Check Point Software Technologies

(CHKP) - Get Report

has successfully fought off hackers with its firewall technology, but has been less successful breaking through recent clamor over accounting concerns.

Wall Street analysts and fund managers started asking questions about a month and a half ago about the Israeli software shop's relationship to SofaWare Technologies, a private company also based in Israel that has been called everything from an "affiliate" to a "subsidiary" in Check Point's press releases and

Securities and Exchange Commission

filings.

Some of those questions have been resolved. But some linger as the company prepares to report the first full quarter in which Check Point is selling products developed by SofaWare -- and recognizing revenue. Some investors are still questioning whether Check Point created SofaWare to offload research and development costs in order to maintain high margins.

The questions have thrown Check Point into a small but growing group of software companies including

VeriSign

(VRSN) - Get Report

and

PeopleSoft

(PSFT)

that have been hounded by concerns over so-called related party transactions.

The relationship has fed into longer-standing worries over whether Check Point could maintain its stellar margins and hyper revenue growth of 1999 and 2000. Not surprisingly, shares have suffered. Check Point is currently trading at $30.66 -- 35% off its high this year of $47.20.

Analysts differ over whether the stock is fairly priced. It's trading at about 25 times 2002 earnings -- the low end for security firms -- but at 15 times revenue -- at the high end of the group, according to a recent comparison by Kaufman Bros. analyst Garrett Bekker, who has a hold rating on Check Point. His firm hasn't done any banking business with Check Point. And shares of other software firms are also off since the beginning of the year:

SonicWall

(SNWL)

is trading off even more -- 37% from its high this year --

Secure Computing

(SCUR)

is down 22% and

NetScreen Technologies

(NSCN)

16%.

Familiar Concerns

The Check Point concerns are similar to those raised against software maker PeopleSoft, which created publicly traded spinoff

Momentum Business Applications

(MMTM) - Get Report

with only one employee to carry its R&D costs. But unlike Momentum, SofaWare is a private company with 15 employees not required to publicly disclose its financials.

"

SofaWare is a company where there is not a lot of information," said U.S. Bancorp Piper Jaffray analyst Gene Munster. "It makes it difficult for us analysts to get our hands around it."

CheckPoint's answers, however, have satisfied some analysts, including Munster, who has an outperform rating on Check Point. "The question is, are you hiding expenses?" he said. "There was a lot of controversy. We found everything checked out." Munster's firm hasn't done any banking business with Check Point.

Munster said Check Point indicated it recognized all of SofaWare's R&D costs on its own books. But in an interview last week, Janine Zanelli, Check Point's director of investor relations, said the company recognized "some" of SofaWare's R&D costs -- about $2 million -- in 2001. Check Point reported a total $33.2 million in research and development costs in 2001, according to its annual report.

"I'm afraid there was some confusion on the Street, and I think post-

Enron

, everybody is really sensitive," Zanelli said. "This is all very clean, and how we are doing this is actually very, very conservative. We pay for the product and we reflect all of the revenue."

Following the Money

Check Point's SEC filings, however, are short on details about SofaWare. They disclose that Check Point holds warrants to own two-thirds of SofaWare and has an exclusive license to sell SofaWare products. SofaWare pays Check Point a licensing fee to use its software.

Check Point helped create SofaWare two years ago in order to expand its customer base from large companies to consumers and small businesses, Zanelli said.

Check Point currently owns 20% of SofaWare, Zanelli said. Check Point's founder and CEO, billionaire Gill Shwed, is the only Check Point executive on SofaWare's board, Zanelli said. Rumors have swirled that Check Point executives own the remainder of SofaWare, but Check Point denied that without disclosing names of the other owners.

So exactly who is paying whom? SofaWare, which has received a convertible loan from Check Point, pays Check Point a licensing fee to use its technology in its appliance products. As the sole distributor of SofaWare's products, Check Point recognizes revenue received for SofaWare's products but pays cost of goods -- or in essence a cut of the sales -- back to SofaWare.

That circular flow of money has made some Wall Street investors uncomfortable. One New York fund manager, who does not own Check Point stock and asked to remain anonymous, wondered why allow a Check Point executive to have any tie to SofaWare because it creates the appearance that transactions between the two companies are closer than arm's length. "The way revenue is recognized clearly benefits Check Point," said the manager, who called the arrangement "egregious."

A sell-side analyst who covers Check Point said he didn't like the arrangement merely because it's off balance sheet accounting. Another sell-side analyst who covers Internet security and has looked into Check Point but does not cover the stock added, "I'm concerned that their operating margins going forward are unsustainable."

Indeed, Check Point hinted in January that margins may go down. And revenue is forecast to grow only 25% to 30% in 2003. The consensus estimate for 2002, meanwhile, shows revenue increasing a mere 3.7% to $547 million and earnings rising only 2% to $1.27 a share, according to Thomson Financial/First Call.

U.S. Bancorp Piper Jaffray's Munster notes that despite the controversy over SofaWare, its revenue and expenses would have little impact on Check Point's bottom line.

Instead, he characterized SofaWare as a "smart move" because it shields Check Point from the risk of developing new products while still allowing the company to reap the rewards from that R&D.

This story as originally published contained an error. Please see

Corrections and Clarifications.