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Check Point Software Technologies Ltd Updates Expectations

By Lee Samaha – Jul 27, 2016 at 12:15PM

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A look at the details behind the IT security company's second-quarter results, and management's commentary.

Check Point Software Technologies Ltd (CHKP -0.86%) delivered good second-quarter results on Tuesday, but lowered revenue and earnings estimates for the coming quarters. Let's take a look at the results and the nuances behind management's commentary.

IMAGE SOURCE: GETTY IMAGES.

Check Point Software Technologies' second quarter: The raw numbers

The headline figures:

  • Second-quarter revenue grew 7%, to $423 million, and came in above the midpoint of the guidance range of $405 million to $435 million.
  • Second-quarter non-GAAP EPS increased 10%, to $1.09, at the top of the guidance range of $1.02 to $1.09.

Now, a look at management's commentary on guidance:

  • Guidance for third-quarter revenue is $405 million to $435 million.
  • Guidance for third-quarter non-GAAP EPS is $1.03 to $1.10.

It's here where things get tricky. Although management didn't change its full-year guidance for revenue of $1,720 million to $1,790 million, and non-GAAP EPS of $4.45 to $4.60, it noted the following:

  • A shift in the business model will result in a lowering of third-quarter revenue by $8 million to $10 million, and fourth-quarter revenue by $16 million to $20 million.
  • Similarly, non-GAAP EPS will be lower by $0.03 in the third quarter, and $0.06 in the fourth quarter

Let's dig into what this means. 

What's happening to Check Point Software's revenue and earnings

There are two points to discuss. First, Check Point sells appliances (product revenue), which come bundled with software blades -- customers can add more blades with different applications later -- and also sells software updates and maintenance.

The following chart shows how strongly software-blade revenue continues to grow. For example, at the start of 2013, software blades were responsible for 15% of revenue compared to 22% in the just-finished quarter.

DATA SOURCE: CHECK POINT SOFTWARE TECHNOLOGIES LTD.

What does this have to do with Check Point guiding revenue and earnings lower in the coming quarters? The answer is that, in accordance with accounting rules, Check Point must separate the software-blade revenue from the product revenue, even though they're sold together initially, and then recognize the blade revenue over time.

The result is a shift from product revenue (recognized immediately) to deferred revenue. Not only is Check Point seeing a general increase in software-blade revenue, but its new appliances contain a "richer software blade package," according to CFO Tal Payne on the earnings call.

The result is a shift in revenue, and that's the main reason why management lowered expectations for revenue and earnings. For reference, the following chart shows how strongly deferred revenue has been growing in recent years.

DATA SOURCE: CHECK POINT SOFTWARE TECHNOLOGIES LTD. ALL DATA IN THOUSANDS OF U.S. DOLLARS.

Competitive markets

While management didn't explicitly blame pricing pressure for lowering revenue guidance, Payne hinted at it in a response to a question:

There's always other things because you're talking about guidance and forecasts. We discussed about the update and maintenance price pressure that you can see. We talked about it last quarter. We're talking about it this quarter so that can have some effect, as well.

Similarly, CEO Gil Shwed talked of a "little bit" more discounting on maintenance contracts, in order to retain the customer base.

Sales and marketing expenses

In a similar vein, Check Point is deliberately pursuing a policy of increasing sales and marketing in order to drive revenue growth. The chart below shows sales and marketing expenses, and non-GAAP operating income as a share of revenue.

DATA SOURCE: CHECK POINT SOFTWARE TECHNOLOGIES LTD.

Looking ahead

Management's lowering of revenue expectations is more about a shift in its business model than any kind of fundamental weakness in its business. After all, it's difficult for management to predict exactly what products/software customers will buy. It's worth keeping an eye on any future pricing pressure -- usually a sign of increasing competition -- and how sales and marketing expenses might eat into operating income margin.

Lee Samaha has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Check Point Software Technologies. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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