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.  We felt that the market overreacted to by dragging the company’s stock price to $45 before the company released its Q2 results.  We were pleased to see that Check Point had reported results that were at the high end of management’s revised guidance and more importantly its Q3 guidance was relatively in line with expectations.

What reinforced our thesis behind Check Point was the announced expansion of its share repurchases.  Check Point had previously made $200M of gross repurchases in 2010.  In 2011 and the first half of 2012, it increased that to $300M annualized.  After CHKP’s results were released the company announced that it was expanding the repurchase authorization to $1B over a two year period, which represents 10% of the company’s market capitalization as of July 23rd.  We see that Israel’s recent tax reform has enabled CHKP to set a more assertive share repurchase program and we are expecting that this tax reform will enable CHKP to potentially pay a dividend.  Even with CHKP spending over $1.6B 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 $3.2B in Q1 2012.  Over 32% of CHKP’s market capitalization consists of cash and marketable securities held by the company.

CHKP had reported solid results for Q2 2012.  Revenues reached $329M and represented an increase from the $301M reported in Q2 2011.  The company shook off slow growth from its product and license segment and enjoys strong growth from its software updates, maintenance and services segments.  To elaborate further on the product and license segment, product and license revenues increased by 3% versus the prior year’s period in spite of the challenging macroeconomic environment.  The company achieved 20% growth in its Enterprise Gateways product suite, which was mostly offset by customers opting to purchase slightly lower-end models due to the weak and volatile macroeconomic environment.  The company also saw pricing pressure as the euro and other foreign currencies weakened against the US dollar.  This is a headwind to CHKP as its financial results are reported in US dollars and its product price list is quoted in US Dollars.

Revenue from software updates, maintenance and service revenues reached an all-time high of $205.5 million this quarter, with outstanding year-over-year growth of 13%. Growth was driven by CHKP’s annuity software blades that are recognized as subscriptions. Deferred revenues as of June 30, 2012 were $536.6 million, an increase of $79.6 million or 17% over June 30, 2011.  CHKP continues to gain larger contract deals: CHKP had 40 customers that each has transactions with a value greater than $1 million, compared to 37 in the same period last year.  Transactions greater than $50,000 accounted for 66% of total order value, which increased relative to the 61% achieved last year.







Source: CHKP Q2 Earnings Call

CHKP continues to enjoy positive operating leverage.  CHKP’s GAAP operating income was $180M in Q2 2012, which was an increase of 20% from Q2 2011 levels.  CHKP’s GAAP operating margin for the quarter was 55.1%, which increased from the 50.1% in Q2 2011.

Source: S&P Capital IQ

We love the company’s ability to generate free cash flows from operations.  The company generated $156M in free cash flows for the quarter, versus $173M in the prior year period.  This decline was due entirely to a negative impact of the stronger US dollar when translated from foreign currencies back into US dollars.  We are absolutely enamored with the fact that its capital investment costs are primarily research and development, which flow throw the income statement and is immediately written off as a tax-deductible business expense.  CHKP doesn’t have to spend much on capital expenditures for hard, illiquid assets like property, plant and equipment.  Its all-time high for annual CapEx was $7M in 2011.  CHKP’s 2012 YTD Free cash flows were $429M, versus $377M in H1 2011.  On a linked-quarter basis, the company reduced its Days Sales Outstanding ratio by 3 days and it now stands at 69 days.

The company is managing its European exposure well.  We were surprised that CHKP saw strong growth in Italy and France, but not surprised to see strength in Germany.  CHKP’s CEO Gil Shwed has found that the company’s customers are excited about the expansion of its vision for IT security and the completeness of the company’s architecture. In the past few years CHKP has been able to deliver many new software blades addressing new security threats and even gaining leadership in some key markets.  The company projects that Q3 revenues will be in the range of $316-$345M and its operating EPS will be in the range of $.74-$.81, with a $.07 adjustment to GAAP EPS.  We noticed that consensus estimates for CHKP’s Q3 EPS are $.78 and this is in the middle of the management’s guidance range.

New products for the quarter include the following:

  • Check Point ThreatCloud™ – The first collaborative network of its type to fight cybercrime.  A network that automatically detects and shares new attack information in real time by collecting and correlating attack information from Check Point customer’s gateways and a dedicated attack sensor network.
  • Anti-Bot Software Blade – Check Point shipped a new software blade that can be activated on every Check Point enterprise gateway,   delivering the industry’s most sophisticated and integrated solution to fight software bots and protect against advanced threats and sophisticated malware.
  • ZoneAlarm Free Antivirus + Firewall – This new product is the most complete free Internet security solution for consumers.  It combines the world’s No.1 firewall with award-winning antivirus into one easy-to-use product that protects consumers against online attacks.
  • Check Point Virtual Systems – New solution for private cloud environments and data centers that enables the consolidation of up to 250 security gateways on a single hardware platform.
  • DDoS Protector™ Appliances – Check Point expanded into a new and critical security market segment.  These new solutions combat a wide range of Distributed Denial of Service (DDoS) attacks and are integrated with Check Point Security Management environment.
  • New Software Version R75.40 & New Secure OS (GAiA) – This includes more than 100 new features, including the Anti-Bot Software Blade, an updated Anti-Virus Software Blade powered by Check Point ThreatCloud.  R75.40 also includes the company’s new integrated secure operating system (GAiA) that simplifies the operations and unifies the capabilities of all the company’s new and previous appliance and software lines.
  • Security Acceleration Module – The Security Acceleration Module with advanced SecurityCore™ technology enables customers in high-performance and low latency environments, such as financial trading and investment companies, to significantly boost network performance by accelerating key security operations.  Customers are able to achieve 110 Gbps of firewall throughput and sub-five micro second (5 µs) latency – enabling the industry’s highest-performing two rack-unit firewall.

In conclusion, we are pleased with CHKP’s performance during the recent quarter and since the price of the stock as of July 23rd ($47/share) is 27% 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.  We are pleased that the company is able to generate solid growth in spite of its exposure to the sick old man known as Europe.  And we are pleased that we are seeing additional clarity with regards to how the company will utilize its ultra-liquid balance sheet in order to return cash to investors to increase shareholder value.


Past performance is not necessarily indicative of future results. All investments involve risk including the loss of principal. This report is confidential and may not be distributed without the express written consent of the original author and does not constitute a recommendation, an offer to sell or a solicitation of an offer to purchase any security or investment product. Any such offer or solicitation may only be made by means of delivery of an approved confidential private offering memorandum.

Investments may currently or in the future buy, sell, cover or otherwise change the form of its investment in the companies discussed in this letter for any reason. The author hereby disclaims any duty to provide any updates or changes to the information contained here including, without limitation, the manner or type of any of the investments.

All of the views expressed in this research report accurately reflect the research analysts’ personal views regarding any and all of the subject securities or issuers. The research analyst is not registered with FINRA, and may not be subject to FINRA rule 2711 restrictions on: communicating with the subject company, public appearances, and trading securities held in the research analysts’ account. No part of the analysts’ compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. The analyst responsible for the production of this report certifies that the views expressed herein reflect his or her accurate personal and technical judgment at the moment of publication.

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

Disclosure: The author has a long position in CHKP

Copyright 2012 Saibus Research. All rights reserved. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Saibus Research.

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