Adobe 2005 Annual Report Download - page 90

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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.
To receive hedge accounting treatment, all hedging relationships are formally documented at the
inception of the hedge and the hedges must be highly effective in offsetting changes to future cash flows on
hedged transactions. We record changes in the intrinsic value of these cash flow hedges in accumulated
other comprehensive income (loss) until the forecasted transaction occurs. As of December 2, 2005, we
estimate that $5.3 million of existing gains will be reclassified into revenue from accumulated other
comprehensive income (loss) within the next twelve months.
When the forecasted transaction occurs, we reclassify the related gain or loss on the cash flow hedge to
revenue. During fiscal 2005, 2004 and 2003, net gains (losses) of $7.5 million, $(0.4) million and $(3.5)
million, respectively, were reclassified from accumulated other comprehensive income (loss) to revenue. In
the event the underlying forecasted transaction does not occur, or it becomes probable that it will not occur,
the related hedge gains and losses on the cash flow hedge are reclassified from accumulated other
comprehensive income (loss) to interest and other income (loss) on the consolidated statement of income at
that time. For fiscal 2005, there were no such net gains or losses recognized in other income relating to
hedges of forecasted transactions that did not occur.
We evaluate hedging effectiveness prospectively and retrospectively and record any ineffective portion
of the hedging instruments in other income (loss) on the consolidated statement of income. The net gain
(loss) recognized in other income (expense) for cash flow hedges due to hedge ineffectiveness was
insignificant for fiscal 2005, 2004 and 2003. 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. Other income (loss) for
fiscal 2005, 2004 and 2003 included $2.6 million, $(2.6) million and $(1.1) million of net gains (losses),
respectively, representing the cost of the purchased options.
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. 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 2, 2005, the outstanding balance sheet hedging derivatives
had maturities of 150 days or less.
Net gains in other income relating to balance sheet hedging for fiscal 2005, 2004 and 2003
2005 2004 2003
Gain (loss) on foreign currency assets and liabilities:
Net realized gain (loss) recognized in other income ............. $ (9,604) $ 4,586 $ 13,535
Net unrealized gain (loss) recognized in other income ......... (4,088) 3,949 132
(13,692) 8,535 13,667
Gain (loss) on hedges of foreign currency assets and
liabilities:
Net realized gain (loss) recognized in other income ............. 9,893 (11,123) (8,726)
Net unrealized gain (loss) recognized in other income ......... 5,747 3,150 (3,483)
15,640 (7,973) (12,209)
Net gain recognized in other income............................... $ 1,948 $ 562 $ 1,458
Fair Value Hedges – Hedging of Foreign Currency Denominated Available for Sale Securities
During fiscal 2004, a portion of our investment portfolio was invested in euro denominated securities.
In order to mitigate the currency risk of those euro denominated securities, we entered into forward
currency contracts designated as fair value hedges. During fiscal 2005 we did not invest in euro
denominated securities.
Net gains recognized in other income relating to fair value hedges for fiscal 2004 were as follows: