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Check Point Software Technologies Ltd (NASDAQ:CHKP)

Q1 2007 Earnings Call

April 26, 2007 8:30 am ET

Executives

Anne Marie McCauley - Director, IR

Eyal Desheh - EVP and CFO

Jerry Ungerman - Vice Chairman

Gil Shwed - Chairman and CEO

Analysts

Sarah Friar - Goldman Sachs

Robert Breza - RBC Capital Markets

John Walsh - Citigroup

Sterling Auty - J.P. Morgan

Walter Pritchard - Cowen & Company

Todd Raker - Deutsche Bank

Roni Biron - ING

Ed Maguire - Merrill Lynch

Shaul Eyal - CIBC World Markets

Dino Diana - UBS

Katherine Egbert - Jefferies & Company

Phil Winslow - Credit Suisse

Ehud Eisenstein - Oscar Gruss

Israel Hernandez - Lehman Brothers

Presentation

Operator

Good morning. My name is Shauna, and I will be your conference operator today. At this time, I would like to welcome everyone to the Check Point Software Q1 2007 Earnings Call. (Operator Instructions). Thank you.

It is now my pleasure to turn the floor over to your host, Ms. Anne Marie McCauley. Ma'am you may begin your conference.

Anne Marie McCauley

Thank you, Shauna. 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 first quarter results.

As a reminder, this call is being webcast live from our website and is being recorded. To access the live webcast and replay information, please visit the company's website at www.checkpoint.com/ir. The replay will be available through May 10. If you would like to reach us after the call, please contact the Investor Relations department at 650-628-2050.

On the call with me today is Gil Shwed, Chairman and CEO; Jerry Ungerman, 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. Forward-looking statements include statements regarding Check Point's expectations regarding our financial performance and growth for 2007, our beliefs regarding the integration of Point Tech and NFR into Check Point, and the integration of their products and technologies into Check Point's products, and our belief that our performance, execution and robust portfolio of existing and new products positions us well for future growth in 2007.

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 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 belief.

Factors that could cause or contribute to such differences include, but are not limited to, the risks discussed in Check Point's Annual Report on Form 20-F for the year ended December 31, 2006 which is on file with the Securities and Exchange Commission. Check Point assumes no obligation to update information concerning its expectations.

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

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Eyal Desheh

Well thank you very much, Anne Marie. Good morning and afternoon, everyone. I would like to share with you our good first quarter results, provide details on the financials, and offer a brief update on our recent acquisition integration efforts.

Our first quarter results were fueled by healthy business performance and marched a good start to 2007. We have put in place many new initiatives over the past year, including both the internal development of products and services as well as acquisitions. And these investments are providing initial results as evidenced by our first quarter financial performance, and we expect this trend to continue in 2007.

Before I dig into the numbers, let me remind you that our first quarter GAAP financial results include an in-process R&D charge related to the acquisition of Protect Data, the impact of SFAS 123R, the inclusion of equity-based compensation expenses in the P&L, and acquisition related expenses for Protect Data and NFR which we include for the first time in Q1, as well as, for Zone Labs which was included in the past.

In our press release, which has been posted on our website, we are presenting GAAP and non-GAAP results and reconciliation tables which highlight this data. Now, let me share with you the financial highlights for the first quarter of 2007.

Revenues for the first quarter were $164 million compared to $134 million in the first quarter of 2006, an increase of 23%. This, by the way, was our highest reported quarterly revenues ever.

Our network security business contributed $146.5 million to revenue, an increase of 10% compared to the first quarter of 2006. Our data security business, which includes business generated by our Pointsec product line, since January 18, contributed $17.5 million to revenues in Q1. Keep in mind that the reported data security revenues would have been higher without a purchase accounting treatment. As such, the comparative growth for the data security business would have been greater than 60% year-over-year without the acquisition fee impact

GAAP net income for the first quarter of 2007 was $47 million compared to $62 million in the first quarter of 2006. The primary difference in GAAP net income in the first quarter of 2007 compared to the first quarter of 2006 is an acquisition related in-process R&D charge in the amount of $17 million for Protect Data and inclusion of acquisition related amortization in the net amount of $5.4 million resulting from the acquisition of Protect Data and NFR.

Total gross amortization amount for the quarter was $9 million. Most of this amount is included in GAAP cost of sales line. Net income in the first quarter of 2007 also includes equity-based compensation expenses pursuant to SFAS 123R of $8.3 million. Non-GAAP net income, excluding acquisition related and equity-based compensation charges, was $79 million, an increase of 5% compared to the first quarter of 2006.

Total GAAP operating expenses for Q1 were $119 million, excluding equity-based compensation and acquisition related charges of $34 million, operating expenses were $85 million compared to $59 million in Q1 last year, and $69 million in Q4 last year. This amount includes $15 million of expenses related to Pointsec, and $1.5 million of expenses related to NFR, so expense level without the acquisition was similar to Q4 2006. The increase in expenses is a result of important headcount growth. Specifically, we added 246 Pointsec employees during Q1. Our total headcount at the end of the quarter was approximately 1,860 employees.

Our effective income tax rate was approximately 19%, on a non-GAAP basis the tax rate was 15%. GAAP earnings per diluted share for the first quarter of 2007 were $0.21 compared to $0.25 last year. These GAAP earnings include acquisition related in-process R&D charge of $0.07, equity compensation expenses pursuant to SFAS 123R of $0.04 and other acquisition related expenses of $0.03. And finally, non-GAAP EPS for the first quarter of 2007, excluding acquisition related and equity-based compensation charges were $0.35 compared to $0.31 last year this is an increase of 13%.

Deferred revenues this quarter were $238 million at the end of the quarter, an increase of $34 million or 17% of in Q4, 2006 and an increase of $60 million or 33% over Q1 2006. With the consolidation of Protect Data, pursuant to its acquisition in January, we added approximately $13.3 million to our Q1 deferred revenues. In addition to data security business, strong software subscription, CES, SmartDefense and consumer business all contributed to an unparallel growth in deferred revenues for the first quarter of 2007.

For the first quarter, our Days Sales Outstanding, the DSO were 66 days compared to 61 days in Q1 last year, as our business continues to be back-end loaded. Cash collection continued to be good. In the first quarter, we generated cash flow from operation of $110 million. Our cash and investment balance at the end of the quarter was $1.1 billion. Please keep in mind that we paid over $600 million in cash for Protect Data shares and continued to buy back our shares for $56 million, which were 2.3 million shares that we purchased during the quarter.

The acquisition of Protect Data has a significant impact on our balance sheet. Total purchase price was $615 million. As a result of the acquisition, we recorded $177 million of amortized intangible assets and $421 million in goodwill.

In addition, $17 million of in-process R&D was written-off this quarter. We also recorded deferred tax liability at the amount of $53 million, resulting from this acquisition. This amount is also included in the balance sheet goodwill.

Our first quarter revenues again were well diversified with Americas contributing 44% of revenues, EMEA contributing 45% and Asia Pacific and Japan region contributing 11%.

As you can see, Europe has a particularly strong contribution this quarter and Jerry, will address geographic business in more detail. During the quarter, we successfully integrated NFR Security and its intrusion prevention technologies into Check Point. IPS-1 is now part of Check Point product family and our unified security architecture. We have successfully integrated NFR's product, services and employees into the company, and we are leveraging the new technologies to offer customers and partners, the opportunity to further enhance Check Point's NGX, Unified Security Architecture, and strengthen network defenses for enterprises world wide.

On January 17, we completed the tender offer acquisition of Protect Data, the owner of Pointsec. We now own 98.6% of the shares, and expect to purchase the remaining 1.4% within three to six-months.

The addition of Pointsec solution to Check Point product portfolio marks the first significant step into data security market. We've made meaningful step towards completing the integration between Pointsec and Check Point. The major goal of the integration plan is to make Pointsec an integral part of Check Point, and not to separate business unit.

Starting in April Pointsec sales forces is integrated into the Check Point region, and we have a unified sales force with data security experts in most location. Pointsec’s management has been playing an important role in contributing to this process as well as the Check Point overall business. Several members of Pointsec management have also assumed corporate roles within Check Point.

In summary, we are pleased with the financial results we posted this quarter. We believe that our performance and execution have improved, and that the robust portfolio of existing and new products we have accumulated, position us well for further growth in 2007.

I will now let Jerry and Gil, speak more about our business and our plans. Jerry, please go ahead.

Jerry Ungerman

Thank you, Eyal, and hello everyone. I appreciate you being on the call today, and for your interest in Check Point. Eyal has provided some additional inside into our financial performance, and therefore I will spend my time focusing on some of our key business activities this past quarter.

On our last earnings call and during the Investor Day earlier this quarter, we mentioned that the first quarter was going to be a very busy one for us with the launch of new products, as well as the introduction of recently acquired products into our channel and our field organization.

Well, all of these actions have transpired and our first quarter results provided an initial indication of the success of our efforts. Let me take a minute to highlight some of the first quarter initiatives.

I think one of the most important elements is the continuation of our strategic initiative to broaden our solution set inline with our customer's input as to what they need; and from the type of vendor they want to provide them their security solutions.

You can see from the financial results today, that we are now providing solutions across two key security segments; network security and data security; yet within our unified security architecture.

This is a powerful and currently unique combination of solutions that address our customer needs in a meaningful fashion. Our customers tell us that they want a comprehensive set of security solutions that will be managed by a single security council and from a company surely focused on security.

This point is made time and time again on meetings we have with our customers all over the world. While they want a more secure operating system, and their routers and switches to be more secure; they say they also need an independent layer of security that ensures the entire enterprise is protected. And they want it from a company focused on security, a company like Check Point.

On February 6, we launched Check Point's UTM-1 security appliances to address the mid-market. A powerful new line of Unified Threat Management Appliances with multi-layer protection against internet threat and based upon our proven enterprise security expertise and our vision as a Unified Security Architecture for businesses.

The appliances are easily deployed and include built-in security management capability. We conducted close to 100 sales seminars worldwide for our partners and customers during the quarter, and we are very pleased with the feedback we have received in the short period of time the appliances have been available.

We also launched NGX R65, the newest version of our core network security technology, which extends the Unified Security Architecture with enhanced features and performance. This new version significantly reduces the complexity of enterprise network security management.

It also includes the ability to add security management plug-ins for better integration of current and future security functionalities, expand internal security through network access control functionality, and includes new features such as Web filtering, Voice-over-IP enhancements, additional security protections and more.

And the VPN-1 Power models under NGX R65 set a new industry standard for security performance for combined firewall and intrusion prevention speed through an open server, 12 Gigabits per second for firewall throughput and up to 5.1 Gigabits per second intrusion prevention throughput.

Another key achievement is the Check Point Integrity Achieved Prominent EAL 4 U.S. Government Certification. Our endpoint solution was certified for endpoint firewall, application, instant messaging and spyware security.

Check Point is now the only security vendor certified for all critical network security categories; firewall, VPN, IDS, IPS, endpoint security and for our data security products.

We believe that we now own the largest number of EAL 4 certifications of any security vendor in our industry.

During the quarter, we saw the continued success of our subscription support programs. This includes our Collaborative Enterprise Support program, a support program that is a combination of subscription and support delivered jointly by Check Point and our partners. It is designed to add more value to customers and partners, by improving the support our customers receive.

And we had very good success again this quarter with our SmartDefense service, which has become a very robust offering since its initial introduction a number of years ago. You can see the success of these programs in subscription support revenue and in the strength of deferred revenues.

During the quarter, we had a healthy number of large deals, which had transactions greater than $50,000 as they accounted for 23% of total orders. In the quarter, we had 10 deals between $500,000 and $1 million, and five deals which were greater than $1 million.

In addition, we continued to grow our install base adding over 19,000 gateways, bringing the total to over 575,000 security gateways. This included a number of major competitive wins.

Geographically, we had good results, but we were especially pleased with the strength of the business in the Europe, Middle East, Africa regions. This geographic region had a very strong quarter across all product segments including product sales as well as subscription and support. We were also pleased with the success of our new products and their adoption by our channel and many customers, including a number of major wins in governments, technology and financial sectors this past quarter.

The plan going forward is to continue to refine our strategy as necessary, and stay focused on execution. We have a vision that resonates with the market and is one that we believe will lead to continued success in the market.

Thank you again for being on the call with us today. And I would now like to turn the call over to Gil Shwed.

Gil Shwed

Thank you, Jerry and hello everyone. In the first quarter, we launched our new team of PURE security from Check Point. This team highlights our commitment and focus to provide our customers and partners with the architecture, technology and solution on which we can build our future IT security infrastructure. The success in the quarter came from both our network security solution and from our expansion into data security, both contributing to the 25% growth in revenues and 25% growth in deferred revenues over the first quarter of 2006.

But PURE security is not just a team. This is truly our focus that makes Check Point unique in this marketplace. In the quarter, we proved our commitment to this strategy by launching many new products and initiative by trying to building block for our future quarter. We required Protect Data and added the Pointsec product line. We completed the acquisition of NFR Security and added new leading technologies in the field of intrusion detection and prevention. We launched a new version of our core product suite NGX R65 adding important management security and performance capabilities.

Finally, we launched the new family of Unified Threat Management, UTM-1 having the best and most integrated solution in this space. This combined effort demonstrates our progress in achieving the Holy Grail of security. A single integrated management console which can manage all layers of security in a consistent, reliable and a secured manner. This new generation of the Unified Security Architecture will make the security consistent across the entire network layer for remote users, security gateways and end points within the network. And expense to the data security layer, to minimize the risk of data loss and leakage.

While we started to see the success of our strategy this quarter, this is only the first step and most of the challenges, opportunities and results for these activities are ahead of us.

For the second quarter of 2007, we expect revenues to be in the range of $166 million to $176 million. We expect the GAAP EPS to be in the range of $0.26 to $0.31, and non-GAAP EPS, excluding the effect of stock-based compensation and acquisition-related charges, to be in the range of $0.33 to $0.38.

For the year, I would like to reiterate our full year outlook and provide GAAP EPS. For 2007, revenues are expected to be in the range of $690 million to $720 million. GAAP EPS is expected to be in the range of $1.04 to $1.18. Non-GAAP EPS for 2007, excluding the effect of stock-based compensation and acquisition-related charges is expected to be in the range of $1.40 to $1.54.

In summary, we believe with our pure focus on IT security positions us strategically is to provide with customers we rely on today and in the future as we build out our IT security architecture. We are pleased with our performance during the first quarter, and believe it, we are well positioned for a successful 2007.

Thank you all, and with that I would like to open the call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question is coming from Sarah Friar with Goldman Sachs. Please go ahead.

Sarah Friar - Goldman Sachs

Good morning, guys. Thanks a lot for taking my questions. Eyal, can you give us any further color on how the Pointsec total revenue split out across effectively your three line items, so in particular, how much was product versus how much fell into something more like subscription?

Eyal Desheh

You have noticed, we have provided the information about our data security business, which is the Pointsec product line, we didn't break it out the component of products at Pointsec is of course higher than Check Point, but that breakdown is not available.

Sarah Friar - Goldman Sachs

But can you give us any sense, is it an 80-20 split kind of product maintenance, reporting?

Eyal Desheh

No, it's not 80-20, it's less than that.

Sarah Friar - Goldman Sachs

Okay. And then in terms of the margins, it looks from your guidance, you're assuming margins can start to pick up again as you get Pointsec integrated and so on. What do you think is a good sustainable margin for Check Point, if you think through '07 and into '08?

Eyal Desheh

Let's first remind us of it, we have the best margins in the industry. And we are not giving margin focuses as you've been following us for many years. You remember that we never give real focus on margins, obviously Pointsec joins in with a lower margin that Check Point had before the combination and that is a result for the margin of this quarter, which is exactly within the expectation where we thought. There is some room for improvement here, but we focus on driving revenues, net income and earnings per share and not driving the margins.

Sarah Friar - Goldman Sachs

Okay and then just one final one for you. The support and training revenues really jumped up; may be it's a question more for Jerry and the success you are having there. I mean how do you balance that with also working with partners and making sure that you are not taking away support and training revenue from them?

Jerry Ungerman

Well, as I said in the introduction of the program, we built this over an extended period of time and we built it with our partners. And we are sharing the revenue, but we are also sharing the expenses, and we are giving our total customers a much better experience with the support that they received by doing it jointly. And it's been very well received. Like I said we've done this on a rollout basis, started in Europe, we're going to Asia, we fine tuned the program as we go forward. But it's been very, very well received by both customers and partners because it's very positive for them and for us.

Sarah Friar - Goldman Sachs

Okay. And so is the goal, because of the U.S. you said you already were doing effectively or they had about some placement the CES less relevant in the U.S.? As you now have the rollout in Asia and Europe get more mature. Do you see ways to bring it to the U.S. in a different form?

Jerry Ungerman

Well, maybe in a different form, maybe a similar form, maybe modified somewhat. We continue to work with our partners here. But we do it geographically, based upon the needs of the customer and the partners in those geographies, as we evolved into. I mean there is no one program we do I think consistently around the world. We try to tailor it to the marketplace and requirements, the language, the culture, the capabilities that the people have. So, we will continue to also enhance the services and support that we provide. The U.S. based customers like we have those in the rest of the world and exactly what form that takes I don't think we know right now. But at some combination of the programs we have in place, which we think is going to have a positive impact on our revenues as well as our partners' revenues and our customer satisfaction.

Sarah Friar - Goldman Sachs

Okay, great. Thanks a lot.

Jerry Ungerman

Thank you, Sarah.

Operator

Thank you. Our next question is coming from Robert Breza with RBC Capital Markets. Please go ahead?

Robert Breza - RBC Capital Markets

Hi good morning and good afternoon. Nice quarter. One question Gil for you; you talked about integrating the sales force into from Pointsec or Protect Data into the Check Point channel. Are we to assume yet that the Check Point traditional sales reps will also be taking on the new product line? And then a question for Eyal, if you could just comment a little bit about taxes and where you think that's likely to go? Thanks.

Gil Shwed

Oh yes, the Check Point channel and the Check Point sales force are all going to carry, promote and sell the Pointsec's product. It's right now on our price list. And all channels around the world can sell it. We've started the process of training the sales people. We've started the process of training the channel and the way is only to work with the Pointsec dedicated data security experts are going to both support and grow the accounts which they've been serving and the pipeline that they’ve been building. And also be a regional resource that can help the entire team around them, learn how to do that and direct even more opportunities that they can do on their own.

Eyal Desheh

Rob, regarding your question on taxes, as you've seen, our GAAP, our tax rate was 19% this quarter, a little higher than the usual. Our non-GAAP tax rate was 15% this quarter, a little lower than the usual. This has to do with some of the acquisition related expenses that we had in the P&L. In general, we focus on the non-GAAP taxes. It could be within that range, maybe a point or two higher later on this year but that is the area.

Robert Breza - RBC Capital Markets

Thank you very much.

Operator

Thank you. Our next question is coming from John Walsh with Citigroup. Please go ahead.

John Walsh - Citigroup

Good morning. Could you give us an update on competitive environment? Any change with pricing or anything you've seen on the competitive front, particularly within the U.S.?

Jerry Ungerman

Let me take that. Not really John, it's still a competitive marketplace. But we are doing well out there. I'm very pleased with our position and our success we had, as I talked about a number of major, major wins. There isn’t anything that isn’t competitive. We had good overall numbers, big accounts, geographically, like I said, it was across governments we did some real nice business with the U.S. government, again this quarter across our product line, financial sector, technology companies, and it really goes across the spectrum, both geographically. We said Europe was very strong. So, I'm very pleased with our position in the marketplace and how well we are doing. As I said’ and I don’t want to repeat all my comments; I just think we are very well positioned with our vision, with our strategy, with our product set, and the needs that the customers have of working with a security vendor as an independent layer on top of everything else they are doing. And I like that position. I think the marketplace does, our partners do, and I think its going to continue to be our focus, which I said is now on execution of what we are doing.

John Walsh - Citigroup

Okay. And then now that you are in the market for a couple of months with the UTM-1 appliance product. Any sense of this, any concerns about channel conflict that now you are selling appliance relative to what some of your partners offer and putting in on their hardware? And then any sense of the revenue contribution from that product for the full year. Do you expect it to be less than 10%, 5% to 10% of the 2007 revenue? Thanks.

Jerry Ungerman

I'll let Eyal give the second part of the question or Gill, but on the first part, no John, there is not a conflict, and one of things that they know and we know and we talked about and maybe it takes us a while to get there is that, we are filling a void in the marketplace. We went to a price point that our partners really did not address and could not address. They are at the higher end of the market and not really addressing the mid market, which is why we took the step that we did. We were the ones that were capable putting together the right set of solutions, the pricing, the packaging, etcetera to fill the void that was in the marketplace. An opportunity in the marketplace that we wanted to address that our partners were focused in a different segment a higher-end segment. So this is very complementary and it is not competitive with them, and we don't have a problem with either one of the major ones or any of the open server guys.

Eyal Desheh

Now, regarding the second part of your question, we think, we understand that the product has been less than two months in the market from launch. Sales cycle is not very long on this product, but it’s not zero and pipeline continues to be built very nicely. For a question, yes, it’s less than 10% of our business at this point.

John Walsh - Citigroup

Okay, great. Thank you.

Operator

Thank you. Our next question is coming from Sterling Auty. Let me do ask that you limit your questions to one question.

Sterling Auty - J.P. Morgan

Yes thank you. You mentioned it in your prepared remarks that you are going to give some additional color on the strength in Europe; I didn't quite understand the detail behind it. Is it because of the geographic contribution of Protect Data or what else did you see in the marketplace during the quarter from that region?

Jerry Ungerman

Yeah, maybe I didn't give enough color there Sterling, I apologize for that but no it’s across all parts of Network security products it was product sales, it was subscription, it was SmartDefense, it was support, it was across the countries in Europe. We just saw a very, very strong business environment there. I think we did well in most of the places and in an absolute sense we are okay, we are just relative, Europe was very, very strong, just the entire environment. I think our execution, the team we have in place there was exceptional for us. We are very pleased with what happened and it was really across the board geographically and from a product set standpoint. There was no one individual area that caused them to outperform the other regions. It was just a combination of every thing as I said across geographies, across products both network security and data security as well as subscription and support in SmartDefense.

Operator

Thank you. Our next question is coming from Walter Pritchard with Cowen. Please go ahead.

Walter Pritchard - Cowen & Company

Hi. I was just wondering Eyal on the services line, it sounds like CES was very strong in the quarter operating, if you classify the maintenance for Protect Data and services or/and if that had any impact on services?

Eyal Desheh

Yeah there is, but definitely the major driver of the gross and services revenues of CES program and the majority of the growth is coming from there.

Walter Pritchard - Cowen & Company

And just a follow-up, are we now at the point where, I know you sort of had a staggered impact of rolling that out over two quarters or somewhere, Q4 you saw some impact in Q1 you saw some impact. Are we now in kind of a steady state in terms of the impact of CES and that it grows more steadily from here in that services line?

Eyal Desheh

I don't know what the meaning of steady state is in this type of business, but just don’t forget, we have deployed the program right now in EMEA and Asia.

Gil Shwed

And Q2 was the first quarter as we made this program. So we don't have yet the four quarters. And like Q3 or Q4 when we are going to end the cycle of full year into the new program, and that's going to be somewhere between Q3 and Q4.

Operator

Our next question is coming from Todd Raker, with Deutsche Bank. Please go ahead.

Todd Raker - Deutsche Bank

Hi guys, on the new businesses, can you quantify the impact of NFR in the quarter and when you gave guidance for Pointsec for full year $95 million to $105 million are you still comfortable with that range?

Gil Shwed

NFR, the numbers from NFR were not very meaningful in the quarter, but this is a longer sales cycle and we are building it, but we are very happy with the progress. Regarding Pointsec, we see no reason at this point to change the original guidance.

Todd Raker - Deutsche Bank

Okay. And one quick follow-up, large deals by over 1 million that's actually up sequentially from your year-end in that core business, is that Pointsec? Can you give us some insight into that?

Gil Shwed

To tell you and all those five deals came from Check Point Network Security business.

Todd Raker - Deutsche Bank

Okay, thanks guys.

Operator

Thank you. Our next question is coming from Roni Biron, with ING. Please go ahead.

Roni Biron - ING

Hi, guys, the question regarding the market. You indicated that a growing demand for unified solutions. Can you talk more about specific demand for certain products such as -- I am sure you mentioned it, but just to elaborate a bit, such as the intrusion detection and UTM, is it picking up as you expected and the same goes for FireWall and VPN? How do you see this market evolving?

Gil Shwed

FireWall and VPN are an integral part of our UTM-1 solution, and our entire VPN-1 UTM family, which is a bigger family, and yes, we do see an increased demand for some of these functionalities and some of these solutions.

And IPS capabilities are also part of some of these products, so we are also there. The independent, the IPS-1 product lines that we have is a new line that we are just starting. The major announcements around these lines actually are still ahead of us. And so it’s not that -- so the contribution there is still small and most of the work there is still ahead of us. But overall, I think, that where we saw the strength was in the overall network security market and in the new data security market move us along quite well in the quarter.

Todd Raker - Deutsche Bank

Okay, thank you.

Operator

Our next question is coming from Ed Maguire with Merrill Lynch. Please go ahead.

Ed Maguire - Merrill Lynch

Yes. Good morning. Looking at the Pointsec business, could you characterize what you see as relative average deal size as compared to the network security business, and also the relative sales cycles to close these opportunities.

Jerry Ungerman

Okay Ed. Hi. The average -- the relative deal size for the Pointsec product is larger than Check Point. Although our five biggest deals came from network security, but by an average a typical Pointsec sale is bigger, and I think also and again, we're still learning the very fine details of the business. But I do believe that the sales cycle is also a little longer. Since these products are new to the market and our customer will like to test and experiment, and start on a small scale, understand it works before they go to the biggest deployment, so we do see somewhat longer sales cycles that can't quantify that exactly.

Ed Maguire - Merrill Lynch

And just a follow-up on the UTM products, are you seeing an early adoption in kind of new deployments, or are you seeing some of the traditional FireWall-1 customers switching or upgrading to UTM-1 platform?

Gil Shwed

I think its still too early to say, but most of the business we are addressing, and most of what we've seen so far is new deployment and new and products for the UTM-1 line specifically.

Eyal Desheh

And with new customers?

Gil Shwed

Yeah.

Operator

Thank you, our next question is coming from Shaul Eyal with CIBC World Markets.

Shaul Eyal - CIBC World Markets

Thank you. Hi, good afternoon; good quarter. Two quick questions. Jerry, back to the ASP's question before, some company, some security related company started to talk about some up tick with respect to ASPs; some uptick in pricing gone up by about 5%, 6%. What's happening maybe more specifically from Check Point on that front?

Jerry Ungerman

I am going to let Eyal answer it for you because he has got the numbers there, I think those might have picked up a little bit, but I don't think there has been any significant change which I want call, 5% or 6%. Eyal, do you have the numbers there exactly or?

Eyal Desheh

ASP? There is a mix, I mean we look at the network security business. I don't think that their ASP has changed. It maybe a little bit up because the UTM-1 products are basically driving more dollars per single sale then our previous UTM software version, but this is still on a small scale.

So, when we isolate the network security business, it's more or less the same, maybe a little bit up but not by much, and data security is new, I mean we don't have anything to compare to, and I don't think that compares and makes sense at this point.

Gil Shwed

The good trend that I can predict for the year is that we've seen an increase in the ASP of network security deal and we'll see a decrease in data security deals because we're going to approach a much broader market and much more of the mid-market with the data security deal.

Shaul Eyal - CIBC World Markets

Got it. Thank you for that, and just kind of one --

Operator

Thank you. Our next question is coming from Dino Diana from UBS.

Dino Diana - UBS

Thanks. Nice quarter, guys. On the deferred revenue strength up 26% year-over-year when you back out Point Tech, is there any more, obviously it’s the highest I think you had seen since the first quarter of 2001? Is there any more license revenue than normal that’s included in that number?

Gil Shwed

No, it’s actually mostly subscription then subscription support and SmartDefense lets not forget the SmartDefense program, which is not a maintenance or support program. It's a security update and it's just an annuity program. So, I mean, these are the three contributors. I don't think that we have seen much product in deferred revenues this quarter.

Jerry Ungerman

Very little. Very, very little.

Dino Diana - UBS

Okay. And then on the UTM side, obviously the checks have been good so far for the first two months. Do you have any idea when this could be, whatever metric you want to try, maybe like $1 million per quarter run rate business? Is it far off from that?

Jerry Ungerman

It’s much more than that already.

Dino Diana - UBS

It's much more than that already, okay. Any sense for how big that was, or what it can be?

Gil Shwed

It is too early, but it's much more than that.

Dino Diana - UBS

Okay.

Eyal Desheh

It's just going to be very good.

Eyal Desheh

We got a question before but it's more than 10% of our business, we said it's roughly 10%.

Dino Diana - UBS

Okay.

Eyal Desheh

More than $1 million.

Gil Shwed

Alright, great.

Eyal Desheh

More than $1 million and much less than 10%.

Dino Diana - UBS

I got it. Okay, thank you.

Eyal Desheh

You're welcome.

Operator

Thank you. Our next question is coming from Katherine Egbert with Jefferies. Please go ahead.

Katherine Egbert - Jefferies & Company

Thanks, good morning. What do you expect for Pointsec for next quarter, and will you break it out?

Eyal Desheh

Well, we will break it out, I think what we expect is in line with our expectation of a little over $100 million for the year, which means that we are going see growth at Pointsec, but we're not going to provide the specific breakdown. It will grow over what we [expect]. [Technical Difficulty]. Two reasons; one, we believe that the business is growing and the other one, don't forget it. In Q1, we didn't have business for Pointsec for the first three weeks of January because we [Technical Difficulty].

Katherine Egbert - Jefferies & Company

Got it, thanks.

Operator

Thank you. Our next question is coming from Phil Winslow with Credit Suisse. Please go ahead.

Phil Winslow - Credit Suisse

Hi guys good quarter. Eyal, I just have a quick question on U.S. versus Europe GAAP and if that had any effect on, and how you recognize, call the Pointsec license revenue versus how Protect Data did previously; we've typically seen we move over to U.S. GAAP. Companies have to shift more into services and subscription deferred revenue versus European GAAP. Did you have a similar effect this quarter in this business?

Eyal Desheh

Yeah, I would not describe this as meaningful. Yeah, there are differences between the U.S. GAAP and the international GAAP that Pointsec has been using. But I don’t think that this is meaningful as to say that they had a major impact on results. And this will go away within a few quarters anyway. Difference is that, yeah the international GAAP is a little more liberal and revenue recognition and we applied very circular step to the numbers. So, might find a little bit more in deferred than the usual, but, I can't say these are meaningful numbers, though.

Phil Winslow - Credit Suisse

Okay. And then also just on the deferred revenue line, you mentioned $13 million coming from Pointsec. How much of that was just from the purchase accounting versus actual incremental deferred revenue growth during the quarter from Protect Data?

Eyal Desheh

This has all came from purchase accounting.

Phil Winslow - Credit Suisse

Okay.

Eyal Desheh

This does not include the regular, the business during the quarter. This is the one step up that we've have done when we added the Pointsec deferred revenue. A balance sheet up to, of course we have adjusted, the number is smaller than what they had because according to purchase accounting you have to reduce it to according to formula so.

Phil Winslow - Credit Suisse

Got it.

Eyal Desheh

This is a one time step up, the rest was ongoing business and of course, we continue to generate business and grow it.

Phil Winslow - Credit Suisse

Perfect, thanks guys.

Eyal Desheh

You're welcome.

Operator

Thank you. Our next question is coming Ehud Eisenstein from Oscar Gruss. Please go ahead.

Ehud Eisenstein - Oscar Gruss

Hi guys, nice quarter, thanks for taking my call. One of the goals for this year is the focus on the medium size business. Can you give us some sense how that worked for you in the quarter? And secondly, we'll appreciate an update on Japan. Thank you.

Gil Shwed

We've been very active in trying to promote our mid-size business. Let's remember, we define mid-size, selling mid-size solutions not necessarily, I mean we think of some large accounts will buy mid-size products and some small and mid-size accounts will buy the same mid-size product. So, we have been pretty active in promoting that message, I think that from the UTM-1 and the success that we have for UTM-1, we are starting to bear the fruit of talking about that. In Japan, I think, we are still recovering from few tough years, but this quarter I think this was an order of magnitude change in the business in Japan. It performed better than our plans for the year, and hopefully within a quarter or two, we are going to start seeing reemergence and growth in Japan again.

Ehud Eisenstein - Oscar Gruss

Excellent, thanks so much.

Operator

Thank you. Our next question is coming from Israel Hernandez with Lehman Brothers. Please go ahead.

Israel Hernandez - Lehman Brothers

Good morning everyone. The question on the rollout of Pointsec into the channel, how far along are we on that process and when do you think we will start to see meaningful acceleration in production that in the channel, because we have seen that's a pretty significant opportunity? And a second question here is, how is Pointsec being integrated into the operations of Check Point is it pretty much being left as a standalone business or are we deep into integration within the Check Point fold? Thanks guys.

Gil Shwed

I think we have addressed a little bit both of these on the previous text. But let me try and reiterate that. The Pointsec product is available to our channel but we are only at the beginning of training, educating, and promoting it. So, every channel partner can own a Pointsec product, every channel partner can sell the Pointsec product. And we are starting to --

Eyal Desheh

We are seeing some orders already.

Gil Shwed

Yes, we already seeing some orders, but it's still very small volume, I expect that between Q3 and Q4, we are going to see more meaningful contribution for the Check Point channel from the Pointsec product. A Pointsec is already integrated into the Check Point structure. It's not going to be an independent or a separate unit. The Pointsec sales people have become part of the Check Point region, and they will continue to serve their customers and work on the large deals, but they are also going to support the entire area or the entire geographical area in which they are and help the Check Point people and the Check Point channel promote that message and grow that business in the different regions. That's probably true also for many other functions that are there. I mean the Pointsec product organization is a part of the Check Point product organization. These are the two bigger organizations, most of the other organizations are going to be just combined and embedded because we are not dependent or will not stay anywhere standalone.

Israel Hernandez - Lehman Brothers

Thank you.

Operator

Thank you. I would now like to turn the call back over to Eyal Desheh.

Eyal Desheh

Well, thank you very much. Thank you everyone for your participation. If you want to speak to management or Investor Relations following this call, please call our Investor Relations department at area code 650-628-2050 and we will be happy to take your calls and return them. So, thank you again and we'll talk to you in three-months. Bye-bye.

Jerry Ungerman

Thanks everyone.

Operator

Thank you. This does conclude today's Check Point Software conference call. You may now disconnect and have a great day.

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Source: Check Point Software Technologies Q1 2007 Earnings Call Transcript
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