"An extraordinary opportunity"

Check Point's Gil Shwed isn't about to sell.

Check Point's share has already taken its punishment for disappointing the market with its third quarter results. It happened when, on October 6, Check Point announced the $225 million acquisition of Sourcefire and at the same time provided updated third quarter guidance for that was at the lower end of its original guidance and below market expectations.

This was the background to the release of Check Point's third quarter financials on Friday. It was also what enabled the network security technology company to provide improved fourth quarter guidance, resulting in a 3.12% rise in the share price by Friday's close, to $22.17, giving a market cap of $5.44 billion.

"Our financial results are excellent," Check Point CEO Gil Shwed said on Friday. "We have presented numbers in the upper end of the range for profitability and cash flow. It's true that revenue was not at the upper end of the forecasts, but we think that to present record levels of profitability in the summer quarter is excellent."

Check Point reported quarterly revenue of $141.1 million, representing an increase of 9% compared with $129.3 million in the third quarter of 2004. Net profit was $78.7 million, representing an increase of 18% compared with $66.8 million in the third quarter of 2004. Net profit excluding acquisition related charges was $80.5 million, representing an increase of 16% compared with $69.1 million in the third quarter of 2004.

Earnings per diluted share were $0.31, representing an increase of 22% compared with $0.26 in the third quarter of 2004. Earnings per share excluding net acquisition related charges were $0.32, representing an increase of 20% compared with $0.27 in the third quarter of 2004. During the third quarter of 2005, Check Point purchased 2.6 million shares at a total cost of approximately $57 million.

For the fourth quarter, the company provided updated revenue guidance of $155-164 million. The mid-point of this range, $159.5 million, is above the current analysts' consensus. The company expects earnings per share of $0.34-0.37 excluding acquisition-related costs, or $85-92.5 million in total, an extremely impressive number, and one that represents a new record. The acquisition of Sourcefire may close in the fourth quarter. If it does, Sourcefire's results will be consolidated, but the guidance does not take this possibility into account.

The revenue forecast for 2005 as a whole is $578.3-587.3 million, which compares with an analysts' consensus of $582.4 million. As far as 2006 is concerned, Check Point is still not providing guidance yet. For the time being, Shwed is prepared to say ,"There are many challenges before us, including our overall security strategy. On the other hand, we have extraordinary opportunities. We are now beginning to plan next year's activity."

Check Point's deferred revenue fell 6% in comparison with the previous quarter to $144.3 million. In the company's conference cal, CFO Eyal Desheh described this fall as seasonal and normal, and said it did not indicate a problem.

This did not of course make the fall any less disappointing, especially when another item is taken into account: weak software license sales. These totalled $65.6 million in the third quarter, 3% less than in the corresponding quarter of 2004, and 8% less than in the previous quarter. Subscription fees totalled $60.4 million, 24% higher than in the corresponding quarter of 2004, and above most investment houses' estimates.

In the conference call, this was one of the things that the analysts particularly asked about. It seems that they failed to understand the division of revenue between the various items and how it could be that despite the rise in subscription fees which ought to find expression in the balance sheet, deferred revenue fell. "All in all, Check Point's financials are positive and good, but the company is not sufficiently transparent to my mind as far as the mix of licenses and subscription fees is concerned," says Oscar Gruss analyst Ehud Eisenstein. "There are many question marks here, and this confuses the investment community."

Shwed tries to explain: "We have customers who buy new products, and others who upgrade existing products. Most of our customers also buy a subscription in order to receive updates and upgrades continually. So there is some movement of customers who in the past did not have subscriptions and only received version updates to customers who now have subscriptions. This element shifts a few million dollars to subscription fees.

What about the fact that this is liable to cause confusion? "We were certainly asked a great deal about this in the conference call. I think that the analysts' job is to examine various indicators, and when those indicators are growing, they should be happy." Shwed refers to that fact that, in total, revenue from products and licenses is growing and amounted to $126 million altogether. "We'll always be asked why one area is growing faster than another, and if one grows more, then what's the problem with the other one," says Shwed.


Check Point's managers never hesitate to declare that the company's technology is the best on the market, that only it has an overall security strategy and a complete architecture, and that the others don't provide this. This time too, when they were asked in the conference call about competitors, co-vice chairman Jerry Ungerman said he did not see Microsoft as a competitor. "They've had security products for eight years now, and we don't see them as competitors with any product," he said.

Juniper (Nasdaq: JNPR), which competes with Check Point via NetScreen, recently released superb financials, and CEO Scott Kriens stated in them that the security field was particularly strong and grew by 8% from the previous quarter, and by 37% from the corresponding quarter of 2004.

Shwed suggests that NetScreen's numbers shouldn't be taken at face value. "Even the perhaps trivial fact that Juniper doesn't disclose NetScreen's revenue shows that the numbers are disappointing," he says. "We see what's happening on the market, especially in large enterprises, at the high end, and they are there less and less.

Check Point had $1.67 billion in liquid assets at the end of the third quarter, after generating $83.5 million from routine operations during the quarter. Since the beginning of the year, the company has had cash flow from operations of $265.4 million.

On the Sourcefire acquisition, Shwed says, "We don't want to be a solutions supermarket, but to give customers integrated solutions. Every acquisition is challenging, and Sourcefire's people suit us very well, and its technology even more so."

Sourcefire is Check Point's third acquisition. The previous one, that of Zone Labs, is considered a success, and has left an appetite for more.

Are acquisitions a strategy for you?

Shwed: "We define our strategy as to give full solutions to customers and an overall security architecture. We will get there by developing new products and enriching existing ones. Part of the execution of this strategy is buying companies. It's hard for me to say whether it's a large part or a small part. An acquisition is a complicated process, and we don't see further acquisitions in the immediate term. We are currently making one acquisition that will occupy us for no small amount of time."

Investors and analysts would like to see Check Point buy more companies and technologies, just as they would like to see it carrying an even larger program of repurchases of its own shares, or distributing a dividend. The market's aspirations are interesting, but what about a bigger move, such as selling Check Point itself?

In the conference call, Shwed was asked how he personally saw a sale of the company. The seven seconds of silence he took to consider what he wanted to say in response to this question seemed very long indeed. Then he answered, "We're a public company, and we have to consider what's right for us and for the company. As far as we are concerned, this is certainly not our direction. We can remain the only independent company that provides network security solutions only, some thing no other company does. Personally, I have always wanted Check Point to be independent and to lead the market.

There is never any lack of rumors on the market. Sometimes they say Cisco wants to buy Check Point, and sometimes they say its Microsoft. Shwed, by the way, didn't meet Microsoft chairman Bill Gates last week, even though he should have since, he says, they were at the airport at the same time. But when you think about it, at the personal level, as a manager and as someone who owns 12.5% of Check Point, and if you take the rumor about Microsoft a step further forward, it's not at all a bad idea for Shwed.

He could become a vice president of Microsoft, the gorilla that is about to invest hundreds of millions of dollars, at least, in security. This wouldn't be just a merger, such as with Symantec or another competitor. It would be a strategic sale, and Shwed could be responsible for a huge budget and for outlining strategy. Something like what Shai Agassi has done at SAP, just that SAP is a $50 billion company, and Microsoft is a $270 billion company.

Shwed listens to this fantasy scenario of mine politely, and then says, "At a personal level, I really am not looking for that kind of thing, and I'm not looking to sell the company. At the strategic level, I always try to look at thing wearing two hats: mine, as a shareholder; and thinking about what's good for the other shareholders, that is, as a manager. There isn't always a contradiction between the two things, but, wearing my own hat, it would not be right to sell the company.

"We have an extraordinary strategic opportunity today to become a company that provides solutions for the network security layer. We are independent. In contrast to Juniper, that has an interest in selling routers as well, and in contrast to Microsoft, that has an interest in selling more operating systems, we sell only security solutions of this kind. There's no-one else who currently does that."

Published by Globes [online], Israel business news - www.globes.co.il - on Sunday, October 30, 2005

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