|
|
 | | | |
- close
- close
- close
- close
| |||||||||
Harman International Industries 10-Q 2011 Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended December 31, 2010 OR
For the Transition Period from to Commission File Number: 1-9764
Harman International Industries, Incorporated (Exact name of registrant as specified in its charter)
(203) 328-3500 (Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No As of January 31, 2011, 95,268,780 shares of common stock, par value $.01, were outstanding.
Table of ContentsHARMAN INTERNATIONAL INDUSTRIES, INCORPORATED AND SUBSIDIARIES Form 10-Q December 31, 2010 Table of Contents
The page numbers in this Table of Contents reflect actual page numbers, not EDGAR page tag numbers. References to “Harman International”, the “Company”, “we”, “us”, and “our” in this Form 10-Q refer to Harman International Industries, Incorporated and its subsidiaries unless the context requires otherwise. Harman International, the Harman International logo, and the Harman International products and brand names referred to herein are either the trademarks or the registered trademarks of Harman International. All other trademarks are the property of their respective owners.
Table of ContentsForward-Looking Statements This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. You should not place undue reliance on these statements. Forward-looking statements include information concerning possible or assumed future results of operations, cash flows, capital expenditures, the outcome of pending legal proceedings and claims, goals and objectives for future operations, including descriptions of our business strategies and purchase commitments from customers. These statements are typically identified by words such as “believe,” “anticipate,” “expect,” “plan,” “intend,” “estimate,” “should,” “will” and similar expressions. We base these statements on particular assumptions that we have made in light of our industry experience, as well as our perception of historical trends, current conditions, expected future developments and other factors that we believe are appropriate under the circumstances. As you read and consider the information in this report, you should understand that these statements are not guarantees of performance or results. They involve risks, uncertainties and assumptions. In light of these risks and uncertainties, we cannot assure you that the results and events contemplated by the forward-looking statements contained in, or incorporated by reference into, this report will in fact transpire. You should carefully consider the risks described below and the other information in this report because they identify important factors that could cause actual results to differ materially from those predicted in any such forward-looking statements. Our operating results may fluctuate significantly and may not meet our expectations or those of securities analysts or investors. The price of our stock would likely decline if this occurs. Factors that may cause fluctuations in our operating results include, but are not limited to, the following:
Although we believe that these forward-looking statements are based on reasonable assumptions, you should be aware that many factors could affect our actual results of operations and could cause actual results to differ materially from those expressed in the forward-looking statements. As a result, the foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this and other reports we file with the Securities and Exchange Commission including the information in Item 1A, under the caption “Risk Factors” of Part I to our Annual Report on Form 10-K for the fiscal year ended June 30, 2010. We undertake no obligation to publicly update or revise any forward-looking statement (except as required by law).
i
Table of Contents
CONDENSED CONSOLIDATED BALANCE SHEETS HARMAN INTERNATIONAL INDUSTRIES, INCORPORATED AND SUBSIDIARIES
See accompanying Notes to the Condensed Consolidated Financial Statements.
1
Table of ContentsCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS HARMAN INTERNATIONAL INDUSTRIES, INCORPORATED AND SUBSIDIARIES (Unaudited)
See accompanying Notes to the Condensed Consolidated Financial Statements.
2
Table of ContentsCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS HARMAN INTERNATIONAL INDUSTRIES, INCORPORATED AND SUBSIDIARIES (Unaudited)
3
Table of Contents
See accompanying Notes to the Condensed Consolidated Financial Statements.
4
Table of ContentsHARMAN INTERNATIONAL INDUSTRIES, INCORPORATED AND SUBSIDIARIES Notes to the Condensed Consolidated Financial Statements (In thousands, except per-share data and where otherwise noted) (Unaudited) Note 1 – Basis of Presentation Basis of Presentation References to “we,” “us,” “our,” the “Company” and “Harman” refer to Harman International Industries, Incorporated and its consolidated subsidiaries unless the context specifically requires otherwise. Our unaudited, condensed consolidated financial statements at December 31, 2010 and for the three and six months ended December 31, 2010 and 2009, have been prepared pursuant to rules and regulations of the Securities and Exchange Commission (the “SEC”). These unaudited condensed consolidated financial statements have been prepared in accordance with the accounting policies described in our Annual Report on Form 10-K for the fiscal year ended June 30, 2010 (our “2010 Form 10-K”) and do not include all information and footnote disclosures included in our audited financial statements. In the opinion of management, the accompanying unaudited, condensed consolidated financial statements include all adjustments, consisting of normal recurring adjustments and accruals, necessary to present fairly, in all material respects, the consolidated financial condition, results of operations and cash flows for the periods presented. Operating results for the three and six months ended December 31, 2010 are not necessarily indicative of the results that may be expected for the full fiscal year ending June 30, 2011 due to seasonal, economic and other factors. Where necessary, information for prior periods has been reclassified to conform to the consolidated financial statement presentation for the corresponding periods in the current fiscal year. The methods, estimates and judgments we use in applying our accounting policies, in conformity with generally accepted accounting principles in the United States (“GAAP”), have a significant impact on the results we report in our financial statements. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. The estimates affect the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. These unaudited Condensed Consolidated Financial Statements should be read in conjunction with our audited consolidated financial statements and accompanying notes included in our 2010 Form 10-K. Allowance for Doubtful Accounts: We reserve an estimated amount for accounts receivable that may not be collected. Methodologies for estimating the allowance for doubtful accounts are primarily based on specific identification of uncollectible accounts. Historical collection rates and customer credit worthiness are considered in determining specific reserves. At December 31, 2010 and June 30, 2010, we had $7.9 million and $8.1 million, respectively, reserved for possible uncollectible accounts receivable. Discontinued Operations: The results of operations of businesses that have been sold are presented separately as Income from discontinued operations, net of income taxes, in our Condensed Consolidated Statement of Operations, in the current and prior periods, where applicable. Amounts in prior periods have been restated in the Notes to the Condensed Consolidated Financial Statements to reflect continuing operations. Refer to Note 19—Discontinued Operations for further information. Note 2 – New Accounting Standards Recently Adopted Accounting Standards Variable Interest Entities: On July 1, 2010, we adopted the new accounting guidance issued by the Financial Accounting Standards Board (“FASB”) within Accounting Standards Codification (“ASC”) 810 “Consolidation” regarding certain amended provisions relating to the consolidation of variable interest entities (“VIE”). The amended provisions primarily include (i) amending the guidance for determining whether an entity is a VIE and (ii) amending the criteria for identification of the primary beneficiary of a VIE. The new provisions also require us to continually reassess whether we are the primary beneficiary of a VIE and require that we enhance our disclosures in the financial statements about our VIE relationships. The adoption of the new guidance did not have any impact on our financial condition or results of operations. Transfers of Financial Assets: On July 1, 2010, we adopted the new accounting guidance issued by the FASB within Accounting Standards Update (“ASU”) 2009-16 “Transfers and Servicing (Topic 860): Accounting for the Transfers of Financial Assets” relating to the accounting for transfers of financial assets. The new guidance requires additional disclosures relating to the transparency of transfers of financial assets. The adoption of the new guidance did not have any impact on our financial condition or results of operations.
5
Table of ContentsMultiple Element Revenue Arrangements: On July 1, 2010, we adopted the new accounting guidance issued by the FASB relating to the accounting for multiple element revenue arrangements issued in ASC 605-25 and ASC 985-707. The new guidance requires a vendor to allocate revenue to each standalone deliverable in arrangements involving multiple deliverables based on the relative selling price of each deliverable. It also changes the level of evidence of the standalone selling price required to separate deliverables by allowing a vendor to make its best estimate of the standalone selling price of deliverables when more objective evidence of selling price is not available. The new guidance also excludes sales of tangible products that contain essential software elements from the scope of revenue recognition for software arrangements. Because of these changes, revenue is recognized earlier for many revenue transactions involving multiple deliverables and sales of software enabled devices. The new guidance also requires additional disclosures relating to qualitative and quantitative information about a vendor’s revenue arrangements and about the significant judgments made about the application of the new guidance and any changes in those judgments or the application that may significantly affect the timing or amount of revenue recognition. The new guidance can be adopted on a prospective basis or in certain circumstances on a retrospective basis. We adopted the new guidance on a prospective basis and applied the new guidance to all arrangements entered into or materially modified in fiscal years beginning after June 15, 2010. The adoption of the new guidance did not have any impact on our financial condition or results of operations. Note 3 – Inventories, net Inventories, net consist of the following:
At December 31, 2010 and June 30, 2010, our inventory reserves were $88.8 million and $75.1 million, respectively. Note 4 – Property, Plant and Equipment, net Property, plant and equipment consist of the following:
Depreciation expense for the three months ended December 31, 2010 and 2009 was $28.5 million and $33.2 million, respectively, and was $54.9 million and $66.2 million for the six months ended December 31, 2010 and 2009, respectively. Note 5 – Accrued Warranties We warrant our products to be free from defects in materials and workmanship for periods ranging from six months to six years from the date of purchase, depending on the business segment and product. Our dealers and warranty service providers normally perform warranty service in field locations and regional service centers, using parts and replacement finished goods we supply on an exchange basis. Our dealers and warranty service providers also install updates we provide to correct defects covered by our warranties. Estimated warranty liabilities are based upon past experience with similar types of products, the technological complexity of certain products, replacement cost and other factors. If estimates of warranty provisions are no longer adequate based on our analysis of current activity, incremental provisions are recorded as warranty expense in our Condensed Consolidated Statement of Operations. We take these factors into consideration when assessing the adequacy of our warranty provision for periods still open to claim.
6
Table of ContentsDetails of our accrued warranties are as follows:
Note 6 – Earnings Per Share The following table presents the calculation of basic and diluted earnings per share of common stock outstanding:
7
Table of Contents
Options to purchase 1,752,421 and 2,512,811 shares of our common stock with exercise prices ranging from $30.08 to $126.94 and $28.51 to $126.94 per share were outstanding during the three months ended December 31, 2010 and 2009, respectively, and excluded from the computation of diluted earnings per share because they would have been antidilutive. In addition, restricted shares and restricted stock units of 18,404 and zero were outstanding during the three months ended December 31, 2010 and 2009, respectively, and were excluded from the computation of diluted earnings per share as they also would have been antidilutive. Options to purchase 1,702,404 and 2,639,805 shares of our common stock with exercise prices ranging from $28.51 to $126.94 and $26.64 to $126.94 per share were outstanding during the six months ended December 31, 2010 and 2009, respectively, and excluded from the computation of diluted earnings per share because they would have been antidilutive. In addition, restricted shares and restricted stock units of 13,733 and 4,363 were outstanding during the six months ended December 31, 2010 and 2009, respectively, and were excluded from the computation of diluted earnings per share as they also would have been antidilutive. We had $400 million of 1.25 percent convertible senior notes (the “Convertible Senior Notes”) outstanding at December 31, 2010 and June 30, 2010. The conversion terms of the Convertible Senior Notes will affect the calculation of diluted earnings per share if the price of our common stock exceeds the conversion price of the Convertible Senior Notes. The initial conversion price of the Convertible Senior Notes is approximately $104 per share, subject to adjustment in specified circumstances as described in the indenture governing the Convertible Senior Notes (the “Indenture”). Upon conversion, a holder of Convertible Senior Notes will receive an amount per Convertible Senior Note in cash equal to the lesser of $1,000 or the conversion value of the Convertible Senior Notes, determined in the manner set forth in the Indenture. If the conversion value exceeds $1,000, we will deliver $1,000 in cash and at our option, cash or common stock or a combination of cash and common stock for the conversion price in excess of $1,000. The conversion option is indexed to our common stock and therefore is classified as equity. The conversion option will not result in an adjustment to net income in calculating diluted earnings per share. The dilutive effect of the conversion option will be calculated using the treasury stock method. Therefore, conversion settlement shares will be included in diluted shares outstanding if the price of our common stock exceeds the conversion price of the Convertible Senior Notes. Refer to Note 8 – Debt for further information. Note 7 – Goodwill We test for impairment at the reporting unit level on an annual basis as of April 30th of every year and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying value. The impairment test for goodwill is a two-step process. The first step compares the fair value of each reporting unit to its carrying value, with the fair value of each reporting unit determined using established valuation techniques, specifically the market and income approaches. Should the results of the first step indicate that the fair value of a reporting unit is less than its carrying value, the second step of this test is conducted wherein the amount of any impairment is determined by comparing the implied fair value of goodwill in a reporting unit to the recorded amount of goodwill for that reporting unit. The implied fair value of goodwill is calculated as the excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities. Should the fair value of the goodwill so calculated be less than the carrying value, an impairment charge is recorded. The annual impairment test conducted as of April 30, 2010
8
Table of Contentsindicated that the fair value of each reporting unit was substantially in excess of its carrying value and, as such, no impairment was deemed to exist and therefore we did not recognize any goodwill impairment charges in the three and six months ended December 31, 2010. During the three and six months ended December 31, 2009, we recognized $4.2 million and $7.2 million, respectively, of goodwill associated with the acquisition of innovative systems GmbH (“innovative”) in a prior year. This contingent purchase price consideration was recorded in our Automotive segment. The annual goodwill impairment test conducted in April 2009 indicated that no goodwill was supportable at that time in our Automotive segment and, as a result, we recorded a goodwill impairment charge of $4.2 million and $7.2 million in the three and six months ended December 31, 2009. The contingent purchase price consideration associated with the acquisition of innovative continues indefinitely unless we or the sellers exercise a buyout option within six months from September 1, 2010. As of December 31, 2010, the buyout option has not been exercised. In November 2009, we also recognized $9.5 million of goodwill associated with a prior year acquisition of QNX Software Systems Co., a component of our QNX business, which was recorded as contingent purchase price consideration when the contingency lapsed. The funds to pay this consideration had been placed in escrow and therefore were included in current assets in our Condensed Consolidated Balance Sheets and, as a result, the payment had no effect on our cash balance. In fiscal year 2009, we reclassified our QNX business to our Other segment. We performed a fair value analysis to allocate the goodwill between the Automotive and Other segments and therefore similarly allocated this additional purchase price consideration goodwill between the Automotive and Other segments. As a result, $5.1 million of this goodwill was allocated to our Automotive segment. As discussed above, our annual goodwill impairment test conducted in April 2009 indicated that no goodwill was supportable at that time in our Automotive segment and, as a result, we recorded additional goodwill impairment charges of $5.1 million in both the three and six months ended December 31, 2009. In June 2010, we sold our QNX business to a third party. Refer to Note 19 – “Discontinued Operations” for further information. Note 8 – Debt Short Term Borrowings At December 31, 2010 and June 30, 2010, we had $1.2 million and $13.5 million of short-term borrowings outstanding, respectively, and we maintained lines of credit of $21.2 million, in the aggregate, in Germany, Austria, Brazil and Hungary and $13.6 million, in the aggregate, in Germany, Austria, and Hungary, respectively. New Revolving Credit Facility On December 1, 2010, we and one of our wholly-owned subsidiaries, Harman Holding GmbH & Co. KG (“Harman KG”), entered into a Multi-Currency Credit Agreement (the “Credit Agreement”) with a group of banks. The Credit Agreement provides for a five-year secured revolving credit facility which expires on December 1, 2015 (the “Revolving Credit Facility”) in the amount of $550 million (the “Aggregate Commitment”), of which up to $60 million will be available for letters of credit. Subject to certain conditions set forth in the Credit Agreement, the Aggregate Commitment may be increased up to a maximum aggregate amount of $700 million. The Credit Agreement effectively replaced our previous revolving credit facility, the second amended and restated multi-currency, multi-option credit agreement dated March 31, 2009, as amended (the “2009 Credit Agreement”), which had a maximum borrowing capacity of $231.6 million (the “2009 Maximum Borrowing Capacity”), including outstanding letters of credit, and is more fully described in our 2010 Form 10-K. As a result of such replacement, we voluntarily terminated the 2009 Credit Agreement. There were no outstanding borrowings under the 2009 Credit Agreement as of December 1, 2010, and we incurred no early termination penalties due to the termination of the 2009 Credit Agreement. Interest rates for borrowings under the Revolving Credit Facility range from 0.875 percent to 1.375 percent above the applicable base rate for base rate loans and range from 1.875 percent to 2.375 percent above London Interbank Offered Rate (“LIBOR”) for Eurocurrency loans based on our Total Leverage Ratio (as defined below). In addition, we are obligated to pay an annual facility fee on the Aggregate Commitment, whether drawn or undrawn, ranging from 0.375 percent to 0.625 percent based on our Total Leverage Ratio. Any proceeds from borrowings under the Revolving Credit Facility may be used for general corporate purposes. Interest rates for borrowings under the 2009 Credit Agreement were 3.0 percent above the applicable base rate for base rate loans and 4.0 percent above LIBOR for Eurocurrency loans. In addition, the annual facility fee rate payable under the 2009 Credit Agreement was one percent based on the 2009 Maximum Borrowing Capacity, whether drawn or undrawn.
9
Table of ContentsThe Credit Agreement contains financial condition covenants that require us to maintain the following ratios, each calculated as of the end of the applicable fiscal quarter on a rolling four-quarter basis:
The Credit Agreement also contains covenants that require us to maintain minimum levels of liquidity in certain specified circumstances, imposes limitations on our ability to incur debt, place liens on our assets, make fundamental changes, sell assets, make investments, undertake transactions with affiliates, undertake sale and leaseback transactions, incur guarantee obligations, modify or prepay certain material debt (including the Convertible Senior Notes), enter into hedging agreements, pay dividends, make capital expenditures and acquire certain types of collateral. The Revolving Credit Facility is subject to acceleration upon certain specified events of default, including failure to make timely payments, breaches of representation or covenants, or a change in control of our company, as defined in the Credit Agreement. At December 31, 2010, we had no borrowings under the Credit Agreement and had outstanding letters of credit of $6.7 million. Unused available credit under the Credit Agreement was $543.3 million at December 31, 2010. In connection with the Credit Agreement, we incurred $7.0 million in fees and other expenses which have been capitalized within Other assets in our Condensed Consolidated Balance Sheet. These costs will be amortized over the term of the Credit Agreement on a straight-line basis. In addition, we wrote off $0.7 million of debt issuance costs, associated with the 2009 Credit Agreement, which represented the portion of these costs that were attributed to the previous revolving credit facility. 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 could also lead to an event of default under the Indenture, as amended, and the acceleration of the Convertible Senior Notes. As of December 31, 2010, 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 December 31, 2010, we had no borrowings under the Credit Agreement and had outstanding letters of credit of $6.7 million.
10
Table of ContentsConvertible Senior Notes We had $400 million of Convertible Senior Notes outstanding at December 31, 2010 and June 30, 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 Condensed 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. The principal amounts, unamortized discount and net carrying amounts of the liability components and the equity components for the Convertible Senior Notes as of December 31, 2010 and June 30, 2010 are as follows:
At December 31, 2010, the unamortized discount is recognized as a reduction in the carrying value of the Convertible Senior Notes in the Condensed Consolidated Balance Sheets and is being amortized to Interest expense, net in our Condensed Consolidated Statement of Operations over the expected remaining term of the Convertible Senior Notes of 22 months. Debt issuance costs of $4.8 million were recorded in connection with this transaction and are included in Other assets in our Condensed Consolidated Balance Sheets and are also being amortized to Interest expense, net in our Condensed Consolidated Statements of Operations over the expected remaining term of the Convertible Senior Notes. The unamortized balance of debt issuance costs at December 31, 2010 and June 30, 2010 was $1.4 million and $1.8 million, respectively. Total interest expense related to the Convertible Senior Notes for the three months ended December 31, 2010 and 2009 includes $1.3 million for both periods of contractual cash interest expense, $4.0 million and $3.7 million of noncash interest expense, respectively, related to the amortization of the discount and $0.2 million in both periods related to the amortization of debt issuance costs. Total interest expense related to the Convertible Senior Notes for the six months ended December 31, 2010 and 2009 includes $2.5 million for both periods of contractual cash interest expense, $7.9 million and $7.4 million of noncash interest expense, respectively, related to the amortization of the discount and $0.4 million in both periods related to the amortization of debt issuance costs. The Indenture contains covenants, one of which requires us to calculate the ratio of Consolidated Total Debt to Consolidated EBITDA, as defined in the Indenture, each time we incur additional indebtedness, for the most recently ended four quarter period (the “Incurrence of Debt Covenant”). On January 12, 2010, we entered into a supplemental indenture to the Indenture (the “Supplemental Indenture”) which amended the Incurrence of Debt Covenant. Under the Supplemental Indenture, we were permitted to, without complying with the ratio of Consolidated Total Debt to Consolidated EBITDA of 3.25 to 1.00: (a) incur revolving extensions of credit under the 2009 Credit Agreement, up to a maximum amount of $231.6 million, and (b) incur additional indebtedness, subject to a requirement to make a pro rata offer to purchase a principal face amount of the Convertible Senior Notes equal to 50 percent of the aggregate amount of such indebtedness so incurred, plus accrued and unpaid interest thereon. The Incurrence of Debt Covenant lapsed on October 23, 2010, and
11
Table of Contentswas no longer applicable to us after this date. At December 31, 2010, we were in compliance with all covenants under the Indenture, as amended. Note 9 – Income Taxes Our provision for income taxes is based on an estimated annual tax rate for the year applied to federal, state and foreign income. Income tax expense for the three months ended December 31, 2010 was $6.6 million, compared to $10.7 million for the same period in the prior year. The effective tax rate for the three months ended December 31, 2010 was 11.1 percent, compared to 38.6 percent for the same period in the prior year. The change in the effective tax rate for the three months ended December 31, 2010 compared to the same period in the prior year was primarily due to the retroactive reinstatement of the U.S. research and experimental tax credit, the U.S. domestic manufacturer’s deduction and foreign tax credits that provided a tax benefit for the three months ended December 31, 2010 that were not available in the three months ended December 31, 2009. Income tax expense for the six months ended December 31, 2010 was $14.3 million, compared to $5.7 million for the same period in the prior year. The effective tax rate for the six months ended December 31, 2010 was 15.1 percent, compared to 44.5 percent for the same period in the prior year. The change in the effective tax rate for the six months ended December 31, 2010 compared to the same period in the prior year was primarily due to the retroactive reinstatement of the U.S. research and experimental tax credit, the U.S. domestic manufacturer’s deduction and foreign tax credits that provided a tax benefit for the six months ended December 31, 2010 that were not available in the six months ended December 31, 2009. As of December 31, 2010, unrecognized tax benefits and the related interest were $26.8 million and $1.7 million, respectively, all of which would affect the tax rate if recognized. During the three and six months ended December 31, 2010 we recorded tax reserves on uncertain tax positions in the amount of $5.5 million in each period. During the three and six months ended December 31, 2010, we recorded an expense related to additional interest expense on uncertain tax positions of $0.1 million and $0.2 million, respectively. Note 10 – Shareholders’ Equity Preferred Stock As of December 31, 2010 and June 30, 2010, we had no shares of preferred stock outstanding. We are authorized to issue 5 million shares of preferred stock, $0.01 par value. Common Stock We have 200 million authorized shares of common stock, $0.01 par value. At December 31, 2010 and June 30, 2010, we had 95,265,521 and 95,129,836 shares issued; 25,599,817 and 25,599,817 shares in treasury stock and 69,665,704 and 69,530,019 shares outstanding (net of treasury stock), respectively.
12
Table of ContentsChanges in Equity: The following is a summary of the changes in Accumulated Other Comprehensive Income (“AOCI”) and changes in equity for the six months ended December 31, 2010:
The following is a summary of the changes in AOCI and changes in equity for the six months ended December 31, 2009:
13
Table of ContentsAt December 31, 2010 and June 30, 2010, AOCI consisted of the following:
We have approximately $1.7 million and $1.6 million of investments at December 31, 2010 and June 30, 2010, respectively, included in Other current assets in our Condensed Consolidated Balance Sheets that have been classified as available-for-sale securities. These securities are recorded at fair value with realized gains and losses recorded in income and unrealized gains and losses recorded in AOCI, net of taxes. Note 11 – Share-Based Compensation On December 31, 2010, we had one share-based compensation plan with shares available for future grants, the Amended and Restated 2002 Stock Option and Incentive Plan (the “2002 Plan”). On December 8, 2010, we amended the 2002 Plan to increase the number of shares available under the 2002 Plan for the grant of stock options, stock appreciation rights, restricted stock and restricted stock units by 1,100,000 to an aggregate amount not to exceed 7,860,000 shares of our common stock. During the six months ended December 31, 2010, options to purchase 346,840 shares of our common stock and 712,224 restricted stock units were granted under the 2002 Plan. No shares of restricted stock or restricted stock units were granted outside the 2002 Plan during the same period. Share-based compensation expense was $5.0 million and $5.3 million for the three months ended December 31, 2010 and 2009, respectively, and was $9.3 million and $10.5 million for the six months ended December 31, 2010 and 2009, respectively. The total income tax benefit recognized in the Condensed Consolidated Statements of Operations for share-based compensation arrangements was $1.5 million and $1.1 million for the three months ended December 31, 2010 and 2009, respectively, and was $2.6 million and $2.4 million for the six months ended December 31, 2010 and 2009, respectively. Fair Value Determination The fair value of each option award is estimated on the date of grant using the Black-Scholes option valuation model, which uses the assumptions noted in the following table.
Groups of option holders (directors, executives and non-executives) that have similar historical behavior are considered separately for valuation purposes. Expected volatilities are based on historical closing prices of our common stock over the expected option term. We use historical data to estimate option exercises and employee terminations within the valuation model. The expected term of options granted is derived using the option valuation model and represents the estimated period of time from the date of grant that the option is expected to remain outstanding. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
14
Table of ContentsStock Option Activity A summary of option activity under our stock option plans as of December 31, 2010 and changes during the six months ended December 31, 2010 is presented below:
The weighted-average grant-date fair value of options granted for the three months ended December 31, 2010 and 2009 was $18.13 and zero, respectively, and for the six months ended December 31, 2010 and 2009 was $14.75 and $12.79, respectively. The total intrinsic value of options exercised for the three months ended December 31, 2010 and 2009 was $1.0 million and $0.5 million, respectively, and for the six months ended December 31, 2010 and 2009 was $0.9 and $1.0 million, respectively. Grant of Stock Options with Market Conditions We granted 330,470 stock options containing a market condition to employees on March 21, 2008. The options vest three years from the date of grant based on a comparison of Harman’s total shareholder return (“TSR”) to the TSR of a selected peer group of publicly listed multinational companies. TSR will be measured as the annualized increase in the aggregate value of a company’s stock price plus the value of dividends, assumed to be reinvested into shares of the company’s stock at the time of dividend payment. The base price to be used for the TSR calculation of $42.19 is the 20-day trading average from February 6, 2008 through March 6, 2008. The ending price to be used for the TSR calculation will be the 20-day trading average prior to and through March 6, 2011. The grant date fair value of $4.2 million was calculated using a combination of Monte Carlo simulation and lattice-based models. Share-based compensation expense for these awards was $0.4 million for each of the three month periods ended December 31, 2010 and 2009, respectively, and was $0.7 million for each of the six month periods ended December 31, 2010 and 2009, respectively. Restricted Stock Awards A summary of the status of our nonvested restricted stock as of December 31, 2010 and changes during the six months ended December 31, 2010, is presented below:
As of December 31, 2010, there was $0.3 million of total unrecognized compensation cost related to nonvested restricted stock-based compensation arrangements, granted under the 2002 Plan. The weighted average recognition period was 0.7 years. At December 31, 2010, a total of 42,000 shares of restricted stock were outstanding of which 36,000 were granted under the 2002 Plan and 6,000 were granted outside of the 2002 Plan. Restricted Stock Units We granted 191,721 restricted stock units with performance conditions and 191,715 restricted stock units with market conditions, in the six months ended December 31, 2010, under the 2002 Plan. The restricted stock units with performance conditions cliff vest three years from the date of grant based on the attainment of certain performance conditions in fiscal year 2013. The restricted stock units with market conditions cliff vest three years from the date of grant based on a comparison of our total TSR to the TSR of a selected peer group of publicly listed multinational companies. The grant date fair value of $5.2 million was calculated using a Monte Carlo simulation model. Compensation expense, for both the restricted stock units with performance conditions and the restricted stock units with market conditions, is recognized ratably over the three-year vesting period based on the grant date fair value and our assessment of the probability that the applicable targets will be met. The probability is reassessed each reporting period for the restricted stock units with performance conditions.
15
Table of ContentsWe granted 380,400 and 133,507 restricted stock units with performance conditions in the six months ended December 31, 2009 and 2008, respectively, under the 2002 Plan. The restricted stock units cliff vest three years from the date of grant based on the attainment of certain performance targets in fiscal years 2012 and 2011, respectively. Compensation expense is recognized ratably over the three-year vesting period, on a straight-line basis, based on the grant date fair value and our assessment of the probability that the performance targets will be met. We have recognized compensation expense based on our estimate of the probability of achieving the targets. In the six months ended December 31, 2010 and 2009, we also granted 328,788 and 347,109 restricted stock units, respectively, under the 2002 Plan that vest three years from the date of grant. In January and September 2008, we granted 34,608 and 28,344 cash-settled restricted stock units, respectively, outside the 2002 Plan. These restricted stock units are accounted for as liability awards and are recorded at the fair value at the end of the reporting period in accordance with their vesting schedules. During the three months ended December 31, 2010 and 2009, none of these restricted stock units were settled, and during the six months ended December 31, 2010 and 2009, 9,647 and 1,608 of these restricted stock units were settled, respectively, at a cost of approximately $0.3 million and 0.1 million, respectively. At December 31, 2010, 3,216 cash-settled restricted stock units were outstanding. A summary of equity classified restricted stock unit activity as of December 31, 2010 and changes during the six months ended December 31, 2010 is presented below:
At December 31, 2010, the aggregate intrinsic value of equity classified restricted stock units was $83.5 million. As of December 31, 2010, there was $29.5 million of total unrecognized compensation cost related to restricted stock unit compensation arrangements. The weighted average recognition period was 1.91 years. Chief Executive Officer Special Enterprise Value Bonus Our Chief Executive Officer (“CEO”) was granted a special bonus award in November 2007 (the “Special Bonus Award”). The award was to be settled in cash based on a comparison of Harman’s enterprise value at November 2012 to the enterprise value at the grant date in November 2007. This award is classified as a liability in our Condensed Consolidated Balance Sheet at June 30, 2009. The fair value of the Special Bonus Award was measured each quarter using a Monte Carlo simulation. On September 1, 2009, pursuant to the terms of an amendment to the CEO’s employment letter agreement, the Special Bonus Award was cancelled and replaced with the right to an annual equity award for fiscal years 2011 through 2013 (the “Annual Equity Grant”). On September 1, 2009, both time-based and performance based restricted stock units were granted to the CEO pursuant to the terms of the Annual Equity Grant. The replacement of the Special Bonus Award with the awards granted pursuant to the Annual Equity Grant was accounted for as a modification of an existing award. As a result of this modification, in the first quarter of fiscal year 2010, approximately $0.5 million was reclassified from a liability to additional paid-in capital and $0.5 million was recognized as compensation expense within SG&A in our Condensed Consolidated Statement of Operations in the first quarter of fiscal year 2010. Note 12 – Derivatives We are exposed to market risk from changes in foreign currency exchange rates and interest rates, which could affect our operating results, financial condition and cash flows. We manage our exposure to these risks through our regular operating and financial activities and, when appropriate, through the use of derivative financial instruments. These derivative instruments are utilized to hedge economic exposures, as well as to reduce earnings and cash flow volatility resulting from shifts in market rates. We enter into limited types of derivative contracts, including foreign currency spot, forward and option contracts and an interest rate swap, to manage foreign currency and interest rate exposures. Our primary foreign currency exposure is the Euro. The fair market values of all our derivative contracts change with fluctuations in interest rates and currency rates and are designed so that any changes in their values are offset by changes in the values of the underlying exposures. Derivative financial instruments are held solely as risk management tools and not for trading or speculative purposes. We record all derivative instruments as either assets or liabilities at fair value in our Condensed Consolidated Balance Sheets. Certain of these derivative contracts have been designated as cash flow hedges, whereby gains and losses are reported within AOCI in our Condensed Consolidated Balance Sheets, until the underlying transaction occurs, at which point they are reported in earnings as gains and losses in our Condensed Consolidated Statements of Operations. Certain of our derivatives, for which hedge accounting is not
16
Table of Contentsapplied, are effective as economic hedges. These derivative contracts are required to be recognized each period at fair value, with gains and losses reported in earnings in our Condensed Consolidated Statements of Operations and therefore do result in some level of earnings volatility. The level of volatility will vary with the type and amount of derivative hedges outstanding, as well as fluctuations in the currency and interest rate markets during the period. The related cash flow impacts of all our derivative activities are reflected as cash flows from operating activities. Derivatives, by their nature, involve varying degrees of market and credit risk. The market risk associated with these instruments resulting from currency exchange and interest rate movements is expected to offset the market risk of the underlying transactions, assets and liabilities being hedged. We do not believe there is significant risk of loss in the event of non-performance by the counterparties associated with these instruments, because these transactions are executed with a diversified group of major financial institutions. Furthermore, our policy is to contract only with counterparties having a minimum investment grade or better credit rating. Credit risk is managed through the continuous monitoring of exposure to such counterparties. Foreign Exchange Risk Management We use foreign exchange contracts to hedge the price risk associated with foreign denominated forecasted purchases of materials used in our manufacturing process and to manage currency risk associated with operating costs in certain operating units, including foreign currency denominated intercompany loans and other foreign currency denominated assets. These contracts generally mature in one year or less. The majority of these contracts are designated as cash flow hedges. At December 31, 2010 and June 30, 2010, we had outstanding foreign currency forward exchange contracts which are summarized below:
Cash Flow Hedges We designate a portion of our foreign currency derivative contracts as cash flow hedges of foreign currency denominated purchases. As of December 31, 2010 and June 30, 2010, we had $538.3 million and $511.6 million of forward and option contracts maturing through December 2011 and June 2011, respectively. These contracts are recorded at fair value in the accompanying Condensed Consolidated Balance Sheets. The changes in fair value for these contracts on a spot to spot basis are reported in AOCI, and are reclassified to either Cost of sales or SG&A, depending on the nature of the underlying asset or liability that is being hedged, in our Condensed Consolidated Statements of Operations, in the period or periods during which the underlying transaction occurs. If it becomes apparent that an underlying forecasted transaction will not occur, the amount recorded in AOCI related to the hedge is reclassified to Miscellaneous, net in our Condensed Consolidated Statements of Operations in the then-current period. Amounts relating to such reclassifications were immaterial for the three and six months ended December 31, 2010 and 2009. Changes in the fair value of the derivatives are highly effective in offsetting changes in the cash flows of the hedged items because the amounts and the maturities of the derivatives approximate those of the forecasted exposures. Any ineffective portion of the derivative is recognized in the current period in our Condensed Consolidated Statements of Operations, in the same line item in which the foreign currency gain or loss on the underlying hedged transaction was recorded. We recognized less than $0.1 million of ineffectiveness in
17
Table of Contentseach of the three month periods ended December 31, 2010 and 2009, and less than $0.1 million of ineffectiveness in each of the six months ended December 31, 2010 and 2009, respectively. All components of each derivative’s gain or loss, with the exception of forward points (see below), were included in the assessment of hedge ineffectiveness. At December 31, 2010 and June 30, 2010, the fair value of these contracts was a net liability of $12.1 million and a net asset of $21.5 million, respectively. The amount associated with these hedges that is expected to be reclassified from AOCI to earnings within the next 12 months is a loss of $15.4 million. We elected to exclude forward points from the effectiveness assessment. At the end of the reporting period, we calculate the excluded amount, which is the fair value relating to the change in forward points that is recorded in current earnings as Miscellaneous, net in our Condensed Consolidated Statements of Operations. For the three months ended December 31, 2010 and 2009, we recognized less than $0.1 million and $0.4 million, respectively, in net gains related to the change in forward points. For the six months ended December 31, 2010 and 2009, we recognized $0.8 million of losses and $0.8 million of gains, respectively, related to the change in forward points. Economic Hedges When hedge accounting is not applied to derivative contracts, we recognize the gain or loss on the associated contracts directly in current period earnings in either Miscellaneous, net or Cost of sales according to the underlying exposure, in our Condensed Consolidated Statements of Operations, as unrealized exchange gains/(losses). As of December 31, 2010 and June 30, 2010, we had $59.4 million and $47.5 million, respectively, of forward contracts maturing through May 2011 and November 2010, respectively, in various currencies to hedge foreign currency denominated intercompany loans and other foreign currency denominated assets. At December 31, 2010 and June 30, 2010, the fair value of these contracts was a liability of $0.4 million and an asset of $5.9 million, respectively. Adjustments to the carrying value of the foreign currency forward contracts offset the gains and losses on the underlying loans and other foreign denominated assets in other non-operating income. Interest Rate Risk Management We have one interest rate swap contract with a notional amount of $23.2 million and $21.7 million at December 31, 2010 and June 30, 2010, respectively, in order to manage our interest rate exposure and effectively convert interest on an operating lease from a variable rate to a fixed rate. The objective of the swap is to offset changes in rent expenses caused by interest rate fluctuations. The interest rate swap contract is designated as a cash flow hedge. At the end of each reporting period, the discounted fair value of the swap contract is calculated and recorded in AOCI and reclassified as rent expense, within SG&A in our Condensed Consolidated Statements of Operations, in the then-current period. If the hedge is determined to be ineffective, the ineffective portion will be reclassified from AOCI and recorded as rent expense, within SG&A. We recognized less than $0.1 million in each of the three and six month periods ended December 31, 2010 and 2009, in our Condensed Consolidated Statement of Operations, and all components of the derivative loss were included in the assessment of the hedged effectiveness. The amount associated with the swap contract that is expected to be recorded as rent expense in the next 12 months is a loss of $0.8 million.
18
Table of ContentsFair Value of Derivatives The following tables provide a summary of the fair value amounts of our derivative instruments at December 31, 2010 and June 30, 2010:
Derivative Activity The following table shows derivative activity for derivatives designated as cash flow hedges for the three months ended December 31, 2010 and 2009:
19
Table of ContentsThe following table shows derivative activity for derivatives designated as cash flow hedges for the six months ended December 31, 2010 and 2009:
The following table summarizes gains and losses from our derivative instruments that are not designated as hedging instruments for the three and six months ended December 31, 2010 and 2009:
Note 13 – Fair Value Measurements Pursuant to the accounting guidance for fair value instruments, fair value is defined as the price we would receive to sell an asset or pay to transfer a liability in an orderly transaction with a market participant at the measurement date. When determining the fair value measurements for assets and liabilities required to be recorded at fair value, we consider the principal or most advantageous market in which it would transact and we consider assumptions that market participants would use when pricing the asset or liability. Fair Value Hierarchy Under fair value accounting guidance, there is a three-tier fair value hierarchy to prioritize the inputs used in measuring fair value. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. The hierarchy gives the highest priority to quoted prices in active markets (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels are defined as follows:
Assets and Liabilities Measured at Fair Value on a Recurring Basis For assets and liabilities measured at fair value on a recurring basis, fair value is the price we would receive to sell an asset or pay to transfer a liability in an orderly transaction with a market participant at the measurement date. In the absence of active markets for the identical assets and liabilities, such measurements involve developing assumptions based on market observable data, and in the absence of such data, internal information that is consistent with what market participants would use in a hypothetical transaction that occurs at the measurement date.
20
Table of ContentsThe following table provides the fair value hierarchy for assets and liabilities measured on a recurring basis:
The following describes the valuation methodologies we use to measure assets and liabilities accounted for at fair value on a recurring basis: Short-term Investments, Money Market Funds and Available-for-Sale Securities: Short-term investments, money market funds and available-for-sale securities are classified as Level 1 as the fair value was determined from market quotes obtained from financial institutions in active markets. Foreign Exchange Contracts: We use foreign exchange contracts to hedge market risks relating to possible adverse changes in foreign currency exchange rates. Our foreign exchange contracts were measured at fair value using Level 2 inputs. Such inputs include foreign currency exchange spot and forward rates for similar transactions in actively quoted markets. Interest Rate Swap: We use an interest rate swap to hedge market risk relating to possible adverse changes in interest rates. We have elected to use the income approach to value our interest rate swap contract, which uses observable Level 2 inputs at the measurement date and standard valuation techniques to convert future amounts to a single present amount (discounted). Level 2 inputs for the swap contract valuation are limited to quoted prices for similar assets or liabilities in active markets (specifically futures contracts on LIBOR, for the first two years) and inputs other than quoted prices that are observable for the asset or liability (specifically LIBOR cash and swap rates) at commonly quoted intervals, and credit risk. These key inputs, including the LIBOR cash rates for very short-term, futures rates for up to two years, and LIBOR swap rates beyond the derivative maturity are used to construct the swap yield curve and discount the future cash flows to present value at the measurement date. As the interest rate swap contract is a derivative asset, a credit default swap basis available at commonly quoted intervals has been collected from Bloomberg and applied to all cash flows. If the interest rate swap contract was determined to be a derivative liability, we would be required to reflect potential credit risk to lenders using a borrowing rate specific to our Company. See Note 12 – Derivatives, for further discussion regarding our derivative financial instruments. Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis Certain assets are measured at fair value on a non-recurring basis. These assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments only in certain circumstances. These assets can include loans and long-lived assets that have been reduced to fair value when they are held for sale, impaired loans that have been reduced based on the fair value of the underlying collateral, cost and equity method investments and long-lived assets that are written down to fair value when they are impaired and the remeasurement of retained investments in formerly consolidated subsidiaries upon a change in control that results in deconsolidation of a subsidiary if we sell a controlling interest and retain a noncontrolling stake in the entity. Assets that are written down to fair value when impaired and retained investments are not subsequently adjusted to fair value unless further impairment occurs.
21
Table of ContentsThe following table provides the fair value hierarchy for assets and liabilities measured on a non-recurring basis and the losses recorded during the periods presented:
The following describes the valuation methodologies we use to measure financial and non-financial instruments accounted for at fair value on a non-recurring basis. Equity Method Investments: Equity method investments are generally valued using a discounted cash flow model, comparative market multiples or a combination of both approaches as appropriate. These investments are generally included in Level 3. Investments in Subsidiaries and Formerly Consolidated Subsidiaries: Upon a change in control that results in either consolidation or deconsolidation of a subsidiary, the fair value measurement of our previous equity investment or retained noncontrolling stake in the former subsidiary, respectively, are valued using an income approach, a market approach, or a combination of both approaches as appropriate. In applying these methodologies we rely on a number of factors, including actual operating results, future business plans, economic projections, market observable pricing multiples of similar businesses and comparable transactions, and possible control premium. These investments are included in Level 3. Goodwill: Goodwill is tested for impairment annually or more frequently if an event or circumstance indicates that an impairment loss may have been incurred. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. We estimate the fair value of each reporting unit using a discounted cash flow methodology. This requires us to use significant judgment including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, the useful life over which cash flows will occur, determination of our weighted average cost of capital, and relevant market data. This asset is included in Level 3. Refer to Note 7 – Goodwill for more information. Long-lived Assets: Long-lived assets, including aircraft and real estate, are valued using the best information available, including quoted market prices or market prices for similar assets when available or internal cash flow estimates discounted at an appropriate interest rate or independent appraisals, as appropriate. For real estate, cash flow estimates are based on current market estimates that reflect current and projected lease profiles and available industry information about expected trends in rental, occupancy and capitalization rates. These assets are generally included in Level 3. Note 14 – Restructuring Program We announced a restructuring program in June 2006 designed to increase efficiency in our manufacturing, engineering and administrative organizations and expanded these activities from that time through the current period to improve global footprint, cost structure, technology portfolio, human resources, and internal processes. In fiscal year 2010, we announced the relocation of certain manufacturing activities from the United Kingdom to Hungary, a consolidation and optimization of our manufacturing capabilities in China and a reorganization of our portable navigation device (“PND”) business in Germany, which resulted in our exit of the PND distribution channel. During the six months ended December 31, 2010, we announced the relocation of certain manufacturing activities from Washington, Missouri to Mexico, the outsourcing of certain manufacturing activities to third party suppliers and continued to refine and expand on activities launched in prior years. For the three months ended December 31, 2010, we recorded $3.7 million for our restructuring programs, primarily within SG&A, of which $3.1 million was related to employee termination benefits. Cash paid for these initiatives was $5.7 million. In addition, we have recorded $1.4 million of accelerated depreciation primarily within Cost of sales. For the three months ended December 31, 2009 our Automotive and Professional segments updated their severance accruals based on new estimates which took into account higher than originally anticipated natural attrition rates. As a result, these restructuring accruals were reduced by approximately $12.0 million to reflect these updated estimates, which are included within expense in the tables below.
22
Table of ContentsFor the six months ended December 31, 2010, we recorded $1.8 million for our restructuring program, primarily within SG&A, of which $1.0 million was related to employee termination benefits. Cash paid for these initiatives was $10.5 million. In addition, we have recorded $0.3 million of accelerated depreciation primarily within Cost of sales. For the six months ended December 31, 2009, we recorded $4.6 million for our restructuring program, primarily within SG&A, of which $4.0 million related to employee termination benefits. Cash paid for these and prior initiatives was $29.2 million. In addition, we have recorded $3.2 million of accelerated depreciation and inventory provisions primarily within Cost of sales. Below is a rollforward of our restructuring accrual for the six months ended December 31, 2010 and 2009:
Restructuring expenses by reporting segment are as follows and include accruals for new programs as noted above plus revisions to estimates, both increases and decreases, to programs accrued in prior periods:
Note 15 – Retirement Benefits Plan Descriptions Retirement savings plan We provide a Retirement Savings Plan for certain employees in the United States. Under the plan, employees may contribute up to 50 percent of their pretax compensation subject to certain limitations. Each business unit will make a safe harbor non-elective contribution in an amount equal to three percent of a participant’s eligible contribution. Each business unit may make a matching contribution of up to three percent (50 percent on the first six percent of an employee’s tax-deferred contribution) and, upon approval of our Board of Directors, a profit sharing contribution. Matching and profit sharing contributions vest at a rate of 25 percent for each year of service with the employer, beginning with the second year of service. Effective January 1, 2009, we suspended the matching and safe harbor non-elective contributions for these plans. Effective January 1, 2010, the employer matching contribution and the safe harbor non-elective contribution were reinstated. Approval for the profit sharing contribution is requested from our Board of Directors at the end of each fiscal year. Management has not requested approval for the profit sharing contribution, nor does it plan on requesting for the fiscal year ended June 30, 2011, therefore no amount has been accrued for the three and six months ended December 31, 2010. Pension benefits We provide defined pension benefits to certain eligible employees. The measurement date used for determining pension benefits is the last day of our fiscal year, June 30th. We have certain business units in Europe that maintain defined benefit pension plans for many of our current and former employees. The coverage provided and the extent to which the retirees’ share in the cost of the program vary by business unit. Generally, plan benefits are based on age, years of service and average compensation during the final years of service. In the United States, we have a Supplemental Executive Retirement Plan (“SERP”) that provides retirement, death and termination benefits, as defined in the SERP, to certain key executives designated by our Board of Directors. The majority of our defined benefit
23
Table of Contentsplans do not have contractual or legal statutes which specify minimum funding requirements. We are in compliance with all existing contractual obligations and legal statutes. The following table presents the components of net periodic benefit costs for the three and six months ended December 31, 2010 and 2009:
During the three months ended December 31, 2010 and 2009, we made contributions of $1.9 million and $2.1 million, respectively, to the defined benefit pension plans which were paid to participants. During the six months ended December 31, 2010 and 2009, we made contributions of $3.8 million and $3.9 million, respectively, to the defined benefit pension plans which were paid to participants. We expect to make approximately $3.9 million in contributions for the remainder of the fiscal year ending June 30, 2011. Note 16 – Business Segment Data We design, manufacture and market high-quality, high fidelity audio products and electronic systems for the automotive, consumer and professional markets. Our chief operating decision maker evaluates performance and allocates resources based on net sales, operating income and working capital in each of the reporting segments. We report our business on the basis of four segments. Our Automotive, Consumer and Professional segments are based on the end-user markets we serve. Our fourth segment includes the results of Other, which includes compensation, benefit and occupancy costs for corporate employees. Automotive Our Automotive segment designs, manufactures and markets audio, electronic and infotainment systems for vehicle applications to be installed primarily as original equipment by automotive manufacturers. Our Automotive products are marketed worldwide under brand names including JBL®, Infinity®, Mark Levinson®, Harman/Kardon®, Logic 7®, Lexicon® and Becker®. Our premium branded audio, video, navigation and infotainment systems are offered to automobile manufacturers through engineering and supply agreements. Consumer Our Consumer segment designs, manufactures and markets a wide-range of mid- to high-end audio, video and digital storage systems for home, multimedia and mobile applications. Our Consumer products feature some of the world’s most recognized audio brands, including AKG®, Harman/Kardon, Infinity, JBL, Selenium® and Mark Levinson. Our loudspeaker and electronic products are offered through audio specialty and retail chain stores. Our branded products for computer and multimedia applications are focused on retail customers with products designed to enhance sound for computers, Apple’s iPod® and similar devices. Professional Our Professional segment designs, manufactures and markets an extensive range of loudspeakers, power amplifiers, digital signal processors, microphones, headphones and mixing consoles used by audio professionals in concert halls, stadiums, airports, houses of worship and other public spaces. We also provide high-quality products to the sound reinforcement, music instrument support and broadcast and recording segments of the professional audio market. We offer complete systems solutions for professional installations and users around the world. Our Professional products are marketed globally under brand names including JBL Professional®, AKG, Crown®, Soundcraft®, Lexicon, Revel®, Mark Levinson, DigiTech®, dbx®, BSS®, Selenium and Studer®. Other Our Other segment includes compensation, benefits and occupancy costs for corporate employees, net of reporting segment allocations, expenses associated with new technology innovation and our corporate brand identity campaign, as well as the results of operations of Aha Mobile, Inc., a provider of on-demand and location-based internet content services, which we acquired in September 2010.
24
Table of ContentsThe following table reports net sales and operating income/(loss) by each reporting segment for the three and six months ended December 31, 2010 and 2009:
Note 17 – Significant Customers Presented below are the percentages of net sales to and net accounts receivables due from customers who represent ten percent or more of our net sales or net accounts receivable, as follows:
We anticipate that BMW and Audi/Volkswagen will continue to account for a significant portion of our net sales and net accounts receivable for the foreseeable future. Our automotive customers are not obligated to any long-term purchase of our products. Note 18 – Commitments and Contingencies At December 31, 2010, we were subject to legal claims and litigation arising in the ordinary course of business, including the matters described below. The outcome of these legal actions cannot be predicted with certainty; however, management, based upon advice from legal counsel, believes such actions are either without merit or will not have a material adverse effect on our financial condition or results of operations. In re Harman International Industries, Inc. Securities Litigation On October 1, 2007, a purported class action lawsuit was filed by Cheolan Kim (the “Kim Plaintiff”) against Harman and certain of our officers in the United States District Court for the District of Columbia (the “Court”) seeking compensatory damages and costs on behalf of all persons who purchased our common stock between April 26, 2007 and September 24, 2007 (the “Class Period”). The original complaint alleged claims for violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, (the “1934 Act”) and Rule 10b-5 promulgated thereunder. The complaint alleged that the defendants omitted to disclose material adverse facts about Harman’s financial condition and business prospects. The complaint contended that had these facts not been concealed at the time the merger agreement with KKR and GSCP was entered into, there would not have been a merger agreement, or it would have been at a much lower price, and the price of our common stock therefore would not have been artificially inflated during the Class Period. The Kim Plaintiff alleged that, following the reports that the proposed merger was not going to be completed, the price of our common stock declined, causing the plaintiff class significant losses.
25
Table of ContentsOn November 30, 2007, the Boca Raton General Employees’ Pension Plan (the “Boca Raton Plaintiff”) filed a purported class action lawsuit against Harman and certain of our officers in the Court seeking compensatory damages and costs on behalf of all persons who purchased our common stock between April 26, 2007 and September 24, 2007. The allegations in the Boca Raton complaint are essentially identical to the allegations in the original Kim complaint, and like the original Kim complaint, the Boca Raton complaint alleges claims for violations of Sections 10(b) and 20(a) of the 1934 Act and Rule 10b-5 promulgated thereunder. On January 16, 2008, the Kim Plaintiff filed an amended complaint. The amended complaint, which extended the Class Period through January 11, 2008, contended that, in addition to the violations alleged in the original complaint, Harman also violated Sections 10(b) and 20(a) of the 1934 Act and Rule 10b-5 promulgated thereunder by “knowingly failing to disclose “significant problems” relating to its PND sales forecasts, production, pricing, and inventory” prior to January 14, 2008. The amended complaint claimed that when “Defendants revealed for the first time on January 14, 2008 that shifts in PND sales would adversely impact earnings per share by more than $1.00 per share in fiscal 2008,” that led to a further decline in our share value and additional losses to the plaintiff class. On February 15, 2008, the Court ordered the consolidation of the Kim action with the Boca Raton action, the administrative closing of the Boca Raton action, and designated the short caption of the consolidated action as In re Harman International Industries, Inc. Securities Litigation, civil action no. 1:07-cv-01757 (RWR). That same day, the Court appointed Arkansas Public Retirement System as lead plaintiff (“Lead Plaintiff”) and approved the law firm Cohen, Milstein, Hausfeld and Toll, P.L.L.C. to serve as lead counsel. On March 24, 2008, the Court ordered, for pretrial management purposes only, the consolidation of Patrick Russell v. Harman International Industries, Incorporated, et al. with In re Harman International Industries, Inc. Securities Litigation. On May 2, 2008, Lead Plaintiff filed a consolidated class action complaint (the “Consolidated Complaint”). The Consolidated Complaint, which extends the Class Period through February 5, 2008, contends that Harman and certain of our officers and directors violated Sections 10(b) and 20(a) of the 1934 Act and Rule 10b-5 promulgated thereunder, by issuing false and misleading disclosures regarding our financial condition in fiscal year 2007 and fiscal year 2008. In particular, the Consolidated Complaint alleges that defendants knowingly or recklessly failed to disclose material adverse facts about MyGIG radios, PNDs and our capital expenditures. The Consolidated Complaint alleges that when Harman’s true financial condition became known to the market, the price of our common stock declined significantly, causing losses to the plaintiff class. On July 3, 2008, defendants moved to dismiss the Consolidated Complaint in its entirety. Lead Plaintiff opposed the defendants’ motion to dismiss on September 2, 2008, and defendants filed a reply in further support of their motion to dismiss on October 2, 2008. The motion is now fully briefed. Patrick Russell v. Harman International Industries, Incorporated, et al. Patrick Russell (the “Russell Plaintiff”) filed a complaint on December 7, 2007 in the United States District Court for the District of Columbia and an amended purported putative class action complaint on June 2, 2008 against Harman and certain of our officers and directors alleging violations of the Employee Retirement Income Security Act of 1974 (“ERISA”) and seeking, on behalf of all participants in and beneficiaries of the Harman International Industries, Incorporated Retirement Savings Plan (the “Plan”), compensatory damages for losses to the Plan as well as injunctive relief, imposition of a constructive trust, restitution, and other monetary relief. The amended complaint alleges that from April 26, 2007 to the present, defendants failed to prudently and loyally manage the Plan’s assets, thereby breaching their fiduciary duties in violation of ERISA by causing the Plan to invest in our common stock notwithstanding that the stock allegedly was “no longer a prudent investment for the Participants’ retirement savings.” The amended complaint further claims that, during the Class Period, defendants failed to monitor the Plan fiduciaries, failed to provide the Plan fiduciaries with, and to disclose to Plan participants, adverse facts regarding Harman and our businesses and prospects. The Russell Plaintiff also contends that defendants breached their duties to avoid conflicts of interest and to serve the interests of participants in and beneficiaries of the Plan with undivided loyalty. As a result of these alleged fiduciary breaches, the amended complaint asserts that the Plan has “suffered substantial losses, resulting in the depletion of millions of dollars of the retirement savings and anticipated retirement income of the Plan’s Participants.” On March 24, 2008, the Court ordered, for pretrial management purposes only, the consolidation of Patrick Russell v. Harman International Industries, Incorporated, et al. with In re Harman International Industries, Inc. Securities Litigation. Defendants moved to dismiss the complaint in its entirety on August 5, 2008. The Russell Plaintiff opposed the defendants’ motion to dismiss on September 19, 2008, and defendants filed a reply in further support of their motion to dismiss on October 20, 2008. The motion is now fully briefed. Automotive Supply Arrangements We have arrangements with our automotive customers to provide products that meet predetermined technical specifications and delivery dates. In the event that we do not satisfy the performance obligations under these arrangements, we may be required to indemnify the customer. We accrue for any loss that we expect to incur under these arrangements when that loss is probable and can be reasonably estimated. During the three months ended December 31, 2010 and 2009, we incurred $4.6 million and zero, respectively, of costs
26
Table of Contentsrelating to settlement of a claim associated with an automotive supply arrangement. During the six months ended December 31, 2010 and 2009, we incurred $4.6 million and $11.7 million, respectively, of costs relating to settlement of a claim associated with automotive supply arrangements. An inability to meet performance obligations on automotive platforms to be delivered in future periods could adversely affect our results of operations and financial condition in future periods. Note 19 – Discontinued Operations On April 9, 2010, we and Harman KG, entered into a share purchase agreement to sell all of the issued and outstanding shares of QNX Software Systems Co., QNX Software Systems (Wavemakers), Inc. and QNX Software Systems, Inc. (collectively, the “QNX Entities”) for $200 million. The sale closed on June 1, 2010. Refer to Note 3 – Discontinued Operations in Item 8 of our 2010 Form 10-K for further information. The operations of the QNX Entities have been segregated from continuing operations and are reflected as discontinued operations in the three and six months ended December 31, 2009 in our Condensed Consolidated Statement of Operations as follows:
Note 20 – Related Party Transactions From time to time we enter into transactions with related parties. In December 2009, we entered into a three-year agreement for engineering and software development services with Neusoft Corporation (“Neusoft”), a Shanghai exchange listed technology solutions provider. A member of our Board of Directors is the Chairman and Chief Executive Officer of Neusoft. On April 20, 2010, our subsidiary, innovative entered into an asset purchase and business transfer agreement (the “Asset Purchase Agreement”) with Neusoft Technology Solutions GmbH (“Neusoft Technology”), which is a subsidiary of Neusoft for the sale of certain tangible assets located at innovative’s facility in Hamburg, Germany. This transaction closed on June 1, 2010. As part of the Asset Purchase Agreement, innovative and Neusoft Technology entered into a five-year agreement for engineering and software development services related to innovative’s vehicle navigation business (the “Services Agreement”). Under the terms of the Asset Purchase Agreement, innovative transferred at closing certain tangible assets and employment relationships to Neusoft Technology and received consideration of €6 million. Our subsidiary, Harman Becker Automotive Systems GmbH and Neusoft Europe AG, a subsidiary of Neusoft, are guarantors under the terms of the Asset Purchase Agreement and the Services Agreement. During the three and six months ended December 31, 2010, we incurred total expenses of $5.8 million and $11.4 million, respectively, for engineering and software development services with Neusoft Technology and Neusoft.
27
Table of Contents
General The following discussion should be read in conjunction with the accompanying unaudited Condensed Consolidated Financial Statements and the related notes included in Item 1 of this Quarterly Report on Form 10-Q, together with Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2010 (our “2010 Form 10-K”). This discussion contains forward-looking statements which are based on our current expectations and experience and our perception of historical trends, current market conditions, including customer acceptance of our new products, current economic data, expected future developments, foreign currency exchange rates, and other factors that we believe are appropriate under the circumstances. These statements involve risks and uncertainties that could cause actual results to differ materially from those suggested in the forward-looking statements. Unless otherwise indicated, “Harman,” “our company,” “we,” “our,” and “us” are used interchangeably to refer to Harman International Industries, Incorporated and its consolidated subsidiaries. We begin our discussion with an executive overview of our company to give you an understanding of our business and the markets we serve. This is followed by a discussion of our critical accounting policies, and then by a discussion of our results of operations for the three and six months ended December 31, 2010 and 2009. We include in this discussion an analysis of certain significant period-to-period variances in our Condensed Consolidated Statements of Operations and an analysis of our restructuring program. We also provide specific information regarding our four business segments: Automotive, Consumer, Professional and Other. We then discuss our financial condition at December 31, 2010 with a comparison to June 30, 2010. This section contains information regarding our liquidity, capital resources and cash flows from operating, investing and financing activities. We complete our discussion with an update on our outlook. Executive Overview We believe we are a worldwide leader in the development, manufacturing and marketing of high quality, high fidelity audio products and electronic systems, as well as digitally integrated infotainment systems for the automotive industry. We have developed a broad range of product offerings which we sell in our principal markets under renowned brand names, including AKG®, Crown®, JBL®, Infinity®, Harman/Kardon®, Lexicon®, Mark Levinson® and Selenium®. We have built these brands by developing our engineering, manufacturing and marketing competencies, and have employed these resources to establish our company as a leader in the markets we serve. We report our business on the basis of four segments. Our Automotive, Consumer and Professional segments are based on the end-user markets we serve. Our fourth segment, Other, includes compensation, benefits and occupancy costs for corporate employees, new technology innovation and expenses associated with our corporate brand identity campaign. In September 2010, we acquired Aha Mobile, Inc. (“Aha”), a provider of on-demand mobile and location-based internet content services for $1.8 million. The results of operations of Aha are included in our Other segment and were not material for the three and six months ended December 31, 2010. Our products are sold worldwide, with the largest markets located in the United States and Germany. In the United States, our primary manufacturing facilities are located in Kentucky, Missouri, Indiana and Utah. Outside of the United States, we have manufacturing facilities in Austria, Brazil, China, Hungary, France, Germany, Mexico and the United Kingdom. Our sales and earnings may vary due to the production schedules of our automotive customers, customer acceptance of our products, the timing of new product introductions, product offerings by our competitors and general economic conditions. Since our businesses operate using local currencies, our reported sales and earnings may also fluctuate due to foreign currency exchange rates, especially for the Euro. New Revolving Credit Facility On December 1, 2010, we and one of our wholly-owned subsidiaries, Harman Holding GmbH & Co. KG (“Harman KG”), entered into a Multi-Currency Credit Agreement (the “Credit Agreement”) with a group of banks. Refer to the heading “Financial Condition” below for further information. Critical Accounting Policies For the three and six months ended December 31, 2010, there were no significant changes to our critical accounting policies and estimates from those disclosed in the consolidated financial statements and the related notes included in our 2010 Form 10-K, except as described below. Recently Adopted Accounting Standards Variable Interest Entities: On July 1, 2010, we adopted the new accounting guidance issued by the Financial Accounting Standards Board (“FASB”) within Accounting Standards Codification (“ASC”) 810 “Consolidation” regarding certain amended provisions
28
Table of Contentsrelating to the consolidation of variable interest entities (“VIE”). The amended provisions primarily include (i) amending the guidance for determining whether an entity is a VIE and (ii) amending the criteria for identification of the primary beneficiary of a VIE. The new provisions also require us to continually reassess whether we are the primary beneficiary of a VIE and require that we enhance our disclosures in the financial statements about our VIE relationships. The adoption of the new guidance did not have any impact on our financial condition or results of operations. Transfers of Financial Assets: On July 1, 2010, we adopted the new accounting guidance issued by the FASB within Accounting Standards Update (“ASU”) 2009-16 “Transfers and Servicing (Topic 860): Accounting for the Transfers of Financial Assets” relating to the accounting for transfers of financial assets. The new guidance requires additional disclosures relating to the transparency of transfers of financial assets. The adoption of the new guidance did not have any impact on our financial condition or results of operations. Multiple Element Revenue Arrangements: On July 1, 2010, we adopted the new accounting guidance issued by the FASB relating to the accounting for multiple element revenue arrangements issued in ASC 605-25 and ASC 985-707. The new guidance requires a vendor to allocate revenue to each standalone deliverable in arrangements involving multiple deliverables based on the relative selling price of each deliverable. It also changes the level of evidence of the standalone selling price required to separate deliverables by allowing a vendor to make its best estimate of the standalone selling price of deliverables when more objective evidence of selling price is not available. The new guidance also excludes sales of tangible products that contain essential software elements from the scope of revenue recognition for software arrangements. Because of these changes, revenue is recognized earlier for many revenue transactions involving multiple deliverables and sales of software enabled devices. The new guidance also requires additional disclosures relating to qualitative and quantitative information about a vendor’s revenue arrangements and about the significant judgments made about the application of the new guidance and any changes in those judgments or the application that may significantly affect the timing or amount of revenue recognition. The new guidance can be adopted on a prospective basis or in certain circumstances on a retrospective basis. We adopted the new guidance on a prospective basis and applied the new guidance to all arrangements entered into or materially modified in fiscal years beginning after June 15, 2010. The adoption of the new guidance did not have any impact on our financial condition or results of operations. Discontinued Operations The results of operations of businesses that have been sold are presented separately as Income from discontinued operations, net of income taxes, in our Condensed Consolidated Statements of Operations, in the current and prior periods, where applicable. Refer to Note 19 – Discontinued Operations in the Notes to the Condensed Consolidated Financial Statements for further information. Results of Operations Net Sales Net sales for the three months ended December 31, 2010 were $956.1 million compared to $928.3 million in the same period in the prior year, an increase of 3.0 percent, or 8.2 percent excluding foreign currency translation. The increase in overall net sales was in our Professional and Consumer segments and were primarily related to increased penetration of the Latin American market which was aided by Selenium, a company we acquired in June 2010 and whose results were not included in the same period in the prior year, as well as improvements in overall market conditions. These increases were partially offset by unfavorable foreign currency translation of $44.7 million and a slight decline in net sales in our Automotive segment, due to the unfavorable foreign currency translation mentioned above, mostly offset by new infotainment awards with European automobile manufacturers and overall production recovery. Net sales for the six months ended December 31, 2010 were $1.793 billion, compared to net sales of $1.677 billion in the same period in the prior year, an increase of 6.9 percent, or 12.9 percent excluding foreign currency translation. The increase in overall net sales was primarily in our Automotive segment due to new business awards with European automobile manufacturers resulting from the launch of new platforms and overall production recovery, as well as the ramp-up of new infotainment business. In addition, increases in our Professional and Consumer segments were primarily related to Selenium and overall improvements in market conditions in these segments. These increases were partially offset by unfavorable foreign currency translation of $88.3 million. In January 2010, we reorganized our portable navigation device (“PND”) business and entered into a trademark license agreement under which we exited the PND distribution channel. Under the terms of the agreement, a third party was permitted to sell our PND inventory over a period of six months ending in June 2010. Thereafter, we are entitled to receive 50 percent of the profits from the sale of PNDs by the third party for the first five years. Subsequent to this, we will receive a royalty based on sales of PNDs for the remainder of the term of the agreement which can be extended for up to 20 years.
29
Table of ContentsA summary of our net sales by business segment is presented below:
Automotive – Net sales for the three months ended December 31, 2010 decreased $3.7 million, or 0.6 percent compared to the same period in the prior year, and increased 5.3 percent excluding foreign currency translation. The decrease in net sales was due to the exit of the PND business and unfavorable foreign currency translation of $37.0 million, mostly offset by new infotainment awards with European automobile manufacturers and overall production recovery. Net sales for the six months ended December 31, 2010 increased $60.0 million, or 5.0 percent compared to the same period in the prior year, and increased 11.9 percent excluding foreign currency translation. The increase in net sales was primarily due to new infotainment awards with European automobile manufacturers and overall production recovery, partially offset by unfavorable foreign currency translation of $74.8 million and the exit of the PND business. Consumer – Net sales for the three months ended December 31, 2010 increased $12.1 million, or 9.5 percent, compared to the same period in the prior year, and increased 15.7 percent excluding foreign currency translation. The increase in net sales was aided by $10.4 million of Selenium net sales and higher net sales in Europe due to improvements in market conditions, partially offset by unfavorable foreign currency translation of $6.8 million. Net sales for the six months ended December 31, 2010 increased $14.7 million, or 6.9 percent, compared to the same period in the prior year, and increased 13.0 percent excluding foreign currency translation. The increase in net sales was aided by $20.9 million of Selenium net sales and higher global net sales due to improvements in market conditions, partially offset by unfavorable foreign currency translation of $11.3 million. Professional – Net sales for the three months ended December 31, 2010 increased $19.2 million, or 14.4 percent compared to the same period in the prior year, and increased 15.3 percent excluding foreign currency translation. The increase in net sales was primarily due to increased $9.5 million of Selenium net sales and increased sales in almost all business units, partially offset by unfavorable foreign currency translation of $1.0 million. Net sales for the six months ended December 31, 2010 increased by $41.6 million, or 16.4 percent compared to the same period in the prior year, and increased 17.3 percent excluding foreign currency translation. The increase in net sales was primarily due to increased net sales in all business units due to improvements in market conditions and $19.7 million of Selenium net sales, partially offset by unfavorable foreign currency translation of $2.1 million. Gross Profit Gross profit as a percentage of net sales increased 1.0 percentage point to 28.1 percent for the three months ended December 31, 2010 compared to 27.1 percent of net sales in the same period in the prior year. The increase in gross profit as a percentage of net sales was primarily in our Consumer and Professional segments due to higher sales volumes and savings achieved from our STEP Change cost reduction program (“STEP Change”) and lower restructuring charges in our Professional segment, partially offset by slight declines in our Automotive segment due to foreign currency impacts on materials pricing. Gross profit as a percentage of net sales increased 1.0 percentage point to 27.5 percent for the six months ended December 31, 2010 compared to 26.5 percent of net sales in the same period in the prior year. The increase in gross profit as a percentage of net sales was primarily due to Selenium, improved leverage of fixed overhead costs due to higher sales volumes and savings achieved resulting from our STEP Change program, partially offset by unfavorable foreign currency translation.
30
Table of ContentsA summary of our gross profit by business segment is presented below:
Automotive – Gross profit as a percentage of net sales decreased 0.2 percentage points to 24.9 percent for the three months ended December 31, 2010 compared to the same period in the prior year. The slight decrease in gross profit as a percentage of net sales was primarily due to foreign currency impacts on material pricing, partially offset by improved leverage of fixed costs and savings achieved through our STEP Change program. Gross profit as a percentage of net sales decreased 0.1 percentage points to 24.1 percent for the six months ended December 31, 2010 compared to the same period in the prior year. The slight decrease in gross profit as a percentage of net sales was primarily due to foreign currency impacts on material pricing, partially offset by improved leverage of fixed costs and savings achieved through our STEP Change program initiatives. Consumer – Gross profit as a percentage of net sales increased 2.3 percentage points to 30.1 percent for the three months ended December 31, 2010 compared to the same period in the prior year. The increase in gross profit as a percentage of net sales was aided by Selenium, lower inventory write-offs and savings achieved through our STEP Change program initiatives. Gross profit as a percentage of net sales increased 2.4 percentage points to 29.5 percent for the six months ended December 31, 2010 compared to the same period in the prior year. The increase in gross profit as a percentage of net sales was aided by Selenium, improved leverage of fixed costs, lower inventory write-offs and savings achieved through our STEP Change program initiatives. Professional – Gross profit as a percentage of net sales increased 1.8 percentage points to 40.1 percent for the three months ended December 31, 2010 compared to the same period in the prior year. The increase in gross profit as a percentage of net sales was primarily due to favorable product mix shift and savings achieved through our STEP Change program initiatives. Gross profit as a percentage of net sales increased 2.2 percentage points to 40.5 percent for the six months ended December 31, 2010 compared to the same period in the prior year. The increase in gross profit as a percentage of net sales was primarily due to favorable product mix shift, savings achieved through our STEP Change program initiatives and new product introductions. Other – Other gross profit improved by $2.6 million in the three months ended December 31, 2010 compared to the same period in the prior year. Other gross profit improved by $4.5 million in the six months ended December 31, 2010 compared to the same period in the prior year. The improvement in both periods was primarily due to vacant facility costs retained at corporate. Selling, General and Administrative Expenses Selling, general and administrative expenses (“SG&A”) were $200.9 million for the three months ended December 31, 2010 compared to $192.0 million in the same period in the prior year, an increase of $8.9 million. As a percentage of net sales, SG&A increased 0.3 percentage points in the three months ended December 31, 2010 compared to the same period in the prior year. The increase in SG&A was primarily due to higher selling and marketing expenses, SG&A attributable to Selenium, costs relating to the settlement of a claim with an automotive supply arrangement, and higher restructuring expenses, partially offset by favorable foreign currency translation of $9.3 million and higher capitalization of research and development expenses (“R&D”). SG&A was $382.7 million for the six months ended December 31, 2010 compared to $385.3 million in the same period in the prior year, a decrease of $2.6 million. As a percentage of net sales, SG&A decreased 1.6 percentage points in the six months ended December 31, 2010 compared to the same period in the prior year. The decrease in SG&A was primarily due to favorable foreign currency translation of $20.7 million and lower restructuring expenses and R&D, partially offset by higher capitalization of R&D, costs relating to the settlement of a claim with an automotive supply arrangement and SG&A attributable to Selenium.
31
Table of ContentsA summary of SG&A by business segment is presented below:
Automotive – SG&A decreased $6.3 million to $109.3 million for the three months ended December 31, 2010, compared to the same period in the prior year, primarily due to higher R&D capitalization, favorable foreign currency translation and lower restructuring expenses, partially offset by $4.6 million of costs relating to the settlement of a claim with an automotive supply arrangement. As a percentage of net sales, SG&A decreased 0.9 percentage points to 16.5 percent for the three months ended December 31, 2010 compared to the same period in the prior year. R&D decreased $16.8 million to $49.5 million or 7.4 percent of net sales for the three months ended December 31, 2010 compared to $66.3 million, or 9.9 percent of net sales in the same period in the prior year primarily due to higher R&D capitalization and favorable foreign currency translation, partially offset by higher gross spending. SG&A decreased $29.0 million to $214.2 million for the six months ended December 31, 2010 compared to the same period in the prior year, primarily due to higher R&D capitalization and favorable foreign currency translation, partially offset by the impact of the settlement of a claim associated with an automotive supply arrangement. As a percentage of net sales, SG&A decreased 3.2 percentage points to 16.9 percent for the six months ended December 31, 2010 compared to the same period in the prior year. R&D decreased $24.4 million to $108.0 million, or 8.5 percent of net sales, for the six months ended December 31, 2010 compared to $132.4 million, or 10.9 percent of net sales, in the same period in the prior year, primarily due to higher R&D capitalization and favorable foreign currency translation, partially offset by higher gross spending. Consumer – SG&A increased $1.5 million to $31.1 million for the three months ended December 31, 2010 compared to the same period in the prior year, primarily due to SG&A attributable to Selenium and marketing activities, partially offset by favorable foreign currency translation and lower restructuring expenses. As a percentage of net sales, SG&A decreased 1.0 percentage point to 22.3 percent for the three months ended December 31, 2010 compared to the same period in the prior year. R&D decreased $0.2 million to $3.4 million or 2.4 percent of net sales for the three months ended December 31, 2010 compared to $3.6 million or 2.8 percent of net sales in the same period in the prior year. SG&A increased $4.4 million to $55.2 million for the six months ended December 31, 2010 compared to the same period in the prior year, primarily due to SG&A attributable to Selenium and marketing activities and R&D in China, partially offset by favorable foreign currency translation. As a percentage of net sales, SG&A increased 0.4 percentage points to 24.5 percent for the six months ended December 31, 2010 compared to the same period in the prior year. R&D increased $1.3 million to $8.5 million or 3.8 percent of net sales for the six months ended December 31, 2010 compared to $7.3 million or 3.4 percent of net sales in the same period in the prior year, primarily due to the transfer of engineering and product development costs from Northridge, California to China, increased programs and new product development and additional R&D attributable to Selenium. Professional – SG&A increased $7.3 million to $37.6 million for the three months ended December 31, 2010 compared to the same period in the prior year, primarily due to higher SG&A attributable to Selenium, higher selling expenses and higher R&D, partially offset by favorable foreign currency translation. As a percentage of net sales, SG&A increased 1.9 percentage points to 24.8 percent for the three months ended December 31, 2010 compared to the same period in the prior year. R&D increased $1.3 million to $9.7 million or 6.4 percent of net sales for the three months ended December 31, 2010 compared to $8.4 million or 6.3 percent of net sales in the same period in the prior year, primarily due to higher program costs and additional R&D attributable to Selenium, partially offset by favorable foreign currency translation. SG&A increased $11.6 million to $71.4 million for the six months ended December 31, 2010 compared to the same period in the prior year, primarily due to higher SG&A attributable to Selenium, higher selling expenses and higher R&D, partially offset by favorable foreign currency translation. As a percentage of net sales, SG&A increased 0.6 percentage points to 24.1 percent for the six months ended December 31, 2010 compared to the same period in the prior year. R&D increased $2.6 million to $19.7 million or 6.7 percent of net sales for the six months ended December 31, 2010 compared to $17.1 million or 6.7 percent of net sales in the same period in the prior year, primarily due to due to higher program costs and additional R&D attributable to Selenium, partially offset by favorable foreign currency translation.
32
Table of ContentsOther – Other SG&A includes compensation, benefit and occupancy costs for corporate employees, new technology innovation and expenses associated with our corporate brand identity campaign. Other SG&A increased $6.5 million to $22.8 million for the three months ended December 31, 2010 compared to the same period in the prior year, primarily due to higher R&D associated with corporate technology, higher advertising expenses and higher corporate development expenses. Other SG&A increased $10.5 million to $41.9 million for the six months ended December 31, 2010 compared to the same period in the prior year, primarily due to higher R&D associated with corporate technology, higher advertising expenses and higher corporate development expenses. Restructuring We announced a restructuring program in June 2006 designed to increase efficiency in our manufacturing, engineering and administrative organizations and expanded these activities from that time through the current period to improve global footprint, cost structure, technology portfolio, human resources, and internal processes. In fiscal year 2010, we announced the relocation of certain manufacturing activities from the United Kingdom to Hungary, a consolidation and optimization of our manufacturing capabilities in China and a reorganization of our PND business in Germany, which resulted in our exit of the PND distribution channel. During the six months ended December 31, 2010, we announced the relocation of certain manufacturing activities from Washington, Missouri to Mexico, the outsourcing of certain manufacturing activities to third party suppliers and continued to refine and expand on activities launched in prior years. For the three months ended December 31, 2010, we recorded $3.7 million for our restructuring programs, primarily within SG&A, of which $3.1 million was related to employee termination benefits. Cash paid for these initiatives was $5.7 million. In addition, we have recorded $1.4 million of accelerated depreciation primarily within Cost of sales. For the three months ended December 31, 2009 our Automotive and Professional segments updated their severance accruals based on new estimates which took into account higher than originally anticipated natural attrition rates. As a result, these restructuring accruals were reduced by approximately $12.0 million to reflect these updated estimates, which are included within expense in the tables below. For the six months ended December 31, 2010, we recorded $1.8 million for our restructuring program, primarily within SG&A, of which $1.0 million was related to employee termination benefits. Cash paid for these initiatives was $10.5 million. In addition, we have recorded $0.3 million of accelerated depreciation primarily within Cost of sales. For the six months ended December 31, 2009, we recorded $4.6 million for our restructuring program, primarily within SG&A, of which $4.0 million related to employee termination benefits. Cash paid for these and prior initiatives was $29.2 million. In addition, we have recorded $3.2 million of accelerated depreciation and inventory provisions primarily within Cost of sales. Below is a rollforward of our restructuring accrual for the six months ended December 31, 2010 and 2009:
33
Table of ContentsRestructuring expenses by reporting segment are as follows and include accruals for new programs as noted above plus revisions to estimates, both increases and decreases, to programs accrued in prior periods:
| |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
