Check Point Software Technologies Ltd (CHKP) 2004 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Check Point second quarter 2004 financial results conference call. At this time, all participants have been placed on a listen-only mode and the floor will be open for your questions following today's presentation. I would now like to turn the floor over to the Janine Zanelli, Director of Investor Relations. Ma'am, the floor is yours.

Good morning and thank you for joining us to discuss the second quarter.

As a reminder, this call is being Web cast live from our Web site and is being recorded. To access the live Web cast and replay information, please visit the company's Web site at www.checkpoint.com/IR. The replay will be available through August 9th. If you'd 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'd like to read the following disclaimer.

During the course of this call, the company will make certain forward-looking statements concerning our expectations for revenue and EPS in 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.

Factors that could cause or contribute to such differences include but are not limited to, Check Point's ability to integrate Zone Lab's operations effectively, the impact on revenue of economic and political uncertainties and weaknesses in various regions of the world including the commencement or escalation of hostilities or acts of terrorism, the inclusion of network security functionality and third party hardware or system software, any unforeseen developmental or technological difficulty with regards to Check Point's products, changes in the competitive landscape including new competitors or the impact of competitive pricing and products, a shift in demand for products such as Check Point's, unknown factors affecting third parties with which Check Point has formed business alliances, timely availability and customer acceptance of Check Point's new and existing products and other factors and risks discussed in Check Point's report on Form 20-F for the year ended December 31, 2003, which is on file with the Securities and Exchange Commission. Check Point assumes no obligation to update information concerning its expectations.

Thank you. And I'll now turn the call over to Eyal Desheh, CFO.

Thank you, Jeanine, and good morning everyone. Let me share with you the results of the good quarter for Check Point and provide some more details on our financials.

Revenues for the second quarter were $126.9 million, an increase of 20% compared to 106.1 million in the second quarter of 2003. Sequentially, our revenues increased 9% from $116.1 million in the first quarter of 2004.

I am pleased with the organic growth this quarter which led to an increase in revenues as well as in deferred revenues. Revenue growth was also aided by a contribution from Zone Lab which we consolidated in our P&L for the first time.

Even more impressive was our growth in licensed revenues which were up 24% year-over-year, to $67.9 million, accounting for 54% of total revenues. Subscriptions were $48.7 million, or 38% of total revenue, and services were 10.3 million, or 8% of total revenues.

Net income and earning per diluted share for the second quarter were $63.3 million, or 24 cents per share respectively. This includes $2.6 million of net after-tax effect charges for amortization of intangible assets and deferred stock-based compensation.

Net income and earning per diluted shares for the quarter excluding the impact of these charges, were $65.9 million, and 25 cents per share, an increase of 9% and 5% respectively over last year. Fully diluted share count increased from 255 million at the end of June 2003, to 267 million at the end of June 2004.

Three elements contributed to the increase. The shares issued in the Zone Lab acquisition, the increase in our share price, and stock option exercised by our employees.

The increase in share count was offset by 1.5 million shares resulting from our buy back program which was implemented for the first time this quarter. We purchased during the quarter, a total of 3.3 million shares for a total cost of $78.6 million.

Deferred revenues increased by 5.6 million in the quarter as a result of continued strong subscription business and our loyal account base. Deferred revenues grew 26% over last year and now stand at $130 million as of June 30, 2004.

Total expenses for the quarter were $61.3 million, including 3.1 million from acquisition-related amortizations. Even with the acquisition of Zone Lab, and the investment we are making in this business, we still achieved industry-high operating margin of 54%.

Our total number of employees was approximately 1400 at the end of the quarter, including approximately 200 Zone Lab employees. With exceptionally strong cash flow this quarter, net cash flow of operating activities was $81.9 million, 27% over last quarter.

Total cash and interest bearing investment as of June 30, 2004 was $1.59 billion. Further evidence of the strength of the quarter, account receivables were $71.2 million, and days sales outstanding, DSO, were a record low of 48 days. Our effective income tax rate was 17%.

I'm pleased with our financial performance this quarter. Thank you for your time, and I'll now the turn the call over to Jerry.

Thank you, Eyal, and hello, everyone. I'm glad you were able to join us on the call today. Let me share some of the highlights and initiatives from the June quarter.

Q2, displayed similar, positive business trends to those we experienced in Q1, as our business again grew in double digits as compared to last year. As you have seen in the financials, we experienced solid growth in product revenues as we continued the rollout of many new technologies and products during the quarter.

The two major new initiatives were the series of new Web security products we began shipping at the end of June, and also a new release of our end point security solution, Integrity Client List Security. In addition, we brought to market a new release of the InterSpect product we first announced in January of this year, including new functions and features.

From a geographical perspective, we were pleased with the demand we saw in all of our operations around the globe, but the Western hemisphere had a very strong quarter as it contributed 45% of our revenues with EMEA contributing 41%, and Asia Pacific and Japan the other 14%.

I mentioned earlier that we experienced strong product growth this quarter and that was true across all the major product categories within our perimeter security portfolio, with special mention again this quarter of our VPN 1 hedge product for the deployment of large scale VPNs by our enterprise customers, and Check Point Express, our mid-market solution. We also saw continued good demand for InterSpect as the rollout of that new product continues and an excited response from both partners and customers to the new Web security set up technologies and products.

In addition, the pipeline continues to grow for our new Integrity Client product, and we were very pleased with the market acceptance of the new Zone Alarm Security Suite which combines the industry's best end point security technology, anti-virus and much more advanced technology in a single product. Within weeks it was being recognized by many industry publications as the best security suite for both its ease of use and quality of protection.

During the quarter, we also announced and began the implementation of our newly improved and upgraded partner program that we will continue to roll out through the remainder of 2004. While we continually fine-tune the program every year, this was a major enhancement that will strongly endorse and help our best and most committed partners to ensure they have the knowledge, products, and capability to be successful in solving the security needs of their customers.

I'm also pleased to report that based on our direct contact with customers and feedback from our partners, we fared very well relative to our key competitors across all geographies and market segments this quarter. The Check Point value proposition of superior security, industry best management, exceptional total cost of ownership, and a variety of appliance platforms continues to win out on the market.

We also hear that the expansion of our product portfolio to include the new and growing importance of internal and Web security solutions, combined with our very powerful and popular application intelligence for perimeter protection, is very important and a big competitive differentiator for our partners and customers.

We also strengthened our leadership team with two recent senior management hires to lead our worldwide sales and technical services organizations.

Kevin Maloney has joined us to head the worldwide sales organization. Kevin has worked in a variety of positions at IBM over the past 28 years, most recently as Vice President at IBM Software Group. He has a strong background in working with channels and selling software, as well as international experience having lived in both Paris and Tokyo during his years with IBM.

Our new VP of Technical Services based in Dallas, Texas, is Robert Dumont, who commands a variety of experiences in most aspects of the software business, including developing, selling, supporting, consulting, and recently being a CEO of a small security software company. We welcome these additions to the Check Point team and look forward to further strengthening our sales and service organizations.

With that, I would like to once again say how pleased I am with our Q2 results and tell you that I look forward to the second half of the year as we continue the rollout of our many new product initiatives.

I'll now turn the call over to Gil to cover some more company highlights.

Thank you, Jerry.

As Jerry and Eyal already discussed, Q2 was really an exceptional quarter from the financial standpoint. Showing many record financial measurements such as DSO, operating cash flow, deferred revenues, and healthy revenue growth, especially since this was driven by all the four product segments.

As you know, we've introduced many new products and technologies over the last year, and we are in the process of [inaudible] the success with our channel partners and customers.

In the second quarter we announced three new Web security products, Connectra, Web Intelligence and SSL Metric Extender. These really put a strong foundation for leading the remote [OPSEC] [inaudible] assembly VPN space as well as the Web security space.

The shipment of these new Web security products in June completed the rollout of our expanded strategy of perimeter, internal, and Web security products. From a competitive standpoint, this puts Check Point in a unique position with the only security vendor to have such a broad portfolio of metric security products and then all of these products share a common architecture so they can actually deliver the security promise.

When you look even deeper into our technology, you'll find superior [inaudible] prevention capabilities, the greatest number of deployment option, unique management capability and many other characteristics that make our solution the best and most secure option for customers of all sizes. In the upcoming quarter we will continue to educate the market and work with our partners and customers to deploy our solutions to make our infrastructure secure. Which is underway already and will continue to be our focus.

As these efforts continue we reiterate our financial plan as we discussed these at beginning of the year. We expect the second half of 2004 to show double-digit growth in revenues with license growth at approximately 20% over last year and driven by a healthy mix of core products and new products.

While Q3's seasonality could play a role, we still expect to show very healthy results in line with our previous guidance, which means revenue growth over last year in the range of 17 to 24%, or 124 to $131 million, and earnings per share of 24 to 26 cents a share, excluding the acquisition-related expenses which have an effect of approximately 1 to 2 cents a share.

I'm very excited with the opportunity ahead of us and hope for the positive trends for Check Point in our marketplace continue.

Thank you and I'll open the call now for questions.

Thank you. The floor is now open for questions. If you have a question, please press star one on your touch-tone phone. If at any point your question is answered, you may remove yourself from the queue by pressing the pound key. If you are using a speaker-phone please pick up your handset to provide optimum sound quality. We do ask that you limit yourself to one question. Again, if you do have a question, please press star one on your touch-tone phone at this time. Your first question is coming from Shaul Eyal of CIBC World Markets. Please go ahead.

Thank you. A couple of quick questions from me. Last quarter you did break out the backlog, the contribution from Zone and the core business. Do you intend to do it again?

Yes, and last quarter we also said if you remember that we will not be continuing to do that and Zone Lab is going to be an integral part of Check Point, our product line, so by our channel and our sales teams we will not break out the results of Zone Lab separately in the future. However, they had a good quarter, but if you all remember, revenue will build up as part of the accounting treatment of the acquisition so we expect very nice in the future.

Fair enough. In terms of linearity trend almost a month into the quarter, anything unusual?

No.

No.

Pretty early in the quarter as you all know, but nothing unusual.

Okay.

Thank you.

Thank you. Your next question is coming from Rob Breza of RBC Capital Markets. Please go ahead.

Good morning and good afternoon. Eyal, can you give us insight into the product breakdown, maybe similar to what the analyst day was between like client products, internal, the core and maybe some kind of growth rates around the product mix, please?

Yeah, we, I mentioned in answering the previous question. We're not going to give a detailed break down of product but it is very well in line with what we expected in the analyst day, very nice growth in our new products and pretty balanced nice growth in our core product, so we're happy with all the product lines that we're seeing so far and with the progress that we're making. But as I said we're not going to break into details.

Can you maybe just give us some insight into maybe which ones grew faster or slower than, or on a relative basis?

I think obviously end point security products grew faster with the additional sales, the Integrity products similarly to the client mix of it that was a good one, but I think when we analyze and highlight [inaudible] in the things I've said we are getting out the very, very balanced quarter. All products [inaudible] grew nicely, all contributed nicely, and it wasn't one that sort of overshadowing the other which makes us very, very pleased with the strategy that we have and with the mix that we have.

Great. Thank you.

Thank you. Your next question is coming from Walter Pritchard of Schwab SoundView Capital Markets.

Hi. On the DSOs, they're quite low this quarter relative to where they usually are. Did you see business push out of June in terms of customers stopping spending or was it sort of conscious on your part? Just trying to get a sense what's going on there.

I didn't see any business being pushed out. It was a good quarter, and it was linear, and we met our expectations, and, you know, you saw deferred go up, so overall it was very good, Walter. There wasn't anything unusual or out of line. I just think Eyal's people did a very good job in cash collection as they usually do.

Thank you.

You're welcome. We have a lot of focus on that, [inaudible] a lot of focus on that, and it was just a very good quarter.

Could you just verify, you mentioned organic growth, was that in products sequentially or could you just put that into context for us?

I think it was both in products sequentially and year-over-year. I think a large percentage of the growth over last year was driven by product developed organically at Check Point, the Zone Lab acquisition obviously added to that, even though I think Eyal mentioned, not to the full effect yet because of the accounting treatment of deferred revenues, but big part of that are not going to be recognized by us but we keep building that and we'll see that later in the year and in 2005 so again, we're very, very pleased, with all that mix.

Okay. Thank you.

Thank you. Your next question is coming from Joseph Craigen of Needham & Company.

Thank you. A question for you on the partner program. In particular in the VARs distributors, did you see any turnover or was there any significant net new adds in the quarter?

I don't know if there was any significant net new adds. We add to our partner program all the time but I can tell you they're very, very pleased about this whole new structure which I can't go into in all the details here, but we're working with our partners. We have partner advisor councils in all major parts of the world both at that the distributor level, at the reseller level.

We've worked on this with them for a long time. There's four major levels to it. We've simplified it. We've added a lot of benefits to it. They're very pleased.

This is really going to help distinguish, you know, the different levels and types of Check Point partners for their benefit, for our customers' benefits, and long-term Check Point's benefit. So it's a very streamlined, well structured, well received by our partners new program with a lot of benefits to them and lot of publicity and focus for them in the marketplace as to who they are and what their relationship with Check Point is.

But we continue to grow the partner program primarily by the new segments we're going into as you may know with medium businesses, small businesses, some of the new security areas, so I'm pleased with the partner program and I think the partners are, too.

And so as far as where new ones are coming from are they coming from any specific geography or any specific competitor for that matter?

Yes, we have picked up, as we move into these new business segments, we do pick up partners that may have carried competitive products before. There may be some Check Point partners where we did not have products in certain segments that are now adding our product to their portfolio and dropping other partners. We see that happen all the time.

Geographically, no, it's more market segments and product segments where we're seeing the additions come into the partner program.

Okay. Thank you.

Thank you. Your next question is coming from Gregg Moskowitz of Susquehanna Financial.

Thank you. Jerry, maybe just to follow up on that last question, wondering if you can give us an update in terms of the timing of roll out of Integrity product to your core Check Point partners.

Well it started back at acquisition time when we closed the transition. We're doing a very, shouldn't say controlled, but we're doing a phased rollout where we started at the top tier of our partner program to where we educated and certified them to begin selling Integrity, and we did that on a worldwide basis and that will continue through end of this year. So most of our largest, biggest partners at the platinum level, at the gold level have already certified to sell the Integrity product and are doing a very nice job with it and that will continue through the end of the year, Gregg.

Okay. And then Eyal, in terms of percentage of orders over 50K, I know that's a metric you normally give out, where did that come in for the 2Q?

It was better than Q1, by about 23%. We saw some more large orders coming in than, definitely compared to last year but also compared to last quarter.

Okay. And then maybe just finally on the tax rate, I know it can fluctuate from quarter-to-quarter. Did it seem to go down a little bit this quarter. What are you expecting for the rest of '04?

Around where we are. It could go up and down by a couple of points which is a lot but anywhere between 17 to 19% I think would be the range for the rest of the year.

Okay. Thank you.

You're welcome.

Thank you. Your next question is coming from Sterling Auty of J.P. Morgan.

Hi, Eyal. Just want to follow-up on that. Is there any NOLs that came over with Zone Labs or have any impact on the tax rate?

Yes, there is, but you won't see it on the cash basis, you don't see it in the P&L, accounting treatment doesn't allow us, so we have to accrue the regular tax rate but as of now this impact is really minimal.

Okay. And then just to clarify back on the guidance, the EPS 24 to 26, that does not include, or that includes the amortization, so if we back that out it'd be somewhere 25 to 28 cents on EPS?

No, that excludes amortization and the stock-based compensation.

Okay. And then just last question, can you talk to the support program? Looks like the subscription line is up nicely. What are you seeing from your end in terms of the adoption on the support program?

What do you mean by support program, Sterling?

I guess the maintenance side. There was the, you went to the account-based support program at the end of last year. Are you seeing it generating incremental dollars or what are you seeing from your standpoint?

Let me just explain one more time. Account-based has three elements to it, the most fundamental is subscription. Our EBS program has three levels, subscription, then you can add standard support, then you can add premium support. So we have all three elements of that account-based support program which we call subscription and support, and subscription is the strongest because that's what allows customers to get bug fixes, service patches and upgrades to new versions.

And then support is a separate one, and as Eyal said, that's 8% of our revenue. And that's been fairly flat, growing a little bit, but it's pretty consistent. Where most of the strength is, is in the subscription portion of the business with the EBS program, the account-based support and subscription.

Okay. Thank you.

Maybe to add to what Jerry says, it's a very positive acceptance. I mean it took us, we basically transitioned the entire installed base over the last six months from the old program to the new program. The new program has a lot of benefits, it's actually costs less for the customer, it generates more revenues to us because of the broader coverage that the customer gets and this was, it's not an easy task to convert almost a $2 billion installed base from one program to another, but I think the results right now are really, really good the way everybody is transitioning and everybody seems to be very happy about the new program.

Great. Thank you.

Thank you. Your next question is coming from Michael Turits of Prudential.

Hi, guys. Just want to check, just make sure on guidance here, we've got 124 to 131 for next quarter, and you're, as far as I can tell, you're fully reiterating all the guidance including op ex, R&D and top line and bottom line that you gave, for full year at the analyst day, I just want to make sure that's correct.

And also, it does seem to imply pretty steep third to fourth quarter ramp if we go to the midpoint of your guidance for the third quarter. So I just wanted to check on the reiteration of all the guidance from the analyst day and also that you do imply that third to fourth quarter ramp.

Absolutely. Very right, Michael.

What should help us out making that ramp third to fourth quarter from the midpoint of the third quarter guidance? I know you get some out of the build back from the maintenance revenue.

I think, as we've said, we've really expanded the strategy. It takes time to bring these products to market, we already show good effect but the pipeline is nice and as we said, predicting the future is always a risky business and there was nothing guaranteed here, but so far everything works as planned, we see the pipeline building up, we see the channels energized, we see the customers happy with that, so we are just think that everything works according to plan and we're pretty pleased about it.

Okay. One follow-up on InterSpect. I'm sorry, did you say that you did have the new version of InterSpect out, and if so, when did that get out and what were the changes there and what was in that response to?

It's continuing development. We'll continue to bring out more new versions of both InterSpect and Connectra. It's part of what we announced. We added new functions, new feature, [inaudible] there's a lot of other new functions and features and performance associated with that.

Moving toward centralized management there's going to be more new versions later this year, so it's just the ongoing evolution of a new product as it matures we add more functions, more features, and more capability and we did this in June and it was very well received by our customers. It's adding new functionality that they like and they want.

Okay. Thanks.

Thank you. Your next question is coming from Alan Weinfeld of Fulcrum Global Partners.

Hi. Can you guys make any statements about the 1.6 billion in cash? Are you possibly looking as the large firewall market continues to consolidate somewhat and there's a lot of room underneath you guys, are you possibly looking at any other acquisitions to use that cash in the second part of the year? Anything we should be thinking about? You guys possibly involved in that you're not today?

Obviously on the last six months we had a lot of use to our cash. Keep in mind that in the past six months we've acquired a company and we used a nice amount of cash to acquire Zone Labs. We started the buy back program in the second quarter, so we used some more cash for that. We intend to continue with the buy back program that we haven't finished yet and we'll keep looking for more options.

But actually this shows even the strength of our balance sheet even with implementing all these plans, doing some pretty aggressive steps, especially compared to our history in Check Point about the use of the cash we still were able to maintain roughly the same amount of cash. So we pretty much used most of the new cash flow to fund that activity and we'll keep looking for more ways to utilize the cash.

And should we look for operating margin sequentially to stay about where they are now in the back half of the year?

As we get, you probably noticed that the change in the operating margin was a result of the inclusion of the Zone Lab expenses and we said that already last quarter as the Zone Lab business continues to become more profitable with more revenues that can be recognized we expect the margin to improve a little bit quarter-over-quarter.

Thanks, guys.

You're welcome.

Thank you. Your next question is coming from Sara Friar of Goldman Sachs.

Good morning, guys. Just to go back a little, I know a lot of folks tried to ask the same question. On Zone for the quarter, I know you're not breaking it out, but if I go back to your original guidance and assume about an 80/20 split, I think where the concern is coming in is it looks like your product license line was more or less flat for the core Xing out Zone. Is that incorrect? Are you saying that actually product license grew even without Zone?

Yes.

Okay. But it can't have grown a significant amount. Maybe at most a million.

I don't know how you come to that, but we're not going to break it out but we're very pleased with what we did both organically and the new products, core and with Zone Labs. I don't know where your numbers come from.

Maybe one thing that to shed some light about Zone Lab, keep in mind that Zone Lab is actually a big part of their revenues are subscription revenues. When you buy the Zone Alarm Suite, the consumer, the Zone Alarm with anti-virus product, a big part of that product goes to the subscription line because these products on the consumer level usually include a year of upgrades and a year of maintenance, so keep that in mind when you look at the comparable numbers.

Okay. That's more helpful. Thank you.

Actually, Sara, more than 50% goes into the maintenance line from the consumer business, and from, the enterprise business the structure is very similar to Check Point.

Okay, great. And so then the next question follows from that. What is the split between consumer and enterprise, roughly, for Zone? And then just wondering, as Service Pack 2 rolls out for Microsoft in the summer, are you expecting any sort of negative hit on the consumer side from the personal firewall?

I think the Microsoft announcement puts a lot of focus on why people need the extra security in the consumer space. I also think that Zone Lab has a pretty revolutionary new product suite in the second quarter, which we only have one month effect in the quarter, but the effect was very positive. When you look at the Zone Alarm security suite it now addresses new markets. It says in it, the broadest basically end point security suite including anti-virus in the marketplace.

One thing that I saw yesterday which was very nice, if you look at PC Magazine, Check Point small business and consumer products were recommended by more categories than any other product. We're now by PC Magazine, we are one of the recommended security suites, one of the recommended end point firewalls, and one of the recommended anti-virus product, not to mention the safest office recommended for small businesses.

So basically on that part of the business of consumer, we've made a pretty big revolution which means that we have a very, very big opportunity ahead of us, which is not, hasn't been historically our focus but we don't intend to miss that opportunity.

Got it. Is that split about 50/50?

No, it's about 60/40 towards consumer.

Towards consumer. Okay. Great. Thanks very much.

Thank you. Your next question is coming from Chris Russ of Wachovia Securities.

Hey, guys. I know you're not disclosing the Zone Lab's contribution this quarter, but could you indicate whether or not it was more dilutive than expected? I think your guidance was like 1 to 2 cents per quarter. Was it at the high end of that or worse than that?

It was in between.

In between. Okay. Now the Zone Lab's revenue this quarter was impacted by the deferred revenue write-off because of purchase accounting rules. Do you expect that Zone should grow meaningfully on a sequential basis in the third quarter? Does your guidance for the third quarter, 124 to 131 assume that Zone's revenue increases significantly on a sequential basis?

No, I think with the buildup of the deferred revenues will take more than one quarter, it usually takes about a year to build up all of that. So we are going to see that part of the equation ramp up only in the 2005. We also, I think, relatively conservative about the contribution for Zone Lab for two reasons.

First, when you look at the consumer part of the business it's still a new market for us, and since big part of the revenues there do go to the third, the effect is going to be a lasting effect and not a one-quarter effect. And in the enterprise space, and again, I'm saying that because we're very, very happy with the Zone Lab acquisition and the financial results we delivered, have actually delivered slightly better than planned.

So don't get me wrong on that but the [inaudible] historically for the Integrity product family for the enterprise was a long, was a long sales cycle. So we are very pleased with the, even in the second quarter, we already saw some new deals driven by the Check Point channel, actually six-digit deals already driven by the Check Point channel over a very quick period of time.

But just to summarize what I've said, we don't expect Zone Lab to have like a one-time big effect on the results moving forward. We expect these results to be lasting and growing over a long period of time.

Okay. So, Gil, you mentioned that the sales cycle is lengthening for the Integrity product?

No, it's shortening based on what it was in Zone Labs but it's lengthening compared to the traditional sales cycle we had in Check Point because Zone Labs, their enterprise sales were mostly, more high-end sales than the Check Point sales. So we're actually both taking those and opening more opportunity to the Check Point sales to the Check Point channel to do higher-end sales and also introducing the opportunity for smaller, mid-size kind of deployment of Integrity. Okay. And in prior quarters you've mentioned the percentage of license revenue from new products categorized at Safe@Office, Check Point Express, VPN-1, InterSpect, et cetera. Are you willing to disclose that this quarter?

Yes, it was close to 35% of the total product revenues.

35%. That's up from 25% last quarter, correct?

That's right.

Okay. And could you, what was InterSpect this quarter?

We don't break out individual products.

No breakout.

Okay. Thanks very much.

Thank you. Your next question is coming from Daniel Cummins of UBS.

Thank you. Gosh, this is an impenetrable black box of revenue. I'll change the subject a little bit. Can you give us some characterization of some of your partners results by partner? The Nokia revenue share, I noticed Crossbeam has picked up InterSpect, do you know if they've written any POs for that yet? And can you talk about McAfee Secure-1 which was introduced in early May? Curious as to why that product got named as a McAfee product? And did you see any traction there?

Let me take it in reverse order, Daniel. The Secure-1 was just built. Now the reason it's a McAfee is it's a McAfee-managed security offering that we're participating in. They already have 2.5 to 2.7 million customers using that service of which we're a new added base component of adding firewall VPN.

It's been an initial rollout. We're adding some new functions and new features as we pilot it. We're doing a phased rollout, I think you might know that. This is a step at a time. It's gone well, it's within expectations. We think there's a lot upside to it.

But as we go through the continued refining, retuning of the product, the pricing, the functions and features, I think it will do fine.

Is that available through your channel as well?

Yes, we're doing it through one major distributor that we both share right now and the United States is the initial pilot of that rollout so it's a shared partner that we're doing it through.

Okay.

Crossbeam, yes, they've announced InterSpect. There's a lot of excitement about that. It's going to be a high-end platform to run our internal security gateway but they've announced that for availability later this year. I don't think they've sold any yet. I'm not aware of that. But it's not deliverable until the end of the year so I doubt it.

Nokia did okay. I think they're in the 35 to 40% range of our platforms now as one of our leading options in the marketplace that the customers like and the partners support. So we're doing very well across our appliance partners and we're very pleased with the number of platforms we deploy on as our customers are.

All right. Thank you.

Thank you.

Thank you. Your next question is coming from Gene Munster of Piper Jaffray.

Hey, good morning. In terms of the competitive front, any thoughts on Juniper and NetScreen, how that's changed? Any way to quantify how that impacted your business last quarter?

I don't know if I can quantify it, but I do think as I've said for a couple of quarters now consistently, is that they're not the same competitor that they used to be in the minds of many, many in the marketplace both at the partner level as well as the customer level. That it really has put us in a position of being the only independent security company that people can look to to bring them a broad range of security technology to secure their network which is primarily Cisco network out there and I think we've done very, very well and I think our competitive positioning is improved.

I talked about it generically in my comments and I guess that would be one of the specific ones. I think we have done very well and will continue to do very well both in an absolute sense as well relative to all of the key competitors out there both with the quality of products and the capability we're bringing to market. I think the shift is underway and has been underway and will continue in that direction.

Okay. And just a second in terms of expense line, Sarbanes-Oxley more of an industry comment here versus specific to Check Point, but did you see an uptick in the amount of spending you're doing on that front? Is that no?

Could you repeat the question again?

On Sarbanes-Oxley side any change in your spending to get compliant on that front in this last quarter?

No.

The answer is still no.

Thank you.

Thank you. Your next question is coming from Ed McGuire of Merrill Lynch.

Yes, good morning. Noticed that gross margins ticked down slightly this quarter. Is that a result of a higher proportion of appliance products?

Very little of that but it's mostly a result of the Zone Lab business model which carry, since they sell via the Internet consumer products sold via the Internet so that carry a higher portion of cost of sales than the regular Check Point software sales model. So they, that's a result of the combination. You look at the Check Point stand alone with our adding Zone Lab would be exactly the same gross margin that you've seen before.

Okay. Looking at the Asia Pac revenues looks like they were slightly down over the quarter and for the year. Did you see any softness in that market?

No, it's primarily Japan, and it's because it's the first quarter of their fiscal year. As you know, their fiscal year for the country and all the companies ends March 31 so this is always their slowest, weakest quarter, and it was primarily Japan. I think the rest of Asia did well.

I think the rest of Asia had the record quarter historically for us so we are pretty pleased about that.

Regarding the breakout, at least for the core Check Point business, what's the proportion of open systems versus appliances that you sold during the quarter?

About 55 to 60% is the open systems right now.

So a bit more historically than had been sold on appliances?

A little bit more but even though I may, one thing I may say here on that, also including here the Check Point platforms and the Check Point platforms are open based but there are also appliances because right now InterSpect, VPN-1 Edge, Safe@Office, Connectra, are all appliances that are delivered by Check Point. So overall it's roughly the same and I think open systems and especially our secured platform is picking up very, very nicely.

Okay. Thank you.

Thank you. Your next question is coming from Tim Kassell of Thomas Weisel Partners.

Good morning, everybody. Quick question here. Of the 5.6 million deferred rev build, can you give us a little bit of color of how much of that was organic and how much of that was just the beginning of the roll-offs of the rules of accounting on the Zone Lab deferred revenue?

First let me make sure you remember and is that we always did a consolidated the balance sheet at the end of Q1. So this is all now the new Check Point business. I think it has a combination of three things of, the Check Point EBS program, which worked nicely of the Zone Lab which also worked nicely and also even more interesting is the smart defense security subscription service. So I think the combination of all three I think accounted nicely for that increase.

Then circle on to customer segmentation can you touch on the small to medium size business, any sort of color there of how fast that grew relative to your traditional higher end segments?

I think we can do much better and we can be much more aggressive in the small to medium business. Having said that, our small business is 50% higher than the year ago which is still very small, our medium sized business and again there's many ways to characterize it, is also very nice, about 25 to 30% better year-over-year so overall we're doing quite well on those two segments.

Thank you very much.

Thank you. Your next question is coming from Erik Suppiger of Pacific Growth Equities.

Good morning, good afternoon. The midpoint of your range is for the September quarter is reasonably flat, 27, 127.5 with what you just reported. The contribution from Zone should be growing so can you comment as to what areas would be offsetting at least the marginal growth that would you expect from Zone? Because I believe there was an expectation for better growth in the September quarter.

I think what we've said is we're reiterating our guidance from beginning of the year exactly. I think we expect a very nice Q3 but remember Q3 is seasonally very weak quarter, so the fact that we are talking about a potential for increasing revenues in Q3 means that we think that business is going well, but overall I think everything is in line there and I think all business should be fine.

Like always, I want to reiterate the point, predicting the future is always risky, and I can throw out any number that would make anyone more or less happy. What you have here is a consistent plan, is a plan that we've double-checked with our field and what they're forecasting and I think everybody now shares this plan and I think it's a very good plan.

Okay. Very quickly, did you say Nokia was 35 to 40% of the platforms out there? Has that come down from where it was?

A little bit, not much but it's a little bit.

Okay. Thank you very much.

Thank you. Your next question is coming from Sean Jackson of Avondale Partners.

Thanks. My questions have been answered.

Operator, we have time for one more question.

Thank you. Your final question is coming from Chris De Biasi of Smith Barney.

Thanks. Jerry, can you give us an update on when you expect full production of the InterSpect and Connectra product?

Full production. I'm not sure I understand that. What does that mean?

Well, get to a full ramp on the production process. It was my understanding that you were rolling it out slowly from a production standpoint.

I understand. Probably by the end of this year. I've always said the full impact will be in 2005, InterSpect before Connectra because they were spaced about six months apart from introduction standpoint, so InterSpect for sure by the end of this year, beginning [inaudible] and Connectra shortly thereafter.

And then on InterSpect, who are you seeing from a competitive standpoint?

All the traditional IPS vendors that you'd see in the marketplace.

Okay. Thanks.

Sure.

Miss Fanelli, I'd now like to turn the floor back over to you.

All right to me. Thank you. Well, I'd like to thank everybody for participating with us this morning or afternoon, depending on where you are. If you want to speak to management or Investor Relations following this call, please call our Investor Relations department at area code 650-628-2050. Again, area code 650-628-2050. We are very happy to have you with us and we will see you next quarter with the Q3 results. Thank you very much.

Thank you very much.

Bye now.

Thank you. This does conclude today's teleconference. You may now disconnect your lines and have a wonderful day.