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Harman International Industries, Inc. (NYSE:HAR)

F1Q13 Earnings Call

November 2, 2012 11:00 AM ET

Executives

Dinesh Paliwal – Chairman, President and CEO

Herbert Parker – EVP and CFO

Bob Lardon – Head, Luxury Audio

Analysts

Ryan Brinkman – JP Morgan

Chris Ceraso – Credit Suisse

Ravi Shanker – Morgan Stanley

David Leiker – Robert W. Baird & Company

Curtis Jensen – Third Avenue Management

Adam Brooks – Sidoti & Company

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Harman Fiscal 2013 First Quarter Earnings Call. (Operator Instructions) Afterwards, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded Friday, November 2, 2012.

I would now like to turn the conference over to Dinesh Paliwal, Chair, President and CEO. Please go ahead.

Dinesh Paliwal

Good morning, ladies and gentlemen, and thank you for joining the Harman’s first quarter fiscal year 2013 investor and analyst call. I am joined in Stamford today by our Herbert Parker, our Chief Financial Officer, Herbert Parker, and by Sandy Rowland, who has recently joined us as Vice President, Investor Relations.

Before we get underway, please allow me to share our deepest empathy with those of you on the phone today or who were directly or whose friends, families or associates affected by this unprecedented storm. We wish everyone a speedy return to normalcy.

As I mentioned, our new Head of Investor Relations, Sandy Rowland, she brings extensive experience in financial management and analysis to Harman from her prior roles at Kodak and PricewaterhouseCoopers, and she looks forward to meeting you soon. And I’m sure there are lots of opportunities where a few of us will be traveling together to see you and be part of your conferences.

Now Bob Lardon, who is taking a new role as Head of our Luxury Audio unit, is also with us today in this room, and we thank Bob for his dedicated service in Investor Relations over the past four years and for his support ensuring a smooth transition. The good thing would be Bob and Sandy will be in the same building, so there’s a complete good sort of handle while in transition.

As you read earlier today, we delivered another strong quarter with growth in local currency, even against last year’s abnormally strong first quarter and most importantly, in a challenging economic environment, which has changed rather dramatically over the last few months.

Our success continues to be underlined by the launch of several of award-winning new products and with competitive wins in the Car Audio business from BMW, Ford and Volvo. We are proud that our relentless execution and continued cost focus have allowed us to post our twelfth consecutive quarter of top and bottom line growth. We’re also pleased to see our solid track record recognized by credit rating improvements to investment grade. We are confident that our excellent liquidity profile will enable to continue to utilize a variety of initiatives to deploy capital, invest in growth and generate strong returns for our shareholders.

We also continued our aggressive growth in the emerging markets, with BRIC country sales up 23% in the first quarter. We remain committed to a strategy of growth, intense cost focus, innovation, and speedy execution regardless of the economic cycles ahead.

At this time, I would like to quickly share with you a few highlights that underscore the strength and resiliency of Harman’s growth strategy, including some significant financial events in recent weeks. As you know, Standard & Poor’s raised Harman’s corporate rating to investment grade. Moody’s followed with an investment grade rating just a few weeks later, citing our strong competitive position, revenue growth, and excellent liquidity profile as factors in their decision.

Concurrent with the latest ratings upgrade, we successfully concluded negotiations last month with a group of banks for a new $750 million unsecured revolving credit facility, obviously at much better rates than before. We also secured a five-year $300 million term loan, which we used, along with $100 million of our own cash, to repay $400 million in convertible senior notes held by a series of investors, primarily KKR and Goldman Sachs Capital Partners. This transaction concludes any direct financial interest in Harman by these investors.

Each of our three divisions scored significant wins during the first quarter, beginning with infotainment, where Harman continues to be a driving force for innovation. Harman celebrated the market launch of two advanced infotainment systems. The latest BMW infotainment system is debuting on the 7 Series and will roll out to all BMW vehicles worldwide this fall. This system is the most advanced on the market, offering sophisticated features such as three-dimensional navigation and real-time traffic update, office function integration, voice command, intelligence, Internet connectivity, and many more.

In addition, Chrysler’s latest Ram truck and Dodge Viper models went to market featuring the next generation Uconnect infotainment. Uconnect system is designed, engineered and built by Harman, which is getting very positive comments in the marketplace from Chrysler and Fiat.

On Aha Radio technology, it was launched as an integral feature in Honda’s new vehicular connectivity system called HondaLink. That, again, is a good example with a lot of technology we have, outside of regular infotainment or car audio, we’re starting to penetrate customers we never had any business with. Honda is one such customer. We had no business, neither infotainment nor car audio. With our Aha connectivity suite, we have penetrated and it’s been a great starting relationship, which I’m sure with bear fruit for many other business to do.

Similar, HondaLink would be rolled out across all car models in the United States in 2013. These launches are similar to the depth of automotive backlog, an industry-leading backlog of our order business that was built on the success of innovation machine.

To continue this leadership position, in September we announced that Harman will establish a new software engineering center in Chicago. To further expand our global network of infotainment, engineering, and mainly focusing on connectivity and development of such feature functionality, within reach of key customers in Detroit and of course many other European and Japanese customers in that area.

In the Lifestyle Division, Harman extended its global leadership in automotive audio. In our accompanying press release issued this morning, we outlined $800 million in new awards from major OEMs in North America, Europe and Asia. This is the single largest order intake in car audio I have seen, at least in my time here, over five-and-a-half years. And most importantly, I’ll stress this $800 million is in net new business. Every single award is brand new and additive to what we already had, bringing in some new customers which we never did business with.

Let’s start first with extremely prized acquisition that is Ford Motor Company. You have heard me talk about Ford and GM for almost three years. And last quarter, we announced General Motors and this quarter we announced Ford. So, Ford has selected Harman as their audio partner for selected future programs.

This newly established relationship is the result of common focus on technical innovation and a shared vision to create an unmatched ownership experience across Ford line of autos. This new award further broadens our reach in the North American market and follows on the news, as I said, $900 million infotainment win from another U.S. auto maker last quarter. We are well on our way to expand our business with the distinguished Detroit Three.

In Europe, BMW has selected Harman for their future cross-car line ultra premium audio system worldwide, where we replaced a competitor. So, it’s a net new. And Volvo has selected Harman to provide ultra premium branded audio system across all cross-car lines. This is our first branded audio award with Volvo and marks the beginning of an important new strategic relationship. As you know, Volvo is owned by Geely, and Geely has awarded Harman already for infotainment and audio business, and we have a lot of joint relationships and development programs happening with that group.

In Italy, the Fiat Group awarded Harman a second luxury branded audio contract for its Maserati sports car line. In addition to the JBL sound system recently launched on the Fiat 500 Abarth Special Edition, these two awards illustrate the breadth of Harman’s portfolio and our ability to satisfy customer needs in wide-ranged price points and price segments. Also to say, scalability of audio system, first I shared with you scalable infotainment, and now we are after scalable audio systems.

Across Asia, Harman has secured eight new program awards with six different OEMs. In China, we have been selected to provide the first ever branded audio solution for JAC, a domestic automaker, as well as additional programs with current customers like BAIC and Geely. In Japan, we expanded our long-term relationship with Subaru and Lexus, with two replacement platform awards for each company. In Korea, we continued to expand our portfolio of business with Kia by securing Harman’s first branded audio award in the C-segment small SUV, once again underlining our effort to have scalability approach in audio market.

Our Professional division continued its sector leadership during the first quarter, installing Harman systems in more than a dozen major arenas and stadiums and other large venues, looking ahead to the 2014 FIFA World Cup in Brazil. We have received major contracts for equipment sales to outfit two new official stadiums.

We also booked a major installation at Rio de Janeiro International Airport, which will serve as gateway to the 2016 Olympics. Just to stress that, this international airport would also be connected with the subway system with 99 train stations. This award would be one of a kind in the world, not just the audio, but it will also have the complete network of IDX for the passenger flow and information management. So this is a very, very unique award which will put Harman on the map of information technology, audio technology and audio video integration at the backbone.

Ladies and gentlemen, these first quarter achievements are further evidence of our commitment to delivering long-term profitable growth while we continue to expand our product portfolio. We recognize that regional economic cycles continue to present challenges, but our results this quarter also show that we are acting aggressively to mitigate potential impacts. Our strong liquidity position, our pipeline of differentiating innovations, and our expanding base of premium customers across every region are the catalysts for growth. This has been our philosophy. This has been our strategy. And we have been executing on it and, unfashionably, will continue to drive this strategy. And we’ll exploit each of these aggressively.

Before I turn the call over to Mr. Parker, let me summarize our key actions and achievements that form the foundation for Harman’s long-term particular growth strategy. We have an industry-leading order backlog, with double-digit operating margins. We continue to grow aggressively in BRIC markets. We’re winning new strategic customers, adding names such as Ford, Volvo, to our brand portfolio of automotive partners. We continue to introduce new market-leading innovations, and in this first quarter alone, we added 175 new patents and patents filings to our base.

Let me reiterate. As I said earlier, it was a tough quarter from the top line perspective. And we are closely monitoring the macroeconomic environment, and in particular, the automotive sector, and we will give you an update on our full year guidance together with our second quarter results.

Now with that, I thank you for your attention and I thank you for continued support. I will now ask Herbert Parker to share a closer look at the first quarter financials.

Herbert Parker

Thank you, Dinesh, and good morning to everyone. We’ve closed yet another very solid quarter of operational and financial improvements and I’d like to review a few of our highlights.

As always, most of my financial comments are provided on a non-GAAP basis, which basically excludes restructuring costs and other non-recurring items. The reconciliation of our GAAP to non-GAAP results is included in the release, but for your convenience, our restructuring charge for this quarter was $200,000.

Okay. As we always start with the top line -and as Dinesh mentioned earlier – although this quarter was challenging for the top line, we still managed to increase our revenues by 2% when excluding the impact of foreign currencies. And we think it is very important to point out that we reported double-digit EBITDA percentages in all three operational divisions, increasing the total company EBITDA margin by 66 basis points to 10.8%.

Our gross margin has expanded by 34 basis points during the quarter, primarily due to our Lifestyle and Professional divisions’ ability to successfully mitigate the near-term commodity cost increases. All divisions continue to benefit from our ongoing global footprint initiatives and our relentless focus on cost efficiency.

We also had significant improvement in controllable costs for the quarter. Our SG&A expense declined by 36 basis points to 19.9% of sales compared to the prior year, even as we increased investment in our global brand awareness campaigns. We continued to be more effective with our engineering investments, as our R&D costs as a percentage of sales, which is included in our SG&A, declined by 36 basis points to 7.8% of sales compared to last year.

These improvements translate to a combined 69-basis points increase in operating income, bringing the total company EBIT margin to 7.9%. This is the highest level we’ve achieved in the first quarter in over five years.

Net income for the quarter was $55 million, or $0.79 per share, compared to $0.69 per share in the first quarter of fiscal year 2012, a 14% increase. Our effective tax rate on a non-GAAP basis was 24%, which benefited from certain discrete items recorded during the quarter. On a full-year basis, we still expect our effective annual tax rate to fall within our 26% to 28% guidance range.

Our total liquidity stands at $1.3 billion, which gives us sufficient capital to cover our future operating, financing, and investment requirements. Now I’d like to move on to capital allocation.

We follow a disciplined process for deploying our capital to the highest and best long-term returns. Each alternative, whether it be an organic growth investment, acquisition, or dividend, is indexed against each other, and against the value that a stock buyback program provides as a key hurdle.

Now having said that, it is our belief and experience that long-term sustainable shareholder value is best created through investing in organic growth opportunities, such as building our footprint in BRIC countries, combined with accretive acquisitions that either add complementary technical capabilities or provide distribution access to emerging markets. We’ve also determined that the delivery of a growing and sustainable dividend stream is an appropriate method of returning value to our shareholders.

I would like to point out that we have executed on all of the capital allocation strategic initiatives noted above. First of all, we invested heavily in BRIC countries, and we’re seeing the results in strong growth in these markets. Second, we made strategic acquisitions, including an embedded audio company, MWM in the U.S., and Selenium in Brazil, and Interchain in India. Third, we doubled our dividend payout rate. Fourth, we executed on our share buyback plan. And five, we did all of this while still achieving an investment grade from both S&P and Moody’s.

These achievements are indicative of our continuous improvement culture and a validation of our strategy to keep strong operational focus with a clear link to our goal of maintaining an efficient balance sheet and delivering shareholder value to our investors.

Operator, we are now ready to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Ryan Brinkman with JP Morgan. Your line is open. Please proceed with your question.

Ryan Brinkman – JP Morgan

Hi. Good morning. Thanks for taking my call.

Dinesh Paliwal

Hi, Ryan. Morning.

Ryan Brinkman – JP Morgan

Hi. And thanks for the color, too, on capital allocation. Now after the last quarter’s share repurchase, I think you had characterized that as more opportunistic in nature, somewhat one-timeish in nature. Given the color on today’s call, the comment in the slide deck, and the increase in the revolver capacity and the rates at which you can borrow, et cetera, is there any change to your thinking in this respect, given the new liquidity of the company? Could regular course repurchases make more sense going forward?

Herbert Parker

Hello, this is Herbert here. No, there’s no change to our strategy. As I stated, we will still analyze that against our – index against the buyback, what would be more profitable. We still are looking at several small type, $100 million, $200 million acquisitions, as we mentioned before. So we’ll continue down that path first. But we have not decided that we’ve levered off in order to make a large buyback. As you may recall, I know we do still have about $71 million left. And since our other original buyback authorization has expired, we’ve got an extension for another year from our Board.

Ryan Brinkman – JP Morgan

Okay. Great. Thanks. And then just throughout this earnings season, quite a few suppliers have guided the calendar fourth quarter lower, or at least have guided industry assumptions in Europe lower, and lower than the figures provided to us from IHS. They’re looking for like -15% for the entire market versus maybe IHS at -10%, really citing the very latest trends in customer orders. I know you’re less levered, obviously, to that. You’re more levered to luxury in Europe, but one of the other things they’ve been saying is that the softness seems to be spreading from southern Europe up into northern Europe and maybe into the Germans. So can you update us maybe on what you’re seeing on the ground? What are your latest trends in customer orders showing you?

Dinesh Paliwal

Yeah, Ryan, this is Dinesh. I have never been more inundated with the data than in the last six weeks. There is so much and so many reports coming out, and they’re all relevant. I personally actually hit the road to get the pulse for the market and from the customers, so I was in – in the last six weeks I’ve been in Germany visiting all our key clients. I’ve been in Korea. I’ve been in China. I’ve been in Brazil. And I’m going to India this weekend. The key – and so is Herbert, so are the division Presidents traveling.

We want to really get to the bottom of it, because any such report may or may not depict exactly where our backlog is coming and where would it turn into revenue and what are the take rates implications. So all in all, I share your sentiments. As I said in my opening comments, that dramatically economic environment has changed in the last few months.

And we’re actually evaluating ourselves that what does this mean, because we’re seeing Europe down 10% for the next two quarters. We’re seeing North America will continue to grow in calendar 2013, which we see nice development. China is still growing 10%.

At the same time, we are growing take rates while our top line due to production step-downs might be coming down, but our take rates might be helping or new technologies like Aha or other things we’ve been launching, that might be helping. Audio take rates are different. So net-net, we are very much part of the softening in Europe you are describing and we are feeling it.

You have seen it in our first quarter. We grew only 2% on a constant currency. But we still feel that we need to evaluate for two more months very closely with our major OEMs, car companies, to be able to assess whether we can maintain the guidance we issued or do we have to address it. We would not know that until end of December. That’s when we’ll know better. But we hope that this European thing is not a mid- to long-term phenomenon. If it is not, I think Harman will do better than peers.

Ryan Brinkman – JP Morgan

That’s super helpful. Thanks. And maybe just for Herbert quickly. Can you help us in terms of how to think again this quarter about the corporate SG&A line? I recall that last quarter you’d guided it higher this year. And you did spend a little bit more this quarter, but can you just remind us how you see that tracking for the full year? Is it any different than your earlier expectations maybe given the environment? And then what are the drivers there? Thanks.

Herbert Parker

Normally we would probably track around $120 million, but as you indicated – the environment, we closely monitor that. We’d like to be able to spend more on our margin. We’re seeing some good return on that. But that number was always – could be anywhere between $100 million and $120 million, depending on the payback that we’re seeing for the year.

Ryan Brinkman – JP Morgan

Okay. And then last question, if I can, just maybe for Bob in his new role. Bob, can you give us any more color on the new business wins and when might you see them actually benefiting the financials? Thank you very much.

Bob Lardon

Ryan, thanks for asking. It’s a pleasure to be assigned to that role. As you know, we cannot at this point talk about the specific brands associated with the specific OEMs. We wish we could, but we can’t. All I can say is that I think you know the premium brands we have and the ultra premium brands that we have, and I’m going to do everything to continue to grow that and help leverage the branded automotive audio business.

Ryan Brinkman – JP Morgan

Okay. Great. Congratulations on your new role, by the way.

Bob Lardon

Thanks.

Operator

And our next question comes from the line of Chris Ceraso with Credit Suisse. Your line is open. Please proceed with your question.

Chris Ceraso – Credit Suisse

Hi. Thanks. Good morning, guys. Can you hear me?

Dinesh Paliwal

Hey, Chris. How are you?

Chris Ceraso – Credit Suisse

Okay. Good. So I understand that there’s a lot of moving parts, and you’re not sure where the full year’s going to shake out, but we’re more than a month into the current quarter. Certainly you’re seeing how business trends are so far. Is there any update that you can give us on what your expectations are just for the December quarter now that we’re partway into it? And then you can come back and reassess the full year number later.

Dinesh Paliwal

You know, Chris, as we never give quarterly guidance, so I refrain from that. And also, project distance is lumpy. You’re right. We are into October, and I’m not even seeing the full October sales report yet, because it’s not done yet. So it’s a bit premature, but I think earlier conversation from some other colleagues were – we’re not different. We’re not totally insulated from what’s happening in the marketplace. Up until now, we held our head up saying that luxury sector was very resilient, but we have seen now that luxury car companies, at least Daimler, came out and said that, look, they may be shutting down for a week or two longer than normal.

So if that’s the trend, that will definitely affect our top line. And top line is as important as bottom line, although we have better control on bottom line because we have much better cost control and productivity measures in place than we have handle top line. So I think we have to wait and see. And based on second quarter development and also based on production releases for the first half of 2013, that would be pretty well informed point of view we’ll be able to share with you end of January when we announce our Q2.

Chris Ceraso – Credit Suisse

Okay. Fair enough. I have a question on the Ford win that you announced on branded audio. Are you displacing Sony on those products? Is this for across the Ford line, or can you give us any more color on which vehicles and the timing for the Ford win in audio?

Dinesh Paliwal

You know what? I got slapped pretty bad after saying much about other Detroit-based automakers. At this time, I’ve been clearly reminded by our account executive that we’re not allowed to talk about models, model year, and which competitor we’re replacing. But I think most of you are so close to Ford, you know exactly what’s happening. It is a competitive placement, as you say, across car lines, selected models. So with that said, we have to let the news come out from Ford when they’re ready to share. But it’s a great win for us, a very, very good win for us.

Chris Ceraso – Credit Suisse

That’s fair enough. Just the last item, Dines, on the Pro business, I think if my math is right to get to your full year numbers this year, you need to deliver some pretty meaningful margin expansion at Pro. First of all, am I thinking about that correctly? And then second, if that’s true, this quarter seemed to be a bit of a disappointment, at least relative to our numbers in terms of the margin at Pro. Maybe you could give us an idea of what happened there. What weighed on the margin in Pro? And what’s going to drive margin improvement in Pro this year?

Herbert Parker

Hello, Chris. Let me just give you a small change we’ve had first, and I’ll let Dinesh jump back in. When we restated the guidance, we just took exactly what we had and restated it in local currency to keep the confusion down. But what we’ve done since then, Chris, we’ve made a model change. So you would basically see about $10 million less in Pro and about $10 million more in Lifestyle division in the bottom line. And so that’s one thing you should keep in mind. So Dinesh, you may want to (inaudible).

Dinesh Paliwal

So basically what that is, so that you’re very clear, everybody, that our consumer headphone business was reported in our Pro division, and now we have made it clear in our SAP system that everything consumer sells should be a part of the Lifestyle division? So that’s one bucket to another bucket. Otherwise, fundamentally, Pro business is as robust margin as you expect. It’s just a movement.

Chris Ceraso – Credit Suisse

Great. So I’m sorry. Maybe I’ll follow up offline. Did that have anything to do with the margin in the quarter in Pro?

Herbert Parker

Yes. It had about 200 basis points in Pro. You can add back to that if you were trying to get to what you were expecting. And also, Chris, at the end of our press release, we have restated the quarters for Professional and Lifestyle. You’ll see at the end of the press release when you get a chance to read it.

Chris Ceraso – Credit Suisse

Okay. Thank you. I’ll follow up.

Operator

And our next question comes from the line of Ravi Shanker with Morgan Stanley. Please proceed with your question.

Ravi Shanker – Morgan Stanley

Thanks. Good morning. Can you hear me okay?

Dinesh Paliwal

Hi, Ravi. We can hear you all right. Thank you.

Ravi Shanker – Morgan Stanley

Thanks. So if I can follow up quickly on the production outlook as well, a couple of the suppliers have told us that they are seeing some changes with option take rate, lower options, options vehicles. Are you guys seeing any of that in the market? In your comments, it seemed like you thought option take rate would be a tailwind, but some of the comments we’re hearing from other suppliers say it’s a headwind.

Dinesh Paliwal

I cannot generalize that, because we are actually seeing uptick in take rates in some customers, in Asia particularly. Hyundai, Kia and others are, actually, the business being done in China. The take rates are better than we anticipated. So I think it’s a mixed bag, but in net-net for us, our take rates are not down. If at all, anything, they are slightly on the positive side, not as high as we had expected, but not lower than last year.

Ravi Shanker – Morgan Stanley

Understood. A couple of questions on the backlog, is it safe to assume that your overall backlog now goes up by $800 million?

Dinesh Paliwal

You know, Ravi, you obviously have done your math, so I will not argue, but we update our backlog on an annual basis. But since this audio award is such a significant news, because audio business’s operating profit is in mid-teens. And $800 million business obviously changing the quality of the backlog, so we wanted to say that that has obviously helped. So in net-net I think our total backlog is pretty much where it was as we opened the year.

Ravi Shanker – Morgan Stanley

Okay.

Herbert Parker

Ravi, this is Herbert here. It’s Herbert. Just remember, as Dinesh said, we don’t update it because of those take rates, but just for your sake, you can’t add just $800 million without subtracting the revenues. So you’ll still just to get the backlog.

Ravi Shanker – Morgan Stanley

Okay. Understood. That makes sense. And just a broader question, Dinesh, on the Audio side, you guys have always said that on the infotainment side, there’s a fair bit of engineering involved. And you have to work closely with the OEM, and you can’t really come in and come out of a vehicle very quickly. Is that the same on the Audio side? Or is it more Plug&Play than compared to infotainment?

Dinesh Paliwal

Pretty much the same in Audio side, because once you’re engineered in a particular model, they let it run the life cycle, then they bring us in. So typically, Audio business from the wire to revenue is two-years cycle. In China and India, it’s a different market, because they never had any Audio, and they in fact push us – do it like next month. And that’s also a bit over-ambitious like TATA and Geely and BAIC. They expect us to do revenue, order to revenue, a book and bill much faster. But in case of BMWs and Fords and Volvos, they already had an audio supplier. So there is a life cycle, and it’s not a Plug&Play. A lot of engineering goes in.

Ravi Shanker – Morgan Stanley

Got it. So it’s two years between order and delivery and after that, you’re pretty much in the life of the product, which is probably five to seven years?

Dinesh Paliwal

That is correct.

Ravi Shanker – Morgan Stanley

Okay. And just last question, can you just clarify what exactly content you have on HondaLink? Is it just Aha, or do you also have more of the infotainment via the middleware. Potentially you’re scaleables with them and also what do you have on the hardware side?

Dinesh Paliwal

At this point, HondaLink is all our software. We did not supply any hardware or middleware for infotainment. It’s done by another supplier. So what they have used, actually rather smartly I would say – the Aha module and Aha engineers obviously worked with them. They have used that as a layer, aggregation – software aggregation layer that brings in all the personalized information for the driver and provides to the Honda car and they’re launching it. So there’s a lot of engineering with us. Our engineers spend a lot of time co-located with their engineers. So we don’t have a scalable Ahn infotainment system in Honda yet.

Ravi Shanker – Morgan Stanley

Understood. Thank you.

Dinesh Paliwal

You’re welcome, Ravi.

Operator

And our next question comes from the line of David Leiker with Robert W. Baird & Company. Your line is open. Please proceed with your question.

David Leiker – Robert W. Baird & Company

Good morning, everyone.

Dinesh Paliwal

Hi, David. I hope you’re safe and sound.

David Leiker – Robert W. Baird & Company

I’m in Milwaukee.

Dinesh Paliwal

Good.

David Leiker – Robert W. Baird & Company

We have different kinds of storms here. Couple of housekeeping items, Herbert, can you break out what the R&D number was in the quarter?

Herbert Parker

Okay, Mr. Leiker. Net R&D for infotainment was $54 million. Net R&D for the company was $78 million. Restated rates net R&D for fiscal year 2012 Q1 were $53 million for infotainment. For the company for the fiscal year 2012 Q1 was $79 million, so basically no change.

David Leiker – Robert W. Baird & Company

Great. Thank you. And then can you give us any characterization of the performance regionally across the business, North America, Europe, Asia, any context like that?

Dinesh Paliwal

I think I can restate as I said earlier, Asia came through pretty much as expected, high growth, 23%. China was 27%. North America was slight positive surprise and Europe was slight negative.

David Leiker – Robert W. Baird & Company

Okay. Great. And then, Herbert, on the neodymium, is there a number there in terms of year over year how much of a benefit there was from the unwinding of the costs last year?

Herbert Parker

Yes, David. We had one. It was about $11 million in the quarter for the total company.

David Leiker – Robert W. Baird & Company

Okay. Great. And then a couple of other items here in terms of the products. The BMW contract that – you know what I’m talking about here for the ultra high-end, ultra premium product. Is that replacing a more standard Harman Kardon system you might have in there, or is that replacing somebody else’s product?

Dinesh Paliwal

It’s replacing somebody else’s product.

David Leiker – Robert W. Baird & Company

Okay. And am I right to presume that the way it’s written, that that would be at a higher-end level of what you’re currently supplying on audio for BMW?

Dinesh Paliwal

That’s correct. So David, since you are very deep in this, let me just take you quickly through. Typically as most cars are, they have four trim levels, right? So trim 4 is the ultimate, and generally they put in the most exclusive audio, most exclusive everything. So that part of BMW we never had. We had Harman Kardon at 3 and 2 and 1 trim levels, as an option or standard some places. And now, with this win, which is a different brand than Harman Kardon, we have replaced a competitor and now we are in all trim levels in BMW. So suffice to say, that BMW is pretty much Harman technology end to end, audio, connectivity, infotainment, multi-media, telephony, and what have you, going forward.

David Leiker – Robert W. Baird & Company

Okay. And then on the infotainment system that you’re just starting to launch there with BMW, this next generation system, in terms of dollar value that Harman is – is that meaningfully different than what you were providing before? I know the content is significantly different. The functionality’s a lot greater, but in terms of the dollar contribution to Harman?

Dinesh Paliwal

In my last – I remember – I looked at the numbers, it’s almost one-to-one replacement. It was – we were supplying L7, or CIC, as they used to call it, and now it’s called NBT. It’s pretty much one-to-one replacement for what we had before, with the exception that the penetration rate in the high-end side would be higher because of a lot more connectivity built into this NBT than prior generation infotainment.

David Leiker – Robert W. Baird & Company

Okay. Great. And then on the Ram contract, is this the first contract – or the first product you’re shipping out of that – I know it was 18 months ago or so you talked about this global contract with Fiat, Chrysler. Is this the first product that comes out of that?

Dinesh Paliwal

Very absolutely correct. That’s our new system called, CMC, we call it internally. They call it Uconnect. That will be rolling out on all car platforms and the Dodge Ram and the other name I mentioned to you. But those are the two models. They wanted to launch as a premier first, to explain the word. So it will be coming out on all car lines, both Chrysler and Fiat.

David Leiker – Robert W. Baird & Company

And that’s going to a position, I would suspect, as the high-trim level type product offering.

Dinesh Paliwal

That is actually going – as an option, they are offering that on all trim levels. They will make it standard on the high-end luxury sedan or SUVs.

David Leiker – Robert W. Baird & Company

Okay. And then on the comments you made here on Subaru and Lexus, I found the language a little interesting. If you could clarify what’s meant there when you said you’re nominated for two replacement platforms at those two main OEMs, does that mean you were awarded a contract, or you’re in the running for it?

Dinesh Paliwal

No, no, no. We are awarded the contract. That’s the automotive wording. Sometimes they call it letter-of-intent, sometimes nominated, because we might be close to shipping the product and we may not have the contract yet. Sometimes that also happens, as you know well, and it is hard to sometimes justify it with our own auditors. We don’t have the contract per se, but we have production releases. We have nominate letter, so it’s an award. Otherwise, we would not put that in print.

David Leiker – Robert W. Baird & Company

One last item here. We can sit and figure out a little bit, and on the revenue line, when we look – your December quarter versus a September quarter, but are there any things in particular on the margin side that might swing things differently in December versus September? Or any cost-cutting actions or things like that that you’re implementing?

Dinesh Paliwal

Only thing which can swing the profitability is the volume. If sales goes either way – if there remains a swing either direction, it affects the drop down contribution margin. That’s the only thing I can think of. There’s no major restructuring. There’s no major product mix change anticipated in second quarter.

David Leiker – Robert W. Baird & Company

Okay. Great. Thank you very much.

Dinesh Paliwal

You’re very welcome, David. Take care. Bye.

Operator

And our next question comes from the line of Curtis Jensen with Third Avenue Management. Please proceed with your question.

Curtis Jensen – Third Avenue Management

Good morning, fellas. Just a couple of questions, can you talk about cash flow in the quarter? It looks like cash was down a little bit, and some of it went to working capital. Is the first quarter a little bit seasonal in that sense? And what do you expect for the year and CapEx, too, for the year?

Herbert Parker

Yes. Hello, Curtis. This is Herbert. Yeah, this is seasonal. We had basically an operating use cash of about $100 million, $102 million for the quarter, and it was in line with the same period of last year. So seasonally, this is what we normally have. We expect it to pick up strongly, especially in the third quarter, as we deliver a lot in this second quarter of ours. And then we will start to collect in the third quarter. So that is a main thing. In our ForEx CapEx, we still normally run around 2% to 2.5% of our revenues. We expect that to be continuous in line with what we’ve done historically.

Curtis Jensen – Third Avenue Management

Okay. How much – following the retirement of the convert in October, how much cash of your total cash is in the U.S.?

Herbert Parker

We have about $300 million in the U.S. is what we have from that after retiring that convert.

Curtis Jensen – Third Avenue Management

Okay. Last thing is any commentary on Brazil and kind of opportunities there? I mean the fleet there is probably a lot of opportunity in terms of ethanol and other things in terms of growth. Any just kind of color there?

Dinesh Paliwal

Yeah. I just came back from Brazil. I spent a few days there, traveling and meeting a lot of clients. Brazil is single most upbeat regional economy I have visited in the last six months. That’s really profound statement I make, because people told me they cannot find engineering companies. They cannot find enough earth movers. They cannot find enough workers. Unemployment is all-time low, and a lot of money chasing so many projects, but not enough people to take on.

And we definitely are benefiting from this boom in infrastructure build-up, building up not just for FIFA 2014, but also Olympic 2016. We mentioned two big stadiums, but total, 12 plus six, 18 stadiums are being built, and we expect at least one-fourth of those to come to us. In addition, we have entered, for us very first time in Brazil, a semi-OEM relationship with one of the automakers which we have not announced yet, but we will soon.

And car audio is picking up. In fact, we have a very healthy car audio business, which I expect to grow 25% every year. So all-in-all Brazil is looking good, and for us to do more there – we have two factories, one in Manaus up north in a tax-free zone and one in south of Brazil Porto Alegre. And we are actually expanding our facility in Porto Alegre down south and we are also moving some automotive and Pro product lines to Manaus facility so we can do CIC ID from here, assemble it and sell it. That way, we expect Brazil to grow 25%, 30% year over year for the next two to five years.

Curtis Jensen – Third Avenue Management

Great. Thank you. That’s it.

Dinesh Paliwal

You’re welcome.

Operator

And our next question comes from the line of Adam Brooks with Sidoti and Company. Please proceed with your question.

Adam Brooks – Sidoti & Company

Yeah. Good morning, guys. Maybe just a quick update on what you think you can manage the business to on a decremental margin basis on the info side. And maybe if volumes do stay quite low in Europe, are there any things you’re going to do to take more cost out of the business?

Herbert Parker

Hello, Adam. This is Herbert. What we’re doing to take more cost out, as we mentioned before, we went to a more flexible workforce than we had in prior years. So we can eliminate some of the external temporary workers quicker than normal if things tend to get worse. We also have various strategic meetings, which we will continue, but we will have to consider doing more of them remotely, although we think face to face is what gives us the better improvement. So those are just some of the items that we could go to continue to cut the costs and maintain margin, or let’s say mitigate the effect of the margin if we have lower revenues.

Adam Brooks – Sidoti & Company

And Dinesh, you gave us some nice color on Brazil. Can you maybe give us an update on what’s going on on the ground in China from your perspective, just overall economy and your business as well?

Dinesh Paliwal

Yeah. China – when I share what I saw in China, people don’t believe, because Chinese on the ground are not feeling any different upbeat environment than they were six months ago. However, our western press and media shows quite the contrary. The truth is somewhere in between. The fact is there is a bit of a softening in China, and we forget that. We are seeing a lot of stand-still sort of – paralysis of decision making in United States, because we have a President to be elected in November. And China will elect a President at four weeks after our President. So six months before President and six months after, the big decisions are generally put off.

However having said that, our industry, particularly the luxury sector, is still doing quite well. Getting a little more challenging, because different standard, different EPS standards, and what have you and they want domestic automakers to pick up the speed, but they’re not there yet. So some of those tug of war goes on, but I expect China to continue to perform at fairly good levels. I’ve said pretty strongly that with Harman’s portfolio and our cost structure, we can grow three times the GDP in China year over year, and I’m still repeating that. Three times GDP is something you can expect from us. So even if they grow 7%, 8%, we’ll grow 25% year over year.

Adam Brooks – Sidoti & Company

Okay. Thank you.

Operator

And we do have a follow-on question from the line of David Leiker from Robert W. Baird and Company. Please, proceed with your question.

David Leiker – Robert W. Baird & Company

Yeah, Herbert, just one last thing on the follow-up, here. With the convert paid off now, where do you think your interest expense is going to run on a quarterly basis going forward?

Herbert Parker

David, it’s going to be bush league. We had about $5 million, so we should probably be about $1 million per quarter, now.

David Leiker – Robert W. Baird & Company

$1 million per quarter.

Herbert Parker

Yeah.

David Leiker – Robert W. Baird & Company

Okay, perfect. That’s all I needed. Thank you.

Operator

And we have no further questions on the phone lines at this time. Mr. Paliwal, I’ll turn the call back over to you. We have no further questions at this time.

Dinesh Paliwal

Sure, sure. Now, we generally give our audience 30, 40 seconds to see if they’re looking at some of the follow-up questions. While they are looking at their own material, let me take this opportunity to read the forward-looking information statement that generally gets read at the beginning of the call. So let me just read that.

Let me remind all of the listeners that except for historical information contained herein, the matters discussed in this call are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act. One should not place undue reliance on these statements. Well, let’s see if there are any other questions, follow-ups.

Operator

We have no further questions at the phone lines at this time.

Dinesh Paliwal

Very good. In that case, let me conclude the call by saying, ladies and gentlemen, thank you for your interest during our call and I look forward to speaking with many of you directly. As I said earlier, Herbert and I and our head of Investor Relations, Sandy Rowland, will be traveling visiting you as we continue to execute on our strategy in fiscal 2013. And as many of you continue to recover from this week’s traumatic events, I wish you a safe and speedy return to business-as-usual. And please stay safe. Thank you very much. Bye-bye now.

Operator

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

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