Adobe’s Disclosure Highlights

10-Q from the Quarter ended June 1, 2001

(1) What’s FAS 133? - The disclosure provides a clear paragraph explaining the essence of FAS 133. "Effective December 2, 2000, we adopted SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 establishes accounting and reporting standards for derivative instruments and hedging activities and requires us to recognize these as either assets or liabilities on the balance sheet and measure them at fair value. Gains and losses resulting from changes in fair value are accounted for depending on the use of the derivative and whether it is designated and qualifies for hedge accounting."

(2) Different hedging strategies – The disclosure goes through the various hedging strategies at Adobe (economic, balance sheet and equity) providing information for category each about:

• The risk management objective
• Type of instruments being used as hedges
• Duration of instruments
• Exposure (the source of the risk exposure)
• Effectiveness (how the hedge and hedged item compare)
• Results for the quarter
• Finally, a table summarizing gains/losses on particular derivatives in those hedge strategies for the quarter and year-to-date

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 have a duration between three to twelve months. Such exposures result from portions of our forecasted revenues denominated in currencies other than the U.S. dollar ("USD"), 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 fair value of the derivative instruments designated as cash flow hedges of forecasted non-USD revenue from the licensing of our products 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 other income on the consolidated statement of income at that time. During the quarter, 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 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 on the consolidated statement of income. The cost of purchased derivative instruments are deemed to be ineffective and are recorded in other income on the consolidated statement of income when the contracts are entered into."

Gain (Loss) on Hedges of Forecasted Transactions:

"As of June 1, 2001, $5.2 million in other comprehensive income represents the total anticipated gain to be reclassified to revenue over the next twelve months as the forecasted transactions occur; $2.6 million represents the total recognized in revenue during the quarter relating to hedged transactions which occurred; total loss recognized in other income was $0.9 million which consisted of a $3.1 million realized loss of which the majority relates to the cost of purchased options, and a $2.2 million gain that was recognized for the ineffective portion relating to hedges for forecasted transactions.

During the first six months of fiscal 2001, $3.3 million was recognized in revenue relating to hedged transactions which occurred; total loss recognized in other income was $3.5 million, which consisted of a $3.7 million realized net loss of which the majority relates to the cost of purchased options, and a $0.2 million gain that was recognized for the ineffective portion relating to hedges for forecasted transactions.

Balance Sheet Hedging—Hedging of Foreign Currency Assets and Liabilities

"Furthermore, we continue to 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 marked-to-market through 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 offset gains and losses on the assets and liabilities being hedged. At June 1, 2001, forward foreign exchange contracts outstanding had maturities of 60 days or less."

Net Gain (Loss) Recognized in Other Income Relating to Balance Sheet Hedging:

Equity Hedging

"We also have a policy that allows us to hedge our equity holdings in publicly traded companies. We use forward contracts to hedge the fair value of these equity investments. These are accounted for as "Fair Value Hedges" in accordance with SFAS 133. The difference between the cost and market value of the equity investments prior to entering into fair value hedges remains in other comprehensive income. As of June 1, 2001, an unrealized gain of $5.0 million remains in other comprehensive income and is expected to be reclassified to other income when the equity is sold within the next twelve months. Subsequent to the hedge, any changes in market value of the shares being hedged, up to the date of delivery against the forward contracts, and any changes in the value of the forward contracts are recognized in nonoperating income (loss).

As of June 1, 2001, we had one forward contract outstanding relating to equities. The fair value of the forward contract was $4.9 million. An unrealized loss of $4.7 million on the underlying equities was recorded in investment gains (losses), while a gain of $4.7 million on the forward contract, which hedged the underlying equity, was recorded in other income. The ineffective portion, a gain of $0.2 million relating to the forward premium, was also recorded in other income."