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SolarWinds Inc. reported fourth-quarter 2012 non-GAAP earnings of 36 cents per share, which increased 24.1% from the year-ago quarter. Including stock-based compensation, earnings came in at 32 cents per share, ahead of the Zacks Consensus Estimate of 29 cents per share. The upside in the earnings was driven by robust top-line growth and margin expansion.

Revenues

Revenues for quarter increased 32.2% year over year to $73.5 million and exceeded management’s revenue guidance of $69.3 million-$70.8 million. Reported revenues also surpassed the Zacks Consensus Estimate of $71 million. On a sequential basis, the company’s revenues were up 2.5%.

The encouraging top-line expansion was aided by higher license and maintenance revenue. License revenues, which accounted for 45% of the total revenue, increased 30.8% year on year to $33.1 million, primarily attributable to the robust performance of the commercial business and the U.S. Federal business. SolarWinds recorded 29% growth in the commercial new license sales.

Maintenance revenues, which accounted for the remaining 55% of revenues, increased 33.3% from the year-ago quarter to $40.5 million on strong customer retention.

Margins

Gross profit (including stock-based compensation) increased 32.3% from the year-ago quarter to $70.4 million. Gross margin for the quarter expanded approximately 10 basis points (“bps”) from the year-ago quarter to 95.8% due to higher revenue base.

Operating income (including stock-based compensation) increased 33% from the year-ago quarter to $35.4 million while operating margin increased 30 bps to 48.2%.

Non-GAAP net income increased from $21.8 million or 29 cents per share to $27.7 million or 36 cents. However, including stock-based compensation, net income came in at $24.5 million or 32 cents.

Balance Sheet

SolarWinds exited the quarter with cash, cash equivalents and short-term investments of $229 million versus $195.7 million in the previous quarter. Cash from operations increased sequentially from $35 million to $47.2 million. Free cash flow for the quarter was $48 million, which improved from $37.2 million in the previous quarter.

Outlook

For the first quarter of 2013, SolarWinds expects revenues in the range of $74.9-$75.7 million, reflecting a 26%-27% upside on a year-over-year basis. Management expects non-GAAP earnings per share to be 37 cents for the forthcoming quarter. The Zacks Consensus Estimate expects SolarWinds to report 31 cents per share in the first quarter.

SolarWinds also provided its fiscal 2013 guidance. Management expects revenues in the range of $330 million - $338 million and non-GAAP earnings per share between $1.57 and $1.62.

Recommendation

We believe that SolarWinds is well positioned to grow on its recurring maintenance revenue stream. Moreover, strategic acquisitions are expected to be incrementally beneficial over the long run. Moreover, the company’s expanding product portfolio and expansions in the Asia-Pacific and the Latin American countries, particularly in Brazil, should act as a positive catalyst going forward.

However, increased investments in products and expansionary initiatives will likely impact margins in the near term. Moreover, volatile macroeconomic environment and competition from bellwethers such as IBM Corp. , Hewlett Packard Company and BMC Software are the major headwinds going forward.

Currently, SolarWinds has a Zacks Rank #3 (Hold).

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