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Check Point Software Technologies Ltd. (NASDAQ:CHKP)

Q4 2008 Earnings Call

January 27, 2009 8:30 am ET

Executives

Kip Meintzer - Director of Investor Relations

Gil Shwed - Chairman and CEO

Jerry Ungerman - Vice Chairman

Tal Payne - Chief Financial Officer

Analysts

Robert Breza – RBC Capital Markets

Phil Winslow - Credit Suisse Group

Walter Pritchard – Cowen and Company

Shaul Eyal – Oppenheimer

Daniel Ives - Friedman, Billings, Ramsey

Garrett Bekker – Bank of America Securities

Brian Freed - Morgan Keegan

Katherine Egbert - Jefferies & Co.

Sarah Friar - Goldman Sachs

Todd Raker - Deutsche Bank

Rob Owens - Pacific Crest Investments

Michael Turits - Raymond James

Operator

(Operator Instructions) Welcome to the Check Point Software Technologies Fourth Quarter and Fiscal Year 2008 Financial Results. It is now my pleasure to introduce your host Kip Meintzer, Director, Investor Relations for Check Point Software Technologies.

Kip Meintzer

This is Kip Meintzer, Director of Investor Relations for Check Point Software. On the call with me today are Gil Shwed, Chairman and CEO, Jerry Ungerman, Vice Chairman and Tal Payne, Chief Financial Officer. We'd like to thank all of you for joining us today to discus Check Point’s fourth quarter and fiscal year 2008 results.

As a reminder this call is being webcast live on our website and is being recorded for replay. To access the live webcast and replay information, please visit the company's website at CheckPoint.com. For your convenience, the conference call replay will be available through February 10th. If you'd like to reach us after the call, please contact investor relations at +1-650-628-2050.

Now, before we begin with management's presentation, I’d like to bring the following to your attention. During the course of this call Check Point representatives will make certain forward looking statements. These forward looking statements may include our expectations regarding the announced available for repurchase of our ordinary shares, our beliefs regarding the proposed acquisition of the Security Appliance Business of Nokia including the expected closing date, our expectations regarding our sales pipeline, our expectations regarding the potential impact of market conditions on our business as we move forward and our expectations regarding our business outlook for the first quarter 2009.

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 the purposes of the Safe Harbor provided by the Private Securities Litigation Reform Act. Because these statements pertain to future events they are subject to various risks and uncertainties and actual results could differ materially from Check Point's current expectations and beliefs.

Factors that could cause or contribute to such differences include but are not limited to the risks outlined in the press release that we issued today and the risks discussed in Check Point's annual report on form 20-F for the year ended December 31, 2007, which is on file with the Securities and Exchange Commission. Check Point assumes no obligation to update its forward looking statements.

Now, I would like to turn the call over to Tal Payne, Check Point's Chief Financial Officer.

Tal Payne

I’m happy once again to begin the review of an excellent quarter and what turned out to be an exceptional year for Check Point. We achieved record quarterly and fiscal year results from revenues, non-GAAP net income and non-GAAP EPS perspective. Our results both quarterly and for the full year came in the high end of our projections as we continue to demonstrate solid growth across all regions. We continue to see the adoption of our products from new and existing customers throughout this quarter and the year as customers continue to embrace our unified security architecture and total security solutions.

Before I go further into the numbers let me remind you that our fourth quarter and fiscal year GAAP financial results include equity based compensation expenses according to FAS 123R, expenses relating to our acquisitions including our motivation of intangible and acquired in process R&D, impairments of marketable securities in accordance with FAS 116, and the related tax effects of such items. Keep in mind that the non-GAAP information is presented excluding these items.

In our press release which has been posted on our website we present GAAP and non-GAAP results along with reconciliation tables which highlight this data as well as the reasons for our presentation of non-GAAP information.

Let’s take a look at the financial highlights for the quarter. Fourth quarter revenues were $218 million an increase of 5% compared to $207 million in the fourth quarter 2007 and a 9% sequential increase over the third quarter 2008. From a geographical standpoint our revenue growth was led by our Enterprise business in the America’s as well as an increased demand across the Asia/Pacific region.

Revenue distribution for the quarter was as follows; America’s contributed 43% of the revenue, Europe/Middle East/Africa was 45% and Asia/Pacific/Japan region contributed the remaining 12%. Our product and license revenues were $94 million, the highest quarterly revenues for products and licenses in recent years. This was accomplished while we began shifting more toward subscription based technology programs that deliver recurring revenue. This program includes our smart difference services and our Total Security subscription packages.

Software maintenance service revenues were $124 million in the fourth quarter of 2008 representing 9% growth over the fourth quarter of last year and 5% over the third quarter 2008. GAAP net income for the fourth quarter of 2008 was $86 million, $0.41 per diluted share. Non-GAAP net income for the quarter was $106 million or $0.50 per diluted share. Both came in at the high end of our guidance, primarily as the result of our top line performance and expense control.

From an operating perspective we posted exceptional results. Our non-GAAP operating margin went up to 65% for the quarter an increase from 52% in the comparable quarter last year. It is mainly the result of our expense management coupled with improved strength of the US dollar against other currencies. Bear in mind the currency exchange rates are still below their year ago levels.

Our effective GAAP and non-GAAP income tax rate for the fourth quarter were approximately 18% and 19% respectively. Deferred revenues as of December 31, 2008, were $331 million an increase of $67 million or 21% over December 31, 2007, and an increase of $58 million over the deferred revenues balance as of September 30, 2008. We have maintained our rate of customer renewals at the very high rates for our industry.

For the fourth quarter our DSOs day sales outstanding were 82 days compared to 72 days in the third quarter 2008. The increase is first and foremost the reflection of the strong Q4 bookings which were also back end loaded. An exceptional number of large deals which tend to close at the end of the fourth quarter contributed to the strong quarter but also to the increase in the DSOs.

Our cash and marketable security balance at the end of the quarter increased to $1.444 billion. The credit quality of our portfolio remains high and consistent with our service and investment qualities. During the quarter we recorded a write down of $8.9 million to reflect a charge of other than temporary impairments in accordance with FAS 116. This reflects non-cash adjustments to the current valuation of certain investments. So far all the issuers of the securities included in this group are paying interest on their debt as committed.

During the quarter we purchased approximately 3.4 million shares for a total cost of $67 million as part of our share repurchase program. Moving forward we have approximately $234 million remaining from the $400 million plan approved by the Board in 2008.

Now let’s take a look at our 2008 fiscal year highlights. For the year ended December 31, 2008, revenues were $808 million an increase of 11% compared to $731 million for the year ended December 31, 2007. Our double digit revenue growth for the year is reflective of the continued customer demand for our products despite difficult economic conditions. We believe our success can be attributed to the quality of our products and the mission critical nature of the securities products in general.

GAAP net income for the 2008 was $324 million an increase of 15% compared to $281 million for 2007. Non-GAAP net income was $386 million an increase of 8% compared to $359 million last year. GAAP earnings per diluted share for 2008 was $1.50 an increase of 20% compared to $1.25 last year. Non-GAAP EPS for the year was $1.78 an increase of 12% compared to $1.59 for 2007.

On the operating side this year was an unusual year. The dollar has fluctuated against many other currencies and resulted in a headwind that reduced EPS in the first half of the year while in the second half of the year the trend churn was still below the year ago levels. We also had more appliance in our product mix which increased our cost of goods sold. Despite these challenges we were able to achieve a non-GAAP operating margin of 53% for the year up from 51% of last year. This was the result of our focus on efficiency and productivity but driven mainly by the higher revenues we achieved during the year.

Let’s turn the call over to Jerry for some color on the fourth quarter and the year end.

Jerry Ungerman

Two thousand eight turned out to be quite a year for Check Point from a financial perspective as Tal has explained and I am very proud of too. Now I would like to speak to you a little about what made our impressive financial performance possible. The underlying key to our success has and always will be delivering security products that address the needs of our customers.

What has allowed us to achieve the success to date is our Total Security strategy and our unified security architecture which makes it possible for Check Point to deliver a unified line of security gateways that are designed to address the needs of our customers by providing them with an open choice of software solutions that can be delivered on the customer’s own hardware, a partner’s hardware or as a Check Point appliance.

In addition, we also introduced the industries first virtual environment security gateway this year called the BPN1 Virtual Addition which is designed to address the special security needs of virtual environments. Regardless of the size of the organization we have a unified security gateway to address their network security needs.

In the fourth quarter we announced an agreement to further expand our network security gateway strategy with the proposed acquisition of Nokia’s Enterprise Security Business. As a result, once the acquisition is completed Check Point expects to be able to provide customers with an expanded line of integrated security solutions with a single source for development, delivery, and service for their entire security solution. The acquisition is expected to close in the first quarter of 2009.

We also delivered another industry first during the year with the introduction of Check Point Single Agent for end point security which provides VPN, remote access, NAC or Network Access Control, firewall, program control, media encryption port control and data protection with our industry leading full disc encryption with pre-boot authentication.

The introduction of our Single Agent for end point security provides us with the ability to deliver a comprehensive security solution to our customers that spans the network, end points and even the virtualized environment. These security products are all designed to work in harmony together utilizing our single management console which provides our customers with the ability to manage their complete Check point security infrastructure from a single console.

Our management console has become a compelling aspect of our Total Security strategy as customers look to reduce the complexity and costs of their security infrastructure while maintaining the highest levels of security.

Throughout the year we have continued to expand our partner ecosystem as we have continued to develop relationships with partners worldwide to enjoy the benefits of selling our expanded security portfolio. To date we are encouraged by the results of our efforts worldwide but especially in the emerging markets of Asia/Pacific, Latin America, Eastern Europe and the Middle East where we experienced double digit revenue growth for the year.

During the quarter we saw an increase in the percentage of larger deals which was reflective of the trend for the whole year. This is the result of many of our larger established customers standardizing on Check Point security products as well as larger customer we have acquired to competitive wins. As such, transactions greater than $50,000 accounted for 56% of total order value compared to 46% a year ago. During the quarter there were 22 customers that each had transactions that valued greater than $1 million coming from both network and end point security products.

In conclusion, I would like to highlight one interesting item. This is Gil’s fiftieth earnings announcement with Check Point and I hope you will all join me in congratulating him on this milestone. With that I will turn the call over to Gil.

Gil Shwed

I really hope that we can generate as much success in the coming quarters. As for 2008 first it’s nice to have record results $0.50 per share for our 50th earnings announcement and in general you can see that our financial performance for 2008 turned out to be quite exceptional by our standards.

When we look to 2009 we expect to have a busy and productive year. However, we can’t be more afraid of the economy and the potential affect it may have on us. Therefore, we need to be careful when trying to plan and forecast 2009. This also means the level of economics forecast that we will make will be rather high.

Having said that I believe that Check Point is well positioned as we enter this new year and we have what we believe is very strong technology roadmap and we expect to make some important announcements regarding innovation in our core software. We’re expending our appliance product line new modem and expect to expedite significantly with the addition of Nokia Security Appliance Business when we close the acquisition. We also expect to release more products in more security areas during the year.

All of these activities should contribute to the success of Check Point and have a long term affect on our performance and are also well balanced between things like appliance announcement that can have immediate impact on results to more innovation.

Keeping in mind though that in a period like 2009 it will be hard to know what will impact the business more; our execution and technology or the economy. This brings me to the financial outlook part for 2009. As we look to 2009 clearly we are well positioned from a product standpoint as well as from an operations perspective. This unique position should allow us to emerge from the current economic uncertainty in an even better position than we entered it.

While we also continue have healthy pipeline and forecast for the first quarter but with a change that our business is about to go through upon the completion of the Nokia acquisition combined with the uncertainty of the economy could be premature to make revenues for the entire year so I’ll focus right now on the first quarter.

For the first quarter we expect revenues to be in the range of $190 to $208 million and non-GAAP EPS to be in the range of $0.40 to $0.46 per share.

Now let’s open the call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Robert Breza – RBC Capital Markets

Robert Breza – RBC Capital Markets

I was wondering if you could give us a little bit of color around the Nokia acquisition specifically if you could drill into what your plans around headcount, do you anticipate bringing all those people over? Then maybe talk a little bit about how you’re going to structure the sales force going forward?

Gil Shwed

First we’re just starting now to have the plan for the acquisition of Nokia. When we announced the deal about a month ago our focus was on closing the year. Now as we enter into January we are just now developing the plan, we haven’t finalized anything. To give you a little bit of background, the Nokia Security Appliance Business has today about 450 employees and some more contractors. The combination of contractors and outsourcing we do expect the vast majority of people to join Check Point but we now are planning and seeing exactly which functions we need, what stays and what goes. That’s the general plan.

We also expect to sell all the Nokia Appliance lines to keep sales up to produce all the product lines that we have either good product lines and Nokia today is a very up to date appliance line op and most of that are being sold today are relatively new mobiles that are on the latest versions in terms of processors and performance legs. The near term customers can expect full availability support for all the products, that’s in the near term, also in the long term.

Moving forward what we will do between 2010 and 2011 is every time you release a new appliance model keep in mind that as you look at all the Check Point product lines it is also brand new to us, all the models that we have right now were now in 2008 they are all the latest chip set and latest technologies on them and available performance.

In the short term we expect to be in full speed ahead we are delivering all these product, as we move forward every time we will refresh or come up with a new model to complement the lineup of products, hopefully with unified products because moving forward the expectation for everyone is that we will have a single product line from Check Point.

Robert Breza – RBC Capital Markets

Is it safe to assume or consistent with your prior comments that you expect the acquisition to be accretive upon closing?

Gil Shwed

We expect the acquisition to be accretive. There are some accretive this year and accretive. There are a few accounting issues and so especially within the non-GAAP basis. There are a few accounting issues that might for example depending on the timing of the closing they may not be accretive the first month, maybe not the first quarter that depends how much the deferred revenues we will be able to recognize. Overall the expectation is that the deal would be completely accretive to us in 2009.

Operator

Your next question comes from Phil Winslow - Credit Suisse Group

Phil Winslow - Credit Suisse Group

When you do look at the Nokia business it’s obviously very hardware weighted. I wonder if you could give us a sense for the gross margins obviously there’s also the larger current component. Then also when you think about operating margins for Check Point are really more operating expenses when you think about 2009. How should we expect operating expense trends ex the additional headcount from Nokia?

Gil Shwed

It’s actually a pretty good opportunity for us. I think we will have some work in the opportunity to be more effective and more efficient on producing appliances. You can see based on our experience in Check Point we’ve been asked that question many times and now that we’re shipping more appliances would that hurt your operating margin and you can see that we finished 2008 with better operating margins than we had in 2007 and the same thing for the fourth quarter 55% compared to 53% operating margins for the quarter and 53% for the year compared to 51%.

You can even see the more we sell appliances so far our margins keep growing and not shrinking. That’s not just because appliances but that’s because of many other things we do in the business. Its just an indication that, I don’t forego the crazy impression that our margins will keep growing but it clearly shows that there is not necessarily a link between the amount of the appliances to the overall margins and to our focus is on growing the top line and bottom line not about managing what’s already the industry best operating margin of any company.

Nokia is quite interesting for us especially in the uncertainty with an economy like this when we entered 2009 and Nokia provides us with a very good addition to our team. In this environment it will be hard to justify for example hiring another 150 or 200 people in our field operations. With the acquisition of Nokia on one hand we don’t need to make this big investment in uncertain economy. On the other hand we do get 200 people that will join our field organization worldwide roughly 200 people that already know our business, know all our customers, know all our partners and bring with them positive results.

This is actually going to be a good thing for us in terms of growing the business. Obviously in the first year it will have impact on the operating margins especially if we want to be able to recognize the entire business that we get from Nokia and especially the deferred revenue from that. It will have an impact on the operating margin. It should be for the year positive on the bottom line and positive on the other parameters.

Operator

Your next question comes from Walter Pritchard – Cowen and Company

Walter Pritchard – Cowen and Company

Around the channel programs I know Nokia had their distinct channel program, is it stay in your lanes just keep the existing channel program going with Nokia or any detail around that would be helpful.

Jerry Ungerman

Not yet, we’re working on all that. There’s a lot more similarities than are differences. As Gil said the great thing about this is we’re getting some very experienced people with existing partners, with existing customers, they know our software, we know their hardware, and they know ours. It’s very synergistic in what we’re doing and we all work through the same partners out there. They have relationships with them.

We’ll continue to work in the best of the both and I think everybody is very pleased with it right now. They’re very excited about it and anxious to close it. I’m optimistic that it will continue to flow the way it has been.

Walter Pritchard – Cowen and Company

On operating expenses you made the comment around currency which is a bit complicated. If you could simplify down and tell us what the impact was on operating expenses for the entire year in ’08 if the currency were the same as ’07. Also what the impact was in Q4 if the currency was the same as what it was in December ’07 quarter.

Tal Payne

In the fourth quarter the effect was around $0.01 and $0.02. For the entire year is a negative $0.02.

Gil Shwed

Overall for the year just to give you our expenses are higher by roughly $20 million if you use the same currency exchange that was in 2007.

Operator

Your next question comes from Shaul Eyal – Oppenheimer

Shaul Eyal – Oppenheimer

I keep asking this question every time you make an acquisition; I asked you last time on Pointsec. Already with a number of acquisitions under your belt and obviously with Pointsec being an entry caught into a new domain what is it that compares and contrasts about the Nokia and probably the Pointsec acquisition. What are you taking with you on the good side from Pointsec and importing into Nokia and what are the points that need to be improved having Pointsec already close to two years with you guys.

Gil Shwed

I think we learned a lot and we are learning all the time about how to make a better acquisition. Nokia and Pointsec are very different. Pointsec was entering a new domain for us and that was a very important and I think still very important and still one of the most promising sectors that will be in complementing our end point security offering and extending the end point security.

Nokia on the other hand plays directly into or core market and we already have pretty sizeable appliance business so it’s not even shifting the business it’s more augmenting it. Keep in mind that Nokia sells 100% to the same channel that we sell to 100% to the same customers and 100% the same products that we already have in our lineup.

That’s quite different in what it does and again each one of them has different qualities. Each one of them represents a different potential and a different quality to the business. One thing we learn in every acquisition that some things move faster and make more changes more quickly. I think with Pointsec we were pretty good about that and we made a lot integrated the business into Check Point right away. With Nokia we hope to be even faster around that.

The major lessons which we’ve learned, we will need to be very sensitive to the channel needs and to the customer needs. We know all of that and we’ll keep that in our mind. Overall the feedback which we got from customers and partners is 100% positive on the Nokia acquisition I think we should be very positive as we move forward.

Shaul Eyal – Oppenheimer

Do you think you’re going to be in a position post the acquisition assuming it closes within the next eight weeks or so to provide annual guidance?

Gil Shwed

I hope so. I hope that once we get into March or April we will be able to provide to better share our plans for the year. We’ll see based on that, based on the economy. There’s a lot of moving parts. We’re all very concerned about the economy and I think for good reason. So far what we’ve seen the world continues to revolve and our business was pretty good. I don’t want to sound like I know something which you don’t know about the business or about the economy.

Actually the main thing that may worry me about that is that so far inside Check Point our forecasts are positive, our customer reactions are positive so we actually don’t see big warnings signs about the economy that actually what makes us a little bit more concerned. People that have today plans that are different based on the forecast from the field we will share them right away. You can see that our forecast right now is very consistent with what you knew before. Inside Check Point there are no major changes because of what we’ve seen so far.

Operator

Your next question comes from Daniel Ives - Friedman, Billings, Ramsey

Daniel Ives - Friedman, Billings, Ramsey

On the appliance upgrades where do you think you guys are in terms of penetrating the install base on the appliance side?

Gil Shwed

Very low. I don’t have the exact number but we sold in the past year in terms of enterprise appliances the big appliances not the small ones well over 10,000 appliances. This is quite impressive number for the first two years that we’re in this business. To give an estimate our high end software license business includes today close to half a million gateways. If you just look at Nokia, Nokia shipped today 220,000 appliances most of them are enterprise and high end appliances.

If we look at renewal cycle says that every four years the trend is from three years to five years renewal cycle you can clearly see that the potential is probably between five to ten fold what we’ve done. That means that we are relatively in an early position in the cycle of appliances.

Operator

Your next question comes from Garrett Bekker – Bank of America Securities

Garrett Bekker – Bank of America Securities

Could you walk us through the guidance a little bit? I know its early in Q1 but maybe you could just give us some color on the assumptions either in terms of vertical contributions or geographic contributions and also maybe how you’re looking at your pipeline and close rates as you set your guidance for Q1.

Gil Shwed

I don’t think there is too much difference. Our sales organizations all over the world continue to have positive plans for the year. Actually we just met with them the last two weeks. We had our sales kickoff meeting last week for Europe and Asia and two weeks ago we had a sales kickoff for the US. Very surprisingly or not surprisingly because we had good results. I never met a sales force that was so optimistic and energetic and positive and all the sales kickoff in my history in Check Point.

Even the service that we did for the sales force shows that they material they see what they have on hand to sell at the highest level for many years. On one hand we have on one side sales force that is very positive and generated good results. On the other hand we have an economy with a lot of uncertainty. Some people will say that just a lot of security and people will buy more security.

At the same time if you know the environment better than I do but we also know that some companies may have new budgets for 2009 and 2008 their operating on another budget. Some companies are using this economy to save costs which is also very natural. We have to sensitive to that and we can’t ignore that. We are planning for an organic growth in terms of quarters and the sales plans that we have.

In terms of operating expenses we think that we can achieve some savings next year. At the same time we do want to recruit few new positions to essential areas. Because of the Nokia acquisition I believe that most of the new hires that we will need to do will actually come from Nokia. As I said before the Nokia acquisition whether we need to recruit 30 people or 80 people to our sales force worldwide now if we get between 150 to 200 people from Nokia they will fill most of these positions except maybe in places that are really, really unique and exceptional.

This is kind of some of the thinking that we have around that.

Tal Payne

The way we provide the forecasting or the guidance is based on the same way that we always did which is coming from the bottom up from the field and being judged throughout the management channel. The reason why we provide the wider range is to reiterate the gap that can be between the high end and the low end depending on macro economic that we can’t foresee at this point.

Gil Shwed

Maybe I’ll share one division of the last quarter. Every quarter in every technology business and every software business, the business tends to be very low even more very low. Every quarter towards the end of the quarter we become more and more nervous and every quarter so far you can look at our history for 50 quarters we had excellent quarters and almost all the quarters we finished after making the plan and so on.

Every quarter we get a few calls at the end even though we go back to the field and we check the forecasts and so on and so forth. Every quarter we have some regions or some deals that fall through. Even though up to like December 31st were in the pipeline the falling the last date.

This quarter was even more back end loaded. On December 31st were very nervous about especially with the economy, especially with being so much back end loaded. We waited to see which deals would fall and which regions will have surprises. Interestingly enough we didn’t have many this quarter. We actually don’t think that we had any. All the forecasts that we had for all regions were met. All the large builds that should have come came. We actually had pretty good execution as we closed that quarter.

Fifty quarters as a public company and doing that for 50 quarters I know that what happened last quarter may not be negative of what happened last quarter. I just want to be clear but the uncertainty built into where we are today in the world it’s not built into we see in Check Point. Closing Q4 which was again back end loaded, the strongest quarter, the quarter all the things that should make it risky was the smoothest end quarter close that I remember for the past few years.

That kind of contradicts with everything else that we’re seeing in the economy but that was a reality. Just to give you some light on what I’ve seen.

Operator

Your next question comes from Brian Freed - Morgan Keegan

Brian Freed - Morgan Keegan

You guys have $1.44 billion in cash; do you guys plan on accelerating the stock repurchase or potentially using your cash for something else?

Gil Shwed

I don’t think that we know at this point. Right now we still have a lot of money in our share buyback program. We haven’t decided on growing or shrinking at this point. At this point I think we are well balanced. On one hand I think we’ll deliver in our future and it’s a good opportunity to use the cash in buyback.

On the other hand there are more opportunities to acquired businesses in the market and we believe even more opportunities moving forward so we may want to preserve the cash for other types of extensions that would more meaningful. At this point we’re operating conservative. We’ll keep the buyback program but we’re not going to make significant policy changes at this point. Every few quarters the Board, we review the plan and revise it. This quarter we haven’t done any revision so far.

Operator

Your next question comes from Katherine Egbert - Jefferies & Co.

Katherine Egbert - Jefferies & Co.

For those of us that follow the company for a while you’re pattern of M&A over the last few years has helped you quite a bit but was a big break from what you’d done in the past. Going forward will Check Point become a company, a serial acquirer, will you make an acquisition once a year of size?

Gil Shwed

The short answer is yes. The long answer is I don’t know. Our plan is to grow and part of growth is through acquisitions. We started to learn how to do it and we’ve very focused on that. The long answer, the main focus of what we have is going what we’re doing for healthy way in the right strategic way complementing our vision and not do acquisitions for the sake of acquisitions or for the sake of making up numbers.

The sake of the acquisition is how it would fit our strategy, the right price to it and really mixed with our customers and partners. These are not easy qualities to find because we are serving a very, very large community of customers of all sizes and all types. It’s really not hard to find technology products that appeal to such broad markets to niche companies that serve very small segments. That’s the main difficulty in finding these extending areas and the extending products.

In the last two years we were able to find one every year Pointsec and Nokia. I hope that we will have more of these.

Operator

Your next question comes from Sarah Friar - Goldman Sachs

Sarah Friar - Goldman Sachs

With your many years of experience I’d like to get a little perspective from you on the current environment. Clearly when we went through the last downturn security was the massive out performer but it was also a very under penetrated base in a way. This time around I’d love to understand your sense is there still enough under penetration to keep the industry relatively healthy in a downturn? What are you hearing when you go out to customers in terms of their needs to still keep upgrading their security architectures?

Gil Shwed

Generally I wouldn’t call the security industry at this point under penetrated. I hope that it is but there’s no indication that I’m guessing. What I do feel that people do need security and it’s critical. People don’t take out a security product for cost savings or for anything. Secure network gateways, slow you upgraded because keeping up the network for slaying and running is much more important than the cost between them.

Secondly, and that’s how you relate to your comments about penetration. Security IT budgets are still very, very small compared to the other IT budgets. That’s not necessarily good news for us because we would like to see the budgets grow. The good news from the standpoint that we have a lot of room for growth. We are not a big portion of any companies IT budgets and therefore we are not the first in line to be cut. We are and companies can justify growing the investment for something that’s on one hand a difficult infrastructure and on the other hand is a lot less expensive overall.

Check Point unique value proposition is that we will provide in the next few years customers with the ability to consolidate multiple purchases with us and achieve both operational and also purchasing savings in a pretty big way, the way we will do this, that’s one thing important to our line. Keeping in mind that because we are providing critical infrastructure product cycle refresh.

I don’t think it’s a one time product cycle like 2008 or 2009 is a one time product refresh cycle but an ongoing refresh cycle and especially now with us doing more and more client sales we will take a much bigger piece of that refresh cycle which in the last five years we were a very small portion and represented a big part of specifically the firewall VPN markets. These are all the elements that should help us in the future.

Jerry Ungerman

I don’t fully relate to the penetration comment. As both in an absolute sense as well as relative. Relative to the threats today, relative to the environment people are in, relative to the use of the internet. It’s so much greater today and dependent on it then it was back then. People need to keep on adding new items, that why we bring out new technology, new functions, new features, new capabilities to protect them in 2009 that they weren’t worried about in 2003 or 2004.

There is need for this new product, this new capability that we’re bringing to market through our Total Security strategy and the Unified Security architecture we have. I think we’re really well positioned. One of the reasons we did so well in the fourth quarter as we said is because we’re doing very well against competition. We’re getting a lot of competitive lens, displacing product, the single management console, the costs; the effectiveness of broad product lines at Check Point is very compelling.

It doesn’t mean we’re going to be immune from anything or impacted by it. That’s the unknown and that’s what Gil mentioned. Our sales people right now see a strong pipeline, a lot of activity, a strong forecast. Will that materialize because the economic crisis, we don’t know which is why there’s reason for caution there. We are very optimistic about where we stand and what the customer is doing and what the customers need.

Sarah Friar - Goldman Sachs

Could you give us any sense for the full year fiscal ’09 of where the tax rate should go because I know it jumps around a little, is 19% a good rate to think about?

Tal Payne

I don’t see any reason at this point to change it from this rate.

Operator

Your next question comes from Todd Raker - Deutsche Bank

Todd Raker - Deutsche Bank

Can you address the competitive landscape? Your growth profiles have been very nice here. How much of this is competitive share gain versus organic market growth and how do you see the lens changing here as you guys buy the Nokia Appliance side?

Gil Shwed

So far well balanced. We had few competitive wins and competitive replacements. We obligations to existing customers, we have extension to existing customers and we even refer cycle to existing customers. I don’t know to quantify exactly but overall in the business I think it’s very well balanced between all the three factors.

Operator

Your next question comes from Rob Owens - Pacific Crest Investments

Rob Owens - Pacific Crest Investments

Realizing that you no longer break out appliances as a percentage of license sales, could you give us any color in terms of what that did either sequentially or year over year? Are you still seeing that trend increasing?

Tal Payne

For the annual the appliance portion of the product was 37% which is an increase from the 22% that we saw last year. Pretty much almost double this year.

Rob Owens - Pacific Crest Investments

On the deferred revenue with all the strength sequentially was there much unshipped product in there or is that largely maintenance?

Tal Payne

The majority is deferred revenues relating to the services. We’re starting to see some increase in the portion of the long term content.

Gil Shwed

One thing to remember when we are taking about deferred revenues most of it is support and subscription software update models. We have an ever growing part of what we call all in services or software services. We have smart defense service that’s pretty sizeable today. It’s about $65 million a year like software; security updates on demand business which we intend to grow further. We started offering some; we have a top end security package with smart of class and best provider. Many other types of security objects to customers which we are promoting more and more.

We started offering customers last year the ability to view our products on a pay per month type which generate a couple million dollars for us. You haven’t seen that in the financial results because we actually even in the deferred revenues the last portion. That’s something that we just look at it on a month by month basis. We have 36 months contract, three year contract for $0.5 million what you see is $10,000 to $15,000 every month or $60,000 every quarter which is not huge on a quarterly basis but if you look at the overall cost structure that it would have been $0.5 million, we had a few of those.

We are moving more and more and we will keep doing that smoothly not in a disruptive way to business to move customers to a unique base model. I think its good for us, its good for customers and we are trying to build this business model as the business moves forward.

Operator

Your last question comes from Michael Turits - Raymond James

Michael Turits - Raymond James

Is there any contribution to revenues or to expenses from Nokia in your first quarter guidance?

Gil Shwed

No. We may find ourselves with some; probably not very big but right now in the guidance we haven’t included anything.

Michael Turits - Raymond James

You’ve done a great job with getting very attractive margins out of your own appliance business. Can you contrast at all what as you pick up the Nokia business what the gross margins and the operating margins are each like on the Nokia business as compared to what you’re getting right now in your own appliance business?

Gil Shwed

I don’t think that we can share much especially because Nokia doesn’t want us to release any numbers. I can share the very general sense that the Nokia business today the way it operates is a healthy profitable business more than even we thought before we moved to with it. It doesn’t have the Check Point margin it has much lower margins. The opportunities that we will have, on the one hand they have potential, the other hand start to move that business to our standards and lever some of the things that we are doing and driving more margins out of it.

In the short term let’s keep in mind that because of some of the transitions it will have a big pressure on that business margin in the beginning. Longer term it should, there’s no reason that the Nokia business should not move to something close to the Check Point business. The underlying architecture, the underlying software and other architecture is very, very similar. There’s no reason there should be a big difference between these two businesses, a few years down the line.

Michael Turits - Raymond James

Can you give us a rough sense, do you think the operating margins are something you could double or raise by 50% there?

Gil Shwed

I think we can improve significantly. You won’t see overnight. Because it’s a good business I would just say that. If it was the best business it was a very easy decision to cut sell backs or cut product lines. Because it’s a very good business the customers actually love these products and they’re high quality products you’re not going to make big disruptive changes overnight with regard to slowly make it more efficient, more effective.

With new appliance models that we will roll on in 2010 to 2011 maybe some even in 2009 these appliances will already be unified having the best technologies and the best innovation from Nokia and Check Point and hopefully having the cost structure of Check Point than of Nokia.

Operator

This does conclude the Q&A session. I’d like to turn the floor back over to management for any closing comments.

Kip Meintzer

I’d like to thank you guys for attending the call. The sell side folks that would like a call back or buy side just pop me an email and we will catch up. Thank you guys and we’ll be talking to you soon. Have a great day.

Operator

This does conclude today’s teleconference. You may disconnect your lines at this time and we thank you for your participation.

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Source: Check Point Software Technologies Ltd. Q4 2008 Earnings Call Transcript
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