SolarWinds Beats 1Q Earnings

SolarWinds Inc. ( SWI - Snapshot Report ) reported first-quarter 2013 non-GAAP earnings of 41 cents per share, which increased 36.7% from the year-ago quarter. Including stock-based compensation, earnings came in at 34 cents per share, ahead of the Zacks Consensus Estimate of 32 cents per share. The upside in earnings was driven by robust top-line growth and margin expansion.

Revenues

Revenues for the reported quarter increased 22.2% year over year to $72.9 million but failed to beat management’s revenue guidance of $74.9–$75.7 million. Reported revenues also lagged the Zacks Consensus Estimate of $75 million.

Higher license and maintenance revenues aided the year-over-year top-line expansion. License revenues, which accounted for 42% of the total revenue, increased 11.9% year over year to $30.7 million, primarily attributable to the commercial business.

Maintenance revenues, which accounted for the remaining 58% of revenues, increased 31.0% from the year-ago quarter to $42.2 million on strong customer retention.

Margins

Non-GAAP gross profit increased 22.4% from the year-ago quarter to $70.0 million. Gross margin for the quarter expanded approximately 20 basis points (“bps”) from the year-ago quarter to 96.0% due to higher revenue base. Including stock-based compensation expense and related employer-paid payroll taxes, gross profit came in at $69.8 million.

Non-GAAP operating income increased 29% from the year-ago quarter to $40.7 million, while operating margin increased 300 bps to 55.9%. Operating margins expanded primarily due to a 280 bps improvement 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 $33.8 million.

Non-GAAP net income increased from $22.8 million or 30 cents per share to $31.2 million or 41 cents. Including stock-based compensation and related employer-paid payroll taxes, net income came in at $26.2 million or 34 cents.

Balance Sheet

SolarWinds exited the quarter with cash, cash equivalents and short-term investments of $265.8 million versus $229 million in the previous quarter. Cash from operations was $30.9 million compared with $35 million in the previous quarter. Free cash flow for the quarter was $34.8 million.

Outlook

For the second quarter of 2013, SolarWinds expects revenues in the range of $77.8–$78.8 million, up 21%–23% on a year-over-year basis. License revenues are expected to increase in the range of 15%–17% on a year-over-year basis, while management expects maintenance revenues to grow in the range of 27% to 28% in the second quarter.

Management expects non-GAAP earnings per share between 37 cents and 38 cents for the forthcoming quarter. The Zacks Consensus Estimate for the second-quarter earnings is pegged at 35 cents per share.

SolarWinds lowered its fiscal 2013 revenue guidance range from $330–$338 million to $326.5–$334.0 million. However, management increased its non-GAAP earnings per share guidance from $1.57–$1.62 to $1.59–$1.65.

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 IBM Corp. ( IBM - Analyst Report ) , Hewlett Packard Company ( HPQ - Analyst Report ) and BMC Software ( BMC - Analyst Report ) are the major headwinds going forward.

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