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SolarWinds Inc. (SWI - Snapshot Report) reported second-quarter 2013 non-GAAP earnings of 40 cents per share, which increased 21.2% from the year-ago quarter. Including stock-based compensation, earnings came in at 35 cents per share, ahead of the Zacks Consensus Estimate of 31 cents. The upside in earnings was driven by robust top-line growth and margin expansion.

Revenues

Revenues for the reported quarter increased 21.0% year over year to $77.5 million but failed to beat management’s revenue guidance of $77.8 million–$78.7 million. Reported revenues also lagged the Zacks Consensus Estimate of $79 million.

Higher license and maintenance revenues aided the year-over-year top-line expansion. License revenues, which accounted for 40.0% of the total revenue, increased 5.7% year over year to $31.1 million, primarily attributable to the commercial business.

Maintenance revenues, which accounted for 58.0% of revenues, increased 31.2% from the year-ago quarter to $45.3 million ($700K from N-able Technologies) on the back of strong customer retention. The company earned $1.01 million as subscription revenues from the N-able Technologies acquisition.

Margins

Non-GAAP gross profit increased 20.4% from the year-ago quarter to $74.1 million. Gross margin for the quarter contracted approximately 50 basis points (bps) from the year-ago quarter to 95.6% primarily due to unfavorable revenues mix. Including stock-based compensation, expense and related employer-paid payroll taxes, gross profit came in at $73.9 million.

Non-GAAP operating income increased 23.0% from the year-ago quarter to $42.1 million, while operating margin increased 90 bps to 54.4%. Operating margins expanded primarily due to a 140 bps contraction in operating expenses as a percentage of revenues. Including stock-based compensation, expense and related employer-paid payroll taxes, income from operations came in at $36.9 million.

Non-GAAP net income increased from $24.8 million or 33 cents per share to $30.7 million or 40 cents. Including stock-based compensation and related employer-paid payroll taxes, net income came in at $27.1 million or 35 cents per share.

Balance Sheet

SolarWinds exited the quarter with cash, cash equivalents and short-term investments of $175.9 million versus $265.8 million in the previous quarter. Cash from operations was $40.7 million compared with $30.9 million in the previous quarter. Free cash flow for the quarter was $41.2 million.

Outlook

For the third quarter of 2013, SolarWinds expects revenues in the range of $84.7 million–$87.2 million, up 18.0%–22.0% on a year-over-year basis. License revenues are expected to increase in the range of 1%–5% on a year-over-year basis, while management expects maintenance revenues to grow in the range of 28% to 30%. Subscription revenues are expected in the range of $2.2 million to $2.5 million.

Management expects non-GAAP earnings between 35 cents and 36 cents per share for the forthcoming quarter.

SolarWinds expects fiscal 2013 revenue guidance in the range of $322.7 million–$327.7 million. Management expects its non-GAAP earnings per share guidance to range from $1.51 to $1.54.

Recommendation

We believe that SolarWinds is well positioned to grow on its recurring maintenance revenues stream. Moreover, the company’s expanding product portfolio and expansions across the Asia-Pacific and Latin America, particularly in Brazil, should act as positive catalysts, going forward.

However, increased investments in products and expansion initiatives will likely impact margins in the near term. Moreover, volatile macroeconomic environment and competition from bellwethers such as International Business Machines Corp. (IBM - Analyst Report), Hewlett Packard Company (HPQ - Analyst Report) and CA Technologies (CA - Analyst Report) are the major headwinds, going forward.

Currently, SolarWinds carries a Zacks Rank #4 (Sell).

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