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Harman International Industries Inc. (NYSE:HAR)

F4Q09 (Qtr End 06/30/09) Earnings Call

August 19, 2009 4:40 pm ET

Executives

Dinesh Paliwal - Chairman and CEO

Herbert Parker - CFO

Analysts

Chris Ceraso - Credit Suisse

Scot Ciccarelli - RBC Capital Markets

Mitul Shah - Duquesne Capital

Tim Garry - Pzena Investment Management

Keith Schicker - Robert W. Baird

Operator

Welcome to the Harman International Industries fourth quarter and fiscal year 2009 Earnings Call. (Operator Instructions)

Please note that certain statements made by the company during this call are forward-looking statements. These statements include the company's beliefs and expectations as to future events and trends affecting the company's business, and are subject to risks and uncertainties. Persons participating on the call are advised to review the reports filed by Harman International with the Securities and Exchange Commission, regarding risks and uncertainties.

With that being said, here with opening remarks is Harman International Industries' Chairman, President, and Chief Executive Officer, Dinesh Paliwal.

Dinesh Paliwal

Good afternoon, ladies and gentlemen, and thank you for joining the Harman fourth quarter and full year 2009 investor and analyst call. I'm joined in Stanford, Connecticut today by Herbert Parker, our Chief Financial Officer, and Robert Lardon, Vice President, Investor Relations.

Along with our full year press release issued this afternoon, I would like to call your attention to a set of supporting slides that has been posted with our press release on businesswire.com, and on our company's website, harman.com. I will mention several of these slides during our discussion.

Ladies and gentlemen, we continue to face significant challenges, amidst an unprecedented global recession that has devastated many companies, but I'm pleased to see some results of our hard work. We were cash positive for all three months of the most recent quarter, continuing a string of four consecutive months that began in March. With our laser focus on cash management and our successful public offering of $200 million in June, we finished the fourth quarter with a $591 million cash balance, compared to $334 million at the beginning of the quarter. This is an impressive 79% increase in our cash position.

Our STEP Change cost-savings program is ahead of schedule, delivering $190 million in permanent savings during the fiscal year. Our successful execution on a record backlog of automotive products is paying off, paying off with customer confidence and new business opportunities. As I have said to you before, although we would love to see a fast recovery in our sales volume, we're not depending on this to turn profitable. Our strategy remains sharply focused on making Harman profitable at the current sales level, and I believe we have made significant progress towards this goal.

Before I ask Herbert Parker to provide a closer look at our fourth quarter results and yearend summary, I will share some other highlights on the performance of our business and current strategic initiatives progress.

Given the unprecedented impact of the current global downturn, comparisons to the same period a year ago are not very meaningful, but on a sequential basis, we have seen some progress. Although our fourth quarter traditionally is better than the third quarter due to seasonality, we are encouraged by the sequential improvement.

Our net sales increased 11.6% from the previous quarter. Our gross profit outpaced this modest topline growth with a 27% gain. Our professional division continued with double-digit profitability during the fourth quarter, while our consumer division made significant progress towards profitability. Given its large share of Harman's business, the automotive sector continues to have a deep impact on our overall results. I do see some signs.

However, automakers are releasing some orders for audio and infotainment units. We believe that a full automotive recovery will be a long and difficult journey, but we are well prepared to participate in this recovery when it happens. As we announced a few days ago, Harman has now successfully completed a record 13 major audio and infotainment launches, spanning eight different automakers in less than 24 months. By the way, that's a history in itself by any company. We made a conscious decision to invest as necessary to deliver these model launches on time and on quality, and this decision has paid off.

I'm extremely proud of the effort from our team to meet these commitments, bringing Harman and its automotive customers the newest and most technologically advanced portfolio in our industry. As a result, we are well positioned to capitalize on the next round of larger audio and infotainment awards. In fact, we are in advanced discussions with key automakers to finalize several significant awards.

Please turn now to slide number nine, which provides some highlights of our fiscal year 2009 automotive activities.

During the fourth quarter, we launched a new infotainment system for the Ferrari California model, new JBL branded audio systems for several Toyota models, and Mark Levinson branded audio for two new Lexus models. Our Audi infotainment system was awarded product of the year by one of Germany's top electronics magazines.

To increase the penetration of infotainment systems, we conducted significant co-marketing activities with several automakers, including BMW, Land Rover, Mercedes, and Mini. We believe these successes will generate incremental sales once the luxury automotive sector starts to recover.

Moving on to slide 10, our scalable, next generation infotainment system, which in the past I might have named as [MIG] system, that is called scalable, next generation infotainment system, is approaching market introduction. By leveraging our combined engineering resources in the mature and emerging markets, we have developed this new system cost effectively in record time, and we will use it to expand our market reach and penetrate a $5 billion market segment that has been largely unaddressed by Harman.

We have shared the details with selected automakers to very positive reviews, and we will feature this new system at customer events in Germany, Japan, the United States, China, and India later this fall, and I'll personally participate in these launches.

Please move now to slide 13 for a recap of our professional division achievements during the year. The pro division continues to be a leader in both profits and new product introductions, leveraging the versatility of its HiQnet software integration protocol. Harman professional systems took center-stage during the past quarter across venues, including the Rock & Roll Hall of Fame, the Michigan International Speedway, and London's Ministry of Sound.

Our systems served an audience of more than one million people at the recent Primo Maggio music festival in Rome, Italy. Later this fall, we will bring Harman Executives and select global customers together for an exclusive partnership dialogue at the new GRAMMY Museum in Los Angeles, which is also by the way equipped with Harman systems for all audio and their other system requirements.

Please refer now to slide 15 for some fiscal year 2009 highlights from our consumer division, which has undergone a period of restructuring and, I stress, product innovation. Our partnership with Apple has taken on new momentum, with premium audio accessories supporting the popular iPod and iPhone line.

Following their debut in the United States earlier this year, AKG consumer headphones, one of our brands, have lead to new partnerships with leading retailers, such as amazon.com and Airport Wireless Stores. Our alliance with fashion leader Roxy is quickly gaining momentum, with extensive press coverage and a recent launch of our co-branded headphones in the Target retail chain.

Moving on to slide 16, our QNX Software Systems unit continues to open new doors for growth. Range Rover, long a Harman customer for branded audio, began shipping its 2010 models equipped with digital instrumentation based on our QNX Software during the quarter.

A leading Italian Tier 1 supplier, in a way a competitor, MTA Group has selected the QNX Neutrino Operating System as the foundation for its instrumentation solutions. The QNX Connected Automotive Reference, we call it CAR, program was welcomed by Pandora internet radio to its consortium of industry leaders, committed to seamless technology integration. QNX developers were recognized during this quarter at two prestigious conferences for Telematics and Embedded Systems.

Let us now move on to slide 17 for an update on our $400 million STEP Change cost-savings and productivity improvement program. As you know, we launched this program more than a year ago, a decision that has proven perceptive, considering the dramatic global recession which soon followed.

Slide 18 provides a qualitative review of what we have accomplished under STEP Change in one short year, or you can call it long year. It feels like it. We have closed or consolidated more than a dozen facilities and reduced 1,900 jobs in high cost countries, while strategically deploying new resources in the emerging markets or outsourcing some of these activities to our partners. We have outsourced several non-core activities and optimized our value chain through new supply agreements and global best practices.

The dashboard on slide 19 reveals the numbers behind a year of very intensive work. We exceeded our STEP Change targets for the fiscal year, achieving $190 million in permanent savings, I repeat permanent savings. We will continue to update you quarterly toward our $400 million STEP Change savings goal, where we are well underway.

Ladies and gentlemen, I am very proud of the work my team, the Harman team has accomplished during the past year. Despite the pressures of a devastating global economic cycle and deep restructuring, we are executing as promised on our strategy of operational excellence and innovation, and this is to create a new and more competitive Harman International as I promised a couple of years ago.

We have delivered without exception, to recap, our customer commitments, successfully launching a record number of automotive products platforms and cementing a multi-year backlog of awarded business. We have continued to invest strategically in innovation from next-generation automotive infotainment to scores of cutting edge new products for the consumer and professional markets.

We have successfully managed our liquidity through a time of crisis and built the liquidity cushion necessary both to endure and grow. We have dramatically rebuilt our value chain, saving significant costs, and more to come, while enhancing our delivery capabilities. We have tested the resolve of an experienced management and employee team, focusing their skills on a brighter future, and they have delivered.

Thank you for your attention, and I will now ask our CFO, Herbert Parker, to provide a closer look at our quarterly results.

Herbert Parker

Good afternoon, everyone. Today, I will focus my comments on our fourth quarter results, but you can review the details of our full year results in our press release, which was issued earlier today. As mentioned in our previous calls, and for the benefit of our new investors, most of my financial comments are provided on a non-GAAP basis, which excludes restructuring costs and any goodwill write-offs where relevant.

You will also find a reconciliation of our GAAP to non-GAAP results in our press release, but for your ease of reference, the restructuring costs included in our fourth quarter results totaled $46 million and the goodwill impairment charge was $2.8 million.

As we all know, our fourth quarter revenues declined significantly. We had steep declines across all segments as compared to the same period last year, primarily due to the continuing global economic downturn, but specifically, our sales for the fourth quarter were $668 million, which is a 37% decrease. Excluding foreign currency translations, our sales declined 32%. We are encouraged however by the fact that our fourth quarter sales increased 11.6% sequentially when compared to the prior quarter. This was led by 15% increase in our automotive division.

However, as Dinesh mentioned a few minutes ago, some of this improvement is related to normal seasonality. Having said that, I am encouraged that the sequential deterioration did not continue.

Now, moving on to gross profit, our gross profit margin for the fourth quarter was 21.5%, compared to 26.8% in the same period last year. This margin decline was primarily due to production under-absorption. To complete the major cost items above the operating profit line, our SG&A expense was $177 million compared to $232 million for the same period last year. Our R&D costs, which are included in the SG&A figure totaled $81 million and $104 million in 2009 and 2008 respectively. Excluding the effect of foreign currency translation, SG&A expense was reduced by $36 million.

Now, despite these cost reductions, due to the significant drop in revenues, we still reported an operating loss of $34 million during the quarter, compared to a profit of $55 million in the same period last year. Our net income was a negative $27 million and loss per diluted share was $0.45. Now, as we have reported a net loss, our effective tax rate for the fourth quarter includes a tax benefit of 32.1%, which includes the effects of operating losses, restructuring expenses and goodwill charges.

Now as most of you may know, in the fourth quarter, we launched and successfully concluded a public offering of 10.7 million shares of common stock at $18.75. This offering raised gross proceeds of $200 million, of which, $38 million or 20% of the net proceeds was used to retire the existing debt. The purpose of this issuance was to strengthen our liquidity, provide financial flexibility and to be used for general corporate purposes.

I will now pause a few seconds to let you take a look at slide 20, where we've provided a summary of our liquidity and debt covenants. In this slide, you will notice that as of June 30, our debt balance was $629 million, which includes a $400 million convertible note, due October 2012, and a $227 million credit facility with a maturity date of December 2011.

Now, moving on to slide 21, you will see that our June 30 cash balance was $591 million, compared to $334 million in the prior quarter. This increase was primarily due to net proceeds from the company's equity issuance in June and cash generated from operations in the fourth quarter of $94 million. This positive cash from operations, which mostly resulted from working capital improvements, was primarily driven by strong inventory management.

In total, these aggressive measures have significantly increased our cash balance, improving our liquidity position and provide much greater financial flexibility.

Now, on that positive note, I would like to thank you for your attention and we will now take your questions. Operator, please open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We'll go to the line of Chris Ceraso with Credit Suisse. Please go ahead.

Chris Ceraso - Credit Suisse

Why don't we start with the new business awards that you referenced, that you're getting close to. Obviously, you can't disclose what they are or you would have, but maybe you can give us some color around two things. One, what type of business is it? Is it high-level system or mid-level system? Two, if you win these programs, when will be the start of production? Are these 2011, 2012, 2013 programs? Maybe you can give us some of these details.

Dinesh Paliwal

Certainly. Chris, first of all, we are very excited about the situation we are in and that's naturally an outcome of successful launches of 13 programs. I'll really like to remind, because about a year ago, we got a lot of heat from our investment community that, why are we investing so much in R&D. I'm glad that we did, because now we are well positioned.

To answer your question, the awards we are working on to finalize are for both. For high-end premium systems, as well as what we traditionally call mixed systems, and I like to call it, 'scalable infotainment system platform', which we have developed. So, that is the first part of your question.

On SOP dates, Chris, unfortunately I can't comment on it because our customers do not want us to comment on SOP dates, but these will not start to turn into revenue. From the day we receive these awards, we're talking two-and-a-half to three years out.

Chris Ceraso - Credit Suisse

On the new system, the scalable system that you're talking about, you talked a little bit about that last quarter. If you're getting close to the point where you can bring that out to customers and sell it, again, this is kind of like the second part of the last question, so it will be two-and-a-half to three years before those programs are ready to be launched and turned into revenue. Am I thinking about that right?

Dinesh Paliwal

No, Chris, you're always right, but not this time and for good reasons. The scalable infotainment platform we've developed, that's why I stress we have developed, it is so scalable and so modular that it's ready to go, provided our customers are ready to go. So we will only be dependent on our customer's model year cycle or the production cycle. So, let's say, if a customer is ready to launch a new system, it's ready to go. So I would say on an average it might be 12 months, earliest we can see, scalable new platform, new system infotainment would be turning into revenue from the time we received the order.

Again, to recap, this is fully developed. It's like a Microsoft, in and out, you can put features and you can turn them on and off. It's done so wonderful fully. It has got all kind of features. It's a feature-rich system, what we can turn on and off, and get the customer to adapt to what they want to do, so it likes I call it a eagle. It's a little sharp, focused on what the mid-market needs, at the same time, it can spread its wing pretty wide, so it can grow into a very rich, large system, too.

Chris Ceraso - Credit Suisse

Typically, no matter what the component is, you've got to work your way into the product cycle of the customer, like you said. So that's minimum of 12 months, but if it's a new vehicle that's not launching for two years, then you'll follow the product cycle?

Dinesh Paliwal

Precisely. Our purpose of getting into the space is to really go after this $5 billion market space, which we have not really addressed in the past, and that now opens up for us, and this will generate revenue streams earlier than traditionally our premium systems have.

Chris Ceraso - Credit Suisse

Now, I think when you and I spoke about this last quarter, you mentioned that you were using more components and software sourced from other providers, people that are experts at voice or other things. That you're going to use outsourced components. What does that do to the margin profile of this system versus, say, one of your completely self-developed high-end systems?

Dinesh Paliwal

Chris, great question. In fact, those decisions we make based on pure financial, commercial sense. It's something we can get from the market, which is cutting edge technology, and we can get it cheaper than developing ourselves, we will take it. We have lot of IP, intellectual property of our own, so we are obviously leveraging a lot of it. An example would be Nuance. Nuance is a speech technology leader worldwide, undisputed, number one, so we can get from them cutting edge products in the speech area very cost effectively, and much sooner to the market rather than us developing it. So that's a great example. Those decisions are made based on commercial sense.

Chris Ceraso - Credit Suisse

Maybe just a quick one or two on the cost side of things. It seems like you've been realizing about $40 million a quarter roughly, incremental to each quarter for the past three quarters' cost savings. Is there anything that changes the pace of that over the next, I guess you've got another eight quarters to go, right, before you fully finish the STEP Change program?

Dinesh Paliwal

Chris, I wish I could say it's evenly distributed. It just happened to be the way you calculated, 40 a quarter, but that's not the way we see it, because some of our programs would get much more bottom line impact instantly. Some of the programs are long-term. Depends on which one gets completed at what time. Like, a great example in outsourcing, you're not dealing with the reduction in workforce. You are dealing with a time line when your new contracts are implemented, so gives you the bottom line impact, so it comes in, bang, one big sort of a bang. Then if you're dealing with consolidation of sites, the permanent cost reduction may take nine, 12 months out. So I can't tell you what it would be, but our target for this fiscal year is to get to a cumulative number of $283 million by the end of this fiscal year.

Chris Ceraso - Credit Suisse

I think as of the last quarter, it sounded like you still had a fair amount of wood to chop with headcount in Germany. What's the progress there?

Dinesh Paliwal

Tremendous progress we have made. I am very happy you asked. It took us a while to get going, because it does take time to sort of satisfy all the stakeholders, works council, (inaudible) and regular local stuff. Our management team in Germany has done a superb job, and we have actually exceeded our target. We shared with you that 550 people would be out in this fiscal year we just completed. In fact, we exceeded that number, and I think we seem to be going well in that direction. It's not easy, by any means. It's a lot of slugging and slugging and slugging, a lot of curve balls being thrown at us, but I think we've been able to hang on and sort of run the pitcher out.

Operator

(Operator Instructions)

We'll go to the line of Scot Ciccarelli with RBC Capital Markets.

Scot Ciccarelli - RBC Capital Markets

Dinesh, can you describe how you view the competitive environment for infotainment systems in the auto sector right now?

Dinesh Paliwal

A lot has changed in last 12 months and God knows what will happen in next 12. I would say, let's talk with Harman here, I mean we always wanted to consolidate further and gain more market share. I think what has happened is, this liquidity and the economic downturn has pushed out number of people to the edge, and with our cash management and our equity position, our liquidity is such that we have received bunch of accolades from our large key customers saying, "Hey, now you've got a strong balance sheet. We can trust in you for next generation of ours and follow-ups." So that has been very helpful.

I think if you look at our new launches we are gaining market share in Audi, and particularly high end in BMW. We didn't have any revenue here, so we are displacing competitors. You can also assume, if we are successful in finalizing the advanced discussions we are doing, that would also be at the expense of some competitors.

With that said, I think what I have also observed in the last 12 months, due to liquidity situation number of competitors pushed down their R&D and their innovation line, and that was not something in our books, and we have done effectively a very solid job and our customers have seen it. So net-net, we are extremely well positioned. We will see how it shakes out in one year's time, because we are not done yet in terms of consolidation.

Scot Ciccarelli - RBC Capital Markets

I guess one of the things I'm trying to figure out is, and this is especially keeping the e-class dual sourcing issue in mind, how should we think about the margin profile of new awards? Obviously, you guys are in the midst that you've just launched a whole bunch of models. You're in, sounds like advance discussions with some others. How should we think about the margin profile, given the fact that it seems like people are starting to trust, or at least somebody like Mercedes, which is a pretty high profile customer for you, is starting to trust some other vendors to supply infotainment systems in obviously very important models of theirs?

Dinesh Paliwal

You, of course, know what happened several years ago before even I joined the company. There was a strategic decision Daimler and Mercedes made to go from single-sourcing to dual or triple-sourcing, which is the norm in the industry. Whenever you do that, you obviously depress the margins and we were affected with that.

Having said that, all the launches we had just announced and we are ramping up, all of them are profitable business. That's a very important point I want to make. Second, any new business we will take, there is a very clear mandate from my office that, we will take profitable business with an opportunity to improve our profitability even further. So anything we'll take will be profitable.

Now, what has changed, the environment in industry has changed. Five, seven years ago, literally fully integrated system capability, Harman demonstrated and we got bunch of business. Since then, customers have gotten smarter, and competitors have gotten smarter, and good size profit pool attracted more competitors than market perhaps needed. So it has put pressure on margins for sure, and that is what makes it even more critical for those who are determined to stay in the space that they attain cost leadership, because market will only give you what market will give you. The difference would be, how you address between contribution margin, which you get from market, and in between line of SG&A, engineering, manufacturing, how do you get that level down, and that's what makes me feel good about STEP Change. That's what makes me feel good about the scalable new infotainment system, that that system may not bring high contribution margin as in the past, but it will still bring solid operating margins, very similar level as our premium systems have brought in. So we cannot control the market. We can control the cost structures.

Scot Ciccarelli - RBC Capital Markets

The last question is, I believe the pro business benefited quite a bit from I guess almost a year ago at this point, the build out in Beijing from the Olympics. How much of an impact has that had on the pro business, just trying to delineate between what's been kind of broader economic turndown and the end of what was obviously I believe a pretty major project for the pro business?

Dinesh Paliwal

Scot, let me clarify. I think this has been a major misconception. Olympic business actually was booked long before last year. Most of these large products right now, we are already booking Commonwealth Games business in India, which they don't even start until sometime next year. I'll give you another extreme example. London Olympics, which are in 2012, we are already engaged in a specification exercise working with consultants and what have you. So last year, fiscal 2009, I don't think we had any significant Olympic business which helped us.

What has helped us, even in this recession environment, we have seen a pickup in tour sound, like Bruce Springsteen or Celine and others. They have started going out, so major contractors bought a significant chunk of equipment from our professional business drew stock in Europe and Asia and America, and that has helped us. We are starting to see now the installed sound in fourth quarter also picked up like CityCenter in Vegas and MGM Grand and several other such large projects.

So, in net-net, I don't think we have a very large peaks and valleys due to these large Olympic size projects. They spread out. They spread out actually over nine to 12 months. We don't get one large deal from Olympics per se.

Scot Ciccarelli - RBC Capital Markets

So the revenue hit we've seen on the pro business, that's just been delayed projects for stadiums or tours or whatever?

Dinesh Paliwal

More than that. Installed sound obviously slowed down because that's an infrastructure type of business when the economy goes down, all large projects get either pushed out, procrastinated or some of them even get threatened to stop. However, we saw significant drop in our retail business, significant drop in our professional PA business, like Guitar Center, Sam Ash, kids go and buy, the local community bands go and buy these stuff.

First pick up was in touring sound, and then we saw recording and broadcasting business. That business is very strong for us. We do almost all networks, FOX, CBS, NBC, BBC or radio stations, so it's quite a mixed bag. However, we are getting lot of market share, especially in the pro business, because that business as you know is highly fragmented. So, small guys really got squeezed out, and customers are turning to us. So we hope that we can see some significant top line improvement in the coming quarters or so.

Operator

We have no further questions in queue at this time. Please continue.

Dinesh Paliwal

I guess Chris and Scot, they asked many questions. Everybody has doubts, but let's see. We will wait because we have time.

Operator

(Operator Instructions)

Dinesh Paliwal

I guess Mr. Parker you have given such good explanation of your liquidity and your gross margins and your profitability that no questions for you.

Operator

We do have one more that's queued up. We'll go to the line of Mitul Shah with Duquesne Capital.

Mitul Shah - Duquesne Capital

Can you talk a little bit about what you're seeing in the production outlook of major auto customers in the next six to 12 months? Are you seeing noticeable changes? Thank you.

Dinesh Paliwal

I think at the moment, as I said in my earlier comments that we are starting to production order release from many customers for infotainment or audio business, but nothing Mitul is getting to the level where we would say there's a significant recovery. You know we are coming off some 45% reduced production for Europe and also something very similar, 40% reduction in US, so these guys are starting to ramp up, but it's a pretty slow ramp up. We will see.

Right now, the good news is, the emerging market, particularly China is leading the pickup. China has become the largest consumer of the cars ahead of the United States. Of course you know that, but what makes the difference for us is, when we see the luxury cars being picked up, and that's something we are seeing the signs of. I see some green chutes but I'm cautiously optimistic, not there yet to say it has happened.

Another point about US automakers, Chrysler has started to ramp up and GM, we didn't have much exposure, but they are starting to come around, and we are seeing activity, but Chrysler may come back to $150 million on annual basis. This is after we have negotiated with them an early exit of the business which we did not want to continue due to its profitability or rather loss. So, with that said, it's a good development for us.

Operator

We have one from Tim Garry with Pzena Investment Management. Please go ahead.

Tim Garry - Pzena Investment Management

Hi, Dinesh. On the scalable next generation system, just a couple of questions. Is the thought there that that will essentially replace competitor systems or is that a marketplace where there's just not a lot of penetration, and so this is something to try to increase penetration overall?

Dinesh Paliwal

Hi, Tim. It will do both, because as I said we hardly played in the space of mid-range systems, and there are competitive offerings in that space. So, for us to be successful, we had to obviously benchmark and see what is existing and what would this market like to have. Based on that, our CTO and our development team actually prepared the system or developed the system, so it does have something very unique. It's not like this is in a box, you take it or leave it. It's so scalable that customers can still specify what they want, but we don't have to develop. It's like turning on and off feature functionalities.

So, we believe this will replace some of the competitive offerings, but that won't happen immediately, because that depends on when the production cycle of a certain competitor runs out, and it's ready for rebid. However, we are definitely going to participate there, but we are targeting several new customers, not only existing. We are targeting existing customers too, but several new customers, where we never actually approached because we didn't have the true offering to give them. So that would open up many Japanese, Americans, European and Chinese customers for us.

Tim Garry - Pzena Investment Management

Can you just describe in terms of, if you used all the functions, how would this compare to a system that's really for the upper ranges, sort of, for the high end ranges?

Dinesh Paliwal

It's a great question and I was expecting it. You see a full/premium system in BMW 7 Series, which we have just completed, and it won the most technologically advanced car for this year. That system includes multiple points of infotainment capability. So, you have rear seat entertainment system with full functionality, you've got front-end passenger and driver's side, so it's a network system versus a single-point system. That's the big difference, I would say. So the scalable infotainment system is a single system, and the premium system is a network system taking advantage of connectivity.

Tim Garry - Pzena Investment Management

Finally, in terms of coming up with a scalable product, traditionally, you're working directly with a particular auto company for a particular model. Have you been working with any of your potential clients in terms of putting together what this would look like so that you know that it's something that is what they want or how have you gone about that process of making sure you have something that a client base would want?

Dinesh Paliwal

Tim, it's a great question. We took a very unconventional approach, something what I brought from outside the world of automotive. Typically in the automotive space, you go to the customer, and say Mr. Customer, what would you like, and then we go implement it basically. Then you sort of lose the advantage of being innovation leader.

So, what we did, we benchmarked the marketplace, stripped down competitive offerings in the space, learned what is best out there, and then we did interviews, more like, polling key customers, not even our existing customers. Asked them what would be their wish list? Then we came up with our own specification, went on and developed it. Then we took the system to one or two customers.

In fact, one of the awards, which we are working on final details, if it turns into an award, that would be based on our scalable infotainment system, and it's very significant if it happens here.

Tim Garry - Pzena Investment Management

Would you expect the margins, at least on a percentage basis, to be similar to what you've been able to get on premium systems, or how do you think that would work out?

Dinesh Paliwal

That is the intent, and I think our business model seems to come to that conclusion as well, and I believe that's what we wanted to do and that's what we have done. It's all about reuse of bunch of innovation we have done for 13 SOPs, so we learned a great deal, so that's our IP, and we have packaged that in a smart way, so that it' scalable, and we can offer it to the customer if they want short cycle or what have you. So it's a reduced R&D cost, and it would have a very reduced time-to-market. That's the biggest difference. Of course, your SG&A would be less, not just because of engineering, but also sales effort, because you really don't have to do a one-year, two-year sales cycle to convince a customer, what have you. So we believe we can attain similar level of margins which we expect from our premium system.

Tim Garry - Pzena Investment Management

Do you think that the price point at retail will be such that you would have expectations of high penetration or high take rate? Or what's your sense when you're talking with the auto companies, on where it would be priced and what kind of take rates to expect?

Dinesh Paliwal

Since we have not done the official debut, we are working with a customer already where we think we will hopefully finalize if negotiations go well. It would be priced at the retail. We wanted to be in the market price range, but offer them lot more rich feature functionalities. So price performance ratio would be significantly higher for our system, but it would be retail market price.

Take rates, we want to be conservative up front. I think 10 to 20%, but I have a personal belief that with the emergence of the China market, and Russia, and India, and Brazil, and also US, with lot of new feelings about smaller, midsized car, but they want to load them up, so this take rate might be higher once this system is up and running, so we will see. I'll tell you what personal goal we have, I have and the company has, this is about a $5 billion market space, which has not been addressed by us and it's growing double-digit every year. I would like to see 20% market share in five years' time in that space. That's incremental sales revenue for us.

Operator

(Operator Instructions) We have a question from the line of Brian Gustavson from Balyasny Asset Management.

Brian Gustavson - Balyasny Asset Management

Can you talk about, based on the expense structure you have now what kind of revenues you need to maybe be breakeven or have some profitability?

Herbert Parker

What our goal is, is working on our cost structure. We're planning to breakeven at the revenue levels that we delivered in this quarter, so that is our plan. As to when we get there, we're not giving guidance on that, but our plan is to breakeven at this level.

Brian Gustavson - Balyasny Asset Management

So breakeven at $667 million, something like that?

Herbert Parker

That's correct.

Brian Gustavson - Balyasny Asset Management

How many quarters before the cost structure is kind of where you want it to be?

Herbert Parker

Well, that's the guidance we're not giving, but we are getting there as soon as possible, but I can tell on you a run rate basis, we do plan to turn profit by the end of this calendar year.

Brian Gustavson - Balyasny Asset Management

Okay. So by the December quarter?

Herbert Parker

Yes. I'm not giving quarter guidance. I'm saying, that we would be, whether that's the month of November or before, that's what I'm saying.

Brian Gustavson - Balyasny Asset Management

So the month of December might be profitable?

Herbert Parker

If not before, yes.

Operator

We have another question from the line of David Leiker from Robert W. Baird.

Keith Schicker - Robert W. Baird

This is actually Keith Schicker on the line for David, who is flying between Boston and New York right now. Just a real quick housekeeping one right away. Can you provide a D&A and CapEx number for the quarter, just the fourth quarter?

Herbert Parker

For the quarter, we're normally running around $30 million of D&A, but this quarter we've had some write-offs, so it's $45 million for the fourth quarter.

Keith Schicker - Robert W. Baird

Then CapEx was $80 million for the year? I can back into that number.

Herbert Parker

That's correct.

Keith Schicker - Robert W. Baird

So $30 million is probably a good run rate to use going forward?

Herbert Parker

Yes, $30 million's a good run rate. It's normally around that level.

Keith Schicker - Robert W. Baird

If we look at the STEP Change program, can you just remind me sort of how the savings are allocated or broken out between the cost of goods sold and then operating expenses, such as SG&A and R&D going forward? Is there one area where it's concentrated? Or how is that divided up?

Herbert Parker

You're referring to the slide we used at the third quarter.

Keith Schicker - Robert W. Baird

Right.

Herbert Parker

We broke that out. Just a second. Okay. In 2009, what we've got is $116 million. What we've broken it up is manufacturing and sourcing. So, basically, $130 million for the manufacturing and sourcing, $41 million for the engineering and $20 million for the SG&A.

Keith Schicker - Robert W. Baird

Then if we think about going forward, is there any reason to believe that that ratio changes? Did we tackle one area first or how should we think about proportioning those savings going forward?

Herbert Parker

Yes, the ratio may change slightly. G&A, that part may develop a bit more, and sourcing part should kick in a bit more, because that's the one that takes a bit of time and sourcing is more related to the volume to a certain extent.

Operator

(Operator Instructions)

Dinesh Paliwal

Okay. I think now to respect the time of all of our listeners here, although we still have five more minutes, but since there are no questions, let me close the call. First of all, ladies and gentlemen, it's been very helpful for us and also helpful to communicate, but I hope that during our call this afternoon, we have demonstrated the improvements made across the company during a very difficult year, at least I can say in my memory, this is the most difficult year I have seen or faced or dealt with.

We are proud of these accomplishments, and I hope you realize that in this environment, not too many companies can come out and talk with this sense of pleasure and confidence, but with that said, I say yes, we are proud but we are not satisfied yet. We have a long way to go in our own goals and targets.

We recognize that no one can predict the timing of a broad recovery, and we remain committed to making Harman a best-in-class company, and we appreciate your continued candor and your confidence, and look forward to speaking with many of you as we continue our progress towards this goal. I know several of us from the company will be meeting with several of you in one-on-one meetings or in some sort of a large meetings like Credit Suisse Conference or a few other conferences of that sort, we will be there.

So, thank you so much again, and we are very pleased with the company's direction, and management is absolutely motivated to continue to turn this direction into success story. Thanks again, and have a great evening, great afternoon.

Operator

Thank you, Mr. Paliwal. Ladies and gentlemen, your host is making today's conference available by digitized replay for two weeks. The digitized replay is available starting at 6:40 PM eastern daylight time today. Simply dial 1-800-475-6701 or 1-320-365-3844, and at the voice prompt enter the conference confirmation number, 109061.

That does conclude our earnings release call for this quarter. Thank you very much for your participation, as well for using AT&T Executive Teleconference Service, and you may now disconnect.

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Source: Harman International Industries Inc. F4Q09 (Qtr End 06/30/09) Earnings Call Transcript
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