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Harman International Industries, Inc. (NYSE:HAR)

F2Q 2012 Earnings Call

February 7, 2012 11:00 am ET

Executives

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

Herbert K. Parker – Chief Financial Officer

Analysts

Christopher J. Ceraso – Credit Suisse

Joseph Vruwink – Robert W. Baird & Co., Inc.

Adam Brooks – Sidoti & Company

David Leiker – Robert W. Baird & Co., Inc.

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Harman’s Fiscal 2012 Second Quarter Earnings Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded Tuesday, February 7, 2012.

I’d now like to turn the conference over to Dinesh Paliwal, Chairman, President and CEO for Harman International. Please go ahead.

Dinesh C. Paliwal

Good morning, ladies and gentlemen, and I thank you for joining the Harman’s second quarter fiscal year 2012 investor and analyst call. I’m joined in Stamford today by our Chief Financial Officer, Herbert Parker; and our Vice President, Investor Relations, Robert Lardon.

In our earnings release published this morning, we shared with you positive financial results, marking a ninth consecutive quarter of year-over-year improvement to the top and bottom line.

Company wise, we continue to make excellent progress. Our sales increased 18% and our operating income is up 41%. All of our divisions posted higher sales and operating margins, spread by continued higher demand from our automakers, new consumer products, launches and new markets for our professional equipment.

We continue to deliver results in key emerging markets with BRIC country sales increasing by 32%, led by China sales growth of 44%. We are well on our way to meeting the aggressive sales targets. We have set for this sizable BRIC market. We are making further inroads with global and domestic automakers and winning audio contracts for major development and infrastructure projects in BRIC markets.

We told you, we would continue to improve the profitability of our Infotainment division. Well, our Infotainment division sales in the quarter grew by 20% and our operating margin improved to 8.3%. Higher sales were driven by robust demand in the luxury automotive segment and continued strong growth in the BRIC countries led by 35% growth in China. Rapid adoption of the scalable platform is certainly helping us accelerate our margin and reduce our overall cost.

We are also pleased to report that our Lifestyle division sales increased 20% and our operating margin improved to 12.6%. While the world markets continue to manage the effects of the debt crisis in Europe, we continue to gain momentum by executing on our global strategy.

We are investing in our future with the development of connected technologies for the car, the home and on the go. Since, we are first and foremost a technology company, we have cultivated a portfolio of over 4,000 patents and patent spending. Our innovation pipeline has never been more robust.

And at this point, I’d just take a pause to also tell you that today I’m very happy to sit across my colleague Dr. I. P. Park, who had joined the company as our new Chief Technology Officer, and Dr. Park joined us from Samsung Electronics. He had to his credit few dozens of patents, and terrific knowledge of connected space. And he will take over from Sachin Lawande and take us to the next level of innovation.

So coming back to, at CES in Las Vegas, NAM in California, the Detroit Auto Show and the Delhi Auto Show in India, we showcased our latest products and technologies and took home industry awards for innovation, performance and design. These continued investments in innovation positioned us for sustainable profitable growth.

When you have great technology and brands like we have, you got to promote them. We’re investing in our world-class brands with new global campaign for key brands like JBL and Harman Kardon.

To be clear, we launched these to accelerate penetration of our audio systems in the car, at home and on the go, and this strategy is beginning to pay dividends. While we invest in our brands, we remain relentless on our cost and focus. By doing so, we have secured the financial flexibility we need to execute against a number of strategic capital allocation options.

Ladies and gentlemen, we continue to earn your trust and other stakeholders by delivering sound financial returns by investing and bringing new innovation to market and by gaining share from our competitors.

Our hard work to optimize our global footprint has lacked to a sustainable lower cost base. And when you combine with global supply chain management, we have done, it has allowed us to deliver nine consecutive quarters of year-over-year improvement in sales and earnings. With our current production footprint in emerging markets, we have the flexibility and a scalability to meet our future growth targets, while maximizing our return on invested capital.

Our performance this quarter speaks for itself. Harman sales and profitability have improved for nine straight quarters and we reported record sales in this quarter ever. Year-to-date, EBITDA is at 10.6%, up from 9.5% last year. Our balance sheet is strong and our liquidity stands at $1.3 billion. Our Infotainment and car audio backlog of awarded business remains the envy of our industry at over $14 billion.

Now comes the interesting part. More than half of this backlog, more than 50% of this $14 billion backlog is now carrying double-digit operating margin, double-digit operating margin and that is really what I wanted to register. That tells you what to expect from Harman in coming years.

We continue to grow faster than the market and we remain dedicated to execute a global strategy to deliver value to our shareholders. Ladies and gentlemen, when you look at the competitive landscape, we believe Harman is the most attractive investment opportunity in our peer group and we are delivering results to support our belief.

I will now ask my colleague, our Chief Financial Officer, Herbert Parker, to provide a closer look at our financial results.

Herbert K. Parker

Thank you, Dinesh, and good morning to everyone. Following up on our strong first quarter, I’m pleased to report even better results for the second quarter. We were able to generate good leverage on our sales growth during the quarter and we continue to make excellent progress mitigating the neodymium cost increases. I will give you more details on the neodymium topic a little latter in my report.

First, let me walk you through a few of our financial highlights from the quarter. As you know, please note that my comments are provided on a non-GAAP basis, which excludes restructuring cost. The reconciliation of our GAAP to non-GAAP results is included in the release, but for your convenience, we took only a $1 million restructuring charge this quarter.

Okay, let’s start with the revenue line for the second quarter. We grew our quarterly revenues by 18% to $1.127 billion, our new quarter record, actually a new record for any quarter that we’ve ever had during this company’s times.

All three of our segments posted a solid increase versus the prior year with Infotainment and Lifestyle divisions both growing at a strong rate of 20%. Our gross margin during the quarter was 27.1%, down 120 basis points primarily as a result of the neodymium cost increases.

I would now take this moment to give you an update on our neodymium costs as I mentioned earlier. I will start first by reiterating the information we shared with you at Analyst Day event in Nashville on October 26 of last year.

At that time, we said the growth exposure was $90 million, but we had identified $55 million of mitigated actions leaving a net exposure for the full year of $35 million. Out of that $35 million, we had already incurred a net impact of $9 million in the first quarter. Leaving a net exposure of $26 million for the remaining three quarters, that is what we said last year October 26.

Now, as of December 31, the growth exposure has declined to $83 million, while mitigated actions have increased to $60 million leaving a net exposure of $18 million for the full-year. And it is important to note that out of this $18 million, we have already incurred a net impact of $11 million year-to-date. So there is a lot of numbers, but the takeaway for you is that we only have $7 million net exposure for the remaining two quarters.

Okay, I’ll move on. But I’d like to first emphasize that this was not an easy task and it took a lot of hard work on the supply management side, customer negotiations, R&D efforts to design it out and we couldn’t be more pleased with what we’ve achieved so far.

Now, moving back to the financial statements. Our SG&A rate for the quarter was very good. The STEP Change program has really helped instill ongoing cost discipline in the organization and we become much more efficient.

Combined with the strong revenue growth, our push for efficiency enabled us to reduce our SG&A expense about 210 basis points down to 18.6%. As you would expect, the result of these activities improved our operating margin quite nicely growing to 8.5% from 7.6% last year.

Now moving on to the net income for the quarter, we reported $60 million, or $0.83 per share compared to net income of $56 million, or $0.79 per share in the prior year’s quarter. Now as many of you would have noticed, our foreign exchange losses were higher than normal during this quarter and this was related to two specific areas.

First, as the business process change in our profession division, we now have one global USD price book. This required a couple of our non-U.S units to change the approximate currency to U.S dollars. This will create more natural hedging but this change required us to revalue our non-U.S. assets at those units and this cause an unreal live loss of some $5 million.

Second, the addition of $2 million is related to four forward points on hedging which is normal increase of our volatility times. Moving to the taxes, our effective tax rate was 27.8% during the quarter, and our tax rate was higher than previous quarters primarily due to significantly improved profits in the U.S.

Moving on to cash, our cash and cash equivalents balance increased by $79 million in the quarter bringing our total liquidity position to $1.3 billion, primarily as a result of increased earnings.

Now, following on from this strong cash position we have, let me reaffirm our capital allocation philosophy. We will continue to evaluate alternatives, whether it is an organic growth investment, an acquisition, or share buyback. We remain most interested in investing in organic growth opportunities such as building our footprint in BRIC countries, where long-term returns are the most promising. We believe as we saw with the Selenium acquisition in Brazil and MWM in the United States that strategic acquisitions can create and complement this strategy.

In addition, we remain committed to providing a sustainable dividend stream to our shareholders. And as you will recall, our Board of Directors has pre-authorized of share buyback.

Now let me close by highlighting the fact that this makes our ninth consecutive quarter of year-over-year improvement at the both top and bottom line. We maintained a strong balance sheet with excellent liquidity and as a result, we remain positioned to take advantage of a full range of strategic options.

And I finally like to say with two strong quarters behind us and with sufficient visibility to our automotive customers businesses. We are reconfirming our fiscal year 2012 guidance, which we issued to you on October 26 of last year.

And with that said, operator, we are now ready to take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) The first question is from the line of Chris Ceraso. Please go ahead.

Christopher J. Ceraso – Credit Suisse

Thank you, good morning.

Dinesh C. Paliwal

Good morning Chris. How are you?

Christopher J. Ceraso – Credit Suisse

Very good, thanks. A couple of things. You mentioned in your comments Dinesh, in the press release that the adoption of scalable system that’s helping you. Is that the Toyota program, is that the only scalable program that you’ve got in the market so far, can you give us an update on what kind of volume that’s doing in the take rates and any kind of information there that will help?

Dinesh C. Paliwal

Yeah, Chris, if you recall in the last quarters, we have said that we expected during this fiscal year about $100 million in revenue coming from the scalable program and that number had changed too good that means, we expect now about $150 million revenue from a scalable platform is primarily coming from Toyota. And you saw Toyota announcing result this morning very robust, very upbeat about their growth that’s a good thing for Harman. And with that said next year’s number we have given you before like $500 million in scalable, that number has also gone up by at least $100 million to $200 million. So that’s again a good thing because that revenue is generating, we have said single digit, high single-digit. It’s very well achieved that number.

Christopher J. Ceraso – Credit Suisse

Okay. So that kind of dovetails with another comment that you emphasized that the backlog now is greater than 50% of double-digit. Is that why because the scalable piece is getting bigger?

Dinesh C. Paliwal

Total backlog $14 billion for car audio and infotainment that includes $3.2 billion car audio backlog that is generally is in teens very, very profitable business and the scalable is about $4 billion so you added all together, about 54% of our total backlog sitting to a double-digit operating margin.

Christopher J. Ceraso – Credit Suisse

Okay. So I wasn’t sure if you were trying to emphasize that this was a change or you just showing us the math?

Dinesh C. Paliwal

Yeah, it’s the math and we wanted to emphasize that more than half of the backlog carries double-digit margins, I couldn’t say that one year or two years ago you know that.

Christopher J. Ceraso – Credit Suisse

Right, right. Okay. Just a couple more on the strength in the quarter. Was there any business that you were still carrying that you had last quarter a substitute business or business from other companies that you picked up?

Dinesh C. Paliwal

I wish, but we had an interesting about $30 million or 5% of infotainment revenue came from substituting temporarily for competitors and that business tapered off pretty quickly in the beginning of this quarter, second quarter and we just had a low-single digit revenue from this competitor. But we sure hope that we’ve done a good job and hopefully if some situation comes that will be called again. So this is a pretty clean quarter from a revenue point of view, all our own growth, it really didn’t come from any competitive replacement.

Christopher J. Ceraso – Credit Suisse

Okay. And then just the last one, excuse me, I noticed on slide six, when you run through your key drivers there you show the year-to-date through fiscal ‘12, your R&D and engineering as a percent of sales running at 7.5% relative to the 8% target. Is this a timing thing? Or you going to see spending pick up? Or you going to change that target?

Dinesh C. Paliwal

No, we are not going to change the target, it’s generally timing R&D is not streamline quarter-to-quarter, and but few large new programs are already underdevelopment, which we had not publicly talked about. So R&D is a timing issue, I think you should have still hole the target. But we are very comfortable to meet the target.

Christopher J. Ceraso – Credit Suisse

Okay, thank you.

Dinesh C. Paliwal

You are welcome, Chris.

Operator

Our next question is from the line of Himanshu Patel. Please go ahead.

Unidentified Analyst

Hi, this is Amy calling on behalf of Himanshu

Dinesh C. Paliwal

Hi, Amy, how are you?

Unidentified Analyst

Good, how are you? Just a quick question I wanted to ask you there was about $7 million of foreign exchange losses that you called out. Could you give us a little bit more color on that?

Dinesh C. Paliwal

Sure.

Herbert K. Parker

Hello, Amy, this is Herbert Parker. Just reiterate more or less what I stated in just a script you may have missed it. But what happened, we made business process change where we're now in both in our customers in U.S. dollars only in our Professional Division because of that some of our non-U.S. units had to revalue their non-U.S. assets to their function of currency as U.S. dollars now. As a result, we took a $5 million unrealized loss in that area. That’s the biggest component. The other $2 million was normal hedging activities or cost that we have incurred.

Unidentified Analyst

Okay, great. Sorry guys, I think I did miss that earlier. Third question is your infotainment margins have improved fairly nicely and is this kind of the expected run rate that we should think about even for this year – last two quarters typically seems like it’s a little bit weaker?

Dinesh C. Paliwal

Amy, there is no reason for us to believe that anything unusual should happen in the next two quarters, provided we maintain this sort of a top line and we feel reasonably comfortable. However, one caveat, in our business of infotainment. In third quarter, we take annual price reduction. So that’s why we have the simplicity the third quarter infotainment margins always take a slight dip relative to other three quarters. So that’s all, but that’s all well documented and everybody knows about it. Otherwise operationally, if you take the APR out, no reason to expect any change in our margins.

Unidentified Analyst

Okay, great. That’s it from me. Thank you.

Dinesh C. Paliwal

Very well. You are welcome.

Operator

Our next question is from the line of David Leiker. Please go ahead.

Joseph Vruwink – Robert W. Baird & Co., Inc.

Hi, good morning this is Joe Vruwink coming in the line for David.

Dinesh C. Paliwal

Hi, good morning. How are you?

Joseph Vruwink – Robert W. Baird & Co., Inc.

Good. I just to wanted to follow-up on the last question obviously with maintaining guidance that imply something for the second half and specifically for infotainment, where you’ve ran above 8% for two quarters now, that means the second half is going to run, 6% to 7% to hit guidance is that number a fair assumption?

Dinesh C. Paliwal

Well, I think I just have to reiterate what I’ve just said that third quarter you should expect a slight reduction due to annual price reduction as we do every year and every other company does the same, so with that in mind we still hold the guidance.

Joseph Vruwink – Robert W. Baird & Co., Inc.

Okay and then on – I just want to touch on the Toyota Entune system, I’m trying to figure out what role you are playing on that system because a few other suppliers have kind of listed involvement with that program are you more of a system integrator and maybe providing the software where is someone else maybe doing the hardware for that system.

Dinesh C. Paliwal

Yeah, programs like Toyota, typically is never one company and actually you could say the same thing for any large OEM, so in our case the Toyota Entune or for Europe we call it…

Herbert K. Parker

Connected box.

Dinesh C. Paliwal

Connected box, so this is a combined effect but we’re the ultimate system integrator, we supply hardware as well as software, this is our scalable platform which we’ve talked about. And that’s why earlier in my script, I said that we had seen due to Toyota fast ramp up, we’re seeing good development of revenue coming from scalable. So we’re supplying in both side, North America and Europe.

Herbert K. Parker

Hardware and software.

Dinesh C. Paliwal

And hardware and software both in the system integration.

Joseph Vruwink – Robert W. Baird & Co., Inc.

Okay, and then just one last one from me. With the announcements about Aha are reaching agreements with some premium automakers and bringing on Dr. Park who obviously has a smartphone background with Samsung. I’m wondering if you’re getting more and more pull from automakers to develop a integrated smartphone solution after the car, maybe in contrast to the traditional embedded system that basically Harman invented and has been known for so many years

Dinesh C. Paliwal

Yeah. Three part question, let me give you quick one. The Aha, we gone into Aha first in the industry, because we understood the connected car is the way to go. And we have been spearheading that, we’re leading that. One year ago in Geneva, we launched connected car first time based on Aha and everything else. So we continue to lead that. Then your second part was related to smartphone. Look we have been integrating majority of the dominant smartphones in cars already, we have done that. But that’s not the end game. When you integrate the smartphone you’re only integrating 10%, 15% of the capabilities smartphone has, in the car.

You know why? Because you’re not allowed to integrate all feature functionality, because it might interrupt with the car software logic. So the big game is that we have to rewrite most of the car driver related apps and social media. And anything else available in the smart phone in a safe and sound manner, that’s one thing. But then comes the monolithic architecture of the system, which is where we made the change, also that was always a custom development, we said scalable is way to go because we believe technology changing so rapidly, we need to have a modular and a scalable approach.

So our system architecture which is already becoming forefront but continue to be in future years without the powerful drive would be software based. So that your systems would be able to upgrade, download, upload applications, apps and system updates, car, maintenance report, personal information, social media information, all in the car through safe and sound manner through audio.

And we are well on the way by the way. We have hedged on good demonstration in CES and now we are getting ready for first week of March in Geneva to launch few more things. So that’s where we are headed. So there is no change in our strategy, continue to lead in that front.

Joseph Vruwink – Robert W. Baird & Co., Inc.

Okay. Thank you very much.

Dinesh C. Paliwal

You’re welcome

Operator

(Operator Instructions). The next question is from the line Adam Brooks. Please go ahead.

Adam Brooks – Sidoti & Company

Good morning guys.

Dinesh C. Paliwal

Hey, Adam.

Adam Brooks – Sidoti & Company

Just maybe first of all sort of Lifestyle segment for a second. You call that about 250 basis points of a headwind as far as the margin with freight and a neodymium. Maybe you could talk about the remaining 100 basis points? And if those higher freight costs are going to shift into 3Q as well?

Dinesh C. Paliwal

Well, there were two things happened here which we called out. One was obviously Neo, we know that. And another one was this one-time, I call it expediting and shipping things, air freighting to Japan due to Tsunami in fact. So and then of course, we had a one-time gain which is in the SG&A line for $4 million that was an insurance claim. So the $4 million in expediting cost, which is in cost of good sold and $4 million in SG&A, this sort of cancels out. But then we had little bit of a mixed issue, some of the audio systems are non-branded, which are high volume, but low margin. So depends on what cars are being sold more in the market mix changes but what you should look at is the year-to-date margin and you should look at our annual margin development that’s definitely in the right direction and we’re improving on it.

Adam Brooks – Sidoti & Company

Great. And can you give us may be an update on any thoughts of customers on the entry level platforms for Infotainment? Anything you heard thus far?

Dinesh C. Paliwal

Lot of activity, lot of interest, we just launched it in Delhi Auto Show in January, and that actually Adam I am glad you asked, that really rounds out our portfolio of infotainment systems. We are obviously very strong in premium high and with our scalable platform we’re also becoming a major force in mid and now with our entry level, this actually meant to be for two wheelers when we started developing, but then when we took it to a lot of car companies in China, India, we actually have quoted, we have fulfilled our RFQ request with this system offering and we will see what the results would be, but we, either being excited about it. So we should expect something is coming up in that.

And also connected entry level, I mean, this entry level system is not just will gives you a basic turn-by-turn navigation, it would also have connectivity built into it. And Adam if you would remember, I have said in the past that personally I believe in five years time, maximum five years, there will be no new car coming out of the factory floors without some sort of a connectivity built into it. So we’re very mindful of that. Our entry level would have connectivity. Our mid would have connectivity. Our high will have connectivity. It’s the richness of what you have.

Adam Brooks – Sidoti & Company

And can you give us maybe a range as far as ASPs for the entry level systems, it would be what?

Dinesh C. Paliwal

Yeah, less than $200.

Adam Brooks – Sidoti & Company

Okay. And one last housekeeping question, maybe the tax rate you expect for the reminder of the year?

Herbert K. Parker

Yeah, so the tax rate as I indicated, we probably have significant improved profits in the U.S. and if that continues, well we could have a valuation allowance adjustment in the third quarter, which would make our full year tax rate less than 20%.

Adam Brooks – Sidoti & Company

Okay, thank you.

Operator

Our next question is from the line – from Chris Ceraso. Please go ahead.

Christopher J. Ceraso – Credit Suisse

Oh, thanks. I just had a couple of follow-up questions. Just to come back to the discussion about the entry systems. I think Herbert talked about this a little bit in Detroit. Is this something that you could also envision in developed markets to get a screen into the car as a low-end offering for lower priced vehicles?

Dinesh C. Paliwal

Absolutely Chris, in fact that has been a continuous demand from our existing customers be it Germans or Americans or Koreans or Japanese. So this will really round out because all of them they have trim level. So they may want to put a feature option has a high system available on all cars, but definitely making a standard on the highest premium cars, but the mix system would be an option, and the lowest end car would be offered with the entry level system. Because dealers won't be able to sell car without some sort of a connectivity built into it, therefore it’s becoming necessity. Now we believe that will create a nice leverage for us.

Christopher J. Ceraso – Credit Suisse

And I think Herbert mentioned that this was something that he could see in the market in 12 to 18 months is that the timeframe or is it something that you’re already selling?

Dinesh C. Paliwal

It depends on well the system is available today. So if we get an order, we can ship it in 12 to 18 months max because this is not a massive development effort, its more or like a scalable platform, but since its scalable it can go up, its scalable it can go down. So it’s pre-developed 70%, 80% and remaining 15%, 20%, 25% would be customized, therefore 12 to 18 months is the max for delivery. So that means revenue recognition could be from the day of order 18 months max.

Christopher J. Ceraso – Credit Suisse

And you said it’s turn by turn, does it have a screen, or does the car company have the option to have a screen?

Dinesh C. Paliwal

Yes, car companies have options to have a screen and this will have the basic radio, where you show radio and HVAC, other information, car information that’s what would be used. So this is not going to be your 12-inch, BMW or Daimler screen, it will be a smallest screen, which typically radio units have it. And that’s why you will have it, this is an extended feature. And a smartphone connectivity would be also part of the entry level systems. So that makes it even more desirable for dealers to sort of promote that because smartphone would be integrated and they will sort of show some of the feature functionality of smartphone on to the small screen in the car.

Christopher J. Ceraso – Credit Suisse

Right, okay. And then just last thing, I wanted to come back to Herbert’s math on the neo exposure, I was with you through the first part, it was $90 million less $55 million, less to $35 million, you got hit by $9 million already that led to $26 million, that was Phase I. And then Phase II, you said that the gross had come down to $83 million, you’re mitigating initiatives are up to $60 million

Dinesh C. Paliwal

Number should have been $65 million.

Herbert K. Parker

$65 million (inaudible).

Christopher J. Ceraso – Credit Suisse

Got it. Okay that clears it up. Okay, thank you.

Operator

Our next question is from the line of (inaudible). Please go ahead.

Unidentified Analyst

I think you just answered the question regarding the neodymium but do you expect this being an issue going forward into the next two quarters, I mean next year? Or you think you guys have it under control going forward?

Dinesh C. Paliwal

We have it very well under control, but we also told you that we have $7 million net exposure for the next two quarters, which is an outstanding achievement with the exposure of $83 million we will only have total of $18 million net impact for the full-year. We have already taken 11, nine in first quarter, two in second quarter and seven for the remaining two quarters. And for the following year, fiscal ‘13, I will repeat what we have said before. We said, we would not let neo or (inaudible), material effect operating results. So we will address it within this year and we are well underway.

Unidentified Analyst

Thank you.

Operator

We don’t have any other questions at the moment, sir.

Dinesh C. Paliwal

That’s a good thing. But we will wait; we’ll see if there are any other questions people may have.

Operator

(Operator Instructions) Our next question is from David Leiker. Please go ahead.

David Leiker – Robert W. Baird & Co., Inc.

Hi, I just have one follow-up. Dinesh, your comment on the backlog for next year moving from $500 million and adding a couple of $100 million on to that. That would be a cumulative backlog number. So you basically have to take the difference from 13 versus 12 to get the incremental piece, if I’m understanding that correctly?

Dinesh C. Paliwal

No, let me repeat what I said. I said about revenue mix. So earlier in our conference calls, we have said, for fiscal ‘12, we expect revenue coming from the scalable platform around $100 million. We upgraded that number to $150 million for fiscal ‘12. And for fiscal ‘13, we said before $500 million. Now we said that number would be $150 million to $200 million larger that means $600 million to $700 million that means it’s a good news in terms of help into the bottom-line improvement. So it has little to do with backlog, backlog number is $14 billion, and it’s the revenue question, what I was answering.

David Leiker – Robert W. Baird & Co., Inc.

And that’s all incremental in fiscal ’13?

Dinesh C. Paliwal

Well, incremental. You can say, yeah, part of that is because it’s a high margin business. So that will help bottom line, but it’s all in the revenue guidance we have given you. So it’s nothing incremental from that perspective.

David Leiker – Robert W. Baird & Co., Inc.

Okay. Thank you.

Dinesh C. Paliwal

Yeah. You’re welcome.

Operator

Our next question is from the line of Adam Brooks. Please go ahead.

Adam Brooks – Sidoti & Company

Yes, maybe two questions. Maybe you can give us kind of an update on how facilities in China that you recently start up over there. How they’re running, and then also to maybe any sense of capacity utilization globally at this point, where you’re at, maybe where your ideal range is?

Dinesh C. Paliwal

Very well. China factory first, so China factory in fact two factories under one roof in North of China. One, dedicated to our professional audio systems business and other factory is dedicated to our lifestyle car audio business, both are up and in running already as of late November. And we’re very pleased because we did lot of training. Before even we started the factory, we trained the work force in our Suzhou facility near Shanghai and we then we took those people there.

So now they’re running about 70%, 75% utilization, and we’re only running two shifts, so we still have a lot of capacity there. We can add another third shift, we can take utilization to 85%, 90%, which is what we normally do. And we still have lot of land in the building, and also built up areas to add few more production line if China production continues – China demand continues to soar. So that’s why I said, we have flexibility to accommodate our future growth in emerging market production. So that’s China.

Then, you asked the capacity utilization overall worldwide. I think worldwide, I’ll have to take an intelligent guess here. I think we are running at this point including our German facilities, American facilities, Hungarian, Mexican, Brazilian and China, I would say we’re about close to 80% utilization right now. And so there’s another – we have capacity there. We can always add shift also third shift, most places we are running two shifts. So plenty of capacity, fixed cost is there, variable cost we can add as the sales comes up.

Adam Brooks – Sidoti & Company

Thank you.

Dinesh C. Paliwal

You’re welcome.

Operator

Our next question is from the line of [Richard Sanders]. Please go ahead.

Unidentified Analyst

Yeah, I had two questions. First, how much of your neo cost offsets came from customer relief versus internal initiatives, because presumably if neo continues to rollover, you should be able to keep more of that margin for yourself?

Dinesh C. Paliwal

So that’s your first question? Yeah.

Unidentified Analyst

Yeah.

Dinesh C. Paliwal

So let me answer.

Unidentified Analyst

Yeah.

Dinesh C. Paliwal

So I would say, almost 100% came from pass through of the cost to the customers for the first two quarters, because changing the design and doing the new product design and R&D to replace neo with something else, that takes time and that’s well underway. In fact, we launched couple of products at NAMM show in California where we had similar audio characteristics in our professional audio, but they were not using neo. We are using substitute. So we know how to do it, and it’s also an area where we have some patented technology, and real patented, so we can do it.

As far as the majority of the recovery that’s automotive and professional, both that was a hard work to negotiate the price increases, and we have created an index so that answers the part of the question that what happens if the cost comes down for these things.

So it’s an index, if price remains as they are, then we have a zero some gain, we’ll pass it on to our customers. And if cost goes down, internal cost from our suppliers then we will also reduce accordingly to our customers, so it’s a fair game and they’ve been very fair to us. So the index remains, therefore no impact on us, that’s the idea.

Unidentified Analyst

Okay. And then my second question is on your normal seasonal margins, I understand you typically have price downs to your customers this quarter. But at the same time as you look over the next couple of quarters, you had some inflated component cost last year because of Japan inflated shipping costs, freight et cetera. So how are those two issues, which one is present this year, going to impact your normal seasonal margin trends?

Dinesh C. Paliwal

I think we can only talk in a broad terms without being very specific. You’re right, we all hope that one-offs will not come in as they were in the last year, but who knows the same time APR is clearly known to us, and that’s pretty cyclical and pretty seasonal. So if no one else coming in, we’ll definitely have some help. That’s why we said, we are confirming our full year guidance.

Unidentified Analyst

Okay. Thank you

Dinesh C. Paliwal

You’re welcome

Operator

And there’s no other questions at the moment, sir. We have a follow-up question from Chris Ceraso. Please go ahead.

Christopher J. Ceraso – Credit Suisse

Hey sorry, just one follow-up for Herbert on the tax rate?

Herbert K. Parker

Hey, don’t apologize. We welcome your question.

Christopher J. Ceraso – Credit Suisse

I just want to clarify, what your comment was on the tax rate, are you saying that it maybe lower now, what did you mean about the valuation allowance, a lot of companies that we’ve seen have started to reverse those. Your tax rates are going up, not down.

Herbert K. Parker

No, we had opposite. We have our deferred tax assets in our U.S. books and as our profits become higher, there are possibility of us reducing the deferred tax rate, the deferred taxes will give us a tax credit. So we have a tax credit that’s going to reduce our overall tax rate.

Christopher J. Ceraso – Credit Suisse

Okay.

Herbert K. Parker

You understand how that works?

Christopher J. Ceraso – Credit Suisse

I do understand that.

Herbert K. Parker

Right.

Christopher J. Ceraso – Credit Suisse

Yeah, but then I’ve got two questions from that. I thought you said earlier in the call that higher income in the U.S. resulted in a higher overall tax rate. Did I misunderstand that?

Herbert K. Parker

Yes, it did, because we didn’t take the valuation allowance adjustment yet. That’s correct.

Christopher J. Ceraso – Credit Suisse

Okay.

Herbert K. Parker

Right now we didn’t take the adjustments. So as we continue and we become what we do not have our overall loss position, then we would able to take the valuation allowance. Right now we do not.

Christopher J. Ceraso – Credit Suisse

Okay. And then I guess on the same topic, what we’ve seen from a number of companies, because they’ve been profitable now for close to three years. They are having to unwind valuation allowances that they took, where do you stand on that?

Herbert K. Parker

That’s where we stand. We’re at that point, where we’ll be coming profitable for three years. What we start, we’ll become profitable and therefore we have to reduce it. So we’re in a position, where in the third quarter most likely assuming profits continue, we will have to reduce it. And so the big change will be in the third quarter. So the third quarter could likely even be a negative tax rate.

Christopher J. Ceraso – Credit Suisse

Okay, maybe I’ll follow-up offline. Typically what we’ve seen is, as companies have unwound that valuation allowance then they start to accrue taxes at more of the full book rate and not – no longer being advantaged by having that allowance?

Herbert K. Parker

No. Yeah we could take it off line, but it’s definitely not the case with us.

Christopher J. Ceraso – Credit Suisse

Okay, thank you.

Herbert K. Parker

All right.

Operator

(Operator Instructions) There’s no other questions at the moment.

Dinesh C. Paliwal

Let me wrap it up, and just to pause listeners here. Thank you very much for giving us your valuable time. I must say, we are very pleased as management of the company. I think company has clearly established that we’re on a very solid footing with nine straight quarters of top line, bottom line, and we are in double-digit in EDITDA year-to-date for the company. And our strategy of capital deployment has been spot on. We have been investing where the growth is, that’s why we are seeing 18%, 20% growth rates.

We’ll continue to deploy our money where the growth is, and it’s a very profitable growth. So to me to our listener investors this got to be the best investment story right now, because we have $14 billion backlog half of that is in double-digit profit, $1.3 billion cash liquidity sitting here. Innovation is all time high with 4,000 patents and patent spending, and market is still looking good. So with that said, thank you all and have a great day.

Operator

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

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