Editor's note: A previous version of this article incorrectly stated that VMware missed analysts' revenue estimates. The article has been updated to reflect the fact that on a non-GAAP basis, the company met estimates based on data collected from Thompson Reuters and Zacks.
VMware (NYSE: VMW), the leading provider of virtualization solutions, reported its second-quarter earnings after market close on July 21. The results were solid, with the company beating analysts' estimates for earnings and meeting non-GAAP expectations for revenue.
VMware reported second-quarter GAAP revenue of $1.52 billion, up 4% compared with the second quarter of 2014. Currency effects had a negative impact on the company's revenue growth, and on a constant currency basis revenue grew by 8% year over year.
Non-GAAP revenue was $1.59 billion, in-line with analysts' estimates. The company was hit with a $75.5 million charge related to a settlement with the Department of Justice and the General Services Administration. VMware was accused of misrepresenting commercial pricing practices and overcharging the government, which violated the False Claims Act. This adjustment is reflected in the GAAP revenue figure.
Revenue from licenses rose 4% year over year, to $638 million, while services revenue jumped 13.8% to $959 million. VMware's unearned revenue balance sat at $4.81 billion at the end of the quarter, down slightly from the end of 2014.
VMware reported non-GAAP EPS of $0.93, up 15% year over year and two cents better than analysts were expecting. This was far higher than the company's $0.40 GAAP EPS, with the discrepancy mostly coming from stock-based compensation.
Operating costs rose a bit faster than revenue, leading VMWare's operating margin to shrink to 13.5%, compared with 13.7% during the same period last year. If the reduction in revenue related to the settlement is backed out, VMware's operating margin would have decreased further, to 12.9%.
CEO Pat Gelsinger had this to say about VMware's second quarter: "Our second-quarter results are solid, building on our solid start to the year in Q1. We experienced strong industry validation from industry analysts, partners, and customers throughout the quarter and also unveiled our Business Mobility strategy and key announcements enabling organizations to transform their business processes."
Helping boost per-share earnings was the $412 million VMware spent on share buybacks in the second quarter. During the first half of 2015, the company has spent a total of $850 million on buybacks, more than double what it had spent through the first half of 2014. The diluted share count fell by about 1.7% year over year.
Third-quarter and full-year guidance
VMware also provided guidance for both the third quarter and the full year. Non-GAAP EPS is expected to be between $0.98 and $1.00 during the third quarter, compared with $0.87 in the third quarter of 2014. For the full year, non-GAAP EPS is expected to come in between $3.97 and $4.03, up from $3.56 in fiscal 2014 and right in line with the average analyst estimate. Non-GAAP revenue is expected to grow between 12% and 14% in constant currency for the full year, with license revenue expected to grow by a slower 9%-11%.
VMware expects cash flow from operations to total $1.875 billion in fiscal 2015, with $350 million being spent on capital expenditures. The bulk of the remaining free cash flow will be spent on the $1.25 billion of stock the company expects to buy back during the full year. Despite this buyback, an expected diluted share count of 427 million will only be slightly lower compared with the end of 2014 because of dilution from stock-based compensation.
VMware expects its GAAP operating margin to be between 16% and 18% during fiscal 2015, a bit lower than typical margins from the past few years. In fact, in three of the past four years, VMware's operating margin has been above this range, topping out at 21% during 2013. On a non-GAAP basis, operating margin is expected to be about 31.5%.
VMware reported a solid quarter relative to analyst expectations, although GAAP revenue was affected by both currency and the one-time settlement charge. Revenue growth was much stronger adjusting for these items, and guidance was right in line with analyst expectations.
Timothy Green has no position in any stocks mentioned. The Motley Fool recommends VMware. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.