Adobe 2005 Annual Report Download - page 54

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54
As part of our limited partnership interests in Adobe Ventures, we have provided a general indemnification to
Granite Ventures, an independent venture capital firm and sole general partner of Adobe Ventures, for certain events
or occurrences while Granite Ventures is, or was serving, at our request in such capacity provided that Granite
Ventures acts in good faith on behalf of the partnerships. We are unable to develop an estimate of the maximum
potential amount of future payments that could potentially result from any hypothetical future claim, but believe the
risk of having to make any payments under this general indemnification to be remote.
Royalties
We have certain royalty commitments associated with the shipment and licensing of certain products. Royalty
expense is generally based on a dollar amount per unit shipped or a percentage of the underlying revenue and are not
included in the table above. Royalty expense, which was recorded under our cost of products revenue on our
consolidated statements of income, was approximately $17.8 million, $15.9 million and $14.5 million in fiscal 2005,
2004 and 2003, respectively. Certain royalty commitments have minimum commitment obligations, however, as of
December 2, 2005 all such obligations were immaterial.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
All market risk sensitive instruments were entered into for non-trading purposes.
Foreign Currency Hedging Instruments
We transact business in foreign countries, in U.S. dollars and in various foreign currencies. In Europe and
Japan, transactions that are denominated in euro or yen subject us to exposure from movements in foreign currency
exchange rates. This exposure is primarily related to yen-denominated product and support revenue in Japan and
euro-denominated product and support revenue in certain European countries. In fiscal 2005, 2004 and 2003, our
revenue exposures were 26.4 billion yen, 24.1 billion yen and 21.3 billion yen, respectively. In fiscal 2005, 2004 and
2003, our revenue exposures were 411.4 million euros, 375.4 million euros and 274.0 million euros, respectively.
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 intended to reduce the negative impact on our forecasted
revenue due to foreign currency exchange rate movements. At December 2, 2005, total outstanding contracts were
$339.3 million which included the notional equivalent of $133.0 million in foreign currency forward exchange
contracts which hedged our balance sheet exposures, and the notional equivalent of $206.3 million in purchased put
option contracts which hedged our forecasted revenue. As of December 2, 2005, all contracts were set to expire at
various times through April 2006. 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.
In addition we also have long term investment exposures consisting of the capitalization and retained earnings
in our non-USD functional currency foreign subsidiaries. For the fiscal years ending December 2, 2005 and
December 3, 2004 this long term investment exposure totaled a notional equivalent of $56.7 million and $40.1
million, respectively. At this time we do not hedge these long term investment exposures.
Economic Hedging – Hedges of Forecasted Transactions
We use option 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.