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Harman International Industries Inc. (NYSE:HAR)

 F1Q08 Earnings Call

October 25, 20074:30 pm ET

Executives

Sidney Harman - Executive Chairman

Dinesh Paliwal - Chief Executive Officer, Vice Chairman and President

Kevin Brown - Chief Financial Officer and Executive Vice President

Robert Ryan – Vice President and Treasurer

Analysts

Scot Ciccarelli - RBC Capital Markets

Chris Ceraso - Credit Suisse

Peter Barry - Bear Stearns

Peter Friedland - Soleil Securities

David Niederman - Pacific Crest Securities

Jairam Nathan - Banc of America Securities

Jeff Kessler - Lehman Brothers

David Leiker – Robert W. Baird

Operator

Good afternoon. Welcome to Harman International Industries First Quarter Fiscal 2008 Earnings Release. (Operator Instructions).

Ladies and gentlemen, if I may have your full attention: please be aware that certain statements made by the company during this call are forward-looking statements. These statements include the company's beliefs and expectations as to future events and trends affecting the company's business and are subject to risks and uncertainties.

Persons participating on the call today are advised to review the reports filed by Harman International with the Securities and Exchange Commission regarding these risks and uncertainties.

So with that being said, let's get right to this first quarter agenda. Here with our opening remarks, it's always my pleasure and privilege to introduce Harman International Industries’ Executive Chairman, Dr. Sidney Harman.

Sidney Harman

Thank you, Brent, and good afternoon. I am Sidney Harman. Joining me today in Washington, D.C. are Dinesh Paliwal, our Chief Executive Officer, Kevin Brown, our Chief Financial Officer; and Rob Ryan, our Principal Investor Relations Officer.

In our conference call of September 27th, I said that we disagreed strongly with the decision by KKR and Goldman Sachs not to proceed with the previously announced merger. And I said that we would be vigorous in pressing our position--that we have been, and I am genuinely pleased with the results.

As you undoubtedly know, on Monday of this week, October 22, we announced the resolution of the disagreement. That resolution provides the company with $400 million atan interest rate of 1.25%. The notes will be convertible at $104 a share, and the sponsors have agreed neither to sell nor hedge their position for at least one year. Further, and at our request, Brian Carroll, a member of KKR and the member who led the diligence effort, will be nominated to join our Board.

I repeat, we proposed this step because we expect Brian to bring a meticulously developed diligence and knowledge of our business. And we expect that he will learn those critical management nuances that distinguish and build a great company.

Today our employees, our customers, and our largest investors are enthused and reinvigorated by the agreement. We and our Board have no doubt from Harman's point of view, this is an admirable settlement. And we are now back at work, enthusiastically undistracted.

And I add, that inthe process we have learned a rather great deal about our company, learning we will put to effective use. Although I would never have chosen such an indoctrination for our new CEO, Dinesh Paliwal has demonstrated his stunning capacity for analysis and appropriate action and his contagious enthusiasm for hard work.

We have chosen a true leader and I am delighted to call him partner. In recognition of Dinesh's role, I am pleased to forgo the title of Executive Chairman and to work with him and our Board as its full-time Chairman of the Board. It will become effective at our annual shareholders meeting on December 17th.

Now, after that quite modest introduction, I encourage Dinesh to speak for himself.

Dinesh Paliwal

Thank you, Dr. Harman. Thank you very much. Before I comment on our performance during the quarter, let me also tell you, ladies and gentlemen, that I truly share Dr. Harman's enthusiasm for the fact the recent investment agreement with KKR will have on our company.

The real impact is far more significant than avoiding the time and cost of potential litigation. This agreement facilitates the return of wealth to our investor base through share repurchase, and we will benefit from KKR's expertise as a skilled financial partner.

I'm very pleased with the early reaction from key customers, investors, and our employees. A number of direct calls I have received from our large customers worldwide and they were very, very positive. They were very happy to see that we have put this behind so that we can move on with bigger and better and serious things they want us to focus on.

With this foundation in place, we can truly turn our full attention to strengthening our business, as Dr. Harman said. We will implement strategic initiatives for controlling costs, managing risks better, simplifying our global footprint, and expanding our activities in the mid-range markets. Each of these offers tremendous opportunity, and we will pursue them aggressively.

First quarter sales of $947 million were a record, I remind all time high record, and reflect continued top-line strength with double-digit growth for each of our three businesses.

Automotive sales for the quarter, up 14%, were supported by several factors, including higher sales of portable navigation devices, we call PND, the ramp-up of Chrysler Infotainment systems, and sales increased to luxury automakers, including Audi and BMW.

Consumer net sales were up sharply, 28% from the same period last year, as we continue to expand our product offering and leverage the merchandising power of leading retailers such as Best Buy inAmerica and Media Mart in Europe.

Our professional sales continue to grow, up 11% for the quarter, as we serve the leading names in sports and entertainment, particularly in large speaker areas and mixing equipment for touring artists and facilities.

In a few moments, our Chief Financial Officer, Kevin Brown, will review our profitability in three divisions. But I must say I take a great deal of pleasure in sharing at least at the outset, that the guidance we gave you a few weeks ago, we have come out better than that. And Kevin will share with you the details.

It goes without saying, however, that improving this element of our performance inthe Consumer business remains a high priority in terms of profitability margins. Inthe Consumer sector, our strategic relationship with companies such as Apple, Nokia, and Motorola often provide first-to-market opportunities for us. And that is a valuable reward for engaging them in our up-front R&D.

We are among the top sellers through e-commerce sites, such as Amazon and eBay. And we are supporting leading retailers through modular merchandising concepts, such as the Harman Entertainment Lounge. We actually kicked off this great concept of Harman Entertainment Lounge in IFA, Berlin, and there was a tremendous feedback from thousands or hundreds of customers who visited us.

We recently met with more than 1,000 top sales people from Best Buy locations across theU.S. ata multi-day event that brings Best Buy's top achievers face-to-face with their key vendors and new products. We were told and we believe that Harman stole the show. The positive feedback continued after the show, and we're very, very pleased with the prospect that has established for us going forward.

Our professional systems continue to bethe choice of both world-class entertainers and facilities. Inthe first quarter, we delivered Harman systems for such prestigious venues as Gucci inJapan, the Alamo Dome in Texas, and Atlantis Hotel in Dubai.

For the 2008 Summer Olympics inBeijing, we are installing systems for nearly every major venue, including the National Stadium, National Aquatic Center, Olympic Sports Center Gymnasium, Shanghai soccer stadium and Hong Kong equestrian venues.

I'm personally excited by the energy these world-class customers bring to Harman's business. We will continue to serve them with focus and enthusiasm, leveraging both Harman's traditional market strengths and a renewed corporate spirit. We are energized, committed, and moving to reach our full potential at pretty rapid pace.

Ladies and gentlemen, thank you for your attention. And now I will hand over to our Chief Financial Officer, Kevin Brown, for a closer look at first quarter results. And then we will open up for Q&A.

Kevin Brown

Thank you, Dinesh. I will provide certain information on a non-GAAP basis to give you a better understanding of our results, exclusive of merger-related costs. These costs, primarily advisory legal fees, were $4.7 million during the quarter. A reconciliation of first quarter GAAP to non-GAAP results was included in our press release, which is available on our website.

Net sales for the first quarter were $947 million, an increase of 15% compared to the same quarter last year. Gross profit margin was 27.9%, compared to 34.8% last year. Operating income was $41.4 million, compared to $86.9 million inthe prior year period. Excluding merger-related costs, operating income was $46.1 million.

Net income for the quarter was $36.5 million, and earnings per diluted share were $0.55. Excluding merger-related costs, net income was $41.2 million and earnings per share were $0.62, compared to last year's record $0.85.

Foreign currency translation affected our first quarter results as the Euro strengthened about 8% compared to the same quarter last year. The Euro averaged $1.37 inthe quarter compared to $1.27 last year. As a result, foreign currency translation improved sales by approximately $42 million and contributed $0.07 to earnings per share in the quarter.

Gross profit margin was 27.9% during the first quarter, a decrease of 6.9 percentage points compared to the same period last year. During our September 27th conference call, we discussed Automotive's changing product mix and its effect on gross margins. We expected gross profit to decline as we entered the mid-infotainment segment and ramped up our PND business. However, the planned decline was burdened by higher than expected material costs and the launch of new infotainment programs and new manufacturing facilities.

The ramp up at our facility in Missouri was slower than we had expected because over the course of the quarter, our automotive customers slowed its 2008 model introductions to clear out unsold 2007 model inventory. We expect this to be resolved in the second quarter. We believe our material costs will improve going forward and our new manufacturing facilities will gain efficiencies as they approach full production.

Operating expenses were $223 million for the quarter, an increase of $23 million from fiscal '07. Operating expenses inthe quarter include the $4.7 million of merger-related costs mentioned previously. We expect significant additional costs related to the resolution of the merger in the second quarter.

Absolute operating expenses increased in both R&D and other SG&A. Automotive gross R&D is $13 million higher compared to the prior year, reflecting the resources added in the third and fourth quarter of fiscal 2007.

The additional R&D or engineering bulge we discussed in detail in our January and April earnings calls, is necessary to support our many new business awards, invest in new areas of technology such as Driver Assist, and to ensure the delivery of the record number of new programs launching inthe next several years.

The first quarter tax rate was 9.3% compared to 34.5% during the same period last year. The lower tax rate reflects a credit from the settlement of a prior period tax audit inGermany.

As Dinesh said, first quarter sales increased in each of our three operating segments compared to the prior year. Automotive sales increased $81 million or 14% during the quarter. Automotive gross profit, down nine points from the prior year, was affected by product mix, material costs, and new programs. Automotive operating income of 6.7% of sales was impacted by the gross profit decline.

Consumer sales increased $26 million or 28%, driven by new product introductions and strong international sales. Consumer gross profit was 1.7 points below the same quarter last year, as competition inthe multimedia space has depressed margins. Consumer reported an operating loss in the traditionally weak first quarter of negative 2.6% of sales; however, that was a 2.2 point improvement compared to the prior year.

Professional sales increased $14 million or 11%, due to new product introductions atJBL Pro and Soundcraft Studer. Professional gross profit exceeded the prior year in both dollar terms and as a percent of sales. Professional operating profit improved 1 point to 14% of sales.

At September 30th, our cash balance was $77 million and total debt was $183 million. During the quarter we made tax payments of $73 million, primarily inGermany, and paid $18 million to retire our remaining senior debt. Capital expenditures during the quarter were $27 million. And depreciation and amortization was $34 million.

Accounts receivable at September 30th were $580 million. Inventory was $475 million. And accounts payable were $326 million. As we reviewed inthe September call, sales growth remains strong but several factors will affect full-year operating performance.

Full-year sales for fiscal '08 are forecast to be $4.1 billion, an increase of 16% compared to $3.5 billion in fiscal '07. We expect each of our three operating segments to produce higher sales than the prior year.

Full-year gross profit margin is expected to be 31% of sales, approximately 3 percentage points lower than fiscal '07. Lower gross profit margin is forecasted in Automotive, primarily due to product mix, new model and plant launch costs and increases in material costs. Operating expenses before transaction costs are forecast to be $870 million for fiscal '08.

Within operating expenses, we expect R&D costs to improve each quarter but remain higher in dollar terms than our FY '07 record. As a percent of sales, we expect R&D costs to be lower than fiscal '07. Total operating expenses including R&D are forecast to increase about $55 million from fiscal '07. On a percent of sales basis, operating expenses should decrease from fiscal '07.

Finally, we expect fiscal year '08 earnings per share before transaction, legal, and restructuring costs, to meet or exceed the $4.14 reported for fiscal '07.

As announced on Monday, we will implement an accelerated stock repurchase program. An accelerated stock repurchase program allows us to immediately retire over 4 million shares or about 6% of the outstanding shares of the company. We expect that accelerated share repurchase will improve fiscal '08 earnings per share by about 4%.

We will now take your questions.

Question-and-Answer Session

Operator

Representing RBC Capital Markets, our first question comes from the line of Scot Ciccarelli.

Scot Ciccarelli - RBC Capital Markets

Wanted to ask about the gross margin on the auto side. Obviously it was down about 9 points, according to Kevin's commentary. Can you give us an idea of what is an ongoing pressure on the margin, because we're moving into mid- and entry level programs? And what is what you have termed sort of one-time-ish that we should get past?

Dinesh Paliwal

Yes, Scot, let me share my view on that. As we have said, inthe long run, we may have pressure on the contribution margin. But we have also said before, and I said it, and I repeat again, we are aspiring and feel pretty confident to hold on to good profitable operating margins we have maintained. And we're not there yet.

What has happened in last quarter or actually a short period here, we had couple of brand-new plants started up, one in U.S. and one in China; we had also PND portable navigation device business taking off on a very good level; from 2006 to 2007 to 2008, we're seeing phenomenal growth and here we have a lot more material price increase, which has impacted on a short-term basis.

Also, material substitution in our OEMs, which allows us once a year, typically, to take it to our customers for cost reduction or design changes, which will take costs out; typically allows us once a year, but we are in vigorously trying and actually succeeding to do that twice a year. So we missed that in first quarter and we actually ended up taking material price variance inthe wrong direction, which should not happen going forward.

And similar things could be said for some of the ramp-ups, which we had said that the plant start-up in the United States had a slower ramp-up due to our customers' request as they had some unsold old inventory and they wanted us to slow down, so we ended up taking some cost--overhead fixed cost as well as some variable cost--which otherwise wouldn't have hit the bottom line.

So, those are some of the one-offs that put a lot of pressure on our bottom line, which we don't believe should continue, going forward.

Scot Ciccarelli - RBC Capital Markets

I guess what I'm trying to get to, Dinesh , is, as a 9 point decline, was two-thirds of it kind of one-time-ish, the factory costs, et cetera, and one-third was just kind of the structural pressure? I guess I'm just trying to size that?

Dinesh Paliwal

Sure.

Kevin Brown

Sure, Scot. And I think you've captured it accurately.

Scot Ciccarelli - RBC Capital Markets

Two-thirds to one-third?

Kevin Brown

Two-thirds to one-third; the majority were the one-time impacts.

Dinesh Paliwal

Yes, about that, yes.

Kevin Brown

And as I noted for the full company, we were down 7 points in gross profit in the quarter, but we expect that to only be 3 points for the full-year. We anticipated some of that gross profit decline inthe full-year in our planning, based on our product mix change. But some of is the effect of the one-time factors Dinesh discussed.

Scot Ciccarelli - RBC Capital Markets

Very helpful. And just a question about the balance sheet, receivables, inventory up pretty markedly. Is that just a function of the new programs? Or is there something else that might be impacting account that? Thanks a lot.

Dinesh Paliwal

Yes, sure. I think none of us like to see inventory build up but there are times in the year, that particularly now, where we had some inventory build up on purpose. We had a number of new product launches coming up prior to Christmas in our Consumer business that actually put some inventory.

And also Chrysler ramp-up, which was not planned by us, and we had a customer slowdown and that has also forced some inventory with us, and that added a little pressure on. And then receivables and payables, that's another thing and I think we're working on that. So I think we can balance that out between receivables and payables.

So that's pretty much on our radar screen. Every month, Scot, we review that. In fact, next week is our fourth monthly review, half a day with each division President and their CFO and management team. And working capital, particularly these three items, one-by-one, with clear action plan is being pursued.

Operator

Next in queue, we go to the line of Chris Ceraso of Credit Suisse.

Chris Ceraso - Credit Suisse

A couple of things. First, Dinesh, maybe, can you outline for us in any more detail the restructuring plans that you are putting in place, in terms of specific actions, the timing of those actions, and what you expect in terms of cost savings?

Dinesh Paliwal

Yes, I'll certainly respond to that. It's a great question, Chris. Restructuring was something we already talked, even prior to my arrival here. And we started and we did some restructuring in fourth quarter, fairly small. And typically, our experience is you will seethe full payback inthe following 12 to 18 months for the restructuring you do.

Now I come back to specifics. We gave you guidance of about $25 million to $30 million in restructuring in next six months. And that was based on a number of things, which we would like to achieve, assuming our Board of Directors approve the plan management is putting together right now.

And these arein the area of consolidation of manufacturing or assembly sites, both inEurope and inNorth America. Secondly, we would also like to consolidate our supply base, which would have almost--well, I shouldn't say almost--but it had a faster payback because sourcing can really impact your bottom line rapidly.

And right now, we don't necessarily take full leverage of group purchasing done atthe group level. So those are the areas. These restructuring programs will be decided, approved by the board and hopefully, we can start triggering them in second quarter.

And therefore, the payback we will not seein fiscal '08. We will expect those paybacks to start to come and then stay with us from '09 onwards.

Chris Ceraso - Credit Suisse

And that's on a base of $25 million to $30 million that you'll start to pick up in '09?

Dinesh Paliwal

That is correct.

Chris Ceraso - Credit Suisse

Okay. Kevin, what was the magnitude of the tax settlement? And what should we think about on a full-year view for '08, as the normal tax rate for you?

Kevin Brown

The magnitude of the tax settlement was about $8 million, $0.12 or $0.13 per share. For the full-year, we expect the tax rate to be 27%, 28%, running a little lower than what our full-year rate was last year, but Germany also lowered their corporate tax rates inthe past six months or so. So 27%, 28% is what you had to think about on a full-year basis.

Chris Ceraso - Credit Suisse

Okay. And then, the last question, I think on the last call you mentioned that there were 7 new programs launching this year. Can you just give us a quick rundown on the specific models, the timing? And then maybe any ones where you're sort of the co-supplier and who the other co-supplier is?

Dinesh Paliwal

Yes, sure. First of all, let me stress that these are historic times for the company fiscal 2008 and fiscal 2009, which are exciting in some sense and I think they are. Because we traditionally have had start of production, as we say SOP, or the new program launch, one or two a year. And now, we are fortunate to have significantly large portion of business, which was available inthe market, came to us. And that triggered a number of these SOPs. So 2008, we will have 7 of these, they are with Chrysler, Hyundai, SsangYong inKorea, Audi, Porsche, BMW, and PSA.

What is most appealing to me, personally, is that these programs, some of them are mixed segment strategy program, like PSA, which is very good because that's the area where we have tremendous future potential for growth and once we start to take full benefit of scalability of our platform and also amortize the absolute research and development dollars.

Even if we will have lower contribution margin on mixed segment business, our bottom line would benefit from the scale and scalability and the size of this business and also R&D, because we will not require the same level of R&D for the mixed segment.

For ’09, we will have, again, pretty strong historic year in terms of number of new platform or new product launches we will have in OEM business. And these are going to be BMW L6, PSA [], Hyundai will have another one, Porsche, Mercedes E-Class mid-segment, and Mercedes S-Class facelift.

So again, '08 and '09 are historically very busy, cost intensive. That's why the R&D cost has been there and also pretty taxing on all management and employees worldwide, but exciting for future potential.

Operator

Next in queue, we go to the line of Peter Barry with Bear Stearns.

Peter Barry - Bear Stearns

Kevin, can I take you back to your R&D comments, please? You mentioned the gross increase was $13 million inthe quarter, is that right?

Kevin Brown

In Automotive, yes, Peter.

Peter Barry - Bear Stearns

Okay. Could I ask you just to drill down a little bit more, as it relates to R&D. Is it more a QNX or is ita broader Auto unit phenomenon?

Dinesh Paliwal

It is a broader automotive phenomenon. We are investing on R&D across the board on these new launches. They arein navigation area, they are in speech area, multimedia, and of course, the software platform. But it's not just QNX.

Peter Barry - Bear Stearns

But is QNX a large portion of that number, Dinesh?

Dinesh Paliwal

I would not say that. No. I think, it's equally, perhaps in proportion, QNX would not be one of the major ones.

Sidney Harman

Tell me, Peter, why you ask the question. You may be seeking information different from the clear direct answer you got to the question as you asked it.

Peter Barry - Bear Stearns

It has to do with the software initiative, Sidney. And is it growing more and more; is its momentum growing more and more and is it becoming more and more important a part of your outlay effort?

Sidney Harman

It is growing. It becomes more and more important, and without question, it is a significant key to the future of this company. But the real growth in R&D has been driven by the needs to satisfy this enormous set of new undertakings that Dinesh has reviewed with you.

Peter Barry - Bear Stearns

And could I ask, in that regard, Sidney, is it sort of the front-end? Or is it back-end? Middleware? I'm looking for a little more color that in regard, that's all.

Sidney Harman

I want to give what you you're asking for. What is it that you're asking about, is it front-end or middle-end?

Peter Barry - Bear Stearns

Spiking R&D budget.

Sidney Harman

I'll let Dinesh respond to that.

Dinesh Paliwal

These programs, they are not just a couple of months or so in duration, they go on more than one year. I would saythe SOPs, which we have planned for ‘08 we are pretty much at the peak and slightly declining, in absolute as well as percent of sales.

For the 6 SOPs we'll have in '09, they are already being ramped up but they are not, in terms of magnitude of absolute dollars, as large as fiscal '08 SOPs are. So, to answer a bit more specific, I would say for '08 we are already from the peak down, and for '09, we are just about getting up there atthe peak level.

Peter Barry - Bear Stearns

One more cost question, if I may. You referred to materials cost several times during your comments, Dinesh. Could you give us a little more detail on that score?

Dinesh Paliwal

Sure. Material costs, I mentioned in two areas. One is, as our PND business starts to grow--which is good news--PND hasa lot more material costin build up material than you would have, because we buy a lot. There is a lot of hardware in it and some software embedded, but we buy it.

So that becomes a greater portion of our material cost overall. So that's why we will see and if you are not fast enough to move with the market sometimes, there might be some lag from your replacement of thecost and passing onto the marketplace.

Second item I mentioned is to do with traditional OEM business, where you supply infotainment system and there area lot of components. As other industry does, we dothe same. We are constantly aspiring to find innovative engineering design changes to bring the cost down and simultaneously finding better, high quality, lower-cost component, which we can replace.

Traditionally, car industry allows us once a year an opportunity where we have fully tested and proven that the substitutions are perfectly fine and then they allow us to do it, and if you missed that window of once a year, then you start with expensive components, which you are using. So that's what actually happened in first quarter, to some extent.

And third element, inall fairness, our supply chain people are vigorously trying every year to negotiate better prices, better negotiations. And first quarter, when you set the targets, not necessarily you're able to getthe full benefit, which you start to seein second and third quarter.

Sidney Harman

And, Peter, I want to add to that both because of the specifics of the questions and the general implications. You've been around us along time. The hard truth is that we have taken on a very substantial set of challenges and the circumstances of the last year, no one had planned it to be this way, but the hard reality is those circumstances have made it much more difficult to getthe balance that you need to deal with that assembly of challenges.

I am amazed at how easy deep breathing is coming to all of us right now and what a pleasure it is to be back focused entirely on the business. There's work to be done in the areas that Dinesh has reviewed. We can do it now and having gotten through that necessary balance encompassing this significant series of new undertakings, I think you're going to find us a darn sight stronger company than we had been.

Peter Barry - Bear Stearns

Sidney, I'd like to close with two questions for you. One, I was wondering if you, maybe perhaps Dinesh as well, might give us an update on Helmuch Shinagle and how he's doing at Automotive OEM?

Sidney Harman

I am pleased to yield to Dinesh on this one, for a couple of reasons. First, because he's our CEO and second, I am going to enjoy hearing what I know he's going to say.

Peter Barry - Bear Stearns

And one more question for you, when he's finished, Sidney.

Sidney Harman

Okay.

Dinesh Paliwal

Okay. Well, that's a good question, because being new to the company; my personal priority has been to build a very close relationship with the top management team. Helmuch Shinagle is one of the closest and top partners, very large business he runs, and very important business for our company.

And he was brought in the company with the background he has that's second to none. And last week I had the pleasure of traveling with him to major key customers of ours in Germany, and also visiting together a number of key locations of Harman International.

I got to know him a bit more. And also, he was able to share his vision with me and also share his plans how the R&D would be scaled in terms of mixed segment strategy and how we will use the scalability and what our plans are for long-term consolidation in western versus emerging markets.

I will conclude, I'm extremely pleased with him on my team. I would not trade him for anyone right now.

Sidney Harman

Your question to me, Peter.

Peter Barry - Bear Stearns

Yes, first a statement, Sidney. I wanted to wish you all the best of good luck in your new role as non-Executive Chairman. And if you would share with us what the meaning and significance of that change in title might be?

Sidney Harman

Oh, fair enough. I intend to reduce my workweek by at least 50%. I'm only going to work 23 hours a day. Listen, you know me well. You know that work is mother's milk to me. I would have offered you a more qualified answer if I were not enthusiastic as I can be, not only about Dinesh's talent, but about the easy way in which we work together.

I forgo the Executive part of the title, principally as a tribute to him. And you must seeit in my readiness, my eagerness, my pleasure in deferring to him as you ask questions. But the hard reality is that he encourages me to beat it and you know I love being at it.

Peter Barry - Bear Stearns

Good luck, Sidney.

Sidney Harman

Thank you very much, Peter.

Peter Barry - Bear Stearns

Thank you, sir.

Operator

Next in queue, we go to the line of Peter Friedland with Soleil Securities.

Peter Friedland - Soleil Securities

Hi. A few questions, first on the PND side of things, if you could talk about unit volumes for the quarter and what you're expecting for the year?

Dinesh Paliwal

Sure. As I said earlier that PND is an exciting business, where we understand this business and we are driving it pretty rapidly. And we are actually pleased with the growth and the trajectory we are seeing.

In '06, we had 150,000 units sold. And in '07, we sold 425,000 units. And I'm quite happy to share with you, just in first quarter of fiscal '08, we have sold 250,000 units and we expect a significant growth to continue throughout '08.

It might be a good opportunity for me to add, this business is very exciting and attractive, both from the defensive and offensive point of view. One, offensive, more PND business grows more awareness and the knowledge of infotainment develops in consumers out there. And more they seeit the more they want to had in-dash, fully-integrated, fully-functional infotainment system in their next car they buy.

At the same time, we know this business because we've been doing infotainment for long time before our competitors started to dip their toes in. And large OEMs have expectation from us but we drive this business aggressively, so that millions of cars out there who do not have fully integrated infotainment system, they become our targets. So that same OEMs, when they're selling their new car, would be able to sell our infotainment system, which is fully integrated. So it's an exciting business.

Peter Friedland - Soleil Securities

And as far as that 250,000 number, it's a pretty big jump over what you did in the fourth quarter. So was that ramp in theU.S.? Or what was the big driver there?

Kevin Brown

It was a number of things. First of all, we ramped inGermany. And inGermany, we arein the position of closing out some of our first generation technology as we replace with it higher functionality new technology, so we had some closeout sales in those numbers.

But in addition, in our Consumer business, where we've had an effort underway for about six months now, we're now starting to see some traction there as we lead into the holiday season. And we had some consequential volume inthe Consumer segment as well for PNDs this quarter.

Sidney Harman

And I think it’s fair to say is that we have every reason to continue to expect, by far, the dominant part of that business is going to bethe European markets. And we are very pleased with the level of product that we're bringing to it. That, more than anything, explains why we look stronger in the first quarter.

Dinesh Paliwal

I think, it's fair to say that this PND business, as you would expect, with our very strong foothold in European auto industry, that's where we had the larger portion of our PND sales, while we're growing very rapidly inNorth America and other places as well.

Peter Friedland - Soleil Securities

Well, then, maybe this is a good segue, but if you could give more color on what was thekey driver of growth inthe Consumer segment?

Dinesh Paliwal

Well, Consumer business, first of all, it's different in terms of cycles. Cycles are shorter here and if you can be successful in riding the wave and tagging along with the new product introductions of the products like iPhone and iPod inthe past, then you have a great time and a great year. And this is what I think we have seen in first quarter and we expect to see for rest of the year.

Our growth in Consumer business was very, very good. We're very happy to see that. And we have a number of new product introductions planned for Consumer business. Double-digit new product introductions coming up for Christmas season, and again, double-digit new product launches, we’ll seein calendar year 2008. And the whole game is to hit them on time, on budget, ahead of every other competitor, and that's what I think we intend to do. And so far, we are on track.

Sidney Harman

And I want to add, Peter, that what may not be obvious in the raw numbers, but is very important and compelling to me, is our continued growth in Europe. More than anything, that is where you see our Consumer business taking on more and more muscle. It clearly is influenced by new products.

But it is more influenced by the fact that we're penetrating those markets very, very effectively, and generating relationships with key accounts that produce volume. Europe is a very, very big piece of our Consumer story.

Dinesh Paliwal

And I think Consumer business growth helps our OEM business growth in many ways, in terms of the brand building and massive awareness it creates in the hands of consumers.

Operator

David Niederman with Pacific Crest Securities has our next question.

David Niederman - Pacific Crest Securities

Thanks, good afternoon, just a couple of questions. First, hoping you can comment on the DAs development. You talked a lot about the SOPs, but just curious as to where we are with the DAs?

Dinesh Paliwal

Well, this is an exciting area and this was further validated during my trip last week with these big OEMs I personally visited. Our Driver Assist development activities are ongoing. And this is one area where we think tremendous future opportunities are there for us to grow, and also to differentiate from average competitor in future. And we are working pretty closely with an OEM on a development program, but as you may already know, David, this is not to deliver in next couple of years.

This is a fiscal 2012-and-beyond program, but this is where we are putting our R&D now, up-front, capturing early ideas, concepts, and testing those with the OEMs we're working with. And we do not actually break out R&D expense by program, or by customer, but this is one area where we're not holding back.

David Niederman - Pacific Crest Securities

Great. And hoping you could just provide a little color or information as to, there's a lot of headline noise around Chrysler and also soft sales from Hyundai, at least in theU.S., and just […]

Sidney Harman

I’m sorry, we're having a little trouble hearing your question. You wanted a little background on Chrysler and what else?

David Niederman - Pacific Crest Securities

Just confidence in ability to meet sales projections for Chrysler as they're going through their turmoil, at least here in theU.S.?

Sidney Harman

Let me speak to Chrysler in general terms. There is a new, as you well know, ownership and management at Chrysler. That brings with it some problems, and it brings with it some opportunities. Our experience with this group is that they are surprisingly knowledgeable and eager to embrace new technology.

I need not remind you, the tradition in Chrysler, certainly as I was growing up, was that this was the engineering company. It's a joy to find ourselves encountering guys there, who want to understand the technology and want to embrace it.

Obviously, the turmoil you talk about goes on in any situation such as theirs. We think they're dealing with it well, and we are very optimistic about where things are going between them and us. Their sales are disappointing to them, but that's hardly surprising.

You and we will have to take our measure of them over the next couple of years. I expect it to be pretty doing positive.

Operator

Thank you very much.

Sidney Harman

Gentlemen, we're beginning to run out of time. I just want to make the observation that I'm holding a couple of the good gray beards for the last questions. I mean you no disservice when I say that, Mr. Nathan.

Operator

Thank you very much, Dr. Indeed, it is Jairam Nathan of Banc of America Securities.

Jairam Nathan - Banc of America Securities

Hi, thanks. Can you explain for the record, what is your cost structure look like on the growth side? We want to try to understand that better, just to getthe idea of what the economies of scale could be?

Dinesh Paliwal

Nathan, if I understand, please help me. You're talking on a broad base cost structure, how it all would amortize as we grow?

Jairam Nathan - Banc of America Securities

On the infotainment systems. What does thecost structure look like? And how much is materials, how much is labor  - that kind of information?

Dinesh Paliwal

Nathan, first of all, we don't necessarily break out like that, at that level. But, I could give you a broad brush answer, which hopefully, will suffice. We have been pretty generous, and knowingly so, that we have invested in R&D due to 7 in 2008 and 6 in 2009, SOPs - so 13, versus perhaps 2 or 3 in that period, traditionally.

So that has put quite a bit of burden on R&D budget, as we have talked about. But that's something we invested for the future because R&D and revenue cycles are very different. You invest R&D in either one, and by the time you see revenue, it's probably year three or year four, sometimes. So, you will seea percent of sales based on our overall cost, on R&D thebig chunk of overall SG&A. That should slide down as we go forward.

Number two, I like to make, which is important to me personally, before even I came to Harman, we have to push scalability of platform, common architecture of software and we need to bring the culture of inventing every time new for the new SOP. We can't afford to do that and we are pushing that culture. That's great for us, and even great for our customers.

Even BMW and Audi and Mercedes, they want to see that we have more and more common architecture supporting their multiple new SOPs so that lifecycle cost for them is lower. But that helps us overall cost structure to bring down, in absolute as well as in percent of sales. But, these arethe long-term strategic direction I’m sharing with you; we're not there yet in 100%.

Jairam Nathan - Banc of America Securities

Okay. Secondly on working capital, it was big use in fiscal '07, as you were ramping up the PNDs. How should we think about this for fiscal '08? Would you continue to see some use, just because you'll be ramping up in North America?

Kevin Brown

Yes, I think in working capital in this particular quarter, we're inthe cyclically high quarter for working capital as we build into our Christmas selling season. And as our sales are growing, in particular, we're ramping up the Chrysler business, which is driving up some of our inventory and receivable levels.

I think once, we get through the early part of the year, we should begin to leverage our working capital better than we've done inthe past 12 months. We don't expect a repeat of, for example, the inventory levels that we had in PND in the past year. And we've worked those down pretty successfully. You'll be able to see the results of that, I think, inthe bottom line, once we get past the Christmas quarter.

Operator

Representing Lehman Brothers, Jeff Kessler.

Jeff Kessler - Lehman Brothers

The question that I have to ask, Sidney and Dinesh, the growth in Consumer was quite high. Normally, Consumer is going to be negative, at least from an operating income perspective in the first quarter, for seasonal reasons and for ramp-up reasons as well.

Your forward bookings in Consumer, are they strong enough to sustain the type of growth that you saw inthe first quarter? Because it does become material in the second and third quarters of your year, particularly the second quarter, when we're dealing with Consumer. And obviously, it makes a difference if you can sustain that type of growth rate into the second quarter.

Sidney Harman

Well, Jeff, I would like to tell that you our bookings confirm it. But, I remind you that the Consumer business for us, for everybody, simply doesn't work that way. There virtually is no forward-booking. You work it day-by-day, account-by-account. You read the marketplace, you see how well your products are doing, and you generate the business as a consequence of it.

So forward-booking isn't going to be your answer. The only answer you're going to get from us is how confident are we in the first quarter is reflective of how the year is developing. We're pretty damn confident.

Dinesh Paliwal

In this business is not the business where you build backlog. You actually getthe order and you ship it very fast. That's why I said this business is probably one of the most challenging in some aspects and wonderful, because you actually cash in fast. You have a new products; you have the money coming in, too through fast.

Sidney Harman

That's right. If you're building backlog, there's something wrong with you.

Dinesh Paliwal

Exactly.

Jeff Kessler - Lehman Brothers

Okay. Final question. You kept those brands in Consumer to get the brands into the automotive area. What is the payback right now? What is the technology you're taking from Automotive and using in Consumer that is palpable, that is tangible right now that you're going to be using to market with over the course of this and next year?

Sidney Harman

It's a good question, Jeff. The reality is that we are growing in confidence and we will say this in our annual report, that we are getting very close to what everybody has thought to be the Golden Grail of instant, seamless connectivity. We don't and we're never going to have a Consumer business large enough to support the engineering base required for that.

But the transfer of that know-how from OEM and now I'm pleased to point out to you that the large expenditures in R&D that some have condemned are probably the biggest assurance you or any observer may have about our future. That work will transfer and effectively in products we otherwise could not manage.

As for the value of the brands, oh my goodness, it is being confirmed over and over and over again. I've just been reading half a dozen articles on this, including in last week's 'New York Times,' how brand has gotten to be the elixir of the business, and one of the things that the article made reference to was that marvelous summer TV advertising program by Lexus.

They almost forgot to mention that the system they were selling the Mark Levinson sound system, promoted by the likes of Elvis Costello and Diana Krall are contained in an automobile. They almost forgot to mention the automobile.

Brand is crucial. We do more business, I say this, perhaps to the awkwardness, the embarrassment of some of our guys; we do more business with Lexus on Mark Levinson than we do everywhere else in the rest of the world. Brand is king.

Jeff Kessler - Lehman Brothers

Sidney; instant, seamless connectivity, that's a nice phrase for Consumer. What does it mean?

Sidney Harman

It means, my boy, that wherever you want your music, it's immediately at hand. You move from the office to the car and you bring it with you, you move from thecar on a hike, you bring it with you. You take a holiday with your wife or your girlfriend, whichever you choose and you bring it instantly and seamlessly with you. That's what it means. Everybody's been looking for it. Everybody's closer today than they were. We suspect we're closer than most.

Operator

Representing Robert W. Baird, David Leiker.

David Leiker – Robert W. Baird

First a comment on the guidance. I just want to clarify this, Kevin. Your guidance, you gave us GAAP guidance of $4.14 or better, correct?

Kevin Brown

That was excluding restructuring and transaction costs. So, on an operating basis.

David Leiker - Robert W. Baird

Areyou putting any share repurchase in there?

Kevin Brown

No.

David Leiker - Robert W. Baird

Okay. And then two other questions here. Chrysler, as a follow-up to what you talked about before, Dr. Harman--but wondering if we could get some more detail on it--that there area number of vehicles at Chrysler they're looking at discontinuing. And whether that puts that $500 million of business at risk at all? Is that $475 or $450, or do we not know yet? If you can address that?

Sidney Harman

We really don't know yet. And, of course, we hear the same stuff you do. I suppose it is less a matter of how many vehicles and how effectively those vehicles contain the kind of systems that we're interested in.

David Leiker - Robert W. Baird

Right.

Sidney Harman

We'd settle for fewer vehicles and higher penetration rates.

David Leiker - Robert W. Baird

I would understand that. And then the last item here is and a little contradictory here, given that you have a fair book of business that you're launching here today; but what do you think the timing might be on the next wave of new business opportunities for you, that you'd bein a position to talk about something?

Sidney Harman

It's difficult to answer precisely for the reason that you suggested, we've got such a heavy book. But new stuff is inthe works. And I would think that though we'd see little exciting new reports, really exciting new awards inthe course of this year. I think next year you're going to see some serious work let out. And we expect to play our part in that.

David Leiker - Robert W. Baird

Okay. It wouldn't be fair to assume that some of your engineering efforts to get new business have been redirected to launching business, that that pace continues in terms of going after new pieces of business?

Dinesh Paliwal

Absolutely. Look again, this is a continuous relationship with customer-base OEMs. They have worked with us for so many years. They want to continue that relationship. And they also have their breathers to take breathing room when they're launching new business a few years. It's a cycle in auto industry, and it's worked very well so far. So we will definitely take our fair share, as we have inthe past, as the new business opportunities are launched.

Operator

Dr. Harman, back to you for any closing remarks.

Sidney Harman

Well, first let me to take a small personal privilege. I want to comment on our first quarter. There's been, I believe, an unseemly amount of noise about it being a poor first quarter, a disappointing first quarter. I didn't hear itin this conference, but I've read it. And I just respectfully disagree.

In our September 27th conference call, we noted that we had never provided guidance on the first quarter. The Street had almost a year ago. And the Street spoke about $1 plus. Our record is clear on this, we would typically have cautioned restraint when estimates are running beyond what we thought to be reality.

You've often heard me urge analysts to restrain your enthusiasm. We failed to doit when those ambitious estimates were made about the first quarter, because we were headed to being a private company status, and virtually everyone had dropped coverage on the company.

Now, consider just a month ago, we did forecast the first quarter at $0.50. Today, we reported earnings, excluding transaction costs of $0.62. That's a pleasant $0.12, or 24% higher than our own forecast. In that same 27 of September call, we forecast actual operating earnings of $40 million, and today we've reported them at $46 million, again, without the transaction costs.

This year's first quarter is going to represent about 12% to 13% of our estimated full-year earnings. With the exception of the last two uniquely and I think, especially strong first quarters, that's absolutely consistent with our lengthy history.

My view is that we're off to a pretty darn good start with this first quarter. Not as strong as last year's, but consistent with history, consistent with our expectations.

And finally, I'll tell you all that we're--all of us--very happy to be back in normal mode. There's no way we can estimate or tell you how much the distractions of the past year have cost us. But we are breathing clean, fresh air, and we are happy to be back at serious work. I thank you all.

Operator

And the passion certainly comes through. Very nicely said as always, Dr. Harman.

And ladies and gentlemen, your host is making today's call available for digitized replays for one week and also by the web replay for seven days. The digitized replay is available starting at8:00 pm Eastern Time, October 25th. Please dial 800-475-6701, and atthe voice prompt, enter today's conference ID of 891-629. Alternatively, you may go to www.harman.com to listen to the web replay. You will need to enter the access code, once again, of 891-629.

And that does conclude our press release for this quarter. Thank you very much for your participation.

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Source: Harman International Industries F1Q08 (Qtr End 9/30/07) Earnings Call Transcript
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