Check Point Software Technologies Ltd (CHKP) 2003 Q1 法說會逐字稿

Good morning, ladies and gentlemen.

And welcome to the Check Point Software first quarter 2003 financial results conference call.

At this time all participants have been placed on a listen-only mode and the floor will be opened for questions following the presentation.

I would now like to turn the floor over to your host, Janeen Fanelly (ph) Director of Investor Relations.

Please go ahead.

Good morning and thank you for joining us to discuss the first quarter of 2003.

As a reminder, this call is being web cast live from our Web site and recorded.

To access the live web cast and replay information visit the Web site at www.checkpoint.com/ir.

The replay will be available through April 29.

If you would like to reach us after the call, please call the investor relations Department at (650)628-2050.

On the call with me today is Gil Shwed, Chairman and CEO;

Jerry Ungerman, President; and Eyal Desheh, CFO.

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

During the course of this call the company may make certain forward-looking statements concerning trends during the first quarter and revenue and earnings for the future.

Other statements which may be made in response to questions which refer to our beliefs, plans, expectations or intentions 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 Dec. 31, 2002, which has been filed with the SEC.

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

That concludes my comments.

I'll turn the call over to Eyal Desheh, CFO.

Thank you, Janeen.

Good morning and good afternoon everybody.

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

Our first quarter met our expectations with revenue of $104.8 million.

Revenue increased $2.5 million this quarter to $101.7 million.

As a result of continued strong [subsequent business].

Net income was $60.1 million or 24 cents per share diluted.

During the first quarter, the company generated net cash flow of $79.5 million, total cash and interest bearing investments as of Mar. 31, 2003 were $1.4 billion.

For the first quarter, costs of revenues and operating expenses were $43 million, a decrease of $1.1 million from the fourth quarter of 2002.

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

Product revenues were $58.2 million or 56% of total revenues.

Subscription and upgrades were $36.9 million or 35% of total revenue and services were $9.7 million or 9% of our total revenues.

Accounts receivable were $59.1 million DSO days sales out standing were 50 days this quarter.

Most significantly lower than in Q4 2002.

The tax rate was [Inaudible] percent in the quarter, similar to the previous quarter.

Our total VPN, [FireWall] and SAFE@ installation now stand at 273,000 of that, 106,000 were FireWall, 144,000 are VPN at 23,000 SAFE@ [product line]. [inaudible] margins were 59% in Q1 2003.

Wealth is the financial results.

Now I would like to turn the call over to Jerry for further discussion.

Jerry?

Thank you, Eyal.

Good morning and good afternoon, everyone.

I would like to speak about what we have been focused on across all the markets we address around the world today with special emphasis on the traction we are experiencing across many strategic initiatives.

As Eyal mentioned, our revenues were in line with our expectations as customers continued to purchase Check Point solutions to connect and protect their businesses.

Today two thirds of our business continues to come from our VPN-1 products as customers add this technology to connect remote offices, remote workers, and external users users.

In this regard, we experience good success this quarter with very large financial institutions, government agencies, and pharmaceutical and health care companies deploying large scale networks connecting both remote work workers and remote offers.

Many are in the early stages of deploying extra nets to eventually tie in customers, partners and suppliers.

This means the success we have had over the past few years as the VPN market leader has us well positioned to meet the growing demand for VPN solutions Also half of our software is being deployed on open servers and half in purpose built security appliances.

This is very important and unique in that we allow our customers a choice of how best to deploy the security and VPN technology between open servers and appliances or on a combination of both.

There are very valid reasons for each type of hardware platform and the fact that we give customers a choice is very appealing to them, especially with the market acceptance of Linux and the concern commerce have for making the most cost effective decision based on the various characteristics of each platform.

Choice is important and we continue to move forward in our strategic direction to focus on customer’s needs and requirements.

While enterprise customers remain our core market, we have increasingly seen medium and small businesses embrace Check Point security solutions.

Even though we are still in the early stages of putting in all the elements necessary to address these new markets with both products and the appropriate channel structure, we have gotten off to a good start.

In fact, a recent market study from [Infonetics] showed we are already number one with 38% market share in the small business segment for solutions priced under $500.

But we still have a lot of work to do and are busy improving the products as well as our distribution capacity.

Examples of our efforts and successes in this regard, this past quarter we signed up the largest distributor in Korea and the largest in China.

Both have tremendous region focus on the small businesses within their countries.

We are doing the same in the United States and in Europe.

We also have enjoyed continued success with our efforts to move into the high end market.

Two specific examples with new products that we have developed this past year to address the needs of high end customers and service providers are with the GX and VSX versions of VPN-1 and FireWall one.

GX is designed to be installed in the infrastructure of wireless carriers to protect and secure their networks as they began to offer data services, a critical issue for them.

Today we have more than 50 systems installed by a number of major wireless carriers in eight different countries.

This clearly makes us number one in this market segment.

Our newest version of VSX allows 250 VPN and FireWalls to run on a single platform.

It has proven to be very appealing to service providers and large enterprises focused on total cost of ownership and the ability to manage many different companies or divisions.

VSX combined with our provider one management infrastructure has also become the clear market leader in this emerging segment.

We won in a number of major competitive situations again this quarter with very large service providers both in the United States and in international markets who will be deploying this product over the coming quarters.

Another area of focus has been on improving performance and price performance, which I will let Gil address in a minute.

An additional area of focus and success this quarter was with our ability to bring to market the best security sweet via [Opsec], the open platform for security.

The ability to integrate and manage best of breed security with a Check Point management console is very compelling to customers.

They choose among the best technologies, both existing and emerging, without compromise, which is what they require for the most secure environment.

We continue to achieve our targets across the three major geographies.

In Q1 the Americas contributed 42%, Europe 40%, and Asia Pacific and Japan, 18% of total revenues.

We expect to maintain this balance as both our product and market segment focus is being well received in each of these geographies That concludes my comments.

I will now turn the call over to Gil for further discussion.

Thank you, Jerry.

The focus for the years continues to be in providing the highest level of security to our commerce, expanding the market segments and deployments as the economy recovers.

In this respect achievements these past quarter in both the high end and low end market show consistent execution of the strategy.

Also if you visit the Check Point security center on the Web site you will see how the Check Point and [Inaudible] help our customers block the growing number of publication attached launched every week.

This is one of the differential for the unique technology which allows our customers, to effectively and securely deal with the nature of the Internet and something our competitor cannot do.

Further more our customers are able to achieve the highest level of security available and do so with the highest level of performance and most importantly price performance.

We can do this using both applied security devices as well as [open server].

For example, this quarter we announced new secured [Inaudible] cards which turns the Check Point solution into a super fast 3 Giga bits per second security device capable of achieving [low] speeds from VPN and FireWall traffic.

The fully loaded secured [Inaudible] card system software and hardware costs less than $30,000.

This is roughly one-third of the price of other vendors [Inaudible] system.

Also the Giga bit FireWall system from Check Point can be acquired for less than $12,000, again roughly one-third of competing system costs.

At the same time our SAFE@ solution [Inaudible] customers to deploy large scale VPN that are centrally managed and easily be upgraded and extended to hundreds or thousands of types, starting under $400 per site.

These are a few examples of the progress we made during Q1.

To summarize and [Inaudible] during the first quarter the financial results show that even in a tough IP spending environment, Check Point team produces good results.

As we look forward to the rest of the year we see the high level of interest of activity and increasing level of [Inaudible] At the same time you have to remember that we currently live in a period of great economic uncertainty.

We expect to [achieve] at least the same level of revenue in the second quarter with many opportunities for up side.

That concludes my comments for today.

We will be happy to open the call for your questions.

Thank you.

Thank you.

The floor is now open for questions.

If you do have a question, please press the numbers one followed by four on your touchtone phone at this time.

If at any point your question has been answer you may remove yourself from the queue by pressing the pounds key.

Once again that is one followed by four to register your question at this time.

First question comes from Bob Stimson from Banc of America Securities.

You may begin with your question.

Hi good morning everyone and great quarter.

Hey can you guys may be give us a breakdown a little bit more on geography and kind of what you are seeing in the verticals as you are looking out?

Well, you know, the thing I mentioned, Robert, is that we did very well.

Financials, are we looking at FireWalls, VPN large scale VPN networks, I talked about many government agencies we seen a lot of pick up in pharmaceutical health care, financials are still very strong for us.

Retail was emerging this quarter.

I didn't mention that.

But I think the types of verticals where they have very large scale deployments of offices, and remote employees is where we are seeing the most demand right now for our VPN technology for both connecting and doing site to site connections as well as remote access.

We are also seeing a pick up right now.

We saw some of it this year quarter where people are starting to put in extra nets.

Again it's those types of industries that want to connect in partners .

I think you're seeing that in health care a lot and financial institutions.

And the remoteness is, people are really looking at the cost effectiveness of what a VPN does for them.

I didn't quite hear the guidance.

Was the June guidance -- I didn't quite hear what you said.

Was it flat to March quarter guidance?

[Inaudible].

I want to be open about it.

There is a high-level of uncertainty.

There's lots of good things happening in our business.

There's a lot of opportunities and there is a lot of deals going on.

Yes, very high level of uncertainty.

We think in the June quarter going to be at least as good as the March quarter.

Again, we hope for a better result.

Okay, thank you.

Thank you.

Our next question is coming from Walter Pritchard of Sound View Technology.

Please go ahead with your question.

Hi this is Cummins for Walter Pritchard.

I was just wondering if there is any currency impact if any there.

And also by a calculation, the press for gateway was up this quarter.

Is there anything going on there?

More shipments of Fire-1 or other high end products?

Sorry, can you repeat the second part of the question question, please?

By a calculation, the price per [gateway] shipped was meaningfully up in the quarter.

Is there anything going on there in terms of more shipments of Fire-1 or other high priced products?

Not a very big price change.

If we haven’t done today the [Inaudible] analysis of the different units in gateway, but generally I can tell you there is not much price change.

We did have a very nice up tick in the high end infrastructure like [Provider-1] and things like that.

This is one thing that grew year-over-year and quarter over quarter.

The high end management products that we do have .

Is there any currency impact?

No.

Not any -- we are not seeing -- so far our sales are done in U.S. dollars.

We don't see any currency impact in the quarter.

Are you going to make any guidance for license revenues for Q2?

It's not changed from anything that we've done in the past and licenses, you can see that it goes up and down.

We are very happy with our subscription revenues and the increase there.

And we are seeing great success over there.

Thank you very much.

Thank you.

Our next question is coming from Michael Queue of Southwest Securities.

Go ahead with your question.

Thank you.

Good morning.

My question revolves around the revenue mix.

Looks like it has been shifting more in favor of maintenance and subscriptions.

You know, it used to be 75% 2 years ago.

And in favor of software.

Now it's, you know, 55-45 mix.

Could you give us some color on that?

And also if, you know, the software revenue trend continues to be negative, is this a sustainable model?

Well, I think we have to understand what subscription is.

We do a perpetual license and we do annual subscription, which is the way customers get upgrades from us.

So the combination of brand new licenses and subscription is our product revenue.

And the fact that we continue to grow, and grow our installed base means we get new subscription from all our new customers as well as our old customers renewing.

So we have said this for a long time, Michael.

It is going to continue to increase as our company gets bigger and bigger [Inaudible].

All the customers that bought product three years ago are still buying subscription, maybe not new product.

That's the way they get upgrades revenues.

You have to add product licenses and subscription together to figure out what our product revenue is.

We get it in two different components.

Service component is 9% of our revenues.

The vast majority is still product, split between new perpetual licenses and ongoing product revenue that we call subscription.

Okay.

And just quickly on the, you know, product road map, it seems like there's been a lot of announcements made where, you know, people are looking to integrate the intrusion detection, they call it [IEP] intrusion detection with prevention with the FireWall product.

Are you having any plans to tackle that demand from the customers?

There’s been a lot of talk about it, but what is mainly if you really analyze it in this market it's mainly deficiencies of other FireWall companies that drive them to buy new products dealing with the basic security issues.

We came out with SmartDefense which gives you a very high-level of security without requiring the customer to purchase two separate products.

It allows them to integrate two solutions and gives them the high level of security.

This year we continue to expand that technology.

In the coming year we are going to do even much, much more in terms of extending those capabilities.

I think the response you see daily in the marketplace, of different companies trying to build different bundles of different technologies, showed the weakness of our technology [Inaudible] whenever the serious security issue, customers will return to Check Point as the only solution that can provide for high level of security.

Okay, thank you.

Thank you.

Our next question is coming from Sean Jackson (ph) of AufonDale.

Go ahead with your question.

Good morning.

Can you talk about the linearity in the quarter?

The it seems like it wasn't as backend loaded as it has been in the past perhaps.

Is there a reason for that?

The linearity of the quarter?

Well, we got into the second half of March, I think there might have been some impact of the war in Iraq, of people being attached to the TV screen.

So March was not as strong as it could have been, although we are very happy with the results of the quarter.

So we will look -- 40% we are used to, but it was a couple percentage points less than that.

And no, no dramatic differences.

As I said, the war in Iraq might have had some impact on that the business the second half of the month.

Also you mentioned that on the platform side half was open server and half was appliances, which looks like to be pretty steady for the last couple of quarters.

Is there a type of customer that tends to go to an open server and one that tends to go to an appliance?

Whether it be geography or vertical?

Well, it's not gee geography, Sean.

And it's a good question.

I'm not even sure if it is by type of customer.

It really depends upon the environment, the skill set, the capability they have.

There's a lot of benefits to appliances that -- what I see most often is maybe in remote offices they are putting in appliances whereas the central corporate headquarters are putting in servers.

We have seen some sort of movement by very, very large corporation back to a server based deployment, with the realization that they have four or 5,000 servers, she they are very good at it, very capable appeared there are significant advantages to an open server versus some appliances.

And it still is a mix.

I think there’s an advantage to both.

That's why I think we continue to sell both.

It's one of the unique advantages we have.

I said in my comments we are the only ones that really do both.

We give the customers the choice to, mix an match, and to do either one rather than try and pitch them on why they have to do an open server, why they have to do an appliance.

We really address them both but I think there is going to be a strong demand for open server based solutions going forward and that's why we do both.

But I don't really have a solid or very specific answer to your question at this point.

It's something I'll think about going forward.

Okay, thank you.

Thank you.

Our next question is coming from Ed Maguire (ph) of Merrill Lynch.

Please go ahead with your question.

Good morning.

Could you comment on the distribution of deal sizes?

Did you see any $1 million deals in the quarter?

And how was the concentration of large deals in the quarter compared to previous quarters?

It went down again, Ed, this quarter.

I think we are at about 14% of our transactions were in excess of 50,000, which is down from 18.

So we did see a drop off again.

We are in the same general number of orders we had the previous quarter.

The large ones were down again.

We still did a number of very large orders, but the percentage overall was down.

Great.

Could you provide any color on how your relationship with IBM is proceeding?

I think very well.

There's a multitude of relationships with IBM.

IBM global services happens to be a very big reseller of our technology.

IBM, their hosting business is a very big customer of ours.

Then IBM in Europe is building an appliance that they focused first in Germany right now to sell, secured by Check Point security appliance.

We have multiple relationships with IBM in various points of the world going very well.

And one final question, what are your head count plans over the next several months?

I think we are going to keep it flat to growing slightly depending on the needs requirements.

Just as we have watched everything for the last year, as we see growth opportunities we can expand if necessary.

As the opportunity presents itself.

Thanks very much.

Thank you.

Thank you.

Our next question is coming from Christopher Russ of Wachovia.

Go ahead with your question question.

Hi, guys.

A question on Cisco's price reduction which was few weeks ago that they reduced the price on the FireWall line from I guess 16-30%.

I'm just wondering, are you seeing any impact in the market from that today?

Or do you expect any impacts in terms of baseline pricing across the industry?

Well, I can address the first and I'll let Gil say something, although mine might be a smart aleck one.

I don't mean to, but I run into the last two years, the comment out of the market is that picks is free.

They don't charge for it.

I'm not sure what price decline has to do when you are selling it or giving it away.

No, we haven't p seen anything.

They are a competitor in the marketplace.

We do see them.

I think they are reacting to the quality of our price performance and quality of out products and maybe the short comings they have.

But I think between we and our resellers, our entire family of platform partners and distribution resellers still are very cost effective in the marketplace at what we do.

We have such a wide range of choice, we might have some more expensive alternatives, but we also have less expensive alternatives .We give our customers through the resellers very good a range of choice.

I think we are very price competitive with them.

Gil, want to add anything?

Okay.

Okay.

Just a follow-up question on the consolidation going on in security space right now.

Especially in the intrusion detection market.

Does Check Point need to participate in this consolidation?

Do you feel like you need to expand the product offering at this point?

Not really.

I think the intrusion detection market is a very challenging market.

If you look at what we call the security echo system, the market segment of security, the authentication authorization , [Inaudible] the metrics securities, what we call verification in intrusion detection part.

The last part is the smaller part and is under attack from all places.

All the companies trying to participate in that and trying to come up with different solutions.

Some because of the technology innovation and some because existing technologies aren't working or not being used in the right way.

I think the Check Point provides a high level of security without needing to go into this [Inaudible] and this market is a strong strength of our business model and our security.

And challenge for other companies participating in that marketplace.

Great.

And just finally with the cash balance you have, $1.4 billion the strong cash in your model, is there a chance the company might consider a dividend in the near future especially if we have a more favorable tax environment for stock dividends?

We are considering these kind of things.

So far we haven't decided to do them, but we keep watching the environment. [Inaudible] everything around it.

We do what is right for Check Point and for shareholders.

And we will continue to generate strong cash flow.

Great.

Thank you very much.

Thank you.

Our next question is coming from Matthew Barzowskas of First Albany.

Go ahead with your question.

Thanks.

Looking at the subscription line and the maintenance in general, what is the percentage of the maintenance renewals?

Do you track that?

Is that something you track?

Yes, we do.

We have over 80% of our renewal rate and on top of that we do our customers for two or three years to renew it and we have special packages for that.

We are very happy.

We have the highest renewal rate for the industry.

That's a vote of confidence from our loyal customers.

Just to follow up, I don't know than I don't know if you gave the number, but what is the percentage of the Nokia relationship.

I think it was about a between 40-45% I think this quarter it was roughly 44%, pretty consistence for the past two quarters- I think Nokia is doing very well and we are doing them.

Thanks, guys.

Thank you.

Our next question is coming from Jonathan Half (ph) of U B.S.

Go ahead with your question.

Yes, thank you.

This is follow-up on your comment previously regarding March.

Would it be fair to say that so far in April business is back to normal trends?

Are you still seeing any kind of weakness given the war?

We would say that the business was up normal.

The end was not as strong as it could have been.

So far in April it is very, very early, only a couple of weeks into the quarter.

We see very nice business, but I will categorize this as anything other than good business for the beginning of the quarter.

Okay.

And also regarding your guidance, should we expect any change in the break down between product subscription and service in Q2?

Not substantial, not substantially.

We think that we have a very healthy mix.

We always will be happy for more licensed business, but the mix is pretty good.

Okay.

My last question, what should we be expecting for deferred for Q2?

Well, deferred first of all, second quarter in a row, it goes up, we're very happy to see that.

It should be anywhere between $3 million up or down from today's level.

Great.

Thanks and good luck.

Thank you.

Our next question is coming from Todd Raker of Credit Suisse First Boston.

Hey guys two or three questions.

In terms of guidance guidance, at the start of the year you gave full guidance and the end of the year you said you would hopefully return to 10% double digit year-over-year growth rate.

Any comment on that guidance?

I think [Inaudible] the level of global economy uncertainty is still high globally but we see a lot of positive activity, a lot of enthusiasm in many places and we hope it will come.

Following up some of the discussion on the subscriptions, can you guys give us a feel for what your pricing model is?

In your answer to the last question I believe you said something about special packages for two or three year subscriptions, can you give us some in sight into the process for renewing maintenance contracts?

Generally it's on an annualized basis but we do sometimes have customers sign up and commit for a two or three-year period where we they want to do it all at once.

They do the subscription for three years out.

Some do support.

We have enterprise -- we have an enterprise support pricing that they can buy for their entire enterprise and some from a budget standpoint like to make long-term commitments.

Typically it's an annual basis where they go in and renew.

We come forward on a monthly basis.

At times we have seen more of a demand for it this year.

I'm not sure I know exactly why.

A lot of companies are making longer term commitments to get it done, committed to and then it keeps on growing from there.

One of the issues, as the base gets bigger, a bigger percentage of the revenue is going to continue to be subscription.

The customers want the ability to upgrade to new versions.

It's just a very attractive model that our customers have found to be beneficial to them.

Jerry, how do you price the subscription?

15% of list.

Standard across the board?

Right, 15% annual list.

Do you discount off of that for multi-year deals?

Not really.

Last question for you, Jerry.

You talked about 50% of the shipment being open server versus appliances.

Is there any difference economically from your perspective if you know software price the same off of both of those platforms?

Yes, it is.

Absolutely identical.

We have been always platform neutral and let the customer decide which one best fits his -- what offers him the best characteristics between total cost of ownership, easy installation and upgradeability.

So it's very advantageous for us.

Let me throw in one more last one.

Any indications in the Asian business that Sars is having any impact?

I don't think so.

There was nothing abnormal there.

Our people are all fine.

They are doing well.

They all are working.

So I know it's a serious concern, but it doesn't seem to have any impact at this point in time.

Okay, thanks.

Thank you.

Thank you.

Our next question is coming from Dan Cummins with U B.S.

Go ahead with your question.

Two questions.

First, Jerry, you talked about the need to put together more elements of success in small medium enterprise and you had a lot of work to do.

Could you elaborate a little bit on that and what you might be willing to spend in, let's say, in terms of margin in this kind of flat revenue environment?

And what do you see kind of happening at the low end of the market that kind of gives you or doesn't give you a sense of urgency?

Well, I don't know if there is a sense of urgency other than it's been a focus and a plan.

It's one of our strategic initiatives.

I'm not so sure it's a margin issue as much as putting all these elements together from a product standpoint, making sure we have the right function feature, price, positioning.

I mean, everything to do with product side, of the capability, of what a small business is looking for from the enforcement technology, the manageability, of it, the install.

It's also in the channel side.

That's what I was really pleased with.

I happened to be involved in both signing the largest distributor in Korea and the largest distributor in China when I went over there in a combination February and March.

We're doing that all over over, but that's one of the biggest elements we are executing on.

We just announced a small business partner program.

We came up with a small business center on our Web site.

We are putting a lot of elements in place to really attract those who are focused on the small business businesses in the world, which is not than a historical market that we have addressed.

And so we are continuing to execute along that strategic front, signing up the right service providers, distributor , the ISPs.

The resellers that are focused, we take a more vertical thrust.

When you get into small businesses, they focus on lawyers offices, doctors' office offices, et cetera president So it's the emphasis we have of putting these other elements in place to take the products we have been developing and ensure that we have the channel infrastructure in place, the right marketing, the right advertising, running seminars at trade shows where small businesses are attracted.

There's a lot of other things that we need to do that we are doing.

I'm pleased with our success.

We were pleasantly surprised to see the [in-Fenetics] study to see that we have already with the success of over last 12 months become number one in the market for under $500 solution with 38% market share which I said surprised us because we think we have a lot of work to do.

We know what the opportunity is in that market.

We will continue to execute in this direction and I think it's going to prove to be very beneficial to us long-term

The SAFE@ installs for the quarter if I'm not mistaken were 3,000?

I don't have exact number.

I think Gil does.

Gil?

It looked to be below the last two quarters.

I'm wondering if I'm correct on that.

We are starting a new year, it's a new challenge.

Jerry talked about the very nice attraction we got in signing up new major distributors and reseller for SAFE@.

We also talked about the small business partner just now, but we are starting a new year and starting a new set of challenges.

We hope to see a nice, from a much bigger success.

I can tell you the activity in our field is very, very positive up front.

You have now four external partners in SAFE@.

Is that going to grow?

There's actually more than four.

There's only four global partners right now that are visible.

We also have regional partners that have signed up and are signing up, like NEC in Japan is not on that I think is visible on a global basis.

We don't talk about them like we do Nokia.

But NEC in Japan.

There's a company in Spain called Efina.

There's a few more that we will probably announce in the next quarter that are going to be a private label of OEM and the solution also which we think is exciting.

The same thing will probably happen in China where we will have regional appliance partners that will OEM the solution and take it to their market.

The other places, that's been what has been very successful for us, having regional partners that localize it to the small businesses in their community.

So we are going to continue with that thrust.

There are a few others besides the four global partners that we always talk about

Okay, thank you.

Thank you.

Our next question is coming from Sterling Auty of JP Morgan.

Go ahead with your question.

Good morning.

Hey Eyal can you give us what was the head count at the end of the quarter and break it down by functionality?

Yes, head count was flat compared to Q4 and same thing with functionality.

We didn't have any changes to any direction. (Overlapping speech)

Over 300 software developers, 200 in our technical services, same breakdown that we had at the end of the year.

Okay.

And then Jerry, the two distributors you mentioned for Korea and Japan, what are the names of the distributors?

The one in Korea is Kolon and China, it's digital China.

Great.

Any commentary as to the service provider vertical both here in the U.S. and internationally?

It's doing better.

At least among the major carriers carriers.

We haven't seen a lot of orders yet, but we have seen a lot of progress.

As I mentioned, we won a couple of very, very large evaluations for our VSX product both here in the states and outside that is going to be very positive long-term.

They find us a very attractive and cost effective way to deploy polling technology by being able to run running 250 copies of the software on the same platform.

We are seeing a big movement in that direction.

Also with some smaller ISPs that are starting to signing up to take low end solutions.

Where we haven't worked with the low end ISPs.

We focused on the small businesses before, so that’s a net area, adding new channel capacity, as I talked about before.

We are seeing large positive movement in the large [Telecos] working with us on a worldwide basis.

Especially lot of them are starting to adopting the X box, the SAFE@ technology to take after the small business customers that have never really addressed a security solution.

There's a lot of growth opportunity yet but it hasn't happened at this point in time.

Last question, I want to revisit on the licensing side.

If an existing customer wants to add to their, let's say, installed base, is that does that fall under new licensing?

In other words, are they coming back with a new perpetual purchase?

Or does that fall under the subscription format?

No, any additional licenses, brand new ones go under perpetual.

All the existing licenses when they upgrade them goes into subscription.

Okay.

Back to the previous caller's question question.

It seems like if you see a shift to the subscription and maintenance, that's just a growth in the ongoing maintenance from your existing customers.

Don't we need to see an up tick in the perpetual side to show that you've got growth for the future?

But we do.

I mean, if you've got a customer with 50 FireWalls installed paying 15% annual subscription and he buys five more, you are going to get a lot more subscription revenue from him than you are product revenue revenue.

And it's going to continue to roll that way.

As these customers get bigger with 50, 75, 100.

We have some with more than 500, more grater then 1000 gateways.

That's an awful lot of revenue.

As our base gets bigger and bigger, I mean its healthy for us, that's annuity for us that we get year-over-year.

And we get new license revenue on top of that.

I think it's a very strong business model and it's going to continue to grow.

I think that's good.

Well, I think the point is that the perpetual license and that new license revenue is an indicator of what the subscription should be at some point in the future as they roll off and have to renew for their upgrade, right?

Sure is.

I think we have very strong perpetual license revenue.

All I'm saying is that the base gets so big.

It's hard.

There are not many companies that have our same business model, but a lot of them have very, very high services and support.

Ours is primarily product, which we break between the first license and then the ongoing revenue associated with the license.

And I think it's still at a very, very healthy mix.

But the challenge is because the base gets so big.

If customers stay on subscription, with the number of customers we have and the number of licenses we have installed, that's going continue to be a bigger and bigger percentage of our revenue.

Again it's annuity revenue which is very, very good for us

Okay, thank you.

Sure.

Thank you.

We are showing time for one last question.

Our last question today is coming from Brad Leal of Unberg Toabin.

You may begin your question.

Hi, this is Katherine Egbert from Unterberg.

Jerry can you mentioned briefly the [Inaudible] VPN’s can you talk about that and I'm surprised no one has brought up the question of competition yet, talked with that.

Competition?

What is that?

Well. (Laughter)

Okay.

It's safe to say that there's primarily three types of VPN technologies, remote access, site to site or the extra nets where they tie in partners, customers and suppliers.

We always said that's last, although we saw some initial signs of that in healthcare and guess kip is going to move more and more people deploying through extra nets.

Site to site, tying in remote offices, we see that continuing to grow and become a bigger percent of our business.

Some of it is anecdotal.

We don't get perfect data.

We have thousands of distributors around the world selling our product around the world.

We don't know all exactly how it is deployed.

But we do have very good in site under the growth in site to site.

The companies are tying in the remote offices, branch offices, large divisions with VPNs as opposed to frame relay or dedicated lines.

Because of the cost effectiveness.

We've seen that continue and grow as a percentage of our revenue in past quarter and this quarter was the same.

Competition?

I don't see a change in the environment, Kathryn.

Very similar to what we have experienced in the past.

We continue to do very well in my estimation.

It is competitive.

We do have people that are out there on a daily basis.

Offering different alternatives to customers around the world.

And I think we are doing very well.

We have major competitive wins.

We have competitive win back backs and challenges as well.

We don't (overlapping speech)

Does your success with the VSX product, does that preclude sales of the gateway product?

Yes.

They are all gateway products, VSX is.

It combines a number of them on to a single platform.

So we still sell them 25 Gateways, 50, 100.

But 250 Gateways, if they can put it on a single platform as opposed to 250 gate ways platforms.

It's a cost effective way for somebody who is aggregating their FireWalls and their VPN Gateways.

Each is managed as an individual Gateway.

They are virtual Gateways, on a single platform.

Is the pricing different individually than --

Yes, it is more attractive form to buy it and virtualized and it is stand alone.

We do past on cost savings for that.

[Inaudible] virtual Gateway.

Every Gateway, 250. virtual Gateways as one.

That's 250 at a time.

Right.

We only count it as one.

Okay.

The last question is why was the number of shares down sequentially, Eyal?

The share count?

The number of shares?

The number of shares are broken down by share price.

It's counted as [the average] share price in Q1 this year was lower than Q1 last year.

Is it option related?

The confirmation of the options tend to be exercised.

Thank you, nice job.

Thank you, Kathryn.

Thank you.

I would like to turn the floor back over for additional or closing comments.

Okay.

Thank you, everyone, for joining us.

And participating in our call this morning or afternoon.

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I repeat area code (650)628-2050.

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We thank you again and hope to talk to you all next quarter.

Thank you very much.

Thank you.

This does conclude today's teleconference.

You may disconnect your lines at this time and have a wonderful day .