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Harman International Industries, Incorporated (NYSE:HAR)

Q2 2013 Earnings Call

January 31, 2013 11:00 am ET

Executives

Sandy Rowland

Dinesh C. Paliwal - Chairman, Chief Executive Officer and President

Herbert K. Parker - Chief Financial Officer and Executive Vice President

Analysts

Ryan Brinkman - JP Morgan Chase & Co, Research Division

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Douglas Thomas

Ravi Shanker - Morgan Stanley, Research Division

David H. Lim - Wells Fargo Securities, LLC, Research Division

Matthew T. Stover - Guggenheim Securities, LLC, Research Division

Adam Brooks - Sidoti & Company, LLC

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Harman Fiscal 2013 Second Quarter Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded Thursday, January 31, 2013. I would now like to turn the conference over to Sandy Rowland, Vice President of Investor Relations. Please go ahead.

Sandy Rowland

Good day, this is Sandy Rowland, Vice President of Investor Relations at Harman. Thank you for joining us for our 2013 Investor and Analyst call. I'm joined in Stamford today by Dinesh Paliwal, our Chairman, President and Chief Executive Officer; and by Herbert Parker, our Chief Financial Officer. If you haven't done so already, I invite you to visit the Investors section of our website, where you can download copies of our earnings release and supporting slide presentation that we will be referencing today.

Before Dinesh and Herbert provide their remarks on the quarter, let me also address a quick housekeeping item. Certain statements during this conference call and question-and-answer session may be forward-looking statements as defined in the United States Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on management's beliefs, assumptions and current expectations. However, these forward-looking statements are subject to a number of important risk factors and uncertainties, which are fully described in our 10-Q and the press release that we issued this morning.

Now let me turn the call over to Dinesh.

Dinesh C. Paliwal

Thank you, Sandy. Before we jump into the performance details for the quarter, I want to say that our second quarter financial results were short of our expectations. However, as part of the ongoing execution of the 4 pillars of our strategy, I will be sharing with you new growth and restructuring initiatives. We are the market and technology leader in all 3 divisions, and we remain confident in our prospects for long-term growth and investor value creation. The economic headwinds and the slowdown in the automotive sector in Europe created a difficult operating environment for Harman during the second quarter, and we expect these conditions to continue for the first half of the calendar year of 2013. As such, we are adjusting our outlook for the remainder of the year. Herbert will provide more details on this later on the call.

To help address the challenges, we're not wasting a minute. We're implementing restructuring initiatives, which will improve the company's operating performance. Harman will reduce approximately 500 jobs in high-cost countries resulting in annual operational savings of approximately $30 million to $35 million, beginning in fiscal year 2014. The company is also evaluating the sale or closure of a manufacturing site in Europe, which would further reduce an additional 500 jobs over the next few years. These restructuring efforts will allow Harman to reduce cost and compete more effectively. Rebalancing our workforce is a difficult but necessary step that Harman is implementing to deliver improved financial results through the European economic and automotive cycle recovery.

Coming back to our performance, European automotive production was weak throughout the quarter, but the slowdown accelerated significantly in December. Several European automakers ceased production and took longer than normal holiday shutdowns. Industry expert, including J.D. Power Research, estimated and just put out a report that production for personal vehicles in Western Europe declined by 15% during the quarter. Just as an example, one of our key European customers, production volume was 42% lower in December compared to the prior year. If we quantify the impact of this effect, we lost $30 million to $40 million of revenue in this quarter in Infotainment Division and $10 million to $15 million in our Lifestyle Division due to European sudden slowdown. These same recessionary conditions in Europe have impacted our Professional Division as well as customers are delaying capital projects for installed sound and broadcasting.

Our Japanese automotive customers' production volumes were also impacted this quarter by the island territory dispute between Japan and China. Sales of Japanese automobile in China are improving but have not yet returned to pre-dispute run rates. Outside of automotive, the world's 2 largest economies, the United States and China, held presidential elections during this quarter. Many capital projects were delayed pending the outcome of these elections, fiscal cliff and many other uncertainties, impacting our Professional Division in particular. We expect that capital spending will pick up again as the election uncertainty has now been resolved.

In the Northeast, to a lesser extent, Hurricane Sandy, caused our customers to delay some capital projects as well, which have pushed out to next quarter. The outlook for the second half of our fiscal year 2013 shows a modest improvement. And later in this call, Herbert will discuss our updated guidance for the full year 2013.

Despite the challenges, we will continue to aggressively execute on all four of our strategic pillars to strengthen our competitiveness over the long term. Our fundamental strategy remains unchanged as our commitment to long-term growth, innovation and shareholder value creation remain stronger than ever. We are implementing strategic initiatives that we believe will pay dividends and mitigate the impact of regional economic and automotive cyclicality.

Our decision to realign our businesses 1.5 years ago reflects the strength of our position as a global leader in Infotainment and global leader in Lifestyle business, with tremendous brand synergy in audio businesses. This move will also helped optimize reporting transparency for our stakeholders and the fit and focus of each operating unit. Importantly, it allows us to evaluate each business on a stand-alone basis and benchmark their performance against respective peer groups as much as we can do within under a conglomerate. With the right division structure now in place, we believe we have the right foundation for growth. Let me review some of the notable achievements across our divisions from the quarter.

First, let's look at Infotainment Division. As referenced on Page 8 of the slide deck, we had a number of achievements in the quarter, including the U.S. launch of our premium NBT infotainment system for BMW. And by the way, BMW has acknowledged that this has been a best and most significant launch they have done, and we are very proud to be their single-handed partner. We also expanded the production of the Audi MMI scalable infotainment system to the several Volkswagen models. The Audi scalable platform complements the successful launches of the Toyota Entune and Chrysler Uconnect systems, which recently won a Technology of the Year Award at CES in Vegas earlier this month.

Harman's scalable platform continue to gain traction. During the second quarter, we also addressed a new market segment as we expanded our Infotainment portfolio with the new Harman connected radio platform. This platform targets the entry-level segment for the cost of basic radio. The OEM can now add smartphone connectivity into their vehicle, along with Harman's Aha Radio, turn-by-turn navigation, voice prompts and several other features. It's all about fit and focus, cost-competitive and still maintain the profitability.

At the Consumer Electronics Show in January, we expanded our successful scalable infotainment platform with an Android-based open source application environment. I reinforce, Harman is the first commercial company to launch Android-based infotainment system. The platform leverages smartphone functionality to safely bring cost-centric apps and services into the car. We also showcased for the first time in the industry our vision for tomorrow's model premium infotainment solution, our next-generation systems feature interactive head up displays, combined with smart connectivity, augmented navigation, gesture control, high-speed networking and driverless features, to name a few.

These innovations form our position as a world leader in this space and I say it because I was personally very thrilled to see almost every single Harman customer and future customers, when they came they spent hours. They brought their chief engineers and some of them had repeat visits. And some of them actually cried loudly and said how fast can we have this in our current offering. And that is very rewarding, that the investment we've been doing in R&D is really being recognized.

Our Aha platform is also gaining traction in the market. Ten leading automakers from Asia, Europe and the America will offer Aha by the end of 2013. That is a very fast penetration of this great technology. The Aha solution leveraged the Harman cloud platform to simply enable web-based information and entertainment in vehicles. Just imagine, bringing this service in install base of 15 million cars, which have nothing to talk about in terms of connectivity, which we talk about now.

To further expand on our progress in connected in-vehicle services, we're announcing today the formation of Harman Infotainment Services business. This would be a standalone financially reporting unit, would be managed by a general manager, who will run this global P&L business. He'll leverage -- he or she I should back up. We will leverage the installed base of over 15 million Harman infotainment-equipped vehicles on the road today to create a fast-growing recurring revenue stream with high margins in line with our Car Audio and our Professional Audio business. OEMs and car owners want to keep their vehicle infotainment systems current and connected. As you will see on Slide 13 and 14 of the deck, Harman Infotainment services will offer 4G and LTE-connected head unit upgrades for vehicles currently on the road. Cloud-based services to the car such as Aha by Harman and customer relationship management CRM services for automakers using vehicle-specific aggregated data.

The launch of our Infotainment Services business will create a new revenue stream less dependent on our automotive production cycles and drive consistent revenue with 2 to 3x higher margins than the current Infotainment system business. We expect service business to grow fivefold within the next 5 years from current levels of approximately $100 million, which is currently being booked in our systems business. Our technology launches at CES and our Infotainment service launched today are generating true excitement among our customers.

Now let's shift to our Lifestyle Division. In Car Audio, we continue to expand our relationship with our existing customers and, this quarter, we secured 4 awards from Toyota, Lexus and Subaru. BMW selected in addition, Harman's HALOsonic technology for their next-generation cross-car line active noise management cancellation outside the car and synthesis of engine sound inside the car and outside.

In addition, as referenced in Slide 9 of our deck, we have a number of car audio solutions launched by our customers this quarter: Maserati, BMW, MINI, Mercedes-Benz, Toyota, Honda and Kia all had launches for audio solutions ordering our industry-leading brands. Now these launches will start to ramp up in the second half, but fully gain the full production volume in -- starting fiscal '14.

On the technology front, we introduced QuantumLogic 3D, a new three-dimensional surround sound experience for the premium automotive experience. This innovation is based on Harman's patented QLS digital signal processing technology. QuantumLogic 3D uses proprietary algorithms to add the dimension of height inside the car for a true immersed listening experience while maintaining the integrity of the original recording.

During the second quarter, we continue to build momentum with our home and multimedia products. As a matter of fact, this business, which used to generate losses, if those of you know 5 years ago, has turned around and it grew in the last quarter 22% and actually generated good mid- to slightly higher operating margins. Our dedication to delivering superb audio performance and design excellence helped Harman achieve a company record, 20 design and innovation awards. These awards reaffirmed that our research and development focus is delivering meaningful products, meeting the needs of today and tomorrow's consumers.

Turning now to Professional Division, referenced in Slide 10 of our deck. We maintained our sector leadership and provided sound reinforcement for several high-profile events, including the 12-12-12 Sandy relief benefit concert at Madison Square Garden. Our focus on transportation vertical market continues to pay dividends, particularly in the emerging markets.

Following the successful installations in several countries, our IDX, had an integrated audio video paging solution will soon be installed in the Guangdong airport in China and Bangalore International Airport in India. Recently, we also launched an agreement to purchase Martin Professional, the world leader in professional lighting and video solutions for the entertainment industry. This acquisition will be an excellent complement of our professional customers in all our global markets, including the fast-growing BRIC nations who require increasingly advanced and integrated audio lighting solutions. Upon close of this transaction, which we expect to be completed during our fiscal third quarter, Harman will be able to offer a full audio, video and lighting solution for a wide range of live entertainment.

Before I turn the call over to Herbert, I want to reiterate that no one is more excited for the future than our dedicated management team. And we continue to believe that with the recent blip in our performance after 12 straight quarters of top and bottom line, we believe that fiscal '14 and '15 will be strong years for Harman. We expect that the global economy will be stronger as we are already seeing improvements in the United States and China. More importantly, as you see reflected on Slide 5, we will have ramped up to full production on several higher margins scalable infotainment platforms in '14. This will mean half of our Infotainment revenue will come from our high-margin scalable platform compared to only one quarter in 2013.

Now taking a page from our success from the scalable infotainment platform, we will also be launching a scalable audio platform in our Lifestyle Division for car audio, which will help to increase our take rates and profitability. Despite the current difficult operating environment, we continue to take actions to position the company for top and bottom line growth as the European economy recovers. To enhance return for our shareholders, we're taking the right steps to reduce costs, drive innovation and expand our portfolio to achieve profitable growth.

I thank you for your attention and thank you for your continued support. I will now ask Herbert Parker to give you a closer look at our second quarter performance and details on our updated financial outlook for 2013.

Herbert K. Parker

Thank you, Dinesh, and good morning. As Dinesh indicated earlier, the European economy was very challenging this quarter. However, we continue to position the company for long-term success. Now I'd like to take a closer look at our second quarter performance, as well as our outlook for the remainder of the year.

As usual, most of our financial comments are provided on a non-GAAP basis, which basically excludes restructuring cost and on other nonrecurring items. The reconciliation of our GAAP to non-GAAP results is included in the press release issued this morning. Starting with the top line. Our revenues in the quarter were $1,056,000,000, a decrease of 6% compared to the prior year or 4% if you exclude the impact of foreign currency. At the total company level, our gross profit in the quarter was 25.8% compared to 27.1% in the prior year primarily due to reduced operating leverage on our fixed costs.

In the Infotainment Division, gross margin declined 230 basis points primarily due to our reduced operating leverage on fixed costs. In the Lifestyle Division, gross margin declined 160 basis points. This was primarily due to the product mix change within the Lifestyle Division and the fact that our Car Audio business was negatively impacted by the slowdown in the European automotive sector. Gross margin in our Professional Division improved 220 basis points primarily due to the improved profitability of our new product introductions and benefits from footprint migration projects. Our SG&A expense increased 190 basis points primarily related to lower sales.

Our consolidated operating income on a non-GAAP basis was $57 million and net income of $41 million in the quarter or $0.59 per share. We continue taking actions to shift our global footprint to best-cost countries. And as Dinesh mentioned earlier, we will take restructuring actions, which will reduce 500 jobs in high-cost countries. We expect to book a restructuring charge of $30 million to $35 million in the second half of fiscal year 2013 with a payback of 1 year.

And as promised last quarter, I will address our updated guidance. We now expect that our fiscal 2013 revenues will be between $4,175,000,000 and $4,250,000,000, and EPS will be between $2.70 and $2.90 per share. With respect to taxes, we're now projecting that our effective tax rate will be between 22% and 23%.

Now similar to my comments I made for the quarter, the guidance figures are also non-GAAP items, which excludes nonrecurring items such as restructuring costs. Now we have already addressed the revenue headwinds that we and other companies are facing. However, I want to explain in detail the changes to our profitability forecast, which is, of course, primarily impacted by lower sales volumes.

First, when you take a look at the midpoint of our guidance, we are lowering our organic revenue outlook for fiscal 2013 by approximately $300 million or 7%. When you take into account reduced operating leverage as a result of lower sales volumes, this impacts our bottom line by $60 million to $80 million. Please note that our updated guidance includes approximately $50 million in incremental revenue from our pending acquisition of Martin Professional, which is expected to close to end of fiscal third quarter. Contribution earnings for the Martin acquisition will be modest in fiscal 2013 as we will be focused on integrating the 2 companies.

Next we also have a revenue mix shift compared to our initial guidance in our Lifestyle Division. As mentioned earlier, our home and multimedia products are performing well. This strong performance fortunately offsets the performance on our Car Audio business, which is impacted by the slowdown in the European automotive sector. While we have improved the profitability of our home and multimedia products, the margins are lower in Car Audio. We estimate this mix shift impacts our profitability by $5 million to $7 million. In addition, our research and development cost will be higher by $7 million to $10 million in the Infotainment and Car Audio.

And with that short summary of the guidance update, I'd like to thank you, and we are now ready to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Ryan Brinkman with JPMorgan.

Ryan Brinkman - JP Morgan Chase & Co, Research Division

Previously, you repurchased shares in the high $30 range after a similar-type decline in your stock. Back in May of 2012, one might say you even defended them. Given the combination of today's selloff with your recent large increase in liquidity and given your confidence that profits could inflect higher in FY '14, does it make sense to take a harder look at more aggressively allocating capital to share repurchases?

Herbert K. Parker

Ryan, yes. We always continue to look at that. And as you know, we still have the $70 million remaining from our prior buyback. And obviously, there's nothing that stops us from going to get additional authorization from our board. But this is something we strategically look at and we will evaluate what's happening in the market.

Ryan Brinkman - JP Morgan Chase & Co, Research Division

Okay. And then I appreciate the color that you just gave on the decremental margins. But maybe just little bit more on the steepness of the decrementals during the quarter, could you talk about any factors specific to the fiscal second quarter that might have impacted decrementals that perhaps could abate as we go forward, for example? I mean does it just simply relate to the steepness of the decline in customer production or maybe does it relate to the suddenness of that decline? I think we calculated that the decrementals on the organic decline and revenue at Infotainment this quarter was about 43% or so. Do you have a goal as to what you limit those decrementals to? How did you perform relative to that goal, if you have one during the quarter? And just how generally should we think about those decrementals trending as the fiscal year progresses?

Herbert K. Parker

Yes, basically it was the suddenness of the decline, as you mentioned. We are building up capacity or transfer. And as you say, a lot of capacity from high-cost to low-cost. In the interim we do have some counting there twice. But additionally, the steepness of it was a big decrement and we also had additional launch costs during the quarter as well that made that a bit steeper than it normally would be.

Dinesh C. Paliwal

And just to clarify, traditionally you would not expect launch costs to be significant to report. But as we have successfully launched Chrysler Uconnect with no additional launch cost and [indiscernible] the launch cost. But the BMW one was a mammoth launch, which we are so proud to be part of the NBT. And that, as a safety factor, our client wanted us to run parallel processing, and that had about $5 million. So that you can say was a one-off and would not repeat. And we have got few other SOPs coming up but not planning to have any incremental cost on them. Other than that, it's the leverage. That's it.

Ryan Brinkman - JP Morgan Chase & Co, Research Division

Okay. And then my last question, can you just comment on the take rate environment for various different vehicle options during the quarter? Did you sense anything different there? We have been hearing from other suppliers Gentex, others like Autoliv too, that maybe there's a little bit less-rich content mix. And of course, that would severely impact you more than a company building brakes or something, of course. So did you detect the change? And if you did see any sort of change, can you just comment about whether you believe that as a cyclical factor or secular factor, most likely cyclical, and when that could inflict differently.

Dinesh C. Paliwal

We're not seeing a global trend off a take rate going down. As a matter of fact, listening to automakers and chief engineers of Audi and BMW, they're very bullish that take rates should go up. And they want to drive it up to claim that their cars have connectivity and they want us to have modularity so that at least we put some sort of an infotainment in there and audio. But however, what we're seeing, Ryan, it might give some color to the whole battle of gaining market share from one automaker to another, we have seen VW and Toyota and Hyundai getting into the mudslinging and there we have seen de-contenting by trim levels. And that seems to be a short-term thing because you cannot sell car in long term and still be able to provide connectivity and audio. So that obviously has affected. But if you talk to same clients, they say, well, we have to gain our market share in certain geographies and we wanted to make it a car as they're born to compete against each other. So that is a point I don't draw a line as a trend.

Operator

And our next question comes from the line of David Leiker with Baird.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

A couple of things here. First, in the restructuring that you're talking about, can you just put a little bit more color on, I guess, 2 steps. One is some overhead cost reduction. The second is on the manufacturing side. I guess at the manufacturing, as the legacy products roll off, you don't need those manufacturing assets with what you've built in lower-cost regions. But if you can put some color on that first piece of it first, please?

Dinesh C. Paliwal

Yes, so there are 2 buckets. The first bucket, we have announced we're going to pull the trigger now and that will all be done in this fiscal year so that we can annualize, savings can be booked into fiscal '14, $30 million to $35 million. So that's very clear. And these are bunch of small activities. Out of 500 jobs, about 100 jobs would be in manufacturing. We're moving some parts of the value chain from high cost to best cost country, but the 3/4 or 4/5 of the restructuring would be in engineering and application, some of the hardware pieces which are done proper now, more effectively in some other countries or some other people can do, or engineering. We are doing a lot of engineering in Ukraine. We're doing a lot of engineering in India and China now and high-quality and high-speed. So that is first part. That's 500 jobs. Permanent reduction in high-cost countries. Permanent reduction. Then comes the second bucket. That is a factory in Europe, which I cannot say which country yet, but we are further along. We have been discussing this with the European Works Council for 2 years, actually, and we have a very well-established social plan and everything. Either we will shut it down ourselves by 2015 so that we can start full savings in '16, or even prior to that already, or we will sell it. And so one way or the other, we will lose 500 permanent jobs in Europe. Now we don't need to replace those jobs because we have plenty of capacity in Hungary, in China and in Mexico and Brazil.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

So it sounds like both so those actions are part of the long relocation of the cost structure as opposed to the reaction of what demand is or order rates or anything along those lines.

Dinesh C. Paliwal

Precisely David. That's been part of our backlog-based analysis. Because we know there is a lot of tailwind and there will be a bigger growth in infotainment car audio. So we have been building capacity like we have 3 factories in Mexico. We have 11 production lines in Hungary. We have 3 factories in China. Now slowly, we need to sort of go after the high-cost factories that are not relevant anymore, going forward. So we have plenty of capacity and we will take that permanent cost out. And that would help us rebalancing our cost and also improve our profitability, so even the same backlog will be running through lower-cost operations that will also improve on top of what we already see in '14, '15, '16.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then as we look at these cuts that you went through in Europe in December, as we've talked with a variety of different people, it sounds like some of those are carrying over into January. Are you saying that carryover as well?

Dinesh C. Paliwal

I expect that -- we expect that the third quarter, which is the calendar first quarter, would be not much different from our second quarter. Although prolonged shuts won't happen, but traditionally our third quarter is a weaker quarter because of the APIs and what have you. And in this situation, it would -- since second quarter was already subdued, it would be very similar to third quarter and second quarter would be same. However, if you back out the first half of sales and profit performance from our full year guidance, you will see we are projecting a modest improvement in our second half, which means our fourth quarter would be definitely stronger quarter, and we have a pretty good, high degree of confidence that we're going to pull it off.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

And as what you're seeing here in the March quarter, is that one-week, two-week type production shutdowns, or is it a lower daily build a rate coming out of the holidays?

Dinesh C. Paliwal

It's the lower daily build rate coming out of the holidays. It's not the prolonged shutdown. I think all of them are back to work.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Okay. One last item. Herbert, can you break out, first, the R&D expenses in the quarter, please?

Herbert K. Parker

Yes, David, for Infotainment, we had R&D expenses of $44 million and for the total company, $72 million.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

And do you happen to have that for Pro and Lifestyle too?

Herbert K. Parker

Yes. Lifestyle was $80 million and Pro was $7 million. The other $2 million is in Corporate and Other.

Operator

And our next question comes from the line of Chris Ceraso from Credit Suisse.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

So a couple of things. You mentioned Volkswagen. I wanted to dig into that a little bit. It seems like some of the pressure that you felt this quarter that maybe some other European-exposed suppliers didn't feel quite as much might be as a result of exposure to Volkswagen. VW had a pretty good quarter in terms of build rate, some of your customers not as good. So can you give us an update on your ramp with the Volkswagen brand vehicles, how much are you doing now and when does that really gets steep? When do you start to hit critical mass on Volkswagen vehicles?

Dinesh C. Paliwal

So let's just break this question to two. The drop we saw was as reported by J.D. Power, that Audi had a 42% drop in month of December, and that obviously, Audio is a big customers of ours. We also said that we launched MMI plus, and that scalable platform on some of the Volkswagen vehicles is just being launched. I think the ramp up will continue during this second half and full production we expect in the fiscal '14.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Okay. Maybe just a similar type question but across more automakers. When do you hit the critical mass of some of these scalable platforms? You mentioned it would be 50% of your business in fiscal '14. Is it something that comes on early in the year or when do you really start to bring on the bulk of the new business that's in your backlog.

Dinesh C. Paliwal

You know, if you want granularity, I can give you. Uconnect has been a great success with Chrysler, as well as the best product of the year, they're very delighted. So I think they're going to be ramping up. So let's say that would be already coming in, in first quarter. Toyota is already happening. Volkswagen would also be happening and other programs. So all in all, if I were to take a pretty comfortable position I would say, it's second quarter of fiscal '14, which is the second quarter of this calendar year. That's where we're going to be hitting at full production. Fourth quarter of this calendar year and second quarter of our fiscal year. We're going to be hitting at the highest production, full production and that has been calculated in our calculations so that the 50% of our revenue in Infotainment Division during full fiscal '14 will come from high-margin scalable platform, which has the margin from 9% to 11%.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Okay. And those are the customers to watch for? Toyota, Chrysler and Volkswagen?

Dinesh C. Paliwal

That's correct.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Okay. Herbert, you mentioned the revenue decline that you saw in Automotive Infotainment was $30 million to $40 million and the $15 million in the Audio business. What was the associated profit hit in terms of EBIT on those numbers?

Herbert K. Parker

I'm sorry. In the Lifestyle Division or Infotainment?

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Well, both. First, you said the Infotainment was $30 million or $40 million And then in Lifestyle, the Audio piece, you said, was $10 million to $15 million of revenue decline.

Herbert K. Parker

Oh, sorry. Okay. In the Infotainment Division, we had about 20%, 20% to 25% related to the volume. And then we have the launch cost was around $5 million to $10 million. Up from the bottom line.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Okay. And then in the Audio side?

Herbert K. Parker

Audio side was more of a mix problem. So our car audio went down significantly but we don't give that separately now. But I could tell you that the biggest -- the change there was about 50/50 between the car audio being lower, as well as the home and multimedia being higher accounting for the mix.

Dinesh C. Paliwal

But the question you asked, the $10 million to $15 million deduction in the quarter, there we would have the higher hit actually on the bottom line, as you know that the margins are higher in the Car Audio.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Okay. That makes sense. And then maybe just one last one on the services that you're launching today. Is that something that is going to be a subscription service and we'll be able to track subscriber ads? Or how are we going to see the progress in that business over the next few years as you look to grow it fivefold as you said?

Dinesh C. Paliwal

Yes. Service business would have multiple components. There'll be a classic upgrade of the head unit. That means it'll require hardware upgrade, software upgrade and so that will be one piece. And I would say, most of the customers who desire to have the connectivity, they have to have their upgrade first. Then we will have, on top of that, multiple subscription-based and onetime sold services. So those services could be either downloaded over the -- from the Harman cloud or through our OEM sites or through dealers, or it could be on a USB stick that you can launch it yourself, or you can do it from your home computer. So division of what would be subscription-based, what would be onetime paid service, and then you use it for life, we don't have that granularity to give you right now. But all I can tell you, we will have subscription-based services. We will have onetime-based services, but a lot of services are software-based and some hardware, which will allow those services to be launched and enable those head units. But the fact is, imagine the car which was bought 3 years ago, that is still a great Audi, great BMW, but it's totally antiquated when it comes to technology, and there is no solution to it. So we're going to be the first company to have a solution. And guess what, we have the secret sauce because we know exactly where the wiring harnessing is, where the connectors are, what the head unit design is, what exactly needed to be plugged-in. In fact, there's a lot of work going on besides Infotainment, we have similar things going on which we will hopefully announce the next quarters that how about car audio services programs. So that comes next. So we have captive lock on it, and we should be able to really monetize the service. And that would get a lot of personal attention from me in the next 6 to 9 months.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

And then just to clarify, you said it would be up fivefold over what period and how do you get to that? What's the rationale behind that growth rate? How do you get there?

Dinesh C. Paliwal

So currently, we do about $100 million in services, which is a combination of all -- everything. There's no subscription service today we do. We do change orders for customers, those who have requirement to tweak some things for existing program. We sell map data. We sell navigation on the desk. You can go and buy for $250 just to update your map in Connecticut from Daimler dealership, stuff like that, and we have some hardware and some spare parts. So this is passively managed because systems boys are managing it. Now we're going to have a general manager who will be tasked with P&L responsibility and will have the global sales network, will have the global engineering arm, global R&D associated, but no capital structure required for that, no factory required for that. We have all the IP. We have ton of IP and NBT and NTD 5 [ph]. So coming back to growth, this business is about how fast can we touch those cars. All of them would love to be touched same time, but it's our own capacity issue. We're in a public company. We cannot just go ahead and hire a thousand people and not have revenue, then you guys will grill me. If I was a private company, I probably will do it but I'm not going to do it right now. My point is I am going to do what is right and how much we can do safely and soundly and also keep our OEMs in the loop because a lot of service product, Chris, we will be selling with full certification from Daimler, from BMW and Audi, that is the key. Because our services are unique, you cannot just buy from just another Joe. These are validated, certified and they will function safely in any car. Because end of the day, Audi's always belong to Audi as a company. So that's why it's unique to us and we can grow it pretty rapidly. And we feel the initial assessment we have done, that tells us that we can double this business initially and then afterwards a fairly high number. And by the way, we have done that similar things in China. We started with $20 million revenue 4 years ago and we finished last year at $380 million. So there, it was a cold start. Here, we don't have a cold start.

Operator

And our next question comes from the line of Doug Thomas with JET Equity Partners.

Douglas Thomas

Dinesh, I have a quick question for you. I appreciate the comments that you made about the quarter and the challenges you're facing and so forth and which, honestly, given the comments on the last conference call, were not surprising to me as I guess it was to some. And I also appreciate the updated guidance. I've always been, as you know, I think, pretty confident about the outlook for particularly '14 and '15 as you go through some of these near-term challenges. But I was wondering in light of that, Dinesh, if you could kind of elaborate on the fit and focus efforts in particular as it relates to what's an evolving restructuring. I know there was a prior question about it. But in terms of specifically fit and focus, if you could talk about what that means and what we should expect to see.

Dinesh C. Paliwal

That's a great question. Thank you for picking this one up. I mean I thought it would be lost in the midst of the hoopla of second quarter but it's very futuristic for us. Go back 1.5 years ago, we actually split out Infotainment and Lifestyle Division because I absolutely believe that each business should act as they are independent company, and they should compare with their peer group. An irony is, we, as a company, half of our business is non-infotainment. But frankly we get all the attention from infotainment which we don't mind. But we'll love to have love from non-infotainment as well. So we want Infotainment Division to be definitely be competing against Delphis and Malcos [ph] and Contis and Bosch, but our Car Audio Lifestyle business should be comparing with Bang & Olufsen, with Bose and likes of them, and our Pro division should be compared and benchmarked for their performance, on their return on capital, on return on equity. I mean these kinds of things. And what's their RAC [ph]? What's their capital requirement? What are their business risks? They're very different for these 3 businesses. So we want to bring that sort of a notion that each division president should feel, if I was a CEO of the company, how would I run this business as tightly, as cost effectively and aggressively? And I want to have same pressure from outside on me to be able to answer questions on all 3 divisions. So that, to me, is fit and focus, that operate like you were the CEO, operate like you were a private company, how would you do the best you can? And that's a bit of a mindset issue which many public companies don't think they're under the conglomerate and they hide behind each other. I don't want our division president to hide behind each other. We want true transparency, and I think we are well underway there.

Operator

And our next question comes from the line of Ravi Shanker with Morgan Stanley.

Ravi Shanker - Morgan Stanley, Research Division

A couple of questions for Dinesh and a couple questions for Herbert. Dinesh, if I can follow up on the services question. It sounds like a pure retail business to me. So how do you plan to distribute these products?

Dinesh C. Paliwal

I'm glad you said that because it has element of retail, you're right. But at the same time, as I said earlier in my comments, I have a distinct feeling that our automaker clients would be want to be part of this, which is not a bad thing, because that brings the validation these are Daimler-certified services, these are Audi-certified services. Even if we have to give a little bit of the value chain, I don't mind. But it would be retail in many aspects. That's where we hope we don't have to worry about annual price reductions on that and we'll distribute through various channels whether dealer networks or Harman site portal or a car -- AutoZone kind of a company, the car decoration shops, what have you. So this would be our nature of going online versus calling on clients. This will be a lot of online nature to it.

Ravi Shanker - Morgan Stanley, Research Division

Got it. And you mentioned scalable audio in your comments, how is that going to work? Is that using a similar hardware components across the different brands on the audio side that you have?

Dinesh C. Paliwal

Absolutely, Ravi. I mean, we really learned a great deal when we developed Infotainment and scalable. We learned that you don't need to have a mammoth elephant as a foundation for everything you do. The same thing we're finding out, when I asked that question from our Lifestyle Division President, why aren't we going fast enough? Well, the base is heavy. It solves all the great problems of a car company, of Toyota and Lexus and Maserati and others. But I said they also make entry in mid-segment car, just like scalable platform, so why wouldn't you have a scalable platform which you can modularize and vary like a LEGO structure. An example would be Tata Nano. Who would ever consider -- Harman to even consider doing Nano? Now we took it as a challenge. We brought a Nano here in Farmington Hills, Detroit. We fitted the car with a proprietary technology that's not going with multiple-speaker approach, with a very unique approach is central global speaker sitting in the middle of the car console and giving a rich sound. And that is really 1/4 of the cost of what you will do for a regular sound system. So that is the scalable approach we want to bring. So idea is to expand the audio market for us, continue to do what Lexus needs are, the Toyota needs are and enrich them. But also go down their value chain because right now, they're not offering us a standard on trim 1, trim 2. I'm not happy to be just offered as a trim 4 solution. I'd like to be on 3, standard. I'd like to be offered on trim 1 as an option, at least. Right now, cost is not there. So we got to take cost out, we have a lot of IP, we have to spread it over a much bigger base.

Ravi Shanker - Morgan Stanley, Research Division

But just to play devil's advocate, the difference between your Infotainment business and your Audio business is that your Infotainment business is not branded but your Audio business, you have a distinct family of brands. So if you apply the same scalable approach to your different audio brands, does that risk diluting them?

Dinesh C. Paliwal

Not really. At the surface, it sounds like it but that's why we had a debate, technology debate and what we understood is the feature, is the design set. I would absolutely be open to say that what Lexus gets from Mark Levinson system or whatever $1,000 or $2,000, you're not going to expect that in Nano when our below material is $100. You're going to get a nice sound quality, which is better than an average radio will give you from Delphi or from Clarion or from of Alpine. Much better radio, clear sound and it has possibility to add more modules to it. Application modules even daughterboard or the motherboard can go in. That's how they approached that miniature amplifier design that will help us. I don't know whether you recall, one of the calls I made reference, Pro audio developed ruby chipset. That is a 1-inch diameter chip. That's an amplifier on a chip. You think about that, we have the Pro sound bringing into car audio. We can also modularize that that how can you add more hardware through silicon to create a much bigger module sort of scale, and you can still scale it down. So it's a branch -- brand have their own architecture. So Mark Levinson being the top brand and then JBL representing hip and party and young generation, and Harman's going to represent another personality. So we maintained those, a lot of market research. But within those brands, we want to offer our clients, Toyota, Chrysler, Mercedes, BMW, the scale so that they can launch these across more car models. Right now, they're offering on a very few models.

Ravi Shanker - Morgan Stanley, Research Division

Very helpful. Herbert, a couple questions for you. I'm sorry if I missed this earlier if you said it, which segments will the restructuring plans be benefiting the most? So when you look for the 30%, 35% gains in 2014, which segment will that go in?

Herbert K. Parker

No, it's in all of the segments. So there's no one particular one, it's pretty much split.

Ravi Shanker - Morgan Stanley, Research Division

Okay. That's pretty much split. And the 22% tax rate, is that a change from your previous guidance? Because I believe you were indicating something more in the high 20s at one time.

Herbert K. Parker

Yes, it is a change.

Ravi Shanker - Morgan Stanley, Research Division

Okay. Is that expected to be a sustainable rate for 2014 as well?

Herbert K. Parker

No. For 2014, we'd probably have a higher rate than that. I mean we're making more money in the -- the scalable's coming on and the jurisdiction is scalable. Most if it is in the U.S. and we get in a more -- much less in Germany now, and we got some more distributions on tax rates that we've had. So a lot of changes. We expect it to go back up to a higher rate.

Ravi Shanker - Morgan Stanley, Research Division

Got it. And final question, what's the content per vehicle from Aha?

Dinesh C. Paliwal

Oh God, I don't think we have ever disclosed that because then our customers may not like. Because they are not going to sell pure Aha as a product offering. They're combining it with others. Ravi, I know -- you probably know the answer because you deal with lot of technology, I know. So I'm afraid I won't be able to divulge that.

Operator

And our next question comes from the line of David Lim with Wells Fargo.

David H. Lim - Wells Fargo Securities, LLC, Research Division

Just on some -- I just wanted to peel the onion on the Infotainment Services business a little more. I mean given that the OEMs would like to maintain control of infotainment and funnel through their dealership and then you mentioned stuff about AutoZone. Where are you in trying to convince them to get the OEM blessings for this part of your new venture?

Dinesh C. Paliwal

I mean this is not really -- David, it's a great question by the way. AutoZone was just an example. We're not talking to any one per se because we have not launched this business yet. So I think -- what I was trying to say, this could be multichannel. And the automakers would definitely like to be part of that, and I would like them to be part of that, so that we can say, say Daimler certified service. But we'll still be able to sell multichannel. They will get some piece of it with whatever goes through their dealer network, I'm quite happy with it. But I think they will understand because one thing I made very clear, hey guys, you make a ton of money off my products, I don't. So I need to find ways to improve my profitability, you hit me with APR all the time on systems business, services, our business opportunities the IP which we develop, we need to take it backward. Now we may be able to give them a little bit, but nothing close to what we give them today in APR.

David H. Lim - Wells Fargo Securities, LLC, Research Division

Now since you're also talking about, I know that you mentioned AutoZone. Have you guys ever thought about going to the aftermarket with your Infotainment Systems where it would be some sort of -- where a person might buy a lower-end vehicle, bring it to some sort of third-party shop you guys would supply that infotainment head unit?

Dinesh C. Paliwal

David, that's spot on. That will be a part of the service. When I said upgrade also new ones. We call it semi-OEM business because a lot of cars actually this model in China is becoming almost like a second nature. A lot of dealers for Daimler, BMW, Toyota selling the car, which are designed for our system or from a competitor system. But to be able to make a sale, they sell the car without anything and they say, "come back to me in 6 months or 3 months, I'll install the whole thing for lower cost because" -- so they're going direct that the OEM's getting cut out. So there, all kind of things are emerging. End of the day, OEM will realize they have to release a bit more to increase the penetration so the consumers will ask for it. So I think we'll find a happy medium. We have good relationship and we run a pretty open book. They know what we make and we know what they make.

David H. Lim - Wells Fargo Securities, LLC, Research Division

Okay. So then is it safe to presume that if you were to go to this aftermarket channel with your infotainment that you could realize more robust margins relative to what you're currently getting from the OEMs?

Dinesh C. Paliwal

Without a doubt. I mean aftermarket business should generate higher margins and much better control as well because we control inventory, we control forecasting and what have you. So aftermarket when you combine that with application services we're talking, we can really come up with a pretty neat cost-effective bundling of a light, footprint-based head unit which those costs, low-end costs would never imagine. But when they hear that Harman has an offering in the aftermarket, which they know they associate us with very high end, it has the same kind of the same DNA but significantly lower costs, those costs would be a prime example for that, or even old cars.

David H. Lim - Wells Fargo Securities, LLC, Research Division

But given that -- my last question is given that, wouldn't that cause some sort of dynamic friction between you, as well as the OEM in knowing that the Infotainment space is going to get a little bit more crowded? Wouldn't there be some sort of strain on the relationship?

Dinesh C. Paliwal

I hear you what you're saying. In fact, I encourage that positive tension to be discussed openly as soon as we possibly can. Because ultimately, their game and our game is to increase penetration. Right now, the current model they have is not helping anybody to increase the penetration. To increase the penetration, either they settle with not make too much money on what they give to them and clean up their sort of value chain, or allow us to partner with them so they still have to design cars for Infotainment. They still have to sell the car saying it's Harman Infotainment-ready or Harman Audio-ready, that kind of a thing, and they can still get something out of it. Or they can take a status quo but that won't help. So I think they're pragmatic and they're starting to realize it.

Operator

And our next question comes from the line of Brendon Mason with Guggenheim Securities.

Matthew T. Stover - Guggenheim Securities, LLC, Research Division

This is Matt Stover. One follow-on question. When you think about the new guidance as we think through the March and June quarters, Dinesh, are you folks taking on board the production expectations in Europe that J.D. Power has publicly disclosed?

Dinesh C. Paliwal

We absolutely have. I mean I'm glad you asked because when we are putting out guidance, which is only 5 months out, we really sort of added and collected as much as current information so that everybody comes to the same page. J.D. Power said that production in Europe shrunk 15%, and they're actually saying third quarter, which is our third quarter, first quarter calendar year will also be a shrinking 15%, this means in line of second quarter. And the fourth quarter, our fiscal, which is second quarter calendar, would be shrinking 10%. So they are saying there's a modest improvement, but the second and third quarter is pretty flat in terms of where we just left behind. And fourth quarter will improve. So we have factored that in and we are taking a look SAR [ph], we're taking a look at, at J.D. Power, of course, and most importantly, we're listening to customers. And we also told them, don't pull a rabbit on us what you did in month of December. I think we are pretty much tied to all information sources we can and our guidance is based on all that information.

Matthew T. Stover - Guggenheim Securities, LLC, Research Division

Okay. And so if I think about the decremental margin on the forward schedules, it'll be a little bit better than what we saw on the fourth quarter because you're preparing for it. Are there any other things on a near-term basis we should think about that might be favorable variables that aren't immediately obvious?

Herbert K. Parker

No. This is Herbert. No, there's nothing actually exceptional. We gave the specific items when I gave you the guidance. I told you some of the things that we have been considered, like a little bit more R&D in Infotainment, and those type of areas. And of course, you know we have annual price reductions, which usually starts in January, which is our fiscal Q3, but that's all considered.

Dinesh C. Paliwal

I would like to add, you should expect definitely a better half for us in our Professional business because Professional business was hurt for no fault of ours. The fiscal cliff and the capital project delays and uncertainty, and we have a pretty good inquiry level in that business. And that's a pretty rich business when it comes to profitability.

Operator

And our next question comes from the line of Adam Brooks with Sidoti & Company.

Adam Brooks - Sidoti & Company, LLC

Just 2 quick questions here, guys. As far as the info segment as we look into 3Q, that typically is a quarter where you see sequential compression. Is there anything that would make us believe that wouldn't happen this time around? Maybe just a little bit of color what 3Q looks like compared to 2Q?

Dinesh C. Paliwal

You know, I'll just reiterate. It's a great question, Adam, thanks. J.D. Power believes that third quarter, our third quarter and our second quarter are pretty similar in terms of production. So both are showing 15% shrinking in Europe, and the fourth quarter would be 10%. So that's why we said I don't expect miracles in this quarter. It would be very similar to our second quarter. But I definitely expect fourth quarter to be stronger as everybody is expecting and automakers are expecting. With that said, anything else can happen, but I don't expect.

Adam Brooks - Sidoti & Company, LLC

Okay. And then real quickly on the scalable Audio business, you already have a nice mid- to high-teen margin there. With the scalable, would you expect to have a bit of a jump like you do on the Info side?

Dinesh C. Paliwal

You know, it's all about leverage. We have factored -- you know, we're the only company. Not even Bose actually make their own -- we make all car audio business ourself. We design, we manufacture, we engineer. So volume, the leverage can be wonderful. I mean, we get what we get today without really stretching our factories to the highest level. And we have invested brand-new capacity in Mexico, in Hungary and in China, and we're not running them at full capacity. So we're definitely looking for volume and the scalable will add volume and that will help us improve profitability. You know, I'm just targeting mid-teens. I don't want to have anything less than mid-teen but I have a feeling we'll probably get a little upside when we kick off the scalable, which is 12 months out at least.

Adam Brooks - Sidoti & Company, LLC

And just maybe if you can what our utilization rates look like in Western Europe at this point?

Dinesh C. Paliwal

December and November should not be the benchmark. But prior to that, what were we running? 75% or so? Right around that.

Operator

And we do have a follow-up question from the line of David Leiker with Baird Investment.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

I just I have 2 last questions here for you, Dinesh. On the Infotainment Services business, I think you identified that as $100 million in revenue. What portion of that's coming from Aha Radio today?

Dinesh C. Paliwal

David, I hope I can have that answer perhaps in a couple of quarters when we have a bit more granularity. Right now, as I said earlier, Aha is embedded. Aha actually is helping us pull through a number of things because it's a necessary glue for them. But as a percent of revenue, Aha may not be huge, but it will pull a lot. And Aha, we will also be selling to our competitors and we right now are actually on the car companies who do not use our infotainment, like Honda. So there, we will be licensing and there, we will have a bit better financials. But at this point, I'm not ready to share that.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

But that's where Aha would fall is in this $100 million, correct?

Dinesh C. Paliwal

Aha will fall in both category. Aha will be part of the futuristic all new systems infotainment and Aha would also be a connected services for our business unit services.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then the last item on the connected radio that you were showing us in Vegas at the CES. What do you think the timing is for you to be able to book or announce some contract awards in that space?

Dinesh C. Paliwal

Actually, we are selling it now. So we are hoping that -- and plus this doesn't have an 18-month cycle time. I mean this is a quick book-and-bill. So this one is being released to Tata. So Tata will actually demo this product at first week of March in Geneva at what the basic radio will look like.

Operator

Mr. Paliwal, there are no further questions at this time. I will now turn the call back to you. Please continue with your presentation or closing remarks.

Dinesh C. Paliwal

Thank you. Well, I'd like to thank all of our shareholders, our owners and our analyst community. First of all, as I said, you don't close a call with a sorrow, but I'm not pleased with this past quarter's result, and I hope you get the feeling that we're not going to let it happen again in the way it happened. So in short, we have just wrapped up a pretty challenging quarter and some of the headwinds that we experienced in the second quarter will continue as you know from J.D. Power and others for the next couple of quarters. However, we remain very optimistic about fiscal '14 and '15, and that is not new, I'm saying. We've been saying that for a good 18 to 24 months based on our backlog. And our long-term prospects for growth and value creation are pretty strong. But a couple of words, I would say, small breadth but long-term -- mid- to long-term great opportunity. Thank you very much and have a great day.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.

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Source: Harman International Industries, Incorporated Management Discusses Q2 2013 Results - Earnings Call Transcript
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