Check Point Software Technologies Ltd. Soothes the IT Security Sector

Following fellow IT security company Fortinet Inc.'s near-20% drop after it reported results last Friday, investors in Check Point Software Technologies Ltd. must have had a nervous weekend waiting for earnings on the following Monday. In the end, Check Point's third-quarter earnings were fine, but the real question is: What will happen in the fourth quarter?

Check Point Software Technologies Ltd. results: The numbersTotal revenue increased 9% in the quarter to $403.9 million, slightly ahead of the midpoint of the guidance range for $392 million to $410 million. Meanwhile, non-GAAP earnings per share came in $1.04, above the top of guidance for $0.92 to $1.02.

In other words, the headline results were pretty good and mimicked how Fortinet beat guidance the previous week. Of course, the likely problem with Fortinet's results wasn't the earnings, but rather that guidance wasn't raised as much as the market had hoped, probably creating an excuse to sell a highly rated stock.

Turning to Check Point's guidance for the fourth quarter:

  • Fourth-quarter revenue of $440 million to $470 million, implying a growth rate of 4.6% to 11.8%
  • Fourth-quarter non-GAAP EPS of $1.10 to $1.18, implying a growth rate of 2.8% to 10.3%

If you are wondering why EPS growth isn't keeping pace with revenue growth, it's largely because operating expenses are increasing as Check Point invests in order to generate revenue growth. Operating expenses increased to 49.3% of revenue in the third quarter compared to 46.7% in the same period last year. Around 60% of the increase in operating expenses came from sales and marketing increases. Ultimately, third-quarter operating margin fell to 56.4% from 58% in last year's third quarter.

Was guidance OK?To put the revenue guidance into context, here is a graph of sequential (in this case, from the third to fourth quarters) growth rates for Check Point. As you can see, the midpoint of revenue guidance is for 12.7% sequential growth -- slightly below the average of 13.5% in the previous seven years.

Data source: Check Point Software Technologies Ltd. presentations. Growth rate is from third to fourth quarters.

That said, in my opinion, Check Point's management tends to be conservative with guidance.

What happened with the underlying trends in the quarter?Check Point's business model involves selling hardware in the form of products and licenses (around 33% of nine months' revenue) and then selling software blades (around 20%) -- blades perform a range of differing functions -- which work on Check Point's hardware. In addition, software and maintenance (48%) are sold into the installed base.

All of this means that growing product and license revenue is the key to future growth, and as you can see below, the growth rate increased to 7.2% in the quarter. This bodes well for future software and maintenance growth.

Data source: Check Point Software Technologies Ltd. presentations.

What management had to sayListening in on the earnings call, management vowed to continue investing in sales and marketing efforts and spent time highlighting the company's expansion onto new platforms. CEO Gil Shwed made this statement on the earnings release:

Looking forwardIn common with Fortinet, Check Point delivered a good set of results but guided a little bit below what some optimistic observers may have hoped for.

Check Point investors should keep an eye on operating margin because management is keen to invest for growth. The good news is that Check Point is clearly generating revenue growth, and expanding into platforms such as smartphones and tablets offers good long-term growth prospects.

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Lee Samaha has no position in any stocks mentioned. The Motley Fool 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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