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Executives

Dinesh Paliwal – Chairman, President and CEO

Herbert Parker – CFO

Analysts

David Leiker – Robert W Baird

Chris Ceraso – Credit Suisse

Adam Brooks – Sidoti & Company

Himanshu Patel – JP Morgan

Jonathan Mueller – Invesco

Anthony Josephson – Carmel Capital

Harman International Industries Inc. (HAR) Analyst Day Conference Call October 26, 2011 11:00 AM ET

Dinesh Paliwal

So having said that, let’s start the Phase 2 or the second stage where we’re going to take you through some of the presentation we have prepared for you to clarify some of the questions and guidance numbers. We’ll walk you through and take your questions at the very end. Herbert, you want to join me here while we go through? Music for Herbert.

Herbert Parker

Go ahead, Dinesh.

Dinesh Paliwal

Great. So what I’ll try to do in the next 10, 15 minutes here is to walk you through, we’ve been doing a lot of things in our company in the last several years. A team of 12,500 people with one goal, and there’s only one goal that drives many things we do is unlocking the shareholder value. And that all started a few years ago when we said we need to transform our company, the culture, the leadership in innovation, the leadership in cost and leadership in buyers for action. We do not like to stay with what we do even if we are captains of the industry called automotive. Nearly half of our revenue comes from non-automotive or things that generate superior return than anybody in automotive industry does.

So with this perspective we started to transform the company and we also recently understood that our customers, particularly automotive car audio customers. They want us to connect the dots from our professional therapies, from our lifestyle therapies, to connect the dots as if they’re one equal system and we must tell the story. We must do some sort of say coordinated marketing campaign, which is built jointly by our customers and Harman. That’s my thought when you asked the question how much money you’re going to spend. I said we can do things very effectively because our customers are going to fetch in big money and they’re going to come up with lots of ideation and we can bring the star power from our pro experience and legacy.

So we have started that, and we believe continuing to transform the company, which is based on innovation culture, based on cost culture and based on growth mindset, wherever the growth is coming from. Our world is not limited to few countries. Five years ago, Harman was active. Now, we are going, reaching out to all geographies. We believe we can continue to drive profitable and accelerated growth, and that’s what I think we have shown you in the last eight quarters.

Then we’re going to walk you through, Herbert will walk you through the first quarter recap, guidance, he will give you an update of where we are. I think we’ve done a lot of good work here but Herbert will give you detail. And also, he will update you on fiscal ‘13 guidance, and then we’ll open it up for the questions live as well as people, those who are listening over the telephone lines, we’ll take their questions.

So this is just a quick update; we put it out every quarter, LTM data, last 12 months. We’re happy that we are back to $4 billion mark. That’s something Herbert and I have been looking for. Let’s get this $4 billion before we start to do some other things. We’re there now and two of the divisions are already double digits EBITDA and percent numbers of sales, and I think we’re well underway even in our Infotainment, which is our largest business where industrial partners’ ability is significantly lower. We have broken away from the pack, we are already profit leaders, but we’re not there yet at all. As we like to say, we have a lot left to do but we know exactly what will it take to get to double digits.

I’m very proud of this because it all starts from the top, the Board. I’ve worked in European Board structure and I’ve worked in the United States, U.S. Board structure. Both play the key role. If you have very active, engaging Board, a diverse Board who bring various matter subject expertise. In our Board I’m very proud to say obviously, we are an American headquarters company. We have great American Board members but we also have a British, Swiss. We have a Chinese on our Board. Actually, one of the four Chinese CEOs who sits on American company Board. We must be something special, and this CEO, Dr. Liu, was 2008 CNBC CEO of the Year for Asia-Pacific, including Japan, India and China. So we’re very grateful to have such Board members and myself, Indian-American origin, and one German, Dr. Einsmann. He is the former CEO of Procter and Gamble.

And then if you see to your left the management team, this is a hand-picked management team. I’m pretty selfish because I always say we can only win if we have great team. And I don’t like to lose. Some of you have seen and so did Herbert so we have surrounded ourselves from the best people we could hand-pick, best people, I say, and this team has already shown what we are able to do.

So moving on quickly, transformation. While this is more like rearview mirror, I think we’re going to share with you more how we’re going to take the company forward, but it’s always nice to know what we have done so that what momentum we have in our sales. We have taken $434 million cost out. A number of people sitting in this room didn’t believe that we will be able to do that because that was 10% of our sales. It has never been done. I don’t know any company which has taken permanent cost, 10% of sales. Never been done. But we saw the opportunity; we did it.

And we have also taken a very decisive directional approach in transforming our footprint, our capital investment, where it goes. We created higher (inaudible) rates for high-cost countries like Germany, Switzerland, U.K., United States, to invest in manufacturing. We will be wanting them to come up with higher productivity levels like the factory you’re going to visit this afternoon when you go to Franklin, Kentucky. One of the best factories in the world, and I’m not saying it because I’m the Harman CEO; you see it for yourself. It’s going to get an award from the U.S. Manufacturing Association in coming years.

Then, we also, not only we were transforming our footprint, existing footprint, we shut down five factories in high-cost environment, which did not have the future of turning into high-productivity facilities. We opened five world-class factories in Hungary, Brazil, China, and we’re very happy these factories are either up and running or just about to come in full production. Last night, we had a governor from China coming to thank the Board of Directors and the management, the kind of approach we take in nine, ten months’ time from greenfield groundbreaking to full production in a world-class factory which a lot of people can come and learn from.

We opened R&D centers in Brazil, in Ukraine, in China and India. It’s not about going into the best-cost countries. By the way, we don’t use the word LCC, which is low-cost country. We call it best-cost country. Anything which gives us better leverage, we will go there. We also opened a world-rate R&D lab in Palo Alto. In fact, a BCC not quite, but it’s a very high-productive location. And Dr. Robert Acker, he’s chief of R&D there and we’re building it up because we want to capture all the greatest ideas, first time work gets that, come from Palo Alto, at least the majority of them.

We’ve been realigning our sourcing and cost, currency base and cost base. People ask about hedging and we say natural hedging comes if you can balance your payables and receivables in one country, and that’s what I think our directional approach has been and we’ve done a good job. And you see the sourcing number has jumped up from 30% to 69% coming from BCC. We don’t like middlemen. If someone’s sitting in U.S. and Germany, buying from Far East or West Coast country and giving up, and making a 20% cut in between we don’t like it. So I think we have centralized our operations and we go straight to the source and take benefit of BCC sourcing.

We have workforce rebalancing done. We have added some 4,000 people, we have grown the employee base in BCC from almost nothing to 4,000; 1,100 of them are in Hungary; nearly 1,300 people are in China from almost zero; 300 in India; 500 in Brazil; 300 in Ukraine. And I love it because now you’ve got a global workforce. We follow the sun; work is going on 24/7. We’re not relying on two times in Germany and the United States as we used to. So a lot of work has been going on which I want you to recognize as the owners and the analysts of this company.

Also transforming, we are expanding our infotainment profitability. That’s something you spotted, we spotted. We didn’t like it, we did something about it. We don’t like to be in the pack. The fact is Japanese investors are very different that U.S., than you all are. They have patience for 1%, 2% profitability and they will keep the stock. You guys dump it if we don’t show you quarterly improvement. I understand where you’re coming from. I hope you’ll give us sort of annual year-over-year breaks because the business we are in is an annual improvement business, not quarterly. Anyway, we have done that too.

So we have also moved in that direction in a very decisive manner. And moving on profitability again, this was a business which was going in a wrong direction. And you saw last year’s full profitability, 4.2%, and first quarter was amazingly good quarter and we like the performance, we like the direction.

Then we have also done the operational alignment. We split it, the all audio businesses which touch the consumers. So home audio, car audio, on-the-go, professional, all of these we have brought in the Lifestyle division and that division’s focus is to go, because this division has so much going on for it that they can generate double-digit profitability in coming years. And I think we are well under the way there.

Professional division has been our star performer all along. There we had to go and we have been going and we’re going to show you some more things as we do here.

BRIC country, you know the focus of what happens if Greece goes down under, the whole stock market suffers and Harman stock goes more, down more than anybody. I don’t understand what we’ve got to do with Greece, but that’s why you guys have a better answer than I do. But, anyhow, that’s what happened three months ago. We had no reason why stock went down because Greece go down, but anyway. We figure out one thing, we said we need to expand ourselves in geographies so we can take away the volatility of U.S. versus China, Germany versus India, Brazil versus Hungary and that’s where we are going. And we grew 68% in a month in three countries in fiscal 2011. In first quarter, we grew 91% in three countries. I don’t know any company, which can come close to these numbers, but that also should give you confidence as owners of our company that this management team gets it and we are putting where what we are worth. Yeah, and we have been very focused on that.

This is a dashboard. I don’t need to spend much time. You’ve been seeing it. This is a product of what you asked us to, we listened to you. You asked us, give us more of that, give us less of that. We’ve been following and giving you. So this dashboard of value drivers gives you clear direction. We changed STEP change with return on invested capital because STEP change is done. We still have the process going on; we still look for the cost improvement. We have added that and you can see the development. Year-over-year we’re very happy and nowhere we are close to where we think we should be. We continue to drive improvement. Global footprint index is a clear validation of comparative sustainable advantage. Jaguar said it well. He said if you want to be profit leader for a long-term, you’ve got to be cost leader. And that’s what global footprint index is all about. This is the best practice we brought with us from some other company and we’ve implemented here so well.

R&D engineering, we said 8% of the sales is the target we like it, I think we are there. As we grow, we’ll grow the absolute dollars, but percent of sales I think we’ve got it right. Then look at the China five year, very, very ambitious plan from nearly $20 million in 2008 or $35 in we did $269 in 2011. So we’re on a very good path here to achieve $1 billion, most ambitious target I’ve seen or actually ever given, but we feel comfortable achieving that.

Looking at R&D, this is the key. That is the secret sauce. I hope you as our brains of the company and analysts and investors and hopefully some of their analysts who should also be looking at this company because we are beyond automotive, we are in the luxury sector. We are a highly innovative company. You can see that how we have focused on expanding the brand trust because some of the comp – 40% of the companies launched in the United States since 1985 were not launched by Americans who were born here. 40% of the companies are launched who came from outside to this country, which are Fortune 500 companies.

But I tell to you even if our innovation policy sucks, I’m sorry for that, we’re going to reach out to the top talent of Sergey and those who launched Googles of the world and real companies. For that, we need to have R&D labs in places like China, India, Brazil, Ukraine and Hungary because that’s where those talented people are not able to come to this great country. They wanted to, but we’re going to reach out to them and we are.

A strong innovation pipeline tells a story. If you follow our patents to 3,500 patents, we’re very happy. The second largest audio company, I don’t have to name the name, they have been declining their patents filing five years in a row. That tells you it’s like pharmaceutical industry. If you’re not filing patents, your pipeline is going to shrink and you probably won’t have any DNA left.

Disruptive innovation culture. That’s something our CPO has inculcated in the company. We’re paranoid, starting with me, that who can disrupt our business model tomorrow, years from now, five years from now? We should be looking at it and disrupt it ourselves. That’s why we developed a scalable platform. A lot of people say why are you doing those developments when you don’t have an order? I said, hello? This is the problem with this industry. You listen, you have the customers trail you after six months of thinking and you take two and a half years to develop. By the time you launch this three-year-old technology, I don’t like it.

So we developed ourselves a scalable platform launched in September 2009 with no order; that was the intent. We have booked now nearly $5-billion order against that. That’s the sum of its success. That’s only one example; we have many other such disruptive technology-based innovation. And the worst innovation is another mantra, which we have sort of embraced in our culture.

Moving on very quickly, Harman has a history of a lot of firsts. I’m not going to repeat all the firsts, but I’m going to just share with you the last couple of years, there were so many firsts. We have launched some of the key ones. The Quantum Logic where we are able to take the compressed music and uncompress it.

I have a serious worry this whole new generation. My daughter, my son, 23, 21-year-old, they never heard on the real vinyl like they grew up with the real music how I just intended to hear, and they hear this compressed music just like the PDF file. When you have a PowerPoint file, you compress it to PDF, yes, you can move the damn thing around but you lost all the fidelity of highs and lows. That’s what you do to your music. We have a patented technology. We can uncompress and you can hear as the music was really offered, as artist meant it to be. That’s our technology; nobody else has it.

Here is sonic. That’s the sound management. We can propagate sound outside the car for electric and hybrid, that’s a safety requirement, and we can cancel the sound inside the car. That is not a child’s play. This is our patented area where we continue to excel extremely well. And you will see something today when you go to Franklin.

Aha Mobile. I think we jumped onto the problem which the whole world is wrestling with, how do you bring texting and voice mail and e-mail, safety and sound. Andrew Ross Sorkin of CNBC included me last Friday and he asked me, Dinesh, people think once they have a cell phone in their pocket, I don’t have it by the way. People are drunk. I said I don’t know about that, but what we are doing with Aha Mobile, we’re bringing entire social media to audio. Audio is the safest way to deliver news to you, any updates whether it’s Facebook, YouTube, Twitter, a text, voice, what have you. They are the least distracting at all because we all are trained when we are born how to filter out noise, but we’re not trained when you see something it distracts, when you touch something it distracts even more. And some of you heard my other story. I’ll go there later.

GreenEdge. This is the technology which is being embraced by Japanese and Americans and German car companies. It gives you 100 or better performance at top energy levels or less. Imagine for electric and hybrid cars what play this will have. And HiQnet, we had a proprietary network. This whole room, the lighting, the audio, the audio/video and everything is all hanging on a bus called HiQnet. That’s what we brought to the industry and now we are leading the development of audio/video-grade AVB. Ethernet ABV. And that’s where we have partnered. We’re working with Intel, Cisco, Apple, Samsung and a few others. But we are the founding president of this association.

Moving on, automotive market outlook. You have this in your deck so I don’t think I’ll go in detail, but the point I want to make is the car sales, we believe, is going to go 6.8% CAGR compounded as we get a grade for five years. And you can see who are the, which other countries will lead as the BRIC countries, China, India, Brazil, will lead double-digit growth of car sales, so not a surprise.

Then when you look at infotainment market from coming out from that market is 9.2% growth, that includes everything, the entry, the mid, the high level. And again you can see the growth rate will be drive from emerging markets or BRIC countries, particularly Brazil, India, China; and U.S. coming right behind, almost double-digit, 10%, and Europe will follow after that.

And then comes audio – I mean our market situation here, today Harman in infotainment is clear world leader. Clear world leader with 22% market position. And then comes the Japanese, the Delphi, the Aisin’s of the world. And they were, used to be so-called leaders from Germany that lost position big time in the last four years. They’ve forgotten that in this business.

And we believe with our pipeline, with our backlog, the way we are delivering and procuring, we’re going to gain market share. It will be 26% of the largest pie; that’s going to be $14.4 billion world and we’re going to have 26% by expanding from premium-high into premium-mid, from premium-mid into entry. We are already playing premium-mid and we’re launching this year premium entry system, so we’re going to play all three areas.

Then when you look at the similar data set for audio, you can see the same pattern. Emerging markets will drive and here I’ll be making one point. It may not be so natural for most of you. You as an American, you didn’t but a car the first time in your family. You had family, your friends, all the time, and even that wasn’t your first car. But Asians or emerging-market people are buying maybe first car in their family, maybe first car in the whole neighborhood, maybe the first car in the whole damn village.

So the way they buy a car, they don’t talk how many cylinders was the horsepower, how many exhaust, how many walls. They sit in the cockpit are, and somebody will turn it on and say, look, this looks like 707. Look, turn on the volume; this sounds better than your home, and it’s all so true. That’s how they buy, they buy based on experience. So all the research we have done, all the research our German auto makers, our Japanese have done, it tells us the audio and infotainment paid rate will be driven very high as car sales start to go up. Even if car sales start to slow down a bit, their growth will continue to go up. That’s very clearly we have added it with our own research.

If you look at Harman’s position here, we are clear leader. We have Bose, another American company as second, and then you’ve got other players. We believe the market is growing, market is growing about 9.1%, and we’re going to gain market share from 33% to 38%. That means we’re going to go over 12.5%, 13%. So we’re going to take over more markets from the current competitors.

Moving on to how we’re going to bring those effective marketing to create the traction and the track and the paid rate, particularly audio. And that’s something I was, just give you a little glimpse of what we’re doing. We are signing up artists who believe in what we do. Those who started their career with JBL, with AKG, with Crown, with DigiTech, they are the naturally spokesperson. A.R. Amon, he started with a pair of JBL when he was poor man. Same for Lu Wang, number one artist of China. Same thing Tim McGraw, who’s going to perform tonight for us. Absolutely. So that’s all I know. I don’t know anything else. I knew JBL, I knew Crown. Here you have Maroon 5. So the top artists of the world and they are coming in and it’s not about money anymore because they’re not signing up with a company who makes cornflakes or who makes something else. They don’t have anything to relate to. They relate to this because this is their life.

Harman Kardon, we had a similar campaign. Harman Kardon is, as research says, it’s a beautiful sound. You arrived, the lead, and we can associate that with a similar campaign with BMW and Mercedes and other people those are used. So a lot of good things happening in the company. It is a very exciting time for me personally and it’s a very exciting time for 12,500 people. They are seeing appear a light through the tunnel. We’ve been through some rough patch with – transformed our company. We’re in a Phase 2 or we have rebooted the company, we’re in a growth mode, we’re in a possible growth mode, it’s a culture of cost and innovation.

At this point I’ll ask my colleague Herbert Parker to take it for financials.

Herbert Parker

Good morning, everyone. Thank you, Dinesh. Some of you may not know it but I am from Chattanooga, Tennessee. So I feel good to be back at home and I’m glad to see a lot of you all were able to make it down here. So we will give you an update, as Dinesh said. I’ll first talk about the recap of the first quarter for some of you that may not have been around when we gave the release last week. Then I’ll give you an update on the neodymium cost. I will discuss, for the first time, our infotainment backlog and when the revenues developed. Talk about that a bit. And also I’ll discuss the Fiscal Year ‘12 guidance as well as an update of fiscal year ‘13.

Whoops, can I go back?

Dinesh Paliwal

Can you go back one slide, please?

Herbert Parker

There we go. Thank you. Okay, I have discussed the first quarter as you have seen already. We delivered 35% growth. Sorry, 26% growth but 35% in infotainment and this was led by all three divisions. And when you come to the earnings part you’ll see we delivered the 7.3% earnings and infotainment, again, led this development. We did have a small dip in Professionals and the Audio division, the Lifestyle. But we discussed that last Friday and told you that neodymium was the main reason for that. In case any of you have any other questions about it, we can discuss that during the Q&A. Also, I’d just like to point out on EPS we basically doubled going from $0.35 to $0.69 per share. And so we are very happy with this development as Dinesh said earlier.

At this time I’d like to spend just a little bit of time on we’d like to show our investors that we’re delivering on our promises. Any time you look at us year-over-year you’ll see consistent improvement. And I’d like to also remind you that it’s best to look at our business year-over-year as opposed to sequential. We are appeased analogy, not just in revenues but also in cost and cost savings. For example, we typically did our cost savings starting July 1 with our suppliers. Although we’re consistently working to get more throughout the year, we get the majority started in July 1.

We’re giving annual price reductions to our customers starting January 1 primarily. So you have a big mismatch there when you try to do the sequential, so keep that in mind, but having said that, we’re very happy with the trend of eight quarters of top and bottom line growth.

Now as we do have $1.2 billion of a liquidity we’d like to let you know how do we think about deploying our capital. First and foremost, our goal is to invest in those areas that gives our shareholders the best value. That’s number one. When we talk about specifics we like to maintain very high credit metrics. This helps us get back to investment grade, as well as reduce our cost to capital. We believe in investing in accretive acquisitions and you’ve seen us demonstrate that with a couple of acquisitions we’ve talked about in the past.

Also, we definitely invest in organic growth with our CapEx, and we look for 20% returns or higher. We plan to consistently give a dividend at the current rate or increase that rate. Also we benchmark all of this to a buy back, and as you have seen this morning, we issued a press release where we have pre-authorization from our board to spend up to $200 million for a buy back. That’s our capital deployment strategy.

Next an update on the neodymium costs. As we told you in the first quarter, we identified gross exposure of $85 million. We had identified mitigation actions of $30 million at that time, which left us a gross exposure of $55 million. Due to our expected sales increase the gross exposure is now $90 million, but the good news is we’ve identified $55 million of mitigation actions so now our net exposure for the full year is $35 million. Out of that $35 million we’ve already incurred $9 million in the first quarter, so the thing you should take away is we have $26 million remaining of net exposure as we see it today.

Now let’s talk about the famous buckets. I’d say over the last year at least, we’ve talked to many of you about four buckets we had of our backlog. The fourth bucket which is not there is the Lifestyle business, which was called Audio at that time. And as Dinesh showed in the earlier slide, it’s $3.1 billion, but as we’ve now disclosed infotainment separately we are only discuss the three buckets here, and for your reference, for some of you who haven’t followed us, that bucket of $3.1 billion Audio business delivers mid-teens EBITDA margins. Now let’s go forward with the three buckets that we will discuss now and going forward.

The first bucket of $2.9 billion or 25% of our backlog is the business we booked prior to fiscal year 2009; and that was booked at basically close to zero percent margin. The second bucket, and we call this customized business, built it from the beginning up to the start as opposed to skeletal that we’ll get into later. The second bucket is also customized business, but we booked that at a better margin. And that’s after fiscal year ‘09, and that was booked at around 5% margin. And as you can see, there is 35% of our backlog of $3.9 billion. The last bucket and the best bucket, I may say, is 40% of our business at 4.6% billion backlog and that’s booked at 8% to 10% margin. Now we talked about this before and you’ve heard it before, but what you haven’t heard and what you haven’t seen specifically is the next slide.

This slide gives you granularity of when this will roll off in revenues and what we expect the margins to be. If you look at the first column, fiscal year ‘10, what you can see over 90% is the first bucket, which is 0.1%. And as you can see on the right we booked it at 0% to 2% margins. All of you are very familiar with STEP change program. We did a lot of hard work this team, 12,000 employees, put a lot of time into it and we worked hard and we improved that first bucket from 0.1% to 4.2% in fiscal year ‘11. Because as you can see, fiscal year ‘11 90% was still that first bucket. In fiscal year ‘12 going out forward it’s still a significant part at 80% of that bucket, but again, that 4.2% improvement continued to improve, not just from STEP change but also from footprint migration, and at the same time, we helped bucket two coming in and bucket one. So when you take the blended revenues, it’s producing an EBIT of 6.8% to 7.2% is what we expect this year in fiscal year ‘12.

Fiscal year ‘13 it gets better as that’s the first time that the majority of our business will be from bucket two and three. And, again, we’re not losing because we always told you STEP change was permanent savings. So we’re not losing that. So taking what we’ve done and the consistent improvements, the blended portion will be 7.4% to 7.7% for fiscal year ‘13, and, of course, it gets better as you go out. And you can see the backlog as it stands today more than 55% will be in the skeletal business in the future, which is at the 8% to 10% range. Thus we believe that by fiscal year ‘16, we will be at double digits in our infiltrating the business.

Now just to discuss the guidance that we’ve issued this morning, we’re expecting $4.2 billion to $4.4 billion in sales for this year with EPS of $2.75 to $3.00 as compared to $2.08 last year. And this would give us somewhere between 12% and 17% growth from fiscal year ‘11 and below you can see the makeup of the divisions.

Continuing our improvement, we’re expecting $4,550,000 in fiscal year ‘13 to $4.8 billion. And EPS we’ve tightened the reins, we initially told you back in April of 2010 we had an EPS range of $3 to $4 and we have said in several calls we expect to be at the higher end of that range. Thus we are at the higher end now. We’ve tightened it up from $3.75 to $4.00 EPS. And again at the bottom you can see the makeup of the divisions.

So now in honor of our respect your time, we’ll pause here and give you a chance to take some Q&A. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions)

Unidentified Analyst

Thanks. A couple questions. You mentioned you were paranoid. That was an interesting segue into one of my questions. You guys are clearly pretty early on the scalable system. How much do you worry about this product eventually being reverse engineered by some of your competitors, which presumably, you know eventually maybe there is some risk at the double-digit margin that you’re enjoying, when that business starts receding?

Dinesh Paliwal

You know that’s part of paranoia. And we should be paranoid that somebody would do it and that should drive you what is next. And our next has been and you will see an example, we take a scalable fact from which we develop. At this point we say we should develop this thing for one-third the cost and half the market price. You heard me say that 2 years, 2.5 years ago and now the new product which we are about to launch, we said save this what we have just developed and take further one-third the cost and half the price so that we can go after, penetrate the large number of cars which we don’t penetrate because of cost reasons.

And with of the research – and mind you, we just completed, we found out 80% of the people, those who buy new cars and likes to have some system, 80% of people complain about price is too high where the automakers do it, when they bundle it up. So we’re going to drive price reduction without comprising profitability. So that’s an example. Now, others follow? Well I hope they do because that would bring even more competitiveness and change the culture of the business, because customized business doesn’t generate profitability for anybody. I’d like to drive it more towards real-time, real process control systems, which is what scalable systems is all about.

Unidentified Analyst

Okay. Two more follow-up questions. Maybe this one’s for Herbert. You guys have talked about the customized business being breakeven, but I think we all know last year, infotainment was a 4% margin business and I think you’ve kind of explained that that’s because those old customized contracts are kind of at the mature state of their life cycle. Can you just take that same discussion and talk about the scalable margins? You’ve talked about high single-digit margins for that business. Is that high single-digit when those contracts are mature? Or is it inclusive of the one to two years of development costs that you incur before the revenues starts launching?

Herbert Parker

Well, it includes development costs, but also I would point out that we don’t expect the scalable, or let’s put it another way, there’s no reason it would not exceed 10%. That’s just where it’s 8% to 10% is more or less a starting point. So when we go out to the further years as they mature as well, we expect that to even get higher.

Unidentified Analyst

Earlier we saw a discussion on Pro about IDX. I just wanted to – that was a new product, I wanted to understand that a little bit better. Is that a product that itself contributes materially to revenue? Or is it really just kind of a segue to be able to sell more Harman hardware into some of these institutional applications?

Dinesh Paliwal

It’s both. You will – obviously as a company, we’ll try to solve a complete systems solution. So we actually differentiate ourselves saying we are a complete professional systems company. There will be situations where our competition may sell bits and pieces, and we’ll be asked to come in for this new, segue, which you called it, new system offering. But you know, as you think about 57 new airports are being built in China in five years; next five years, 57 airports. So give and take, we’re going to succeed in that marketplace. So this offering will bring us in for a total offering, so this will create pull-through in fact, for all our other products in Professional division.

David? And after David, can we take Chris Ceraso? He’s online, I see him. After David Leiker.

David Leiker – Robert W Baird

Yes, we can. David Leiker at Robert Baird. If you – I mean, the technology is changing pretty dramatically from two years ago, and you guys keep moving the bar in terms of what the capability of what your product is. Where’s the competitive landscape stand today with the other folks that you’ve competed with historically? And some newer people that seem to be coming into the business?

Dinesh Paliwal

I think the automotive industry we’re clearly hearing from the leading OEMs that connected cars are here to stay. Therefore our research and our development are all geared and laser focused on bringing safe and sound, connected, work in the car. So that’s the direction. I honestly don’t see a whole lot being developed in that area by major competitors. That doesn’t mean that others aren’t doing it. That means there are lots of small companies are trying to enter, and that’s a good thing, because they will bring in point solutions, which we might be able to bring it in either as a point solution and we bring the total solution to the car, or understanding total solution. As you know David very well, it is a very, very high competence, very high entry to barrier for most companies. I think this will benefit.

An example is when Google entered with free navigation, someone asked me what does that mean to Harman and I said it’s good news, because either they sell free or they charge small subscription, we buy that from somebody today. If you can lower the cost, there’s still a lot of system integration and application engineering. So that’s the automotive.

In Professional and lifestyle side, we also see connectivity. You heard audio-visual bridge. Audio and video are converging, and we’ve been asked that we’re the largest supplier to the GRAMMY and to the Olympics, to C-Class, half of the Las Vegas audio recording studios and cinemas. So we are looking into very drastic, very aggressively either to acquire the technology or develop and win our city. We’re developing ourselves, and if we find something we’ll get it for just that area.

Lifestyle, the new word at home and on the go would not be what it was. Steve Jobs has truly changed this industry. So people are just expecting to have the ecosystem travel with them or move with them in their home, office or on the go. I have a 23-year old daughter and 21-year old son; they say I will never buy the car you guys do, because this is not me, because I need to have what I carry with me all the time with my iPhone, iPad. So even Lifestyle is changing, so new AVRs for the new multi-medias will be coming in the market that will be more on the air play technology, connected world, with the cloud being the server for all multimedia, audio, video, Internet gaming, any content anywhere.

David Leiker – Robert W Baird

And then just one other item. You put some numbers out there that go up to 2016, the market data. How much of what you’re expecting in your market share in ‘16 versus the market sizes in your backlog, how much of that have you already booked? Or is there business that you need to book to get to those numbers that you’re showing?

Dinesh Paliwal

The question is how much new book-and-bill you will need. Well, I think historically you’ve seen in automotive it’s an easy answer. 2012 is in the bag. We’re not going to book business with the converted revenue, so we have it all. In Professional, backlog doesn’t really carry the same meaning because we literally book that business and ship it, so maybe you have a backlog of two to three months. Same, Lifestyle is even smaller from the home side. From the car audio side we have the $3.1 billion backlog. So there you have a backlog with, I would say, in car audio we will say the same thing, 85%, 90% in the bag. So you have to keep booking business.

My assessment tells me if tells me, if you’re $4 billion in the last 12 months, to grow and hold onto the backlog, or even slightly grow, you have to book more that your this year’s revenue in new orders. And I think we have been successful doing that. So net, net you can do your weighted average, 55% is infotainment, so probably, and I’m just picking number from my head here. For the whole company, Herbert, what would you pick? You would pick 50%?

Herbert Parker

Yes.

Dinesh Paliwal

Is in the backlog for the given year, and the next you have to book-and-bill for infotainment, almost 100% for the given year.

Herbert Parker

Let’s get Chris.

Dinesh Paliwal

Can we get Chris Ceraso, please, telephone caller?

Operator

Certainly. Our next question comes the line of Chris Ceraso from Credit Suisse. Please go ahead.

Chris Ceraso – Credit Suisse

Thanks. Dinesh, can you hear me.

Dinesh Paliwal

Very well, Chris. How are you? How is Ford doing?

Chris Ceraso – Credit Suisse

Not so great. But first, thank you very much for allowing me to dial in and ask questions. I appreciate that, and I apologize if anything that I ask was already covered, but I do have a few questions. First just sort of a numbers question for you or Herbert. What’s your expectation for corporate expense in 2012 and ‘13? I’m just trying to foot to your bottom line numbers which look like they either assume a higher run rate of corporate expense than what you’ve running at and/or a higher tax rate. So that’s the first question.

Herbert Parker

Okay, Chris. We have said that we expect incremental expenses and corporate around a half a basis point of our sales, so about $20 million for the next year compared to what we had last year, 50%, 50 basis point or slightly north of that. What we do, we look at our marketing campaigns which you didn’t see. But if we see good payback we will spend more in that area or we could even spend less, but we control this. So you can do the same thing for fiscal year ‘13 and add another $20 million, but this is all done with the expectation that our take rates will also increase. That is the way we invest in our corporate expense.

Chris Ceraso – Credit Suisse

Okay. That makes sense. So if you were running at, call it $70 million or $80 million, maybe it’s closer to $100 million in fiscal ‘12 and possibly higher if it looks like it’s working?

Herbert Parker

That is correct.

Chris Ceraso – Credit Suisse

Okay. And what about the taxes, Herbert? What are your expectations for tax implied in that bottom line guidance?

Herbert Parker

What we’ve done for this year, we went ahead and used what we had as actual for Q1, 23.6%. Well for next year as we begin to make more profits, in our higher tax jurisdictions like the U.S. and Germany, we’ve gone back to the 28% that we’ve always quoted as our long-term tax rate.

Chris Ceraso – Credit Suisse

Okay. Makes sense. On the Pro division, it looks like, based on your guidance here, that you’ve got some very high margin expectations there. Is there – and higher than what you’ve done in the past historically. So what’s new there? Are there changes in the cost base? Are there new products that are coming through? What’s going to let you get to new heights in terms of operating margin in Pro?

Dinesh Paliwal

Chris, it’s very simple. I think we’ve said that over the call that Pro is a systems business and we had a couple of projects, which slipped from first quarter into second quarter. So we didn’t have enough revenue. At the same time, our investment in emerging markets, particularly in infrastructure buildup, are at full speed and I’m very happy they are. So hopefully we’ll pick up that business which slipped out from first and second and this is an elaborate business. So we expect us to be back on track as we had been. Nothing had changed. This business is fundamentally sound and I expect as we have given you guidance, to come through.

Chris Ceraso – Credit Suisse

So if you look out to your 2013 guidance, you’re looking at 17% or 18% margins. I can’t recall when you were quite that high in the past?

Dinesh Paliwal

Well, our past is not our indicator because we have done a lot of better things than past. So Professional business as I recall from April 2010, we gave you guidance between 16% to 19%.

Chris Ceraso – Credit Suisse

Okay.

Dinesh Paliwal

So we’re well in that area. I will just say that Pro business is so solid that the kind of things Blake and his teams are doing and product proliferation and large application development that they can take it, this business, to close to 20% EBIT margin and that’s going to happen.

Chris Ceraso – Credit Suisse

Okay. That’s great. And then just one last one. Ford today actually was talking about work that it’s doing collaboratively with Toyota on things like hybrids. But, also, it mentioned specifically In-Car Telematics. Is this something that you think could be an opportunity for Harman? Is Ford a potential candidate here for a scalable infotainment system? And we also note that Ford seems to be having some pretty public problems with its new MyFord Touch system. Is that something that you’re in there working on, trying to show them how to do it better? Possibly with a Harman system?

Dinesh Paliwal

Chris, the answer is very simple, we’re an American company and, honestly, we – I personally feel it’s really not the right thing that we are here with the best technology in the world and we are not even helping GM and Ford, we’re doing it with Chrysler. But that’s history, that’s legacy. We have reached out, very humble demeanor, that look, guys, we’re very proud of what you’ve done, but we’ve got something that can help you. Now it’s up to them, and I think you people, as the brain trust of this industry, you need to do some connecting of dots. I think you need to ask the same questions to Ford and GM, where are they and why aren’t they using the greatest, the best technology that German cars and even Toyota and Lexus has started using?

Chris Ceraso – Credit Suisse

Great. Okay. Thanks again for taking the questions, Dinesh. Good luck today.

Dinesh Paliwal

Very well. That was Chris Ceraso from Credit Suisse. Thank you, Chris. Adam?

Adam Brooks – Sidoti & Company

Adam Brooks, Sidoti & Co. Can we touch on China first? Second, maybe any other obstacles you’re having procuring more infotainment with other OEMs, then maybe even talk about possibly even branding infotainment over those?

Dinesh Paliwal

That’s a great question. Not really obstacles. It’s a new market, new world. First time, people are buying. Pretty much started from ground zero, then it comes to infotainment, branded audio. So I think it’s more of the education, training campaigns for the dealers and other places like we did in U.S. and Germany many years ago. So I think it’s starting to pick up. You saw the press release we put out yesterday, Changan for their high-end car. So we’re happy, but good thing is that we are already going for infotainment in a big way with VW, with Mercedes, with BMW, with Fiat, with other car companies.

So in terms of cost comparativeness and also understanding their needs, their needs, I’ll give you one very good anecdote. Germans and Americans thought they were leader in advanced driver safety systems. When we went to China two or three years ago, they told us this is a necessity for us; it’s not a luxury. You need to find a way to get it cost comparative scope of supply and your pan efficient can be 50%. So we moved our center of competence from Germany to Shanghai, and we’re very happy. You will see some of the stuff today in Franklin, what sort of the work that camera-based system they have developed, which is second to none and we’re taking a lot of cost out. So to a nutshell, we believe the penetration of infotainment without even vending and audio branded systems in China will be pretty rapid.

Second part of your question, I think concerning branding infotainment, absolutely. That’s a part. We have our Chief Marketing Officer; he’s doing market research. And if that makes sense, we’re going to definitely launch it because we have a great brand call backer. That’s how our infotainment and audio radio started in Germany.

Adam Brooks – Sidoti & Company

And one more question. If we look at Consumer or I guess it’s Lifestyle now, you had a margin compression in 1Q but to the back half of the year, just seems a pretty big pickup over what we had last year. Still having some neodymium costs. Can you maybe frame what’s causing that pretty big margin expansion?

Dinesh Paliwal

Well, first of all second quarter for our former Home and Multimedia is always stronger quarter because of the holiday. First quarter is always a very poor quarter. So with something of that nature you should see coming up. And also in neodymium side, I think a lot of what’s going on in terms of how to pass the price, the cost increase also design changes, and also take rate, that’s the most profound rate. Take rate increase we’re driving, and that’s where the marketing campaign is coming in. And also book-to-bill in Audio business, Car Audio business will shrink. That what will also help us bringing more revenue the second half.

Himanshu Patel – JP Morgan

Himanshu Patel, JP Morgan. Two follow-up questions. Can you give a little bit more color on the Volkswagen contract that you guys announced this morning? And then number two, I’m curious; just so we understand the kind of customer discussions and the brand of business, on the neodymium issue, I think you said its 90 million gross, 35 million net. Of the 55 million or so of offsets, how much of that was price recovery directly from the OEM as opposed to material substitution?

Dinesh Paliwal

Let’s start with Volkswagen. Yeah, we’re very happy. We have been in discussions. This is actually Volkswagen Group, but particularly this is specific is the Porsche. We’re very happy that we got a fairly large order from Porsche. It is the flagship car of the VW Group and that’s going to start to come in, in 2013 in some parts it’s 2015 in some parts. It’s part of our backlog. We got the order before the first quarter numbers were closed, but we could not get approval from them. And I must tell you that this is not easy to get approval from these people, and we’re not allowed to say a whole lot more about models and what model unit is coming. So it’s a nice order. It’s a very good order. It’s based on scalable platform, so very happy.

Second part, the neodymium, Himanshu, most of the price, most of the cost recovery in neodymium is going to come from passing on the cost increase to our customers. It also tells you one thing, which is very, very important for us to realize, it’s the pricing power. We just tested that we do have pricing power in branded audio, because we’re so large we can sit across from the customer and make sense out of it, and they said we understand that. So I think we’re well underway. That’s why we said when Herbert said that we will resolve this one way or the other on a run-rate basis by the end of the fiscal year. So clean fiscal year ‘13 start. So we do not have anything as a hangover from neodymium going into ‘13. So during that time we’ll also do some design changes and also a spot agreement and what have you. Back there?

Jonathan Mueller – Invesco

Jonathan Mueller, Invesco. Can you maybe discuss how the discussions are going on with making Mercedes and BMW as far as potentially adopting scalable infotainment systems versus the current customized systems that you’re doing for them?

Dinesh Paliwal

It’s a great question, Germany industry gaining traction for scalable track form beyond Volkswagen. I think so. It’s a slow process and also it’s a timing issue. BMW and Mercedes both we’re working on their next generation platform, and they’re not ready yet to make any new decision. So when that time comes, we’re hoping that we will be able to get our story across that you can get everything and more if you choose to go with a scalable platform. Does that answer your question? You guys know how to do things on time, exactly on the dot. We’ve got one more question.

Anthony Josephson – Carmel Capital

Anthony Josephson from Carmel Capital. I have a question around your capital allocations strategy that you guys have highlighted today, its two parts. The first one is what size or amount of liquidity do you think you need to run the business on a day-to-day basis? And then the second one would be with respect to the share buyback. Is there a piece of that calculation with respect to the price of the stock where you guys would feel comfortable buying back more stock, less stock and how you think about the price of the stock with respect to the share buyback?

Herbert Parker

First, let me address your first question amount of capital we need, I mean the cash. We like to have a $150 million just to run the company. However, with the global dispersion of cash in China and Germany, we need a bit more of that just to run the company in general. As far as debt we like to keep the nice credit matrix. So we like about $1.5 to $1.2 debt to EBITDA, and as far as amount of what we – first of all, we feel that our stock is a good value. But as far as what value we would buy, obviously we wouldn’t discuss that at this setting. We’d have to – we do have these certain metrics we’ve looked at within our management team for what we think would be the right time. But we obviously won’t disclose that and we, at x we would buy x amount of stock. Sorry, can’t disclose that.

Dinesh Paliwal

Okay. Let’s just wrap it up so we can continue with your program. We have very exciting factory tour for all of you. So let me just say on behalf of Herbert and I, once again, sincere thank you for making to Nashville. I know it’s not an easy place for many of you to get to. We sincerely appreciate you being here because we wanted to show you the technology. We can talk to you from anywhere and we do that in the quarterly calls. We also wanted you to feel the energy in this room, not just the national but also after the management team.

We’re very excited and I think we are making all the steps we get education from you. We have always said to our investors and our analysts, we have no ego. We learn. We learn from our investors. You tell us good things, if it makes sense we adopt it. And we have been conforming to that strategy and even this morning’s announcement, it’s not an accident, it’s not a pressure from anybody. We’ve been thinking about it.

We’ve been saying that for a few quarters and we think we wanted to have a pre-approval from our board of Directors. It gives us absolute opportunity if our stock grows into value, which we believe it’s really, really low, then we take advantage of that. Is today the right day to buy? Absolutely. Our stock is actually very good opportunity to buy but we’re not buying today. We’ll buy at the right opportunity but we keep the powder dry for other things as well, and Herbert mentioned that.

We continue to believe that we are without metrics here. Most rating agencies should look at us differently. They haven’t. There are companies we can see have different ratings much better than our numbers but you know who are we to decide that.

But anyway we decided to move on and do what is right thing for our shareholders and we’ll continue to sort of see what to do. So that’s why the capital structure we have deployed we expend to you at this point.

Okay. With that, once again thank you very much and look forward to seeing you a little later this afternoon when we have the customer panel and a panel discussion on macroeconomic and technology direction. Have a great afternoon and see you later.

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