental M&A at this point? Obviously, you're spending more on sales and marketing, but curious on sort of R&D and/or M&A. How do you kind of think about that?
We continue to look for attractive companies for acquisition. I think we really look for unique breakthrough technologies, and it's not that easy to find especially because I'm very, very confident about the technology and innovation that comes from within Check Point so far. But there are some promising ideas and promising things outside, and I think we're trying to look at them with more intensity.
Great. Thanks, Gil.
Thank you. Our next question is coming from Karl Keirstead of Deutsche Bank. Please go ahead.
Thank you. Tal, I apologize if this has been asked. I dropped for a second, but on the last earnings call you mentioned that you had a high level target to hit $1 billion in operating cash flow in 2018. Just in light of the investments that you and Gil have discussed, are you still comfortable with that or no?
In general, I don't expect changes there, right? So in general, anything can happen, but when you look at it, it's pretty much in line with what we see in the operating income with a delay of a quarter, right, in general, taking into account the operating cash flow. So I think it can be slightly more or slightly less but yes, I think I feel comfortable at this point of time with around $1 billion. Yeah.
Okay. Thank you.
All right. Guys. That was our last question. Thanks for working through the adversity with the hail with us today, and we look forward to speaking to all of you throughout the quarter. And we'll look for your calls coming in later today. Thanks, and have a great day.
Ladies and gentlemen, thank you for your participation. This concludes today's conference. You may disconnect your lines at this time and have a wonderful day.