Check Point Software Technologies Ltd (CHKP) 2002 Q2 法說會逐字稿

Please stand by, we're about to begin.

Good day everyone, welcome to this Check Point Software Technologies fiscal year 2002 second quarter financial result announcement.

Today's call is being recorded.

For opening remarks and introductions, I will now turn the conference over to Eyal Desheh, the Chief Financial Officer.

Thank you very much.

Good morning and afternoon, ladies and gentlemen.

This is Eyal Desheh, Check Point CFO.

I would like to thank you for joining us to discuss the 2nd quarter of 2002.

As a reminder, this call is being webcast live from our website, and a replay will be available through August 5 on the company's website at www.checkpoint.com/ir and via telephone replay.

If you would like to reach us after the call, please contact the investor relations department in Redwood City at 650-628-2050.

You can also call my office at 972-3-611-5064.

On the call with me today is Gil Shwed, Chairman and CEO, and Jerry Ungerman, President.

Before we start our management presentation, I would like to read the following disclaimer.

During the course of this call, the company will make certain forward-looking statements concerning trends during the second quarter, and revenue and earning per share growth for the future.

Other statements, which may be made in response to questions, which refer to our beliefs, plans, expectations, or intensions, are also forward-looking statements.

Because such statements deal with future events, actual results could differ materially from the company's current expectations and are subject to various risks and uncertainties as discussed in our report on form 20F for the year ended December 31, 2001 which has been filed with the Securities and Exchange Commission.

The company assumes no obligations to update information concerning its expectations.

I will now begin by reviewing Check Point's financial highlights for the second quarter of 2002.

Hopefully, you have all had a chance to review the press release and financial results.

Net income for the second quarter of 2002 was $64.7 million, or 26 cents per share diluted, an increase from $63.5, and 25 cents per share in the first quarter of this year.

The management, Check Point product, and services brought total revenues for the second quarter to $108.6 million, an increase of $4 million compared to the first quarter of 2002.

Cash flow for the quarter was strong at $75.6 million, $11 million better than our net income, bringing total cash to $1,182,000,000.

We continued to watch our expenses closer this quarter, like we always do, and we continued to increase our investment in both sales and marketing, and R & D as planned.

This resulted in an operating expense increase of $2.6 million to a total of $44.5 million, and most of the dollar increase was in sales and marketing.

Number of employees grew by 21, to 1,194, almost 1200 employees.

Now, let's look at some additional financial metrics for the quarter.

Product revenues were up 4% to $67.7 million, accounting for 62% of total revenues.

Software subscription revenues were $32.5 million, or 30% of our total revenues for the quarter.

Software subscription increased by 10% from Q1 this year.

Technical services were $8 million, or 8% of total revenues, down from 9%, which they were last quarter.

While the number of orders processed this quarter were similar to last quarter, we did see an increase in number of large orders, which are over $50,000, which accounted for 15% of total ordered products compared with 13% last quarter.

Jerry will provide some more details on our major customer wins in his review.

Strong collection reduced accounts receivable from $63 million to $59 million and improved DSO, days sales outstanding, to 49 days this quarter compared to 54 days in Q1, 2002.

This is an exceptional result and definitely below our anticipated range of 55 to 65 days for DSO.

The deferred revenue at the end of the quarter was $94.6 million, similar to Q1 levels.

While this summarizes the financial results, I would now like to turn the call over to Jerry to discuss the quarter.

Jerry.

Thank you, EYAL.

Hello, everyone.

I would now like to share some of the trends we've seen during the quarter.

Check Point continued to generate strong earnings despite the difficult business environment.

Macroeconomic conditions and global IT spending have not improved in time frame, or to the degree that was anticipated at the beginning of the year.

Despite this, Check Point had a solid quarter and continued to experience very high levels of interest from customers around the world for our industry-leading security solutions.

Security remained at the forefront of the minds of CIOs and IT purchasers worldwide, and market studies continue to confirm this.

Just last month, CIO Magazine published the results of a recent poll stating that CIOs have security software at the top of their spending and priority list and intend to increase spending in this area above all other technology areas.

In an economic environment of uncertainty, customers are turning to market leaders that they can count on, which means most specifically, they're turning to Check Point for our world-class security solutions and services, and this has allowed us to gain market share again this quarter in the fast growing market segment for appliance-based firewalls and BPMs.

We also won a number of very large and important transactions in what I would describe as a very competitive environment.

Our sales portion channel partners validate this.

They continue to encounter many exciting opportunities in the marketplace every day.

Customers are extending their networks to securely connect and protect new sites, users, and mobile devices, and are adding new security solutions throughout their enterprise.

I will now talk about the second quarter specifically.

Geographically, the Americas and Europe contributed 45% and 39% respectively, while sales in Asia Pacific and Japan contributed 16%.

The global economic state has effected business around the world, and we saw general business levels still lower than demand in all geographic segments.

During the quarter, we saw seasonal in Japan, slight increase in Europe and Asia, and a 10% increase in the United States.

Our customer installations grew by 4% in Q2, now totaling more than 236,000 VPN and firewall gateways, 130,000 of these or 55% of VPN gateways.

The number of remote-access clients, our secure remote and secure client products climbed to approximately 109 million users.

During this quarter, we won some significant new sales with industry-leading companies around the world.

Some include Soft Bank Commerce in Japan, signed on to be the first distributor of SofaWare's SBox in Japan.

MTT communications is basing its firewall management service on Check Point's market-leading FireWall-1 and Provider-1 management.

Lockheed Martin made a significant commitment to us this past quarter, as we now have become a strategic partner with installation of our Provider-1 management infrastructure.

We won a number of government opportunities around the world and in the United States, as well.

For example, two states, Louisiana and Delaware, made major commitments to Check Point as their security provider, and we were also selected by a large Department of Defense agency made up of over 25 subagencies that is now standard on Check Point, VPN-1, and Provider-1 architectures .

This DOD agency will implement two Provider-1, Check Point's unique hierarchical enterprise security management solution.

They have awarded a multi-year contract for Check Point products and support, providing product revenues to Check Point in excess of $2 million over the life of the contract.

We also saw continued success with enterprises adopting our Provider-1 management infrastructure.

A product we originally developed for service providers is now used by many large companies to manage their global networks.

This quarter alone, we saw, just on the upper Midwest, three large corporations -- Best Buy, Cargill, and United Health Group, all select our Provider-1 to manage their global networks.

In addition, we won a number of bids for our GX version to be installed in the core of many different wireless carriers around the world.

Those are just a few examples of new wins this past quarter.

Additionally, many of you may have seen our announcement last week about a global reseller agreement with Hewlett-Packard to provide end-to-end solutions that span across Check Point security products and HP servers and devices.

HPs global sales force and channels can now resale Check Point solutions.

This is significant in that it extends our reach into new accounts and allows us to take full advantage of the HP global services and Compaq deck system's integration organization.

Overall, we are pleased with our results this quarter and are highly confident about our positioning in the market.

As the leading security vender, Check Point has the largest breadth of security products in the market, with world-class solutions for enterprises, small-medium businesses, and consumers, communicating in wired or wireless environments, and whether they want to run it on an open server or deployed in an appliance-based platform.

No competitor in the market can make this claim today.

We are optimistic about the future and believe we are well positioned for continued growth as global economic conditions improve.

That concludes my comments and I will now turn the call over to Gil for further discussion.

Thank you, Jerry and hello everyone.

I'm proud of our performance this quarter.

As the market leader, we continue to raise the bar for internet security by delivering truly innovative customer-focused solutions.

This translated into success in our core markets and in emerging marketplaces.

We [ INAUDIBLE] promoting our security vision and introduced the SmartDefense technology and product, that takes internet security to new heights.

SmartDefense will commence shipping in the coming few weeks and has the potential to expand Check Point's security leadership, as well as expand our long-term business model with the security subscription revenue model.

We've created the new [ INAUDIBLE ] category for the deployment of security and wireless corporate land.

We also continue to build our unique, and the industry's best, management infrastructure, with the introduction of SmartCenter and SmartCenter Pro management bundle.

One of the most important trends that we see in the marketplace is the success of our platform strategy.

We hear our open approach continuing to gain mindshare, and winning the marketplace.

Our secure plantform open solutions are proving that open servers can provide the best price performance, delivering three gigabytes per second security performance, and almost one gigabyte of VPN performance running on a sub-$4000 standard server.

At the same time, our appliance partners, headed by Nokia, are continuing to gain shares in the security appliance marketplace.

We now [ INAUDIBLE ] hardware appliance sales done by our partners.

This data shows that their growth, in both percent and absolute dollar, is higher than any of the published competitive results.

The platform [ INAUDIBLE ] the choice and price performance leadership, coupled with our leading software, are showing what it takes to strategically lead the market.

The combination of leading technology in both software and hardware, a unique architecture of its scale, from the lowest 10 to the highest 10, with a business model that is profitable across all segments.

As we look forward, we believe that the high level of activity in our field will continue into the second half of the year.

If the economy improves, this level of activity can translate to increased results.

However, currently the economy doesn't show strong signs of change, and we all have to be conservative about that.

Given that, we believe we can make our current DPS estimates of 25 cents for Q3 and 27 cents for Q4.

We intend to keep growing our market shares and will keep investing in the future of internet security and the future of Check Point.

That concludes my comments and I believe we can open it to questions.

Thank you.

Today's question-and-answer session will be conducted electronically.

In order to pose a question, press the star key followed by the digit 1 on your touchtone telephone.

If you would like to ask a question, please press the star key, followed by the digit 1.

We'll go first to Matt Barzowkas of First Albany.

Thanks.

Talking about the HP distribution agreement, and I think you also signed one with Hitachi, I was wondering how that is different from other relationships or is it more -- if you could explain it a little more, on how it's going to work, going forward?

Well, Matt, it's similar, but it's adding a whole new channel to it.

To have the entire HP worldwide corporation with all of its sales force, all of its channels, it's entire consulting, global services organization that has now selected, you know, the Check Point product suite as its security offering that it's going to deploy on its servers, build into appliances and, you know, integrate through its systems integration business for a total solution, we think is a very, very big deal to us and to the market in general.

They bring thousands of relationships.

They've got customer base, distribution capability, and the platform.

In the past, um, were they offering a number of different solutions or were they offering you -- and now it is just going to become an expanded relationship?

No, this is a new relationship.

They were not -- they were offering other products and other technologies.

Okay, great, thank you.

We'll go next to Chris Russ of Wachovia Securities.

Congratulations, guys.

Nice quarter.

Question on the SBox shipments.

Did you disclose what the unit shipments were for SBox this quarter?

I think it was 3600 units that were shipped last quarter.

I just want to track the progress of that product.

The progress of SBox is pretty good.

The numbers of the quarter continue to show progress.

We did, by the way, start to shift the hardware portion of the business to our appliance partner, and now we have four appliance partners, headed by Nokia, that are offering, SBox [INAUDIBLE ] solutions to the marketplace.

Shipments this quarter are close to 5,000 units and we'll keep monitoring it as much as we can as we move this business to our hardware partners.

Okay, great.

You mentioned that large orders defined as greater than 50,000, um, increase sequentially to 15% of revenue from 13%.

You also had a metric, I think, last quarter, defined as orders greater than 10,000, I think, and that had fallen to 52% of revenue.

Do you have the comparable metric for this quarter for orders greater than 10,000 and what percentage of revenue they comprise?

It was a little bit, um, higher, consistent with the increase in the large orders, so, I was -- it was a little bit, a couple of percentage points higher than it was last quarter.

Okay, and Eyal, finally, any guidance on the third and fourth quarter of this year in terms of revenue?

Um, yeah, the thing that revenue prediction is difficult, and probably around where we are now, give and take a couple million dollars, but as we said, visibility is limited and we -- we have to wait and see.

Okay, so like a flat revenue outlook for the third quarter.

Something like that, and I think we all hope to see uptick in Q4, and given the business environment, we can expect that.

Again, we'll discuss that again next quarter.

Okay, and in an EPS line, any increase in spending in the second half that would impact EPS or do you expect EPS similar to this quarter, or there about?

I think we've said that we think that we can make the 25 cents, expecting for Q3, and the 27 for Q4.

I don't think there are dramatic changes in the expense lines, but we do keep investing, we keep hiring people, we keep doing more stuff, and we balance between the different quarters.

The expense levels are going to be again within the same next quarter, plus or minus a million dollars.

Okay, great.

Thank you very much.

Yeah, absolutely.

We'll go next to Dan Harverd of HSBC.

Hi, could you just, um, expand now that we're about seven months into the broadened relationship with Nokia?

How that has actually manifested itself in practice in terms of distribution channels?

And also R & D work?

I think it's gone extremely well.

I happen to travel a lot and I talk to people all over the world.

I think they're very pleased with the Check Point/Nokia relationship, and what we're doing.

Fact is, you're going to see it continue to expand, continue to get closer.

You can't see the internals of what we're doing with R & D in development and product tightness and integration of what we're doing, but some of the more visible things, external to the market, is that Nokia is going to begin reselling our product again on their price list, um, so it's an evolution and expansion of the business model and of the relationship that we have, um.

They'll build building bundles out of the product and bring it to marketplace to get at the ease of use, the ease of procurement, et cetera, there are going to be a lot of choices out there.

I'm very pleased with what we're doing with Nokia.

They're a great partner, and we have been successful together.

Okay then, just in terms of the sales and marketing costs in the quarter, was there something specific in Q2 that led to that increase or -- or should we see a similar level going forward?

Yes.

Q2 is normally our biggest quarter in marketing efforts.

We had two very large Check Point experiences with about 2500 customers and partners participating.

This is the biggest number that we have ever had.

One was in the U.S., and Disneyland, the other one, the European one, was in Dublin Ireland and that is definitely a big part of the increased sales and marketing expenses.

Beside, we kept adding sales people as we have said last quarter, and that is a part of the increase in sales and marketing.

But mostly the marketing effort, the Check Point experiences, and the two big events

Okay, thank you very much.

You're welcome.

We'll go next to Shaul Eyal of CIBC World Markets Corp..

Thank you, good afternoon.

Good quarter.

Two quick questions.

With respect, you know with the Hewlett-Packard agreement, when do you expect, you know, to have revenues kick into the model?

I think it will happen right away, Shaul, but like anything, it's a big corporation.

They have a lot on their minds, a lot on their hands, so now there is a lot of education, a lot of training, a lot of knowledge transfer, it will be rolled out, but they're very excited.

The people we're working with, about doing this.

There is a great receptivity within Hewlett-Packard that this is a strategic core capability they want to take to market, so we're just starting down that road and we'll visit again in three months to see what the impact is.

Long term, it's going to be positive for us though, so, I can't give you anything short term right now other than they're very excited through all the people, now they have to start deploying and rolling it out within the corporation.

Okay, thanks.

Two more quick questions.

With respect to hiring, what type of people are you currently hiring?

Is that across the board, sales and marketing, R& D?

My second one, with respect to share account, what are you expecting, basically, for the second half of this year in terms of shares outstanding?

Let me try and answer that.

In terms of head count, at least the first part.

In terms of hiring, we're hiring all types of people.

It's mainly sales and security engineers in the field with results of a lot of R&D people that we're hiring, even though most of the head count growth comes from the sales part.

In the R&D, a lot of it is they're replacing and upgrading the level of people that we have.

So in R&D, the head count stayed flat.

In sales and marketing, the head count grew in both areas, we're actually hiring a nice number of people.

Sure.

On the share, let me try the share count.

Share count, what do show right now is 253-254 million share.

You know there is a direct relationship between the average stock price for the quarter and the share count.

Absolutely.

So, since we don't control the stock price, or can't really tell what the share count is, but the numbers can go up and down a couple million shares, no more.

The influx is minimal.

Fair enough.

Thank you very much.

Congratulations again.

Thank you.

You're welcome.

We'll go next to Stephen Mahedy of Salomon Smith Barney.

Thanks.

A couple of questions.

First would be on cash collections.

What was it during the quarter that effectively led to a little bit more efficiency there?

Next question would be, on the balance sheet and the cash balance generally speaking, um, you know, what do you do with that?

There seems to be an effort underway within the industry to offer more services into the enterprise by a single provider.

What are some of your thoughts there, and then one other question after that?

Hi, Steve, let me try to take the first one on the collections then probably Gil and Jerry can answer the second part of your question.

Collection, obviously collection was a little better than revenues.

We normally don't provide collection numbers, um, but just the one cash flow figure, but we did collect more than we have bills, and as you all know in this environment, this is quite an achievement because, um, the companies in general try to keep their money as much as they can.

We have been blessed with very well-paying customers, so, that's the result that you see.

We have a strong channel basically

And we have a very strong channel.

But as I mentioned in my opening remarks, the 49 DSO is extremely low, and extremely efficient.

I won't anticipate that to further improve our current range, anywhere between 55 to 65 days that's where we normally are, that's where we're happy with.

This is a very good time, an exceptionally good number, the other half of the question, Gil.

I'll start maybe with security services.

I think the fact that most people want to offer security services is great.

Many of these companies are very large Check Point customers by buying the infrastructure from us to provide the managed security services, and we hope that this will continue.

We are also, by the way, offering subscription services.

We don't -- we do offer technical support services, but in terms of managed security services, I think we would like to be partners with as many as possible, and I think if we start offering this kind of managed security services, we'll compete with some of our best channels, so we try to stay out of the markets on its own.

Okay.

In regards --

No, I was just going to move on to one or two other questions if that's okay.

The next question would be, as related to the growth in VP and firewall units, and specifically gateway's relative to the revenue growth.

Do you look at the correlation and the incremental growth of the two?

With that in mind, could you comment on the incremental license, pricing, and maintenance pricing?

Well, Gil's looking up the data.

You've done the analysis.

What does it say to you?

Well, effectively on the increment. it looks like there might be have been perhaps a little bit of discounting.

You mentioned the competitive landscapes, so I'm wondering, you know, list pricing, do you hold that steady on some of the larger deals that you're going after?

Jerry had mentioned there was a little bit more competition in the environment.

There is.

I think what you're seeing is, you know, as we have expanded our product offerings in the small office in the Safe@, or whatever, we have gone into much lower price point products on a gateway basis than what we had historically, which is what I think the biggest issue is.

I find in individual deals, and it's interesting, price is an issue in the marketplace.

We find, overall, the most compelling issue is security.

And, as long as you have a right product and a right price going for a market segment, security wins out, not price, so that's my general view.

I think there are two different things mixed into a number you're looking at.

Okay in, light of that, maybe you could comment on when the Department of Defense,-- I know a lot of that information is proprietary and subject to nondisclosure, but, maybe just the scope of work, what are the products, who are some of the competitors that you went up against, and is that through a larger SI or VAR?

No, this is -- they'll buy the products through multiple VARs.

We worked it directly with them, they picked us as the security standard, which they have notified, as I said, there are 25 subagencies within the one, that anybody that wants to buy any firewall or VPN technology will buy Check Point.

So now as they go through over the next couple of years, and procure the technology to deploy it throughout their networks, it will be Check Point technology, and we had almost everybody there was in the market competed with us on that, and, um, we won it.

That was just one of many.

We have done many others also, both civilian and defense, both U.S. and outside the U.S., and we see a lot of activity in that marketplace and expect to see continued positive results there.

Okay, thank you.

Uh-huh.

We'll go next to Stephen Sigmond of RBC Capital Markets.

Thanks, I guess, for Jerry.

If you could comment a little bit on the go-to-market strategy for active defense, you guys are entering the intrusion detection market with this product, you said, in a couple of weeks, you have a number of very good partners there.

A followup to that question would be, in light of Symantec's recent string of acquisitions, are you rethinking or broadening the scope of the product that Check Point will deliver versus OPSEC partners?

Thanks.

I'll do part of it and then I'll make Gil jump in and add to it, Steve, but the active defense is not an intrusion detection product, first and foremost.

It's got some of the attributes, some of the capabilities that might be in an intrusion detection product, but that's not what this is.

We think it's fundamental to the evolution of what -- I keep on saying the firewall tomorrow's going to be different than the firewall of today and yesterday.

We add a lot of new functionality and capability in that.

We don't have an intrusion detection product to go out and compete with our partners.

We have a much more actively robust, secure technology in our firewall VPN than anybody else, but it doesn't displace the need or the requirement for an intrusion detection product.

It does a lot of other things that we don't do.

We think we do what is very important and most critical for an active defense management architecture, or defending the network on a realtime basis, and that's why we see so much excitement out there.

But we don't see anything right now that causes us to violate the premise, the capability, the functionality of OPSEC.

Fact is, Symantec is a very good OPSEC partner and is continuing as a very good partner.

The fact is, one of the acquisitions they made is a very good partner of Check Point, and we think will continue to be a very good partner of Check Point, in their manned services business, so we can continue to operate and do very well in this environment.

We think the whole Check Point ecosystem is very strong and doing very well.

Great, thanks very much.

Okay, Steve.

We'll go next to Robert Breza of A.G. Edwards.

Good afternoon, everybody.

Really quickly, maybe for Eyal, could you give us a little bit of guidance on where you see the balance sheet specifically -- you talked about DSOs, I want to get some flavor here for where you see deferred revenues overtime?

Yeah, Hi, Bob.

On the first, you know we don't have formal guidance on deferred revenues.

It's a function of what we sell, and um, and the mix of subscriptions and [ INAUDIBLE ] for the quarter, and normally, we believe that our deferred can go up and down by $5 million, um, next quarter, and I think that's where we are now.

Regarding receivables and DSO, I think I said that before, I think our DSO is extremely, extremely low, which is a good place to be, which means we can allow ourselves to use a little bit of our cash for payment terms to, um, and use some of the money to improve sales, but I would not anticipate any dramatic change on the balance sheet.

Great.

Other than the increase the cash next quarter, which we anticipate to do.

Great, maybe one quick question for Jerry or Gil, here.

As you look at the partnership front, and obviously signing HP, can you give us an update on what you see, maybe more on the partnership side, maybe future competitive wins or signings here of other large partners and specifically looking internationally, maybe?

Um, I'm not going use any names, but I think you will see a number of announcements through the course of this year that will be similar in nature.

Very sizable, very significant partners are working with us.

I mean, we're working with a number of them today, and we have a lot more that I think you'll see sign on, both regional in nature, as well as global in nature.

Thanks.

We'll go next to Walter Pritchard of Soundview Technology group.

Hi, good morning, I was wondering if you could give us some specifics on the SmartDefense, ActiveDefense subscriptions and if that was a contributor to the increase of the subscription revenue in the quarter?

We haven't started actively selling SmartDefense.

We just announced the product.

We will commence sales in the next few weeks.

Like always, we know that with the multi-tier challenge that we have, it takes time to penetrate the markets with a new product and show significant results.

So far, the results didn't represent the security subscription of SmartDefense in the future of a real -- it's too hard right now to estimate at which rate, but obviously we will let you know over time.

One follow up, on the NG rolling through the install base, how are you seeing that progress as a percentage of units out there?

I understand all the new shipments are NG.

But as far as existing customers upgrading?

I don't have the upgrade numbers in front of me.

But I think it's a very nice number, it's a few hundred customers a day that are upgrading.

In terms of installed base, we jumped this quarter from about 40% of installations last quarter, to almost 80% of installation this quarter, which means pretty much all new sales or almost all new sales are now NG, and that's actually a very big shift in the quarter that we neglected to mention here.

Thank you very much.

We'll go next to Bob Lam with Bear Stearns.

Thank you.

A few questions here.

Could you update us on the progress you're making in entering the wireless market?

Have you closed any large wireless deals in the quarter, and also back to the competitive landscape, have you seen any change in large enterprise deals, fiscal versus [INAUDIBLE] and also, um, can you comment on the pricing environment?

Thanks.

We had a number of successes, Bob, in the wireless base again.

I mentioned we had sold many, many more of our GX systems, we are dominating that whole market with that kind of product and that technology in there.

We see a lot of competition, as I said earlier in my remarks.

I don't see it being an issue of pricing, it's turning out to be more of an issue of security.

We do compete with those other companies, and all of the large enterprise deals, and I think we do very, very well, Not that we win 100%, but I'm very pleased with our win rates, I know some others claimed some numbers that I find laughable, as to how often they beat us.

It's not factual.

It's not real.

We are still the dominant leading provider out there, We do 300 to 500 transactions a day.

If you look at just, not only our revenue, but look at the Check Point ecosystem, and all the hardware revenues we generated, if you look at what a customer paid, they probably spent between $350 to $400 million easily this quarter to buy Check Point solutions, of which we only get the software component.

We're by far the leading supplier, both in the appliance-based, we gained a lot of share, we know again this quarter in the appliance-based marketplace, and I think we will continue to do so.

It's about security, and we do have the best security, Bob, without question.

Great.

How many seven-figure deals did you close during the quarter?

I don't know if we disclosed that.

We close a few, but we try to close six-figure deals because we believe it is better during one quarter.

But we closed several seven digit deals, and much more six-figures deals which we consider very large ones.

Thanks

We'll go next to Todd Raker of CSFB

Hi guys.

Nice quarter.

Can you give us some insight in terms of stock options issued to the employee base?

I assume most of them are under water today.

What your plans are, and how is that effecting ongoing compensation costs?

Let me start with the facts. 70% of our options are in the money.

So, in terms of percentage of employees, it's like a different percentage.

It depends on when the employee joined the company.

As we move forward, we continue to run stock options for employees, I think our employees are doing quite well.

Not as well as we all did two years ago.

I think we're doing reasonable well and compared to the market, again, when 70% of options are in the money, I think it's quite good.

Can you guys talk about what percentage of revenues today you would attribute to appliances, versus, you know, open servers and other things?

I think 40% roughly, I mean, it's not an accurate number that I'm giving you, but it's 40% roughly, maybe a little bit higher.

It's now ranging between the 40 to 50%.

On appliances.

Right, and, um Gil, given that you had $1.2 billion of cash, and your stock has been suffering here, why not buy stock back?

You have so much excess cash today.

We keep analyzing that.

When we will find that it's the right course of action, we might do that.

I think these days, with what we see in the marketplace, we think that cash is a very, very valuable asset to secure the company future and to enable us the maximum business flexibility.

We keep analyzing that, however, and if at one point of time we will find it the right corpore action, we might do it at well.

Last question for you.

You guys have talked about active defense and how firewalls are going to change going forward.

Can you talk about what ActiveDefense means in terms of a revenue option to a customer who already bought FireWall-1?

Is there an automatic upgrade?

Is it a revenue upcharge?

The way we deal with ActiveDefense and SmartDefense, is basically, that the technology is available for all customers that are on software subscription or new customers.

NG.

As long as they have NG, they will be able and software subscriptions will be able to get it.

And what we will charge there, is an annual subscription to get the realtime upgrades, realtime information about the tax, and all that we call security subscription, that gives you a lot of information to do that.

The price for that right now is about $10,000 per customer, even for large networks.

I think it's limited by size, but it's pretty large size, I think 100 gateways or so.

So if you look at our install base, let's say almost a -- close to 100,000 customers, that's the potential there.

Now, how long will it take us to penetrate 1%, 2%, 10% of the market?

It will take us some time, like every new technology.

Definitely in today's marketplace.

We do think that the subscription model may be a little bit easier in which to start as the various active price points for the customers.

If you have 20 gateways paying $10,000 a year, it's not a big expense for the customers, um, so -- but we will start more seeing that as we start selling it, ant that will happen in the next few weeks.

You talk about subscriptions here quite extensively.

Can you talk about what percentage of orders, new orders are coming in for subscriptions versus licensing, and why are customers subscribing versus doing perpetual license?

The customer, just to clarify this, we sell perpetual licenses, what we call software subscriptions is a subscription for software and software upgrades.

Okay.

The new revenue modeling in SmartDefense, is a model that's only subscription.

You don't buy it to just pay subscription.

Eyal, I don't know if you can highlight how many customers buying the software scription out of the new orders.

The attachment rate we measure from time to time.

It's difficult to track.

Sometimes there is a time lag between, um, orders, but we believe that we have anywhere between 85 and 90% attachment rate on subscription, and a pretty high renewal rate.

As I mentioned earlier, this quarter subscription revenues, which are basically sales of licenses, in a perpetual way, would be 30% of our overall business for the quarter, which is a nice, recurring business, and it has been growing very nicely over the last few quarters.

I'm sorry, guys, I'm a little bit confused.

If I'm buying FireWall-1, can I buy it solely on a subscription basis or is there a perpetual license portion and then a subscription that is basically maintenance?

Perpetual only.

You can only buy FireWall-1 with a perpetual license

See so what does the subscription revenue really apply to?

We have subscriptions, which means if you want updates, new versions, bug fixes, the whole package of what we give.

You can buy that subscription on an annual basis.

Now, SmartDefense, there is another subscription service that we give with the SmartDefense technology for those wanting to use it, which will be imbedded in FireWall-1 and VPN-1.

Okay, given that answer, why are basically, you know, maintenance contracts or what you call subscription, you know, growing so much faster than -- perpetual license this quarter.

You said it was 10% this quarter over last quarter on subscription side but licenses were up 4%?

Probably because of renewal.

Okay.

Because the installed --

The base is rolling over and renewing.

Selling it at a higher% to those buying new products.

Is there any price increase on the subscription side?

No.

Okay.

Thank you, guys.

Okay, Todd.

We'll go next to Jordan Klein of UBS Warburg.

Hi, guys, nice quarter.

You need a drink of water after all of that?

No.

Okay.

Not yet.

Thanks.

Okay.

Maybe, Jerry or GIL, can you give us a little bit of an idea of what you see as the contributors for the improvement in the Americas?

I mean from what we've seen in the enterprise space, it's still continuins to be very tough.

Would you say that, you know, customers that delayed in Q1 came came back in Q2?

Check Point is doing something specifically better than they did in Q2, or new products What is going on that helped things improve so much in such a tough market?

First, I mean, I would start and let Jerry continue with that, by saying we do see the same thing you see in the market.

It's not an easy market.

However, I do think we have a strong pipeline of large deals, I can say from hearing our Americas sales meetings,saying that they never had such a nice pipeline of large deals, and that means mainly that customers need large scale deployment of security.

We have customers that are now putting the 10, 20, 50 site VPNs. 10, 50, 100 sites of firewalls and these customers are delaying, they're waiting, would like to push it to the next quarter, but eventually they do buy, and in this quarter, we have seen more closures of that than last quarter.

Jerry.

I agree.

That's exactly what it is, Jordan.

I mean they have been putting off, putting off, and toward the end of June, we did one of our largest single transactions ever in the Americas.

And it was something we thought we could have closed six months ago.

They were fighting the budget issues, the spending issues and finally it became so important and compelling that, you know, the transaction was finalized in June, and we're seeing more of that, but it's still very competitive, very difficult, very challenging, but I think we're very well positioned, and we continue to win, you know, more than our fair share of large transactions, in our view.

Okay, great, and then on the government, um, you know, people are looking at the second half of the year wondering when the federal government maybe steps up spending.

You had a big DOD win, you have the common criteria certification.

As you look into the pipeline, would you expect anything abnormal, either on the upside potentially in the second half, or is it too hard to tell in the government?

It's hard to tell because it's the government, but not because of activity.

We have significantly more large transactions than big deals on the table right now across a lot of agencies, some of which I expected to happen a long time ago, some that I expect to happen soon, but having been involved with that market for a long time, you can never tell.

Now, one, you know, the year ends in September, so will there be year end spending or will it all start with a new budget share?

I do expect a larger percent of our business to come out of the government sector and specifically the U.S.

Government over the next, um, quarter to year and a half.

Great, and then just the last one would be, um, it seems like you had notably improvement success on the Provider-1 product, and um, you know, it's a great product.

I'm curious why this quarter, maybe this quarter you mentioned more of the wins, but it sounded like in your prepared remarks, enterprise started to sign up or purchase that um, anything there in terms -- terms of on the sales side that you're doing differently, either pricing wise, or any reason for why that would be seem to be a little bit stronger this quarter?

No, I think it's just the ultimate success of our focus on it.

We started out as a service provider product, and more and more we got into the enterprises, -- about a year ago we brought out a couple of smaller models, Jordon.

Probably didn't make a big deal of it, but it became much more attractive for the enterprises from a price point than the very high end original Provider-1 we brought out, so we brought out smaller versions.

This has been well adopted by large large corporations.

It truly is the only management structure that will allow someone to effectively and efficiently manage a global infrastructure.

Thanks a lot, guys.

At this time, due to time constraints, I will turn the call back to Mr. Desheh for additional remarks.

Okay, thank you very much.

I really appreciate the participation of all of you.

If you want to speak to management, or investor relations following this call, please call our investor relations department at Redwood City at phone number 650-628-2050.

You can also call my office in Israel, country code 972-3-611-5064.

We're looking forward to seeing you three months from now and the release of Q3.

Thank you again for all your participation.

Bye now.

Thank you very much.

Thank you, gentlemen.

That does conclude today's conference call.

We thank you for your participation.

You may disconnect at this time.