We entered into a long position in Check Point Software Technologies (CHKP) after it reported its Q1 EPS because we were shocked at the price drop that resulted from its report.  While we can understand that there were a number of momentum investors who were expecting CHKP to raise its forward earnings outlook, we felt that investors overreacted to the news.  We would like to remind everyone that CHKP generated non-GAAP EPS of $.68 in Q2 2011 and the company projected $.74-$.77 per share, which represent a healthy 9%-13.25% EPS growth for CHKP.

CHKP had reported strong results for Q1 2012.  Revenues reached $313M and represented an increase from the $281M reported in Q1 2011.  Towards the end of last year, CHKP released its new appliance line. It was received with great enthusiasm in the market; approximately 80% of CHKP’s enterprise appliances sold this quarter came from the new product line.  Revenues from the 61000 security system doubled versus Q4 2011 and helped drive CHKP’s revenue growth.

Revenue from software updates, maintenance and service revenues reached an all-time high of $202.9 million this quarter, with outstanding year-over-year growth of 15%. Growth was driven by CHKP’s annuity software blades that are recognized as subscriptions. Deferred revenues as of March 31, 2012 were $542.2 million, an increase of $82 million or 18% over March 31, 2011.  CHKP continues to gain larger contract deals: CHKP had 34 customers that each has transactions with a value greater than $1 million, compared to 27 in the same period last year.  Transactions greater than $50,000 accounted for 60% of total order value, similar to last year.

 
Source: CHKP Q1 Earnings Call

CHKP continues to enjoy positive operating leverage.  CHKP’s GAAP operating income was $173M in Q1 2012, which was an increase of 22% from Q1 2011 levels.  CHKP’s GAAP operating margin for the quarter was 55%, which increased from the 50% in Q1 2011.

As CHKP is headquartered in Israel, it will be impacted by Israel’s new tax reform.  The reform simplifies the tax structure, reduces many tax uncertainties, and lifts the tax limitations of cash distribution from future income. As a result of the reform, the effective tax rate in CHKP’s P&L is expected to reduce next year, while we will see an increase in CHKP’s tax payment.

We are expecting that this tax reform will enable CHKP to increase its share buyback program and potentially pay a dividend.  Even with CHKP spending over $1.5B in share repurchases net of proceeds from employee stock program issuance, CHKP has seen its cash and liquid security holdings increase from $1.3B in 2002 to $3.1B in Q1 2012.  Nearly 30% of CHKP’s market capitalization consists of cash and marketable securities held by the company.


Source: S&P Capital IQ

CHKP recently introduced ThreatCloud, which is the world’s first collaborative network to fight cybercrime.  We believe that ThreatCloud will see strong growth due to the emergence of cloud computing.  Gateways participating in ThreatCloud will be able to contribute to the network. When CHKP becomes aware of the new attack, it updates ThreatCloud and all its network participants will be able to quickly detect and block the attacks. In addition, ThreatCloud employs a network of sophisticated sensors in key places in the Internet in order to further identify threat. This collaboration should shorten the response time to attacks from days, weeks and even months to hours or even minutes and extend the scope of addressable threat by orders of magnitude providing for great breakthroughs in cyber security.

ThreatCloud isn’t another long-term vision. It is actually working now and is part of R75.40 software which CHKP released last week, which powers its new Anti-Bot Software Blade which is now shipping in its enhanced Antivirus Software Blade by providing threat updates directly to customers’ gateway, enabling them to enforce preemptive protection against advanced threats such as bots, APTs, and other forms of sophisticated malware. And, ThreatCloud is only one part of CHKP’s R75.40 product. R75.40 has over a hundred new features in all areas of management and security.

ThreatCloud can work on any network environment, whether the client uses it on the client’s network or if the client uses a managed outsourcing provider.  CHKP’s CEO Gil Shwed had some discussions with some telecoms that were interested in offering ThreatCloud as a service that they provide, and CHKP is fully ready to provide ThreatCloud not only as a big service from Check Point, but also as a private service from whoever wants to build such a network.

One of the most important features is the new secure operating system, GAiA.  GAiA combines the two operating systems CHKP had in its product portfolio. The Nokia IP operating system and SecurePlatform both offer some unique characteristics and have earned some loyal customers. Loyal IP series customers were reluctant to move to CHKP’s newer client model, who didn’t try the IP operating system. Now with GAiA, these customers will be able to move to CHKP’s unified product line, taking advantage of its familiar interface and all the available features and getting the benefit of the great new platform CHKP provides. Many customers have been waiting for GAiA for a long time, and the client reactions so far are very positive.

In conclusion, we are pleased with CHKP’s performance during the recent quarter and since the price of the stock as of June 7th ($53.59/share) is 18% off its 52-week highs, we will be looking at adding to our position as markets become more volatile.  We are encouraged by the company’s increased revenue and new product offerings, particularly the ThreatCloud application, which will benefit from the increased growth in cloud computing services.

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Disclaimer: Under no circumstances must this document be considered an offer to buy, sell, subscribe for or trade securities or other instruments.

Disclosure: The author is long WEC shares.

 

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