Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Harman International Industries Inc. (NYSE:HAR)

Q4 2008 Earnings Call

August 14, 2008 4:30 pm ET

Executives

Dinesh Paliwal – Chairman and Chief Executive Officer

Herbert Parker - Chief Financial Officer

Kevin Brown - Chief Financial Officer

Robert Lardon - Head of Investor Relations

Analysts

Chris Ceraso - Credit Suisse

Scot Ciccarelli - RBC Capital Markets

Peter Friedland - Soleil Group

David Leiker - Robert W. Baird

Jeff Graf - Springhouse Capital

Luis Sykes - Pennant Capital

Andrew Mahoney - Green Arrow

Operator

Ladies and gentlemen, thank you for standing by. Good afternoon, and welcome to the Harman International Industries Fourth Quarter and Full Year 2008 Earnings Conference Call. At this point, all our phone lines are muted or in a listen-only mode. However, later during the conference there will be opportunities for your questions and those instructions will be given at that time. As a reminder, today's conference is being recorded. Please note that certain statements made by the Company during this call are forward-looking statements. These statements include the Company's beliefs and expectations as to future events and trends affecting the Company's business and are subject to risks and uncertainties. Persons participating on the call today are advised to review the reports filed by Harman International with the Securities and Exchange Commission regarding these risks and uncertainties.

With that being said, here with our opening remarks is Harman International Industries, Chairman and Chief Executive Officer, Dinesh Paliwal. Please go ahead, Mr. Paliwal.

Dinesh Paliwal – Chairman and Chief Executive Officer

Thank you, Doug. Good afternoon ladies and gentlemen and thank you for joining the Harman fourth quarter and full year 2008 investor and analyst call. I am joined in Washington today by Herbert Parker, our new Chief Financial Officer, Kevin Brown our outgoing Chief Financial Officer; Robert Lardon, our Head of Investor Relations.

I look forward to talking with many of you in the weeks ahead as we maintain a proactive dialogue with Harman's key stakeholder. Now I should begin with key message, I am very pleased to report some encouraging developments during 2008. Although we face, like others an economic climate that is very fragile. We increased net sales in double-digits for both the fourth quarter and full year. Our cash flow from operations increased by 47%, and our professional division posted both record sales and earnings for the year. We are continuing a serious of strategic initiatives to make us more competitive across every business while executing on our still substantial backlog of new automotive projects. Net sales for quarter ended June 30, 2008, were $1.670 billion, a 17% increase compared to $911 million for the same period last year.

Earnings per diluted share in the fourth quarter were $0.54 compared to $1.58 in the same period last year. Excluding restructuring charges non-GAAP earnings per diluted share was $0.68 for the fourth quarter compared to $0.98 for the same period last year. For the full year ended June 30, 2008, net sales were $4.113 billion, a 16% increase compared to $3.550 billion in fiscal year 2007. Earnings per diluted share were $1.73 for the year compared to $4.72 for the previous year. Excluding these structuring and merger related charges non-GAAP earnings were $2.35 per share compared with $4.14 last year.

As noted earlier all three Harman divisions enjoyed net sales increase for the year during the period of general market weakness. The Harman professional division continues to be an operating income leader in the group posting a gain of 29% for the quarter and 13% for the full year.

Automotive operating income declined 51% for the fourth quarter and 65% for the year. Remaining has the focus of many operational improvements which we will discuss later in the call.

In the consumer division we have hard work ahead at both the top and bottom line, we will improve our execution on new product launches and geographic penetration while sharpening our cost structure so that we may seize the right market opportunities and those opportunities will come.

Before I offer additional comments on our initiatives to translate opportunity into results, now I'll invite Herbert Parker to provide a closer look at the quarterly and full yearly numbers. Herbert?

Herbert Parker - Chief Financial Officer

Good afternoon everyone and thank you Dinesh. I will provide certain information on non-GAAP basis to give you a better understanding of our results exclusive of restructuring and merger related costs. Restructuring costs were $12 million during the fourth quarter. For the fiscal year we incurred $60 million of restructuring and merger related costs. A reconciliation of our GAAP to non-GAAP results was included in our press release earlier today.

Net sales for the fourth quarter were $1.670 billion, a 17% increase compared to the same period last year. Gross profit margin was 26.5% compared to 32.8% in the prior year. Operating profit was $43 million versus $81 million last year. Excluding restructuring charges operating income was $55 million. Net income was $32 million for the quarter, which resulted in earnings per share of $0.54. Excluding restructuring charges net income was $40 million and earnings per diluted share was $0.68. Net sales for the fiscal year were $4.130 billion an increase of 16%. Gross profit margin was 27% compared to 34.1% last year. Operating income was $139 million versus $386 million a year ago. Excluding restructuring and merger related costs operating income was $199 million.

Net income for the fiscal year was $108 million and earnings per diluted share were $1.73. Excluding restructuring and merger related costs net income was $146 million and earnings per diluted share were $2.35. A full year cash flow from operations increased 47% to $370 million.

Foreign currency translation had a positive impact on our fourth quarter results as the Euro strengthened approximately 16% compared to the same period last year. The currency translation improved net sales by approximately $80 million and had a positive impact on earnings per share of $0.19 for the quarter. The gross profit declined during the fourth quarter was primarily related to increased shipments of lower margin midlevel entertainment systems through our automotive customers, higher automotive margin costs and lower consumer margins.

Gross profit for the fiscal year was further affected by nonrecurring warranty charge during the third quarter related to a compatibility issue between a memory chip and existing software. This incompatibility developed over the product’s life cycle and was more fully described in the last quarter’s call.

Selling, general, and administrative expenses for the fourth quarter were $240 million compared to $290 last year. Restructuring charges included in the fourth quarter SG&A expenses were $12 million. Engineering costs were $104 million for 9% of sales. This represents a decrease of 60 basis points from prior to the same period last year.

Our effective tax rate for the fourth quarter was 16.1%. This was influenced by our change in German Tax Law, which lowers their effective tax rate. Excluded restructuring charges the tax rate for the quarter was 20.3%.

Our June 30 of balance sheet had a cash balance of $223 and a total debt of $428 million. Our debt balance includes the proceeds from the issues of 400 million of convertible notes used for repurchase and we charge $70.2 million, 7.2 million shares of the company stock.

Accounts receivable at June 30 were $574 million and inventory was $391 million. Inventories were $63 million lower resulted in an improvement in turns from 5.2 last year to 7.7 this year. Cash flow from operations for the fourth quarter was $174 million and capital expenditures were $49 million. Depreciation and Amortization was $43 million which included $3.8 million of accelerated depreciation related to restructuring charges.

I will now turn it back to Dinesh for recap of ongoing strategic initiative before we take your questions.

Dinesh Paliwal - Chairman and Chief Executive Officer

Thank you, Harman. Our fiscal 2008 has been a time of remarkable transition at Harman International as you will all recall. A cancelled private equity transaction following a complex one year CEO succession search destructed Harman from it’s execution on a record backlog of new automotive platforms. We obviously paid the price in engineering cost, warranty issues and other corrective actions. Although, these clearly impacted margins we met our launch commitment so far and maintained the confidence of our customers. 2008 also prompted a change in our approach to the portable navigation device because PND market. A mixed deep competition and price cutting we experienced significant short from cost. We have since dramatically limited our engagement in PNDs exciting the mass market consumer sector where others are still struggling. We continue to value the premium automotive PND sector as a strategic in this area we call it as strategic tool for us to test drive new development in our in-dash business. And that also reinforces our Harman Becker brand, which is very strongly recognized in German speaking markets in Europe.

During the year we added four new independent directors to the Harman board and five new members to the executive management team. These changes bring a rich global diversity which now spends five nationalities from the Americas and Europe and Asia. They’ve also strengthened our pool of expertise in restructuring, global finance, human resources and brand management. I’m very pleased that we continue to attract top talent at this level.

In May of this year Dr. Sidney Harman announced that he would retire as Chairman concurrent with the new fiscal year. He has retained his equity holdings in the company and remains it’s largest individual shareholder. I’m privileged to succeed Dr. Harman as Chairman and Chief Executive Officer from 1 July and thank him for his support and more than 50 years of leadership, quite remarkable. While executing on a record backlog of new automotive platform launches Harman has continued to enjoy the confidence of prestigious customers. Project awards in fiscal year 2008 include new or extended contracts from such customers as Audi, Ferrari and Mercedes-Benz. Ferrari also honored us with its prestigious technology award for 2008. Successful project launches extended our penetration of the Asian markets at Subaru and SsangYongin in Korea.

We also formed an exclusive global alliance with UK Bowers & Wilkins Group adding another premium brand to our automotive infotainment portfolio. We consummated a long-term agreement with NASDAQ a premiere supplier of digital mapping solutions for our infotainment systems. During 2008 the consumer division launched a number of innovations during new docking stations for apple iPod and iPhones product a new line of premium aftermarket automotive speakers and new home theater solutions. The professional division continues to serve an array of world class entertainers, sporting figures and venues. Included are 2008 events such as academy awards, NFL Super Bowl, and the NBA all star game. Touring artists such as Celine Dion, Leon Rhymes, Ross Stuart and Bob Dylan. They all performed around the world with support from companies professional products and systems. Harman systems are installed in more than a dozen key venues at this month’s summer Olympic games in China. They even played a starring role in the astonishing Olympic opening ceremony from Beijing’s famous Bird’s Nest stadium a few days ago. Quite remarkable to integrate and coordinate the 2500 human played drums and everything else in same synchronous clock. That was remarkable for professional PA systems.

During May, we conducted a comprehensive review of long-term business strategy with the Harman board of directors. This strategy blueprint recognizes both challenges and opportunities, including more aggressive penetration of emerging markets, global footprint optimization, and matching the company’s technology efforts with evolving market trends. Harman is privileged to enjoy a product diversity that I sincerely believe surpasses its competitors. We will leverage this advantage to provide customers with a rich and integrated infotainment experience and to see a greater share of customers’ discretionary purchases.

During fiscal year 2008 we announced the closure of four facilities, launching an era of dramatic footprint optimization. We completed a world class automotive manufacturing factory and a large facility in China while we doubled the capacity at our plants in Mexico and Hungary. A cross functional team was appointed in Germany recently to review simplification and optimization of the company’s substantial resource base serving our global automotive markets.

A number of significant structural initiatives were also taken in 2008, including the outsourcing of companies IT infrastructure services creation of shared financial service center in Farmington hills and outsourcing our certain warehousing and distribution activities. Complementing these initiatives, we launched a sweeping cost and productivity improvement program called staff change on that was launched on July 1st formally. This 24 months program will employ a bottom up approach involving every level of the organization to deliver measurable improvements in organizational simplicity, supply chain excellence and global footprint optimization to name a few. Consistent with the goals we discussed in February this program is expected to yield about 400 million in enterprise wise setting beyond fiscal 2010. And ladies and gentlemen, you may recall we shared with you thought process on February 5th that how we intend to go 7 to 10 percentage operating income points for our automotive business and that process has been further matured and now we have launched to make that happen and beyond at company level this $400 million savings plan and that is being orchestrated with the help of a team which has done this number of times and companies and I had privilege to work with them in launching a similar at much larger scale successfully.

To help drive top line growth Harman has launched a major market opportunity assessment and channel strategy for China market. This will accelerate the penetration of our premium brands and products in these large fast growing regions. This initiative will also provide a template for expansion of our activities in Russia and India which I think absolutely great growth opportunity that I would say great profitable growth opportunities. To characterize the new energy of Harman International and to unify its voice we had implemented several programs to strengthen both internal and external collaboration. The cross functional team spanning executive management functional and geographic managers now guides key decision making. A new growth internet and town hall meetings, with executives are reinforcing to employees the rewards of working as one Harman with no silo mentality and cascading our strategy and embracing our key strategic principal all the way to the grass root level.

New corporate advertising and sponsorship activities will commence in the fall of 2008 to strengthen the company’s brand presence and highlight the stock parlor that characterizes every element of our global business. As I deflect on my first year at the helm of Harman International, I’m gratified by the company’s achievements and energize by the opportunities that lie ahead. Continuous improvement will be the guiding principal as we leverage Harman’s robust product portfolio. Talented people and global market opportunities to create sustained profitable value for our shareholders.

Ladies and gentlemen, I thank you very much for you r attention and operator now we will open the lines for the questions.

Question-and-Answer Session

Operator

(Operator Instructions) That our first question will comes from the line of Chris Ceraso with Credit Suisse. Please go ahead.

Chris Ceraso

Thanks, good afternoon Dinesh.

Dinesh Paliwal

Hi, Chris, How are you?

Chris Ceraso

Well, thanks to you. Could I have a few items here first maybe you can recap some of the item from the quarter in particular what the total sales worth to Chrysler and what the profit profile is on that program now I think as of the last quarter you characterized it is somewhere round break even and then secondly, the sales level in the PND business for you right now and the profit profile there as well?

Dinesh Paliwal

Okay. Well I start with Chrysler Chris. The good thing is the Chrysler business program is now fully ramped up and it is stable and performing as expected. We are now on all Chrysler platforms in terms of profitability Chris it is the status what we shared with you last quarter the total business with Chrysler is just about breakeven, we had a half business which we like it’s profitable and another half since genuinely don’t like because it’s not making money. So, in total it is break even and there is no change there. Your second question is on PND, PND business has we have learnt quite a bit on PND as you know after burning our fingers, and we sold in fourth quarter 121,000 units relatively consistent with 116 we sold in Q4 of 2007 but significantly less than we originally made plans for which I’m very happy with it not sell many more it won’t have been profitable for the full year 2008 we sold 583,000 units as far as the profitability of PND is concern you know this is we don’t actually break out at that level of business that particular vertical but I think we have wall and away the way we are going to operate in a very selected niche PND and after market automotive sector high end where we will generate value at the bottom line otherwise I won’t keep this business as no secret goal. So, Chris I hope I have answered your two questions.

Chris Ceraso

Just on the Chrysler which if it is fully ramped up now you are running somewhere close to a 100 million a quarter in revenue or is it that finance?

Dinesh Paliwal

We are about that I mean I would say give and take 5 million up and down it’s about that number. Yes, fully year would be if you do that because we just ramped up for the full year 2008 but not be 100 times for because we were ramping up Chris as you recall so fully I would have been somewhere around 330/340.

Chris Ceraso

Okay. Next, can you recap for us which program launched in the June quarter and how those went and which programs are launching now in the September quarter?

Dinesh Paliwal

June quarter let’s say we have bit a very busy we have launched in June quarter of 2008 quarter or we should give you the first half actually the second half of ’08 because that’s for the activity was happening so, that would be Hyundai, DX program, program, BMW, Ruko, Audi 3G, there was a nice press release on Audi Porsche had launched PCM3 those were done. And incoming quarters here we are very focused right now on BMW, 6 program PSA program Hyundai 6 that the American launch and Porsche and other version 3.1, and couple of there is launches. So, roughly classify I think it would be fair to say we have 13 historic high to be delivered in 24 months period and half of are done which means they have just been launched they would be ramping up in coming quarters and at the same time in fiscal ’09 we would be launching remaining programs while ramping up the one which I have already launched. So, it’s going to be a very busy execution wise and in terms of activity wise.

Chris Ceraso

Thanks. And then just lastly, a housekeeping question, I think Herbert mentioned in his comments that there was some excess warranty cost in the quarter there was a comment about this in the 10-Q how did that play out what was the total cost was it beyond your normal allowance per warranty in the quarter?

Herbert Parker

Yes, it was slightly above it was 25 million for the quarter, but our normal rate it was just slightly above the normal rate.

Chris Ceraso

And now is that taken care of or do we have to just still worry about this issue cropping up in subsequent quarters?

Herbert Parker

Well you know, we are still in the romp up stage of the 13 launches and we think they were get warranty at a reasonable level and it should remain in 2009 as a similar level that we had in 2008 overall.

Chris Ceraso

Okay.

Dinesh Paliwal

Chris if I may because this is an important one and I’m actually at large Herbert’s in depth deep dive already he is been here for 6 weeks, just like to add to it, when we compare fourth quarter versus fourth quarter ’07 versus ’08 in ’07 we actually consummated certain previous engagement warranty settlements so in fact, we had an unusually better second and fourth quarter in ’07 so that’s not normal it was not normal for ’07 even, was it much lower than historic fourth quarter so compared to fourth quarter ’07 it is higher compared to Q3 of ’08 it is lower as you would expect. So, significantly lower but then I do want to remind us and all of you colleagues that ’09, where we will be ramping up number of programs we have recently launched are ramping or launching new ones. The history is when you launch these programs for ROM customers as well as for our suppliers of infotainment, the cost of quality and warranty in the initial phase of few months at the launching time it’s always little higher than the normal life cycle. So, we think we have strengthened our processes, and we’ve all prepared for finding these things at anything pops up and cover them. But, as of now our positions are well under of what we know and every thing, we think, we know is been colored provided for.

Chris Ceraso

Yeah maybe one last one as you bring up ‘09, you mentioned in the press release that you thought ‘09 would be challenging previously, did you outlined the expectation at margin might actually go down from ‘08 to ‘09. Do you think from the profit standpoint ‘09 are going to be weaker than ‘08, just even directionally?

Dinesh Paliwal

Yes. Even I know each, you know, I’m not in the position to give, any guidance for ‘09 as we said last time and for good reason, I would say and I hope you appreciate. This is a year of highest level of execution, I would say compared to ’08, ‘09 or even ’10, ‘09 would be a most execution driven here for all of us. there’s so much happening and the economy going very volatile not knowing what happen where in terms of what cost would be ramping up more and less it is hard to actually give any guidance and stick with it and you know I want to establish creditability with all of you that if we guidance we better come through and our last year’s performance wasn’t good. So, with that said I stick with what we said in February second quarter time we said. We actually put out six slides if you recall and there’s still on our website that functional cost which includes on our engineering cost, there are still relatively high but they are coming down in fact they have come down 60 basis point in the fourth quarter. So, I like the trend I see but I don’t like the level of engineering cost with that said we know exactly what the contribution margin is in the backlog of our business and we know what we’re going to be delivering from backlog.

So, those things being so fine at, it is going to be a difficult challenging year at the same time following years, I going to develop extremely well as well as those graphic showed because each new program as it ramps up year-over-year, we will gain as in the history 100 to 150 basis point on each program, the same time my literally being paranoid based worldwide that’s going to start to kick in, we done tremendous restructuring in ‘08 and we’ll going to be really pushing hard on best in class productivity in our company. So, that all kick in beyond 2010, as we said. So, ‘09 is going to be a challenging year that’s for sure.

Chris Ceraso

Okay. Thank you, very much.

Dinesh Paliwal

Thank you, Chris.

Operator

And, our next question comes from the line of Scot Ciccarelli with RBC Capital Markets. Please go ahead.

Scot Ciccarelli

Hi guys its Scot Ciccarelli

Dinesh Paliwal

Hi, Scot.

Scot Ciccarelli

Hi, guys. Dinesh, thank you for that. But, just to be clear you do expect the profitability of automotive lower in ‘09 and ‘08 that’s kind of what we should take away from it correct?

Dinesh Paliwal

Well I really don’t want to go there, Scot because that would not be fair for us. We are working through of course donate, but we will do every thing we can, we only want to improve but right now with what’s going on here, this is a high productivity that would be difficult for me to give you any guidance at this point.

Scot Ciccarelli

Okay. Can you talk about maybe just a little more broadly, the impact of the contraction throughout the automotive industry. Even BMW and Mercedes have announced the first production cuts in how long. And relative to how you're going to map out your own blueprint and game plans. What you expect that impact to be?

Dinesh Paliwal

It’s an excellent question and thank you, Scott. This is something from the board and management. This has been a topic for us and we're very much on it as a part of our enterprise risk managements, resource and reliability and what might happen, to be honest with you. We stunning to feel down term little bit as recently. And, in 2008 a number of new product launches helped us sustain our top line growth amidst a challenging economic environment. Of course, we'll be ramping up these. As you may recall I've indicated previously that this past quarter and next year would prove challenging. So we'll wait and see. If you see these gas prices going up and down, luckily, they've come down a bit. But, they also impact beyond just the car, I mean gas price increase and have primarily impacted our financial results in the form of higher costs of goods manufactured. Like Material prices have gone up. Running factory costs have gone up. Transportation costs have gone up. And not necessarily we were able to pass on those costs to our client base immediately but I tell you, we’re going to take a look at the traditional price reduction to each OEM and I'm going to challenge that and being the leader in the high end infotainment, I have a fairly good confidence level if we can justify the feature functionality we are bringing with this new launches which is unique. Why should we be passing on the way we’ve been passing on in the past years? So, in net that to answer your question, we’re feeling it little bit want to see what’s happening Chrysler we have no indication as of yet but if they go down on the vehicles where we have good take rate obviously we’ll see the effect immediately. But in terms of our production, with the way we are managing, we’re not going to run our plant, or our capacity would not be at 100% level, we have found a very good level of in-house versus external support, same applies to engineering. So, we avoid under loading or under absorption. So, I think you can be sure of we from financial and operational point of view very mind pull off, what if scenario, what happens if we have 10% or 15% reduction in top line certain areas, how do we recover. So, cost is very much in my mind all the time.

Scot Ciccarelli

Okay, thank you for that and just I guess this is somewhat similar question regarding the consumer business that’s -- being a consumer electronic vendor has always been kind of a tricky job.

Dinesh Paliwal

You are the expert, you can teach me something on consumer.

Scot Ciccarelli

Well, we can certainly talk about it. So, you guys are obviously that markets can gain comfort for our consumers out there. How should we think about that business, it sounds like part of the restructuring plan might extend to the consumer business but if you could just count that one, what your thought persist is in terms of how you’re going to grow that business? How are you going to improve the profitability of that business? That might be helpful.

Dinesh Paliwal

Alright, I’ll do that but Scot, to begin with, I’m going to be the first one to say we have a problem in our consumer business. And this should not come as just a pride, I’ve said that before and I tell you there are certain things in motion which definitely would help us. At least we should not make things worse than what market is to begin with. So, number of things happening in this business. You may recall, we have brought in a first class president to run this division. He brings some 15 years of consumer electronics expertise from GM from P&G and from Philips. And he’s got his team in place in last four months that’s four, five months he’s been here. I like what I see, he has reduced the SKU’s by 50% because he wants to focus what we want to focus on very few high margin SKU’s products with we know clearly we’ll make money. And we have made a clear choice that top line for ‘09 is not a target. So, you should not be surprised if you see a top line as further reduced because that is by choice I’m going to reduce in consumer. But bottom line has to improve. Thirdly, new product launches, our history as I said to you before our history has not been very good in terms of launching new products on time on budget because we somehow take too much than we can chew. So, we have also killed number of such programs or pushed them away and we are focusing on fewer important ones where we have good market appreciation, technology, superiority and clear leadership from the past and in future. So, you should expect at the same time I want to tell you not just what we will do, what we have done. We shut down the money losing manufacturing facility; I must say that has been a sacred cow in Harman. It isn’t sacred cow, it’s gone. We shut it down and we merged that in our Northridge California. And that consolidation has allowed us to streamline our operation and we ended up reducing 20% of our consumer engineering work force in Northridge. Secondly, as you may recall, we had one warehouse to serve the entire US consumer market, in today’s word that’s just won’t work, time to market and lead time to our customer’s number one tool of expensive transportation cost. So, we dealt with it in fourth quarter very well. We are leveraging our professional division and consumer division, warehousing. So, we have separate distribution in East Coast and in West Coast to serve customers and that has a very sound payback for us in the short term. So, numbers of things are going on in this division. So, in net-net it’s a tough one for us at the same time we are doing a number of things in a very focused manner. And this is not something I would say “let’s get out”. That would be an easy choice for some people not for me because the brand leverage we are getting out from this in professional business, in automotive business is continues to be the same case, it’s the management, it’s the execution. If Pro can grow the way Pro has grown in difficult market, I tell so can consumer. It’s all about execution.

Scot Ciccarelli

Okay, thanks a lot Dinesh.

Dinesh Paliwal

Sure.

Operator

And our next question comes from the line of Peter Friedland with Soleil Group. Please go ahead.

Peter Friedland

Hi, I had few questions. First on Chrysler can you talk about what your plans are for the next generation of that business?

Dinesh Paliwal

Hi, Peter.

Peter Friedland

Hi.

Dinesh Paliwal

Sure. I can only talk as much as our OEMs allow us to do. We have two product lines there. And as I say it we’re on all platforms, all vehicles today, all models, I mean. As life cycle progresses, we will be invited for the refresh or the newer infotainment platform and we been working on it. I think I shared or I will share with you now. We would like to get out from our not so profit or loss making business. And love to give it to any supplier who’d love to take it. And we would like to extend our RER, which is our profitable business high end unit infotainment unit. And we have good reasons to believe that we would be invited for the refresh of that which will take us beyond 2013 into the next generation. So, things should develop well. We obviously work very closely Chrysler management. I personally visit with them at technology and procurement level. And we have undertaken quite a initiative so that we want to be one of their best in class quality supplier, therefore this is a very important North American client. We have reasons to strengthen and improve our relationship in terms of quality and leadership. So that’s all I can share right now. Peter, I don’t know what else you had in mind to find out.

Peter Friedland

Great, thanks. And then as far as the new business pipelines, you’ve obviously got a bunch of new programs that you’ve been rolling out for the last few years. But at some point you’ll have to be refilling with new programs to keep the growth going. What do things look like when we look out a few years?

Dinesh Paliwal

Sure. You know, Peter, with this industry, it’s pretty cyclical. I wish it wasn’t. So, we had a major flurry of awards couple of years ago. And of course, that’s created a little bit of indigestion for us. And we’re delivering all those. So, we do expect a new wave or new cycle of number of new bits out in the market, large ones. And we will certainly participate. And I think we’re aware of some activities. But it has been some smaller activities, which we have won a few and we walked away from few. I can assure on one thing, I do not want to bid on any job, no matter how big it is, if it has not profitable. We have one which bothers us you know that and we don’t want to have another. So, with that said, innovation is what is in our mind right now and most importantly, delivering these remaining launches and ramping up successfully what we have launched in the last two quarters is the key because being a salesmen or marketing man in prior life I know if we successfully deliver 13 launches, we’re going to have no problem getting new awards, either refreshers or from those customers because nobody wants to replace their supplier, they’re happy with technology which we are at the top end. Our challenge would be of course Peter, in mixed segment. Mixed segment is highly price sensitive and will be even more. And I’m honest with you to tell you that we’re not as competitive as I’d like to see ourselves in mid-segment. And that’s fair number of initiatives taken for global footprint optimization, mid-segment system we should be scalable and should be done in bit parts in collaboration with our German competitors in China and India, and that’s what’s going to happen to bring the cost level down and maintain the feature functionality the mid-segment needs. Then only we can bid for those new awards in future profitably. And there’s a lot of work going on and Peter I hope to be able to walk you through in coming quarters with some of the activities and taking when Tom management team to China in November to look at what we are doing, we will have an R&D center in Asia also to help us do things faster with Germany, so lot of things in pipeline now.

Peter Friedland

Great, thanks.

Dinesh Paliwal

Thank you, Peter.

Operator

And thank you. Our next question comes from David Leiker with Robert W. Baird. Please go ahead.

David Leiker

Good afternoon.

Dinesh Paliwal

Good afternoon David how are you?

David Leiker

I’m doing well thank you. Couple of number of questions here first,

Dinesh Paliwal

I have to have my CFO out now.

David Leiker

Just that I understand that they are moving target but, what do you think would be their best guess for tax rate in ‘09?

Kevin Brown

Yes, our tax rate is as you know very low this year about we’d normally slightly below 30% of our tax rate on ongoing basis.

David Leiker

And that’s where your plan for to be here in ‘09?

Kevin Brown

Yes.

David Leiker

Okay. If we when we look at that the fact the business you have taken out from these unusual items of warranty and restructuring things like that, do you think the profitability going from Q3 to Q4 with lower although I don’t believe there pretty that means will ramp up in nearing cost, can you help us to understand that a little bit?

Herbert Parker

Yes, I mean you are right, and proven was all set by an unfavorable mix we had in some of our costs associated with the ramp up as you know normally at the beginning of our ramp ups is when the margins is at his lowest points.

Dinesh Paliwal

That’s one Herbert and another thing was as we were ramping up fourth quarter we had also more than anticipated manufacturing expense. We had increased capacity in Hungary and we had expedited production plant ramping in China, so, that we can start to have more production come from these lines. So that was one and as Herbert said, these new launches start at their lowest contribution margin of their life cycle of course they would very well. In addition, some of our mid-segment products ramped up, including Chrysler. The mix of manufacturing expense ate up the benefit we would have received of not spending the same amount of warranty costs in fourth quarter. That took away that improvement.

David Leiker

And then, as we look at the professional business, you obviously have done a great job there of boosting the profitability. How sustainable is this level of profitability that we were seeing?

Dinesh Paliwal

David, I always -- I should think before I answer and I am, typically profitability is a function of your leadership in technology and innovation. And in this business, again, I would say last 13, 14 months what I have learned. We have got some absolutely superstar products, and if you really put our total portfolio and compare that with competition. I don’t have one name to give you who really compete on a full portfolio basis. So, with this infrastructure boom going on in China India and Russia, China would build even more after these Olympics and these Olympics will take us forward. India is hosting 2010 common wealth games they are absolutely benchmarking with China did at all want to do anything less; Russia is just going crazy right now. And this is on top of what’s going on in North America and Western Europe and Eastern Europe and I don’t want to remiss and I don’t want to miss it the South America we had some good surprises to come from all boom being spent, money is being spent in infrastructure, sports boxes, Opera houses, a music hall, concert hall and same is happening in middle east. So, I think we got a pretty robust situation I want to remind ourselves that economy is not very promising going into ‘09 and we are mindful of that but, I think we are all positioned somewhere of that’s one business where I feel we’ve got a decent positioning of course things can go south. And we will know before that happens.

David Leiker

How much of that business is focused on construction of building stadium and things one is like?

Dinesh Paliwal

David this might be difficult to what actually I don’t have that breakdown. And probably we don’t go that far but, quite a bit is changing overnight I mean over the coming periods because if you remember traditionally we had been big in North America and Western Europe and is still on. But, now we are going rapidly double digits sometimes starting with 2 or 3 even in this newly industrialized market by Russia China and India. So, starting point is fairly low, so in terms of percent it’s not yet the number, I would like to see beyond this with you I would like to see 30/35% of the business to come from Asia in coming years. We are not there yet, no where close to so that’s promising in terms growth but, I don’t have that breakdown.

David Leiker

Two last things. As we look at the China opportunity here and understanding the starting gate kind of putting the plans in place. What do you think the timing is that for to show up in the numbers and what kind of, scale of opportunity do you think might be there?

Dinesh Paliwal

You know, Peter come again. I just want of the specific question first. Would you please?

Peter Herbert

As you look at China.

Dinesh Paliwal

Yeah

David Leiker

What’s the timing of us seeing the initiatives start to show up on the income statement and what do you think this [Overlapping Speakers]

Peter Herbert

Okay, I got it. Peter we are selling today in China this is not that not in Chinese market, we sell, we have distribution in China but what I’m saying I have just launched I call it full potential assessment with some expert those who know China very well external help and who are going to do full mapping of what Chinese needs all for progresses our consumer business automotive business and how much do we have to invest to capitalize on that and how much can we afford to invest and how fast we can go. So, that is incremental growth opportunities so we continue to do what we do today and this study would be done by end of November in fact, my management team is in Shanghai in November we will have a full workshop on that what are the outcomes and by end of this year calendar this year we would have some clear strategic initiatives in place and then we start to put money where our mouth is and I mean as I said we have two factories in China today, we have R&D people in South of China today, so we had a lot there but lot for – not lot for my point of view because I have came from a company that is a $5 billion in China and I know what we can do so, I’m pretty anxious to get us going. Income statement won’t show you in near term let’s deface, this would coming in coming years.

David Leiker

and one last thing on the change plan rear. You outlined $500 million of savings beyond 2007. What do you think the costs are of implementing the savings?

Dinesh Paliwal

You know cost of implement thing we don’t know yet that’s why we said this we have just launched to July 1, we are in project and process identification mode, we will streamline we’ll analyze in terms of what pay back we get by doing what we’ll have lots of initiatives to analyze and that phase would be over by end of this calendar year. And from January 1, implement full fledged implementation so, to give you as (inaudible) answer I can like this year we spent about $45millioin on restructuring, statistics running business my experience David is that you spend about 1.5 percent of sales in restructuring which is an ongoing every company whether GE, ABB, Siemens, Tyco. Typically and that’s get hidden in the numbers you won’t need to talk about it, but in a company like ours where we have huge opportunity in terms of optimizing our engineering and factory and what have you we’re talking 1 to 1.5% of sales in coming quarters here that’s what we spent this year. And I expect that to be around that and that is what we have putting in our budget and we shared the major projects with our board of directors and each division knows exactly where we have to do, what we have to do and of course we are also trying very hard if any projects which associates people then we want to do that fast so that they are self financed within the year but, if we have facility consolidation or process improvements those have to be done in relation of running business because we don’t want to do anything which will disrupt the business. So, it’s the whole gamut. But there will not be any unusual charge than what we have shared with you in fiscal ‘08.

Operator

And thank you. Our next question is from Jeff Graf with Springhouse Capital. Please go ahead.

Jeff Graf

Hi, Dinesh. How are you?

Dinesh Paliwal

Hi, Jeff, I’m alright. Thank you and you?

Jeff Graf

Good. I just wanted to dive into the step change program a little further. I’m trying to compare it with the slide that you outlined back in February of 2008.

Dinesh Paliwal

Yeah.

Jeff Graf

So just to clarify, are there any significant differences between what you outlined in February and the 400 million that you’re setting today?

Dinesh Paliwal

I’m glad just you asked because I wanted to clarify that. Actually, I recently announced this staff change program is actually a continuation of the road map we shared with you during our Q2 earnings call. It is not in addition to what we did. We laid out very clearly at that time for only automotive. If I recall, I think we said we’re going to push supply chain initiatives in the neighborhood of 2% to 3%, if I recall correctly I think our manufacturing well about 2 to 3, our engineering was about 2 to 3 or so. And then we had our product mix which again implied engineering changes, the material changes. So, in that was about 7% to 10% operating income points to the bottom line beyond 2010. And a stat change exactly the same timing beyond 2010 but now stat change is inclusive of automotive initiatives we laid out in February also includes consumer, professional division and corporate. It is really streamlining the whole company and go after anything which we should be doing and we haven’t done. So, that’s why if you do a quick math 10% on $3 billion automotive is about $300 million. And we are talking 400 million as a stat change sustainable savings is the keyword. This is sustainable. Anything which is one off I’m not going to count that. So, it is continuation of what we said basically, stat change is a program to accelerate the implementation of all the structural and operational strategies we have shared with you in the past.

Jeff Graf

Great, okay. That’s helpful. That’s all I have. Thank you.

Operator

And thank you. Our next question comes from Luis Sykes with Pennant Capital. Please go ahead. Mr. Sykes line is open.

Dinesh Paliwal

I guess, we can move on.

Operator

Very good. We’ll go next into the line of Chris Ceraso with Credit Suisse. Please go ahead.

Chris Ceraso

Hi, thanks. Just one quick follow-up. It looks like July, maybe off to a bit of a tough start if we look at the production on some of the vehicles that you supply a BMW and Mercedes. Is that consistent with what you’re seeing? Is it a tougher production environment even versus what you had in the June quarter?

Dinesh Paliwal

Yeah, as I said we’re starting to feel the headwind. We have to watch obviously is typically July, August actually typically very tough months because holidays in Europe and what have you particularly now with uncertainty over the there, oil prices are going to be, people are probably putting off some of the purchases of the new cars and what have now in our automotive company that also reassessing their production and their plans. So, I think we’re in a sort of mode where we’re watching carefully. But that’s all I can say. We will find out in a couple of days our July numbers as they are shaping up. So, July is always a tough month.

Chris Ceraso

Okay, thanks, Dinesh.

Dinesh Paliwal

Sure.

Operator

[Operator instructions]. Our next question is from Andrew Mahoney with Green Arrow. Please go ahead.

Andrew Mahoney

Hi, thank you very much for taking my call. You’ve said a couple of times that one of the primary factor that’s driven this big decline in auto margins from 15% a few years ago to under 7% now is all the excess engineering costs associated with your record number of new launches. My question is back in 2004 when your initially started launching infotainment platforms, margins were very stable and actually increased. So what -- looking after the fact, what was so different this time around?

Dinesh Paliwal

Andrew, you’re asking what I ask myself when I joined the company. But it’s a great question nevertheless. What happened is what we have said so I’m going to just reinforce. We got caught up. We got the wonderful stream of new awards which came. And technologically as reinforce we were literally the game in town with the high expertise and integration and very complex feature functionality which these launches have versus several years. So we got a lot of business. We underestimated the complexity of the job we were taking, and we underestimated the resource requirements. And these are the words I have used all these prior quarters.

And when fiscal year 2007, mid of fiscal year 2007 you may recall I was here, Kevin Brown and Dr. Harman started telling we have an engineering bulge here already in January. We started to feel, we’ve got lot to do and we’re not ready. And our customers were asking questions show us the progress and we could not because we have never delivered 13 in 24 months. We had delivered one or two a year. So, it all compounded and by the time I came in the organization, we already had 50 million, 60 million engineering bulge and I was the one to give bad news that, sorry folks I was there, this engineering is in the going to go down because I have to maintain this or even have to take it up a little bit if I have to because delivering these SOP’s there’s no alternative but to deliver. You miss one, then you’re in the same category as some of our competition has been then you get blacklisted. So, we undertook and when you are under pressure with a gun on your head, you end up getting little panic in terms of hiring whatever you can put your hands on. So, we hired hundreds of permanent engineers, hundreds of consults, those who come $300, $400 an hour cost, very expensive. So, that’s what actually compounded at had huge engineering cost which we carried throughout 2008. We’ve got a much better handle on it. As I said in fourth quarter, we brought it down 60 basis points, we will bring it down. But if you recall, Andrew or if you go to our website, you’ll see I have shown February 5, that 2009, our engineering cost will stay high, slight decline towards the end of ‘09, because we have still a lot of work ahead of us. And at the same time we’re doing two things.

One, we’re going to start to have very good development of resource based in eastern Europe and India for engineering and we will also get rid of as many external consultants first because that’s where you don’t have any severance costs, and these are the most expensive people you have and we have pretty good handle on that now. So, I hope I gave you little long answer but I had to explain to you where we’re coming from.

Now, you also mentioned margin, I had said in the past, we enjoyed the great profitability, not because market had mercy on us. We did it because we had the best in class innovative systems and that we continued to have and continue to be very proud of. These new launches would have some feature functionality which we had not seen in the market place including some driver assist features like night vision, like lane management, a number of other wonderful safety related features which we start to roll in as our rich new feature functionality, tremendous connectivity features. The car would be literally hotspot in some cases. So, with that said, our margins will come back. Will they come back to 16% or 15% or 19% or 12%? I don’t know. What I’ve said Andrew to our colleagues before we are targeting double digit. And I’m pretty damn convinced that we will get there. And that’s why these $400 million savings program as a religion being launched so that it becomes an institution, it becomes a religion and luckily, I tell you, I’ve done it, done it much bigger and complex. So, I feel comfortable that we push it through. So, that’s where we are. A lot of hard work but clear vision. Very clear direction and all the issuance seems to follow that.

Andrew Mahoney

That’s very helpful. Thank you. Has the number of external expensive camps that you are having to use for engineering purposes, has that started to come down? Or will that continue to increase?

Dinesh Paliwal

It’s not -- I tell you one thing. It’s not increasing.

Andrew Mahoney

Okay. And I’m very aware of your longer term margin targets. I guess my question is going forward five to seven years down the road. All the new vehicle platforms you’re launching now are going to have to get replaced again. Should, we assume another big bubble in engineering expenses when that happens or will you be better prepared next time around.

Dinesh Paliwal

You cannot be fooled twice. No seriously I mean. First of all, we have learned our lesson. Second of all, we do things smartly as an organization. We have a much better way of doing. We’re going to consolidate our engineering functions in few location make them strongest. So that they have lot more vertical integration in Germany. So, some of sides in Germany would become bigger and larger in scope. While some will not be there. Same will happen in Eastern Europe and India. So we’ll work as good software engineering houses work. And, I think I know a little bit about that we have done that. Our organization has a lot of knowledge doing that. So, Bubble is good news if it come silent I’ll welcome that, but would we have engineering bulge?

Engineering in absolute numbers may go up if volumes are very high. But in percent of sales would not go up. We have set clear target for ourselves, we are targeting around 8% of sales in engineering. That’s about the number we want to be. Right now we’re running 10% or so. As, I said the direction we are going in the right direction organization charade. Right, now our challenge to get these SOPs done and continue to have the confidence of the industry so that when the bubble comes, we’ll be the first one in the minds of OEMs to award these new jobs. Well, gentlemen and ladies, I would like to say go on please.

Operator

And, thank you for our final questioner and we’ll go back to the line of Luis Sykes with Pennant Capital. Please go ahead.

Luis Sykes

Hi, Bird. Can you hear me this time.

Dinesh Paliwal

I can hear you very well, how are you

Luis Sykes

Great and good. Sorry for the phone troubles earlier. I want to take another stab at this to the question of economic sensitivity for your auto business. If basically if OEM volumes fall say 5% short of what you expected, can you give us a sense for how much auto operating margins would be heard for you?

Dinesh Paliwal

It’s hard, honestly its hard to explain because first of all, it’s a mix, depends which customer and what volume goes down because some of our business is with certain customers. They have a different margin mix, different product mix. So, it depends, if the auto volume goes down where we have very low margin or loose money which is one contract I don’t want to repeat. That’s welcome news. Then it only improves the bottom line. But, if there are volumes where we enjoy high margin due to our very high sophisticated offerings that’s going to hurt the bottom line. So it’s hard to say what impact would be. But it’s clear that impact will be there.

Luis Sykes

But, I’m trying to get at the more the operating leverage, I mean obviously if you loose 5% of sales in a very nicely profitable product, that’s going to hurt. I’m trying to get a sense for how much the margin would decline in those kinds of scenarios.

Dinesh Paliwal

Well, that’s why I said I’m not trying to duck the question, we don’t know how the volume will shape up. So far, we have never seen shrinking in our automotive volume. And we don’t know how ‘09 will shape up and where the volume will either shrink or increase. We really can’t predict that. So that is hard I mean of course, we do track customer by customer. But, I don’t have the breakdown and I can’t really sort of speculate that which customer will shrink the volume and in what proportion. It’s a hard one to predict right now.

Luis Sykes

Okay. And, just as a follow-up to the previous caller who talked about the step change plan and how that compares to your plans in February. So, to be clear, the $400 million or $300 million for automotive that include --?

Dinesh Paliwal

Let me clarify if you please. Allow me to interrupt. I have not said that 300 exclusively for automotive. We have said $400 million for the crop, for the whole company. I was trying to connect that what we said in February on the low side that was about $200 million on the high side $300 million. What we laid out as our direction. At, that time we did not have such clarity. But, we gave that and now we do have a clarity. But, we have not defined which division would get what portion of $400 million. That work is going on now and will continue for next couple three months. 400 is at the company level. That includes corporate, structural changes. Do we have too many legal entities? Do we have too many redundant facilities? How much to go pro, how much go to consumer, how much to go auto? That we have not fine tuned yet.

Luis Sykes

Okay. Thanks for that clarification. And does that include the margin improvement you would expect from just the life cycle progression for the new product launches?

Dinesh Paliwal

Whatever is sustainable year-over-year that would be counted in staff change. Whatever is not sustainable would not be counted.

Luis Sykes

Okay. And, can you give us a sense for whether the mix has changed in a material way from basically just plain cost saves versus what you would expect from sort of a normalization of the product launches.

Dinesh Paliwal

No, I think mix we don’t control. And, in fact we want to change the mix by expanding ourselves into mix segment and maintaining our leadership in high end. Therefore what is important that across the board we get to the best in class cost levels in our industry, and even better. So that’s what we are targeting and that’s why we’re getting some external help to find out the benchmark from like of the industry or outside of the industry. So, that’s what we’re after.

Luis Sykes

Okay. Thank you.

Dinesh Paliwal

All right. Operator – I think now we have it’s been a great engagement. So, I just want to thanks first of all our listeners out there. It’s been very, very interactive. I think I would like to have it closed because a number of you would like to leave soon. So, I don’t want to over delay you now.

Luis Sykes

And, thank you Mr. Paliwal.

Dinesh Paliwal

I have quick closing comment. Ladies and Gentlemen. Just, one minute, I recognize that what I just said we have much hard work ahead. Just as 2008 was a year of dramatic transition for Harman international, the next 12 months must be a time of decisive execution. And I get it and team gets it’s, with our strategy clearly defined and board is fully engaged, we must focus on measuring what we do and clearly benchmarking.

And, the time for celebration is clearly not yet here. But, the spirit and commitment of our team are absolutely here. Our, performance I highlight in 2008, underscores this. With the double digit sales increase nearly of 50% increase in cash from operations, record performance in our professional business, and a clear strategy to reduce our cost base by $400 million. So with that, I’d like to once again thank you for your time, attention, and a very candid dialogue. And I look forward to further reporting on our progress as we execute on Harman’s decisive strategy. Thank you very much, ladies and gentlemen.

Operator

And, thank you Mr. Paliwal. Ladies and gentlemen your host is making today’s conference available by digitized replay for two weeks. The digitized replay is available starting at 6:30 p.m. Eastern Daylight Time August 14, 2008. Simply, dial (800) 475-6701 in the US or internationally at (320) 365-3844 and at the voice prompt enter to conference confirmation number of 956-748. And, that does conclude our earnings release call for this quarter. Thank you very much for your participation as well as for using AT&T Executive Teleconference Service. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Harman International Industries Inc. Q4 2008 Earnings Call Transcript
This Transcript
All Transcripts