Check Point Software Technologies Ltd (CHKP) 2003 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Check Point second-quarter 2003 financial results conference call.

At this time, all participants have been placed in a listen-only mode.

The floor will be open for your questions and comments following today's presentation.

Due to time constraints, please limit yourself to one question to allow the maximum amount of lines to ask their question.

I would now like to introduce your host, Janine Zanelli, Director of Investor Relations.

Good morning and afternoon, and thank you for joining us to discuss the second-quarter of 2003.

As a reminder, this call is being webcast live from our website and recorded today.

To access the live webcast and replay information, please visit the company's website at www.CheckPoint.com/IR.

The replay will be available through August 4.

If you would like to reach us after the call, please contact 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 to like to read the following disclaimer.

During the course of this call, the Company may make certain forward-looking statements concerning trends during the second-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 20-F for the year ended December 31, 2002, which has been filed with the SEC.

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

That concludes my comments and I would now like to turn the call over to Eyal Desheh, CFO.

Thank you, Janine.

Good morning and good afternoon everybody.

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

We are very pleased with the business results of the second-quarter.

Revenues were $106.1m, up from $104.8m in Q1.

The strength of the quarter was also evidenced by the increase in deferred revenue from $101.7m in Q1, to $103.3m this quarter as a result of continued strong subscription business.

Net income was $60.2m or 24 cents per share diluted.

During the second-quarter, the Company generated net cash flow of $73.1m.

Total cash and interest-bearing investments as of June 30, 2003 was nearly $1.5b.

For the second-quarter, total operating expenses were $43.2m, a slight increase over Q1.

Our tax rate was 18% for the quarter and is expected to increase to about 20% in the second half of 2003.

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

Our license revenues continued to growth and accounted for 90% of our total sales.

Of this, product revenues were $54.8m or 62% of total revenues and product subscription and upgrades were $40.8m or 38% of total revenue.

Service revenues were $10.5m or 10% of total sales.

Accounts Receivables net was $61.3m and DSOs, Day Sales Outstanding, were 61 days this quarter, well within our range.

In Q2, we added over 9000 gateways.

Our total gateway installation now stands at over 282,000.

One of the highlights in Q2 was that our average deal size continued to grow.

With orders over $50,000 amounting to 21% of our total business, up 15% of total business in Q1 this year.

We are also very pleased with our operating margin, which was 59% in the quarter.

This summarizes the financial results and now I shall turn the call over to Jerry.

Thank you, Eyal, and hello everyone.

I would now like to speak about the key areas of focus and success we had this past quarter, as well as touch on the general market and our focus going forward.

As you know, we made a major new product announcement during Q2, NG with Application Intelligence, that has unveiled to our customers and the market a significant new technology for securing our customers networks.

We are pleased our revenues this quarter were at the high end of our expectations, as customers continued to purchase Check Point solutions to connect and protect their businesses.

While there was some weakness in Asia due to SARS, we more than made up for that with strong results in the U.S.

We also continued to do well with very large accounts, as you heard Eyal mention previously.

During the quarter, we won some very large and competitive transactions, as well as upgraded customers who had competitive products installed.

This was especially true in the U.S. market, although we had similar success in the other parts of the world as well.

This included some very large site-to-site deployments where the strength of the Check Point management infrastructure was key to the win.

You will also see in the numbers that we continue to enjoy ever-increasing business from existing customers as they purchase our software subscription, which allows them to upgrade to NG.

Software subscription has become even more important with the announcement of NG with Application Intelligence, where we now provide protection against both network level attacks and application layer attacks, a capability no other company can provide.

We believe these capabilities are becoming a mandatory requirement for firewalls.

The interest in our new Application Intelligence capability is reflected in the large quarterly increase we experienced in our bookings of SmartDefense, the subscription service which gives customers the latest updates in these attack protections.

Our strategy of how we deploy our firewall and VPN code is again proving to be successful as we continue to be the only company that can address the market needs for a solution on an open server and an deploy in an appliance.

The fact that we are number one in both segments is a testament to the quality of the features and functions of our firewalls and VPN solutions.

The market requires choice, and the ability to decide on the right deployment platform which changes over time.

We provide the capability while preserving the investment in the application, something hardware-only vendors or software-only vendors do not do.

During the quarter, we continued to make progress across many other new initiatives.

SecureClient, our personal firewall product for enterprise customers, is doing very well in the market.

VSX, the virtualized version of our firewalls and VPN, continues to do very world with many telcos and service providers around the world.

We again had empirical wins with wireless carriers with our GX version, which uniquely protects the core of their wireless infrastructure.

Another key product highlight was with the high-end of our management products, where we saw a nice increase in Provider-1 sales to both service providers and to enterprises.

I mentioned earlier that we experienced continued strengthening in the U.S. market.

In Q2, the Americas contributed 44%, Europe 39%, and Asia Pacific and Japan, 17% 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.

Going forward, we have many new initiatives that are currently in testing with our key partners and customers.

These include new solutions to address our three areas of focus, perimeter security, internal security, and Web security, that I believe are going to be very important to the continued growth and success of Check Point as the leader in providing the best solutions for securing the Internet.

That concludes my comments.

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

Thank you, Jerry.

As Jerry and Eyal has mentioned, the second-quarter showed good progress in our business.

We grew our average deal size, won a record number of large orders, and introduced a breakthrough Internet security with our application intelligence technology.

Over the past ten years Check Point keeps trying to find Internet security.

Both in technology and in our business services model, we build strong channels for Internet security and really find that the (indiscernible) several times.

This has been a key ingredient of Check Point success.

We shocked the industry with introduction of inspection in firewall one, and led the creation of the VPN market, and now with the application intelligence, we are defining the true Next Generation of attack protections.

Today we have more utilization in our pipeline than ever.

Some of which is going to be introduced as soon as the second half of this year.

We are going to expand our solution for perimeter security, introduce new utilization in internal security, and develop new and more comprehensive concepts for Web security.

As for the next quarter, we expect Q3 to continue our strong earnings performance and improve our overall business.

Even with this summer's seasonal business, we expect financial results to come in at similar levels to Q2, with revenues in the range of $102m to $108m, and EPS of 22 to 24 cents a share.

This concludes my comments for today.

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

Thank you.

Thank you.

The floor is now open for questions.

Michael Turits of Prudential Equity.

First at all, the subscription was strong, but license was a little below expectations.

Maybe you could comment on what trends are in each, why subscription was so strong, whether was driven by AI, by upgrades to NG and again why and now license revenue, we saw less than growth that was down?

Also, the guidance for next quarter is kind of a wide range as well as looks like the midpoint is one penny down from where we are?

First, if you look in our revenues both subscription and products what we call subscription and product are licensed.

One is license for a new product and one is license to get upgrade and update.

Now keep in mind, it's very important to notice that some of the subscription revenue is old customers that are renewing their subscriptions.

But also, a big part of subscription is new customers that are doing new deals with us and part of these new deals is subscriptions.

So we are seeing today the subscriptions, for example, from deals that we did in Q4 and Q1, which is now coming through.

Generally when we analyze our business to see the level of new business, new business being done as opposed to just renewals from previous years, and this level is pretty consistent over the quarter and it is well over 60% of our business.

So this is actually a good trend and I think a very strong trend to every software company.

With regards to the range for next quarter, I think the high level of uncertainty in our margins is always high.

These days is definitely high.

We are very positive about the prospect we are seeing.

The strength that we saw in the U.S. was a very, very good sign last quarter.

Yet, having said all of that, there is a range.

There is also upside, but this is where we believe what makes sense for the next quarter for right now.

Obviously, this can change all the time and we hope for the best.

Also on the EPS guidance, the midpoint is down one penny from current, where the midpoint of revenues is flat, so what would drive that compression of narrow EPS?

I do not think it is a result of anything particular.

There is, by the way, interest in the EPS, we keep spending.

We have seen currency changes in Europe and in Israel; we do have a small effect on our expenses.

I think Eyal can say something about $1m expense impact that we had, which will continue over Q3 unless there is going to be a big change in the currencies, the euro versus dollar.

And also some uptick in tax rates.

We still pay very low tax.

I think overall the numbers are very good, but we do have (indiscernible) coming through and again, there is nothing these numbers suggest that will tend to come the low, the high or the middle.

Just envision what we believe after analysis is a reasonable range for the time that we are right now, but keep in mind, it is still early in the quarter.

Chris Russ of Wachovia.

A question on the pricing structure for NG with Application Intelligence.

Also, what the pricing matrix looks like, as well as the number of paying customers that will be included in the 6000 copies that you referenced in the press release?

First, the 6000 copies sent are software copies.

Some of them are customers that are buying.

So basically, every customer that has both since May/June has bought the new version. (indiscernible) re-evaluation and some of them to existing customers, actually, it is hard for us to know where each copy went because usually what happens is our resellers and distributors order a few hundred copies each, and they distribute these for their customers.

So maybe in the next quarter -- it's really very early -- I mean NG with Application Intelligence started shipping in the middle of June, when we are a little more educated about how many people have actually upgraded.

For the period that we are in, so far is positive.

Customers that do the upgrade are happy.

They are giving very good testimony to the quality of the release.

With regards to the pricing structure, the application intelligence technologies included into every product that we sell today, is included in all the enterprise level products that we sell today, but if the customer wants to get a real-time security update, then we have a special service for security update.

Then we have to subscribe to that and the cost for that is $1000 per gateway per year, or up to 10,000 gateways for 100 gateways.

So if you look at the typical enterprise account, that is a fairly good build today.

Actually, it is a very good price right now, about $10,000 for a typical enterprise.

Okay, great and then just a follow-on question.

Nokia in early July introduced a new high-end system called the IP 1260 running Check Point NG.

Could you comment on your expectations of that product and whether you have had any competitive wins against Cisco or Net Screen with that new high-end system?

I'm sure we did even though right now I can't quote anything in example.

I do think that the new system is a very, very good system.

I think the previous model with Nokia had their IP 740 is now three years old, it has a great success, especially if you consider that it is a three-year old product.

So with the new model and much newer technology and lots of innovation that Nokia put into that, I think we are going to see the reemergence of Nokia's success in the high-end again, coming from a pretty good success that they have right now.

As another reminder, please limit yourself to one question.

Steve Sigmond of RBC Capital Markets.

What was Nokia as a percent of revenues this quarter and could you also please comment on other OEMs, how they are doing?

I think Nokia was still in that forty plus percent range, Steve.

They continue to do very well on a worldwide basis.

I did not answer the question about the 1260.

I just got back from Japan and we had one big partner event and one big customer event and the Nokia folks were obviously there as our partner and they were very pleased with the success in that marketplace.

I have not talked to them yet on a global basis, but I know the product has been very well-received.

On the high-end, we have a number of partners doing very well, specifically I would mention both Nortel and Crossbeam seem to be having a real good success at the high-end of the enterprise marketplace.

The two big ones that we signed at the end of last year that seemed to be getting traction in the marketplace now are both Sun NHP.

Sun is going through a product refresh, which I think is available in August that has a lot of people excited.

I know there are some big promotions going on.

So we are real pleased with a number of them, but I think they're going to do very well in the marketplace as we continue to go forward with NG with Application Intelligence.

Shaul Eyal.

CIBC World Markets.

Eyal, if you can just comment on the August quarters average in trends, what you see out there, any change from previous quarters?

And just the split between appliance and non-appliance revenue, if you do have it?

In terms of the linearity, it was a very typical quarter.

About 40% of our business came in June, around 60% in April and May.

So we did see a strong ending, but it was a regular, linear quarter.

In terms of the split between appliances and OpenServer, we don't have the full granular analysis yet, but from the initial number that we analyzed, it didn't change compared to Q1, which is a little over 50% from OpenServer and a little under 50% on the appliances.

Robert Breza of AG Edwards.

I was wondering, Jerry or Eyal or Gil, could you touch a little bit on the product roadmap?

You talked about some things you would be releasing here in Q3 and Q4.

Specifically, also, if you could comment on the product roadmap as it relates to Nokia and we have heard some rumblings out there in the channel that they are going to be introducing their own SSL-based VPN.

If you could comment on that, that would be great.

Thanks.

At first, I would not like to deliver too many details about the upcoming announcement.

We felt it is important to share with our shareholders the direction we are going but obviously for many competitive reasons we don't want to preannounce new product.

I think we will see on the perimeter side we have a very, very strong portfolio product.

We will see great new additions there and great new upgrades and great new offers for businesses of all sizes.

On the internal security side, that is something that a lot of our funds are being used and we have a lot of technology.

We are going to see some new solutions and new products, and on the web security, I think you're going to see very, very comprehensive concepts of web security from CheckPoint.

So what you said about Nokia and SSL, Nokia did introduce its SSL VPN solution late last quarter.

This is some capabilities like that we do have in our products, but generally CheckPoint was not a strong player in this market up to now.

We may be in the future, but obviously we believe that Nokia extension to special places that we were not very aggressive on is a good thing, because we believe if our partners will be strong, the partnerships will be strong.

So generally I think it is good that Nokia is diversifying and extending their security portfolio.

Just as a follow-up, Gil, could you comment a little bit on the SofaWare relationship and where that stands today?

SofaWare relationships are wonderful.

At SofaWare, we have a great team there that is doing a very, very good job in coming up with new products and new innovations, and really going very, very well.

Matt Barzowskas of First Albany.

Could you talk a little more about the large deals you saw?

You said they had increased, average deal sizes has gone up.

I'm just trying to get a feel of how that is booked, what is the average length for these larger deals, is it over a couple of quarters, is it all up front?

Does any of that get into deferred revenues?

Trying to get a better feel of the big deals.

There is some of everything, Matt.

There is some very large orders that all of our revenue was recognized in the quarter, they took all the product and sold all the product and deployed it all, and there is some that will be recognized over the coming quarters.

So we had a mixed bag, but there was very, very strong at the high-end, some very large transactions that we were pleased to do.

As I said in my comments, most of them are in very competitive environments.

So it was across the board.

Some were fully recognized, some are in deferred.

Some have yet to be booked, but it is a strong suit this quarter as to how well we're doing around the world in very large accounts with very large deals.

Do you see that as a growing trend where there would be more large deals coming forward, or is this kind of the level you think you could maintain each quarter?

I'm optimistic.

I know from our activity that there is a lot of them out there and I think we are going to continue to do very well not only with the products we already have, but as Gil mentioned, some of the announcements that we will be making yet this year that we have been sharing with some customers.

As we said, some of the stuff is in test right now that is leading to this level of business with large deals with large accounts.

Richard Power of Seligman (ph).

One, I believe on the foreign currency side, you gave the expense impact.

Can you give the revenue impact?

And then two, a separate question, can you help us understand how we should think about how your business mix may change between the product sales and the subscription sales over time?

Is this the beginning of a trend where we will see more subscriptions over time?

How should we think about that?

Let me take the currency impact on expenses and revenue.

Basically, almost all our sales are denominated in dollars, other than Japan, where we hedge.

So basically, there is no impact on the top line.

On expenses, as mentioned before, the impact compared to Q1 was about $1m.

On the strengthening of both the Israeli shekel and the euro, compared to the dollar because we were on dollar accounting and as I report, this is not meaningful but $1m is a $1m, so that expenses were kept very well in line.

That was our plan.

Jerry, want to talk about the mix as well?

Richard Power, I don't think it is anything that is beginning.

It is something that has been going on for a couple years and we've talked about it almost every quarter.

As the base continues to get larger and the base rolls over and renews and we are especially seeing it with NG, where the base insuring their own subscription, they're looking at the upgrade price.

We are going to see that continue to increase over time.

As the base gets bigger and all the new customers buy it, so I think you're going to see that continue in the direction it has been going for a couple years now, so just my perception it is not the beginning of it, it's a continuation of what has been happening.

I think it is probably most evident this quarter, though.

Maybe.

Just maybe revenue shift sequentially.

Let me comment on the subscription.

Just keep in mind, as the SmartDefense is sold on subscription basis and it is growing nicely.

We believe it will be a nice product for us going forward, and you see that on the subscription part.

Application Intelligence is in the subscription piece as well?

The Application Intelligence is part of a SmartDefense series which is as Eyal just described to you.

Ed Maguire of Merrill Lynch.

Could you speak about strength in particular verticals during the quarter?

And did you do any million dollar deals?

I will start by saying we did a record number of million dollar deals this quarter ever, so that was a good sign.

And Jerry, I don't know if you want to comment more about verticals?

I saw a continuation in the governments, not only the U.S. government, also many governments around the world, saw a pickup with some service providers; financial sector was again very strong, retail environment I think, just to name a few of the ones that come to the top of my mind.

I don't have a report right here, but it was a good quarter in that regard.

The technology area we did well, technology companies.

And could you comment on the number of CeBIT installations you have right now?

About one-third of our new gateways that were sold this quarter were CeBIT.

Greg Moskowitz of Susquehanna Financial.

Just a couple questions, one being, I know Asia Pac seemed pretty weak, partly because of SARS, but were there any early tractions you can report from the two distributors you signed up last quarter in digital china?

And also it seems like SmartDefense showed a little bit of a pick up here in Q2.

Is there anything you can provide in terms of roughly what you are seeing on gateway per customer for those buying SmartDefense, as well as attach rates, or just kind of anything that can give us a little bit more insight, to some of the uptick there?

The first one is not yet with either one because of the impact of SARS.

Our office was shut down for five or six weeks in China and many of the other ones were too.

There was impact through all of the Asia-Pacific marketplace, so they have not yet gotten the traction, but we see some good signs.

It was an unfortunate time period there.

Like I said, fortunately we did so strong in the U.S. that we made up for the impact they had there, but there is a lot of potential, a lot of opportunity, but we've not yet seen the numbers, but I think we will in the very near future.

Regarding SmartDefense, for competitive reasons, I am probably not going to shed too much light on what we saw.

One thing I can tell you, we saw an increase a little over 50%, in the number of our partners selling SmartDefense this quarter, which is very encouraging.

So we have many, many partners now selling SmartDefense, promoting this either to the existing install base or to new customers who are looking at installing our product and I think this is going to be a very meaningful product for us in the future.

Walter Pritchard of Soundview Technology.

Just one last question for you on the subscription line.

Could you at all breakout for us in terms of base level maintenance?

And I guess what I am trying to get at is I know in front of the NG upgrade you had some people paying a legacy subscription rate that was a higher maintenance rate.

Can you kind of get at what maintenance would have been ex any NG impact?

Walter, there is no maintenance associated with subscription.

That is only for products service packs and upgrades.

All the maintenance, what you call maintenance is in our support line, which is 10% of our revenue, as Eyal said.

We separated those two components a long time ago and they are pretty clean between what is support versus what is subscription.

Could you at all tell us just any NG impact in terms of changes you saw in the business, given that you had the end of support on 4.1 this quarter?

That is a misnomer.

We have not ended support on 4.1.

We continue to take support calls and we will support it.

We always encourage our customers to go to the newest release, but it is not an issue of support.

It is an issue of fixes or service packs are going on the new releases versus old releases, but they are very stable anyways.

We will continue to support our customers for a long time using previous generation product, so that is always misunderstood in the marketplace.

People are going to NG.

NG is a very good version of our software, especially NG with Application Intelligence.

We see a big pickup in demand right now.

So that is what is driving a lot of the product subscription upgrade the revenue that we're getting.

Sean Jackson of Avondale Partners.

Can you talk again about some of the larger deals?

It looks like those are increasing, it seems like the high-end market is increasing as well, but yet revenues are still kind of flat and the outlook is flat.

Is there anything to be gained, from looking at those metrics to formulate something about the midsize market?

Are you seeing anything different in the midsize market that perhaps is a little more sluggish than normal?

I guess maybe the thing we did not say is the total number of deals is not declining, so it's the size of the order and maybe some of the modules that we are selling into those markets are lower-priced than they had been historically.

So there is a mix as to what is going on out there that I think will evolve overtime, but the overall business was still, from an order standpoint, was still the same.

It just at the high-end we saw much bigger deals come in and that would be a much bigger percent of our revenue from the size of the transactions.

But the medium market to the small market was probably just a lower-priced because we did still the same number of units.

And just last, if the cash balance continues to grow, any new plans to do that, considering that growth is been muted somewhat recently?

We are still evaluating all the options of using our balance sheet pay options and I don't want to set any expectations that we will see any changes there, but we are aggressively trying to see how we can expand the business or to do any other usages of the cash.

At any rate, I think it is a market like the mark that we have it is a great asset to have this kind of balance sheet that we have.

One more thing that I want to add to what Jerry said about the mix in deals that we do see, one trend that we do see between smaller size deals and larger size deals -- I think in the past many enterprises purchased VPN or firewall, just one at a time.

Today we are looking at larger deals.

So they're shifting to fewer bulk transactions.

Instead of buying 10 firewalls for every quarter is coming up and buying 15 or 20 at once.

So the overall deal size gets bigger, the number of small deals may actually shrink in some cases, but the overall amount of business is actually growing on that.

Let's say for reasons, again, it is a very slight change.

It's not a big change, but we are seeing more and more customers coming to us, and not just saying we need the product today, coming in saying our (indiscernible) for the next two years is that we also have 10, 20, 50, 100 replace a hundred firewalls from the competitor, or so on, let's do a much larger deals than we did before.

I think that is a little bit of the shift, and that is why you need a number of deals remaining can in many cases stable, yet deal size gets bigger.

Martin Masar of CA IB Investments.

My question is with regard to the overall VPN market.

What kind of a growth would you be assuming over the next three years to 2005?

Would you have a number for me?

I don't think I have a number for you but I think the VPN numbers can be very, very strong.

I think if you read every survey, it says that a huge percentage of companies intend to deploy VPNs.

I think now we have been widely available, the benefit of VPNs is out there, and it has been huge.

The fact that in the last year, 1.5 years, we haven't seen a huge growth in VPNs, we have seen some, it means that eventually the economics of the markets are going to catch up.

Unlike other parts of security which are high priority, but it is very hard to estimate their return on investment and economical value (inaudible) investment security like VPNs, it can be done.

I believe that over the next two years, there is a very nice potential for the VPN market in general and for Checkpoint in particular to really pick up.

One maybe proof point that we have in this quarter is the remote action VPNs, and we are seeing that increasing in a very nice rate.

We have several 10,000 user size deals for our SecureClient's products this quarter, a nice pickup which shows that very large enterprises are now rolling from having dozens or hundreds of people connected to really connecting tens of thousands of people with secure VPN remote access.

Todd Raker of Credit Suisse First Boston.

Historically you have given us the breakdown by installation VPN, firewall, safe@, can you give us that information this quarter?

And secondly, can you quantify what percentage of your base has already converted to NG?

Let me try to answer that.

I am not sure I have all the data in front of me.

First, we decided not to break it out this quarter, because basically all our VPN products contain the firewall, and by now I think that the vast majority of what we sell is the VPN 1 product, about 80%, so I mean basically it is quite the same.

All the gateways have the VPN and the firewall capability, for most of them.

Therefore, it doesn't make too much sense to try and break it to a more granular level.

We do sell about two-third of the gateways are the high-end gateways and one-third of low-end gateways, which I think Eyal mentioned before.

So I think that is another data point we didn't say before but we are sharing it now.

And finally, to how much of our install base have upgraded to NG, I'm not sure I have the updated number.

My guess is between 40% to 50% of the number.

It should be a little over 50% by now.

Jerry say it should be a little over 50% by now.

Eyal, can you just address gross margins?

Up nicely this quarter.

Where do you guys see your gross margins going in the next six months?

First, let me say I'm not sure that gross margin is an important line in our P&L.

We are on a 95% gross margin, our cost of sales about 5% of revenues.

Most of this is service and support, which is mostly people, and that number is not expected to change and the future of the cost of product, as you all well know, is about $10 per copy.

So that is really a meaningless quirk in the total mix of expenses.

By the way, a few quarters ago like many other software companies, we decided to limit the gross profit line from our P&L.

You have all the numbers there.

The cost of sales and the sales because again, this is not an important thing.

The operating margin and the operating profit is the right number to focus on if you want to understand our business models.

If we look at the trend towards subscription, though, and the content updates, do the economics change the gross margin level?

No, the economics change mainly on the support side.

If you look at our cost of sales, most of the cost of sales is the cost of support, and we do have pretty good margins on the support.

Basically, if we can grow the support line, you will see the cost of sales number going up too.

Thanks, guys.

Dan Cummins of UBS.

Jerry, you said you were just back from Japan.

Was wondering if you could give us some color on what is really happening on the ground there in the Japanese market?

If SARS had an impact this quarter, I'm curious if the Japanese market was a little bit stronger.

I have got regional revenues up year-over-year, and just from Gil, like to hear a little bit more on what has really been the technical breakthrough for getting the deep packet inspection from a lot of the vendors are kind of approaching gigabit speed, these claims are kind of widespread now in the industry.

Relative to Japan, what specific point did you want to cover in Japan?

How is the Japanese market going for you?

It's going okay.

It is going to be well.

It was their first quarter, so as you know, their fiscal year ends March 31st, so this was their first quarter of their fiscal year, so it's always a little bit lighter than the prior quarter, but we tend to have very, very good activity, and I think we're doing okay there.

I think there is big opportunities for us.

I think we could do better in the whole Asian marketplace, but I want to wait-and-see another quarter off of if the activity materializes into bookings like it is in the rest of the world there, that shows that was SARS related, so I think Japan is going to do fine.

I think it has been a good market for us, has been a very good market for us and I think it will continue to be.

In regards to the second half of the question about more deep inspection and Application Intelligence, there are a lot of venders that are trying to spread weaken the market, so maybe some vendors are claiming they will have it next year and they are working on it.

So I would be very, very careful confusing what is shipping today versus what is planned for 2004, and maybe in 2004, maybe late 2004, maybe 2005.

I think CheckPoint has a huge leadership on those.

What is really working and addresses all attacks versus what can cover sixteen parts (indiscernible) which doesn't help the companies protect against attacks, but we can still claim some level of deeper inspection.

So I would be careful to compare what we have today because I'm not aware of any other companies today has what we have, which is blocking application level attacks on the firewall in line, and definitely at high-speed.

I just want to put that.

Now, what is the rate for innovation and there is a lot of different technology, not just one.

I think part of this is the emergence of computers performance, computers are faster and can deliver a very, very fast performance.

We have a lot of what we call streaming modules so we can reassemble packets, analyze the stream of data that is coming through, and do it from a technical perspective at the current levels the underlying operating environment.

So it doesn't need to do to run application or do a content search which can slow the communication down and takes up a lot of overhead and performance.

So we have been implementing a lot of that, in our product and Application Intelligence is pioneering some of that.

Future versions will do even more so.

So these are some of the things, just to give it a little perspective, there is much much more.

And part of it, by the way, from a technical innovation is the fact that we have gathered a lot of experience over the past few years in helping customers protect against various attacks.

We've seen today in the competitive environment that the customer takes the competitive products, we put it there, we turnout some feature, and then it is extremely easy to show the customers if you just change something small in the behavior of the communication, like fragmented packets, the other competing products will just let their attack go through without even stopping it.

I

It is amazing to see how companies can sell solutions like that, claim high level of protection and how much customers are uneducated.

So in many cases they like technologies that are well, well below the security levels that I would feel comfortable giving to customers.

Kevin Merritt of Fiduciary Trust.

Eyal, could you comment on booking trends, how the growth has been there?

And if you could offer any comments on your thoughts on Q4?

Thanks very much.

I will start with the second half of your question.

We believe that there is a lot of upside to the business in Q4 and but we chose to provide guidance for Q3.

We will take it one-quarter at a time.

Regarding the booking trends, I think I mentioned that linearity we have 60% of the business came in April and May and 40% in June.

It was tracking according to our historical trends very similar to what we know about the CheckPoint business models and the linearity.

Just in terms of the total amount of business that was booked in the quarter, how did that compare to Q1 or Q2 of last year?

We report revenues on deferred revenues and I think all the numbers are there and booking is not a number that we ever reported, and we're not going to start now.

Todd Weller of Legg Mason.

Eyal, just wondering if you could comment on where you expect deferreds next quarter and maybe looking out to '04 and the tax rate, talk about the direction that is headed?

Thanks.

Regarding deferred, I think one of the things which is a little bit more difficult to predict trends swing anywhere between plus and -minus $3m.

We always hope that it will grow.

Regarding taxes next year, allow the 20% that we're predicting for the second half is probably were we're going to be, but again, we get closer we will analyze it better, but that is more or less what we believe it will be.

Rob Owens of Pacific Crest.

Eyal, just to clarify you said tax rate should be 20% in the second half of this year?

Yes, expected to be, yes.

Sarah Friar of Goldman Sachs.

Just quickly on the SMB market, the small to medium-sized business market.

I know last quarter you announced that would be a new focus for you on the marketing side, but it sounds like the number of installations has stayed fairly flat quarter over quarter.

Could you talk about the dynamics that you are seeing in that market?

Is it weaker than you had anticipated or just harder to crack competitively?

Actually, it is a very good market.

The number of installations went up slightly, doesn't have a huge impact on revenues these are very small, very slow ASP kind of product, but the number did grow nicely.

We did have a lot of nice programs also our website with the small office resources.

It gives the market like every market takes time and we are putting our efforts all around the world to address that.

We have some places where we can learn how to do some successes, so overall we're making progress.

We think we're doing very well competitively and we know it will take time.

So I think it is generally all positive.

Okay, so that should grow sequentially.

Secondly, on government spending, I know you have already talked about government being a vertical trend.

As you head into the third quarter, particularly in the U.S., which is obviously their federal government's fiscal year end, are you seeing strong pipeline there?

Do you have good expectations for the September quarter?

Yes, Sarah, we do.

There's a lot of activity in the federal government, so we are as optimistic as ever that this should be a strong quarter for them, as it typically is, assuming the government still has money to spend by the time they get to September.

Gary Spivak of Kaufman Brothers.

Can you provide a rough percentage of business from service providers, and how that differs in various geographies?

We don't remember what it is.

I can tell you generally the service provider was showing some nice recovery side last quarter, so we've seen some nice upticks from service providers.

Many of them getting back on subscription contracts, many of them actually combine some real new products, and some are just working on future deals, which is also very positive.

Generally, after about two years of declining that business, I think Q2 of the first-quarter that I can say it is not just stable but actually going up.

Good news for the future because it looks like there's some recovery there, especially with U.S. service providers.

That was part of the strength in the U.S. business was the U.S. service providers.

Would you classify it as 10% or greater, or is it less than 10% of business or bookings or however you want --

Globally, approximately 10%, maybe a little more.

I would like to turn the floor back over to the speakers for any further remarks.

Okay, we thank you very much for your participation.

If you want to speak to management or to our Investor Relation department, following this call, please call our Investor Relations at phone number 650-628-2050.

This is Eyal Desheh, and you can also call my office in Israel.

We hope to see all of you with the rest of the results for the third quarter, and thanks again for your participation.

Thank you.

This does conclude today's teleconference.

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