SolarWinds Reports Stellar 2Q

Zacks

SolarWinds Inc. (SWI) reported a stellar second quarter 2012 with non-GAAP earnings increasing 50.0% from the year-ago quarter to 33 cents per share. The upside in the earnings was driven by robust top-line growth and solid margin expansion.

However, including stock based compensation of 5 cents, but excluding amortization and acquisition related expenses of 5 cents and proportionate tax item of one cent, earnings came in at 29 cents a share, exceeding the Zacks Consensus Estimate by a nickel.

Quarter Details

Revenue for quarter increased 39.7% from the previous-year quarter to $64.0 million driven by higher license revenue and maintenance revenue. License revenue, which accounted for 46.0% of the total revenue, increased by 39.7% year on year in the second quarter. Maintenance revenue, which accounted for the remaining 54.0% of revenues, increased 39.7% from the previous-year quarter.

Gross profit (including stock based compensation but excluding amortization and other one time items) increased 39.7% from the previous-year quarter to $61.5 million. Gross margin for the quarter remained flat year on year at 96.0% due to unfavorable business mix.

Operating expenses increased 31.4% from the previous-year quarter to $30.9 million due to 12.3% increase in the general & administrative expenses and 37.6% increase in both sales & marketing expenses as well as research & development expenses. However, as a percentage of revenue, operating expenses declined 310 basis points from the previous-year quarter to 48.3%.

Operating income increased 49.1% from the previous-year quarter to $30.5 million. Operating margin increased 300 basis points to 47.7% primarily due to the decline in operating expenses as a percentage of revenue.

Net income for the quarter was up 51% from the previous-year quarter to $22.1 million. Net margin expanded from 31.9% in the previous-year quarter to 34.5%.

SolarWinds exited the quarter with cash, cash equivalents and short-term investments of $183.1 million versus $171.2 million in the previous quarter. Cash from operations increased sequentially from $28.3 million to $34.1 million. Free cash flow for the quarter was $35.2 million, which improved from $30.8 million in previous quarter.

Outlook

For the third quarter, SolarWinds expects revenues in the range of $66.0-$68.5 million, reflecting a 22%-27% upside from the previous-year quarter. Management expects non-GAAP diluted earnings per share to be in the range of 29-31 cents. The Zacks Consensus Estimate expects Solarwinds to report 28 cents per share in the third quarter.

During the third quarter, management plans to set up sales teams focused on selling new SolarWinds products, such as SolarWinds Storage Manager, SolarWinds Virtualization Manager and SolarWinds Patch Manager. Management also plans to expand the cross-selling teams across domestic circles and internationally.

For fiscal 2012, management expects revenues in the range of $257.0-$263.0 million and non-GAAP diluted earnings per share of $1.20-$1.24.

Recommendation

We believe that Solarwinds is well positioned to grow based on its recurring maintenance revenue stream. Moreover, strategic acquisitions are expected to be incrementally beneficial over the long run.

However, volatile macro-economic environment and competition from bellwethers such as IBM Corp. (IBM) and Hewlett Packard Company (HPQ) are the major headwinds going forward.

We have a Neutral recommendation on SolarWinds over the long term. Currently, SolarWinds has a Zacks #3 Rank, which implies a short-term Hold rating.

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