Check Point Software Technologies Ltd (CHKP) 2005 Q3 法說會逐字稿

Good morning.

My name is Toni and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Check Point Software Technologies third quarter 2005 financial results conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks there will be a question-and-answer period. [OPERATOR INSTRUCTIONS]

It is now my pleasure to turn the floor over to your host, Anne Marie McCauley.

Ma'am, you may begin you conference.

Thank you, Toni.

Good morning and afternoon.

I'm Anne Marie McCauley, Director of Investor Relations for Check Point Software.

Thank you for joining us to discuss the third quarter results.

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

To access the live Webcast and replay information, please visit the Company's Web site at www.checkpoint.com/IR.

The replay will be available through November 11th.

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, Vice Chairman and Eyal Desheh, Executive Vice President and CFO.

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

During the course of this call, the Company will make certain forward-looking statements concerning our expectations for revenue and EPS in the future, large license orders, plans for emerging products, plans for the fourth quarter generally, our continued success as a provider of security solutions and our release regarding the benefits of acquisition of Sourcefire.

Other statements which may be made in response to questions which refer to our beliefs, plans, expectations or intentions are also forward-looking statements for purposes of the Safe Harbor provided by the Securities Litigation Reform Act.

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 the impact on revenues of economic and political uncertainties and weakness in various regions in 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 difficulties with regard 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, 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 including NGX-based products, the parties ability to consummate the Sourcefire transaction including satisfaction of conditions and regulatory approval on the terms expected or on the anticipated schedule, unanticipated expenses associated with the merger, the possibility that the parties may be unable to achieve all of the benefits of merger within the expected time frame or at all and to successfully integrate Sourcefire's operation and technology into those of Check Point, operating cost, customer loss and business disruption, including without limitation, difficulties in maintain relationships with employees, customers, clients or suppliers may be greater than expected following the transaction and other factoring risks discussed in Check Point's form on Form 20F for the year ended December 31, 2004 which is on file with the Securities and Exchange Commission.

Check Point assume no obligation to update information concerning its expectations

Now let me turn the call over to Eyal Desheh for financial review.

Thanks, Anne Marie.

Good morning, everyone.

Let me share with you the results of the quarter and provide some more details on the financials.

We posted solid financial results for the third quarter.

Revenues were $141.1 million compared to 129.3 million in the third quarter of 2004, an increase of 9%.

Net income for the third quarter of 2005 was $78.7 million, an increase of 18% compared to 66.8 million in Q3 last year.

Net income excluding acquisition-related charges was $80.5 million, an increase of 16% compared to 69.1 million in the third quarter of 2004.

Earnings per diluted share for the third quarter of 2005 continue to grow nicely and were $0.31 per share, an increase of 22% compared to $0.26 per share last year.

Excluding acquisition-related charges EPS was $0.32, an increase of 20% compared to $0.27 in the third quarter of 2004.

Deferred revenue for this quarter was 144.3 million, an increase of $19.6 million, or 16% over last year.

Sequentially, deferred revenue showed a seasonal decline.

Operating expenses excluding acquisition-related charges were $57.8 million for the quarter compared to 57.4 million in the third quarter of last year.

Operating income excluding acquisition-related charges increased by 16% to $83.3 million from 71.9 million in the third quarter of 2004.

As a result, operating margins improved to 59% from 56% last year.

Our effective income tax rate was stable at 17%.

Cash collections continued to be good resulting in days sales outstanding, DSO, of 54 days compared to 49 days in the third quarter last year.

We again generated strong cash flow from operating activities of $83.5 million.

Also, our cash and investment balance at the end of the quarter was over $1.67 billion.

During this quarter, we purchased 2.6 million shares for a total cost of just over $57 million as part of our share repurchase program.

Our third quarter revenues were well diversified with the Americas leading the way contributing 47% of revenues, EMEA contributed 40% and Asia Pacific and Japan region contributed 13% to our revenues this quarter.

In the third quarter our large orders, which are greater than $50,000 accounted for roughly 27% of total orders.

We also had good growth in our installed base, bringing the total number of security gateway to roughly 440,000.

As a summary to my part, we posted solid financial results for the quarter with strong profitability and cash flow.

Now, Jerry and Gil will speak more about the business and strategies.

Jerry, please go ahead.

Thank you, Eyal.

Hello, everyone.

It's good to be with you today to discuss Check Point's business results this past quarter.

We have been speaking about a vision for unified security architecture and the corresponding strategy to deliver best-in-class perimeter, internal, Web, and end point security for roughly the past two years.

We believe this vision of the unified security architecture is becoming a reality as evidenced by a number of factors.

First, since the availability of NGX, approximately 20,000 new licenses and upgrades have been issued.

This high level of interest from partners in both new and existing customers underscores the market demand for our truly unified security solutions and management capabilities across product lines.

You can see the positive impact of NGX in our subscription revenue.

Not only today, but it will also be a positive contributor in the future.

Second, we have seen healthy interest in strong growth for new products.

Again this quarter emerging products contributed approximately 30% of new business.

Drilling down a level, our SSL VPN solution, Connectra, while still small on absolute revenue contribution was the fastest grower in the emerging market category and growing faster than the rate for this market segment.

Finally, we are also very pleased to be adding new technology and capability to our internal security offerings with the announced acquisition of Sourcefire.

On October 6th, we announced an agreement to acquire Sourcefire, the creator of Snort and a leading provider of intrusion prevention and real-time network access solutions for a total consideration of approximately $225 million.

The pending acquisition is expected to further enable Check Point to provide the most comprehensive internal securities solutions portfolio and another milestone in achieving our vision of a unified security architecture.

We continued product and technology introductions in the third quarter.

During the quarter, we rolled out VPN-1 VSX NGX, the latest version of the Company's innovative virtualized security gateway, to provide unmatched security protection and simplified deployment and management for enterprise and service provider customers with complex security environments.

We also introduced multi-layered security for consumers in the form of ZoneAlarm Security Suite 6.0.

This solution debuted with a radical new OS firewall and anti-spyware solution to prevent the most dangerous Internet threats, including spyware, root kits, viruses and more from invading PCs.

These new products and new versions are very important to both our partners and customers.

As we continue bring to market new technologies that increase the robustness of our offerings, our customers are able to effectively deploy a multi-layer security architecture that is easy to manage and provides the highest level of security.

This is also a value to our partners as it improves their solution set and capability to meet the needs of their customers.

In summary, we continued our focus this quarter on meeting the needs of our customers by providing them with the most secure solutions at the best total cost of ownership.

Thank you for listening and now let me turn the call over to Gil.

Thank you, Jerry and good morning and afternoon, everyone.

Q3 is typically the seasonally challenging one and this third quarter was no exception.

Overall given the tendency for slowness in our summer quarter, I'm pleased with the results we reported today.

Revenues were within the range we provided going into the quarter and our earnings for stability and cash flow were all at the higher end of the range.

Additionally, we continue to be [inaudible] for Q4 and believe we are gaining traction within the market for our securities solutions.

As Jerry mentioned earlier, we are pleased with the progress we are making in implementing our vision for a unified security architecture through our strategy of providing best-in-class perimeter internal Web and end point security, all managed by a single management console.

We believe this approach provides us an advantage in the security marketplace and will help to lead to our continued success of provider of worldwide security solutions.

Let me also briefly reiterate our enthusiasm about the acquisition of Sourcefire.

We believe the Sourcefire technologies will compliment the Check Point internal security portfolio making it the most robust and comprehensive in the industry.

We also believe this transaction creates additional opportunities to embed Sourcefire technology across the Check Point portfolio of security solutions.

As we have mentioned today, it is a very important step in executing our [expanded] strategy and provided the customers the best security solution now and going forward.

We expect the fourth quarter will be another active one for Check Point.

Over the next few months we plan to complete the rollout of new product versions associated with the NGX [inaudible].

Now we'd like to share our guidance for the fourth quarter of 2005.

For the fourth quarter revenues are expected to be in the range of 155 to $164 million, and earnings per share, excluding acquisition-related charges, are expected to be between 34 and $0.37.

Including these charges we expect the EPS range to be approximately $0.01 less for the quarter.

So in summary, Q3 showed some very nice financial results.

We expect the fourth quarter to be an even better one.

With that, I'd like to thank you again for joining us on this call today and open it up for questions.

Thank you. [OPERATOR INSTRUCTIONS] We'll pause for just a moment to compile our Q&A roster.

Our first question is coming from Ed Maguire of Merrill Lynch.

Yes.

Good morning.

Could you speak about the, what looks to be slightly weaker performance in Asia Pacific?

Are you seeing anything in the macro economic environment in that region?

Ed.

I don't know if it's macro or not, we have had some challenges as we talked about, I think last quarter in the Asian market, specifically Japan.

In Korea, we're adding new capability, new staff beefing up but we just have that slow traction over there the last couple of quarters.

Okay.

And could you also provide an update in terms of what products are already manageable and rolled out on the NGX platform and what's coming at least in the near-term?

I think for now, most of our products are under the NGX.

I think we still need to roll out for NGS is Integrity NGX and InterSpect NGX.

These are the two primary ones that will be rolled out in the next few months.

Okay.

Thanks very much.

By the time we get to the end of the quarter, Ed, it should all be done, all in place.

Thank you.

Our next question is coming from Sarah Friar of Goldman Sachs.

Good morning, guys.

I had just a question on guidance.

It seems like you slightly lowered the top end revenue guidance based on the full-year guidance you've given before, but at the same time it looks like you've actually raised the earnings guidance slightly.

Could you just talk about those two dynamics in particular are you a little more cautious on any particular areas for the fourth quarter on the top line?

And then where does the incremental pop on the bottom line come from?

I believe we are raising a little bit the guidance for Q4, and maybe for the year, it adds up to be slightly less than what we anticipated earlier but for the fourth quarter we are fairly optimistic.

I don't think that we know, and I'm always saying that predicting the future is always a challenge.

There's upside in the number, there's risks in the number.

So I'm not sure that it indicates too much [expect], but reiterating what our current sales forecasts are showing us.

With that forecast we know if it was a margin, always the margin for improvement.

Okay.

And then just as a follow-up, on the license revenue front, so you did see a decline in license revenue in the September quarter.

Do you put then just to the slower seasonality that you talked about, Gil, or is there something going on with the core licensed revenues around pricing that we should be cognizant of?

I don't think that we see a pricing issue, quite the contrary.

I think if you're talking about trends we've seen in the third quarter, one thing we've seen is I think we're stretching our competitive advantage.

We've seen a lot of wins with, we haven't seen, I mean, we're seeing, let's put it this way, some of our recent competitors weakening and we're seeing less and less of them in the core market.

What we do see in shift of, for example, customers that before have both the product upgrades to our subscription program and that means that the dollars are moving from the new license line to the subscription line.

They are both licensed revenue, but that is a shift that we are seeing and I think it's a very good shift, but we are seeing an increasing number of customers already on the subscription program that we have.

We do see many large deals that become more and more back-end loaded.

Back-end loaded in the quarter and back-end loaded in the year so we are seeing some deals that are moving into the fourth quarter and that evidence.

And we're also seeing that due to our subscription program, or EBS program, customers are moving, actually all the customers are now on annual contracts and more of these annual contracts tend to close in Q4 than in any other quarter.

Before it was much more uniform across the year.

So I think these are some of the trends that we are seeing.

All-in-all these are generally positive trends.

I think [inaudible], but we do have impact on the seasonality, from the seasonality of the results.

Great.

Thanks for the color.

Thank you.

Our next question is coming from Jonathan Half of UBS.

Thank you.

Good morning.

Can you give us a little more color on your expectations regarding the breakdown of revenues in Q4, and also if you can comment on your expectations for emerging products in Q4 as I think this was the first quarter if a while that they've been flat as a percentage of revenues?

I don't know if we have the breakdown for Q4 for the emerging products.

I think we expect them to continue in the merge and continue to show good results.

Again, I don't know if I can break into that group.

I'm very pleased from the fact that we already in the second quarter we've reached our percentage target for emerging products and I think we still expect them to be around the 30% range.

And as far as product and subscription and service, should we expect a change in the product line?

As far as the percentage of revenues, please.

I think it should be higher, yes, but we do expect, especially because the subscriptions have a more long-term effects.

I mean, yes, we do expect higher, much higher product percentage in the third and fourth quarter.

Thank you and good luck.

Thank you.

Our next question is coming from Gregg Moskowitz of Susquehanna Financial Group.

Okay.

Thank you.

Good morning, or good afternoon, guys.

Starting on deferred revenues, Eyal, you mentioned the seasonality, although deferred, I guess, coming down about 6% is a little bit more than what you typically see in a Q3.

Was there anything notable that drove that, that kind of would be, you know, worth mentioning or nothing really at all?

No, there's nothing exceptional in these numbers and no one big item that does it [inaudible].

The deferred is getting bigger and bigger.

We can expect some of the quarterly changes to move a little more than in the past.

Just to reiterate what I said earlier.

First, I mean, you can see the deferred is there, much higher year-over-year, which is the big evidence for that.

But again, most of our installed base right now is on annual contracts and annual contracts tend to close in the, more in the fourth quarter, in the first quarter and the second quarter and much less in the third quarter.

And I think that's a shift from the pattern we've seen two years ago and a little bit from a year ago.

I think by now the shift may be complete so maybe for next year, we'll be able to better see, predict the seasonality of the sector for Q3.

I don't think it's going to be very different next year.

But I think that's the good news about that.

Now maybe for next year more predictable in terms of annual contracts.

Okay, thanks, Gil.

And then are you still planning on releasing the universal updatability platform before year-end?

And is that going to have any additional charge associated for that capability?

We do have capabilities for universal updatability already in the product and that's one of the fastest growing revenue source.

It appears as part of the subscription line of our results.

We do expense universal updatability [inaudible] to be the focus for next year and not this year.

I think we'll see more and more of those components as part of our products in 2006.

And does the customer have to be on NGX in order to have that feature or service?

It depends.

The SmartDefense subscription is already available in NGN, [inaudible] people are using NGX will feature more and more such capabilities in the product.

Okay.

And then just one final question.

There's been some recent talk about Microsoft and Nokia possibly teaming up on a UTM appliance for the SMB market.

Just wondering if can you give your thoughts there and also whether or not you think Check Point Firewall VPN technology could be component of such a product if it were to come out?

I'm unaware of any of that and obviously can't comment on that.

I do think that we are doing very well in the marketplace, and that I don't see, actually Microsoft as a competitor in the marketplace.

Microsoft has products in our space for the past eight years probably, and we have not seen any emergence of their products as players in our space.

Okay.

That's helpful.

Thanks, Gil.

Thank you.

Our next question is coming from Robert Breza of RBC Capital Markets.

Good morning and good afternoon, everybody.

Gil, or Jerry, I was wondering if you can kind of help me out.

If I'm doing my math correctly and I'm assuming the emerging products group is that 30%, then the flip side to core products is that 70%, and if I'm doing my math correctly, you know, on the contribution to product licenses it looks to me like the core products have been declining year-over-year for the last three quarters, and, you know, I'm just wondering is this the proper way to be looking at it?

Or what's going on in core products?

I mean is SSL VPN taking away some of the IP section?

You know is server consolidation affecting the core products?

Why are we seeing this decline year-over-year?

Let me go back to one thing that Gil said earlier, just to make it clear, that the product side is both new licenses and upgrades, historically.

As we become more and more successful of getting people to go the EBS program that lowers the number of people that are buying upgrades out of the product so we're shifting product revenue and the EBS revenue, which is primarily in the core.

It's the people that have had Firewall VPNs for a long time.

Now that they've gone on an account-based EBS program with annual renewals, they get their upgrades for free.

So the percent of the base that was not on subscription but buying product upgrades showed up in product revenue.

Now it's showing up in EBS.

So that's one of the key shifts that you're seeing, I think.

Again, if you compare it to maybe, let's say [inaudible] more company models.

In [harder] company models, every, if the customer wants to come up to a [inaudible] solution, or a new version, that usually means a new purchase.

In our case, it's all part of the annuity business, which I think is a better business, but I think that might sometimes confuse the comparison.

The other point I would like to highlight on that, while some of the segments that we are seeing growing very nicely or very quickly, especially year-over-year are things like branch office gateways, small office gateways and they're all part of the Firewall VPN business.

So the fact that we are seeing a very nice number of branch office gateways and the year-over-year growth of [inaudible] percentage, but close to 50% year-over-year, for branch office gateway for example, is part of the emerging products.

That's actually very good news.

Is there a way, Eyal, that you can help investors kind of figure out, you know, what Jerry's talking about with this shift?

Can you tell us how the EBS program has been growing over the last, you know, call it three quarters and so we can kind of see that shift?

Or how did that work at least for September to June?

First of all, I think the number are very well communicated.

You can read them.

You want me to read, I can.

But the numbers are in the press release and they have been consistent.

What Jerry said before, I can just repeat and try to help everybody understand this, is that we, some of the upgrades that traditionally, we have seen customers come in every few years, not having current EBS contract and coming every few years and buying an upgrade for a discounted price.

Similar to what we see with the hardware model.

This has been shifting over time to EBS which is for us is a better business model because it's stable, it's renewed every year and it's much easier to predict and to manage with the customer because when they are upgrading year after year, you never know when they are going to come.

So this is a much better model for us.

There's a few million dollars in product revenue that have shifted to EBS over time.

It's not something that happened in one quarterly event, it's been happening over the last, I think, at least six quarters.

Okay.

Thank you.

Thank you.

Our next question is coming from William Becklean of Oppenheimer and Company.

Thank you.

This is Pria Bartsummons in for Bill.

I was wondering if you can tell us what, how much large deals constituted as a percentage of revenues?

I missed that.

Our large orders, we measure orders not deals.

We categorize them orders over 50,000 per order and this quarter, they were about 27% of the business.

Okay.

And do you give a number where you have percentage of revenues from NGX-based products?

No, but it's also very hard to do because every new customer that buys the products now is eligible for an NGX license.

Not all of them use it but a big percentage use it but they're all eligible for NGX license.

Okay.

Thank you.

Thank you.

Our next question is coming from Michael Turits of Prudential Equity.

Hi, guys.

How are you?

A couple of question.

First, for Eyal on the sales and marketing line, it dropped very nice, $4 million, about two percentage points but how did you do that and is that sustainable?

Well, first of all, the third quarter is always a little slower with marketing events.

You know that in the second quarter we had the two large Check Point experience events in Europe and in the U.S.

These are large, expensive and very productive customers and partners events.

They didn't repeat in Q3, we had smaller events in Asia and the marking activity in the summer is slower.

Everybody is on vacation for us.

Our partners with our [core] program, which mixes [inaudible] with our programs, everyone is spending less money.

That's the lion share [inaudible].

You can't expect this to continue.

In Q4 we'll be spending more money on marketing.

To be sure on that.

Okay.

And then technical services has continued to increase as a percentage of revenues.

I know it's a small increase but it's gone up a couple of points over the last year or so, is this any discernible trend?

We hope so.

I mean we are working very hard to strengthen our technical services.

I believe that the fact that we have the EBS also helps because we are coming to the customer once a year with the full proposal as opposed to every product at a different date.

But we are investing a lot in technical services.

In new programs for technical services we hope that in the next two years we're going to be able to grow that significantly as part of our revenues.

And lastly, I know it's always hard to compare different companies and its' not always apples to apples, but Juniper had good sequential growth in their security business in a quarter where it's was a fairly weak quarter for you.

Do you think this is indicative of a market share shift or at least in the quarter?

How should we read this?

I think you already said it, Michael, it's not apples and apples.

And, you know, I won't go into, anecdotally I tell you, we see less and less of them.

I still see a number of competitive wins.

I think what's very confusing for you and the challenge, because I looked at it, but when you start calling, you know, your security business and you have J-series routers as part of your security business, and start to show that as revenue growth, which is not something that was there a year ago, I think it's very confusing because routers are not security products.

So it's become very confusing in looking at networking companies and what they lump together and what they refer to as security.

So I don't think you're talking apples and apples at all.

I'm very happy with the progress that Juniper is making, but I think they have a good reason not to break their security results separately.

Okay.

Thanks very much, guys.

Sure.

Thank you.

Our next question is coming from Vikram Kaura of Unterberg Towbin.

Thanks.

Good morning, everyone.

Just a couple of questions.

Gil, talking about this long-term trend shifting of revenue from license to subscription, do you think that the subscription line will cross the license line, you know, by the end of '06?

I don't know that and I don't have the modeling for all of our plans for next year, so, I mean, it's hard for me to answer that one.

Our focus is to growing every element of the business, not to grow one at the expense of another.

Generally speaking an annuity business and a subscription business, it's a good business and we'd like to see as much as we can on that kind of business, and we also like to see many customers buying new gateways and new emerging products that we sell and so on.

You know, talking about new customers, are there incentives in place to have them buy more subscription content up front?

Suddenly that effort is reflected in your product line with the capabilities like universal upgradability, et cetera, but are you actively going and pushing that part of the business?

It's still, most of our sales today, I mean, are still when you buy a new product, you still buy a new product license and not just a subscription license.

A subscription license is for the upgrades and updates.

We do have, we are very open with customers and they're trying to encourage them to buy the full products and subscription but most customers still prefer to buy a product [inaudible] and a subscription to upgrade it.

And then they get a very good total cost of ownership from Check Point because their investment that they are making today or that they made ten years ago in a Check Point product keeps [inaudible] at the top end of the functionality, for all the set of features and functions and performance that they need.

So I think the combination is very powerful.

One more question.

Jerry, you mentioned, you know, the access of the VPN business growing faster than the market.

Can you give us an idea, you know, what do you think the market is growing as?

I mean, I'm not going to give you a specific number, but I know what our growth rate is, and it's significantly faster than IDC, META, Gartner or any company is claiming they are growing at right now.

Let's put it this way, the market is not doubling or tripling every year.

Okay.

Thanks, guys.

Thank you.

Our next question is coming from Walter Pritchard of SG Cowen.

Just a couple of questions on the guidance.

Eyal, is there any Sourcefire contribution assumed in that Q4 number?

Not yet.

It might be but it's not factored in right now.

The numbers --[overlapping speakers]

As a follow-up to that, it looks at the midpoint of that range you're looking at about a 13% sequential growth rate.

If I go back and look at history here, you guys haven't caught up to 13% sequential growth Q4, I have to go back to 2000 to find the last time that happened.

Are you guys feeling better about macro environment, is it your pipeline or is it just a slight shortfall in Q3 that makes that Q4 number look easier?

First of all, this is 2005 and not 2000.

We don't go back.

We look forward.

We don't look backward.

The numbers are based, as always, very detailed forecast pipeline.

The macro environment, well, the assumption is that it will continue to be the way it works throughout the year.

I mean, we're not betting on the macro environments to change in any direction, we're not exactly.

That's not our profession to forecast micro.

We read the same magazines and the newspapers you guys do.

But it's based on our pipeline and on the forecast of our feel in our channel.

Great.

And then just lastly, a question was asked earlier on sort of this issue between the license and the subscription line.

Just wondering if you could help us sort of figure out if you look forward, you know, when does that get normalized?

Is it with EBS being anniversaried again that you have less license decline at the expense of subscription growth?

I'm just trying to normalize those two factors.

We still don't have 100% of the people on EBS.

There is still product upgrades.

And the more and the bigger installed base, the more people we have on EBS and we also introduce new subscription programs all the time.

I think the nature of the Company is that it's never going to stable, we're always going to introduce new products, new services, new subscriptions and we always going to challenge ourself what we can do more to grow each part of the business and each quarter and each year will see new parts behaving differently.

Thanks a lot, guys.

I think you can see a lot of stability in our EBS the last five years it's growing very consistently.

That's the good news.

Great.

Thanks.

Thank you.

Our next question is coming from Todd Raker of Deutsche Bank.

Hey, guys.

I hate to beat a dead horse here but I think EBS is clearly confusing people.

Can you give us a sense for where penetration stands at the base?

How many people are actually on EBS contracts?

I don't think that we have ever provided that specific number of coverage rates.

It's a pretty high coverage rate, but there's still a way to go, as Jerry mentioned.

And we, I think, we're very proud of our renewal rate.

We, once we land customers on EBS, the renewal rate is extremely high.

We still have pretty nice number of customers.

Mostly the smaller ones that we could penetrate and increase the level of coverage.

It's not the 100%.

It's not [1200]%.

And maybe you guys could give us some insight from an economic perspective, if I'm a new customer, what's the cost to me to become an EBS subscriber versus just remaining on normal upgrade?

There's no, first, most customers do sign up for EBS, there's no good incentive to you to just get the product upgrades every few years.

It's actually a bad proposition.

But EBS, generally the rate is about 15% annually of the list price for the product you purchase, if you're larger account, you get, like, a better rate, but that's generally the rate that you get.

So would you conclude that most of your new customers then are choosing to go EBS automatically?

Yes.

I mean, the places where we found that customers are not EBS is mostly not an economical choice not to do it, it's mostly negligence and things like that with older customers.

It's not generally, I mean, I don't know many customers or any customers that just choose not to get product upgrades.

It was back when we did product-based subscription, Todd, was the primary issue.

The channel likes it.

The channel's very, very good now at including EBS because it's account-based as opposed to individually product-based so.

Okay.

And just to go back to this last question, again, I know it's a tough question to answer.

You said you've seen the shift over the last six quarters, you know, from an apples to apples comparison, when should we start to see this normalize or stabilize, I guess this transition?

I think it's now.

I think it's now.

We pretty much converted the, I mean there's no more product space subscription anymore.

And let's put it this way, Q2 of '04 there was still some.

Q3, and Q4, I think probably are the first two quarters that there's a, but everything is EBS to EBS now.

Were you asking about product upgrades over to the subscription line, Todd?

Yes.

There's still people that are not on subscription or EBS that are still buying product upgrades so that transition is not complete yet.

We'll always have some, but I think that we've gone a long way in shifting the line.

Stabilized, yes, the numbers now are not meaningful.

Okay.

Two separate questions for you.

First, you know, your stock buy back plan, you know, given that your stocks were treated here, can you give us some insight for your appetite?

We probably will continue to do what we have done over the last six or eight quarters.

I don't think that we plan any changes or we review it every quarter internally and with our board.

You can see the behavior judged by that.

Okay.

So I mean, can we read into that, you'll probably move to the higher end of your --

No.

You can't read anything into it.

We'll act, you know, and make decisions as we go along.

Okay.

And question for Gil.

In terms of your strategic direction with the Company, would you ever consider selling Check Point?

I think it's a public company.

We have to consider whatever is right for the interest of our shareholders.

If you're asking me if that's the direction we are taking, absolutely no, I think Check Point can and will remain an independent provider of security.

I think the strategic shift in our marketplace gives us a unique opportunity to be that independent provider of security layer for the network.

There's actually nobody else that's doing this right now.

And personally, of course, I'd like Check Point to be an independent company that's leading the marketplace.

I think that's the direction that we are taking.

Okay.

Thanks, guys.

Thank you.

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

Yes, thanks.

Can you tell if there's any trend yet of NGX actually driving incremental purchases by existing customers?

In other words, are they expanding out the number of their gateways just because of the introduction of NGX?

I think the answer is yes, Sterling, but I don't know if I can quantify that for you yet because we do see some of our big customers both upgrading to NGX and buying additional gateways, as well as winning new customers, brand new customers have never done business with us because of NGX.

I don't think I have the data on insight yet either fully analyzed or anecdotal to fully answer your question.

And then maybe from even a higher level, is there any sense at this point kind of the, you know, the contribution of gateway purchases between new and existing customers?

I don't think we've analyzed it at the moment.

That's the Web trailing edge data that we get through our licensing centers.

We don't have that yet.

Okay.

And then just last question.

What's been the initial reaction from your key channel partners to the Sourcefire acquisition?

Very pleased.

Very, very pleased.

Many of them carry Sourcefire, were going to carry Sourcefire, were looking at Sourcefire as an additional technology to compliment InterSpect and they think this is absolutely fantastic.

We've now made it much easier for them and both with the ability to get both products from us starting next year as well as what we'll probably do long-term in the future with combining these technologies as Gil said, not only into our internal security solutions but across a lot of our other product technologies.

At a reseller level a lot of them are also, you know, [key] ISS resellers.

You've also been a technology partner with ISS for many years.

How do you see that changing going forward?

Well, it changed a long time ago.

I mean, we've evolved in different directions, different ways.

We think we've got the newer, better version of technology to protect companies internal networks.

We have always had the premier perimeter Firewall VPN, and I think, you know, it's becoming clear that we're going to have the same product excellence, product leadership and technology in internal security and intrusion prevention and intrusion protection as we do in Firewall VPN.

And when you look at NGX, if you look at this unified security architecture and you talk to customers and partners, that is very, very, very powerful as to what it does for a customer in deploying and managing their security both from the quality of security as well as the total cost of ownership.

So this is resonating very, very well in the marketplace and people are real excited about NGX and now you start adding all this other technology that we've done with Integrity that we got from Zone Labs and now what we're going to do with Sourcefire, it's a very positive story.

All right, great.

Thank you.

Thank you, Sterling.

Thank you.

Our next question is coming from Kathy Egbert of Jeffries.

Hi, good morning.

I'm wondering as you make this shift to more subscriptions, why you've shown a sequential downtick in deferred revenue and if the answer is that, you know, maintenance is seasonally weak, can you tell us what the offset in the deferred revenue line is for the subscriptions versus the maintenance renewals?

I don't think that they are related.

I think that the decline is deferred, as we said it before, it's purely seasonal and as a lot of the large maintenance or subscription order goes forward for EBS and for support are coming in Q4 and that should make up for the changes.

We've seen it every year, and when we moved to the EBS model, the customers consolidate a number of orders that have been placed throughout the year into one, and a lot of them are shooting for year-end.

I think just maybe to give some number, the software subscription for this quarter because they're annuities an annual annuity for the software subscription contract this quarter compared to a year ago, we are more than 16% higher on just the EBS component our software subscription compared to Q3 a year ago which shows that seasonally we're actually doing okay compared to last year.

Okay.

That's helpful.

And then the operating margin spiked up pretty nicely to 59%.

Was this a function of expense control or is it a better, higher mix of software and what do you think the operating margin can be in Q4?

I think it's mostly running expenses the right way.

We mentioned before there are also some seasonal aspects of marketing expenses but we're not unique in some [inaudible] less marketing expenses [inaudible] and we'll continue to spend them in Q4, you'll see.

I think it's a Check Point efficient culture of using resources to drive revenues.

Any color on the margin for Q4?

It's going to be similar, plus/minus a couple of points to Q3.

I think it depends, again, I think it mostly depends on where revenues are going to come.

Most of our expenses are fixed except maybe for some of the commissions and maybe some of the coop expenses for partner activities are most of the expenses are fixed.

Now if revenue comes up much higher then we're going to see a higher operating margin than this margin.

The question didn't come up so maybe I'm helping someone who's waiting if line, but we have increased the number of our employees this quarter very nicely.

Mostly in R&D and in sales and that will also show up a little bit in the Q4 expenses.

Okay.

That's great.

Thank you.

You're welcome.

Thank you.

Our next question is coming from Horacio Zambrano of Wedbush Morgan.

Thank you, good morning.

A question about you now have released an end point spyware solution and it sounds like the feature set is pretty current with the route capability.

What are you doing on the gateway with spyware today and are you looking to fortify some of your capabilities there going forward?

We have the Check Point express CI with very interesting capabilities for gateway inspection against the different types of spyware.

Even though I think the main issue with spyware is still at the end point because the main thing is things that are allowed to be downloaded not things that are not allowed to be downloaded and how they [behave] from the client.

I don't think with on the client we have today the most advanced capabilities and I think they are different than, and better than everything else that's available in the marketplace because we're the only ones with a, because we're the only ones that have an anti-spyware, it's not just based on signatures but based a lot on behavior at operating system level.

And that's what we call a trickle defense firewall at the end point and that unique technology was met with great enthusiasm with all the PC Magazine and Consumer Magazine.

They picked it up very quickly on the advantage of that so I think that there are some great advantages.

I think we'll have some capabilities in InterSpect and I think we'll have some with the Sourcefire [inaudible] will have catching up for things at the network level, but I still think there's a room for end point solutions there and that's why we invested in the end point area.

You guys, can you comment on how Integrity is doing and if the mix between consumer and enterprise will change from two-thirds consumer, one-third enterprise from last year by the end of the year?

Integrity's doing well.

We definitely have the best solution in the marketplace and looking at very long pipelines which are finally beginning to materialize into orders and sales at a higher pace.

The two-thirds one-third, you probably refer to the zone of businesses, for very a long time is no longer no longer is zone of business.

The Check Point and we have consumer and we have enterprise sales and Integrity is part of our enterprise sales that we're now looking at an internal mix of an acquisition that happened a year and a half ago.

But Integrity is doing well and the end point security section of the market is one with very nice [growth rates].

How much is the total access protection, a leading driver of sales for that and as the market starts to get more crowded with Symantec buying Sygate, Cicso, obviously version [inaudible] McAfee get in the market.

How much of that is driving sales versus just a hook into NGX manageability?

I think there's two things here.

First of these markets are still in the very early stages.

I don't think that the market's right now, it's still a very small market.

I think what you are seeing happening and what you describe in terms of competitive trends is actually pretty interesting.

One company there, Cisco, is promising things and showing road map for things that we're delivering for a year or two years and Symantec, clearly validating the marketplace.

Symantec is obviously the leading vendor for end point solution in general, but their acquisition activity clearly validates the fact that we have the lead here.

So we're all right in what we are announcing that means this market is going to be an important market moving forward.

So far I think still a relatively small market in terms of managed end point security within corporations.

Thank you.

Thank you.

Our next question is coming from Chris Hovis of Morgan Keegan.

Good morning.

Good afternoon, guys.

Hi.

The question for you with regards to how to think about, you know, the potential success of Integrity as I believe, Eyal mentioned, and it's consistent with what we've been hearing.

There's been a high level interest in Integrity and they're starting to see some of that being drained from the pipeline.

But how does that impact the business model?

Is it going to show up more in deferred revenue and subscriptions going forward or product license?

I think it behaves very similar to the rest of the business.

There's a product sale component when you buy a new product and then [inaudible] subscription and annuity for that.

Some people, again, if you look at the end point, some companies are just selling, they don't call it annuity but we sell you a new license every year or every two years which is in effect an annuity business.

But right now I think it's too small to have any effect on the business model but still most customers still look at this as buy a product and they buy subscription every year.

Okay.

And then one question with regards to Sourcefire.

Sourcefire has, my understanding shifted their products typically on a hardware platform.

What are your thoughts about bringing on an appliance as part of your business model or do you plan to partner with [inaudible]?

We trend to keep our partnership focus even though [inaudible] then when we need to sort of jump start the market or provide things that are not available by ours.

We do ship our own appliances that's true for Connectra, for InterSpect, for VPN-1 Edge, for [inaudible].

For [inaudible] and VPN-1 Edge is because of the lack of platforms, at the best price range of the marketplace.

For a Connectra and InterSpect that's because it's a new market but for Connectra InterSpect, that's for Connectra, for example, that's why we also ship a software version, and for InterSpect we also allow and work with other partners to ship the software on their appliances like [Crossbeam] and [inaudible].

So I think the value which that we provide in the software.

Some places we will come up with the hardware to [inaudible] when we believe that's what the customer needs or what the market is missing.

And along those lines do you expect any kind of changes in the type of hardware required for internal IPS deployments?

One of the things we've heard is a lot of companies as that deploy it internally want very high performance and may require networking-type hardware as opposed to off-the-shelf hardware.

That's one requirement that does exist, and I think we will see some evolution there.

You have to keep in mind when people [inaudible] networking-type equipment there's also one big problem in that, but most of what people call today, networking-type equipment in the world is not very flexible platform and one of the strengths of what we do in Check Point is the fact that we have a system that changes that learns and that adapts all the time.

So I think the focus which we have is providing those open systems that can grow very quickly and very, not just in terms of [inaudible] performance but in terms of the functionality they can provide and the level of finalities they can do, and that's pretty hard to do with what people used to call five years ago and actually also stopped doing that asic [inaudible] or networking-type [inaudible] gear and that's one of the big strengths that we have in Check Point.

Having said that, we are working to make sure that we are staying at the top of the line and providing more and more a robust and high performance grade equipment type for internal security deployment.

Thanks.

Thank you.

Our final question is coming from Jeffery Englander from America's Growth Capital.

Good morning, guys, are you?

Fine, thank you.

Can you talk a little bit, Gil and Jerry, about the integration and how smooth you anticipate or difficult you anticipate it will be to integrate the Sourcefire technology into your technology?

I will let Gil take this one.

I think there's going to be, I think every acquisition is a challenging task but I think with Sourcefire we are very, very optimistic on that.

In terms of the people that's a very good match, in terms of technology, it's even a better a match especially because the Sourcefire technology was developed in a very open manner in different compliments.

Some parts of it are open source and are designed to be incorporated in our system.

The other parts that are not open source, that provide a lot of value are based on their technology.

So, it's going, it should be a very smooth ride in that respect, much smoother than most other technology acquisition and that's part of the decision to acquire Sourcefire.

We're not just looking to be a supermarket of a point product but we are looking to providing an integrated architecture and the Sourcefire technology is a perfect match for that architecture.

Any sense in terms of a timeframe as to is that more of an early '06 thing?

Is that later in '06 or is that even an '07 thing?

I think most of it will be '06, some in '07.

I think we'll try to do it sooner rather than later.

But I think so far our focus was on closing the transaction.

I think we're getting the next two months in conjunction with all the regulatory approval to develop the detailed plans and we want to make sure that both organizations stay focused on business and that's why we are not trying to artificially accelerate things and just move with the right pace for both organizations.

One last follow-up.

Just in terms of Asia and Japan, can you talk about actions you may be taking there either in terms of incentives or on the sales front to, you know, rekindle sales and counter what Juniper is doing?

First of all, I'm not sure how well they are doing in the security space in that region, but in terms of our sales force this year we completely restructured the organization that we have and we now have great leaders in the Asia Pacific region of Check Point, one focusing on the North Asia one in South Asia.

In Japan, there's still a way to go, especially because the Japanese culture, implementing changes in Japan is takes a little bit longer than in other places in the world.

Still we have a very, very efficient and very good results in Japan.

So the fact we are saying that we should do and we can do much better in Japan, doesn't mean it would result in good business there, it's actually maybe one of the most productive and most profitable sales organizations for Check Point.

Great.

Thank you very much.

Thank you.

Well, okay.

Thank you all for your questions, for your participation.

If you want to speak to management or to our Investor Relations Department following this call, please call our Investor Relations Department at the Redwood City office at area code 650-628-2050.

Again, area code 650-628-2050.

We will be happy to take your call and call you back and answer.

We'll talk to you on when we will release the results for 2005.

Thank you again and good-bye.

Good-bye, everybody.

Thanks.

Thank you.

This does conclude today's teleconference.

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