Harman International Industries, Incorporated (NYSE:HAR)
Barclays 2012 Global Automotive Conference Transcript
November 13, 2012 2:25 PM ET
Herbert Parker - Chief Financial Officer
Well continuing on, a company we don't cover as of this point, but it's still nevertheless a very interesting company, Harman International, unlike some of the people have Delphi had electronics, but I'd like most of the auto parts, or the metal benders these are obviously audio and infotainment, unlike any other auto company I know, it's headquartered in Stamford, Connecticut, as opposed to the Detroit area. Market cap $2.6 billion.
We're pleased to have with us Herbert Parker, the Chief Financial Officer, as well as Robert Lardon. Is Robert here?
Robert didn't make it, maybe different. As well as you can introduce ourselves.
Hello, everyone. Yes, we've had a change in our Investor Relations, Robert Lardon, who's President of [finally] he was head of it, he's now taken a new role, in a division we call Luxury Audio, so Sandy Rowland has taken our now Investor Relations, and our (inaudible) is also working with us.
To tell you little bit about this story of Harman, I think a lot of you maybe don't know us and haven't seen us before so you may have follow-up questions later, we'll be happy to discuss. What I will do is go through the slide presentation that we've showed at our recent first quarter results, just remind you through that and then you can ask questions on it.
But first of all to just give you the highlights, from Harman and our first quarter, we just – we improved our earnings EPS by 17% and also $0.79 so we're still going very strongly in our BRIC markets we are growing 23%, led by China about 27%, you'll hear a lot discussion about the softness in China that was, but still they're well ahead.
We're very proud of the fact that we were awarded some $800 million in business and it's all new customers within (inaudible) and included BMW, Ford and Volvo, and audio side the sound system in your car, so that's very strategy for us. So some of the payoff and similarly in revenues of another 12 to 18 months.
We have been working for the last two years, towards becoming upgraded to investment grade, we do know that some investors only invest in companies that are investment grade and plus it definitely gives us a more borrowing rates. And we're very proud of that because if you looked around I saw very few companies while $4 billion of revenue up the investment grade, so it was quite a struggle but we've improved 12 consecutive quarters, and we finally got there.
And we have a $400 million note from KKR, that we retired recently and reason that's significant is that Harman, for some of you that may not know, takes care of our maintenance jumped to buy the company back in 2007, and back down during the crisis and the returning of - they felt that there was a [match] but there was a negotiation and a settlement where they invested $400 million in the convertible notes, at a nice rate of 1 in a quarter.
And they have a board member so we paid that out and the board member would no longer sit there. And the reason is significant as so many investors have expressed some concern about the possible rating results, and the ratings agencies always asked us what was his role, I mean he was a very good board member to [pursue that] served well but they had no more influence than anybody else. So it wasn't a threat to us, we actually saw somewhat of the benefit but externally it didn't look good so we just made the comment in our announcement that we paid off the $400 million debt and he would not longer sit as a director. And of course we have a new revolving credit facility of $750 million which prior to that we had $550 million
Give you just a little slight point of how we structured those our three divisions with the Infotainment being the largest then the lifestyle division see the note, and Professional Division. And on three of those divisions have double digit EBITDAs, that's new, we didn't have that year. The second two always had it. The first on Infotainment we will move things up in that area.
First, 14,000 employees, this is what we did from the first quarter, you considered with your own growth we like to look at the local currency but we can't control in currency of course we're down in normal rate. But up 2% which wasn't great by our standards but pretty good given the markets that we're in and what's happening in Europe, to the see the growth was up there, Precision division were slightly up Professional division allowed.
You can also see the improvement from Q1 12 this year we're on fiscal year calendar on to Q1 '13, the improvement there on 10.1 to 18% EBITDA margin and we could see the various divisions going to improve likewise with infotainment being slightly healthy slightly down.
This is what we call our dashboard. Short – just short quick snapshot of some of the things we're focused on. You can see we had 12 consecutive quarters of the top and bottom line growth and if you look that we update that quarterly and as you look to the right and every time the invested capital is up 12.6%. It's expected to be higher. I don't know which markets you're covering much, but we check most of our peers, on average they around 16% return on invested capital. So we are quite happy with that.
And we have very strategic plans in growing aggressively in China. You can see the growth that we've done so far, we put our (inaudible) management team because prior to the CEO coming five years ago and then I can fit myself in the arm. There was not much focus on developing markets and we have put in a local management team, which is easily doable, but we have actually empowered those people to have as much responsibility as the price did not move up than in division managers in Germany and the US. So, we're very happy with the growth in that area.
This is a choice that a lot of our analysts and investors had asked about, I thank them all. How much is new business versus old business. What you think for the top shot, you can see the shaded brownish orange carrier is showing a new business. So you can see we are growing in that area. If you take the bottom it's a different business, so we are maintaining the business we have got and going ahead as well, but you are going to look at the infotainment in the right or on top and you look at the audio [for it] to the bottom right.
One of the critical slides we have got is the bottom left. A lot of people ask when were these backlog revenues, what margin would they deliver and win. Well we are showing them exactly what the margin would be, you can see fiscal year '12, we have this business in green, which is what we call our high margin business, which is 9% to 11% margin and in yellow its 6% to 8% margin. And only 7% of that high margin by exists in fiscal year '12. Fiscal year '13, which is the year that we currently had we only have 26% of that. So, you see a big inflection point in fiscal year '14, where it goes close to 50%.
Now analysts ask about a question as you and try to ask me what's going to be the exact margin as well. I will not give revenue guidance for the next three years. So you have to assume what our revenues are going to be in '14, '15 and '16 to get the exact number. But based on constant, a revenue number achieved internal what it will be, you can see the margin will be simply sticking at 49%, since the 9% and take a 51% kind of 6% of the low end if things are stagnant and if things were to takeoff, you can just simply take them out and do that to the high end and you can come out with our margins.
So we think that is much visibility, as everyone is giving the margins going out therefore. All we have fiscal year '16. Another question has been asked that margin, how you – it is going to help, but what if you get pressured from the OEMs. While these orders we book, they are booked for four, five years. All the priced down, which are 4% or 5% per year is included in those number. So we don't think there's much width in those numbers, except for the volume. Yes, it's going to happen like there were a major rescission again then that's a different story.
This slide we would like show because if you go to our 10-K, you'll see about 55% to 60% of our business being in Europe. We should concentrate on just the middle of the circle. We would like show it again, use the where do our best ultimately, even it was selling this to Europe. I mean, the BMW is going to the US, going to China.
So when you look at it that way instead of the 60% close to you will see in our 10-K our market in Germany and Europe has stayed only 30%, and out of that 30% 74% is in Germany, That's significant because as you know until the last two months, Germany really wasn't affected very much by what was happening in Europe. And then Germany is going to be affected so it's starting to have some .
We were just taking a few highlights. Starting with our Infotainment Division, which I'd just like to mention some of the S&P regarded started production and already booking order two to three years ago as starts of the ship, which they call start of the junction few deals latter, so we just launched some of those. As you can see the BMW had started production that happened, the rest of it, I think many of you have handouts I won't go through each one of them. Just sort of mobile sales slide shown with some of the things we are doing.
Here I'd like to make a point, because if anyone followed us you may have ran some auto sometime ago about the smartphone's and how they have been potential traditional task, [Audi] is a big problem, where we go in and talk to the OEMs and the major people on what they believe. First of all, I must say we booked an audio with BMW. It doesn’t start shipments with fiscal year ‘17 and they are the most technologically advanced company out there.
So they gave us an order early approved that we’re going to stay. On top of that, these are some quotes from CEOs and other people. You can see the top one, in five years, Infotainment take rates will double to 40% to 50%. Most of you may know that lot of times you get instructions that go through any soccer matches or the KS. Most people don’t give you direction, they just give you an address. They assume every one has an embedded system.
Second one, they’ve talked about developing and integrating the technologies. Safety that’s going to be achieved for the car. I’d like to also mention to people that let’s assume that smartphones do have the right to go into the dash and that they may solve the problem that they don’t always connect because even in places when you need the smartphones the most is when the connectivity go away.
Then you got to save good factor and that’s where we stand by. We do all the connectivity in the car. We’re connected in a very safe way where you can search any button on those navigation systems and the car was still running. So safety is a big point.
And then the last one, you can see that driver distraction that you hear a lot about. Well, we talk about hands on the wheel, eyes on the roll, we get voice to text and text to voice where you’re not distracted. We are fortunately look at things. So those are just only three statements that we’re hearing from the major people who make the decisions regarding the future of navigations, embedded navigation.
$800 billion order I just talked about is the part of the highlight. There was a really big highlight was to break through in the Detroit about a year ago. First of all, we did talk last quarter about our large ordinary guy from one of the big Detroit three were not allowed to see the name again. So if we go with the transcript of our old slides you can find it. That was not $100 million and that’s the first time ever that we got that (inaudible) order in Infotainment, were one of the big one in Detroit.
Then also first time ever we won an award from Ford, first time ever, we won an award from Volvo. So it was a very good quarter for us to start. And as you get these orders, once you get into those company, that gives you a better opportunity to get more businesses, normally like, you get one order and you’re out. So we feel very good position in North America. We dominate in Europe. Always out with BMW, Daimler, Volkswagen, Porsche, Ferrari, Hyundai but not so much in U.S. with Subaru beyond Chrysler, we’ve always deals.
For Chrysler division, this is our division. This is smallest but maybe good margins 13%, 15%. Our base was about the sound systems that we have in the major things around the world like the Beijing Olympics, is in the Madison Square Garden, is in the Yankee Stadium. It’s in every Olympic, every democratic and republic convention. We’re pretty much dominated that market and professionals and that’s our division there, I’ll just you few of the highlights with that.
Our strategy doesn’t change the strategy overtime. We’re just continuing to grow smart Infotainment. We are paranoid about being to held our competition. We want to keep it that way. We’re growing in our automotive audio division that we make very hard margins in our branded audio. Our emerging market is a big driver for us.
I’ve mentioned China earlier. We are doing better well in Brazil. We bought a company there two, three years ago. Well, $50 million revenues at the time should turn about $100 million revenue in the next year and getting our cost to capital structure right. I’ll just mention that we will upgrade it by S&P and Moody’s and we got a new credit facility more than $1 billion liquidity. So as we’re well positioned in executing on all four of our strategic goals.
With next slide, I will walk through that, just a reconciliation of some people that might ask what happens when you cash but take note of the red bars of $400 million we paid off. The real key to that slide is at the bottom right hand corner for some of the people who want to look at the interest we pay and you just see the old rates we had on our revolver versus the new rates that we have now, just showing that we got a better rates on all of our those section.
Upgrade, investment grade thus had advantages, I mean, a lot of time the bankers will tell us we don’t need it but they won’t give us a same rate because they are credit -- raise their credit. The company’s insight internally won’t allow them to give us a good rate on this reinvestment rates. So we do see an advantage to that.
And in summary, I mentioned the ‘12 quarters overall, that we are growing in top and bottom line, strong balance sheet, industry leading backlog, dollar digit margins, when it rules out, the BRIC sales up as we’ve been doing every quarter and we’ve got more 175 new patents for just that quarter. We’re on the top by more than 4,000 patents that we have.
And our global footprints with the world-class structure now we used to have just four or five years ago, 1% of our engineering outside the Germany and U.S. that has well over 30%, manufacturing was about 19% and rest of the world 15%. So we are driving the company for the future with continuous improvement and I will stop there and take any questions.
Questions from the audience.
When I kick it off, you touched on it a little bit with some of those quotes but why don’t you (inaudible) around the stock as it looks pretty cheap as they’ve taken iPhone and put it out on the seat next year or crop it up or even plug it in and some are even, some people are having some interfaces where it goes up on to the -- smartphone will go up onto the screen. Where do you fit in all that? How can you possibly keep up? Is there any regulatory sales that might actually kind of create more of a valve guard in the car?
Well, first of all, we are working with the smartphone people who do the integration. So we are the first one who actually integrated the Apple System. So the connectivity will always have to be done by some one like our sales when it gets to $80 of sophisticated level, number one.
Number two, the regulators definitely would still be in as you know they don’t want one fixed in and driving as most people are doing unfortunately. But what our expertise is to bring that won’t do it. We get the questions from our Board of directors with that screen has so many things, aren’t you make it distracted and we concluded that people will text and drive.
So its our job to make it safer, and we will make it safer, is there easier we will only use the voice activation and use in texting email as you can speak about verbally, having read to you, depend on whose you are calling, you may say, you don’t want that. So we are coming up with all those titles, checking all of these, and we are the first at that.
So those are the main things. Then also like the sales people tell safety is a real big issue. Forget the government, it depends only of the reputation of your company. I still think about (inaudible) the last mortgage share and I don’t think they told you peopled gained it back yet. And it wasn’t even their fault, so just imagine something that could happen, if you really made mistake. So we believe that the OEM will consistently rely on someone like us to make it see, because Apple, Google, they are not going to take that responsibility, or that liability. So we believe all those are barriers to entry.
Now having said all of that, we have such paranoid management team. We are consistently looking at, how can we make it cheaper, which we are doing, how can we make it faster, how can we make more productivity and we’ll do it all of those things, because I believe that the route system costs, let’s call it $300, $200 versus $2000 or so, versus a smarthphone and maybe about the same, people going to choose the embedded system has much more convenient, easy-to-use.
I’ll like to encourage you of those days, a lot of you too young, when you use to have this all CDs that we own, plugged in and pulled out, everyone was very happy when the CD was embedded and after while it became standard. No one want to glorify the leaders who did it. So I believe the Infotainment system will similar, whether that happens in four years or seven years, no one know exactly, but I think it just a matter of time the board become standard. Yes.
The decline, the secular decline in the speaker business and I guess with iPads and what not kind of talk to me about how you see that going over the next five years and how you are planing for that, because we know PCs are selling lot less?
Okay. If I understand correctly you mean the secular decline in the speaker business, but you are not speaking about -- are you speaking about the automobiles or just …
…speaking to gentlemen.
Yeah. Having nothing to do within the care, having everything to do with the desktop speaker business?
Okay. Then we have the business in Lifestyle call it home and multimedia, used to be call consumer, and we sell a variety of type of speakers in the home. That point we are actually definitely the leaders of home. We’ve got several nice systems there. We’ve got a chance go the Harman and look at what we’ve got on our website that you can have your iPhone because one thing that Apple never concentrated on was to sell. They just make the devices.
So we have the nice system that Bluetooth you can sit here and stand here and you speak a niece sitting next of you while we can play your sound in this way, little small device, teenagers love it. They can take it to any party and just play it. We got bigger devices that you can play.
We’ve got kind of that you can plug into the wall as it gives just a little plug-in system that plays a sound. So yeah, I agree there are systems coming out now. We don’t need all these big systems at the home, but we are with iPhone, and the iPod they don’t have good sound system at all, so we’ve made the system that could make it all when you can play the sound and you have good quality sound.
(Inaudible) pricing for on that versus the desktop speaker, like, five years ago, you guys were widely known for having the best in desktop speakers and whatever. So, how does pricing and units compare from that?
The price is still good because we get very good margins on those. That’s not a price war, it’s not commodities, not everybody’s into it and it changes just like the smartphone. Whatever speakers and then we built on those types, the designs are being part of it.
So we’ve got to change those every year so to make sure people think they are happy, cool and achieve bottoms. So we are getting very good pricing on that. There has not being a price reduction in that area.
And speaking on other side that’s almost bigger one, that’s in our professional division. So that’s what the professional people. They cannot risk starting in a concert or starting to convention when it doesn’t work perfectly.
In terms of a large part of your safety in the cars, you do voice recognition and voice recognition has been around for a long time and is well equipped. I know when my car says, call Peter and it calls Harry. I mean, when will we get that and when will it work?
I agree. First of all, let me say, I wanted to say that the biggest part of our car safety is the voice recognition, yeah. And I’m not sure that will be -- the other things like land detection is telling you that you need to go forward, you need things like steering wheel is shaking because you are dozy. You add much or drink whatever.
So those are somewhat I have been, but you are absolutely right about the force. It identifies, we don’t feel that. One story came out (inaudible), big deal. We’ve always had. That’s just we’ve had and I’m glad you recognized it.
But a lot of people didn’t and my folks indeed, voice recognition but you are right. It’s not working well. That’s why we are working on. (Inaudible) is the voice recognition company. We actually work very well with different set of part of our business.
We feel our own voice recognition. So, I’m saying that we are prepared in the next couple of years, but it is not there yet today. We are on the forefront and I think will be just as good, or better than all of what we are trying to do.
Let me jump in with a few questions. Maybe just continuing this line. You sort of an audio, Infotainment Company, which is talking more and more about safety. What are you beginning to do win, sort of what’s in the past been a separate area, which is electronics safety and then our freights, not involving or lane departures warning systems you mentioned all the way up there.
Google, your competitor partner whatever they are, showing up a car that doesn’t need a driver. How do you see Harman short-term, mid-term and longer-term fitting into that way?
Short-term, I would say that our point of safety is what we are doing to do that you as a user do not see, is more of the operated system, the middle web of bank born to make sure that they depart one, safely every time.
That when you are driving all of a sudden, you push one button it doesn’t pick at all. It causes you some kind of a crash at the time with the car, yeah, today. In the future, a best driver assistance, we call it a dock. And that is things like delaying rejection and giving you warnings.
Integration, there are several people making note. We as automaker are making more ourselves. But someone will have to integrate it. Whoever comes up, the people are developing today, we are the ones to integrate it through our system when it becomes a part of our nervous system of our car.
So that is our expertise to date, which will not change. We don’t believe. What we will add to that is starting to build a more of those safety system ourselves and we’ve brought a company in India call Interchange just about a month ago that will also is on the forefront of some of those developments in those telematics is the area that we are driving.
And in terms of getting OEM credibility there, are they still looking at B&W, [Autolead], Delphi I preferred to ask, safety, Conti and Bosch been in electronics safety. How could Harman break into that again, some pretty formulaically?
Well, we are not sure what will break into that area of noteworthy. And we are actually moving on infotainment business faster on so far in last few years, they’ve been under our division. But that’s because cars were down so much and the speeds taken off.
It’s the primary set of our business. So, our hope is really not to go out and try to bring more into the infotainment side. We are looking more on growing through acquisitions and on getting growth on professional and audio side, where our margins are higher here and risk are lower.
Infotainment, we were always interested in growing that if we bought business, heading into different countries. So we can get more market share. And we are the leader in the technology in what we do. But we are not interested going so forth, as to the companies you mentioned to do the things they are doing.
But when it comes to peer telematics, it’s an activity, incident connecting bringing Facebook, getting Google mouses we do today. That kind of the technologies we are interested in.
A shorter run, what are you seeing vis-à-vis Europe, common question what are you seeing around fourth quarter production schedules. But in particular, not just between the luxury OEMs and the non-luxury OEMs between take rates on, infotainment loaded versus infotainment as far as cars, is that shifting with their macro issues?
What was there and what we are seeing, even though in the crisis of 2008 and 2009, we never saw freight take rates going down. We saw the number of cars going down in the bottom. And that’s the same thing we are seeing there. As a matter of fact, most people what we found, they were driving a seven series BMW and with down to five, they would still make sure they had all of the same months lists, if not even upgraded more.
So we are not seeing take rates decrease when it comes to branded audio systems. We are not seeing any increase when it comes to infotainment system. A lot of people that don’t try and definitely flip the equipment in the yard, if they go somewhere and have a smartphone and they’ll say, well, what would some bought one buy embedded system.
Well, is I -- it’s very difficult to find someone. I don’t know if anyone but excuse me that had a card with an embedded infotainment system and the second card evolved one without it.
So, I think that our desktop is here to stay and we don’t see take rates going down. It’s been going up, at least when I predicated a CAGR of about 9%, 10% for the next four years where goals from 20% to date overall to 40% to 50% of take rates in the next four, five years.
And I’d say what the OEMs, how much of that goes to the OEMs, to dealer versus Harman? And that’s something that’s…
I will say that one of the OEMs in Las Vegas made a statement that they make more money of the products that we sell to them than they sell through the consumer than the entire car. So they are really making the killing, which we are not seeing unfortunately and you may say why not, we are the competition. We think 7%, 8% margins. There is not another pure infotainment company that you can find.
So we dug in with our intelligence and found out to be Pioneer is making 2% or 3% margin. They are quite happy with that and causes somewhere between 1% and 5% of their business. So the CEO of that those large companies, probably don’t need shareholder, rely what they are doing or they make the story that yeah, I’m continental, I sold guitars and the infotainment.
Someone else sold your safety systems and the infotainment. So the competition has made it difficult for us to get to the margins that we got, where we have gone from a loss to 2%, to 4% in infotainment and now above 7%. And we believe we will continue to move up that number.
Thank you. Do you think the industry consolidates infotainment specifically?
We hope it does, but as interesting, we recall, we look at two or three companies where we know somebody of top management and the discussion is where are these building it. And if you take on several company’s guys CEO or executive of that division, they like it in a whole line and it’s so enormous for the parent company, the parent company is not (inaudible) listed and we need to get out.
They will make the statement that’s selling our other products, of course we have infotainment. So, I would think that one or two may drop off over the next year or two. I’ve been hearing a lot of noise about that -- quite a few would not be at the smaller ones during the crisis. I’ll take one or two more and we drop out.
Okay. Thank you and your team very much, Harman.
Thank you. We have a short break now and we are going to resume at 3:15 with Dana Holding Company. So back to the middle mandates.
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