Harman Kardon 2011 Annual Report Download - page 85

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If we do not meet the forecast in our budgets, we could violate our debt covenants and, absent a waiver from
our lenders or an amendment to our Credit Agreement, we could be in default under the Credit Agreement. As a
result, our debt under the Credit Agreement could become due, which would have a material adverse effect on
our financial condition and results of operations. A default under the Credit Agreement, if the lenders were to
accelerate the amounts due thereunder, could also lead to an event of default under the Indenture, as amended,
and the acceleration of the Convertible Senior Notes. As of June 30, 2011, we were in compliance with all the
financial covenants of the Credit Agreement.
Guarantee and Collateral Agreement
In connection with the Credit Agreement, we and Harman KG entered into a guarantee and collateral
agreement (the “Guarantee and Collateral Agreement”) which provides, among other things, that the obligations
under the Credit Agreement are guaranteed by us and each of the subsidiary guarantors party thereto, and that the
obligations generally are secured by liens on substantially all of our assets and certain of our subsidiary
guarantors’ assets.
The term of the Guarantee and Collateral Agreement corresponds with the term of the Credit Agreement,
which matures on December 1, 2015. Under the terms of this Guarantee and Collateral Agreement, we have
effectively guaranteed the payment of the full amount of borrowings under the Credit Agreement, including
outstanding letters of credit, upon maturity. The potential amount of future payments that we would be required
to pay under the Guarantee and Collateral Agreement is the amount that we have borrowed under the Credit
Agreement, including outstanding letters of credit. At June 30, 2011, we had no borrowings under the Credit
Agreement and had outstanding letters of credit of $7.3 million.
Convertible Senior Notes
We had $400 million of Convertible Senior Notes outstanding at June 30 2011 and 2010 which were issued
on October 23, 2007 (the “Issuance Date”) and are due on October 15, 2012. The Convertible Senior Notes were
issued at par and we pay interest at a rate of 1.25 percent per annum on a semiannual basis. The initial conversion
rate on the Convertible Senior Notes is 9.6154 shares of our common stock per $1,000 principal amount of the
Convertible Senior Notes (which is equal to an initial conversion price of approximately $104 per share). The
conversion rate is subject to adjustment in specified circumstances described in the Indenture.
Accounting guidance issued by the FASB requires the issuer of convertible debt instruments with cash
settlement features to account separately for the liability and equity components of the instrument. Under this
guidance, the debt is recognized at the present value of its cash flows discounted using the issuer’s
nonconvertible debt borrowing rate at the time of issuance and the equity component is recognized as the
difference between the proceeds from the issuance of the note and the fair value of the liability, net of taxes. The
reduced carrying value on the convertible debt results in a debt discount that is accreted back to the convertible
debt’s principal amount through the recognition of noncash interest expense over the expected life of the debt,
which results in recognizing interest expense on these borrowings at effective rates approximating what we
would have incurred had nonconvertible debt with otherwise similar terms been issued.
In accordance with this guidance, we measured the fair value of the debt components of the Convertible
Senior Notes at the Issuance Date using an effective interest rate of 5.6 percent. As a result, we attributed $75.7
million of the proceeds received to the conversion feature of the Convertible Senior Notes at the Issuance Date,
which is netted against the face value of the Convertible Senior Notes as a debt discount. This amount represents
the excess proceeds received over the fair value of the Convertible Senior Notes at the Issuance Date and is being
accreted back to the principal amount of the Convertible Senior Notes through the recognition of noncash interest
expense over the expected life of the Convertible Senior Notes. In addition, we recorded $48.3 million within
additional paid-in capital in our Consolidated Balance Sheets representing the equity component of the
Convertible Senior Notes, which is net of deferred taxes. The effect of this guidance has resulted in a decrease to
net income and earnings per share for all periods presented; however, there is no effect on our cash interest
payments.
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