Adobe 2004 Annual Report Download - page 55

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55
2003 this long term investment exposure totaled a notional equivalent of $40.1 million and $30.8 million,
respectively. At this time we do not hedge these long term investment exposures.
Our Japanese operating expenses are in yen, and our European operating expenses are primarily in euro, which
mitigates a portion of the exposure related to yen and euro denominated product revenue. In addition, we hedge
firmly committed transactions using forward contracts. These contracts do subject us to risk of accounting gains and
losses; however, the gains and losses on these contracts largely offset gains and losses on the assets, liabilities and
transactions being hedged. We also hedge a percentage of forecasted international revenue with forward and
purchased option contracts. Our revenue hedging policy is designed to reduce the negative impact on our forecasted
revenue due to foreign currency exchange rate movements. At December 3, 2004, total outstanding contracts
included the notional equivalent of $110.9 million in foreign currency forward exchange contracts and purchased
put option contracts with a notional value of $221.6 million. As of December 3, 2004, all contracts were set to
expire at various times through June 2005. The bank counterparties in these contracts expose us to credit-related
losses in the event of their nonperformance. However, to mitigate that risk we only contract with counterparties with
specific minimum rating requirements. In addition, our hedging policy establishes maximum limits for each
counterparty.
Economic Hedging – Hedges of Forecasted Transactions
We use option and forward foreign exchange contracts to hedge certain operational (“cash flow”) exposures
resulting from changes in foreign currency exchange rates. These foreign exchange contracts, carried at fair value,
may have maturities between one and twelve months. Such cash flow exposures result from portions of our
forecasted revenues denominated in currencies other than the U.S. dollar, primarily the Japanese yen and the euro.
We enter into these foreign exchange contracts to hedge forecasted product licensing revenue in the normal course
of business, and accordingly, they are not speculative in nature.
We record changes in the intrinsic value of these cash flow hedges in accumulated other comprehensive income
(loss), until the forecasted transaction occurs. When the forecasted transaction occurs, we reclassify the related gain
or loss on the cash flow hedge to revenue. In the event the underlying forecasted transaction does not occur, or it
becomes probable that it will not occur, we reclassify the gain or loss on the related cash flow hedge from
accumulated other comprehensive income (loss) to interest and other income (loss) on the consolidated statement of
income at that time. For the fiscal year ended December 3, 2004, there were no such net gains or losses recognized
in other income relating to hedges of forecasted transactions that did not occur.
The critical terms of the cash flow hedging instruments are the same as the underlying forecasted transactions.
The changes in fair value of the derivatives are intended to offset changes in the expected cash flows from the
forecasted transactions. We record any ineffective portion of the hedging instruments in other income (loss) on the
consolidated statement of income. The time value of purchased derivative instruments is deemed to be ineffective
and is recorded in other income (loss) over the life of the contract.
See also Note 16 in our Notes to Consolidated Financial Statements.
Balance Sheet Hedging - Hedging of Foreign Currency Assets and Liabilities
We hedge our net recognized foreign currency assets and liabilities with forward foreign exchange contracts to
reduce the risk that our earnings and cash flows will be adversely affected by changes in foreign currency exchange
rates. These derivative instruments hedge assets and liabilities that are denominated in foreign currencies and are
carried at fair value with changes in the fair value recorded as other income (loss). These derivative instruments do
not subject us to material balance sheet risk due to exchange rate movements because gains and losses on these
derivatives are intended to offset gains and losses on the assets and liabilities being hedged. At December 3, 2004,
the outstanding balance sheet hedging derivatives had maturities of 90 days or less.
A sensitivity analysis was performed on all of our foreign exchange derivatives as of December 3, 2004. This
sensitivity analysis was based on a modeling technique that measures the hypothetical market value resulting from a
10% and 15% shift in the value of exchange rates relative to the U.S. dollar. For option contracts, the Black-Scholes
equation model was used. For forward contracts, duration modeling was used where hypothetical changes are made