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No Surprise Here: Adobe Beats Estimates in Fiscal 3Q16

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Part 8
No Surprise Here: Adobe Beats Estimates in Fiscal 3Q16 PART 8 OF 12

Adobe Posts Bottom-Line Growth Again in Fiscal 3Q16

Double-digit growth signifies successful transition to cloud

Previously in this series, we looked at Adobe Systems’ (ADBE) fiscal 3Q16 performance. Although its revenue increased by 20% to reach $1.5 billion in fiscal 3Q16, its net income growth exceeded this. Adobe’s non-GAAP (generally accepted accounting principles) net income grew 55% to $270.8 million in the quarter.

Adobe Posts Bottom-Line Growth Again in Fiscal 3Q16

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Adobe’s operating margin improved significantly from 20.2% in fiscal 3Q15 to 25.2% in fiscal 3Q16, as shown in the graph above. A reduction in operating expenses, primarily S&M (sales and marketing) and G&A (general and administrative) expenses, led to an expansion in Adobe’s margins. S&M and G&A fell from 34.7% and 10.1%, respectively, in 3Q15, to 32.6% and 9.8% in 3Q16.

Expansion shows successful transition to cloud

In the past, we’ve discussed how the market was wary of the impact of Adobe’s transition toward a subscription model. Cloud-based subscription revenue is recognized over an extended period. In contrast, software revenue boosts the top line immediately.

As a result, in the short term, the reduction in upfront revenue puts pressure on margins. However, in the long term, it results in higher profitability and visibility due to greater efficiency and the recurring nature of the cloud model.

Although Adobe has decent cash reserves and low debt, its margins were a source of concern. Lower margins translate to a strong likelihood that a company will assume debt to fund share buybacks. This has become a sort of trend in the technology industry. However, we also need to consider that most tech companies have had to resort to bond issuances to borrow for acquisitions, dividends, and buybacks, as their cash reserves are held overseas.

However, as shown in the above graph, Adobe has managed to consistently improve its earnings with each passing quarter, which explains the almost consistent rise in Adobe’s stock.

Oracle (ORCL) announced its biggest bond sale of $14 billion in late June 2016. Oracle had $54.1 billion in debt in fiscal 1Q17.

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